Paulson later said, somewhat jokingly, that when he ran Goldman Sachs, “I used to say to bankers, ‘Listen, people don’t like bankers, and that means you. I know your mother loves you. If you ‘re lucky, your wife and your kids like you. And your clients may like you individually. But they hate bankers. And so, why are you building these huge homes? Why are you pulling up to a client’s office in a limo? Why are you doing this? It is harmful. It’s hurting all of us.’ ”
Even as he landed in New York and rolled up his sleeves to get to work, Paulson was making some key phone calls. One was to Warren Buffett. Could Buffett be the third party to help finance Lehman’s sale?
But Buffett had read Lehman’s 10-K (the company’s annual report filed with the
SEC
) back in April and decided he wasn’t interested.
Even so, Paulson went back to the Oracle of Omaha and, according to Buffett, “gave me his thoughts. Though I’m sure he would have been pleased if I had done so, he did not urge me to make the investment.”
Paulson also called Alastair Darling, the British chancellor. How helpful were the British going to be? Could Barclays get any backup from its government if they could get a deal going?
The conversation was not a pleasant one. According to Paulson, Darling “was very nervous.” He knew exactly what the implications of Lehman failing would be. Nonetheless he wasn’t going to let British money backstop an American deal. It would have been voluntarily moving the U.S. cancer overseas.
Paulson recalled that Darling said that the notion of Barclays as a buyer was “of some concern” and he (Darling) wasn’t hopeful that Barclays could pull it off. “I forgot exactly the words he [Darling] used, but I was hopeful that maybe, you know, the British regulators were independent,” Paulson said months later.
Even so, Paulson had reportedly said to Darling: “Your regulators are asking a lot of questions.” Darling shot back: “They are right to.”
Paulson now knew he was relying on Bob Diamond’s zeal. Maybe the banker really could win over his regulator. “When Barclays . . . started going through the different assets they were going to take, it sounded pretty bad, but they were a motivated buyer,” he says. “So the deal seemed challenging—but doable.”
Saturday morning, Diamond and his team entered the New York Federal Reserve at 33 Water Street, a vast lobby chockablock with lawyers, and were funneled into a room on the fourth floor with a single piece of paper attached to the door. Scribbled on it was the only word that seemed to matter: “Buyer.” Diamond smiled.
“We realized our status had been elevated—and that BofA had gone,” Diamond says. He reviewed with Paulson and Geithner and their staffs what he and his board had agreed would be the terms. He told them: “Rather than buy Lehman, we’ re going to extract what we want and ring-fence the private equity and the commercial real estate and leave that in Lehman. We will put in our fee”—a source pegs this at somewhere between $3 billion and $4 billion—”we will put in all the preferred equity, and by our math the gap in valuation is somewhere between $10 to $15 billion to get it funded.” In other words, the shortfall was $10 billion to $15 billion.
Paulson was flabbergasted: “What!? I told you there’s no government money available for this deal!”
Diamond had more preconditions: “We have to have a guarantee to clear. And I think that has to come from the Fed. We know that the
FSA
[the British regulator] doesn’t have the charter to do it, nor would they do it—we’ re a UK bank, and this is a U.S. deal. So we will look for third parties. I have very little hope that we can get a third party. . . .”
Michael Klein, one of Diamond’s aides, put in a call to Buffett, who once again demurred. “If you fax me something written out about it, when I get back, I’ ll be glad to read it,” Buffett said over speakerphone to the assembled Wall Street luminaries. Then he left with his wife to attend a gala in Edmonton, Alberta.
Treasury and Fed officials spent all of Saturday pressuring the heads of Wall Street’s top banks and securities houses, including Goldman Sachs, JPMorgan, Deutsche Bank, Citigroup, and Credit Suisse First Boston, to come together and raise $35 billion to buy Lehman’s toxic assets so that the firm could be bought at $3 per share.
Meanwhile, Lehman’s representatives—McDade, Kirk, and Shafir, along with the Sullivan & Cromwell lawyer H. Rodgin Cohen—were led to a tiny room on the first floor of the Fed and told to stay put. “It’s like we’ re in a hospital and we’ re the patient,” Kirk joked. But he knew how close to the mark that remark was.
