House of Cards (90 page)

“Merrill could be the next to go,” one banker said. “And Thain wasn't saying anything,” a participant said. “If Thain hadn't been there that morning, the rumors really would have been flying,” one banker said. A few minutes later, Thain got up and left the room “and he never comes back,” one participant said. Thain and his team were focused on negotiating a deal with Bank of America. Merrill had planned to meet with Goldman on Sunday morning, but by this time Merrill had stopped returning calls to Goldman Sachs.

After Thain, Paulson, and Geithner had left the New York Fed Sunday morning, the following exchange ensued, according to several sources who were there. John Mack, the CEO of Morgan Stanley, spoke up. “Maybe we should let Merrill go down, too,” he said.

Aghast, JPMorgan Chase's Dimon pointed out how shortsighted that was of Mack because Morgan Stanley might be the next firm that counterparties lost faith in. “John, if we do that, how many hours do you think it would be before Fidelity would call you up and tell you it was no longer willing to roll your paper?” Dimon's comment quieted Mack. “We thought Mack said that because he might be buying Merrill,” someone who heard Mack's statement said, and wanted to buy the firm on the cheap. (Mack denied he made the comment through a spokesman. A spokesman for Dimon said Dimon did not remember having the conversation with Mack.)

The group quickly began refocusing on putting together what became an agreement that every firm in the room would continue to do business with every other firm in the room and would underwrite a multibillion-dollar credit facility for the firms to use in an emergency in the wake of the presumed Lehman bankruptcy. “We figured all hell would break out the next day,” one banker said. “And everyone else thought so, too. Everyone was then focused on netting out their derivatives positions starting right then.”

Back uptown at Lehman, Fuld and McDade were making frantic calls to whoever would listen to their pleas for help, including Paulson, Cox, and Geithner. “But it crystallized in the course of the afternoon it didn't look like they were going to do anything for us,” a senior Lehman official said, despite Fuld's belief after having dinner with Paulson in April that “we have huge brand with [T]reasury.” Calls also went out to Lehman's internal restructuring group, to Harvey Miller, the lead bankruptcy counsel at the New York law firm Weil Gotshal, and to Barry Ridings, a vice chairman of Lazard and a restructuring expert, that the
end was near and the bankruptcy papers—most likely for Chapter 7 liquidation—needed to be prepared.

There was no other choice, since there was no buyer and no deal to do, but for Lehman to file for bankruptcy. “We walked into that weekend,” Fuld told Congress on October 6, “[and] I firmly believed we were going to do a transaction. I don't know this for a fact, but I think that Lehman and Merrill Lynch were in the same position on Friday night and they did a transaction with Bank of America. We went down the road with Barclays. That transaction, although I believe we were very close, never got consummated.”

For his part, Geithner regretted that the FSA decision did not come sooner. A similar decision rendered on Friday would have given everyone assembled at the Fed that weekend more time to possibly fashion another solution. But by Sunday, there was “no buy-time solution,” he said. “Lots of things might have been possible if Barclays was able to deliver. We could have had the consortium finance that. We could have looked at some way where we did part of it and they did part of it. Lots of things were possible. But when Barclays was unable to come through, then we're left with those banks and they weren't going to buy Lehman or finance them because they looked at this liquidation consortium idea and said there's just no fucking way they could have done that. That would have had them underwriting and guaranteeing a firm that was bleeding away at an accelerating rate. There was just no way. We had no legal authority to solve that problem.”

