Lehman Brothers, the bank that bust the boom

Lehman Brothers, the bank that bust the boom
A year after the collapse of Lehman Brothers, the key players reveal for the first time their nail-biting attempts to avoid disaster - and how the UK and US governments refused to help

By Dominic Crossley-Holland
Published: 7:00AM BST 06 Sep 2009

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Richard Fuld, chief executive officer of Lehman Brothers Holdings Inc., outside a hearing into the bank's collapse in October 2008 Photo: Mannie Garcia/Bloomberg News The collapse of Lehman Brothers, a year ago this week, was the biggest bankruptcy in corporate history. It was 10 times the size of Enron and, more crucially, the tipping point into the global crash, provoking panic in an already battered financial system, freezing short-term lending, and marking the start of the liquidity crisis.

Yet searching questions remain unanswered. Authorities had intervened on both sides of the Atlantic to rescue a litany of stricken institutions, from Northern Rock to Bear Stearns, and mortgage companies Fannie Mae and Freddie Mac, so why let Lehman go down? And was a rescue by Barclays effectively blocked by the UK authorities?


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A TV debate could be sudden political death - bring it on! Now, for the first time, many of the key players involved reveal what really happened on that extraordinary weekend last September. Their accounts provide a unique window into the closed world of how politicians, central bankers and CEOs battled to stave off what one of those involved called "Armageddon"…


Friday, September 12, 2008

"So it was Friday afternoon. I was in Merrill's midtown offices," recalls John Thain, then chief executive of Merrill Lynch. "It was raining hard and I got a phone call at 5pm – 'Be at the Fed at 6pm this evening'. Those type of calls are always bad."

The American Treasury Secretary Hank Paulson, known as "The Hammer", had just swept into town, and with little more than an hour's notice was summoning the chief executives of America's leading banks, the so-called Masters of the Universe, to the Federal Reserve.

The Fed, a granite fortress just around the corner from Wall Street, has seen many dramas, but nothing to match what was to come over the next 48 hours. As the billionaire investor Christopher Flowers, who was at the Fed, says: "I think, in the history of business in the last 50 years, it was the most extraordinary weekend there has been."

For months Lehman had been the subject of Wall Street rumour, with the markets worried about its risky assets and exposure to the sub-prime property crash. By early September the bank was having trouble borrowing and its share price was in freefall, closing at $16.13 on September 2, down from a high of $82 in 2007. Ten days later, as Paulson summoned the CEOs, it closed at just $3.65.

At the Fed it was clear from the start that huge forces were at play. Rodgin Cohen, corporate lawyer for Lehman Brothers, says: "I don't think there was a person there who didn't understand the stakes we were playing for."

Treasury Secretary Hank Paulson and the New York Fed chief Tim Geithner were running the show, and John Thain says they were startlingly clear from the start: "They said to us, 'This is the problem: Lehman needs to be rescued. You have to come up with a solution; we the government are not gonna help.' "

The assembled CEOs were incredulous that there would be no government bail‑out.

Paulson and Geithner took up residence on the 13th floor of the Fed, with other banks – potential buyers – setting up teams on different floors to go through Lehman's books. Principal among the suitors was the South Carolina-based Bank of America and the British bank, Barclays.

In London, Chancellor Alistair Darling was being kept in touch with events. "We knew Lehman was in trouble. Remember, there was constant traffic between our Treasury and the US Treasury, between the regulators, and during that time I spoke to Hank Paulson pretty regularly. On the Friday evening we knew they would have to do something about Lehman."

Barclays had been eyeing Lehman for months, and moved quickly, its team led by the president of Barclays, Bob Diamond. "We certainly didn't know what we were going to find," Diamond recalls, "but we wouldn't have boarded the plane if we weren't that serious."

So how had Lehman, America's fourth largest investment bank, fallen so far – and so fast? Its success was largely down to one man, Richard Severin Fuld, who would go on to become the longest-serving chief executive on Wall Street. Starting his career as a paper trader, he determinedly worked his way up a slew of senior jobs before becoming CEO in 1993.

Under Dick Fuld, Lehman expanded quickly, grabbing the opportunities presented by the waves of deregulation with soaring profits and a share price that rose from $4 in 1994, to $82 in 2007.

