It was the afternoon of Sept. 9, and tensions were rising in the 31 st-floor office of Lehman Brothers Holdings Inc. Chief Executive Officer Richard S. Fuld Jr.
That morning news broke that the Korea Development Bank had pulled out of talks to buy a stake in the New York-based securities firm. By 1 p. m., Lehman’s already battered stock had plunged another 43 percent.
Fuld was rat-a-tatting orders to associates seated at a table in his corner office, one wall of which featured photographs of lions taken by the boss himself in Africa. Herbert “Bart” McDade, installed as president in June, Vice Chairman Thomas A. Russo and Chief Financial Officer Ian T. Lowitt had been in and out of Fuld’s lair all morning. Now the CEO was staring daggers at responses he deemed too slow or too fuzzy to help right his listing ship, said a person familiar with events that day. And he was lashing out at the injustice of it all.
“Here we go again,” Fuld erupted at one point, the person recalled. “Perception trumping reality once more.”
It was vintage Fuld, a man so physically imposing, so volcanically explosive that, even at age 62, he scared underlings and competitors alike. He was raging as a storm engulfed the company he had willed into becoming one of Wall Street’s finest. Couldn’t the short-sellers see how much he had done to shed bad assets ? Couldn’t they understand what a great franchise it still was ?
Fuld was grounded enough in reality to know one thing: “We’ve got to act fast,” he said, “so this financial tsunami doesn’t wash us away.”
Six days later—158 years after its founding as a cotton brokerage in Alabama—Lehman Brothers was gone. Treasury Secretary Henry M. Paulson Jr. said he didn’t want to use taxpayer money to save Lehman, as the government had done in March when it pledged $ 29 billion to facilitate the sale of failing Bear Stearns Cos. to JPMorgan Chase & Co. Federal Reserve Chairman Ben S. Bernanke insisted there was nothing the government could have done in the end, even though Fuld had warned that Lehman’s collapse could trigger a financial Armageddon. Fuld’s failure to save Lehman, after rescuing it three times before, is a story about how the most indomitable man on Wall Street became addicted to leverage and intoxicated with the power it brought. It is a tale about the inability to repair a financial model wrecked by a lack of limits and transparency, a story pieced together from interviews with former Lehman executives and outsiders familiar with the firm. Isolated, surrounded by acolytes and unaware of the rivalries tearing his firm apart, Fuld was too prideful to accept the fast-eroding value of the empire he had built, too slow to cut a deal.
BIGGEST BANKRUPTCY The end came after months of frantic activity to find a solution—reaching out to, then spurning an offer from Berkshire Hathaway Chairman Warren Buffett; meeting with executives of banks on three continents, devising a last-ditch plan to spin off Lehman’s toxic assets; and pleading with government officials.
Then, on the morning of Sept. 14, after a series of weekend meetings at the New York Fed, a private deal to save the firm from bankruptcy was hatched. The government persuaded a syndicate of banks to backstop a new entity that would take over $ 55 billion to $ 60 billion of Lehman’s troubled assets, and London-based Barclays Plc agreed to acquire the rest of the firm, according to people familiar with the negotiations.
When the U. K. ’s Financial Services Authority refused to sign off on the Barclays purchase late that morning, U. S. officials refused to take any steps to save the deal. At about 2 a. m. on Monday, Sept. 15, Lehman filed the biggest bankruptcy in U. S. history.
“Wall Street was giving the impression that after some bloodletting the crisis would be over, and the government bought that line,” said Charles R. Geisst, author of 100 Years on Wall Street and a finance professor at Manhattan College in New York. “The thought was to make an example of a guilty firm, and Lehman just happened to be the next one in line.”
The Dow Jones Industrial Average fell 504 points on the day Lehman collapsed, triggering an increase in bank borrowing costs and a run on money-market funds and financial institutions around the world. By Tuesday, Paulson and Bernanke had reversed course, agreeing to an $ 85 billion bailout of foundering American International Group Inc., at the time the world’s largest insurer. The government has since decided to make $ 250 billion of capital infusions to bolster major U. S. banks. Only Lehman has paid the ultimate price of the financial meltdown to dateobliteration by bankruptcy.