He said the Fed “would have had the legal authority” to do a deal similar to the one that facilitated JPMorgan's acquisition of Bear Stearns by lending $29 billion against a pool of Bear Stearns's assets “whose value was likely to get us repaid over time.” However, he said, with Lehman Brothers, there was nothing like that on the table. That was one very big difference with the Bear Stearns situation, where JPMorgan wanted to—or was urged strongly to—buy the company. There was no buyer for Lehman. When Barclays pulled out, “that left us with doing the whole thing,” he said. “There was no way we could have done the whole thing. That would be like lending into cotton candy or to dry ice. The franchise value of the firm would have evaporated really quickly.” The market had rendered the judgment during the preceding six months that Lehman was essentially insolvent. “To make it simple, central banks do liquidity,” he said. “They don't do insolvency. No central bank I'm aware of has the authority in the law to put capital into financial institutions. That's what governments exist to do.” It was that responsibility, he said, that led Bernanke and Paulson to go together to Congress to seek approval for
what became the $700 billion bailout bill. “With Bear Stearns, with all the others, there was a point when someone said, ‘Mr. Chairman, are we going to do this deal or not?’” Bernanke told
The New Yorker
. “With Lehman, we were never anywhere near that point. There wasn't a decision to be made.”

McDade and Lowitt, on Lehman's behalf, made one last-ditch effort to convince Paulson that taxpayers should bail out Lehman. They went back down to the Fed and walked the Treasury secretary through a presentation that Lehman had put together about the likely global consequences in various markets—foreign exchange, swaps, and derivatives, among others—if Lehman was allowed to fail. After McDade finished, Paulson told him, “You're talking your own book. We've thought this over.” Another senior Lehman banker who heard about this conversation was dumbfounded. “He's an arrogant son of a bitch,” this person said. “You've got to be kidding me! How could any sensible human being say to McDade, ‘You're talking your own book, we've thought it all through'?”

P
AULSON NOT ONLY
told McDade and Lowitt that Lehman had no choice but to file for bankruptcy, he also apparently told them the firm had to file for Chapter 7 liquidation by 7
P.M.
Sunday. That would mean a court-appointed trustee would take over the firm, the firm's doors would be locked, and its assets sold as rapidly as possible. By the time McDade and Lowitt returned to the thirty-first floor of 745 Seventh Avenue, the Lehman board of directors had assembled to vote on the bankruptcy filing. But the directors had decided to hold off until McDade and Lowitt had returned from the Fed with their report. Since McDade had taken over as president of the firm in June, he had displaced Fuld as the firm's day-to-day leader.

“The words,” remembered one participant in the meeting, “that Bart used when he came into the board meeting were that ‘We were mandated to file. We were mandated to file.' He was very, very, very clear on that.” Some shocked board members wanted to know what that meant. What if the board decided to defy Paulson and not file for bankruptcy protection?

Because the Fed controlled Lehman's access to the money it needed to open for business the next day, the point was moot. But then lawyer Harvey Miller had an idea. “They can tell us to do it,” he told his client. “But they can't tell us when. And they can't tell us what form.” The Weil Gotshal team began preparing for a Chapter 11 filing—a reorganization plan, not a liquidation plan—for the Lehman Brothers parent company that would allow the operating subsidiaries, such as the broker-dealer
and the asset management business, to continue operating outside of bankruptcy. In the scheme of things, it was a technicality, but it allowed Lehman a modicum of leverage and the chance to tweak Paulson.

The Lehman board of directors, with Fuld at the helm, met on Sunday night to authorize the bankruptcy filing. As it was coming to grips with the inevitable, Christopher Cox, the SEC chairman, phoned in to the meeting from Washington, and was placed on speakerphone. Cox had kept a surprisingly low profile throughout the financial crisis but had been told by Paulson to call to reinforce the idea that Lehman should file for bankruptcy. Cox told the board, according to someone there, that regardless of what it decided to do, the board needed to take
some
action. The board members then pressed Cox about Paulson's directive that the firm must file for bankruptcy. “Paulson wanted Cox to call in to the board to make it clear,” this person said. “Cox, rather than saying you have to file, was very clear that you don't have to. You could do it or not do it, but whatever you did you ought to do something.” The board considered Cox's ambiguity an act of defiance of sorts, although without much substance at that particular moment. “He made the call,” this person continued, “but he did not say, ‘You have no choice.' In the context that would have been a very difficult thing to say to a board in the middle of a board meeting.” Without the prospect of any funding from the U.S. government, the board authorized the Chapter 11 filing.