How had Fuld done it? In a word: risk. "Dick Fuld essentially said to our head risk-taker in commercial mortgage-backed securities, 'You've got to take more risk,' " says Larry MacDonald, vice‑president of securities at Lehman. " 'Risk, risk, risk, risk, risk, and that risk leads to the bottom line.' "

Lehman then did something that more cautious banks shied away from: it borrowed more and more money. By August 2007, the bank's leverage ratio is believed to have gone as high as 44 to 1 – far beyond competitors like Goldman Sachs and Morgan Stanley, which had ratios in the 20s or 30s.

Huge rewards followed for those who took the risk. By 2007 turnover was more than $19 billion and staff took home $9 billion in pay and bonuses. Between 2000 and 2008 Dick Fuld took home between $310 and $500 million, although the precise figure is disputed.

Back at the Fed, Dick Fuld's wealth and lofty status counted for nothing. Extraordinarily, he hadn't even been invited, with even some on his own side fearing that his combative nature may be a hindrance.

As the night wore on, most of the CEOs headed back to their corporate apartments, leaving their teams of accountants and lawyers to work through the small hours on Lehman's books.

The Barclays' team, led by Bob Diamond, was getting frustrated: "To be frank, we had trouble getting traction. It was clear to us that the management of Lehman Brothers were spending an awful lot of time with at least one firm going through due diligence."

That other firm was Bank of America, and as the night wore on what its team found in the books appalled them. Just a month before, the bank believed its portfolio was worth $40 billion; now it had fallen to around $25 billion.

"When you started adding all those losses up from this property and that property, it ended up a very big number," says Christopher Flowers, who was also advising Bank of America. "A number that was so large, the losses were so large, that it really meant the company was bankrupt unless it got support from the US government."


Saturday, September 13, 2008

What happened next took everyone by surprise.

Returning to the Fed on Saturday morning, Merrill Lynch's John Thain began to fear attention might switch to his bank, as it too was hugely exposed. Standing on the pavement outside the Fed, he made an audacious move, calling Ken Lewis, boss of Bank of America, at his home in South Carolina. "The conversation was relatively short," says Thain. "I said to him I thought it made sense for us to explore some strategic options."

It was this move that led to the announcement on Monday, just as Lehman finally collapsed, that Bank of America had bought Merrill Lynch for $50 billion. The whirlwind romance was proof – if any were needed – of the Wall Street maxim: kill or be killed.

As rumours of the Merrill deal swirled around the Fed that Saturday, all the attention shifted to Barclays. "We got a very positive sign," says Bob Diamond. "We got moved into a much bigger conference room in the Fed and there was a sign on the door that said 'Buyer'."


Sunday, September 14, 2008

Sunday morning started with a sense of optimism that a deal with Barclays was close. Lehman had called in America's most famous bankruptcy lawyer, Harvey Miller, just in case, but the mood remained upbeat.

"I was actually thinking that it might be a fire drill," says Miller. "That there was going to be a deal and they'd announce it some time that afternoon and then I'd be free to go and do the things I had planned."

At the Fed, negotiations had again gone through the night, and Bob Diamond was keeping the Barclays board up to date. "Frankly, we were feeling cautiously optimistic."

Outside, the media had caught on and the rolling news and business channels were giving the story of the embattled bank more and more attention.

By the early afternoon, as the fine print of the deal was being worked on by the teams, the British bank, like Bank of America before it, wanted guarantees for Lehman's debts so it could open for business the next day. A deal was within spitting distance, but who would underwrite it? The British? The Americans? This underwriting was necessary because a bridging loan was needed until the bank was formally bought, and since that would take time, and the markets opened on Monday morning, it meant that in the meantime the British or American governments had to underwrite any business or trading Lehman did.

"The tone of the conversations was beginning to change," says Harvey Miller. "You could hear in the voices of the Lehman representatives a higher level of doubt that things were going to work out."

Telephone calls across the Atlantic were strained as efforts were made to break the deadlock. "Midway through the Sunday afternoon we, the Financial Services Authority, informed the New York Fed categorically that from our perspective we couldn't see how this deal could go forward, given that they were not willing to offer any liquidity guarantees," says FSA chief executive Hector Sants.

The tension was palpable – Lehman would go down unless the US Treasury Secretary authorised the guarantee, and time was running out, as the European markets opened in 12 hours' time.

