Jorn says Fuld didn’t think much of the bailout idea, and was even “abrasive” about it. He had reason to be: Lehman was one of the very few houses to have turned down offers to invest in
LTCM
.
Earlier that summer Meriweather and some associates had come to see Fuld and Cecil and asked them to take 20 percent of the company for $1 billion. Cecil remembers that after the
LTCM
guys left, Fuld frowned at him and said, “Those guys look scared.” To Jorn, Fuld growled, “I want to know what the fuck is going on, and I want to know yesterday.” Jorn turned to analyst Ming Xu, who called every trading desk and every sales manager in the United States to try to assemble the firm’s entire exposure to
LTCM
.
“Dick didn’t feel like he should put in any goddamned money,” Jorn says of the proposed bailout of
LTCM
. “One, because he didn’t have exposure in
LTCM
, and two, because he thought by putting the money in, it would guarantee that everyone
thought
he had exposure.”
David Komansky, then the
CEO
of Merrill Lynch, later told people that Fuld had said to him, “I’d rather reach into my pants, take out my dick and cut it off” before he would give anything to
LTCM
.
But Fuld did, eventually, fold. Lehman agreed to put in $100 million, while the others agreed to put in $250 million and formed an oversight board. Bear Stearns argued that since it was LTCM’s clearing bank it was already overexposed. Bear Stearns put in nothing.
Jorn recalls: “After the first 24 -hour session with the Fed, I went up to Joe Gregory and said, ‘Joe, there is this consortium board. We’ve agreed to put in the $100 million investment. . . . Who is going to be our board member?”
According to Jorn, Gregory replied: “Why don’t you just go hang out [at the Fed] and tell me what’s going on.”
Jorn says, “For such a serious, nearly cataclysmic event, there was a kind of cavalier attitude about it at Lehman.”
Lehman actually emerged from this crisis stronger and richer. David Einhorn, the 40-year-old founder of the hedge fund Greenlight Capital, says that in 2008 he tried to figure out how Lehman had done so well in the bleak conditions of 1998. “I went back and I read their 10-Qs from May and August and November of 1998,” he says, “and research reports from that period. And what struck me was that Lehman, who was rumored to be insolvent during that period, actually got through the entire period without booking any kind of a loss. How had they done it? They ‘d increased their bets as things got worse. And when the market came back, they made record profits in 1999.”
Jorn says he believes that Einhorn is right.
He and Ming had suggested a series of hedges that Lehman could make if
LTCM
went to zero and was no longer a creditworthy counterparty. They calculated that Lehman had 460 trades (Merrill Lynch, by comparison, had around 5,000) and that this left them vulnerable.
They needed to buy $4 billion worth of 10-year notes, $4 billion of 10-year Treasuries, and options on another $1 billion of 10-year Treasuries to cover themselves. The purchase would be scaled out on a declining interest rate path, because Jorn reckoned that if
LTCM
collapsed, the Federal Reserve would inject liquidity and lower interest rates.
Jorn never knew if the trade—which he presented to the head of fixed income, Jeffrey Vanderbeek—got executed, but he believes it was. Events came to pass exactly as he and Ming had bet, and Lehman finished the year ahead.
The cruel twist is that Lehman’s success in 1998 may have led to its spectacular failure a decade later. Einhorn explains how this experience hurt the firm in 2008: “Based on what they were saying publicly [in 2007], they thought the crisis would only last a couple of months. . . . The idea was in August 2007 not to take the write -down, to double down, and that way when the market comes back, they would make even more money.”
In layman’s terms: Lehman Brothers doubled down once, and made a killing. It doubled down again 10 years later, and got killed.
Despite coming through two harrowing crises with banner profits, Lehman was still getting hammered on the Street by rumors that fall. Gossip varied from the absurd to the sinister. One story said that the firm had invested $1 billion in a Russian satellite that had exploded in outer space; another claimed that the Federal Reserve was looking through the books and was about to take Lehman over; a third had it that Lehman was going to declare bankruptcy at exactly 11.30 P.M. on such and such date—and so forth.
