Colossal Failure Of Common Sense Part 4

When the dot-com fias...o...b..oke out, I felt I was living through the third market crisis of my adult life. My vivid recollection of that time is, naturally, how lucky Steve and I were to get out of it when we did. I was also very aware that I'd gotten a real bang out of shorting Cisco and being correct. I experienced a definite charge out of correctly forecasting gloom and doom.

I sensed this was my strong suit-the antic.i.p.ation of upcoming disaster. It may have been in my blood, a G.o.d-given talent, or maybe my dad had just drummed it into me from a very young age. But ever since my front-row seat at the collapse of the dot-coms, I was wary, and ever on the lookout for trouble. I have never wanted to become a perma-bear, always hoping for a profitable short position. I just have an instinct that there is big money to be made when a great beast of a corporation is headed south. I was still devoted to the convertible bond, and that was my specialty, my princ.i.p.al area of expertise.

Allied to my instinct for sniffing trouble, I sensed my future may be as a bond trader in the rough end of the market. In our profession such people are known as distressed-debt traders. And as I sat there surveying the carnage of the dot-coms, my confidence increased that this was my path to the holy grail.

The distressed-bond folks work in an area of immense responsibility, a.s.sessing, valuing, and estimating the worth of companies with big problems. They truly are the vultures of the game, always watchful, circling over corporations that may or may not become a corpse. Such people observe workers being fired, gates being closed, pension funds going down. And yet there is an optimism about them, because their real task is to a.s.sess what remains and when to strike. When can that bond be bought for only 18 cents on the dollar and there is still heavy value in the bankrupt company's a.s.sets and real estate, making it worth perhaps 50 cents on the dollar or maybe even a little more?

It's only a rumor that the distressed-bond guys work in a crypt and wear high-collared black cloaks to work. Closer to the truth is their famous sense of reality. They are often the corporate brakes on the high rollers, the ones who don't quite believe the perceived wisdom. They are always watching the optimists charging ahead, swerving around on the winds of chance, occasionally flying into the teeth of a gale. I call them the high kites.

Warnings from the vultures have saved many an overeager trader from doing something catastrophic, mostly because the market's angels of death have the best handle on value value. Warren Buffett's a vulture. You won't catch him plunging forward and buying a shaky concept. He avoided the entire dot-com disaster because he could see no intrinsic worth in the corporations. He also could not see enough advertising revenue.

And so I secretly consigned myself to the parking lots of life, where I would conduct a permanent patrol. I intended to be the one wandering around out back, where the vultures fly, with maybe a few stray bears for company. You see a lot of high kites (people who were always bullish no matter what the realities of the marketplace) in the parking lot looking for the big turbo-charged machine that will scream to the top of the hill, banners flying. I'm with the guys looking for companies driving 110 miles an hour with no brakes-the best stocks to short.

Somehow or another, everyone weathered the destruction of the dot-coms, and the year 2001 started more or less calmly until Pacific Gas and Electric filed for Chapter 11 bankruptcy in April with debts of $36 billion. This earned the attention of our West Coast offices, since it was the biggest bankruptcy in history to date.

But a few months later came 9/11-a landmark for so many people, and the start of a succession of financial disasters that would affect me for the rest of my career (including a slightly chilling dislike of working in a high tower near the window on an outside wall).

Within weeks of the fall of the Twin Towers the economy was on its knees. Travel and all of its attendant profit centers, such as airlines and hotels, was down by 50 percent. And that was when a very large fire alarm came echoing out of Larry McCarthy's midtown office. He told me he had just taken a substantial short position on the stock of the seventh-largest corporation in the United States and the dominant energy trader in the world.

Its name was Enron, and it made a living behind an enormous operation involving the buying and selling of petrochemicals, plastics, power, pulp and paper, oil, liquid natural gas transportation, other shipping, freight, and broadband. It was also involved in a vast network of futures trading in sugar, coffee, grains, and hogs. Its operations were conducted on a scale that was incomprehensible to most accountants. They were a global Gulliver based in Houston, Texas.

