A Colossal Failure Of Common Sense Part 16

They were all worried about this enormous number. But Mike Gelband seemed for a few moments to be lost in thought. He sat back in a deep armchair, and the other two found themselves awaiting a reflection from their old and trusted friend. For a full minute he said nothing. Then he spoke in a quiet but firm tone of voice. "All three of us have been together before in a crisis. Like 1998, when Lehman was at death's door. The difference was, back then our balance sheet was $36 billion. It was manageable, possible. And we were conservative, playing from a small stack."

They knew Mike was going to a cold and dangerous place, from where there might be no return. But he spoke calmly. "It's different now," he went on. "The balance sheet is probably $150 billion bigger than when I left the firm. It's near $700 billion. That's too much money. Way too much. And Lehman may have borrowed itself out of the game. An investment bank can get just too big to succeed."

Alex Kirk nodded gravely and said, "It's become an endemic Wall Street problem. And no one can see where it ends." With that, despite the overwhelming nature of the task, Mike and Alex both stood up and said quietly they were honored to be asked and would return to work immediately.

Despite all that was facing him, there was a bounce in the step of Bart McDade as he headed back to the investment bank that had sufficient debt to buy Scandinavia.

Even with a new corporate president, there was an inevitable air of suppressed panic in the air at Lehman. It was so p.r.o.nounced that even Fuld could sense he finally had to mingle with the troops, and he uttered no objection when Bart, a natural communicator, requested they make a grand tour of the offices together.

They visited floors two through seven, and Bart carried a small portable podium with him. At each destination he placed it in position and d.i.c.k stepped up onto it to introduce the new Lehman chief to the troops. Bart insisted that when d.i.c.k addressed them he be connected to the "hoot"-the floorwide communications system allowing everyone to hear his words. People were astounded. In the first hour and a half more people saw and heard d.i.c.k Fuld speak than had experienced that in the previous ten years. Dozens of them scarcely knew who he was.

Bart's own appearance on the little podium was less spectacular. Everyone knew Bart McDade, who was often walking around meeting people. And everyone really liked him. At least I think they did. I never met anyone who didn't.

For d.i.c.k Fuld, it was not so easy to climb down from the throne of Lehman. On the day after the meeting at Alex Kirk's apartment, a meeting of ten senior managing directors was called in the office of Andrew Morton, the second man to try to follow in the shoes of Mike Gelband as head of fixed income. Among them were Jerry Donini, Mark Walsh, Eric Felder, Rich McKinney and Mo Grimeh, the Moroccan-born head of emerging market trading.

d.i.c.k Fuld had promised to attend, and for a while he sat quietly listening to the accounts of the potential losses that might occur in real estate and mortgages. He heard Eric Felder mention the profits being made by the hedging tactics, but finally he reverted to his old bullying ways, using them indiscriminately, ranting at guys who were not losing money, like Felder.

"I've had enough," he yelled. "Enough of the f.u.c.king losses. Enough!" He demanded answers, tried to bully them out of making further losses with an air of sheer belligerence, and raved on about hitting the ground running and fighting as a unit under the guns.

Now, a managing director at Lehman is an important executive. And these were not guys with whom to trifle. They formed a group of very clever people, ranging upward to very brilliant. And they stared at him as if he had gone mad. A major section of the group believed many of the losses were down to him alone. After all, it was d.i.c.k Fuld who had somehow lost Gelband and Kirk, had somehow sanctioned the reckless nine-month buying spree initiated by Walsh, Goldfarb, Gregory, Berkenfeld, and Sherr.

Most people who attended that meeting regarded Fuld as a slightly pathetic, out-of-touch, confused old guy who was in office past his time, struggling with a 1970s playbook in a 2008 game. Lehman's balance sheet had grown to gargantuan levels, perhaps nearly impossible for one person to wrap his mind around. This was new stuff, losses, big losses, bigger than he had ever known or even dreamed about. He didn't fully understand the embedded leverage in modern advanced credit derivative products. The guy was confused, but he was also in shock, and he reacted the only way he knew how, the way that had always served him well. He started shouting, trying to intimidate people, as if to scare them into not making any further losses. On reflection, I guess it was was pretty pathetic. But for me, it was sad rather than malicious. pretty pathetic. But for me, it was sad rather than malicious.

Anyhow, Mike and Alex returned to the office on June 24, Mike as global head of capital markets, Alex, replacing Dave Goldfarb, as global head of princ.i.p.al investing. They both arrived around 6:00 A.M. A.M., and there was standing applause when they turned up on the third and fourth floors to make their rounds and shake hands with old friends.

By now Bart and many of his key people had moved up to the thirty-first floor, and the whole atmosphere changed immediately. What once had been a cold, almost eerie, library-quiet corporate seat of power, dominated by two men who led lives far removed from their staff, now became a thriving, cheerful place with the old teams led by Mike and Alex moving in, knuckling down to the urgent business of selling off Lehman's highly suspect a.s.sets.

Not everything changed, however. One of the new a.s.sistants told me that summer that d.i.c.k Fuld walked straight past her desk every single day and never once said h.e.l.lo, despite the fact she was the right hand of one of the great Lehman traders and risk takers. "Mr. Fuld," she told me, "walked right past me every day, as if I did not exist."

