He kept his body and his mind sharp. He worked out religiously, and when not at client meals, he ate Special K for breakfast, lunch, and dinner. He was extraordinarily thin and he dressed in sharp suits. He had a military bearing, which was enhanced when he suddenly—surprisingly—shaved his head upon hearing that he’d been appointed president.
On June 12, Fuld called the executive committee and announced that McDade was his man. The committee approved heartily of the choice, as did most of the people at Lehman, past and present. When Tom Tucker read about it, he e-mailed McDade immediately. “I hope you can right a great wrong,” he said.
One of the few who objected to McDade was Jeremy Isaacs. Echoing the complaints about Pettit, Isaacs considered McDade a “Marine” type.
When McDade got the job, Isaacs handed in his resignation, but Fuld pleaded with him to stay. He knew that losing Isaacs so soon after the jettisoning of Gregory and Callan would play disastrously in the press and in the market. Isaacs agreed to stay on to help see through a merger with the Korea Development Bank (
KDB
), a Korean government bank that had expressed interest in purchasing Lehman. But in all but name, Isaacs was quietly replaced as head of Europe by the young German Christian Meissner and Benoit Savoret.
By Friday, June 13, as news of the shakeup hit the press, Fuld was ready to move on. McDade’s appointment was officially announced to the firm the next Monday at the Sheraton Hotel, close to Lehman’s midtown offices on Seventh Avenue, where both Fuld and McDade made a grand “do the right thing” gesture by announcing that they would forgo their bonuses that year.
Fuld had told McDade he wanted to have Gregory attend the ceremony, as if he were passing the torch. McDade objected—he wanted all traces of the man many blamed for Lehman’s reckless risk taking expunged as swiftly as possible.
In fact, when he was shown Gregory’s office—where most assumed he’d take up residence—he declared that it had bad “feng shui.” Instead he moved into Tom Russo’s office and had it professionally redecorated. He quickly installed an oriental figurine he called “the Money God,” which he’d always kept for good luck. Russo moved into Gregory’s old office.
McDade quickly began making staffing changes. The Tuesday following Gregory’s ouster, he met with his old friends—and Lehman exiles—Mike Gelband and Alex Kirk at Kirk’s apartment and persuaded them to rejoin the firm. By late June, the two were back on the trading floor, where they were greeted with deafening applause.
McDade also brought back John Cecil. He said, “John, I need you in a meeting.” It had been several years since Cecil had looked over the Lehman balance sheets. When he saw roughly $40 billion in commercial real estate and a further $25 million in residential real estate, he was appalled. It struck him as he looked around the Lehman executive floor that even though the mood was grim and determined, everyone seemed exhausted. “There was no sense of sufficient urgency,” he says.
McDade rapidly dismantled Gregory’s costly human resources department. At long last, co-
CAO
Ian Lowitt, a Rhodes scholar and McKinsey-trained polymath who had been widely considered a shoo – in for the
CFO
spot before Callan nabbed it, got the job. (One reason Lowitt may have been passed over, according to one executive, was that Gregory considered him to be a “sloppy” dresser.)
Jerry Donini, the head of American equities, took McDade’s old job as global chief of equities, and an Italian banker named Riccardo Banchetti was tapped to be Christian Meissner’s partner heading the investment bank’s European and Middle Eastern operations, the post vacated by Isaacs. Two new fixed income chiefs were also named, Asian capital markets head Hyung Soon Lee and global credit products chief Eric Felder. In short order, Fuld’s band of loyalists had been almost wholly marginalized.
McDade split senior management into teams to divide the considerable labor of executing his game plan to save the firm. His major objectives included selling the firm by the next quarter, which was less than three months away. The eight specific tasks at hand were, in summary:
1. Get the toxic assets (the commercial real estate loans) off the balance sheet and spin them off into a separate vehicle—which would come to be dubbed “SpinCo”—that would be disbursed to shareholders. The idea was that if SpinCo could somehow be deemed exempt from the requirement to mark all of its 2,500 commercial real estate investments to market, it would eventually ride out the bear market and generate a profit for shareholders.