But Lehman's ordeal that Sunday night was far from over. First came word that the Federal Reserve Board agreed to expand the collateral that investment banks could pledge to the Fed as part of both the Primary Dealer Credit Facility—the name given to the historic facility that allowed investment banks to borrow directly from the Fed window after the demise of Bear Stearns on March 16—and the Term Securities Lending Facility. “These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers,” the Fed stated in its press release. Then, to complement the Fed's action, a consortium of ten global commercial and investment banks agreed to establish a $70 billion “collateralized borrowing facility” to enhance liquidity in the marketplace.

When the Lehman executives started to hear on Sunday afternoon that these changes were in the offing, they called the New York Fed to see if it was true. If the Fed allowed Lehman to pledge its squirrelly collateral to the discount window, “we might get a reprieve,” one Lehman banker said. But the Fed told Lehman, according to this Lehman banker, “‘Yeah, we're doing that for everybody else but you. We're going to let you
guys go.' I can tell you, I've tried to be very restrained about this, but if indeed those are the facts as represented, then Paulson fucked us, excuse my expression.” In less colorful language, H. Rodgin Cohen, the senior partner of Sullivan & Cromwell who first advised Lehman Brothers before the bankruptcy filing and then, with Lehman's permission, Barclays after it, agreed with this assessment. “Had there been government assistance, you could have done either Bank of America or Barclays,” he said. “No question about that.”

As the Lehman and Weil, Gotshal teams began to get comfortable with the idea of filing Chapter 11 for the holding company and keeping the operating companies out of bankruptcy, around eleven-thirty Sunday evening, Mark Shafir, Lehman's global head of M&A, and Mark Shapiro, Lehman's restructuring ace, went to see Fuld in his thirty-first-floor office. They told Fuld there was a way Barclays could buy Lehman's U.S. securities business out of bankruptcy, which would get Barclays what it really wanted and save ten thousand jobs. The three men called Bob Diamond, Barclays's president and chief negotiator on the Lehman deal, on his cell phone. Diamond expressed to them his disappointment that Barclays had failed to get a deal done earlier in the day, but when the men suggested to him he could buy Lehman's U.S. securities business “clean,” he expressed great interest but needed to talk to his lawyers at Cleary, Gottlieb. When Diamond called back twenty minutes later, he told them, “I can't talk to you tonight. Call me at seven in the morning.”

By that time—at 1:45
A.M.
, to be precise—Lehman Brothers Holdings, Inc., had filed for Chapter 11 to, Lowitt wrote, “preserve its assets and maximize value for the benefit of all stakeholders.” At seven o'clock Monday morning, as the calamitous effect of Lehman's bankruptcy began spreading virally to financial capitals all over the globe, Diamond and Michael Klein, his financial advisor and the former Citigroup senior executive, got on the phone with Fuld, McDade, Shafir, Shapiro, and Tom Russo to discuss the possibility of Barclays buying Lehman's U.S. investment banking business. Klein liked the idea, and Diamond authorized him to negotiate with Lehman to get a deal done. The Lehman team told Klein and Diamond, “We absolutely have to get this done before the open on Tuesday because we're out of money.”

With that, Fuld handed the keys to Shafir, the M&A head, and told him, “Go finish it.” For the next twenty-four hours, swarms of lawyers and bankers took over the thirty-second floor of the Lehman building. The terms of the deal had to be negotiated, which required a fast-track appraisal of 745 Seventh Avenue and two data centers in New Jersey that
Barclays wanted to buy. Barclays wanted all of Lehman's U.S. investment banking, fixed income, equity sales and trading, research, and certain support functions. Barclays did not want the investment management division or any of the commercial real estate assets. At one point, Shafir and Klein got into “some great kabuki theater where Shafir told Klein to screw himself at the top of his lungs,” one observer said.