Thin Line Separated Fates of Merill Lynch and Lehman Brothers
By Jenny Anderson and Charles Duhigg 21 September 2008
Early last Monday morning, Richard Fuld Jr., the longtime chief executive of Lehman Brothers, put his 158-year-old firm into bankruptcy, burying a company where he had spent his entire career.
Several hours later, John Thain, the chief executive of Merrill Lynch, climbed a stage in New York and told his employees, most of whom he had barely gotten to know during his brief tenure, that he was selling the troubled firm to Bank of America.
Although both men played starring roles in a cataclysm that has threatened to break the economic backbone of the United States and has rearranged the financial landscape, their firms are hardly the only ones wounded in the crisis. And what began with falling house prices has escalated into staggering bank and stock-market losses, unleashing deep-rooted uncertainty about the resilience of the economy.
Over the last six months alone, the U.S. government has ponied up hundreds of billions in taxpayer funds to try to blunt the impact of outsize financial blunders on Wall Street and at Fannie Mae, Freddie Mac and the American International Group. On Friday, the government took extraordinary and historic steps to save some firms and restore investor confidence by proposing to buy hundreds of billions of dollars in distressed assets.
Lehman had pleaded with regulators for months to use similar tactics to rescue it, but to no avail. Merrill, on the other hand, was able to stay in the game just long enough to find a suitor and benefit from the U.S. government bailout.
Thain and Fuld made different strategic decisions over the last year that shaped radically diverse outcomes for their employees and shareholders. But the chaotic backdrop also spelled death for some companies and unlikely survival for others. Indeed, had last week’s government bailout arrived sooner, Lehman, like Merrill, might still exist.
A reserved and almost robotic executive, Thain approached Merrill’s fate like a technocrat, coolly assessing his options and selling the company before the pain got worse. Fuld, a passionate, dedicated and combative leader, kept struggling to survive until his firm finally ran into the ground.
“We are all prisoners of where we have been. The longer you are attached to a place, the harder it is to see it without rose-colored glasses,” says James Cox, a professor at the Duke University School of Law, in North Carolina. “When Mr. Thain got to Merrill, he started moving quickly to put the problems behind him.”
“But Mr. Fuld helped build Lehman,” he adds. “He had spent his entire career there and helped build some of the assets that ended up causing so many problems. It’s almost impossible to force yourself to completely reconceptualize your career and your life, and undo the company you built.”
Other than being in the same business, Thain, 53, and Fuld, 62, appear to have little in common. Fuld is a classic Wall Street trader — taking big risks, reaping huge rewards, exuding intensity and demanding loyalty. A University of Colorado graduate, he stumbled into the industry and through sheer determination rose from a trading floor to the highest ranks of his profession.
Thain, a dead ringer for Clark Kent, is cautiously amiable and seemed to act out, rather than inhabit, the role of chief executive. A graduate of the Massachusetts Institute of Technology, he spent his career at Goldman Sachs and the New York Stock Exchange before Merrill’s board asked him to calm a firm rife with palace politics and glaringly lax risk management.
In the end, the technocrat brought Merrill a measure of safety, though only by the narrowest of margins.
And the defiance and independence that marked Fuld’s tenure and made him one of Wall Street’s most admired chief executives served him poorly when — like many — he misjudged the severity of the financial upheaval.
“Everyone on Wall Street is navigating uncharted waters right now,” said Jeffrey Sonnenfeld, a professor at the Yale School of Management. “No one could have dreamed it would have gotten this bad, and now that it is, no one is completely certain which choices were right and which were wrong.”
Last October, E. Stanley O’Neal, Merrill’s ambitious chief executive, was forced to resign after reporting a $2.3 billion loss and making a desperate and unapproved attempt to find a merger partner. About two weeks later, the board announced that it had hired Thain.
At the time, Thain said he took the job because Merrill had the best wealth management business in the world and a premier investment banking franchise. Privately, he told friends that he wanted to resurrect the “MGM” days when Merrill, Goldman Sachs and Morgan Stanley dominated investment banking.
But his immediate needs were more prosaic: raising money to fill the firm’s dwindling coffers. Even before Thain arrived, Merrill executives concluded that they needed to raise money in order to survive.
Thain argued to investors that he hadn’t created the debacle enveloping Merrill and that he came to the firm to fix its problems. On Christmas Eve, he announced that he had raised $6.2 billion; a few weeks later, he announced an additional $6.6 billion.
