A Colossal Failure Of Common Sense Part 12

In the teeth of what was now open criticism about the firm's policies, d.i.c.k and Joe began a long, out-of-step march to nowhere. Their determination to buy hedge funds was becoming voracious. By now, they also bought into Europe's largest hedge fund, GLG Partners (London), and another UK-based operation, Marble Bar a.s.set Management. Right after the conference call, they bought a 20 percent stake in D. E. Shaw, the global investment and technology development firm. Back in London, they purchased 20 percent of the $5 billion hedge fund Spinnaker Capital, specialists in emerging markets. Fuld, with the help of Dave Goldfarb, also took a stake in Blue Bay a.s.set Management, another huge European fund. And, being thoroughly global men, and indeed men to whom the world is an exceptionally small place, they pounced to acquire Grange Securities, one of the largest sellers of, of all things, CDOs in Australia.

Likewise Lehman had previously purchased a 20 percent share in a major U.S. commodity hedge fund, Ospraie, which managed about $2 billion of a.s.sets. Unlike the astute Warren Buffett, who despised investing in hedge funds, "Decouple Dave" Goldfarb and d.i.c.k Fuld couldn't get enough of them.

Lehman bought, needless to say, with borrowed money, at the top of the market. These were purchases thoroughly deplored by Larry McCarthy and totally disapproved of by both Mike Gelband and Alex Kirk. The foreign purchases were inspired by the avowed belief of Fuld, Gregory, and Goldfarb that globalization meant decoupling from the U.S. market because it was no longer all-powerful, that China and the emerging Asian economies had stripped the crown from America and rendered all men and markets equal. If the United States continued to falter, then there were smaller but stronger markets bursting out of the East that would make up the slack.

Decoupling. The wave of the future. The globalization of world commerce, the only answer for brilliant investment bankers, as the U.S. of A. finally took a backseat on the world trading stage. Sounded good. Sounded incontrovertibly modern and fa.r.s.eeing. In fact, it was absolute garbage, meaningless, untrue, unadulterated c.r.a.p. That's my capital C C. Because without Uncle Sam, the rest is inclined to be second-rate. When the United States stops buying, the whole shebang bites the dust. But it would be many months before the rest of the world's market makers understood that and stampeded back into U.S. dollars.

Another tactic that met with almost universal disapproval was Fuld and Gregory's latest act of pure bravado in buying back Lehman's stock at $75 a share, to counteract rumors of growing problems on the balance sheet. It was a primitive form of reply, but Fuld was never a subtle man, and like his old mentor Glucksman he reacted to adversity with teeth-baring aggression, once threatening to ram his fist down a critic's throat and rip out his heart. Which stood up interestingly against Glucksman's fabled action of publicly ripping his own shirt off his back in uncontrollable fury.

Under fire, Fuld's instinct was to hit back instantly rather than bide his time. Stung by the rumors of trouble in his kingdom, he decided to charge into the market and start buying Lehman stock, which he must have suspected was already wildly overpriced. With our potential debt, how could it possibly be anything else? And so, with the ever-faithful Joe standing with him, shoulder-to-shoulder, d.i.c.k pounded the market and spent a staggering $1.6 billion of the firm's money on purchasing Lehman shares for the bonus pool as well as for investment purposes.

Mike Gelband actually considered that the boss had almost certainly lost it. For it was beyond the comprehension of that most brilliant risk-taker and trader that anyone could be that out of touch with reality. "Buying it?" yelled Mike at one point. "He should be f.u.c.king selling it, to raise capital."

But Fuld and Gregory were men of the twentieth century, not the twenty-first. They thought they were still in the 1980s and that they could play a high-stakes game of poker, never showing weakness, keeping their cards close to their chest, employing intimidating tactics, Texas Hold'em, with a mighty pile of chips. Used to work. Not anymore. Modern markets are much more sophisticated. There is an army of eagle-eyed hedge funds on the lookout for misplaced hubris and out-of-touch management, especially when there's crushing debt.

They thought they could bluff it out, and they flatly refused to slow down the mortgage origination platform, and to reduce our most vulnerable positions. In answer to the most recent troubles, we had a CEO and a president, both full of bravado, swearing that our latest setbacks were just blips on the horizon of the big picture. And the only way to silence our detractors was confidently to repurchase our own stock in ma.s.sive quant.i.ties, never mind the price. That'll show 'em, right?

You did perhaps notice, four paragraphs back, I mentioned the word kingdom kingdom. I did not do so lightly, and I am mindful that this nation first fought a b.l.o.o.d.y war against its masters and was then refounded on the absolute principle that it must forever be rid of England, with its monarchs, hereditary princes, dukes, peers, and all the other paraphernalia of a kingdom. There are very few Americans who would today wish for a reversal of those principles and a return to the old ways of the United Kingdom, where inherent privilege still, to an extent, prevails. I do not think Richard S. Fuld Jr. or Crown Prince Joe would have been among that vast majority right here in the United States, because they turned Lehman Brothers into nothing short of a straight-down-the-line kingdom. King Richard ruled from a palatial paneled office with his own personal conference room and private bathroom.