Meanwhile, the t.i.tanic task of going through the real estate books to try to unearth the truth was under way, essentially to a.s.sess the amount of concrete the firm had bought with borrowed money. What they found was nothing less than a horror story. Enclosed in a ma.s.sive book the size of three Manhattan Yellow Pages, there were no fewer than twenty-four hundred line items contained in the records of Mark Walsh's transactions. Bart, Alex, and Mike were nothing less than appalled. The numbers alone were enough to cause a heart attack in any normal investment banker. But there was something so utterly out of control about what they had discovered that the issues instantly widened.

Plainly Walsh and his team, operating over on Park Avenue, had required no higher authorization. Anywhere else, they knew, purchasing on this scale would have d.a.m.n near required an act of Congress. The questions began raining down on them: Who knew about this? Was Fuld a party to the transactions? Or was it just Joe Gregory? If Joe knew, did he tell Fuld-or the executive committee, not to mention the board? Who knew about this? Was Fuld a party to the transactions? Or was it just Joe Gregory? If Joe knew, did he tell Fuld-or the executive committee, not to mention the board?

Bart grilled Fuld, who seemed vague. Like Mike and Alex, Bart was frightened. This was beyond logic, this was beyond reason. The terrifying number of maybe $120 billion stood starkly before them. No one in all the world could unload that much commercial and residential real estate. The markets were in a downward spiral, and there were fewer buyers than there had been for years.

For a few moments they just stood there, literally overcome by the enormousness of the task before them. And then a thought flickered across their minds: Lehman Brothers might be finished Lehman Brothers might be finished. There was no satisfaction in having been proven right. Just a sense of profound sadness, and a fleeting moment of desolation at the magnitude of their problem-a problem so vast there might be no mathematical solution to what lay ahead.

Mike, the one who had been gone the longest, instantly tackled the valuations that had been entered onto the ledger. Unsurprisingly, they were all high, some a.s.sessed at their purchase price or sometimes higher. Like David Einhorn, Mike Gelband understood that the mortgage markets had dived and that if Lehman had to sell these positions at the current market value, down around 20 percent, billions of dollars' worth of a.s.sets would be stripped from the plus side of the balance sheet.

Everywhere any of them looked, there was nothing but trouble. Again Bart went back to Fuld, who was unable to shed much light on anything. And with every pa.s.sing hour it seemed more and more probable that the tottering king of Lehman had cast a blind eye to many of the more unpalatable truths.

On one memorable occasion, Mike Gelband exploded: "I wish we could just locate someone with some real answers. I mean, h.e.l.l, did anyone authorize any of this, or did it just happen?"

In the end, it did not much matter who knew or didn't know. The shudderingly huge commercial and residential portfolios remained, and with it unfathomable debt. And planted right in the middle of it, illuminated by the golden sun of the West, stood a name that in the end would live in infamy in the annals of Lehman Brothers-SunCal.

In some ways it was possible to trace Lehman's current problems directly to that corporation, to an enormous development site in the hot flatlands of central California, 120 miles northeast of Los Angeles. Located on the southwest side of Bakersfield, the site was a two-thousand-acre stretch of land upon which it was envisioned there would one day be six thousand homes, forming a recreational community built around a Greg Normandesigned golf course, boating and fishing waters, and a beach house. Lehman was originally in for $150 million in 2005. That made it both a lender and an equity holder. They called the site, with a Hollywood flourish, McAllister Ranch.

By June of 2008 McAllister Ranch was fenced off: three square miles of dest.i.tution, blowing sands like the Sahara, weeds like an abandoned tobacco farm, and a half-finished clubhouse. No houses. No grand lake for boating. Just a scene of dereliction, a place left to die quietly out in California's inland empire, the lands once designated to make untold fortunes in real estate development.

The bigger problem was that since Lehman had first climbed into this doomed enterprise, the original loan had increased to $350 million. And then, in addition, they had raised and loaned SunCal more and more, something close to $2 billion. It was nothing short of a black hole, and a bank the size of Lehman had no business being anywhere near it. SunCal would have made the accounts department gasp at a major multinational commercial bank, never mind a smallish Wall Street investment house with no depositor income.

With McAllister Ranch plainly on its way down the tubes, worth less than half of the purchase price in this market, and SunCal about to default, Lehman's accountants may have been somewhat opportunistic in scarcely recording any write-down on the investment on the balance sheet. It still showed almost the full value. I guess Gregory and Goldfarb thought Fuld might not want to hear much about write-downs.

Mike Gelband blinked in amazement. Every hour this grew worse. He and Alex grabbed the bulls.h.i.tters by the horns and immediately transferred Mark Walsh's real estate operation back to the bullpen. Exit Park Avenue deluxe, back to the factory at 745 Seventh Avenue. They broke up Walsh's hundred-strong team and gave up trying to find out who was actually culpable for the gigantic losses. The fact remained that this crowd had meekly gone along with the out-of-control expansion plans, the ma.s.sive overexposure to illiquid commercial real estate as laid down by d.i.c.k and Joe.

Mark Walsh himself was about to find life very different. The days of sitting there blinding Joe Gregory with the science of real estate ended for him like the slamming down of a drawbridge. Poor Mark, for so long the prince, now found himself under cross-examination that might have made a Gestapo officer blink. And he was ordered to report to the uncompromising Mike Gelband-hopefully to report sales, hundreds of them, to get Lehman out from under the debt created by Club 31, as that all-powerful stretch of skysc.r.a.per real estate was nicknamed by the rest of the staff.