It’s little comfort to Fuld that he was right to forecast Armageddon and regulators were wrong. His reputation is in tatters; his days are filled with lawyers; three U. S. attorneys are investigating whether he misled investors about the firm’s financial condition; his anger is palpable.
Fuld declined to be interviewed for this article as did his lawyer, Patricia Hynes of Allen & Overy.
In October, he appeared before the House Committee on Oversight and Reform wearing his emotions on the sleeve of his dark blue suit.
When asked why AIG was saved and Lehman wasn’t, he leaned into a microphone, scowled and slowly replied: “Until the day they put me in the ground, I will wonder.”
Here’s the kind of year it has been for the man who went from being the toast of Wall Street to toast. In January he was hobnobbing with the elite at the World Economic Forum in Davos, Switzerland. Nine months later he was heckled all the way to his limo after testifying at a congressional hearing.
FULD’S CAREER The fall of Lehman isn’t another tale about an overmatched or under-engaged CEO. For the 16 years Fuld presided over Lehman, he was considered one of the industry’s most skilled chief executives, boosting the firm’s profit from $ 113 million in 1994 to $ 4. 2 billion last year and multiplying its share price 20 times. Fuld was no E. Stanley O’Neal or Charles O. “Chuck” Prince, late of Merrill Lynch & Co. and Citigroup Inc. respectively, who’d gotten top jobs without being steeped in their institution’s businesses. Nor was he a James “Jimmy” Cayne, who played bridge while New York-based Bear Stearns burned. Fuld lived for and identified with his firm. It was his oxygen, a friend says. He had spent his entire career there, so his saga is also a story of Wall Street over the past four decades. When Fuld began working at Lehman in 1969, messengers lugged bags of stock certificates between brokers’ offices to complete trades. His rise embodied the triumph of the trader and of the outsize bonus—he took home about $ 300 million over the past eight years.
Starting on Lehman’s commercialpaper desk, Fuld became a formidable fixed-income trader. He maintained a reputation as a keen risk manager until it became clear Lehman had taken on too many bad mortgage-related assets.
The difference between risk management in the 1980 s and in the new millennium was like the difference between playing checkers and three-dimensional chess. The instruments Lehman issued had become more complex than commercial paper, the stakes incomparably higher.
It was the same all over Wall Street. While CEOs of Fuld’s generation spent their days in top-floor offices taking meetings, some of the firms’ specialists were downstairs cooking up synthetic financial gizmos and mind-bending trading strategies. What they concocted might produce monster profits, or prove a Frankenstein’s monster.
“Fuld took a franchise he’d built from almost nothing, brick by brick, and then trashed it in less than two years,” said Sean Egan, president and founder of Egan-Jones Ratings Co. in Haverford, Pa. “His biggest mistake was in not understanding the risks that had evolved since he was last active in debt markets. And he relied on the support of others whose interests were aligned with him.”
A CEO needs good managers reporting to him to figure out the right risk-reward ratios and make the right decisions. Increasingly, Fuld wasn’t getting good dope. He became isolated in recent years, people familiar with the firm’s operations said. He countenanced little debate and delegated more responsibility to Joseph M. Gregory, 56, who became president and chief operating officer in 2004.
An intimidating figure—he played in international squash competitions when he was younger and is still fit—Fuld was known around the office as “the Gorilla.” His icy stare, people who worked at Lehman say, froze recipients with fear. No one wanted to tell Fuld something was wrong or to question how Lehman was run.
As it turned out, one of the lessons Fuld took away from Lehman’s decline in the 1980 s would contribute to its collapse in 2008.