Henry VIII, George III, William the Conqueror, Ethelred the Unready, and the rest would have been right at home up on our thirty-first floor. If someone could have constructed a decent moat and portcullis around 50th Street and Seventh Avenue, they'd probably have sent for their crowns and ermine and never gone home. Because Richard Fuld had taken several leaves out of the royal playbook, ruling the place with absolute authority, unchallenged, unenc.u.mbered by advice, and mostly unbowed. Whatever he wanted, decreed, or demanded was the way things worked. There was a tiny group of courtiers who were allowed to speak, but they understood it was best to go heavy on respect and decorum, or they could easily be on borrowed time at the Tower of Lehman.

In addition to Joe Gregory and the ex-CFO Dave Goldfarb, both yes-men, there was another character, bowing and sc.r.a.ping to the whim of the king. He was Steven Berkenfeld, the forty-five-year-old chairman of the Investment Banking Commitments Committee, the eight-person panel whose responsibility was to approve or disapprove giant corporate loans. It did no such thing. It said yes when d.i.c.k Fuld wanted it to say yes, and no when he wanted it to say no. They were big on respect, short on incurring the displeasure of the king.

King Richard had even turned Lehman's board of directors into a kind of largely irrelevant lower chamber. This was yet another group to rubber-stamp his decisions and collect generous fees. It was not for supplying well-meant and lucid wisdom in the current wild marketplace, but for agreeing with the monarch, accepting his all-knowing take on the bank's investments. Above all, the board was created not to rock the royal barge as it made its stately way downstream.

In the United States, the t.i.tles of king, prince, emperor, czar, duke, lord, and viscount have been banished for more than 230 years, since the Revolution. Thus the boss settled for "chairman" as his underlings' required form of address to him.

The Lehman Board contained no Prince Hal, the swashbuckling young future Henry V preparing to lead his troops to victory at Agincourt. Nor did it contain a wise and scheming old operator like Pete Peterson, who walked with kings from other realms and nurtured different skills. d.i.c.k Fuld's court contained not one director who could safely claim to be an old Lehman hand, wise in the ruthless ways of the market. In fact, only months before the Lehman directors had accepted the resignation of the veteran actress Dina Merrill, who at the age of eighty-three was an eighteen-year director not widely consulted about the modern, savage upward and downward swerves of the Stock Exchange. Merrill had, however, played a mean Sylvia Blair in the 1950s production of Desk Set Desk Set, with Katharine Hepburn and Spencer Tracy.

Nine members of the ten-person board were retired. Four of them were seventy-five years of age or older. One was a theater producer, seventy-five-year-old Roger Berlind; one was a former CEO of the energy giant Halliburton, Thomas Cruikshank, seventy-seven; one was the chief economist at Salomon Brothers in the 1970s and '80s, eighty-one-year-old Henry Kaufman. The last of this septuagenarian-plus quartet was the former senior partner at McKinsey and Co., John Macomber, age eighty.

In addition, there was Marsha Johnson Evans, a former Navy admiral and head of the American Red Cross; Sir Christopher Gent, a former CEO of England's cell phone empire, Vodafone; Roland Hernandez, the former chairman and CEO of the Spanish-language television company Telemundo Group; Michael Ainslie, former president of the auction house Sotheby's; and John Akers, the retired chairman of the board and CEO of IBM.

Only two of them had direct experience in the financial services industry-and they were all from a different era. None of them was tuned in to the ma.s.sive securitization of the modern economy, the minefield of credit default swaps, derivatives trading, and all the risks those products created. On that board, there was no stern voice of censure, of warning, of old-fashioned logic. There were only the deep melancholy tones of Henry Kaufman, known locally as "Dr. Doom," who believed the world was on the verge of global calamity and that the Fed was remiss in its idle oversight of commercial banking. Old Henry was on the right track, but the fire in his belly was dimmed, and the chairman had little trouble silencing him.

From this disparate group of old stagers, Lehman created a risk committee, chosen and controlled by Fuld himself. It met only a couple of times a year, which was an unusual way to monitor the company's ongoing risk, as it continued to acc.u.mulate a ma.s.sive portfolio of real estate a.s.sets. And right here we stumble upon the one man in the organization who might well have acceded to the t.i.tle of prince.

This was the somewhat aloof, slightly disdainful former lawyer Mark Walsh, the forty-six-year-old head of Lehman Brothers commercial real estate investments. He was a prince among the worker bees, the blue-eyed boy of the thirty-first floor, the favorite of Fuld, with an expandable departmental budget that would have made the eyes of the Sun King water. For not even Louis XIV, that most profligate of spendthrift French monarchs, builder of the Palace of Versailles, had access to cash on that scale.

