Dick Fuld, chairman and chief executive of Lehman Brothers, was seriously out of touch with reality became palpable. Speaking just weeks after the collapse of Bear Stearns, a rival investment bank, had caused Lehman’s share price to fall by 48% in a morning, he told his shareholders he thought “the worst is behind us” in the financial markets. Soon afterwards the markets became so dislocated that Lehman’s clever hedging strategy — the techniques that had protected it from bad losses – came unstuck. A gigantic loss position built up that would very likely prompt the firm to report its first quarterly deficit since its stock-market flotation in 1994.
Investors were unaware of this looming black hole. As a member of Lehman’s communications team, I became aware of it when the chief financial officer, Erin Callan, initiated internal discussions as to how we would present the loss in our next quarterly results in June. The worry, even then, was that it could be of a magnitude to cause a run on the bank.
There was, of course, no way to spin it. The numbers would be atrocious. Lehman would simultaneously have to shore up confidence by raising fresh capital from increasingly wary investors.
To offset the $2.8 billion (£1.8 billion) loss, management scrambled to drum up $6 billion from hedge funds and institutional investors. I relocated from London to New York to help fight the fire. We shuttled between the 45th floor of the Time Life building and the executive floor of Lehman’s main tower on 7th Avenue, surviving on junk food and soft drinks.
The problem, it seemed to me, was that Fuld still did not “get” how deeply in trouble he and his bank now were. He rejected the idea that he take the lead in talking to investment analysts on the day the loss was announced – which might, if he had shown a degree of humility, have won him some friends among investors.
He also refused to mount a “hearts and minds” campaign among opinion-formers or in the wider Wall Street community. Instead, after The Wall Street Journal revealed Lehman’s discussions about raising new capital, he ordained that no Lehman employee anywhere in the world should talk to any Journal reporter. Asked how this was likely to improve coverage of the worst results in Lehman’s history in America’s premier business paper, Fuld’s entourage could not say.
At a drafting meeting in New York on the day before the results, Fuld even questioned the volume of explanatory detail being prepared. “Why are we spending all this time on this?” he snapped. “We made a loss; we move on.” Instead of recognising a catastrophic series of bad decisions over more than a year, he saw just one lossmaking quarter after 55 profitable ones. He assumed that his almost mythical track record of success meant investors and employees would forgive him this $2.8 billion blip.
Just how wrong his assumption was became instantly clear once the news was out. Lehman’s share price dropped like a stone. Rumours started to fly around the markets that executives had been fired, predators were preparing to bid, creditors and clients were pulling back, and counter-parties were refusing to trade. There was blood in the water, and the “death spiral” had recommenced.
Only those who have been on the receiving end of a market feeding-frenzy of this kind can begin to understand what it is like. To me and the other communications guys, it felt like wartime: tin hats on and duck the incoming fire. The army of Lehman traders around the world were being bombarded with alarming questions from other banks and investors.
Under pressure, Fuld panicked: he replaced Joe Gregory, his long-standing No 2 with the poker-faced Bart McDade, an ambitious lieutenant who was jockeying for Fuld’s own job.
This was a fateful choice. Among its consequences was an ugly standoff at the very top of the firm over strategy and control. When it came to taking crucial decisions that could have saved the firm, senior Lehman management was paralysed. Jeremy Isaacs, the London-based head of European and Asian operations, handed in his resignation on the day of McDade’s appointment, but agreed to Fuld’s request that he stay on for the sake of appearances. The fissure that already existed between Lehman’s New York and London headquarters became a gulf.
As the top team in New York descended into a bunker mentality, those of us charged with communicating on its behalf were ordered to say nothing, save to squash the most damaging rumours. Yet the rumours kept coming: that one of America’s leading investment firms had stopped trading with Lehman, that a British bank was preparing an offer at a huge discount to the share price, that Lehman did not have the money it thought it had raised.
Increasingly, the executives receiving instructions from the bunker resembled headless chickens. Studies were initiated for spinning off the bad assets and selling the important investment management division. There was talk of a “strategic investor” being found to shore up confidence. Was this a strategy to get out of jail? Hardly. The obvious answer, to many inside the firm, was a sale of the whole company. There were only two problems with this argument: Dick Fuld and Bart McDade.
Lehman Brothers had been Fuld’s life for 42 years. He had no desire to become part of a larger conglomerate or take orders from elsewhere. And he had a very clear view of what the firm was worth – a lot more than the market indicated.
As for McDade, he had his own reasons to find a sale of the firm less than appealing. It might extinguish his hopes of ousting Fuld and landing the top job for himself. “Bart was completely fixated on controlling the firm at all costs,” said another former executive. “He thought it was only a matter of time before he could oust Fuld and take the prize.”
So although Fuld and McDade talked to potential strategic investors and purchasers, their hearts did not appear to be in it. More than one member of the executive committee concluded that Fuld’s personality – his entire being – had become so bound up with Lehman that he was not capable of making rational decisions about its fate. In other words, he had become sentimental. That is the only way I can explain the fact that he told a journalist of my acquaintance in the first half of July: “I will never sell this firm.”