Around 4 P.M. that Saturday, as the Wall Street heads bickered about how much money, if any, they should spend on Lehman, Geithner—according to Paulson—received a call from the Barclays’ board in London saying, “We’ re going to need a shareholder vote. . . .We have a question as to what happens with the trading book.”
It was the same red flag that Alastair Darling and Diamond had raised. Even if a merger could be agreed to, Barclays did not have the authority to fund Lehman’s trading book on Monday morning. That funding would have to come from elsewhere, presumably the Fed.
Paulson was faced with a Sophie’s choice: He could use tax dollars via the Federal Reserve to bail out Lehman or to help it with a merger, or there could be an economic catastrophe.
Geithner hedged on the call with Barclays, according to someone in Treasury. “Tim said, ‘We’ ll certainly keep working to solve it, and don’t let that stand in the way. You come up with a deal you can do, and then we’ ll look at all the options.’”
Diamond recalls that Geithner had told the Barclays board to just “get a deal done, and then we ‘ll deal with the funding issue.” Diamond was hopeful he could work with the Fed.
They were looking for a miracle. And to some extent, they got one.
Late Saturday night, the Wall Street CEOs agreed, with some government assistance, to buy the toxic assets, reportedly worth around $35 billion. Paulson now believed he had the deal done, even though the issue of funding the Lehman trading book had not been addressed. Barclays was notified that it should go ahead and bid for a “CleanCo.” Everyone was optimistic.
Paulson, meanwhile, was hoping the
FSA
would come through for him.
In hindsight it appears as though neither party had quite communicated these thoughts to the other—or if they had, that much had been lost in translation.
At around 10 A.M. on Sunday, September 14, McDade phoned Fuld, who was waiting anxiously at Lehman’s offices for news, and told him: “We have a deal.” Barclays was willing to buy the firm for $5 a share (or roughly $3.5 billion).
But then Sir Callum McCarthy, the outgoing chairman of the
FSA
and Hector Sants’ boss, called up Geithner, “ranting and raving,” according to a source, and angrily told him that there was no way the
FSA
would guarantee the Lehman trading book.
“There was no way forward,” recalls Paulson. “The
FSA
just wouldn’t approve the deal.”
Sources at the
FSA
say they were stunned that no one had called them earlier. “Why on earth, if Paulson was serious, didn’t he check with us sooner?” someone close to
FSA
Chief Executive Hector Sants says.
Paulson thought Diamond had spoken to his regulator, and that he’d got them on board.
Diamond appeared to be as dismayed by the FSA’s news as Paulson was, and was furious that McCarthy had called Geithner without first coming to Barclays. He believed that he might have been able to make headway with the U.S. Fed and was distressed to learn that an inflammatory phone call from the
FSA
had seemingly killed the deal. Diamond e-mailed Bob Steel two damning sentences after McCarthy’s phone call: “Couldn’t have gone more poorly, very frustrating. Little England.”
Paulson was devastated. For the second time that weekend he placed a call to Darling, not, he stresses, to ask the UK government for a bailout, but to gauge their mood.
He got his answer. Darling’s attitude was the same. It was very bad news for everyone if Lehman failed, but the problem was theirs, not his.
According to Treasury sources, Paulson asked his team of financiers, including Steven Shafran and Dan Jester, both retired managing directors of Goldman Sachs, and others from Credit Suisse, to take another look at Lehman’s balance sheet.
According to someone present at the Fed meetings, one Treasury staffer estimated that Lehman had overpriced its assets by about $100 billion (Paulson was never told it was this bad); others said the hole was maybe $50 billion to $60 billion.
Paulson lost his cool. He was tired. He was worn out. It was time to tell the Fed and the
SEC
he could not find a buyer to save Lehman Brothers. He was out of options.
By Sunday afternoon, Lehman was not Paulson’s only headache. Sitting in another room in the New York Federal Reserve was a team from American International Group Inc. (
AIG
). Its stock price was down over 90 percent for the year, the company was being forced to post more and more collateral, and its credit ratings were at risk of a downgrade, which would in turn mean posting more collateral.
AIG
needed cash quickly, or the company would default and have to file for bankruptcy.
The Lehman situation was bad; this was worse.
