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Authors: Vicky Ward

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Perhaps, but these were also a way of dying.

Erin Callan later told
Fortune
that in the minds of Fuld and Gregory the gamble was nothing more than a rerun of the Russian crisis; they thought they were playing high-stakes poker. In her words, “The commercial real estate portfolio really was the albatross of the firm.”

Late in the summer of 2007, just as investors were beginning to panic, realizing that the subprime mortgage meltdown might have much broader consequences, Gregory decided to make more personnel changes. At this, Madeleine Antoncic, the head of risk, who was already heading out the door (sources say she had been demoted to a seat in charge of government relations), threw up her hands. She says she couldn’t believe the stupidity of what she was seeing—and she had seen a lot. She left.

Gregory went ahead with his plans, which were implemented a few months later.
CFO
Chris O’Meara was demoted to chief risk officer (replacing Antoncic)—and the new
CFO
was Erin Callan.

Skip McGee—who, as Callan’s boss, had to make the announcement—deliberately moved it to the bottom of his agenda during a managing directors meeting in London, because he dreaded the incredulous reaction he knew it would elicit. Callan had zero accounting background, even though Lehman was about to head into the worst financial crisis in decades.

“When Skip McGee announced that she had become
CFO
and that she would join the executive committee, it was as close to sort of open rebellion [as] I’ve seen at the firm,” says one attendee.

“Some people who’d worked for her for a long time were basically shouting, and it was just pandemonium,” remembered a former member of the executive committee. “A detached view is that she had worked for some of the guys in the room, and if somebody gets promoted one or two steps ahead of you, you ‘re not going to be too happy, almost regardless of the circumstances. So I guess you have to discount some of it. But basically, people thought that she was a bad person.” Or maybe not bad, but a political person who dealt with male colleagues in an inappropriate way and was not qualified.

“She had zero clue about accounting . . . and she had never run a team bigger than 50 people. So the combination of no external experience, no finance background, no management background, and this, the most difficult market ever, doesn’t exactly strike you as the most qualified individual to get that job,” one colleague said. It was a cry that echoed around the firm.

Some members of the executive committee complained to Fuld. Ros L’Esperance, arguably the second most senior woman in the investment banking division, told Fuld point blank that Callan did not have the right skill set to be the
CFO
, and that this was the worst possible time to experiment. They were courting disaster. Her arguments fell on deaf ears.

Gregory was thrilled—he had put a woman on the executive committee. To celebrate, a dinner was given in Callan’s honor at La Grenouille, something that hadn’t been done for anyone else promoted to the big table.

Callan was given three months to get up to speed, which meant that Chris O’Meara put out the earnings call in November 2007 announcing yet another record year, with revenues reaching $19.3 billion, along with the boast that the firm had “maintained a conservative funding framework to mitigate risk.”

The company’s liquidity pool had grown by $7 billion in the last year. All divisions had record revenues. Marquee transactions had included work on the Blackstone
IPO
, the Fortress
IPO
, Man Financial
IPO
, Citi, and Ochs Ziff. Banking got its first significant advisory assignment for General Electric, which was for the sale of GE Plastics. Standard & Poor’s rated Lehman at A+, while Moody’s had it at A1 and praised the “scale and breadth of the franchise.”

The other big banks were mystified. How could they all be suffering while Lehman was doing so well?

Lehman held a dinner for its alumni in 2007, at the suggestion of Scott Freidheim, who had taken it upon himself to copy Goldman Sachs and McKinsey—both companies found that an alumni network was a useful ecosystem of relationships that often spawned new business.

Fuld was a gracious host all evening. He was thrilled to greet successful men such as Steve Schwarzman, Peter Solomon, and Peter Cohen, who all came to toast Fuld and the extraordinary story of a phoenix rising from the ashes—in this case, literally, after 9/11.

A cocktail reception was also held for the so-called A-minus list in the pool room of the Four Seasons restaurant. Fuld spoke to a packed crowd.

Not everyone was blinded by the bonhomie. Steve Carlson, the former head of emerging markets, who was now the chairman of Provident Group, had a question for Steve Lessing: “Stevie, aren’t you worried about the real estate?”