Just as important, he began an internal charm offensive. In January, a day before Merrill announced its annual earnings, Thain traveled to Arizona to meet with 800 of the firm’s wealth managers. He warned them that the firm’s results would be bad. But he promised that the company was on the right track. As he exited the stage, he was followed by Money, a live bull who was a flesh-and-blood embodiment of Merrill’s ubiquitous corporate logo.
The next day Merrill announced a huge hit: $9.8 billion in losses and $16.7 billion in write-downs. Speaking to investors, Thain said he was “confident that we have the capital base we need to go forward with 2008.” A few weeks later in a private meeting with a group of investors at the company’s headquarters in New York, Thain reassured them that he would take a tough-love approach.
“We’ve got fresh eyes on these problems, and we’re not wedded to believing this company has done everything right for years,” he said, according to two participants in that meeting, who requested anonymity because the talks were confidential.
“Look at Citi,” he said, referring to Citigroup, the banking giant. “If the 800-pound gorilla has to raise money, then everyone should be asking if it isn’t time to do the same.”
As Merrill wrestled with its financial demons, Lehman seemed in better shape.
Earlier this year, Fuld, who started as a Lehman intern 42 years ago and had run the firm since 1994, was basking in two quarters of surprisingly good results. Investors were hammering his stock, but he saw those downturns as opportunities to dole out more shares to employees he believed would benefit when the storm passed.
After all, he was fond of noting, life on Wall Street was war.
“Every day is a grind, every day we’re in it, really trying to trudge through the stuff, and don’t think this is a walk through the park,” he said in an interview last fall. “Every day is a battle: think about the firm, do the right thing, protect your client, protect the firm, be in it, be a good team member.”
Lehman executives took comfort in the fact that their balance sheet was heavily weighted with commercial real estate — which they felt was immune to the mess in residential housing. Moreover, Lehman didn’t hold the same type of bundled mortgages, known as collateralized debt obligations, that had hamstrung Merrill.
Earlier this year, when Lehman’s chief financial officer, Erin Callan, met with some investors at the company’s headquarters in New York, she exuded confidence.
During the meeting an investor challenged Callan, according to two participants who requested anonymity because they did not want to jeopardize their relationships with senior executives. With firms like Citigroup and Merrill raising capital, the investor asked, why wasn’t Lehman following suit?
Callan was brusque, the two participants recalled. Glaring at her questioner, she said that Lehman didn’t need more money at the time — after all, it had yet to post a loss during the credit crisis. The company had industry veterans in the executive suite who had perfected the science of risk management, she said.
According to both investors, she said Lehman’s real estate investments were top-notch. “This company’s leadership has been here so long that they know the strengths and weaknesses,” participants recalled her saying. “We know when we need to be worried, and when we don’t.”
In an interview, Callan challenged that version of events and said that she was never defensive with investors. While conceding that she may have said those things, she thinks that investors who met with her took her comments out of context.
Lehman had been searching for a strategic partner for almost two years to buy a 10 percent or 15 percent stake in it — a move that would have made its stock less volatile and expand its business — according to people briefed on the discussions.
In 2006, it had unsuccessfully tried to team up with American International Group, the insurance behemoth. A year later it considered links with state investment agencies in Kuwait and China. Fuld and other Lehman executives also held discussions with Mizuho Corporate Bank of Japan, these people said.
But those deals hadn’t panned out. And as the credit crisis grew, investors were increasingly wary of the firm.
After U.S. government regulators intervened to stop a collapse of Bear Stearns in March, Lehman’s stock fell 45 percent in two days. Shortly after, it reported meager profits of $489 million and write-downs of $1.8 billion — and soon after, it raised $4 billion in new capital.
With Bear gone, Lehman became the smallest investment bank on Wall Street. A chorus of whispers began: Lehman is next. Critics began opining that a world of woe lurked on its balance sheet. In May, David Einhorn, a well-regarded hedge fund manager, began publicly questioning the company’s accounting and mocking Callan’s self-assurance.
As the stock declined, Fuld authorized his executives to seek a minority investment from a deep-pocketed investor, which would give the market confidence, according to people briefed on the discussions. Potential investors were said to include General Electric, HSBC and Barclays.
Top executives still believed Lehman could remain independent. The market, however, disagreed.
As Lehman tried to make a case with the media and regulators that investors betting against its stock were unfairly going after the firm, top executives increasingly realized that their strategy was failing and assets were withering.
In June, Lehman was forced to unveil its second-quarter earnings early — an unexpected loss of $2.8 billion. Fuld replaced the president, Joseph Gregory, his closest friend at the company, and demoted Callan, who later left.