Bart, Alex, and Joe also removed David Goldfarb from his position as head of princ.i.p.al investing and installed him in the brand-new, slightly ephemeral seat of chief strategy officer, no longer a big financial power with stop-go authority over major real estate investments. Remember, Decouple Dave had also been a final authority in the purchase of hedge funds, in which he was responsible for eight more of Lehman's major screwups that Alex was desperately trying to undo, write down, and sell.

Bart's great buddy, the brilliant Jerry Donini, a forty-four-year-old domestic equities whiz, was promoted to global chief-another neat move in line with their policy of trying to get the very best people into their right spots in the company, now, for a change, with access to "Club 31."

Erin's replacement as chief financial officer was the South Africanborn Ian T. Lowitt, Lehman's global treasurer, and a former Rhodes scholar at Oxford. His appointment was widely applauded, although Wall Street was still talking-reeling, actually-from a devastating lecture David Einhorn had delivered a month earlier at the prestigious Ira W. Sohn Conference in New York on May 21. He had made his speech at 4:00 P.M. P.M. right after the market closed, and before he spoke, the mere rumor that he might try to nail Lehman had already sent the stock down 2.44 percent that day, making it around 70 percent on the year. right after the market closed, and before he spoke, the mere rumor that he might try to nail Lehman had already sent the stock down 2.44 percent that day, making it around 70 percent on the year.

Einhorn had disappointed none of the Lehman detractors, who were beginning to short the stock wholesale, much as Einhorn himself was. He argued that the firm did not recognize the declining value of some of its real estate holdings. He cast serious doubt on the value Lehman placed on around $6.5 billion of collateralized debt obligations backed by nonresidential mortgages. And he specifically mentioned a real estate venture called SunCal, in hard-hit central California. He said Lehman had not disclosed a material charge against that SunCal holding, and noted that Lehman had taken only a $200 million write-down of its entire nonresidential CDO position in the first quarter of 2008. That was about 3 percent. And like old Senator Everett Dirksen nearly said, "You start fooling around with a few billion here and a few billion there, pretty soon you're talking real money."

Einhorn scarcely had a good word to say about the way Erin Callan had presented the firm's financial report, with its suspect declaration of $489 million profit. And he reminded his big audience that she'd used the word great great fourteen times, fourteen times, challenging challenging six times, six times, strong strong twenty-four times, twenty-four times, tough tough once, and once, and incredibly incredibly eight times. eight times.

"I would use the word incredible incredible in a different way," Dave said. in a different way," Dave said.

It was not anything absolutely specific about that lecture. It was just the overall tone: David Einhorn thought there was something rotten going on in the Lehman accounting department. He never claimed inside knowledge, never even suggested he had a source inside the firm. He just recounted what the numbers were telling him. And the lack of transparency on those property write-downs had told him a great deal.

There it is again. That word transparency transparency. Wherever there's trouble in big financial matters, that word pops up, over and over. I'd very nearly say capitalism cannot work without transparency. And whenever it tries, there's always a problem.

In the days that followed Einhorn's lecture, Lehman seemed to be under attack from a different source every day in some publication or other. Not just Lehman's stock but its reputation was being questioned. Both before and after the June 12 coup d'etat, d.i.c.k Fuld was affected by this, but his rage diminished as more and more of his power was transferred to Bart McDade. The rage became a growl, and as the new men struggled with the ever-growing burden of the debt, Fuld finally grew more sanguine-not totally, but a little. In fact, those who remained in the wider information loop were often surprised by the calmness with which d.i.c.k Fuld increasingly began to accept bad news. It was as if he knew something that others didn't, as if he believed that in the end, all would be well: Lehman would take some hits, some of them savage, but nothing could genuinely knock the old firm from its pedestal.

It took a while to become clear why Fuld seemed so sanguine, but in the end it did. Eventually it became known that several months earlier, shortly after the Fed had moved forward to bankroll JPMorgan-Chase's takeover of the stricken Bear Stearns on St. Patrick's Day, d.i.c.k had arranged a private dinner in New York with the seventy-fourth secretary of the Treasury. To most of the world, Henry Merritt Paulson was possibly the most powerful of all the global investment bankers. To senior Wall Streeters, he was Hank Paulson, former chairman and chief executive officer of Goldman Sachs, far removed from the financial market trader, but nonetheless still widely regarded as a Wall Street insider, respected and esteemed, a lifetime free-marketeer, a Republican with rigid principles about capitalism and America's tried-and-true ways of doing business. But to a man like d.i.c.k Fuld-and there weren't many-Paulson was an equal, a fellow investment bank chief, no different from himself.

Fuld perhaps should have known better, because Hank Paulson's resume outlined a career of unusual toughness: one of Dartmouth College's best offensive linemen, All-Ivy All-East, honorable mention All-American. The guy could hit. He'd worked as a staff a.s.sistant at the Pentagon. He'd been a.s.sistant to John Ehrlichman during the cauldron of Watergate. At Goldman he'd been one of the driving forces that made that bank the source of so much irrational envy in the mind of d.i.c.k Fuld. In his glittering career he had forged friendships and business a.s.sociations with some of the biggest financiers in China. Also, he had more personal bread than Fuld. Real bread, that is. Not borrowed. In broad terms, Paulson was not a man to be taken for granted.