Paulson once again put in a call to Buffett, who told the Treasury secretary that he could not afford to let
AIG
go under. “All bets are off,” Treasury sources say Buffett advised Paulson. “You must find a way to save
AIG
. It’s too big and too global.”
AIG
was the world’s largest insurer. It had been widely considered to be a much more dependable counterparty than someone like Lehman or Bear Stearns. It was, after all, an
insurance
company. But the reality was that it had trillions of dollars in bets on the markets, and if its credit rating got downgraded—as most expected would happen within days—it could be hit with collateral calls for billions upon billions it did not have. Millions of Americans had policies with
AIG
.
Paulson started clearing problems off his desk. First, Lehman needed to file for bankruptcy—a token sign, as Congressman Barney Frank would later say, mockingly, that there was still a free market in America—for one day, at least.
After letting Lehman go, Paulson was pretty sure he would be forced to intervene to save AIG—and God knows who else.
In his mind it wasn’t right to equate
AIG
with Lehman—at the time,
AIG
looked like it had only a liquidity problem, whereas Lehman had both a liquidity crisis and a capital problem. It was legal for the Fed to make a loan that was secured by valuable insurance subsidiaries; a loan to the firm would, it was hoped, avoid systemic collapse.
“Loaning against stable insurance businesses with independent credit ratings was very different than lending to Lehman Brothers. You can’t lend into a bank run and save a company,” Paulson later said. “And the run on Lehman had begun before the weekend.”
The afternoon after Paulson told Geithner and Christopher Cox, the head of the
SEC
, that Lehman would have to file for bankruptcy, Fuld sent McDade and his team back down to the New York Fed to make sure Geithner fully understood the ramifications of letting Lehman go. When McDade returned, Fuld asked him: “Did they get it?”
“They got it,” McDade replied, wearily.
Meanwhile, Scott Freidheim was drafting an assortment of press releases about the possible fate of the firm. George Walker entered his office at one point and took a look. “We’ve got to take investment management off the table,” said the nimble-minded Walker. “Our portfolio managers have to be allowed to continue to manage clients’ assets or there will be massive client losses.”
Walker was working feverishly to sell Lehman’s investment management division. After almost two weeks of round-the-clock negotiations, Bain Capital and Hellman & Friedman agreed to purchase the majority of the investment management division in two equal parts for $2.15 billion on September 29, 2008. The investment management division, which consisted of NeubergerBerman, Lincoln Capital, and Crossroads, among others, was immediately renamed after its largest operating unit: NeubergerBerman. Walker would remain its chief executive.
But the story didn’t end there.
U.S. bankruptcy law dictates a subsequent re-auction to ensure that the business had been bought for a fair price.
Against the backdrop of plummeting global equity markets, few companies were willing to top the Bain and Hellman & Friedman bid, which itself was looking less certain as the S&P 500 index dropped beneath the agreed floor of 903. NeubergerBerman could be in limbo and might, like its parent company Lehman, be sold for $1.
To ensure the survival of the business, should the Bain and Hellman & Friedman bid not close, Walker submitted a bid from NeubergerBerman’s own management.
On December 3 he won; 51 percent of NeubergerBerman was now owned by the management and 49 percent by the Lehman creditors.
For Walker, who had done a straight stock swap when he joined Lehman from Goldman, it was a remarkable end to a two-year roller-coaster ride.
Around 6 P.M. Sunday night, the Lehman board convened at 745 Seventh Avenue. In the middle of the meeting,
SEC
chairman Christopher Cox phoned Fuld’s office. Fuld transferred the call to the board. “The Fed and the
SEC
are in agreement you should file for bankruptcy,” Cox told them. The implication was that if they didn’t, they could be personally liable.
Fuld looked stunned. So, too, did Harvey R. Miller, the veteran bankruptcy attorney of Weil, Gotshal & Manges, who had to put together the quickest bankruptcy papers of his career. Too fast, he reportedly said. This is going too fast.
There was also a hitch. Before Weil, Gotshal & Manges could proceed, it needed its payment of around $20 million for the filing. According to Steve Berkenfeld, this was because “they had a claim as a secured creditor against Lehman.” As both the firm’s attorney and creditor, “they had a conflict.”