On the Brink (29 page)

And then Tim hung up.

“I made no progress,” he said simply. The FSA continued to be unwilling to say what it would take to approve the deal.

With that, we walked to the elevators. To reach the conference room, we had to wade through all the Wall Street executives milling around the first floor. It was like pushing through a crowd at a stadium. Everyone, it seemed, wanted to speak to us. They were working hard and were eager for an update, and I felt as though they were all scanning my face or Tim’s to guess the verdict. I wish I could have been buoyed by their energy and effort, but I felt numb. The news I was about to deliver could only hurt them. Some of the crowd tried to follow us into the conference room, but we shut the door on them, limiting the meeting to the CEOs.

It was shortly before 1:00 p.m. when Tim, Chris, and I addressed the CEOs again. I was completely candid. Barclays had dropped out, and we had no buyer for Lehman. We were going to have to make the best of it.

“The British screwed us,” I blurted out, more in frustration than anger.

I’m sure the FSA had very good reasons of their own for their stance, and it would have been more proper and responsible for me to have said we had been surprised and disappointed to learn of the U.K. regulator’s decision, but I was caught up in the emotion of the moment.

“We’re going to have to all work together to manage this,” I went on. “We’ve got no buyer, and there’s nothing to do about it.”

Having been forewarned of this possibility at the morning’s meeting, nobody seemed shocked by the bad news. They may even have felt momentary relief not to have to commit billions to an iffy rescue. But as the reality sunk in they became somber. And then they quickly began to come together, focusing on a single question:
How are we going to prepare for the markets’ opening on Monday?

Chris Cox talked a little about the process going forward. He said the SEC had been working for a long time on detailed plans for handling a Lehman bankruptcy.

As I made my way from the conference room, a number of executives rushed up to me for news. A contingent from Lehman crowded close to the doorway. Rodge Cohen, who was advising Lehman, approached me, accompanied by Bart McDade.

“Hank, what’s happening?” he asked.

I gave them the bad news. “We had the banks ready to do the deal, but the British wouldn’t approve it.”

Rodge grabbed hold of me and said, “Hank, this is terrible.”

I remember how he and McDade implored us to try something else. I could see the devastation in their faces as they took in the cold, stark reality: this was the end. They had scrambled all weekend, and I felt terrible for them, and particularly for McDade, a stand-up guy who had been thrust into an impossible job at the last possible minute.

Back in my temporary office on the 13th floor, a jolt of fear suddenly overcame me as I thought for a moment of what lay ahead of us. Lehman was as good as dead, and AIG’s problems were spiraling out of control. With the U.S. sinking deeper into recession, the failure of a large financial institution would reverberate throughout the country—and far beyond our shores. I could see credit tightening, strapped companies slashing jobs, foreclosures rising ever faster: millions of Americans would lose their livelihoods and their homes. It would take years for us to dig ourselves out from under such a disaster.

All weekend I’d been wearing my crisis armor, but now I felt my guard slipping as I gave in to anxiety. I knew I had to call my wife, but I didn’t want to do it from the landline in my office because other people were there. So I walked around the corner to a spot near some windows on the other side of the elevators and phoned Wendy, who had just returned from church. I told her about Lehman’s unavoidable bankruptcy and the looming problems with AIG.

“What if the system collapses?” I asked her. “Everybody is looking to me, and I don’t have the answer. I am really scared.”

“You needn’t be afraid,” Wendy said. “Your job is to reflect God, infinite Mind, and you can rely on Him.”

I asked her to pray for me, and for the country, and to help me cope with this sudden onslaught of fear. She immediately quoted from the Second Book of Timothy, verse 1:7—“For God hath not given us the spirit of fear, but of power, and of love, and of a sound mind.”

The verse was a favorite of both of ours. I found it comforting and felt my strength come back with this reassurance. With great gratitude, I was able to return to the business at hand. I called Josh Bolten and New York City mayor Michael Bloomberg to alert them that Lehman would file for bankruptcy that evening.