Lessing, careful not to ruin the spirit of the night, raised his glass in toast, and said, “Oh, don’t worry—we’re hedged.”

Chapter 16
The Talking Head

I guess you could argue that Erin Callan was an interesting idea—and at a different moment in time might have been a brilliant choice. But it was the worst moment to put a rookie in the seat—very unfair to her.

—Peter A. Cohen

I
n the middle of a bank run, perception is reality. In the early spring of 2008, Bear Stearns was perceived to be the Wall Street firm most vulnerable in the mortgage crisis—and as soon as one big client began asking questions about its solvency, it was fighting for its life. Erin Callan, a new species of
CFO
(Conspicuous and Female) was perceived to be one of Lehman’s biggest assets, and was, to some, a welcome change from the old way of doing business.

She was tall, five feet eight inches, blonde, and had dimples. She was confident and voluble. She looked and sounded like a straight talker. Meanwhile, Bear Stearns
CEO
Jimmy Cayne’s marijuana habit had been news since the
Wall Street Journal
first reported it in November—the sort of gossip that corroded the image of the firm as it slouched toward the abyss.

Bear Stearns’s stock lost more than half its value the week of March 10, closing at $30 on Friday, March 14, after JPMorgan agreed to facilitate a Federal Reserve maneuver to keep Bear afloat while they could look at the implications of its demise.

That weekend JPMorgan
CEO
Jamie Dimon and about 150 of his employees descended upon Bear to begin scouring the books, and by Sunday, March 16, he had determined that about $30 billion of the firm’s securities were too risky to take on without government help. Much to the horror of the Bear board, the Federal Reserve agreed to guarantee the loans—as long as Dimon offered shareholders more than the initial offer of $2 a share. (The offer would be raised to $10, but not before the $2 figure sent panic through the market.)

On Monday, March 17, Bear Stearns died—and Lehman looked like it might follow the firm into the grave. Fuld had rushed home from a business trip in India the weekend that the deal was hammered out under the direction of Treasury Secretary Henry “Hank” Paulson, who knew that Lehman’s exposure to the distressed real estate market was similar to Bear’s. He had also seen Lehman narrowly escape ruin in both the 1995 Mexican peso crisis and the double whammy of the Russian crisis and the implosion of Long-Term Capital Management in 1998, so he was worried. He wondered, he said later, whether Fuld was “like a cat with nine lives.”

The near-overnight collapse of Bear was stunning. Until that fateful week in March, few but the most sophisticated investors appreciated the magnitude of the risk inherent in the prevailing Wall Street business model.

“No one expected an institution that was 85 years old and had relied on wholesale funding . . . could just vanish because of a run on the bank,” said a senior Fed official. “Everyone was doing business with them—until they weren’t.”

If Fuld had any doubt as to which firm the market believed would be the next to fall, it was erased when the market opened at 9:30 A.M. Lehman stock plummeted 48 percent in the first hour of trading.

That same Monday, the April issue of
Conde Nast Portfolio
, an issue devoted to “Sexism in the Workplace,” went on sale with a profile of Callan (aka “The Most Powerful Woman on Wall Street”).

Accompanied by a two-page photograph of her stepping out of a gleaming black limousine in a short dress and high heels, the article seemed wildly inappropriate. “I don’t subordinate my feminine side,” she told writer Sheelah Kolhatkar. “I have no problem talking about my shopper or my outfit.” Even during booming markets, this might have seemed strange, but given Lehman’s situation, the article and photograph were incongruous, bordering on the suicidal. It was no time for flattering and flirting. Lehman was fighting for its life.

The next day, however, Tuesday, Callan lived up to the hype during the firm’s scheduled conference call to announce first -quarter earnings. She exuded confidence, competence, and, seemingly, candor. When the call was over, the bearish banking analyst Meredith Whitney complimented her performance--and Callan got a standing ovation from the trading floor. The investment bank’s net income had fallen by more than half from the year earlier, but times were tough, and Lehman had still booked nearly a half-billion dollars in profits. After closing Monday at $31.75, Lehman shares roared back to $46.50 per share on Tuesday. Gregory led the executive committee in a round of applause for Callan at its next meeting. Like the dinner at La Grenouille, this was unprecedented. But Callan was a hero. She had overnight become the public face of Lehman Brothers.