The dinner Paulson and Fuld had in the spring became known as the "huge brand dinner," a reference to the fact that d.i.c.k Fuld tried to convince himself and others that the meeting had gone his way, and ever afterward a.s.serted that the Treasury chief had loved his idea of raising new capital and keeping the firm a single publicly traded ent.i.ty. Elated at the success of the dinner, d.i.c.k had e-mailed his legal director, Tom Russo, and said categorically, "We have a huge brand with Treasury, and Hank loved our capital raise." In the months thereafter, several Wall Street journalists referred to the "cheerful" dinner and the amicable nature of the conversation. Articles appeared in New York New York magazine and magazine and U.S. News & World Report U.S. News & World Report to that effect. to that effect.

Wrong. It was in fact an antagonistic encounter between two inveterate enemies, with Hank Paulson advising Fuld to sell both Lehman's a.s.sets and the firm, the former much more aggressively than had happened so far. While immediately after the Bear Stearns fiasco Paulson and Ben Bernanke had agreed that the Fed's PDCF, the Primary Dealer Credit Facility-known colloquially as the enhanced Fed window-should be opened to all investment banks for the first time, Hank took a poor view of the fact that Lehman planned to access this Fed window for cash, essentially taxpayer funds, while still taking on substantial risk. He actually gave Fuld orders, coming close to an outright demand, that Lehman get their act together. He wanted the place deleveraged in a big hurry, and he all but accused Fuld of dragging his feet. Hank was irritated that the ma.s.sively leveraged Lehman, with Fuld's blessing, was investing in leveraged hedge funds. It was leverage on leverage, with taxpayer funds as the backup. Moral hazard, anyone?

He also advised they should consider seriously a secret but firm offer from the state-owned Korea Development Bank (KDB). It was believed to have been around $23 a share. Hank Paulson knew this offer had been on the table for several months and understood, doubtless from his Chinese friends, that it reflected a genuine desire on the part of KDB to own Lehman Brothers. He may not have been thrilled that Fuld had not placed the offer before his board of directors, because an outright sale to one of the Pacific Tigers would have saved everyone a lot of trouble. He did, apparently, make his feelings on this point quite clear to Fuld.

"I've been in my seat a lot longer than you were ever in yours at Goldman," Fuld retorted. "Don't tell me how to run my company. I'll play ball, but at my speed."

The Treasury chief glowered, and quite possibly Lehman's fate was sealed at that moment. Fuld came out of that dinner with even more of an enemy than when he went in. I am told Hank considered the Lehman chairman to have demonstrated something between arrogance and disrespect.

From all accounts, Hank Paulson was already worried about the calamitous effect a Lehman collapse might have on Wall Street, but he plainly did not consider d.i.c.k Fuld the right man to be at the helm. Doubtless Mike Gelband, during his time in the wilderness, had brought him up to date with other examples of d.i.c.k's less-than-inspired financial beliefs.

It was strange how d.i.c.k clung to two beliefs about that dinner right up until Bart, Mike, and Alex took over. Number one was that it had all gone well and that in the end, come what may, Hank would save both him and Lehman Brothers. Number two was a sense of security that the Fed PDCF window would never be closed to him. Both beliefs were misplaced.

And so the steady sound of the jackhammers crashing into Lehman's real estate, trying to knock down the terrible wall of debt, continued into July. Bart, Mike, and Alex worked tirelessly, late into the night, all the time further marginalizing d.i.c.k Fuld.

For several days, the markets held their own. Then, on Friday, July 11, there was another catastrophic bank failure, which instantly threatened to be the biggest ever. IndyMac Federal Bank, the Pasadena-based operation with a.s.sets of $32 billion and deposits of $19 billion, suddenly collapsed, closed down by the Office of Thrift Supervision and transferred to the FDIC. Right here we're talking bolts, bars, and padlocks, the biggest trouble there is in American banking, when the feds move in hard. Estimates were that the bank would go down for between $4 billion and $8 billion. IndyMac was the seventh-largest mortgage originator in the United States, and the largest savings and loan a.s.sociation in the Los Angeles area. It was the fifth American bank to fail in 2008 so far. Indeed, nothing on this scale had happened since the late 1980s and early 1990s. Between 2005 and 2007 only three other banks had failed in the entire country.

The cause was so predictable I have no doubt it made Hank Paulson cringe: low-doc mortgages, thousands of them. Not quite NINJAs or no-docs, but highly questionable loans to people who could not afford the repayments. It was not a major surprise on the Richter scale of probability, maybe a 3.4. IndyMac lost $614 million in 2007 and another $184 million in the first quarter of 2008 as the housing market cave-in moved sharply beyond the weakest borrowers and firmly into the Alt-As. With the complete collapse of the securitization market, outfits like IndyMac had no way to get new loans off their books, and the Pasadena bank was now steaming toward disastrous delinquencies.

Back in New York, investment houses with similar or related problems braced themselves for even bigger trouble. That Friday became a day of pure Wall Street theater: a towering city tragedy, like Oth.e.l.lo Oth.e.l.lo, not a pastoral comedy, like As You Like It As You Like It. This was not anything that anyone liked.

News of the bank collapse hit around midday. Then the oil market, which for several weeks had been doing a reasonable imitation of a rocket, shot up again to a new high of $147.27 a barrel on NYMEX, with every sign it might go higher. Forecasts of $200-a-barrel Brent crude flashed across the Atlantic. The whirling, bloodstained G.o.d of galloping inflation danced mockingly across the floor of the New York Stock Exchange.

The Dow, which had opened low for the month at 11,226, shuddered as traders slammed on the brakes. In midafternoon it briefly dipped below 11,000 for the first time since February 2006 but climbed back to 11,100 by the closing bell. All day Lehman shares had taken a pounding. After tumbling to an eight-year low the previous day, they fell $2.53 pre-market to $14.77, now making a 75 percent loss on the year.