Lehman raised $6 billion more in capital and explored selling parts of its business. But neither management shake-ups nor promises that a dramatic turnaround was forthcoming stopped the stock from dropping.
As Lehman publicly struggled, Merrill was quietly trying to right its ship.
In spite of Thain’s assurances in January that Merrill wouldn’t need new capital, the plummeting value of its mortgage securities soon made it apparent to its executives that they needed more funds.
Inside Merrill, Thain had drawn criticism for being aloof and for surrounding himself with a small cadre of colleagues from his previous jobs.
By July, when the stocks of mortgage giants Fannie Mae and Freddie Mac began spiraling downward, it was clear to investors everywhere that problems within the housing market were getting out of control.
Most consumers could see the reality of collapsing home prices for themselves. Within banks like Merrill, other hidden dangers existed: a dizzying array of complex products, known as derivatives, that tied mortgage-related securities, other assets and debts to companies here and overseas — a daisy chain that amplified the downturn.
Knowing he was caught in this web, Thain announced in July that he would sell some assets, including the firm’s stake in Bloomberg, the financial data and media company, for $4.4 billion. Merrill also raised $8.5 billion in a deal that severely diluted Merrill’s shareholders. It reported a second-quarter loss of $4.6 billion and $9.7 billion in write-downs.
A few weeks later, Thain announced a deal that stunned the markets: he offloaded $31 billion of toxic mortgage assets to Lone Star, a small investment company, for 22 cents on the dollar. Merrill had to finance 75 percent of the sale. Analysts uniformly agreed that Lone Star got a sweet deal.
“We have over 60,000 people working every day,” Thain said in an interview at the time, responding to criticism that he had sold the assets for a song. “All the efforts of these people were overwhelmed by the write-downs in the mortgage-related assets.”
Within months it would become clear that the Lone Star deal had, in fact, helped give Merrill extra time by untethering it from a block of ugly assets that might have stood in the way of a merger.
As the crisis escalated in July and August, Lehman was also racing to shore up its weaknesses. But investors had been burned by earlier investments in struggling financial service companies and were tapped out.
Still, Lehman executives held out hope that they would be able to save themselves by selling a stake to the Korea Development Bank, a state bank. But when Fuld, ever the tough negotiator, pushed the bank to take over some underperforming loans, the Koreans balked.
By the U.S. Labor Day holiday last month, a tidal wave was crashing down on the entire economy and Fannie Mae and Freddie Mac had become the centers of concern. Hoping to prevent companies of all sizes from toppling into one another like dominos, the government bailed out the two mortgage giants for about $200 billion.
While most banks and brokerage stocks soared on the news, including Merrill’s, Lehman’s stock dropped more than 50 percent in the two days following the bailout.
As government officials quietly said they were done rescuing financial firms, Lehman scrambled to find a solution. It was waiting for bids on its investment management division, a deal it hoped might secure $5 billion to $6 billion. It also floated the idea of splitting itself in two to create a separate company to house its troubled assets.
Then, just over a week ago, Lehman announced a $4 billion loss and a $5.6 billion write-down. It also said it would spin out $30 billion of troubled assets into a separate company.
“We’ve been through adversity before, and we always come out a lot stronger,” Fuld said in a conference call on Sept. 10, sounding unusually resigned and utterly exhausted.
The markets didn’t buy it. Clients pulled money from Lehman, other firms wanted trading guarantees and Lehman finally ran out of cash. After surviving more than a century, Lehman would be dead within days unless someone stepped in.
On a rainy afternoon 10 days ago, with just an hour’s notice, Timothy Geithner, president of the Federal Reserve Bank of New York, summoned Wall Street’s leading chief executives to a meeting at the Fed’s cavernous New York offices. Many were getting ready to leave for the weekend, and all of them were worn out after a treacherous week.
Notably absent from the meeting was Fuld, who was scrambling to strike a deal with Bank of America, said people briefed on the negotiations. Geithner, who declined interview requests, told the gathering the government wouldn’t rescue Lehman, according to various participants. It was up to the industry to find a solution, he said.
Although Lehman’s woes were in the headlines, some participants wondered if they shouldn’t be talking about other troubled firms as well. Weren’t AIG’s problems just as big, if not bigger? James Dimon, JPMorgan’s chief executive, said AIG had hired his bank, which was trying to find a solution.
Others in the room focused on Merrill’s sagging stock and huge debt burden. If Lehman collapsed, participants wondered to themselves, was Merrill next? Some banks were so concerned that they considered stopping trading with Merrill if Lehman went under.
