On the Brink (24 page)

I had hoped that the GSE takeovers would give Lehman a bit of breathing room, but I was wrong.

Tuesday, September 9, 2008

I arrived at the office shortly after 6:00 a.m. and headed straight to the Markets Room. Lehman’s shares were headed toward single digits, and its credit default swaps were under pressure. I went to Ken Wilson’s office to get the latest on Dick Fuld. The KDB deal, Ken told me, was dead.

“Does he know how serious the problem is?” I asked.

“He’s still clinging to the view that somehow or other the Fed has the power to inject capital,” Ken answered.

I felt a wave of frustration. Tim Geithner and I had repeatedly told Dick that the government had no legal authority to inject capital in an investment bank. That was one reason I had been pushing him to find a buyer since Bear Stearns failed in March. Fuld had replaced Lehman’s top management, laid off thousands of employees, and pitched restructuring ideas, but the firm’s heavy exposure to mortgage-backed securities had discouraged suitors and left him unable to make a deal.

Ken had been telling Dick with increasing urgency that he needed to be ready to sell, but Dick did not want to consider any offer below $10 per share. Bear Stearns had gotten that, and he would accept nothing less for Lehman.

After I spoke with Ken, I had an important obligation to fulfill. I was scheduled to address Freddie Mac’s employees. Many people at Treasury couldn’t believe that I wanted to meet with a group that was sure to be angry with me. It was simple. I felt bad for them, and they deserved to hear straight from me where they stood. And I wanted them to know that our actions had not resulted from any fault of theirs.

David Moffett, the new CEO, and I stood on a stage in an auditorium at the company’s headquarters in McLean, Virginia, facing hundreds of disheartened and confused Freddie Mac employees who wanted to hear about their futures and whether their shares would ever rebound. I knew that Freddie Mac stock had made up a big percentage of their net worth.

I was very direct. I told them that the odds were low that they would ever recapture the equity value that had been lost, but I emphasized that as long as they kept learning, honing their skills, and helping Freddie perform its vital function, their careers would likely remain intact. I couldn’t say what Freddie’s ultimate structure would be—that was for Congress and the next administration to decide—but I noted that the old business model was flawed and didn’t work. It was a difficult meeting, but I was glad I went.

I returned to my office to find that once again all hell was breaking loose. Dow Jones Newswire was reporting that Lehman’s talks with KDB had fallen through. The firm’s shares were plunging and credit spreads widening—they would top 400 basis points by day’s end. But I didn’t need a Bloomberg terminal to tell me what was happening. Once more we had a big financial institution under assault, and no clear solution in sight. If Lehman didn’t find a buyer soon, it would go down.

I couldn’t help but think of all those Freddie Mac employees worried about their jobs and savings. We had staved off disaster with Bear Stearns and the GSEs, but the stakes just kept growing. Unlike in March, when Bear went down, the overall economy was now clearly hurting: unemployment had hit 6.1 percent in August, the highest level in five years, and we were clearly in a recession. The last thing we needed was a Lehman failure.

With these thoughts weighing on my mind, I met Commerce secretary Carlos Gutierrez for a scheduled lunch in the small conference room next to my office. I couldn’t fully concentrate on our conversation. All I could think was,
What do we do about Lehman? There’s got to be something—we’ve always managed to pull a rabbit out of the hat.

Forty minutes into lunch, Christal West, my assistant, interrupted to tell me that Tim Geithner was on the line and needed to speak to me urgently. Maybe, I hoped, he had good news. But Tim was calling to say that the markets were very jittery, and that he did not see how Lehman could survive in its current form. He said he had already spoken with a shaken Fuld.

Thinking back to our experience with Bear Stearns, I wondered if Lehman would last long enough for us to pull an industry solution together over the weekend. I asked Tim, “Can we hold this situation together through the close on Friday?”

Tim said he thought we could do it. But the markets would need reassurance that we were working on a solution. They’d get that if it was clear that Lehman was looking for a buyer.

“I’ll lean on Ken Lewis,” I said. “Maybe at the right price BofA will be willing to do something.”