AS the summer wore on and Lehman’s position weakened, the circle of interested investors shrank to one: Korea Development Bank. To market observers this was ominous because South Korea is not a big-league financial player, and a small, state-owned development bank was far from the obvious answer to Lehman’s prayers.
Nonetheless, the talks, initiated by Isaacs’ international team in Asia, were serious. In early August, they agreed in outline on a deal to sell a 25% stake in Lehman at $22 a share with a tender offer for a further 20% to follow.
Most chroniclers of Lehman’s demise have assumed the transaction that could have saved the firm was torpedoed by Fuld’s demand for a higher price. That is not so: he was by then desperate enough to do the deal. The problem lay in the tens of billions of dollars of commercial property assets sitting like a dead weight on Lehman’s balance sheet and – with the property market bombed-out – dragging the firm towards further quarters of loss.
Before they would seal the deal, the Koreans wanted comfort that these toxic assets would be ring-fenced into a separately capitalised entity, limiting their exposure. Faced with this demand, Lehman management floundered. The Koreans pulled out, furiously accusing McDade in particular of acting in bad faith.
Some of those involved go so far as to accuse McDade of deliberately torpedoing the talks for his own ends by producing new data about commercial property losses at the eleventh hour. To these insiders, the deal was deliberately scuppered to stop Isaacs from winning the kudos of saving Lehman – and with it possibly Fuld’s job. Whatever the truth of these allegations, subsequent efforts to revive the talks all foundered on the basic question of trust.
When news broke that the negotiations had ended in disagreement, it was truly over for the House of Lehman. The share price plummeted towards zero; management rushed out news of another quarterly loss of $3.9 billion; and, belatedly, it detailed what it was doing to stabilise the company. This was, by then, irrelevant.
Frantic talks among the leaders of the American banking industry and representatives of the Treasury and Federal Reserve over the weekend of September 13-14 revealed that the authorities were not prepared to lift a finger by way of providing government support.
Instead of providing guarantees that would have enabled a sale to the only bidder left – Barclays Capital – US Treasury secretary Hank Paulson told McDade to prepare to file for bankruptcy. On Monday September 15 at 2am Eastern Standard Time, that is what the American Lehman holding company did.
The manner of its passing could have been calculated to cause maximum damage. Instead of filing for bankruptcy as “one firm”, management in New York cast Lehman’s foreign subsidiaries adrift. Instead of transferring the $8 billion float London needed to start its trading day as normal, New York simply sat on the money.
Traders in Canary Wharf were left twid-dling their thumbs as the administrators arrived. As financial panic spread across the world, I joined thousands of other employees in packing my belongings into flimsy cardboard boxes and heading home.
MORE than three months on, the shockwaves from Lehman’s chaotic failure are still spreading: a near-collapse of the global banking system, massive government interventions channelling hundreds of billions of dollars of taxpayers’ money into failing institutions from California to Clydeside; an international economic downturn with a scale and severity not seen since the second world war. Nobody knows where it will end.
Yet amid the ensuing activity – bank nationalisations, huge taxpayer-funded rescue packages, trillion-dollar liquidity injections by central banks – one astonishing fact remains: the only big private-sector financial institution that has been allowed to disappear is Lehman Brothers.
Though much smaller, Bear Stearns was considered too important to the markets to fail. Insurance giant AIG was rescued to the tune of $85 billion only two days after Lehman fell and has since been rescued again. The sprawling and dysfunctional giant that is Citigroup was bailed out by the authorities on remarkably generous terms only a few weeks ago.
Whatever else will define its place in financial history, Lehman Brothers looks like one gigantic anomaly. Could it have saved itself? Should it have been saved by others? Or was the collapse inevitable – even an essential step on the road towards fixing the deep-seated ills of the world financial system?
It is hard to answer any of these questions with any certainty – except perhaps the first. It seems to me, and to almost everybody from the firm I have spoken to, that Fuld could have saved Lehman if he had acted more resolutely at an earlier stage. He could, for instance, have sold Lehman to a bidder – and there were plenty interested – when it was riding high in 2006 or early 2007. In that event, history would have taken a different course, and Fuld could have retained his status as one of the most respected chief executives of our time rather than becoming the pantomime villain of the credit crunch.
When the need for a sale became urgent – after Bear Stearns collapsed in March – it was not a topic for debate in Fuld’s inner circle. “You couldn’t discuss it,” said one former executive. “To raise such issues was to risk being seen as disloyal.”
Even in the late summer, Fuld and McDade had an option to sell to the Koreans – though precisely how solid this was remains in dispute. What seems certain is that a difficult task was rendered impossible by Lehman’s bitter divisions and personal rivalries.
There was one other factor muddying matters, both from Lehman’s perspective and from that of potential bidders: they all assumed that the American authorities would not, in the end, allow Lehman Brothers to fail. Bidders calculated that Lehman, like Bear Stearns, would eventually be forced into a sale, so held back from offering a decent price.