Mark Walsh had been at Lehman for twenty years. After seventeen of them, he had taken complete charge of the firm's global real estate group. Right now he held the keys to the kingdom, with astounding personal authority to commit capital any way he saw fit. Mark was by nature a risk taker. Fuld liked that a lot, and he loved the way his young real estate Turk went for high-risk, high-return bridge debt and equity financing for large acquisitions. He also liked the fact that Mark was a proven moneymaker over the years at Lehman.

Before long every other branch of Lehman's commercial real estate business was answering to Mark Walsh. He shared responsibilities with no one, and was building a Lehman portfolio of billions and billions of dollars' worth of buildings, mostly huge. At this time estimates were that Lehman had $30 billion worth of commercial-mortgage-backed securities exposure, more than triple that of Morgan Stanley, which had a much bigger balance sheet. Go get 'em, Prince Mark.

I hope he'll forgive that final burst of informality, because, like Fuld, this studious-looking character was utterly distant from the rest of us. Neither Christine Daley, Larry McCarthy nor I had ever met him. He was just this shadowy junior G.o.d who spent money like a drunken sailor and could do no wrong in the eyes of the king. Some thought all it represented was too much power, too much autonomy, in too few hands.

But Mark Walsh's popularity with the great powers was boundless. d.i.c.k and Joe even presented him with his own domain, a kind of corporate fiefdom at 399 Park Avenue, one of the greatest high-rise buildings in Manhattan, occupying the entire block between Lexington and Park Avenues and East 53rd and East 54th Streets. The world HQ of Lehman Brothers Real Estate Partners was bang in the middle of the gla.s.s skysc.r.a.per that housed the main offices of Citigroup and a host of other blue-chip companies. Nothing was too good for Mark. h.e.l.l, the annual rent paid for the Property Prince's 436,000 square feet of office s.p.a.ce was $43 million! That was more than it cost the Sun King to build Versailles.

And these were turbulent times. Despite the continuing deluge of available cash, another little zinger of a scare came winging in on Friday evening, March 2. The NYSE-quoted company Fremont General, a mortgage industry leader out of Santa Monica, California, suddenly announced it was getting out completely from subprime mortgage lending, citing mounting pressure from loan repurchases and likely regulatory action. That rather bland statement plainly obscured an absolute uproar out there in the golden West, because the FDIC was in there, in some kind of towering rage, slapping a cease-and-desist order on Fremont. They cited loans made to subprime borrowers who couldn't pay them back. And they demanded sweeping changes to Fremont's residential and commercial mortgage business, alleging the company had violated Section 23B of the Federal Reserve Act by engaging in shady transactions with its own affiliates.

When the cage of the FDIC gets that seriously rattled, it's usually accompanied by a SWAT team screaming into the offending corporation, brandishing chains, padlocks, bolts, and bars. Wall Street was buzzing with tales suggesting that this had indeed happened, and that half the executive committee had been on the golf course when the feds came marching in. In any event, workers were warned of layoffs, and Fremont set about trying to sell their entire mortgage operation, confirming simultaneously that it would delay its latest earnings report.

There had been a total of about two dozen mortgage lenders either closing or selling out their businesses in the past year, and Fremont's very obvious problems sent a lightning bolt through all the investment banks, especially Lehman, which was sailing very close to the same cold, gusting breezes that capsized the Santa Monica flagship. Fremont's demise was very good news for Rich Gatward and me, as we had a large short position on it. We pocketed over $5 million profit for the firm that next Monday as the news of Fremont's tough day on the course crushed its stock by 20 percent.

The latest casualty, in a sense, drove d.i.c.k and Joe ever closer to the Lehman commercial real estate business, which they both thought represented a vital hedge against the forthcoming collapse of the residential market. And there, at the head of this crusading cavalry of hope and glory, rode the white knight himself, Prince Mark, fresh from a sensational 2006, with his sword arm ready to cut a mighty swath through any challenge that presented itself.

But it was not just Fremont that was driving our thirty-first-floor monarch toward commercial real estate. It was also the trumpeted success of the Wall Street private equity firm the Blackstone Group, managers of the world's largest buyout fund. Blackstone in 2006 agreed to terms to purchase billionaire landlord Sam Zell's Equity Office Properties Trust for about $39 billion, the biggest takeover of a real estate company in the history of the world: office buildings in New York, Washington, and Los Angeles, 580 of them. It was their eleventh publicly traded real estate takeover in the past two years. And it made Blackstone owners of the premier office portfolio in the country, ahead of the crowd, especially Lehman.

d.i.c.k Fuld's dark eyes glowed with envy, because Blackstone was owned and run by two old Lehman men: Pete Peterson and Stephen Schwarzman. Peterson, his former boss and effortless superior, the co-CEO who had been so brutally fired by d.i.c.k's old mentor, Lew Glucksman, who had, in turn, groomed the young Richard Fuld to eventually replace him. Schwarzman, another elegant and richly talented banker, a man who had gazed with mere amus.e.m.e.nt at the pushing and elbowing of Glucksman and his ambitious disciple Fuld.