GLUCKSMAN VS. PETERSON The earlier crisis grew out of a power struggle between two senior partners: Lewis Glucksman, who headed trading and was Fuld’s mentor, and Peter Peterson, who ran investment banking. Glucksman maneuvered Peterson out of the chairmanship, setting off a rift between traders and bankers that so weakened the firm it wound up being acquired by American Express Co. in 1984. It was traumatic for the partners, since the dispute cost them their independence and considerable income. When Lehman was spun off in 1994, Fuld vowed that no one would ever do unto him as Glucksman had done unto Peterson. For Fuld, that meant not having a strong No. 2.
Christopher Pettit, a longtime friend and ally of Fuld’s, was forced out as chief operating officer when he balked at an executive reorganization in 1996. (He died three months later in a snowmobile accident. ) Six years would go by before Fuld installed another chief operating officer. In the meantime, Fuld pushed potential rivals aside, say people familiar with the firm’s operation. Michael F. McKeever, who ran investment banking, was stripped of his duties bit by bit and left in 2000. John Cecil, chief financial officer until 2000, was demoted to an adviser because he dared oppose Fuld, the people say.
The man Fuld finally appointed chief operating officer was Gregory, a trusted lieutenant who had worked at Lehman since 1974. He would make it his mission to keep Fuld’s life uncomplicated by debate.
Any meeting with Gregory, say people who worked with him, was a soliloquy. The COO delivered lectures on matters as minute as improving the look of sloppy dressers. Management-committee meetings were conducted without discussion, attendees say.
The same was true of executive-committee meetings presided over by Fuld. While reviewing budgets for 2007, one committee member questioned the performance of a unit, according to a person who was in the room. Fuld stared at him coldly, then broke the silence: “You’ve got some balls to say that, knowing how much I hate that topic.”
As Fuld returned to studying the papers in front of him, Gregory continued dressing down the committee member for his impertinence. He also upbraided him after the meeting, demanding that any objections be brought to Gregory privately and not voiced in front of the committee. Gregory didn’t return calls seeking comment.
Word on proper comportment spread through the ranks. Fuld conducted an employee Webcast every three months. He’d always end by asking if there were any questions. There rarely were.
The problem with this authoritarian climate was that when Lehman began to sputter, Fuld was cut off from dissenting opinion. Woe to the messenger who came to the 31 st-floor bearing bad news.
The refusal of fixed-income chief Michael Gelband to play the yes-sir game cost him his job and Lehman one of its best risk managers. He was forced out by Gregory in May 2007, people familiar with the circumstances say. Four months later Gregory also shunted aside risk chief Madelyn Antoncic, when she fought for hedges on some of Lehman’s investments. She was demoted to a peripheral government-relations job.
‘CHEAP TAR’ Gregory also set factions within Lehman against each other, the people say. New York executives, led by Mc-Dade, then head of equities, jousted with those in London, who gathered around international operations chief Jeremy M. Isaacs and who believed they deserved more power because the firm’s top growth areas were outside the U. S. The intercontinental rivalry would prove a critical fault line for Lehman. As cut off from information as Fuld may have been, it wasn’t as if he didn’t recognize the firm’s problems. In November 2004, more than two years before the bull market reached its peak, Fuld was telling people around him that low interest rates and cheap credit would create a bubble that could one day pop.
“It’s paving the road with cheap tar,” he told colleagues in a meeting at the time. “When the weather changes, the potholes that were there will be deeper and uglier.”
Fuld also warned against taking on too much risk, such as leveraged loans, which are used to finance buyouts of firms, as Lehman tried to compete with commercial banks that used their bigger balance sheets to support investment banking operations. “We’re vulnerable if we throw our balance sheet around,” Fuld said, according to a person at the meeting.
As early as March 2006, Fuld approached Martin J. Sullivan, then CEO of AIG, about a possible merger. Fuld saw Lehman becoming the investment banking unit of the insurer. A combination would have given Lehman a trillion-dollar balance sheet, funded by stable insurance premiums, which it could use to provide leverage to its clients, Fuld told his executive committee at a meeting at the Fairmont Turnberry Isle Resort & Club near Miami, according to a person who attended.