Also the a.n.a.lysts at the rating agencies, Standard & Poor's and Moody's, persisted in giving it blue-chip ratings, so the position of Enron seemed virtually impregnable. Larry McCarthy did not buy it. He said the accountants could not understand the company's balance sheets. Specifically, he said those balance sheets were constructed specifically to confuse the friggin' life out of anyone who studied them. "Larry," he told me, "you have to trust me on this. These balance sheets are designed to bamboozle people. The whole company is structured to bamboozle people. So far as I am concerned, there's something real shaky going on here."

He also knew, as I did, there was an Enron convertible bond being issued, and I had customers to whom all this mattered. I began to examine Enron's financials with renewed vigor. As an a.n.a.lyst in a major finance house, I was able to plug into the Enron conference call, in which shareholders and bondholders could speak to the corporation's financial officers and ask questions about the way things were running.

All kinds of financial inst.i.tutions were on those phone lines, including guys from Goldman Sachs, Smith Barney, and Merrill Lynch, all paying attention to the opinions of Andy Fastow, the chief financial officer, and the president and CEO, Jeff Skilling. I was on the line when a nervous stockholder fired a hostile question at Skilling about off-balance-sheet debt. Skilling, in front of everyone, called him an a.s.shole, which I thought was a slightly unorthodox name to give a part owner of your corporation. It's funny how little things like that can make a huge impression, but I remember thinking right then, Whoa! I'm not too sure about this crowd Whoa! I'm not too sure about this crowd.

I delved into their financials, studying them night and day, until I could see that many of Enron's debts and losses simply did not appear on the balance sheet. I helped clients to bail out of the Enron bonds.

It seemed that within days the company started to come unraveled, and the fraud, the false accounting designed to inflate their revenue, came glaringly into the spotlight. That did it-the stock, which had been trading that fall at $85, crashed to 30 cents once it became obvious what had been happening. The scandal took down the hitherto respected accounting firm of Arthur Andersen, the fifth largest in the world. The colossal deception was so convoluted that it managed to provide the illusion of billion-dollar profits when the company was actually losing money. If a deal looked bad or went wrong, they just left it off the balance sheet, which was of course effective, if blatantly dishonest.

There was one astonishing issue that resulted in several convictions. Like many of Enron's more nefarious operations, this one took place in a relatively remote part of the world-off the coast of Nigeria, where three energy-generating barges were anch.o.r.ed. Enron sold a stake in this business to Merrill Lynch for $7 million but promised to pay it back, thus making the cash a loan. The Enron accountants subsequently booked it as a $12 million profit.

Many insiders knew what was happening and began wholesale selling of stocks before the crash. Regular stockholders or bondholders were trapped in the disaster unless they were clients of Larry McCarthy, or to a lesser extent me.

Skilling and his cohorts, meanwhile, kept talking up the stock, swearing to G.o.d it was going to $130 or even $150. And they had issued bonds on such a scale that it was impossible for investment advisors to get everyone out. Kenneth Lay, the founder and chairman, was as guilty as Skilling, and, if anything, even worse in his demeanor, a.s.suring shareholders who were losing money on a daily basis that all would be well if they just kept their nerve. Even his wife, Linda, was unloading the stock while he continued to exhort the supporters of the corporation to keep the faith.

Before his trial for fraud and conspiracy, Skilling had a nervous breakdown and turned into a gibbering wreck on a New York Street, afraid, as well he might have been, to face the majesty of the United States law courts. Enron, his mighty corporation, had already gone bankrupt on December 2, its $65 billion in unpayable debt a new high-water mark, almost double that of Pacific Gas and Electric. It was also a brand-new landmark for ma.s.sive and unending accounting fraud, and for pure corporate villainy.

I have never understood what was wrong with the world that autumn, or whether the catastrophe in lower Manhattan had sent people off the rails. But in the seven months after the Enron collapse, a spate of bankruptcies would rock our once-conservative systems. And they all issued convertible bonds: Global Crossing, Qwest, NTL, Adelphia Communications, and WorldCom.