Blackstone's two vastly experienced sophisticates now operated a leveraged-buyout business that had opened up a brand-new era in American finance. There were probably no other men in all of New York whom Richard S. Fuld Jr. would rather see fail. And now they were on the rise, making money and headlines faster than he was, and announcing the launch of an IPO. Jesus Christ! They were going public and probably going to collect a billion dollars each. d.i.c.k Fuld would have walked barefoot through broken gla.s.s to prevent it.

But he and Joe could not prevent it. They could only try to match it. And they summoned Prince Mark and told him to saddle up his white battle charger and go to it-storm the boardrooms, lay siege to the world's most grandiose commercial real estate, and the h.e.l.l with the expense. And the risk.

Mark gathered his troops and began a search for the finest real estate deals on earth. They would all cost a lot of money, but he had a lot of money-at least his master, Fuld, appeared to be able to lay hands on a lot of money, even if it was borrowed. There was nothing too big for Mark, because he had the unreserved backing of the king of Lehman and the support of Prince Joe.

And there was nothing too big for them. Mark had already been permitted to spend billions upon billions on European real estate, and even while he was a.s.sembling his forces, Lehman was right in the thick of two ma.s.sive deals that involved almost $50 billion-both leveraged buyouts, together involving more than four times the entire net tangible equity value of the investment bank on Seventh Avenue.

The first was a major investment in the biggest buyout ever, the $45 billion takeover of the Texas energy colossus TXU Corporation. Our old friends Kohlberg Kravis Roberts, which for so long had held the world buyout record, $25 billion for the tobacco and snack company RJR Nabisco, now teamed with the Texas Pacific Group to make the purchase.

The smaller Lehman partnered with giants Goldman Sachs, Citigroup, and Morgan Stanley to partake in this ma.s.sive undertaking to take TXU private, just as the energy company began a program to build no fewer than eleven coal-fired electric power plants in Texas, to the outright fury of the green lobby. It was never made public whether Fuld was swayed in his judgment by the fact that Henry R. Kravis was about to upstage his longtime rivals, Peterson and Schwarzman, as the new master of the takeover universe, a distinction he had lost when Blackstone grabbed what seemed like half the occupied office s.p.a.ce in the free world.

The second deal that involved Lehman was the $3.1 billion takeover of Claire's Stores, a three-thousand-property necklaces, handbags, and headbands corporation out of Pembroke Pines, Florida, a few miles west of Fort Lauderdale. Apollo Management was the buyer, with Bear Stearns, Credit Suisse, and Lehman providing the finance. Between them they took a family corporation with no debt as of October 2006 and almost $250 million in the bank directly into a bankruptcy situation with debts of $2.5 billion, ten times its annual earnings.

I don't know what it was about the Lehman chiefs and debt, but they seemed to be drawn together in an unending dance of death, swept up in the euphoria of the times. And what times they were. In this twelve-month period, June 2006 to June 2007, nine of the ten largest LBO deals in history were launched. And Fuld and Gregory were fighting, scratching, and clawing their way into the contest, trying to eat with the big dogs, the men with the big commercial bank balance sheets, Citigroup, Bank of America, and JPMorganChase.

With hindsight, the investment banks Goldman Sachs, Bear Stearns, Lehman, Morgan Stanley, and Merrill Lynch ought not to have been competing. Indeed, before Bill Clinton signed the repeal of the Gla.s.s-Steagall Act in 1999, it would have been illegal to do so. But now it was all different. And the much smaller Lehman Brothers had a chairman and a president who were determined to join in the biggest financial operations on the planet. There was a ferocious leverage arms race among bankers, and Lehman was prepared to stretch themselves out in order to achieve their aims. And boy were they ever stretched. At first, liabilities that totaled twenty-two times our worth seemed okay. Then it was twenty-six to one. Now, in the late winter of 2007, it was thirty-four to one and rising. By year's end it would be forty-four to one.

In the opinion of d.i.c.k and Joe, the boys at 399 Park Avenue were the light of the future. And in the middle of March, Mark Walsh struck-in probably the most expensive square mile of the most expensive real estate outside one of the world's most expensive cities, in the heart of one of the most expensive countries in Europe. With the blessing of the board, he actually went in on his white charger and purchased the largest office complex in France, in the heart of the Parisian business district: two enormous round thirty-nine-story gla.s.s towers, like a couple of upturned tubes of tennis b.a.l.l.s standing on end, in the shadow of the legendary Grande Arche de la Defense. He paid $2.81 billion for Coeur Defense, the name given to this most prestigious construction, right in the center of La Defense, the s.p.a.ce-age French skysc.r.a.per "city" of modern architecture and multinational corporations, which stands twenty-nine miles west of the Cathedral of Notre Dame.