When the meeting broke up at 8:30 p.m., Geithner asked the executives to return at 9 the next morning and to count on spending most of the weekend trying to build a bulwark against the biggest economic firestorm since the Great Depression.
On Saturday morning, when Thain arrived at the Fed, Lehman had returned to the center of discussion. Various scenarios, including the impact of a Lehman bankruptcy, were considered; everyone knew that Bank of America and Barclays were considering buying Lehman but had wanted government backing. Regulators made it clear that that wasn’t going to happen.
During the morning session, Thain sat across the table from Herbert McDade 3rd, Lehman’s president. “I don’t want to be in his seat,” Thain thought to himself, according to a person familiar with his thinking.
And to make sure he didn’t wind up in that seat within days, Thain decided Merrill had to do something bold by Monday. His hope was to sell about a 10 percent stake to a cash-rich partner.
His first call was to Kenneth Lewis, Bank of America’s chief executive, who had long coveted Merrill. Thain got Lewis’s phone number from Gregory Fleming, Merrill’s president, who wanted a tie-up between the two. Fleming was worried that if Bank of America purchased Lehman first, the bank wouldn’t cut a deal with Merrill.
Lewis raised the ante: he said he wasn’t interested in buying just a stake in Merrill. He wanted the whole company. Lewis flew to New York from the bank’s headquarters in Charlotte, North Carolina, to meet with Thain on Saturday afternoon in a corporate apartment.
Those conversations went well. But then Thain trekked back to the Fed, where another surprise awaited. Peter Kraus, his head of strategy, told him that Goldman Sachs was interested in buying a 9.9 percent stake and extending a $10 billion credit line, according to people briefed on the discussions.
And Goldman wasn’t the only other interested suitor. John Mack, chief executive of Morgan Stanley, told Thain that “we should talk,” according to people familiar with the discussions. A two-hour meeting was held that afternoon on the Upper East Side with the chief executives and their advisers.
But by Saturday afternoon, Fleming was already leading Merrill’s bankers and lawyers through a quick scouring of Bank of America and its proposal, giving the North Carolina bank a leg up.
Around 9 on Sunday morning, Henry Paulson Jr., the Treasury secretary, told the Fed group that Lehman hadn’t found a buyer and that they should brace for its bankruptcy.
Attention immediately shifted to Merrill Lynch, which many were certain would be the next to topple. Bankers started discussing the possibility of creating a vast liquidity pool that the next troubled institution could tap into.
Meanwhile, Thain set a noon conference call with his board. He said he expected a bid from Bank of America and had held discussions with Goldman Sachs and Morgan Stanley, according to people briefed on the discussions. He concluded that Lewis’s bid — a takeover of the entire company at a premium price — was the best offer.
At a 6 p.m. meeting with his board at the St. Regis hotel, Thain recommended to his board that it accept. The deal was unanimously approved.
For Lehman, the weekend shaped up very differently.
On Friday night, Lehman executives believed a deal with Bank of America was possible, according to people briefed on the negotiations. But by Saturday, they couldn’t get Bank of America to return their calls.
Fuld stayed in his office from 7 a.m. until after midnight on Saturday and on Sunday, calling regulators, potential buyers and his own team. But his options were fading. Even promising talks with the British bank Barclays were running aground.
Late in the day on Sunday, Fuld learned that the Fed would expand its lending by allowing banks to post a wider variety of collateral, and that the banking industry had cobbled together a $70 billion lending pool.
According to people briefed on the conversations, Fuld implored the regulators to let Lehman have access to those new funds — a move that he believed would have saved the firm. No, he was told: these measures are to stabilize the market in the aftermath of a Lehman liquidation, not to prevent it.
In fact, the pool was intended to help Merrill, industry participants said. Ironically, though, Merrill wouldn’t need that capital because it was completing its deal with Bank of America.
Regulators and bankers tried to wait for Lehman’s bankruptcy filing before announcing the two new lending options. But by 10 Sunday night, Lehman still hadn’t filed, because Fuld was still trying to do a deal with Barclays.
After Barclays fell through, Fuld directed his lawyers at 12:30 a.m. Monday to file for bankruptcy. Within hours, Thain announced his deal.
On Wednesday, Barclays offered the bankruptcy court $1.75 billion — far less than Lehman wanted for that firm’s core capital markets and investment banking business, its headquarters and two data centers.
And with each day the drama continues. On Friday, the rumor mill was speculating that a huge market rebound sparked by the U.S. government bailout of Wall Street might mean that Merrill wouldn’t need to sell itself to Bank of America.