Still, some were puzzled. Those earnings just didn’t make sense. What about Lehman’s huge exposure in real estate and mortgages?

Chief among the skeptics was Hank Paulson. The Treasury secretary was aware of Gregory’s toxic influence at the firm, in part because he had talked to Lehman’s former fixed income chief, Mike Gelband, who had come to interview at the Treasury after leaving Lehman. The Treasury team didn’t have a job for him, but they were impressed.

They were vaguely aware that Fuld was cut off from people at the firm who had the intellectual firepower to handle this crisis, says a member of the Treasury team. So, while Gregory assured his old buddy, Fuld, that the firm would pull through, just as they had done before, the Treasury secretary was trying to send a different signal. “Hank was consistent in emphasizing to Dick, ‘ You’ve got to have a plan B and C. Hope isn’t a strategy,’ ” says Paulson’s then deputy, Bob Steel.

When Paulson called later that week to encourage Fuld to consider raising capital, he was gratified to learn that Lehman was already working on it, and by April 1 the bank had raised $4 billion in convertible preferred shares. On April 12, at a G7 dinner in Washington, D.C., Paulson took Fuld aside. “I congratulated him on his capital raise,” Paulson says. “I encouraged him to do more.” Paulson was trying to use positive reinforcement to get Fuld to be even more cautious and even consider selling the firm, but that’s not what Fuld heard. Later that night, he e-mailed Tom Russo the following memo:

Just finished the Paulson dinner.

A few takeaways//

1. we have huge brand with treasury

2. loved our capital raise

3. really appreciate u +Rieders work on ideas

4. they want to kill the bad HFnds + heavily regulate the rest

5. they want all the G7 countries to embrace

Mtm stnds

Cap stnds

Lev + liquidty stnds

6-HP has a worried ed view of ML [Merrill Lynch]

All in all worthwhile.

Dick

No doubt emboldened by her home-run earnings call, Callan began appearing more often on television—particularly on the business channel CNBC—to brag about Lehman’s huge brand and its many successes. There was a personal benefit to this as well: She told colleagues that a former high school friend, now a fireman, had contacted her after seeing her on the network, and they were dating.

On April 1, as Fuld dealt with Paulson, Callan was talking to longtime
CNBC
anchor Maria Bartiromo about the capital raise. She hedged expectations (“pretty solid results, [but] not on an absolute basis”) and kept with her line about transparency: “We’ re happy to open the kimono and let everyone see the story.” It was another articulate, confident performance.

“As you know, Maria, we’ re in a market where perception trumps reality,” she said.

That would not be the case for much longer, thanks to the 40-year-old hedge fund manager David Einhorn.

Einhorn hadn’t applauded when he’d heard Callan’s earnings announcement. He increasingly suspected the firm had been resorting to accounting fraud to juice its earnings, and he said as much in various investor conferences. He even said he believed that the Securities and Exchange Commission (
SEC
) was letting it slide to avert a bigger crisis. (Einhorn had been badly burned by the foreclosure crisis as a major shareholder and director of the subprime mortgage behemoth New Century Financial, which had gone bankrupt almost overnight in 2007.)

Einhorn figured the only way Lehman could be reporting profits was if it was vastly—and illegally—overvaluing those assets. And he had some convincing evidence: a $1.1 billion discrepancy between the results posted in Callan’s March earnings call—in which she said the bank had written down the value of its Level 3 assets to the tune of $875 million—and those in the quarterly report filed with the
SEC
a few weeks later, which claimed the bank’s Level 3 assets had actually risen in value.

He asked Callan to call him—via e-mail. And, against the advice of the executive committee, who felt Einhorn was best ignored, she did. On the call, Einhorn challenged Callan to explain how the firm had come to write up its assets during a period when everything, from equities to fixed income to real estate and private equity, had lost value.

BOOK: The Devil's Casino
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