At the time, Lehman was in the hole for about $465 billion. So why the h.e.l.l not? In for a penny, in for a pound, right?

Coeur Defense was built in 2001 for $886 million. Three years later, when Goldman Sachs' Whitehall Fund bought 51 percent, the building was valued at $1.8 billion. Three years after that, Mark Walsh's real estate group bought it for $2.8 billion, which meant it had increased in value by $330 million a year. The deal was financed by commercial mortgage-backed securities.

In a sense, Coeur Defense was the crown jewel of Lehman's property empire in Europe. Flush in the center of the largest new office development in Europe, it did not come cheap. But that was no problem in these freewheeling days of ready cash, and the forthcoming CMBS sales would finance it with ease. Just so long as those bonds kept selling on the world market.

No one could accuse Mark Walsh of lacking guts. He'd already been involved in enormous deals in California and China, and he was working on a whole bunch of new ventures. I am obliged to say that Larry McCarthy really resented the way the Lehman balance sheet swayed in favor of the real estate guys. I guess he believed the commercial game was as lethal as the residential business. The entire diversification theory was a complete anathema to him. He believed it was a fraud, some kind of a bear trap. But Mark Walsh was not finished yet. Not by a long shot.

At the time I detected no appreciation by our highest management that we were right in the middle of a global a.s.set bubble. Everything was awash with liquidity, at the top of its price range: steel, real estate, almost all commodities, corporate bonds, fine art, wine, LBO deals. Everything was expensive. So expensive that Wall Street's diva of distress had fled nearly a thousand miles and five states away, to the guitar-and-fiddle lands of the good ol' boys beyond the Appalachian Mountains.

And those ma.s.sively overvalued prices had polarized the corporation. The group that surrounded d.i.c.k and Joe was blindly unaware, since they could always get hold of cheap money while truly great financiers like Mike Gelband, Alex Kirk, and Larry McCarthy were spitting mad at what they saw as the potential destruction of the entire corporation.

Looking back, it's clear to me that it all affected Mike Gelband the most. By March, he was an out-and-out bear. As Lehman's global head of fixed income, he could not possibly approve of the program to buy back our own expensive stock on the open market just to show strength. And he found a way to tell d.i.c.k Fuld precisely how crazy he considered that to be. He was absolutely convinced the markets were at a top, and that Lehman was using leveraged money to buy leveraged hedge funds on margin. In his view this was the road to h.e.l.l.

He scorned the whole concept of Lehman Brothers' diversifications, because the new "investments" were being conducted at the pinnacle of the market. He was certain of that. And he hated the current fad of buying commercial real estate in India, Asia, and Europe because they were all at the top of their markets-known in the trade as "top-tick prints."

Mike wanted subprime eliminated from Lehman's operations. He wanted to fire the bodybuilders and slash by half Lehman's program of originating mortgages. At the urging of Alex Kirk and Tom Humphrey, he had gone around Joe Gregory and begged d.i.c.k Fuld for a reduction in Lehman's mortgage origination at BNC and Aurora. This infuriated Gregory. And that was not the only battleground Mike was carving out for himself.

Mike never believed in decoupling, a strategy based on the idea that the United States was finished as the world's number one world financial power. He wanted to downsize, regroup, and stay healthy. And he repeated his concerns and fears both to the heads of departments and, over and over, to the men in the big chairs on the thirty-first floor. No one could have listened to him and still believed the chairman and his president any longer knew what they were doing.

This was the voice of a very senior Lehman managing director, and it was one of cold reasoned logic. We all knew that, but it was not anything Richard S. Fuld wanted to hear. He wanted risk, more risk, and if necessary bigger risks, because that was the way to the big bucks, the multimillion-dollar bonuses for him and Joe Gregory. He was never going to listen, perhaps because he would be so rich by the time the end came that he would not care one way or another what happened to the firm. Maybe that's being uncharitable. But the fact remained that Mike Gelband was a vastly superior financier. He'd been with the firm twenty-six years, and just as only the very rich understand the difference between themselves and the poor, only the truly brilliant comprehend the difference between themselves and men of moderate intelligence. Mike Gelband thought d.i.c.k Fuld was thick. And he believed Joe Gregory was, if anything, thicker.