“Nobody in their worst nightmares thought the outcome would be a complete wipe-out,” said one senior executive. “Everybody assumed that official support meant there was an implicit ‘put’ on Lehman. Dick thought that; the market thought that.”
Everybody was wrong. The universal assumption that Lehman would not be allowed to go down was a classic case of group-think, of collective faith in untested assertions. That helps to explain the scale of the shockwaves that ravaged the markets after Lehman collapsed.
So could or should the authorities have intervened to help? They certainly had the opportunity. Lehman’s management tried to persuade the Federal Reserve to allow the firm to take deposits like commercial banks. This would have helped generate market confidence in Lehman’s funding. For reasons best known to itself, the Fed refused. And yet, after Lehman collapsed, the regulator agreed to similar requests from Goldman Sachs and Morgan Stanley almost on the spot. Once disaster had struck, the authorities settled quickly on a hard line. To Lehman’s urgent pleas that the Treasury and Fed facilitate a Barclays deal, Paulson and crew gave legalistic answers: we would love to help, but our hands are tied.
There were sound political reasons for this stance. A backlash was gathering in Congress in early September against the prospect of endless bailouts for Wall Street fat cats. Moreover, although Fuld talked to Paulson almost every day during the summer, he had worn out any credit he might once have enjoyed in government by his failure to do a deal. In the end, Lehman was perceived as not falling into the category of “too big or dangerous to fail”. Paulson said repeatedly that after the fright caused by Bear Stearns in March, the markets had had ample time to prepare for a failure at another firm. In light of the global cardiac arrest that Lehman caused, that statement seems unbelievably naïve. But it captured the mood of the moment: that a line needed to be drawn and that maybe one of Wall Street’s finest should be punished for its errors.
Most policymakers now appear to accept that Lehman should not have been allowed to fail, and that doing so has turned out to be a mistake with painful consequences.
Perhaps it is more interesting to ask a slightly different question: would saving Lehman have averted economic disaster? I doubt it. The world had changed; the markets now expected banks to operate with less leverage and much more capital. It took the failure of Lehman to awake everyone to the scale of the problem. But if it hadn’t been Lehman, it would very likely have been another bank. LEHMAN was not unusual in what it did. Like Goldman Sachs, Morgan Stanley and other investment banks, it lived by trading an ever-increasing array of assets, designing, packaging and selling evermore complex financial “products” such as derivatives, and from taking speculative positions in the markets on its own account using “leverage” – huge borrowing – to turbocharge returns. Like the others, it profited from innovations such as securitisation – whereby assets such as mortgages or corporate loans are bundled together before being sliced and diced and sold on to investors – and from the proliferation of new financial players such as hedge funds.
What we now know is that every link in this value chain is broken. Securitisation markets are all but closed. Asset markets are so volatile that profitable trading is the exception rather than the rule. Complex derivatives – truly proven to be “financial weapons of mass destruction” in investor Warren Buffett’s famous phrase – are discredited. Hedge funds are going out of business en masse. In other words, the money that fuelled the machine has gone. The bankers were surfing a wave of liquidity – a vast global flood of easy money generated by lax monetary policy and loose regulation. They sprayed the liquidity around with ingenuity and abandon. But it has now dried up, and it may never return in like form. during the golden years, that investment bankers lived on a different planet from the rest of us, that is because they did. Lehman epitomised the species in its own way. Here are a few of the things that might have lost some of their gloss with its demise. - Command and control leadership. Dick Fuld was a walking stereotype – the aggressive and domineering corporate chief who rules by fear, his closest underlings promoted above all for loyalty, his executives inculcated with the belief that to challenge his word was to breach his trust. As Professor Lynda Gratton of London Business School points out, it may be a dying breed: “The dominant leadership style that allows a chief executive such as Fuld unilaterally to make decisions about the whole company will increasingly come under scrutiny. Crowds are wise, so why do we put our faith in the decisions and knowledge of a tiny fraction of people?” - Supine boards of directors. American corporate boards are famously cosy affairs, stuffed with cronies and timeservers. But even by those standards, Lehman’s was a joke – elderly, hand-picked by the chief executive, woefully short on banking expertise. One nonexec was a theatre impresario whose last experience of Wall Street was in 1972. All are now preparing to spend a lot of time and money defending their reputations from shareholder lawsuits. - Compensation culture. Investment banks were, of course, all about money, and nothing more clearly illustrated that fact than the annual month-long discussions on “comp” – bonuses to you and me. Lehman’s top people were paid largely in deferred stock that is now worthless. You won’t find many bankers falling for that one in future. - Private jets. Top Lehman executives rarely left home without one; most had not taken a commercial flight for a decade or more. There will be quite a few shiny monsters looking for new owners now, as aviation’s bargain basement opens for business. - Corporate flower arrangements. Fuld was obsessive about the impression he made on clients – right down to the flowers in the meeting room.
He had a top executive whose job was to manage such details for him. Ahead of one of his imperial tours overseas, she would demand that outposts send her photos so she could check the flowers. Hers is another skill-set that will now be forced to take its chances on the job market . .