Sullivan wasn’t interested, and the proposal didn’t go beyond the initial contact, the person said. Sullivan, who left AIG in June 2008, didn’t return calls seeking comment.
Lehman used its balance sheet to finance leveraged buyouts anyway. So did other Wall Street firms forced to compete with commercial banks, which were allowed to practice investment banking after the 1999 repeal of the Glass-Steagall Act.
Leveraged loans weren’t Lehman’s undoing, though. Fuld saw the dangers they posed and rid the firm of the riskiest ones in the fourth quarter of 2007, according to company filings.
What Fuld failed to do is take advantage of a rebound in the prices of fixedincome assets at the time to sell some of Lehman’s $ 84 billion mortgage portfolio. He took false comfort in having hedged the firm’s mortgage positions at the end of 2006. Because of the hedges, insiders say, Lehman executives were sanguine after the July 2007 implosion of two Bear Stearns hedge funds that had invested in subprime securities. Fuld even loaded up on mortgage-backed securities at the beginning of 2008, not seeing how vulnerable the firm would be when the subprime cancer metastasized to other asset classes.
DAVOS PREDICTIONS The disconnect was on display at the World Economic Forum in Davos in January. On the one hand, Lehman Vice Chairman Russo, 65, presented a paper entitled “Credit Crunch: Where Do We Stand ?” predicting the reset of interest rates on $ 550 billion of subprime mortgages in the next 12 months would trigger foreclosures and economic woe. On the other hand, Russo said it was no big deal for Lehman. “Dick Fuld is very conscious of risk,” he said in a Bloomberg TV interview. “He’s created a culture that’s enabled us to do fine.” Others weren’t so sure. A Lehman employee of more than 20 years says she sat her subordinates down in January and told them to start considering options outside the firm. By the end of the fiscal first quarter in February, after New York-based rivals Citigroup and Merrill had taken about $ 45 billion in writedowns, Lehman’s mortgage portfolio had increased by 2 percent from the previous quarter. Associates say Fuld had concluded the market for mortgage-backed securities had hit bottom, and he didn’t have people around him to warn about the spread of subprime troubles to so-called Alt-A mortgages—those made to borrowers without full documentation—and the commercial real estate market.
Roger Nagioff, 44, a London equities trader who succeeded Gelband as fixedincome chief, was struggling to learn the business as the subprime rout began. He quit in February 2008 after realizing he couldn’t get his head around Lehman’s mortgage-related positions, people close to Nagioff said.
Lehman also had a rookie chief financial officer. Erin M. Callan, a 43-year-old investment banker, had been elevated to the job in December by Gregory, although she had no experience in the company’s treasury, a typical training ground for CFOs. Fuld went along with the appointment and allowed her to become the public face of Lehman because he trusted Gregory and didn’t get involved in staffing decisions, people say.
On March 17, a day after the sale of Bear Stearns, Lehman shares fell as much as 48 percent in New York Stock Exchange trading on concern the firm would be Wall Street’s next victim.
COUNTER-PUNCHING To Fuld, the idea was outrageous. The hit was a matter of wrong perceptions, not weak fundamentals. So he got on the phone with the firm’s biggest clients to tell them Lehman was no Bear Stearns, and he ordered other executives to do the same. This was pure Fuld: When bloodied, counter-punch. That’s how he turned things around in 1998, when Wall Street rumors had Lehman over-exposed to the Russian currency collapse and the “Asian flu.” His jawboning with clients, regulators and others pulled Lehman’s stock out of a spiral from $ 21 to $ 6. This time around Fuld also reached out to Omaha billionaire Buffett, the man who had ridden to the rescue of Salomon Inc. in 1987, according to two people with knowledge of the approach. He asked investment banking chief Hugh “Skip” McGee, 49, to call David L. Sokol, chairman of Berkshire Hathaway-owned MidAmerican Energy Holdings Co., and see if Buffett might be interested in a stake in Lehman. The answer was yes, Sokol told Mc-Gee. So Fuld called the 78-year-old Buf-
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