2. Raise at least $3.8 billion by selling an equity stake in the newly sanitized “CleanCo” to a partner, an endeavor that was named “Project Blue.” Skip McGee and the bankers were put in charge of “Project Blue,” and worked off a document that outlined a possible merger with the Korean Development Bank (
KDB
, Korea’s national bank), which, Lehman hoped, would own 55 percent of Lehman’s investment management division, which included NeubergerBerman, which had no debt and was worth perhaps as much as $9 billion (some insiders even thought $10 billion). Aside from
KDB
, there were also merger talks with Bain and Hellman, Kohlberg Kravis Roberts, and Blackstone.
3. Reduce “less liquid asset exposures in mortgages, commercial real estate, and high-yield acquisition finance”—in lay terms, stop plowing money into risky real estate ventures.
4. Reduce head count and expenses.
5. Make multiple management changes to improve performance and risk management.
6. Finalize a restructuring of all “securitized product origination platforms.” (Translated into English, this generally referred to finishing off the mass purge of Lehman staffers involved in the mortgage business.)
7. Slash nonpersonnel expenses by $250 million.
8. Reduce the common dividend to $1.25 per quarter.
By now an emissary from the government—either Treasury, the New York Federal Reserve, or the Securities and Exchange Commission—was inside Lehman (and most other Wall Street firms) daily. Paulson had even persuaded his old Goldman Sachs buddy, Ken Wilson, to act as a liaison with Lehman.
Paulson was prepared to help Fuld try everything, but the SpinCo venture—which the folks at Treasury quickly renamed “ShitCo”—worried him.
“They came up with this goofy idea of the SpinCo,” he recalled a year later in a room in Johns Hopkins University in Washington, D.C., his brow furrowing with puzzlement. “I just kept questioning Dick: ‘Why do you think you can raise equity in your bad real estate if you can’t raise it in your company?’ ”
In other words, how could they expect to raise the money to pay ShitCo’s prodigious bills without committing securities fraud? The only remotely viable option the firm had floated was through the sale of the asset management firm NeubergerBerman. But the bankers had made clear that selling that was considered their funding option of last resort.
Essentially, what Lehman and/or SpinCo needed in the short term was an unlimited line of cheap credit at the Federal Reserve discount window.
“Main Street” banks, with depositors, bank branches, and
ATM
machines, have access to the discount window because their depositors are insured by the Federal Deposit Insurance Corporation (
FDIC
), which in turn has the authority to seize, take over, and sell off banks whose managers get too sloppy with the books. It was a long shot, but within a matter of months both Goldman Sachs and Morgan Stanley would be scrambling to do the same thing. So, with the help of a Sullivan & Cromwell lawyer, H. Rodgin “Rog” Cohen, a Lehman team drafted a proposal called “The Impact of Becoming a Bank.”
Lehman’s SpinCo team—Fuld, Russo, McDade, Lowitt, Freidheim, Lessing, and Lehman treasurer Paolo Tonucci—floated the idea on a conference call in July with the president of the New York Federal Reserve Bank, Timothy Geithner. He instantly vetoed it.
On the fly, one person on the call remembers, Russo stepped in. “If you don’t want us to convert to a bank holding company,” he pleaded with Geithner, “then let us make a one-time election, where we move certain assets, our mortgages and commercial real estate. Move those assets to our Utah bank. We then can post to the window. And it’s over. It’s over.”
“You can formally apply,” Geithner said tersely, according to someone on the call.
But there was little doubt that Lehman was light-years from meeting the qualifications required to become a bank holding company. Approving the firm’s application would have hurt the Fed’s reputation, according to a senior source there.
(It didn’t help that Russo wasn’t taken particularly seriously by government officials, who called him “Radio Tom” for his penchant for babbling. “He transmits but he doesn’t receive,” said one former Treasury official, who remembers holding the phone at arm’s length during some of Russo’s more tedious monologues.)
Lehman applied, but the whole thing “was theater on their part,” someone close to Federal Reserve Chairman Ben Bernanke later said. Their application was rejected.
With the benefit of hindsight, however, Russo’s idea looks pretty smart, concedes a former Treasury staffer. “He was absolutely right to want to become a bank holding company.” But the Fed wasn’t in the mood for such “outside-the-box” thinking just weeks after the Bear Stearns bailout. What it really wanted Lehman to do was the same thing Paulson wanted Lehman to do: Sell. Now.