But these crashes made a major impression on me, as they were my first close-up lessons in corporate greed, dishonesty, and corruption on the grandest scale. Little did I know they had been mere dress rehearsals for something a hundred times worse in the not-too-distant future, when the double-edged sword of gigantic debt again would figure prominently.

Quite honestly, I could not believe how significant the convertible bond was in all these fiascoes. Every one of those doomed corporations, including Enron, had issued bonds just before they filed for bankruptcy, bonds to help them raise money, even though all was lost. I was rapidly arriving at the undeniable truth that many convertibles represent Wall Street's Last Chance Saloon-the only bar where you can still get a drink at 3:00 A.M. A.M., when it's starting to get real late. They're that magic wand, the one investment banks wave when they suddenly turn unadulterated debt into an investment opportunity. All those corporations are doing is borrowing money. Bond means debt, nothing else.

In the case of the aforementioned outfits, we're talking about the most dangerous bonds ever placed on the market by reputable finance houses, and all issued by corporations that must have already known the barbarians were at the gates. I guess they just wanted to keep the dream alive, at whatever cost. They issued several bonds in the months leading up to their demise, and you may see this happen again in the future. Should it do so, remember my words about the Last Chance Saloon, because these guys are headed for their last drink.

My job at this time was as a convertible bond securities a.n.a.lyst and researcher, and it fell upon me to study the bonds when they were issued and a.s.sess how reliable they were. After those months, I was becoming more careful than I had ever been-and I'd been pretty careful before. My clients were counting on me as much as on the long reputation for excellence of Morgan Stanley. But I noticed that these days their questions were ever more searching, always probing, testing me to ensure that I really understood what I was talking about. That kind of atmosphere concentrates the mind. Everywhere you looked there was something that seemed fishy, and no U.S. corporation was above suspicion; there were too many guys headed for the slammer. We had gone through a period that was like the Battle of the Somme with bank statements. And I ended up expecting to find dishonesty around every turn in the road. My cynicism, generally speaking, was without boundaries.

Don't let me sound as if I was some kind of one-man troubleshooter. Morgan Stanley had wall-to-wall experts on every subject, including plenty of high-yield credit a.n.a.lysts. I was talking to them constantly, because at that time-late 2002 and early 2003-anything with a high-yield coupon was something that needed to be investigated. I became particularly close to Anand, who understood the subject as well as anyone I ever met, and I think together we developed sharp instincts for spotting the suspect, the unlikely, and the downright dishonest. Anything Anand did not know about high-grade credit a.n.a.lysis was not worth knowing. Like me, he was keenly aware that those giant corporations had made one last-ditch bid to raise money with convertible bonds just before they crashed.

In the end, when a new bond issue was announced by any corporation in a troubled industry, my inner voice was shouting at me-Watch it, Larry. These b.a.s.t.a.r.ds are probably going down. It might not have been healthy or optimistic, but it sure as h.e.l.l eliminated mistakes. I still was not a true bear, but I was certainly learning the trade of the vulture, perfecting the fine art of locating impending death.

These months permitted me to lay the cornerstones of my future-the ability to a.s.sess value and to spot the deep flaws in proposals and the possible corporate weakness in new bond issues. For a while I was closer to becoming a detective than a trader. This was not all bad, given the enormous number of financial wizards who had been successfully lied to over the previous year. However, I was rapidly arriving at the conclusion that some of those so-called experts couldn't find an elephant in a chicken coop.

Larry McCarthy's view was very similar. He believed that very brilliant financiers who worked on the inside of major corporations and set out to baffle, bemuse, and generally bamboozle the outside forces that sought to regulate them were, as a rule, a whole lot cleverer than the regulators. Some of those guys had gone on for months, even years, pulling the wool over the eyes of accountants. Their only problem was the sheer volume of people who began to grow restless when things got shaky, when guys like Larry and to an extent me started to get beady-eyed, wondering what the h.e.l.l's going on.

