In the final of a five-part series Yalman Onaran and John Helyar chronicle the demise of investment bank Lehman Brothers and the fall from grace of its leader Richard Fuld.
KEY POINTS:
The beginning of the end came two days later when the Korea Development Bank talks fell apart.
"The possibility of a Lehman deal wasn't big from the very beginning," Jun Kwang Woo, chairman of South Korea's Financial Services Commission, said after the collapse.
Still, by September 9, it was all Lehman investors had to pin their hopes on. With shares trading at US$7.79 ($13.48) each, below what KDB had been willing to pay a few days earlier, Lehman had a market value of US$5.4 billion, one-sixth of what it had been a year earlier.
The cost of insuring Lehman's debt surged by almost 200 basis points after the KDB news, rising to 500, still not as high as where Bear Stearns' credit-default swaps were trading before its collapse. (A basis point equals one-hundredth of a percentage point.) That caused Lehman's hedge fund clients to pull out, and short-term creditors cut lending lines. New York-based JPMorgan, Lehman's clearing agent for trades, demanded additional powers to seize cash and collateral in the firm's accounts.
The next day, September 10, Fuld pre-announced quarterly results - a US$3.9 billion loss, after US$5.6 billion of writedowns. He also said Lehman would auction off a majority stake in its asset management division, and he revealed his Spinco plan. He was still talking defiantly.
"We have a long track record of pulling together when times are tough," Fuld said in a conference call with investors. "We are on track to put these last two quarters behind us."
Once again, Fuld was a step behind events. Before the day was out, Moody's Investors Service said it was reviewing Lehman's credit ratings and would downgrade the firm unless it made a deal with a strategic partner. Lehman's shares fell a further 42 per cent the next day to US$4.22.
As things were spinning out of control, Fuld turned to the federal regulators with whom he had been talking since the fall of Bear Stearns.
He had approached Timothy F. Geithner, 47, president of the Federal Reserve Bank of New York, in July to see whether Lehman might become a bank holding company, which would allow it to widen its funding base. Geithner was cool to the idea, according to a person close to the discussions, saying it would not solve the problem of Lehman's troubled assets. Fuld never made a formal application.
Now, Fuld went back to Geithner. With Lehman running out of cash - it had only US$1 billion left by week's end - it had to borrow money from the Fed's broker-dealer facility by Monday if it wanted to stay in business. Again the New York Fed, on whose board Fuld had sat until the day before, was of no help.
He was told Lehman's assets did not fit the criteria for collateral, Ben Bernanke would later say. The Fed also raised its "haircuts", or collateral requirements, a person familiar with the discussions said, making it harder for Lehman to borrow from the facility.
Meanwhile, Treasury Secretary Henry Paulson was putting out the word there would be no more federal bailouts, that the Government could not rescue every failing investment bank.
With the clock running out, Lehman executives reached out again to Bank of America. They also called Barclays, the second-largest British bank by market value, and Nomura Holdings, Japan's biggest brokerage. The message went out: Fuld was ready to sell.
On September 12, one team of Lehman executives was camped out at the Lexington Ave offices of New York law firm Simpson Thacher & Bartlett, showing the firm's books to Barclays. Another group was at the Park Ave office of Sullivan & Cromwell doing the same for Bank of America. CEO Kenneth Lewis agreed to the talks after Paulson urged him to consider a deal, a person with knowledge of the discussions said.
Two other Lehman executives - Bart McDade and Alexander Kirk, global head of principal investing - were dispatched to the New York Fed on Liberty St, where Geithner and Paulson had gathered a group of Wall St leaders. There, Paulson reiterated that no taxpayer money would be used to save Lehman.
He challenged the group to find a private solution to rescue the firm, saying it was in their own best interests.
One of the attendees, Merrill CEO John A. Thain, 53, took stock of his own company's best interests and initiated merger talks with Bank of America. Lewis had concluded on Friday that he could not do a deal with Lehman without Government backing. After Paulson made it clear to Lewis that a Government role was not on the cards, the Bank of America CEO pulled his team out of the Lehman talks.
That left only Barclays, since Nomura told Lehman it was unable to move fast enough. Fuld, who rarely left his office that weekend - working the phones, fielding calls from deputies, talking to Barclays executives - thought he had a deal on Saturday night. Barclays was willing to buy Lehman for about US$5 a share if it could leave behind the most troublesome assets, the ones Lehman had proposed spinning off into a separate company as well as some others
Barclays did not want. Sunday morning brought a false dawn. Geithner and Paulson had talked a syndicate of banks into backstopping the creation of a new entity that would take over US$55 billion to US$60 billion of Lehman's problem assets, according to people with knowledge of the talks.
Everyone was basking in what seemed a done deal until word came at 11.30am in New York that the Financial Services Authority, which regulates British banks, refused to waive normal shareholder approval requirements or to allow Barclays to guarantee Lehman's debts until obtaining that approval. The reason, people familiar with the decision say, was that Barclays lacked sufficient capital to absorb Lehman.
"The only reason it didn't happen," Leigh Bruce, a Barclays spokesman said, "is that there was no guarantee from the US Government, and a technical stock exchange rule required prior shareholder approval for us to make a similar guarantee ourselves. We didn't have that approval. No UK bank could have done it."
It was a technical rule that could not be overcome. At that point, the only way to save the deal would have been for US regulators to make the temporary debt guarantee. They didn't. Paulson, who told the New York Times he lacked the authority to rescue Lehman, did not answer questions about Sunday's events submitted by Bloomberg. Nor did Geithner.
Fuld thought Paulson was in his corner, he told a person familiar with events, even as the Treasury Secretary publicly resisted spending taxpayer money to help Lehman.
Fuld was stunned, the person says, when Paulson did not offer a lifeline at the end.
It was McDade who called Fuld from the Fed meeting on Sunday afternoon, not Paulson. Far from helping Lehman, Paulson, Geithner and other officials, including SEC chairman Christopher Cox, began pressing Lehman to declare bankruptcy. McDade told them that would have serious repercussions for other firms. Wall St executives gathered at the Fed said a bankruptcy would not be the end of the world. Goldman Sachs and Morgan Stanley both had war rooms with charts detailing Lehman's subsidiaries and their exposure to each one, and they thought their potential losses would be limited.
No one, not even Lehman, knew what furies the firm's failure was about to unleash.
The end came at about 2am on September 15, when Fuld, out of running room, filed for bankruptcy. That day the Standard & Poor's 500 Index had its biggest daily drop since the September 2001 terrorist attacks, and bank lending rates soared. Paulson, who was poised to let AIG fail, quickly rethought the wisdom of that decision and approved a US$85 billion bailout. He and Bernanke also went to Congress to push for a US$700 billion federal bailout to buy bad assets from troubled banks.
Only Lehman ended up in the wrong place at the wrong time.
Fuld was hard-pressed to explain his fate when he appeared in front of Congressman Henry Waxman's committee on October 6. To many of the congressmen's hostile questions he had no answers. "I wake up every single night," Fuld said, "thinking, 'What could I have done differently?"'
It might have ended differently had Fuld not risked so much on mortgage-backed securities. It might have ended differently had Fuld been willing to acknowledge Lehman's falling valuations. It might have ended differently if Fuld had made a deal in June, or July, or August.
That would have required acknowledging that time had run out on Wall St's over-leveraged, overpaid gilded age. Instead, in his stubbornness and isolation, Dick Fuld failed to save the firm he lived for.
- BLOOMBERG