Rarely had traders been more jumpy, and the sunlit second weekend in July was filled with apprehension for anyone who worked on, near, or around Wall Street, from bank presidents and bond traders all the way to the pretzel sellers outside the ma.s.sive offices of Merrill Lynch. The city seemed subdued, the Hamptons depressed. Even Arturo Di Modica's three-and-a-half-ton charging bronze bull, Wall Street's symbol of America's strength and power, now gazed balefully up Broadway, and the light of battle in his eyes seemed unaccountably faded.

Monday was glum but uneventful. Then, on Tuesday, July 15, after the Dow reached 11,123, the market dived and the Dow actually closed below 11,000, at 10,963. It had not finished that low in two and a half years. Simultaneously, the price of oil took a steep decline, which, absurdly, seemed to cause more consternation than when it went high. The NYMEX price for a barrel of crude closed at $138.74, nearly $10 off its high the previous Friday. Gold hit a four-month high at $987. June automobile sales were reported to have declined more than 3.3 percent. But the worst possible news for any Wall Street investment bank was the near collapse of Fannie Mae, which suffered a 50 percent stock crash from $12.87 to, at one point, $6.82 in less than 24 hours. And that was off a high of $70 the year before.

Fannie Mae and the other government-backed mortgage giant, Freddie Mac, were two of the most gruesomely misleading corporations since Enron. Originally established to help make mortgage loans to lower-income families, they were, in the twenty-first century, way beyond that simple and quasi-philanthropic brief. They existed now only to buy gargantuan swaths of mortgages from the shadow banks. Data from The Economist The Economist shows that ownership of other firms' mortgage-related securities by Fannie Mae and Freddie Mac was up over 100 percent from 2002 to 2007. In effect, they were operating like Lehman or Merrill Lynch. They were thus effectively underwriting the mortgages on behalf of the government, but unlike Lehman and Merrill Lynch, they weren't trying to securitize them and unload them onto the world market as RMBSs and CDOs. They were keeping them on their books, billions of dollars' worth of mortgages they believed, wrongly, to be excellent investments. But now Fannie's earnings were out, and second-quarter losses had totaled $2.3 billion, the fourth straight quarter of red ink, for a grand total of $9.44 billion. Fannie Mae had pledged all those thousands of mortgages as collateral to raise more money, so that it could borrow more. It was a perfectly hideous loop, and between them, Fannie and Freddie owed $5.2 trillion, with leverage of sixty-five to one. Remember I explained that this kind of endlessly rolling loan system was known in the business as a carry trade. And now, at last, Wall Street was compelled to recognize that Fannie and Freddie const.i.tuted just a giant government-backed carry-trade hedge fund. As a government-sponsored ent.i.ty Fannie and Freddie have access to sub-LIBOR financing. They could borrow at LIBOR minus 20 basis points and lend at LIBOR plus 180 by owning piles of mortgages. They were making a lot of cash on this carry trade but lost billions on the underlying real estate values behind all the mortgages they owned. I'm told you couldn't give away their shares on that Tuesday afternoon. shows that ownership of other firms' mortgage-related securities by Fannie Mae and Freddie Mac was up over 100 percent from 2002 to 2007. In effect, they were operating like Lehman or Merrill Lynch. They were thus effectively underwriting the mortgages on behalf of the government, but unlike Lehman and Merrill Lynch, they weren't trying to securitize them and unload them onto the world market as RMBSs and CDOs. They were keeping them on their books, billions of dollars' worth of mortgages they believed, wrongly, to be excellent investments. But now Fannie's earnings were out, and second-quarter losses had totaled $2.3 billion, the fourth straight quarter of red ink, for a grand total of $9.44 billion. Fannie Mae had pledged all those thousands of mortgages as collateral to raise more money, so that it could borrow more. It was a perfectly hideous loop, and between them, Fannie and Freddie owed $5.2 trillion, with leverage of sixty-five to one. Remember I explained that this kind of endlessly rolling loan system was known in the business as a carry trade. And now, at last, Wall Street was compelled to recognize that Fannie and Freddie const.i.tuted just a giant government-backed carry-trade hedge fund. As a government-sponsored ent.i.ty Fannie and Freddie have access to sub-LIBOR financing. They could borrow at LIBOR minus 20 basis points and lend at LIBOR plus 180 by owning piles of mortgages. They were making a lot of cash on this carry trade but lost billions on the underlying real estate values behind all the mortgages they owned. I'm told you couldn't give away their shares on that Tuesday afternoon.

Back at Lehman Brothers, dark storm clouds were gathering, seen by some, ignored by others. The less perceptive carried on more or less as usual until the sudden arrival on the trading floor of Lehman's own private storm cloud: Mike Gelband emerging from the elevator like the Prince of Darkness from his thirty-first-floor grotto.

Mike had seen enough. Everywhere he looked, all around the sweep of Lehman's endless horizons, there were tempestuous winds building. Mike knew many things, and he had many ideas about how to stave off the oncoming doom. But what he knew better than anyone else was the urgency of selling our positions in almost every corner of the trading floors. The debt. The debt The debt. The debt. No one was quite as scared as Mike about Lehman's borrowing.

All day he stalked around floors three and four, the trading ops rooms of high-yield and mortgages. He grabbed the list of positions and went from trader to trader, to Mark Walsh's guys and all the rest, naming positions and demanding, "Whose f.u.c.king position is this? I need to know now." Once he located the trader, he was yelling, "I want this sold yesterday! yesterday! Am I clear?" Am I clear?"