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Thin Line Separated Fates of Merill Lynch and Lehman Brothers
By Jenny Anderson and Charles Duhigg
21 September 2008
Early last Monday morning, Richard Fuld Jr., the longtime chief executive of Lehman Brothers, put his 158-year-old firm into bankruptcy, burying a company where he had spent his entire career.
Several hours later, John Thain, the chief executive of Merrill Lynch, climbed a stage in New York and told his employees, most of whom he had barely gotten to know during his brief tenure, that he was selling the troubled firm to Bank of America.
Although both men played starring roles in a cataclysm that has threatened to break the economic backbone of the United States and has rearranged the financial landscape, their firms are hardly the only ones wounded in the crisis. And what began with falling house prices has escalated into staggering bank and stock-market losses, unleashing deep-rooted uncertainty about the resilience of the economy.
Over the last six months alone, the U.S. government has ponied up hundreds of billions in taxpayer funds to try to blunt the impact of outsize financial blunders on Wall Street and at Fannie Mae, Freddie Mac and the American International Group. On Friday, the government took extraordinary and historic steps to save some firms and restore investor confidence by proposing to buy hundreds of billions of dollars in distressed assets.
Lehman had pleaded with regulators for months to use similar tactics to rescue it, but to no avail. Merrill, on the other hand, was able to stay in the game just long enough to find a suitor and benefit from the U.S. government bailout.
Thain and Fuld made different strategic decisions over the last year that shaped radically diverse outcomes for their employees and shareholders. But the chaotic backdrop also spelled death for some companies and unlikely survival for others. Indeed, had last week’s government bailout arrived sooner, Lehman, like Merrill, might still exist.
A reserved and almost robotic executive, Thain approached Merrill’s fate like a technocrat, coolly assessing his options and selling the company before the pain got worse. Fuld, a passionate, dedicated and combative leader, kept struggling to survive until his firm finally ran into the ground.
“We are all prisoners of where we have been. The longer you are attached to a place, the harder it is to see it without rose-colored glasses,” says James Cox, a professor at the Duke University School of Law, in North Carolina. “When Mr. Thain got to Merrill, he started moving quickly to put the problems behind him.”
“But Mr. Fuld helped build Lehman,” he adds. “He had spent his entire career there and helped build some of the assets that ended up causing so many problems. It’s almost impossible to force yourself to completely reconceptualize your career and your life, and undo the company you built.”
Other than being in the same business, Thain, 53, and Fuld, 62, appear to have little in common. Fuld is a classic Wall Street trader — taking big risks, reaping huge rewards, exuding intensity and demanding loyalty. A University of Colorado graduate, he stumbled into the industry and through sheer determination rose from a trading floor to the highest ranks of his profession.
Thain, a dead ringer for Clark Kent, is cautiously amiable and seemed to act out, rather than inhabit, the role of chief executive. A graduate of the Massachusetts Institute of Technology, he spent his career at Goldman Sachs and the New York Stock Exchange before Merrill’s board asked him to calm a firm rife with palace politics and glaringly lax risk management.
In the end, the technocrat brought Merrill a measure of safety, though only by the narrowest of margins.
And the defiance and independence that marked Fuld’s tenure and made him one of Wall Street’s most admired chief executives served him poorly when — like many — he misjudged the severity of the financial upheaval.
“Everyone on Wall Street is navigating uncharted waters right now,” said Jeffrey Sonnenfeld, a professor at the Yale School of Management. “No one could have dreamed it would have gotten this bad, and now that it is, no one is completely certain which choices were right and which were wrong.”
Last October, E. Stanley O’Neal, Merrill’s ambitious chief executive, was forced to resign after reporting a $2.3 billion loss and making a desperate and unapproved attempt to find a merger partner. About two weeks later, the board announced that it had hired Thain.
At the time, Thain said he took the job because Merrill had the best wealth management business in the world and a premier investment banking franchise. Privately, he told friends that he wanted to resurrect the “MGM” days when Merrill, Goldman Sachs and Morgan Stanley dominated investment banking.
But his immediate needs were more prosaic: raising money to fill the firm’s dwindling coffers. Even before Thain arrived, Merrill executives concluded that they needed to raise money in order to survive.
Thain argued to investors that he hadn’t created the debacle enveloping Merrill and that he came to the firm to fix its problems. On Christmas Eve, he announced that he had raised $6.2 billion; a few weeks later, he announced an additional $6.6 billion.