Time after time, as a member of the Lehman executive committee, Mike voted against big spending projects, railing to Joe about blowing out all the fabulous profits accrued between 2004 and 2006. Mike stayed awake nights churning over in his mind the unchallengeable truth that Lehman had so many brilliant people, all being led by a couple of commercial paper traders out of touch and out of their depth. The World War I British Army was once described by a German general as "lions led by donkeys." Mike Gelband's opinion of the chain of command in Lehman's little army could scarcely have been more succinctly phrased.

Here he was, the head of fixed income, the only expert on the subject on the entire executive committee, and his recommendations to protect the firm were being resolutely ignored. Mike warned them of the coming credit crunch. He warned them of the lethal danger of that $15 trillion to $18 trillion of leverage out there, the credit derivatives issued between 2001 and 2007. It was a paper phantom that Lehman had done more than its fair share to create. At one meeting he pounded the table and shouted, "This is not going to be just a credit crunch. This is going to be the granddaddy of all credit crunches. And you're trying to buy into a giant global a.s.set bubble." This took place in the middle of a d.i.c.k Fuldinspired attempt to buy yet another inflated hedge fund. And again Mike voted no. He voted no-no-no, over and over. And not once during all these anguished months did one member of the Lehman board of directors call him to clarify his overriding concern about the future of the company he so loved. Not once.

The trouble was, d.i.c.k Fuld could not understand the technicalities of market finance at the highest level. And when Mike tried to explain, the boss just glazed over and tuned out. One day Mike was attempting to point out the enormous dangers to the firm caused by SIVs-structured investment vehicles. These were like supersized CDOs that borrowed in the commercial paper market and bought mortgages and other debt involving colossal leverage, billions of dollars. And if the surging commercial paper market ever froze up, Mike thought, the global financial system might cave in.

The chairman didn't get it. But he realized he needed clarification. In front of Mike, he called Henry Paulson, the secretary of the United States Treasury and a former CEO of Goldman Sachs. d.i.c.k did not even try to get into the details of the problem, and quickly handed the phone to Mike, who pointed out with immense clarity the serious problems recently developing in the a.s.set-backed commercial paper market and its deadly potential impact on the giant leveraged SIVs, to which Wall Street and the largest commercial banks were exposed. Mike thought this would lead to a serious credit freeze, one that he believed was shimmering on the horizon. To this day, Henry Paulson, with a supreme grasp of the subject, insists that the first person ever to warn him of the coming catastrophe was Mike Gelband, of Lehman Brothers, in that phone call from d.i.c.k's office.

Still, Fuld wanted Mike to accept his view. The chairman decided to bully him, to belittle him publicly, rather than relying on mere persuasion. "I don't want you to tell me why we can't," he said at one meeting. "I want you to be creative, and tell me how we can. You're much too cautious. What are you afraid of?" Then Joe Gregory began to hara.s.s the firm's one world-cla.s.s expert on fixed income, telling Mike how d.i.c.k was not happy and that it was essential Mike begin to take much more risk, make bigger deals, relentlessly pursue growth. "You just have to make a change in direction," said Joe. They wanted him to buy hedge funds, take out leveraged loans, purchase real estate all over the globe, get into commodities-steel, gold, and oil. What mattered was to catch and then pa.s.s Goldman Sachs, Citigroup, and Blackstone, to show them who was boss.

Joe invited Mike to a private lunch meeting in the executive dining room on the thirty-second floor. But the two men had very little in common. Both of them observed company policy by wearing suits and ties up there in the holy of holies. But while Mike ate seared tuna, with no dessert, Joe hit a major plate of pasta. And Joe's views, so far as his guest was concerned, were absurd. Later that day, Mike confided to Larry and Alex, "Neither he nor our chairman understands the dangers of securitization, the leverage in the system. They cannot understand. And they will never understand. When I beg either of them to listen to what I am saying, their eyes glaze over."

On the evening of that luncheon, Mike Gelband, close to tears, had a long discussion with his wife, Deborah. He was an extremely rich but modest man, uneasy with glitzy people, and uninterested in private helicopters. He and Deborah understood that he needed to be true to himself and his conservative principles, that he needed to make a stand for what he believed was right. And in Mike's opinion, enough was enough.

The following day he took the elevator up to the thirty-first floor, walked into Joe Gregory's office, interrupting a meeting, and quit. "You said I was to make a change, Joe. And that's what I'm doing."

d.i.c.k Fuld's right-hand man was scared. No doubt about that. He tried to backtrack, called d.i.c.k, tried to reason with the departing head of fixed income. But Mike had made up his mind. And his departure made Wall Street headlines.

The news broke the following morning on the Bloomberg tape, and Larry McCarthy was not so much shocked as shattered. Mike Gelband was his lineman, our blocker, the big hitter who was a huge sponsor of all of our risk and short positions. He'd had the most phenomenal career, punctuated by success after success. In a democracy he'd have been swept to power, most certainly by Larry McCarthy, who regarded him as the most talented guy in the building. The chairman and his deputy had somehow found a way to lose him, and that had to rank as one of the most stupid acts he'd ever seen anyone do-anywhere.