” ‘Wounded’ Lehman Looks Like Next Merger Target” read the
New York Post
in November 1998. “The omens are ugly,” a Lehman banker in London told the
New York Times
.
Cecil recalls that Rumor Storm lasted for about six weeks, and he noticed that the nasty bits of gossip usually appeared on Fridays. “We were now kind of in the Land of Shorts. And a classic trick, if you’ re shorting a stock, is to circulate some rumor of bad news about that company on a Friday, particularly in the afternoon. Nobody can do much about it, but the traders talk about it over the weekend, and everybody who’s got exposure to the subject of the rumor gets nervous over the weekend—when they can’t do anything about it, of course. And then they cut their exposure on Monday, driving the price down. And that seemed to be what was happening to us.”
Since drops in the stock price are taken as an indication that a company might be in trouble, Lehman knew it was crucial that it calm investors and clients. “We started to get pressure on liquidity,” Cecil says. “Basically people wanted larger ‘haircuts,’ wanted more secured financing, less unsecured financing. It became generally more difficult for us to get financing for certain kinds of assets.”
Cecil says that both Jeff Vanderbeek and Steve Lessing, together responsible for all sales, equities, and fixed income, “did an absolutely wonderful job of keeping together the firm’s funding base,” and kept the firms ‘ clients in place.
Lessing says, “I would spend 16 hours a day on the phone with clients. We’d say, ‘This is where the firm is, we ‘re fine, we’re viable. We’ re going to have a profitable quarter. . . . ‘ At that point the whole executive committee worked extremely hard; we were all hunkered down on the client side, keeping the funding of the firm going. Those were the most intense days that I’ve experienced in my 22 years—the patch in ‘98 where there was a real thought that the firm could fail, and we actually ended up having a record year.”
Fuld had his own uncharacteristic fix for this problem: he decided to go on the offensive and go out to the market, especially the equity market. He hit the road and visited client after client, along with Cecil and Lehman’s talented risk manager, Maureen Miskovic, recently hired from Goldman Sachs.
What Fuld told the market was this: Lehman’s credit exposure to hedge funds amounted to $447 million, of which $72 million was uncollateralized. The firm’s potential jeopardy in regard to Long-Term Capital Management was $32 million, against $41 million of U.S. Treasury collateral. The firm’s emerging markets risk was $305 million. Contrary to the rumors, the firm was in good shape.
This was the moment that all of Fuld’s elocution and public speaking lessons paid off. Cecil says Fuld calmed his investors. “Clients were looking at us the way we’d looked at Meriwether—’ Do they seem scared, or do they seem comfortable with their position? Do they have a good plan for the short-term period of difficulty and for the longer term?’ In times like that, Dick can be very, very effective. And it ‘s kind of a ‘What makes you good makes you bad’ kind of thing—he was very forceful about the firm. And it worked.”
Fuld also worked with Cecil to placate the rating agencies, which wondered if Lehman’s credit risk was going up because of pressure around liquidity. At one point Cecil feared Standard & Poor’s wouldn’t hold its rating. He went to Fuld and said, “We’ re dead.” Fuld replied, “Can’t be. Go back.” He then lay down in the corridor outside of his office and looked up at the diminutive
CFO
.
“Do you just want me to lie down like this?”
Cecil went back to S&P and prevailed.
By November the fuss had died down. At the end of the year, the firm had $4.1 billion in revenue—an increase of 6 percent. Earnings per share rose from $4.72 to $5.19, meaning that Lehman shareholders received a 20 percent increase in their common stock dividend.
But Cecil took his time signing off on the balance sheet. He was concerned that as
CFO
he could announce earnings that spoke of the size of the balance sheet not just for the year-end, but for the future. He wanted to be sure the figures were correct and easily verifiable.
Cecil does not recall Gregory “or the guys in banking” having any involvement in any of this. “Joe had absolutely nothing to do with the financials,” he says pointedly.
Yet Gregory’s dictated notes in 2002 show that he went berserk over Cecil’s hesitation.