But they also knew there were few, if any, buyers. Who would want to take on those toxic assets?
“They went around the whole world, trying to find investors,” Paulson said a year later. “I essentially knew that they had been to everybody you could think of. No one wanted to invest in them.”
“If there
were
buyers for an investment bank, there were other firms with more attractive franchises. With Bear Stearns, we had been very fortunate to have JPMorgan there as a buyer.
And even if a buyer miraculously appeared, would Fuld actually commit to a deal that he thought undervalued Lehman? Paulson was not sure that he would.
“Although Lehman was a storied old firm with a rich heritage, Dick was the guy who had, in many ways, founded the new Lehman when it spun out of American Express. So, his ego was tied up with the company, with the price of the stock,” Paulson said. “He was very focused on the price of the stock.”
On the other side of the Atlantic, Peregrine Moncreiffe ran into a friend who worked for hedge fund king John Paulson. “Fuld told us he’ s deliberately going to keep the balance sheet big,” he told Moncreiffe. “He thinks that this way, the government will have no choice but to save him.”
One problem with the Korean deal was that Dick forgot
E. S. Min was not still his employee. He treated him as though
he was.
—Lehman executive committee member
T
here were only a handful of potential buyers strong enough to purchase Lehman. The list included the United Kingdom ‘s
HSBC
Holdings
PLC
, Germany’s Deutsche Bank AG, Japan’s Nomura Securities, and Spain’s Banco Santander SA. There were also the sovereign wealth funds in China and the Middle East that had invested billions in Citigroup and Merrill Lynch earlier in the year. But the Chinese were still smarting from some major losses its state – owned China Investment Corporation had taken investing in the crew of ex-Lehman guys who founded Blackstone Group. Negotiations in the Middle East went nowhere.
Behind the scenes, the U.S. government was contemplating that if the worst happened, there might be two major buyers. One was Bank of America, which, Paulson felt, might be interested in acquiring an investment bank. That was his first choice. In the back of his mind there was the British investment bank BarCap, the investment arm of Barclays
PLC
, which Paulson would not have thought of were it not for his friend Bob Steel, the outgoing undersecretary for domestic finance at the U.S. Treasury (who would later briefly helm the ailing Wachovia until its speedy government-brokered takeover by Wells Fargo at the end of 2008).
In May, Steel had told Paulson that Robert “Bob” Diamond Jr., the
CEO
of BarCap, wanted to move back to the United States from London. “I suggested to Hank that Barclays was an excellent route to go; they wanted a much bigger U.S. business. Bob Diamond knew investment banking and capital markets cold, was an excellent leader, and was keen to return to the U.S.,” Steel says.
But Paulson was skeptical. “When Barclays came to me the first time, I was thinking, first of all, do they know how to complete a deal? They’d lost out to
RBS
and
ABN
Amro.”
Meanwhile, Lehman had spent the summer hoping to pull a rabbit—and its corporate backside—out of a hat with “Project Blue.”
The Korea Development Bank (
KDB
) ‘s Capital Corporation was interested in purchasing a minority stake in Lehman to give itself a global platform. Lehman took this seriously, and the executive leading KDB’s talks was a former Lehman employee—their chairman and
CEO
, Min Euoo-sung (E.S.).
In late July, Fuld, McDade, Isaacs, Russo, McGee, Kunho Cho, and Bhattal flew to Hong Kong to meet with Min, a passionate and bright financier. The deal they imagined was a “significant but non-controlling investment . . . coupled with three joint ventures,” says someone with knowledge of the discussions, and included various agreements to possibly integrate Lehman’s and KDB’s investment banking operations in Asia.
Min clearly wanted to make a deal, but he had to contend with a continually shifting backdrop. The South Korean currency was beginning to crumble in the summer of 2008. By summer’s end, the South Korean won had lost nearly 20 percent of its value since the start of the year, and reached a four-year low. There were serious issues concerning the South Korean current account deficit (which had reached $12.59 billion between January and August), South Korea’s dollar reserves, and the general state of its domestic economy. Further, because
KDB
was owned by the South Korean government, government officials, according to a source involved, from “various agencies and political factions . . . wanted the ability to review any transaction” before giving their approval. They told Min that they wanted a formal “management consultant” style study performed on the merger before it could be approved.