We start checking. And investigating. And telling people. Until someone screams b.l.o.o.d.y murder and everyone rushes for the exit. The ch.o.r.eography is consistent and, in the end, brutally predictable, because the villains always alienate too many people, and that's when things start to go south. In this business, they always get caught when the money runs out.

All of this did not escape the government. The controversial Sarbanes-Oxley Act was enacted back on July 30, 2002, nine days after the WorldCom collapse. Its purpose was to create a near-hostile environment for corporations planning to issue bonds. The CFO and the CEO were suddenly obliged to sign a statement declaring that everything was truthfully disclosed, personally guaranteeing the validity of both their financials and the company's a.s.sets. The requirements applied to any and all SEC filings, especially companies' 10Q and 10K statements, quarterly and annual. The penalty for failing to comply or withholding the truth was a jail sentence. The sheer anger of the government affected everyone. In turn, the big lenders and mutual funds felt so burned by all the fraud that had taken place in the past couple of years that they pulled in their horns and at the slightest hint of suspicion refused to lend anything to anyone.

By the end of 2002, Wall Street was predictably in trouble; not only was it reeling from the lingering effects of the dot-com bust and September 11, but its lucrative fee engines, the huge income generated from major bond issues, had ground to a halt. Balance sheets were beginning to look a bit ragged. And in the time-honored way of that particular world, the big hitters of investment banks began to rally their forces, searching for a way to slide under the SEC regulations. What they were after was a method of dodging the stiff penalties that now went with any type of dishonesty appertaining to bonds. They were seeking a new investment vehicle that did not come under such heavy scrutiny from the SEC. Just as crooked financial officers in now-bankrupt corporations had sought to bamboozle their accountants and investors, now the Wall Street elite, the lawyers and bankers, set out to bamboozle the SEC regulators. We suddenly had a commando squad of MIT- and Harvard-educated multimillionaires preparing to go into combat against $120,000-a-year civil service regulators. It never did seem like an even match to me.

What Wall Street's financial maestros came up with while the SEC guys were consumed with backdated options, insider trading, and naked short-selling was something brand-new-a fee-generating machine hereinafter referred to as the dreaded credit derivatives, also known as securitization. They invented a method of turning a thousand mortgages into a bond with an attractive coupon of 7 or 8 percent. This high-yield bond could be traded, and hence turned into a profit generator; it would enable the mortgage brokers, investment banks, and bondholders to reap a very nice annual reward-just so long as the homeowners kept right on paying on time every month, and the U.S. housing market held up the way it always had. One of the unintended consequences of Sarbanes-Oxley was the drying up of the corporate bond market. Securitization of credit derivatives helped fill the revenue gap.

Meanwhile, Larry McCarthy's firm had been taken over by Dresdner Bank of Germany, and there was a brand-new set of executives, none of whom would ever be suspected of moonlighting as nightclub comics. The fun seemed to drain out of Larry's life, and he's one of those characters who cannot survive without some lightheartedness. You often find that people with giant brains need the stimulus of humor. There was, for instance, no finer wit or humorist than Sir Winston Churchill. It's as if their minds leap so far ahead of the pack they have an unstoppable compulsion to satirize a tricky situation. Of course, there is always a danger that those lagging in their wake don't get either the problem, the solution, or the joke. Which is when McCarthy is apt to become a bit tetchy. He likes dialogue, interaction, repartee, and cross fire. He's always sharpening his wits, and usually comes out well in front. It would not be uncharitable to a.s.sess that his new German masters from Dresdner Bank failed to tune in to their very brilliant managing director of high-yield bond trading. Larry could be hugely amusing, but his boardroom jokes now fell upon stony ground, his consummate ability to find humor in the most parlous situation was unappreciated, and his capacity to make his new colleagues laugh was no longer possible. While almost all of his colleagues were running around kissing German a.s.ses, trying to ingratiate themselves with the new leaders, Larry McCarthy was not among those particular executives, and there was no possibility he was going to last there for more than three or four months, his great expertise notwithstanding.