We had tried during the summer and more intensely in the last few days to be ready for this moment. Beginning right after I had informed the CEOs that Barclays was done, the Wall Street firms, under the guidance of Tim and the New York Fed, got down to work. Among other things, they divided the industry into teams to try to minimize the disruptions that were likely to occur the next day.

A group on the 13th floor worked through other issues. The Fed had decided it could and would lend directly to the Lehman broker-dealer arm to enable it to unwind its repo positions. (Over the next few days, it would lend as much as $60 billion for this purpose.) Separately, the International Swaps and Derivatives Association had agreed to sanction an extraordinary derivatives trading session. It began at 2:00 p.m., and though originally scheduled to run until 4:00 p.m., it would be extended another two hours. The aim was for the firms to unwind as much as they could, and to offset their exposure to Lehman, before the firm declared bankruptcy and threw the market into disarray.

With a company like Lehman that had operations across the globe, bankruptcy raised enormously complex issues. Which entities would file for bankruptcy, and which would not? Would the European and U.K. entities file before the New York holding company? The Federal Reserve and the SEC had to work these details out with Lehman in order to orchestrate the proper sequence of filings. Lehman’s broker-dealer had to be open for business on Monday for the Fed to be able to backstop the unwinding of Lehman’s giant repo book.

One of the biggest issues was that the firm did not appear to have taken seriously the possibility of having to file for bankruptcy until the last minute. A Lehman team, accompanied by their counsel Harvey Miller of Weil, Gotshal & Manges, would not arrive at the New York Fed to discuss bankruptcy options until early Sunday evening, and even then Lehman appeared to have no immediate intention of filing.

In the midst of all this, President Bush called me at about 3:30 p.m.

“Will we be able to explain why Lehman is different from Bear Stearns?” he asked.

“Yes, sir,” I replied. “There was just no way to save Lehman. We couldn’t find a buyer even with the other private firms’ help. We will just have to try to manage this.”

I had to add that Merrill, now in talks with BofA, was the next-weakest investment bank, and that AIG had a severe liquidity problem. I also told the president that in my opinion we might need to go to Congress to get expanded powers to deal with the crisis. The problems we had to contend with were coming at us fast and all at once. The case-by-case approach we had been using since Bear Stearns was no longer enough. President Bush—reassuring, as always—told me we would figure out how to work through the crisis. We agreed to meet the next day after I returned to Washington.

Even as we struggled with Lehman, AIG rushed to center stage. That afternoon, Chris Flowers called Dan Jester to say he’d made a proposal to AIG to acquire some of the company’s most valuable subsidiaries. It sounded to me like Flowers was trying to take the company for next to nothing. At the same time, other private-equity firms were doing due diligence on various parts of AIG’s operations. But Bob Willumstad had his own proposal for us.

A little before 5:00 p.m., Willumstad returned to the New York Fed with his advisers, and we again met in the conference room on the 13th floor. Willumstad delivered terrible news: The only proposal he had been able to generate from private-equity investors came from Flowers, and his board had rejected it as inadequate. Further, AIG had discovered another major problem: huge losses in its securities lending program. AIG had been lending out its high-grade bonds and receiving cash in return. It reinvested the cash in mortgage-backed securities, hoping to earn some extra income. As counterparties sought to unwind the deals to avoid exposure to AIG, the insurer faced the prospect of having to sell the illiquid mortgage-backed securities at big losses. It was clear that AIG’s cash crunch would likely occur sometime within the week—sooner than we had been told Saturday morning.

But Willumstad had a new plan, in which the Fed would provide a $40 billion bridge loan, in addition to the $10 billion AIG would generate from unencumbered securities. The company would sell some of its insurance company subsidiaries and use the proceeds to pay back the loan.

It was unnerving. Tim and I knew that an AIG bankruptcy would be devastating, leading to the failure of many other institutions. In one day the company’s shortfall had mushroomed to $50 billion. Tim said that the Fed was not prepared to lend to AIG and that the company should get a consortium of private lenders to make a bridge loan.