Carlos and I finished lunch, and about an hour later I spoke to Fuld. The short sellers were all over him, and he sounded panicked. He wondered if he should release his earnings early and simultaneously announce his restructuring plan. I didn’t know if these measures would be enough to appease investors, but I told Dick it was up to him to decide whether to try. I also said I would try to persuade Ken Lewis to acquire Lehman—even though Bank of America had looked at the firm twice over the summer and walked away both times. Dick agreed this was the best solution.

Ken had a love-hate relationship with Wall Street. The previous fall, announcing trading losses for BofA, he’d famously declared, “I’ve had all of the fun I can stand in investment banking at the moment.” But he wanted to grow his bank through acquisitions and craved a business platform outside the U.S. I knew him as a man of few words, a tough negotiator who liked to do deals. With its big balance sheet and history of moving quickly, Bank of America would make an ideal buyer for Lehman.

Still, as much as I hoped that Lehman’s bargain-basement stock price might entice Ken to take another look at the firm, I suspected from the start that he would be interested only if he could leave behind a large chunk of undesirable assets. What’s more, neither Merrill Lynch nor Morgan Stanley was looking strong, and I suspected Ken might prefer to acquire one of them. Both had bigger investment banking businesses than Lehman, and both had retail franchises that Lewis wanted. In fact, I knew Ken had long coveted Merrill.

By Tuesday afternoon, the entire industry was beginning to understand the gravity of Lehman’s situation. Few perceived this more keenly than Merrill CEO John Thain, who called me with his concerns. In the 29 years I’d known him—first as a young MIT graduate with a Harvard MBA, then as one of Goldman Sachs’s rising stars, now as the self-confident CEO of Merrill Lynch—he had always been confident and analytical. But Merrill was generally considered to be the weakest bank after Lehman, and he could see the problem for the markets and his firm.

“Hank, I hope you’re watching Lehman,” he said. “If they go down, it won’t be good for anybody.”

John wanted to know how we planned to handle Lehman and how he could help. He had called me over the summer as Lehman had faltered, offering to play a role in any industry solution.

I thanked John for his offer, and after hanging up I called Ken Lewis. He said he’d been watching the Lehman situation, and I told him that we wanted him to seriously consider buying the troubled firm. I pointed out that Lehman was a lot cheaper now. Could he take a closer look at it, as soon as possible?

“Hank,” Ken told me, “we’ve looked at it a couple times before and determined that the risks were too great relative to what we might be getting.”

Still, he said he might be willing to buy the firm if he could leave the commercial real estate assets behind in a Bear Stearns–type deal. I told him we couldn’t put government money in but pressed him to get back to us with a decision as quickly as possible.

“This would be a big bite for us,” he said.

He then raised another issue. BofA had bought Countrywide Financial, the troubled mortgage lender, in January for $4.1 billion, and had expected the Fed to give it some form of relief from regulatory capital requirements for having done the deal. Instead, the Federal Reserve Bank of Richmond, BofA’s direct overseer, had been putting pressure on BofA to redo its capital plan and cut its dividend. Lewis wanted help getting his dispute with the Fed resolved.

On the face of it, the request was reasonable. How could BofA do a deal with Lehman and further strain its capital ratios without first clearing up this issue with the Fed? The solution, however, was out of my jurisdiction. I told Ken I would relay his concern to Tim and Ben Bernanke. I asked him to call Dick Fuld and start to do due diligence.

Next, Tim and I got on the phone with Dick. We had agreed that whenever possible we would speak to the Lehman CEO together. We wanted to be sure that he heard the same thing from both of us. I shared my reservations about Lewis’s seriousness, but Dick was excited.

“The key is speed,” he told us. “Can Lewis get his people here tonight? We’re willing to work around the clock.”

I called Ken and urged him to get a team together as soon as possible. We then convened a conference call with Chris Cox, Tim, Ben, and Treasury staff at 5:00 p.m. to deal with a possible Lehman bankruptcy.

Over the summer, the Treasury, the Fed, and the SEC had put a team together to deal with this contingency. We knew how disastrous it would be: a Lehman
Chapter 11
would trigger a global shock. Tim and I stressed the urgency of the situation now.

“Lehman has been hanging like a dead weight in the market,” I said. “Thank God we got to Fannie and Freddie before this.”