It all came to a head one evening during a corporate dinner, at which, having failed utterly in his attempts to get one single laugh out of his audience, Larry reached the point of total exasperation, his repertoire exhausted. Glaring at the new German chiefs, he suddenly decided the h.e.l.l with it, and snapped, "f.u.c.k this. You've got the personality of a lampshade." Still no one laughed, and Larry quit that week, for several reasons, not just the lack of humor.

Two months later he was being sounded out by Lehman Brothers, and his hiring is another one of those Wall Street tales that might seem too good to be true, but it is. According to the story, Larry arranged to meet two of Lehman's top people in the bar at Ben Benson's steakhouse. This is home ground for Larry, so much so he has his personal plaque on the bar, a s.p.a.ce reserved at all times for one of Wall Street's most revered figures. The Lehman guys arrived, Alex Kirk and Tom Humphrey, extremely powerful figures, and Larry McCarthy told them his best stories, and in the end stood them sufficient drinks to ensure they were absolutely s.h.i.t-faced. When he was quite satisfied that Kirk and Humphrey had achieved this state of grace, he hit them with one of the most demanding sets of requirements ever presented to a Wall Street firm. One of them, according to Larry, was they laugh at his best jokes at all times. In fairness to Kirk and Tom, they both knew Larry well, but now they knew he had true chutzpah as well as recognized brilliance.

At this point Tom delved into his pocket and produced a short doc.u.ment that guaranteed Larry McCarthy a $2 million bonus for the year, win, lose, or draw. Larry stared at it, then ripped it into a dozen pieces. "Two million?" he exclaimed. "I haven't earned that little since I was in high school. If I only earn $2 million we're both in trouble. Pay me what I'm worth at the end of the year." And they hired him right there, on his terms. Larry joined Lehman as managing director and head of distressed trading, a position of enormous responsibility and one which he occupied with immense distinction.

Meanwhile, back at Morgan Stanley, along with all the other bond people, we were experiencing an upsurge in the market after mid-2003. Alan Greenspan, head of the Federal Reserve in Washington and probably the most powerful man in the country, was in the process of cutting interest rates to near-unprecedented lows. He began the process to prevent damage to the U.S. economy from the dot-com bubble, and he cut rates again to prevent a sharp recession after 9/11. He cut and cut, all the way from 6 percent in December 2000 down to 1 percent on June 30, 2003. Thus began one of the greatest consumer-borrowing bonanzas since the 1920s.

There was, of course, not the slightest use in putting savings in a bank. Yields were so low that the money might as well have been under the mattress. Better to put it on a couple of short-priced favorites at Belmont Park. Better yet, buy high-yield bonds. In those months around the summer and fall of 2003, high-yield started to become once again a mantra for American investors. Especially high-yield bonds, because those little darlings had the advantage of hewing to sound business practice and providing important protection for the investors. (This is inclined to be absent with beaten favorites at Belmont.) Greenspan, in some quarters, was a national hero because his actions essentially provided people with free money, with hardly any interest to pay on funds borrowed at 1 percent. Mind, there were rumblings of discontent in very high places, and as ever, the bears thought the whole system could go south. But no one argued with Alan Greenspan.

Into the picture came the soft tread of the Chinese, with their dirt-cheap consumer products and an economy exploding with growth. China made it possible for Alan Greenspan to hold those interest rates down, avoid inflation, and keep the U.S. economy buzzing. China actually made it possible for the whole world to keep the lid on inflation, which surely would have gone mad without the armies of devoted workers slaving away in the Chinese industrial cauldron.

It's always amusing to hear European leaders, especially England's, blithely pointing to their own exemplary records in holding down inflation and talking about their own prudence and foresight, when in truth it had nothing to do with them. It had to do with China and their cheap products. Nothing else. From ports like Shanghai, freighters were steaming toward the United States, laden to the gunwales with consumer products priced at around half of what anyone else would have charged. The whole world was trying to buy inexpensive goods from China, and the Chinese were delivering, loading up on cheap American money. All this did keep the lid on world inflation, but as many as ten thousand American jobs a week were disappearing over the long horizon to the Far East-to India, Malaysia, and Taiwan as well as to China. The key to all this was, of course, the abundance of cheap labor available in the People's Republic, with its population of well over one billion souls.