At last people began to tune in, to hear at last the gospel according to Saint Mike, once a mere cry in the wilderness but now echoing throughout the building. He was trying to get across one message: "We're in DEFCON 1!" That's the highest form of alert in the U.S. military: maximum readiness to repel a foreign attack on United States territory. For comparison's sake, the government sounded DEFCON 3 on September 11, 2001, and DEFCON 2 for JFK's Cuban missile crisis in 1962. That was the extent of Mike Gelband's concern.

All through the following weeks, amidst ma.s.ses of ruffled feathers, the Lehman traders tried to obey orders, tried to sell whatever they could. But slowly it became apparent that the task was too great. In the end Bart, Alex, and Mike were beginning to accept that the only way out might be an outright sale of the entire firm to a bigger bank. But such a merger might prove beyond their hopes, because the chief executive officer was still d.i.c.k Fuld, and whatever else could be kept away from him, the sale of the corporation could not. That summer the Korean Development Bank had once more made an offer of around $18 a share, but d.i.c.k had turned it down. There had also been an approach from the huge Chinese finance house Citic Securities, suggesting a 50 percent interest in Lehman, but those talks had failed. Now the only serious interest came from KDB, which apparently was not concerned by the precipitous drop in Lehman's stock. They were still hopeful of buying the big American investment bank, and the U.S. markets evidently believed there might be a significant chance of that happening, because Lehman's stock rallied to $16.55 on Friday, August 22.

A Korean government minister actually made a statement confirming the interest, and a third offer of $6.40 a share came in, which would have valued the corporation at $4.4 billion. Fuld turned it down because he wanted $17.50 a share. The two sides were not even close, and from there everything went quiet and no more was heard. Lehman, given Hank Paulson's plain skepticism toward d.i.c.k Fuld, was on its own.

Worse yet, the dying of the Korean bank's interest caused Lehman's stock to continue its downward slide, to below $10. For the many thousands of us watching substantial stock positions still on hold from our bonus payments, we were seeing our life savings diminish by the day. Almost half of all I had earned at Lehman was payable in stock. If the stock price fell by half, so did our money. And the stock had done one h.e.l.l of a lot worse than that in 2008.

At the end of that August, Anabela and I were on vacation on the Cape, and so was Larry. Both Larry and I had something to smile about. We had pulled off some great trades and made money pretty steadily since I left the firm. But I had given a big hunk of it back when I misjudged the oil market and took a major short position when crude went to $120. Of course, it continued rising to $148 before ultimately flopping back down into the $30s. Unlike a lot of people, I was right on the money with the coming oil crash. Pity I was three weeks too early! Luckily I bailed out long before the highs.

In those summer days on the Cape, every time Lehman stock even trembled or there was a glimmer of communication from Seoul, McCarthy and I were on the phone, encouraging, hoping for the oncoming rally. But it never came. And we just had to wait, gazing at Nantucket Sound from beaches where both of us had been brought up. We were two temporarily lost souls, still looking for the rainbow's end, while lesser men, or so we thought, struggled to help Bart, Mike, and Alex tackle the problems. If things did not look up pretty soon, we figured, we'd both end up driving the old pork chop truck down the very same highways I'd traveled twenty years before.

We were all back after Labor Day, and the following weekend, the two biggest mortgage lenders in the world, Fannie Mae and Freddie Mac, darned near went bust and took with them half the inst.i.tutional investors in the country. Hank Paulson and Ben Bernanke went white with fear, and on Sunday, September 7, Paulson nationalized them both. The government fired the management and a.s.sumed 80 percent ownership of the mortgage giants, guaranteeing them each $100 billion if necessary. This sent a shock wave through the entire economy.

On September 8 there was another major surprise when Lehman brought its third-quarter conference call forward ten days, presumably to try to head off market fears that it might go under as soon as its results came out. But when the garrison is under sustained fire, there's usually first one hit and then another.

The next day, Tuesday, September 9, Lehman's bankers, JPMorganChase, called with some grim, maybe terminal news. Steven Black, their cochief of investment banking, speaking directly to d.i.c.k Fuld and our CFO Ian Lowitt, announced that he wanted $5 billion in extra collateral, and he wanted it in cash. If not, that would be the end of Lehman's credit line. As of the next day, the tenth, there would be no more business. Lehman's accounts would be frozen. Which meant that the funds Lehman needed to operate from day to day, such as to pay salaries, bills, and expenses, would be unavailable. And, at this point, Lehman had no access to the commercial paper and overnight repo markets.

JPMorganChase's chief executive officer was Jamie Dimon, a fifty-two-year-old New Yorkborn son of a Greek immigrant, Harvard-educated, and one of the greatest financiers on earth, creator of Citigroup and former CEO of BankOne. Wall Street legend has it that in October 2006, he called a top JPMorganChase executive in the middle of the Rwandan jungle, where he was checking out a coffee plantation, and told him to get the firm the h.e.l.l out of subprime mortgages, "because this stuff could go up in smoke." You could have tied Jamie Dimon to the bow of a patrolling nuclear submarine, so sensitive was his sonar. Now he was worried about Lehman, had been for weeks, and that sonar was pinging like Lionel Hampton's vibraphone.