I joined Tim and Fed governor Kevin Warsh on a call with Ben, Fed vice chairman Don Kohn, and the rest of Ben’s team in Washington. We reviewed the day’s dreadful events. We were doing all we could, in Tim’s phrase, to spread foam on the runway to cushion the coming crash of Lehman.

Among these measures, the Fed had expanded the range of collateral that brokers could pledge to receive loans via the Primary Dealer Credit Facility (PDCF) to include anything accepted in the triparty repo system—such as stocks and non-investment-grade bonds. The big worry was that in the wake of a Lehman failure repo lenders would shy away from investment banks and other financial firms heavily dependent on that kind of financing. By expanding the PDCF’s eligible collateral, the Fed aimed to reassure repo lenders that if any investment bank counterparty ran into problems, it could get cash from the Fed for any collateral and use that to repay the triparty repo lender.

Separately, with encouragement from Tim and me, ten of the Wall Street firms had come together to create a $70 billion facility of their own that would provide emergency liquidity support for any of the participating banks that needed it.

After all these measures, though, we had run out of gas. None of us had any confidence that they would be sufficient. Some in the group asked if we should revisit the idea of putting public money into Lehman, but Tim said there was no authority to do that.

We were all frustrated to have worked so hard and come up empty. We knew that the consequences of the Lehman failure would be awful, but even so, we did not know what would face us in the morning—or in the days to come. I had a sense that the situation had gone beyond our ability to handle it on our own. I told Ben and Tim and the others on the call that the time had probably come to go to Congress for fiscal authorities to deal with the unfolding crisis. We had all wanted this for some time.

After the Fed call, I heard the only good news of the weekend: Bank of America was going to buy Merrill Lynch for $50 billion. Thain had managed to arrange a sale at $29 per share, a 70 percent premium over Merrill’s market price. I was relieved: without this, I knew, Merrill would not have lasted the week.

We had planned to announce Lehman’s bankruptcy at 4:00 p.m., four hours before Japan’s markets opened, to allow as much time as possible for market participants to prepare themselves. The SEC was supposed to take the lead on this, but all afternoon I got reports from the Fed that the commission was moving slowly. Chris Cox had been in his office for hours working on a press release to assure Lehman’s broker-dealer customers that they would be protected under SEC regulations. He was also supposed to discuss Lehman’s planned course of action with the company’s board of directors, but he had yet to do so.

Pressed by Tim and others, I finally walked into Chris’s office around 7:15 p.m. and urged him to move quickly to execute the SEC’s plan. “The Asia markets are opening!” I said. “You need to get your announcement out soon, and you can’t do that unless you are coordinating with Lehman. It is essential that you call the company now.”

Chris was waiting for Lehman to file for bankruptcy of its own volition. I understood that it was unusual and awkward for a regulator to push a private-sector firm to declare bankruptcy, but I stressed that he needed to do something to get the process moving for the good of the rest of the system. And although Chris wanted Tim and me to join him on the call, I said that as Lehman’s regulator, he should make the call by himself.

Finally, sharing the line with Tom Baxter, the general counsel of the New York Fed, and other Fed and SEC staffers, Cox called Fuld shortly after 8:00 p.m. to reiterate that there would be no government rescue. Lehman had no alternative to bankruptcy. Fuld connected Cox to Lehman’s board.

“I can’t tell you what to do,” Cox told them. “I can only tell you to make a quick decision.”

As it was, Lehman did not file for bankruptcy until 1:45 a.m. Monday, well after the Asian markets had opened.

While Tim and I waited together for Chris to complete the call with Lehman, I phoned Michele Davis and told her that despite the good news on Merrill Lynch, I was expecting a tough week. As difficult as it was going to be to get fiscal authorities from Congress, we didn’t have much choice, and it was going to take an all-out effort on the Hill. I told her I had alerted the president.

Kevin Fromer had been dealing with the legislative staffs, but I needed to brief the major congressional players and called Chuck Schumer, Barney Frank, Chris Dodd, and Spencer Bachus. “How are all of these free-market people going to feel about letting the markets work?” Barney asked me pointedly. But he clearly understood the ugly ramifications of these developments. He added that he was disappointed not to have heard from me earlier.