Never in modern history has a labor force numbered so many and been prepared to work for so little. At least not since the Egyptians laid to rest the Fourth Dynasty Pharaoh Khafre, in his pyramid 2,500 years before Christ. In turn, the Chinese purchased billions of U.S. Treasury bonds at 3 percent, which in effect meant they owned a vast obligation from the U.S. government. In simple terms, China made one heck of a bet on the success of Uncle Sam, and it's a bet they could not afford to lose. America's ultimate success must be theirs as well. But let's face it, when you have a cash flow like Niagara Falls and that much money in the bank, there's not much left to buy except U.S. Treasuries.

There were American economists who were concerned about the Greenspan strategy and how long his free-money approach could continue, but he was a man of such influence it was impossible to utter any criticism except in the softest terms. Nonetheless, there were people who simply thought it was too good to be true-that this new nirvana, where anyone could borrow anything, with hardly any interest, would last forever.

The truth was, this was the starting point of America living in a false economy, because all this free money was in defiance of the natural laws of the universe. All bubbles, down the centuries, have started that way, leading to the inevitable time when people begin to think it's normal, that nirvana has finally arrived. It happened with a resounding clash of heavenly cymbals when the dot-coms went bananas, and people all over the planet began to believe this was a brand-new easy-money world. But of course it wasn't. It never is. You can ask my dad, who watched the start of the insane credit boom in late 2003 by observing, dryly, "Here we go again. Straight back to the edge of the cliff."

This was a time when the convertible bond a.n.a.lysts and researchers were still being ultra-careful and were still mindful of the spate of bankruptcies in 2002. Investors began to grow quite cavalier about their stocks and bonds. They had easy lines of credit but increased personal debt and decreased savings. They were part of a consumer-spending bonanza in a country that would ultimately lose several million jobs to China. The United States had a trade deficit with Beijing that amounted to billions of dollars of debt. There was a new category of money, "borrower dollars"-dollars that weren't quite real because they had been borrowed from banks and credit card companies by the consumers. And they were winging through cybers.p.a.ce by the trillions, headed for China and India.

Back home, where it was impossible to make money in bank accounts with a 2 percent rate, high-yield bonds were plainly the answer, and they became as fashionable as stock in dot-com companies had once been. But Wall Street had outsmarted everyone, and instead of the old-fashioned regular reliable bonds, investors now stampeded for residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), collateralized debt obligations (CDOs), collateralized loan obligations (CLOs), and structured investment vehicles (SIVs), paying around 5 to 8 percent.

Securitization. What a stroke of pure genius. Turning those mortgage debts into tangible ent.i.ties. Hardly anyone noticed the minor flaws that would, in time, bankrupt half the world.

The year 2003 turned into 2004, and still the flame of my ambitions burned as strongly as ever. I still wanted a seat at Wall Street's top table, right up there in the major leagues, and I thought I had what it took to make those final steps. And there I would prove my dad was wrong to be so gloomy, and so devoid of optimism. In short, I was still trying to become a trader.

Larry McCarthy, currently setting the world alight at Lehman, remained encouraging, and somehow even in the early part of the new year, I was aware that my future did not lie with Morgan Stanley, because there was seething unrest in the old firm. Guys began to leave, big important guys, such as Steve Newhouse and Vikram Pandit. Our head of investment banking, Guru Ramakrishnan, also headed for the exit in what became a ma.s.sive exodus of talent. Even Anand quit, a devastating blow for me. It was a terrible time. The atmosphere was poisonous. Most people dreaded coming to work. Everywhere you looked there was disquiet, unhappiness, malice, and unrest. New people arrived who did not fit in, and established staff members could feel the difference so sharply that at one point it seemed everyone I knew was looking for a new job.