As far back as July, Dimon's risk department had been requesting collateral from Lehman because JPMorganChase's clients were becoming concerned at the bad news that kept emanating from 745 Seventh Avenue. The first request was for a straight $5 billion, which did not arrive until August. It came in structured securities that JPMorganChase found impossible to value but darned sure believed were worth a lot less than $5 billion. All the while Lehman was saying it would raise capital again, and Dimon may have believed this.

On September 4, with no further Lehman capital raised, JPMorganChase asked for another $5 billion in collateral, this time in cash, because they now knew that the first tranche of securities posted by Fuld had deteriorated to a value of only $1 billion. No further money arrived. Steve Black's September 9 demand for the $5 billion collateral was thus not entirely unexpected.

Fuld came up with $3 billion, which had the effect of making his bankers even more worried than they had been before. Then, along with the rest of us, Jamie Dimon learned Lehman was going to pre-announce its losses the next day, and that Fuld himself would be on the line.

News of that preannouncement sped around Wall Street. There were those who believed this kind of preemptive strike, accompanied by a billion-dollar pep talk about the future, would take the sting out of Lehman's third-quarter losses. But JPMorganChase was horrified. In company with Citigroup, Jamie Dimon asked to see Mike Gelband, Lehman's head of capital markets. At the hastily arranged meeting, both these banking giants tried to persuade the corporation not to go ahead with the announcement, on the grounds it would spook the markets unless somehow capital could be raised.

The Lehman team claimed Fuld would reveal an upcoming sale of Neuberger Berman, its investment management division, for around $8 billion. Dimon's men thought it was worth no more than $3 billion, which was not much good since the firm required $4 billion minimum.

The following morning at seven o'clock in the fourth-floor auditorium, eighty of the Lehman faithful showed up for a meeting to discuss the fate of the firm. In a matter of hours, Richard S. Fuld would stand before the nation to plead Lehman's case. The auditorium was tense as Tom Humphrey and the newly appointed fixed-income chief, Eric Felder, briefed the troops on a survival plan, centering around the creation of an ent.i.ty to house their shocking commercial real estate portfolio. It was to be called SpinCo, and Lehman would place all those huge cash-losing concrete liabilities in there, thus removing them at a stroke from the balance sheet, and sending the Lehman stock back to $20.

The auditorium went sepulchrally quiet. But suddenly, a voice of quivering rage and indignation was raised. Mo Grimeh, managing director and global head of emerging markets trading, a man to whom more than 150 people reported, was up and yelling. It was a never-to-be-forgotten outburst, referred to variously in the weeks to come as "the Moment" or, alternatively, "Mo's last stand."

"That's it?" he roared. "That's f.u.c.king it? Well, what the h.e.l.l have those f.u.c.king idiots up on thirty-one been working on for the past two months? This? You have to be kidding me. If this is all we have, we're toast."

At this point there was total chaos: shouting, arguing, raging, raised voices, furious faces. But no one was angrier than Mo, and he pressed on at the top of his lungs.

"All we've done is to take a dollar out of our right pocket and put it in our left," he yelled. "The heavy debt load would make it insolvent before it started. This is ridiculous. The market will see straight through it."

Everyone understood how hard the Lehman team had worked to put something together, and a lot of people believed it could temporarily work out. But the truth was SpinCo could not be activated until January, four months from the present time, and Lehman needed a buyer for the whole firm in the next three days. Mo had hit it: it wouldn't work, couldn't work. And by the time Tom Humphrey stepped forward to remind Mo that his time was up, the damage had already been done.

If d.i.c.k Fuld really intended to swing that plan in the conference call, he was, like Lehman, essentially on his own. And with most of the audience dumbfounded at the revelation that the bank had lost a shudder-inducing $3.9 billion in the third quarter, d.i.c.k Fuld stepped up to explain how all would be well.

On that Wednesday morning, he spoke with confidence, but the bombast was gone. He revealed his plans, but without the att.i.tude that dared anyone to question him. The commitment was there, but this was not the pugnacious old warrior of the past. He spoke of "aggressively reducing our exposure to both commercial and residential real estate a.s.sets" (SpinCo). Of "substantially de-risking the balance sheet." And of "reinforcing the emphasis on our client-focused businesses." "This will allow the firm," he said, "to return to profitability and strengthen our ability to earn appropriate risk-adjusted equity returns." He blamed intense public scrutiny for causing significant distractions among Lehman's clients, counterparties, and employees.

In summation, he declared there was a concrete plan in place to exit "the vast majority of our commercial real estate." Lehman was reducing residential real estate and leveraged loan exposures "down to appropriate operating levels." The firm was in the final stages of raising capital, and the dividend was being cut to 5 cents a share.

The fact that Lehman Brothers was in debt to the tune of $660 billion was not given major prominence in the speech. The other lasting memory of that day was Fuld's a.s.sertion that Lehman's vast property portfolio had retained much of its value. There was a view inside the top tier of the firm that this could not be so, and Jamie Dimon could not accept this either. Lehman's princ.i.p.al banker was by now unconvinced that d.i.c.k Fuld's bank could ever get out from under that debt.

With awesome symbolism, Lehman's stock hit a ten-year low on the New York Stock Exchange in the middle of Fuld's speech, hitting $7, and thousands of employees saw their nest eggs, large and small, dwindle drastically. The speech did not help, and the revelation that the bank had lost a total of $6.7 billion in hard cash in six months was as bad today as it would have been next week. Only a very brave, and probably half-witted, soul could possibly have placed a bet on Lehman's survival.