On the day Mike left, May 2, 2007, everyone trooped down to the third floor around eleven to say good-bye. So many people wanted to shake his hand that a huge receiving line formed. Everyone owed him something. He was such a big part of our strength and standing in the corporation. His presence made us count. Some of the women were in tears as the great Lehman banker moved from friend to friend. How could anything ever be the same again?

Mike could have saved his job, could have gone on collecting $10 million to $20 million a year, every dollar of it earned. But he was not that kind of guy. Like Larry, Mike was certain we were steaming toward the iceberg, with a balance sheet he thought was catastrophically overleveraged. He had to be true not only to the firm but to himself, and he could not countenance the wishes of the chairman. And so he walked away from one of the highest-paying jobs on Wall Street, walked away from those enormous earnings. It took a real man to do that.

He came over to say a last good-bye to Larry, Joe, and me. And there was a strange silence throughout the trading floor as he did so. When he finally turned away and walked toward the door, there was a sustained and heartfelt burst of applause-not the raucous outpouring that greets a touchdown or a home run, just a fierce clapping of hands, like the kind that greets a pitcher when he's finally relieved in the eighth with his team out in front after a long job, brilliantly done. For the record, he did turn around one last time and, typically, just smiled and nodded to his fans. If he'd been wearing a cap, he would have doffed it-for the good times.

I glanced over at Larry and could see how upset he was. For the first time, the old poker player was wearing his heart right where everyone could see it. And somehow I knew, with pure certainty, that Larry too was about to jump ship. We completed our afternoon's trading and left the building in a somber mood. Already things seemed different.

I arrived on the trading floor the following morning at around six, opened a couple of markets, and waited for Larry, who showed up at eight o'clock. I will not easily forget the sight of him as he marched along the corridor wearing a 1960s Lilly Pulitzer suit in lime green, sky blue, and white, with little plovers woven on it. He wore no socks, light brown loafers, and a preppy blue Vineyard Vines tie with a little Santa Claus motif.

"What's with the tie?" someone asked, presumably trying to take their eyes off the rest of him.

"It's kind of a battle honor," he joked instantly. "For all my years here, getting you guys paid." Last word, as always, to Santa McCarthy, who had, in fairness, always guarded the interests of his troops with enormous generosity.

And even now he was about to deliver his morning largesse. In his arms he carried two large brown bags that contained fifty sandwiches for the traders, salesmen, and a.s.sistants who surrounded him. He was always aware how hungry people can get who were up soon after 4:00 A.M. A.M. and had been hard at work for three or four hours before the rest of the nation got out of the sack. Today he had a gourmet selection of egg, cheese, sausage, and ham. He never wanted to eat alone. and had been hard at work for three or four hours before the rest of the nation got out of the sack. Today he had a gourmet selection of egg, cheese, sausage, and ham. He never wanted to eat alone.

"You're going, right?" I said, somewhat unnecessarily.

"I can't stay," he replied. "Not the way things are moving."

"It's Mike," I said.

"Not entirely. But he was my main man. And I hoped he and I, with Alex, could turn us away from the G.o.dd.a.m.ned iceberg. But now we're probably gonna hit it. And I don't want to be here for that."

For the second time in less than twenty-four hours I was looking into the eyes of a top-cla.s.s Lehman managing director who was leaving. I actually felt physically sick, and the whole floor somehow, by some strange act of telepathy, now knew that Larry McCarthy was following the revered Mike Gelband out the door. Everyone Everyone felt physically sick. This was not just bad. This was chilling. And the balance of power would now tip away from the distressed-debt department. felt physically sick. This was not just bad. This was chilling. And the balance of power would now tip away from the distressed-debt department.

I never remember the trading room being so quiet. Every eye in the room watched as Larry went up to human resources to conduct the traditional Lehman Brothers exit interview. When he came back I asked him what he'd told them, and he laid it right out, both barrels.

"I told them I'd heard a lot about d.i.c.k Fuld over the years. He's a former commercial paper trader, but not once, not one time in all my years here, did I ever see him on the trading floor. Not even on the day me and the guys had the single most profitable day in the history of Lehman's fixed-income division-two hundred fifty million clams, and the guy's a no-show."

It's hard for Captain Cool to show outrage. But I could see it on his face at that moment, just at the memory of that shining day when we sold the Delta bonds and never even received a note or a handshake from the head of the corporation.

"I said I just thought it was very odd, that's all-a pretty unusual way to stay close to your troops."