Just as important, he began an internal charm offensive. In January, a day before Merrill announced its annual earnings, Thain traveled to Arizona to meet with 800 of the firm’s wealth managers. He warned them that the firm’s results would be bad. But he promised that the company was on the right track. As he exited the stage, he was followed by Money, a live bull who was a flesh-and-blood embodiment of Merrill’s ubiquitous corporate logo.
The next day Merrill announced a huge hit: $9.8 billion in losses and $16.7 billion in write-downs. Speaking to investors, Thain said he was “confident that we have the capital base we need to go forward with 2008.” A few weeks later in a private meeting with a group of investors at the company’s headquarters in New York, Thain reassured them that he would take a tough-love approach.
“We’ve got fresh eyes on these problems, and we’re not wedded to believing this company has done everything right for years,” he said, according to two participants in that meeting, who requested anonymity because the talks were confidential.
“Look at Citi,” he said, referring to Citigroup, the banking giant. “If the 800-pound gorilla has to raise money, then everyone should be asking if it isn’t time to do the same.”
As Merrill wrestled with its financial demons, Lehman seemed in better shape.
Earlier this year, Fuld, who started as a Lehman intern 42 years ago and had run the firm since 1994, was basking in two quarters of surprisingly good results. Investors were hammering his stock, but he saw those downturns as opportunities to dole out more shares to employees he believed would benefit when the storm passed.
After all, he was fond of noting, life on Wall Street was war.
“Every day is a grind, every day we’re in it, really trying to trudge through the stuff, and don’t think this is a walk through the park,” he said in an interview last fall. “Every day is a battle: think about the firm, do the right thing, protect your client, protect the firm, be in it, be a good team member.”
Lehman executives took comfort in the fact that their balance sheet was heavily weighted with commercial real estate — which they felt was immune to the mess in residential housing. Moreover, Lehman didn’t hold the same type of bundled mortgages, known as collateralized debt obligations, that had hamstrung Merrill.
Earlier this year, when Lehman’s chief financial officer, Erin Callan, met with some investors at the company’s headquarters in New York, she exuded confidence.
During the meeting an investor challenged Callan, according to two participants who requested anonymity because they did not want to jeopardize their relationships with senior executives. With firms like Citigroup and Merrill raising capital, the investor asked, why wasn’t Lehman following suit?
Callan was brusque, the two participants recalled. Glaring at her questioner, she said that Lehman didn’t need more money at the time — after all, it had yet to post a loss during the credit crisis. The company had industry veterans in the executive suite who had perfected the science of risk management, she said.
According to both investors, she said Lehman’s real estate investments were top-notch. “This company’s leadership has been here so long that they know the strengths and weaknesses,” participants recalled her saying. “We know when we need to be worried, and when we don’t.”
In an interview, Callan challenged that version of events and said that she was never defensive with investors. While conceding that she may have said those things, she thinks that investors who met with her took her comments out of context.
Lehman had been searching for a strategic partner for almost two years to buy a 10 percent or 15 percent stake in it — a move that would have made its stock less volatile and expand its business — according to people briefed on the discussions.
In 2006, it had unsuccessfully tried to team up with American International Group, the insurance behemoth. A year later it considered links with state investment agencies in Kuwait and China. Fuld and other Lehman executives also held discussions with Mizuho Corporate Bank of Japan, these people said.
But those deals hadn’t panned out. And as the credit crisis grew, investors were increasingly wary of the firm.
After U.S. government regulators intervened to stop a collapse of Bear Stearns in March, Lehman’s stock fell 45 percent in two days. Shortly after, it reported meager profits of $489 million and write-downs of $1.8 billion — and soon after, it raised $4 billion in new capital.
With Bear gone, Lehman became the smallest investment bank on Wall Street. A chorus of whispers began: Lehman is next. Critics began opining that a world of woe lurked on its balance sheet. In May, David Einhorn, a well-regarded hedge fund manager, began publicly questioning the company’s accounting and mocking Callan’s self-assurance.
As the stock declined, Fuld authorized his executives to seek a minority investment from a deep-pocketed investor, which would give the market confidence, according to people briefed on the discussions. Potential investors were said to include General Electric, HSBC and Barclays.
Top executives still believed Lehman could remain independent. The market, however, disagreed.
As Lehman tried to make a case with the media and regulators that investors betting against its stock were unfairly going after the firm, top executives increasingly realized that their strategy was failing and assets were withering.
In June, Lehman was forced to unveil its second-quarter earnings early — an unexpected loss of $2.8 billion. Fuld replaced the president, Joseph Gregory, his closest friend at the company, and demoted Callan, who later left.