The following day, Thursday, September 11, JPMorganChase found out their initial request for Lehman collateral of $5 billion had not been paid. Dimon, the same man who just six months before was used by the Fed to inject emergency funds into Bear Stearns, now ordered credit lines to Lehman halted. But somehow, pulling every string at his disposal, including raiding the London office for $2 billion, Fuld began finding the money, and by the close of business on Friday, he had delivered the $8 billion Dimon now demanded.

While Fuld labored to try to locate unenc.u.mbered funds, the three prospective Lehman saviors, Bart, Mike, and Alex, had been working for more than a week to pull together some kind of a merger with Bank of America. But that was never going to fly What BofA really wanted was Merrill Lynch, and though the mighty Merrill's debts were worse than those at 745 Seventh, Merrill had sixteen thousand retail brokers with over three million brokerage accounts, mostly belonging to individuals. The retirees were especially lucrative-there was over $1 trillion in a.s.sets under management. In the ten days leading up to that Friday, the Lehman negotiators always thought there might be a deal, but by close of business, Bank of America, citing the fact that there would be no federal help, backing, or underwriting, was gone. Gone the way of the guys on the sh.o.r.es of the Yellow Sea. The fact that Hank Paulson had made no move to encourage or a.s.sist the Koreans was one thing, but when he refused to make any kind of move to help BofA save Lehman, that was a significant sign. And for negotiations supposed to be kept top secret, these were echoing around like calls to prayer in downtown Cairo.

It took about three and a half minutes for news of Bank of America's exit to reach Seventh Avenue, where the mood was already mutinous, with hundreds of people ready to sign a pet.i.tion for the outright removal of d.i.c.k Fuld from the CEO's office. On the third floor of the building, my old domain, the hundred-foot-long south wall had become a giant billboard designed to insult and mock Fuld, Gregory, Goldfarb, Berkenfeld, Walsh, Callan, and the ancient board of directors, all accused of destroying this great inst.i.tution. The Wall of Shame, they called it.

There was a giant photo of d.i.c.k and Joe arm in arm in tuxedoes with the catchphrase "Dumb and Dumber." There were pictures of Erin and Joe together arm in arm. Hank Paulson was portrayed sitting on d.i.c.k Fuld's head, with the line "We have a huge brand with Treasury." They had contrived photos of different board members in nursing homes, propped upright with walkers, with the caption "Voting in Braille only." There were dozens of quotes from Fuld and Gregory exhorting people to greater efforts, warning of the dangers of risk, urging traders "to execute like champions today." Where once those orders had rung around the Lehman floors like the commandments of the G.o.ds, now they were just hollow, the words of paper tigers. Silly, really. Big thoughts from little people.

Perhaps the most supercharged piece of bitter irony on that entire wall was a quote from Fuld himself uttered at a different time, when he still mattered. There was no ill.u.s.tration for this one. The staff had blown up and highlighted the stark words, stopping only just short of neon lights: "The key to risk management is never putting yourself in a position where you cannot live to fight another day."

Right now, what mattered was the only game left in town: the British-based bank Barclays. They had the mark of the cynical London street trader all over them, however, seeming to want the good a.s.sets but with no intention of taking the $50 billion worth of bad a.s.sets. The possibility did not look promising, but at least it was still alive.

By now news of Bank of America's withdrawal and the Treasury's disinterest had leaked widely, and the media, like sharks speeding toward a tropical shipwreck, were arriving in ghoulish antic.i.p.ation. The big television trucks were parking outside. There were lights, cameras, microphones, reporters in search of interviews, photographers in search of pictures, desperate to find someone in tears, even someone too upset to talk.

The night wore on, and by 1:00 A.M. A.M. I had spoken to over a hundred people. My cell phone battery had run out as out-of-towners pursued us New Yorkers as if somehow we would know more. On Sat.u.r.day morning, Bart and Alex, in company with Lehman's top legal advisor, Jim Seery headed downtown to the Fed's Manhattan offices. While they sped south through the quiet Manhattan streets, I was awakened by the phone. And then again. And then again. By midmorning things were looking and feeling very bleak. And then, shortly before noon, someone called it, no ifs, ands, or buts. Guess who? Christine Daley, on the line from the far side of the Appalachians, way down there in Nashville, announced, "It's all over. They're filing." I had spoken to over a hundred people. My cell phone battery had run out as out-of-towners pursued us New Yorkers as if somehow we would know more. On Sat.u.r.day morning, Bart and Alex, in company with Lehman's top legal advisor, Jim Seery headed downtown to the Fed's Manhattan offices. While they sped south through the quiet Manhattan streets, I was awakened by the phone. And then again. And then again. By midmorning things were looking and feeling very bleak. And then, shortly before noon, someone called it, no ifs, ands, or buts. Guess who? Christine Daley, on the line from the far side of the Appalachians, way down there in Nashville, announced, "It's all over. They're filing."

I did not even bother to ask how she knew. Over the years Christine had been invited to every holiday party of every big law firm in the city that dealt in distressed or restructuring corporations. There was no senior lawyer in this field with whom she was not familiar. Someone had told her, no doubt of that. Christine's sources were always impeccable, and she always knew how the numbers stacked up.

In a sense we were both in shock. Because we were each about to lose a huge amount of money, as our bonus stock would shortly become worthless. h.e.l.l, I was still on the payroll, and Christine had years of work and reward tied up in those atomized Lehman shares, once worth $86 apiece and now on their way to zero.

"I guess we're finished," she said. "A triumph for a colossal failure of common sense."