For the rest of the morning Larry walked around saying his goodbyes and spending time with the support staff, Janice, Olivia, Maribel, Sylvia, and Jessica. He told me he was leaving the building right after lunch, but he didn't mention precisely what lunch would mean on this day. It turned out he'd ordered twenty carts of food from the outstanding steakhouse Ben Benson's. That's where he ate, and that was the food he wanted for his guys. When fifteen waiters started pushing them in I thought the A train had veered off its tracks. There were huge metal trays of prime rib, filets, porterhouses, creamed spinach, mountains of potatoes. There was enough shrimp and lobster to feed the population of Martha's Vineyard. Larry had decreed, "No plastic," so there was only the finest cutlery and linen napkins. The feast cost him around $14,000.

He and I talked quietly while we dined, and he came up with some true McCarthyisms-"Never tell anyone on Wall Street your problems, old buddy. Ninety percent of those you tell don't care, and the other 10 percent are glad you have them."

He told me to stay short in this market, no matter what. "Because something doesn't smell right. There's a lot of funny money flying around, crummy coupons on crummy credits, distressed debt trading at par. Crazy LBO deals one after another. This smells like the top to me-it's got all the makings."

Like Mike, Larry was really uneasy about the amount of debt Lehman was carrying. We could not know the precise details, but we knew it was thirty-four times our tangible equity value, which added up to a little over $500 billion. That's only half a trillion, and if you say it quickly enough, it doesn't sound that bad. But it did to Larry, and I know that was one of the reasons he was going. Same as Mike.

I remember he attempted to misquote the old Republican senator from Illinois, Everett Dirksen. "You know what he said, right? A billion here, a billion there: pretty soon you're talking real money."

But Larry was not really joking. He was upset, serious, and concerned. "You know," he said, "this is one of the most prestigious merchant banks there has ever been. Lehman. That's a name for the ages. But we don't have any bread. Not real bread."

"I understand," I replied. "How can anyone who owes half a trillion dollars have any bread? We're one of the great and feared Wall Street inst.i.tutions. But we're f.u.c.king broke."

"Larry," he said, "the Texans have a pretty good phrase for that: big hat, no cattle."

I guess I was the last good-bye, after Gat and the guys from the second floor had sought him out for their final farewell.

"I gotta go," he said to me. "I love you, buddy, but I'm out of here while the going's good." He gave Gat, Terence, and me a big hug, picked up his briefcase, and headed for the exit in his Lilly Pulitzer suit, a defiant figure who had made over $400 million profit in a four-year Lehman career.

There were eighteen rows of people between Larry and the door, and one by one they stood up and applauded as he walked past, just as they had with Mike.

Larry never looked back. But just before he reached the gla.s.s doors, he raised a clenched right fist high in the air. And then he was gone. Something in the soul of Lehman Brothers was gone with him, and it never came back as we steamed ever onward toward Larry's iceberg.

10.

A $100 Million Crash for Subprime's Biggest Beast It was impossible to move the CDOs on. The G.o.dd.a.m.ned cat was out of the bag, and we were staring at an ugly, sneering face engraved on a very hot potato.

LARRY M MCCARTHY HAD scarcely aimed his black Mercedes-Benz north up the FDR Drive when a detonation four thousand miles away on the banks of the Rhine River triggered an explosion on Sixth Avenue in New York, about a block from the Lehman tower. UBS, based in the city of Basel, suddenly decided to shut down one of the storied names of Wall Street, Dillon Read Capital Management, located on the Avenue of the Americas at West 50th Street. Time: immediately. Reason: first-quarter losses of $124 million. Cause: U.S. subprime mortgage defaults. scarcely aimed his black Mercedes-Benz north up the FDR Drive when a detonation four thousand miles away on the banks of the Rhine River triggered an explosion on Sixth Avenue in New York, about a block from the Lehman tower. UBS, based in the city of Basel, suddenly decided to shut down one of the storied names of Wall Street, Dillon Read Capital Management, located on the Avenue of the Americas at West 50th Street. Time: immediately. Reason: first-quarter losses of $124 million. Cause: U.S. subprime mortgage defaults.

The news ripped through the financial world, sending a shiver through our trading floor, which had not yet recovered even a semblance of equilibrium after the departure of Gelband and McCarthy. The collapse of Dillon Read shocked everyone, but nowhere worse than at Lehman Brothers. We currently stood at the top of the table of subprime lenders, and this was bad enough without yet another hedge fund crashing. Dillon Read, with Wall Street roots going right back to the 1920s, had been acquired by the giant Swiss bank UBS and then relaunched in 2005 with an investment of almost $3.5 billion.

Its sudden failure, so heavily linked to subprime, came hard on the heels of the New Century bankruptcy and the subprime distress signal fired skyward by HSBC and Fremont General. And now we were hearing ferocious rumors that General Motors' first-quarter profits were off 90 percent because of mortgage losses at its 49-percent-owned GMAC finance company because of subprime defaults. And anyone still standing in the brokerage game was in the process of rushing for cover-but not in time to prevent the carnage.