“In 1998 John was both
CFO
and
CAO
at a time of great stress when everyone was dumping our stock and it got down to 22 and as low as 19 intraday,” Gregory wrote. “We needed the
CFO
to say the firm is financially sound. John responded that he wasn’t sure he could say that for threat of being sued. It happened on a conference call and I remember it like it was two seconds ago. We were all at home on the conference call and when he said that, we all went nuts. How could he say that? We were trying to keep the company alive—12 or 13 thousand people’s lives were at stake.”
Cecil points out that there were not 13,000 lives at stake, since the firm only comprised 7,500 at the time. He also says it did take him a while to get a detailed portrait of the balance sheet together and he wasn’t going to rush something so important, nor was he going to tell investors things were okay without giving them solid proof. He has absolutely no recollection of Gregory’s reaction, though he remembers the business heads were anxious to placate the market. He was, too, but he was going to make sure of his facts first.
Fuld, according to sources, shared Gregory’s frustration with their
CFO
, who stood his ground. They felt this was a time for Chris Pettit’s mantra of
team, team, team
and instead Cecil was holding out on the firm.
In the end—after two weeks of careful analysis, and only when he was truly happy with the financials—Cecil signed. He still believes he was absolutely right to take his time. He reflected recently: “I might point out that if the same care had been taken ten years later on the signing off on the financials, Lehman might have avoided all sorts of problems. It might even still be alive.”
Following the earnings report, the
SEC
ended its investigation and things appeared to return to normal.
A colleague says that Fuld never forgave what he viewed as recalcitrance on the part of Cecil, and he made him pay for it down the road. Tom Russo says that although he believed Cecil was just being “meticulous . . . others thought that he was just more worried about himself than the firm.”
Cecil thought the episode was over and just wanted to get on with his job. He was startled when he later heard what Gregory thought of him. Gregory wrote that “he was a man who thought he was going to be ‘offered the keys to the city’ but ‘Dick didn’t really want him in that job.’ John made a series of mistakes and some really bad ones, especially in 1998, that made Dick very uncomfortable with John.”
When asked what ultimately happened to Cecil, Bob Genirs wrote succinctly to a colleague: “Joe shot him.”
Dick Fuld admitted to his senior managers that he had learned two things from 1998. Before the Russian crisis, he believed that talking to the press never worked out. “I was wrong,” he said during one of the summer retreats he held for his executive committee. “It was one of the major lessons I needed to learn.”
The other was that there was no time to lose.
Lehman could not stay vulnerable. Goldman Sachs was now finally going to float—offer its shares to the public on the stock market. He urged everyone at the company, whenever he could, to “bleed Lehman green.”
“I want you to make money for this company,” he said to everyone on staff. “Just keep thinking about ways to make money.”
Lehman had already opened offices in Tel Aviv, Beijing, and Singapore in the mid-1990s. In addition to broker -dealers in Mexico, they had a banking license in Tokyo, a reporting dealer who was able to make trades in France, and a primary dealer closely monitoring the central bank in Italy. Fuld wanted Lehman’s stock price to get up to $150 per share.
In 1999, Bradley Jack was promoted to be the sole head of banking; Cecil was still CFO and chief administrative officer (CAO); Vanderbeek was still head of global fixed income; Gregory was still head of equities; Michael McKeever was co -head of private equity; Lessing was head of global sales and research. Fuld was still growing into his role. He wanted people near him he could trust, but after the many power grabs that came after Pettit was forced out, he didn’t know if the friends he trusted today would be enemies tomorrow.
By 1999, the front-runner to take over Fuld’s throne was the young and popular Bradley Jack. He was beloved by Fuld and by all those who worked for him, even though some people thought that he was “in over his skis” running banking, because his background was in capital markets. Like Gregory, Lessing, Tucker, Pettit, and Fuld, Jack had grown up in Lehman Commercial Paper Inc. (
LCPI
). He was tall, blond, athletic, good-looking, and very charismatic. Like Pettit, with whom he was often compared, Jack was a natural speaker. But unlike the soulful, militaristic Pettit, he had a lightness about him.
Jack had met his wife, Karin, in the office. She worked for him, recruiting on the sales desk. After they were married in 1991, she became a housewife, but one who understood the ways of Lehman and never demanded anything of her husband that might interfere with his work.