We discussed ways to forestall a Lehman collapse. Tim suggested a reprise of the 1998 rescue of Long-Term Capital Management. Back then, a group of 14 Wall Street firms had banded together to craft a $3.6 billion package, receiving 90 percent of the imperiled hedge fund, which they proceeded to liquidate over time. To do something similar, I said, we would first have to get Lewis interested—no small thing—then allow him to buy what he wanted and convince an industry consortium to take on the remaining assets. John Thain had already declared himself willing to aid in a private-sector bailout, but we would need to persuade the other CEOs. This wouldn’t be easy to pull off, with the entire financial industry under increasing pressure. Of course, the alternative, Lehman’s demise, was far worse.

While I was on the conference call, Dick Fuld phoned me to report that he hadn’t yet heard from Bank of America. I reassured him that we were doing everything we could, then I got hold of Ken Lewis and let him know that I had passed on the word about Countrywide.

“I’ve spoken with both Ben and Tim. They understand how important this is,” I said, assuring him the issue could be resolved. At my urging, he agreed to send a team to Lehman right away.

A few minutes later, I heard back from Lewis. He said that he and Fuld had spoken, and they were going to begin discussions. Dick called after that, excited, to say that Lewis’s team was ready to go. Despite all the back-and-forth of that afternoon and evening—we logged nearly a dozen calls with Lewis or Fuld in three hours—I wasn’t completely convinced of Lewis’s seriousness. My doubts only grew when he called back one last time and once again pressed the point about his unhappiness over the Countrywide business. He wanted to be sure to get that matter resolved with the Fed.

I called Dick a little after 7:00 p.m. to reassure him that Lewis was still in the game. “We’ve got some things to work out,” I said. “But he will be getting there.”

That day the Dow had fallen 280 points, to 11,231, erasing Monday’s gains. Lehman shares were down 45 percent, to $7.79, and its CDS had jumped by nearly 50 percent, to 475 basis points. And there was other worrisome news: investors concerned about AIG’s exposure to mortgages had driven its stock down 19 percent, to $18.37.

But AIG was not my foremost concern that night as I lay sleepless, wondering how Lehman would manage to pull through to the weekend.

Three days was a long time.

Wednesday, September 10, 2008

I had barely gotten to my office early Wednesday morning when Dick Fuld called to let me know that BofA still hadn’t shown up. It was just after 7:00 a.m.

“We haven’t heard from them,” Dick said, exasperated. “We missed a whole night.”

“You haven’t heard a thing?”

“Nothing,” he said.

It was a bad start to a bad day. I assumed that the Fed still hadn’t satisfied Ken Lewis on BofA’s capital issue, so I followed up with Tim and Ben. Less than an hour later, Lehman pre-released its third-quarter results—a $3.9 billion loss, stemming from a $5.6 billion write-down on residential and commercial real estate. The firm also announced that it would sell a majority stake in its asset-management subsidiary, Neuberger Berman, and spin off between $25 billion and $30 billion of its commercial real estate portfolio.

Investors were having none of it. Lehman’s shares fell in premarket trading, while its CDS jumped to 577 basis points. The market smelled a corpse.

Even as I wondered whether Bank of America would come through, another possible partner for Lehman popped into view, taking me by surprise. Bob Steel—my former undersecretary for domestic finance, now CEO of Wachovia—called just before 8:00 a.m. to say that he’d spoken with Bob Diamond, the president of Barclays, the British bank. The two bankers knew each other from Steel’s stint on Barclays’s board a few years before.

Steel told me that Barclays was interested in Lehman. I admit I had to ask him if they were serious. The British bank had not previously demonstrated an ability to move fast or to consummate major strategic transactions. Barclays was still stinging from losing a takeover battle in 2007 for the Dutch bank ABN AMRO to the Royal Bank of Scotland. I also had some concerns about whether Barclays had the financial strength to do a Lehman deal.

Although I mentioned Barclays’s potential interest in my discussions that day with Tim, Ben, Chris, and the group in New York, we were focused on Bank of America. Lewis had promised to get back to us by Thursday evening if there were no leaks. We understood that the Charlotte bank might well decide against buying Lehman or insist, despite my guidance to Lewis, that it would need financial support.