Lehman raised $6 billion more in capital and explored selling parts of its business. But neither management shake-ups nor promises that a dramatic turnaround was forthcoming stopped the stock from dropping.
As Lehman publicly struggled, Merrill was quietly trying to right its ship.
In spite of Thain’s assurances in January that Merrill wouldn’t need new capital, the plummeting value of its mortgage securities soon made it apparent to its executives that they needed more funds.
Inside Merrill, Thain had drawn criticism for being aloof and for surrounding himself with a small cadre of colleagues from his previous jobs.
By July, when the stocks of mortgage giants Fannie Mae and Freddie Mac began spiraling downward, it was clear to investors everywhere that problems within the housing market were getting out of control.
Most consumers could see the reality of collapsing home prices for themselves. Within banks like Merrill, other hidden dangers existed: a dizzying array of complex products, known as derivatives, that tied mortgage-related securities, other assets and debts to companies here and overseas — a daisy chain that amplified the downturn.
Knowing he was caught in this web, Thain announced in July that he would sell some assets, including the firm’s stake in Bloomberg, the financial data and media company, for $4.4 billion. Merrill also raised $8.5 billion in a deal that severely diluted Merrill’s shareholders. It reported a second-quarter loss of $4.6 billion and $9.7 billion in write-downs.
A few weeks later, Thain announced a deal that stunned the markets: he offloaded $31 billion of toxic mortgage assets to Lone Star, a small investment company, for 22 cents on the dollar. Merrill had to finance 75 percent of the sale. Analysts uniformly agreed that Lone Star got a sweet deal.
“We have over 60,000 people working every day,” Thain said in an interview at the time, responding to criticism that he had sold the assets for a song. “All the efforts of these people were overwhelmed by the write-downs in the mortgage-related assets.”
Within months it would become clear that the Lone Star deal had, in fact, helped give Merrill extra time by untethering it from a block of ugly assets that might have stood in the way of a merger.
As the crisis escalated in July and August, Lehman was also racing to shore up its weaknesses. But investors had been burned by earlier investments in struggling financial service companies and were tapped out.
Still, Lehman executives held out hope that they would be able to save themselves by selling a stake to the Korea Development Bank, a state bank. But when Fuld, ever the tough negotiator, pushed the bank to take over some underperforming loans, the Koreans balked.
By the U.S. Labor Day holiday last month, a tidal wave was crashing down on the entire economy and Fannie Mae and Freddie Mac had become the centers of concern. Hoping to prevent companies of all sizes from toppling into one another like dominos, the government bailed out the two mortgage giants for about $200 billion.
While most banks and brokerage stocks soared on the news, including Merrill’s, Lehman’s stock dropped more than 50 percent in the two days following the bailout.
As government officials quietly said they were done rescuing financial firms, Lehman scrambled to find a solution. It was waiting for bids on its investment management division, a deal it hoped might secure $5 billion to $6 billion. It also floated the idea of splitting itself in two to create a separate company to house its troubled assets.
Then, just over a week ago, Lehman announced a $4 billion loss and a $5.6 billion write-down. It also said it would spin out $30 billion of troubled assets into a separate company.
“We’ve been through adversity before, and we always come out a lot stronger,” Fuld said in a conference call on Sept. 10, sounding unusually resigned and utterly exhausted.
The markets didn’t buy it. Clients pulled money from Lehman, other firms wanted trading guarantees and Lehman finally ran out of cash. After surviving more than a century, Lehman would be dead within days unless someone stepped in.
On a rainy afternoon 10 days ago, with just an hour’s notice, Timothy Geithner, president of the Federal Reserve Bank of New York, summoned Wall Street’s leading chief executives to a meeting at the Fed’s cavernous New York offices. Many were getting ready to leave for the weekend, and all of them were worn out after a treacherous week.
Notably absent from the meeting was Fuld, who was scrambling to strike a deal with Bank of America, said people briefed on the negotiations. Geithner, who declined interview requests, told the gathering the government wouldn’t rescue Lehman, according to various participants. It was up to the industry to find a solution, he said.
Although Lehman’s woes were in the headlines, some participants wondered if they shouldn’t be talking about other troubled firms as well. Weren’t AIG’s problems just as big, if not bigger? James Dimon, JPMorgan’s chief executive, said AIG had hired his bank, which was trying to find a solution.
Others in the room focused on Merrill’s sagging stock and huge debt burden. If Lehman collapsed, participants wondered to themselves, was Merrill next? Some banks were so concerned that they considered stopping trading with Merrill if Lehman went under.