"We were asked to come to the main floor," says Lehman's lawyer Rodgin Cohen, "where the group of the major banks was closeted behind these very heavy doors, and we were asked to wait. We spent hours waiting there."

Hank Paulson was on the phone to London. "I spoke to him on the Sunday afternoon," recalls Chancellor Alistair Darling, "and he said, 'Look, your regulators are asking hundreds of questions.' I made the point that they were asking them with very good reason. I think the Americans recognised that the game was up. We couldn't possibly get ourselves into a situation where effectively we were guaranteeing an American bank."

Eventually Paulson called Lehman and declared that the British government was not prepared to let Barclays continue with the transaction, explains Cohen. The Lehman team asked Paulson whether anything could be done. He replied: "I'm not going to cajole or plead with the British government, nor am I going to threaten the British government in terms of a relationship."

The bank's bankruptcy team was summoned and told to be ready to file for bankruptcy by midnight.

"What we wanted wasn't available," says John Varley, the CEO of Barclays. "We walked, end of story." Diamond, who'd been working round the clock, admits he felt "gutted".

Rodgin Cohen now had the unenviable task of reporting back to Dick Fuld. "It was as difficult a call as I have ever made in my life," says Cohen. "He said, 'This is just unbelievable; how can this be happening?', and we spent a few minutes going back over the same ground. Then he shifted to, 'Right, is there anything else we can do?' "

Back on Seventh Avenue at Lehman's HQ there was one last act of desperation. It so happened that a second cousin of President Bush worked at Lehman Brothers. What happened next remains a matter of dispute, but Lehman's securities vice-president, Larry MacDonald, was told by colleagues who were there that they tried to get the President to intervene, although this is denied by George Herbert Walker.

"The President is [George's] cousin, but to reach out to the White House under duress is a very stressful situation for everybody. Finally he agreed to make that call to the White House," says MacDonald, "and the operator put him on hold, which to the people in the room seemed like an eternity. As the seconds ticked, everybody's pulses were racing. Finally the operator came back on the line and she said, 'I'm sorry, the President cannot take your call at this time.' There was just a horrific, blood‑curdling feeling in the room of potential destruction and potential despair."

Dick Fuld and the board of directors had one last task to perform: to pass a resolution winding up the bank. At their peak, Lehman shares had been worth $85; now they were 3 cents. "It was very dark outside," remembers Miller, "and Dick Fuld looked up, clearly a man in turmoil, and said, 'I guess this is goodbye.' "

In the middle of the night the bankruptcy lawyers had completed the preparations and were ready to file the petition.

"It is like sending an email," explains Harvey Miller. "So, yes, we filed it and it was the end of an institution that had been one of the originators of Wall Street. Here it was, all coming to an end by pressing a button on a computer."

By the end of trading on Monday, September 15, about $700 billion had been wiped off global stock markets. The next day the experiment of leaving the market to decide the fate of major financial institutions was over, as the US authorities intervened with an $85 billion bail-out of insurer AIG. Within a week, scores of companies were fighting for survival, and Hank Paulson was asking Congress for a $700 billion bail-out package.

Historians will debate whether the crash could have been avoided if Lehman had been saved. One of Paulson's deputies at the Treasury, Neel Kashkari, concedes that everyone underestimated the consequences of letting Lehman go down. "It obviously turned out to be very bad; it was worse than we feared. And as you know, while the credit markets basically shut down two days later, the real depth of the damage was not seen for weeks – or even months."

In London, too, the Governor of the Bank of England, Mervyn King, now admits the scale of the consequences took everyone by surprise. "I don't think any of us easily anticipated that we would see the sort of financial panic that we saw after the failure of Lehman Brothers," he says.

Having witnessed the rise and fall of so many institutions over the past four decades, America's leading bankruptcy lawyer Harvey Miller may be among the better placed to judge what brought Lehman Brothers' proud 158-year history crashing down. "When I went to college, I learnt in economics that you do not finance long-term investments with short-term money, and that is what happened," he says. "And I believe it happened because greed took over and the returns were so big.

"So many people were making so much money that they lost all fear, and risk did not become a factor in doing anything."


* The Bank That Bust the World, the first part of BBC2's series The Love of Money is on Thursday at 9pm. Dominic Crossley-Holland is head of business programming at the BBC

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/6143297/Lehman-Brothers-the-bank-that-bust-the-boom.html