When the meeting broke up at 8:30 p.m., Geithner asked the executives to return at 9 the next morning and to count on spending most of the weekend trying to build a bulwark against the biggest economic firestorm since the Great Depression.
On Saturday morning, when Thain arrived at the Fed, Lehman had returned to the center of discussion. Various scenarios, including the impact of a Lehman bankruptcy, were considered; everyone knew that Bank of America and Barclays were considering buying Lehman but had wanted government backing. Regulators made it clear that that wasn’t going to happen.
During the morning session, Thain sat across the table from Herbert McDade 3rd, Lehman’s president. “I don’t want to be in his seat,” Thain thought to himself, according to a person familiar with his thinking.
And to make sure he didn’t wind up in that seat within days, Thain decided Merrill had to do something bold by Monday. His hope was to sell about a 10 percent stake to a cash-rich partner.
His first call was to Kenneth Lewis, Bank of America’s chief executive, who had long coveted Merrill. Thain got Lewis’s phone number from Gregory Fleming, Merrill’s president, who wanted a tie-up between the two. Fleming was worried that if Bank of America purchased Lehman first, the bank wouldn’t cut a deal with Merrill.
Lewis raised the ante: he said he wasn’t interested in buying just a stake in Merrill. He wanted the whole company. Lewis flew to New York from the bank’s headquarters in Charlotte, North Carolina, to meet with Thain on Saturday afternoon in a corporate apartment.
Those conversations went well. But then Thain trekked back to the Fed, where another surprise awaited. Peter Kraus, his head of strategy, told him that Goldman Sachs was interested in buying a 9.9 percent stake and extending a $10 billion credit line, according to people briefed on the discussions.
And Goldman wasn’t the only other interested suitor. John Mack, chief executive of Morgan Stanley, told Thain that “we should talk,” according to people familiar with the discussions. A two-hour meeting was held that afternoon on the Upper East Side with the chief executives and their advisers.
But by Saturday afternoon, Fleming was already leading Merrill’s bankers and lawyers through a quick scouring of Bank of America and its proposal, giving the North Carolina bank a leg up.
Around 9 on Sunday morning, Henry Paulson Jr., the Treasury secretary, told the Fed group that Lehman hadn’t found a buyer and that they should brace for its bankruptcy.
Attention immediately shifted to Merrill Lynch, which many were certain would be the next to topple. Bankers started discussing the possibility of creating a vast liquidity pool that the next troubled institution could tap into.
Meanwhile, Thain set a noon conference call with his board. He said he expected a bid from Bank of America and had held discussions with Goldman Sachs and Morgan Stanley, according to people briefed on the discussions. He concluded that Lewis’s bid — a takeover of the entire company at a premium price — was the best offer.
At a 6 p.m. meeting with his board at the St. Regis hotel, Thain recommended to his board that it accept. The deal was unanimously approved.
For Lehman, the weekend shaped up very differently.
On Friday night, Lehman executives believed a deal with Bank of America was possible, according to people briefed on the negotiations. But by Saturday, they couldn’t get Bank of America to return their calls.
Fuld stayed in his office from 7 a.m. until after midnight on Saturday and on Sunday, calling regulators, potential buyers and his own team. But his options were fading. Even promising talks with the British bank Barclays were running aground.
Late in the day on Sunday, Fuld learned that the Fed would expand its lending by allowing banks to post a wider variety of collateral, and that the banking industry had cobbled together a $70 billion lending pool.
According to people briefed on the conversations, Fuld implored the regulators to let Lehman have access to those new funds — a move that he believed would have saved the firm. No, he was told: these measures are to stabilize the market in the aftermath of a Lehman liquidation, not to prevent it.
In fact, the pool was intended to help Merrill, industry participants said. Ironically, though, Merrill wouldn’t need that capital because it was completing its deal with Bank of America.
Regulators and bankers tried to wait for Lehman’s bankruptcy filing before announcing the two new lending options. But by 10 Sunday night, Lehman still hadn’t filed, because Fuld was still trying to do a deal with Barclays.
After Barclays fell through, Fuld directed his lawyers at 12:30 a.m. Monday to file for bankruptcy. Within hours, Thain announced his deal.
On Wednesday, Barclays offered the bankruptcy court $1.75 billion — far less than Lehman wanted for that firm’s core capital markets and investment banking business, its headquarters and two data centers.
And with each day the drama continues. On Friday, the rumor mill was speculating that a huge market rebound sparked by the U.S. government bailout of Wall Street might mean that Merrill wouldn’t need to sell itself to Bank of America.
Both companies insist the deal is still on.
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