It's a strange truth, but when you have the right mix of people, and there's mutual respect for what other people do and how they operate, a corporation such as an investment bank runs really smoothly. But it never takes much to screw that up, and once that happens, suddenly the chemistry has gone. I suppose it's like that in sports teams too, probably in everything.

All I knew was I had to get out of there. I was still seeking the holy grail, and the son of a b.i.t.c.h had to be somewhere. But it was not in the hive of buzzing discontent that was my present office.

Larry McCarthy knew the situation. Even from his battle station in midtown Manhattan, he was amazed at what was happening to us. One day he called me and uttered the words that would change my life, "Don't worry about it, Larry. There's a place here at Lehman for you."

Thus began a series of interviews with the great investment house I had revered since I left college. I was totally focused on leaving Morgan Stanley and I trusted Larry, so six times I made the journey from Stamford to the city to speak with the top bra.s.s of the 154-year-old investment bank.

Lehman was one of the giants of Wall Street, and they acted like it. Everyone I met was a cla.s.s act. And then on the morning of July 14, 2004, a letter dropped into the mailbox at my apartment on Forest Street in Stamford. It came from the office of a Lehman vice president I had met, Deborah Millstein. Its words swam before my eyes: Dear Lawrence:We are pleased to extend to you our offer of employment to join Lehman Brothers Inc as a trader in the High Yield Department in the Fixed Income Division, reporting initially to Larry McCarthy and Richard Gatward. Your t.i.tle of vice president will be submitted for official approval by the Executive Committee of our Board of Directors ...

How about that? Into the hierarchy, alongside some of Wall Street's smartest guys. Sixteen years had pa.s.sed since I'd been rejected by more brokerage houses than any other applicant in history. And now one of the biggest had finally seen the light.

Better yet, I'd be working with my old and trusted pal from the rival gas station in Falmouth when we were sixteen, Larry McCarthy. There's a French saying, Plus ca change, plus c'est la meme chose- Plus ca change, plus c'est la meme chose-the more things change, the more they stay the same. I'd just made the move, as it were, from my gas station to his.

Larry had been the catalyst who propelled me into Wall Street. And I could never really express my grat.i.tude to him, because there aren't enough words in the English language for me to do that. But h.e.l.l, just give me the chance, I'd laugh at his jokes all night for what he did for me.

*We a.s.sumed that the yield on a similar risk-free Treasury bond is 4 percent. At this time, Countrywide bonds paid only 1 percent more than the Treasury bond as compensation for risk that the bond could default.

4.

The Man in the Ivory Tower There were mind-blowing tales of d.i.c.k Fuld's temper, secondhand accounts of his rages, threats, and vengeance. It was like hearing the life story of some caged lion.

I ENTERED THE ENTERED THE marble halls of Lehman Brothers on Wednesday morning, July 21, 2004, at the usual start time, six o'clock. The sun was rising over the distant East River, yellow cabs were thundering through quiet streets at the highest speeds they would reach all day, and G.o.d was in his heaven, probably applauding me as I pushed open the doors below the towering gla.s.s ramparts of 745 Seventh Avenue. marble halls of Lehman Brothers on Wednesday morning, July 21, 2004, at the usual start time, six o'clock. The sun was rising over the distant East River, yellow cabs were thundering through quiet streets at the highest speeds they would reach all day, and G.o.d was in his heaven, probably applauding me as I pushed open the doors below the towering gla.s.s ramparts of 745 Seventh Avenue.

The breathtaking history of this great finance house had not begun in here. That had happened back in 1868 down in lower Manhattan, where the ghosts of the long-dead Lehman brothers probably still resided. But nothing died when the corporation made its move here in 2002, and a thousand Wall Street legends, fables, and sagas down all the years somehow slipped silently into the carpeted hallways of this modern Tower of Babel. I could feel them, every step I took.

Lehman. The very name conjures up visions of a select men's club, a paneled haven from the world's vulgarities, especially formed for men of breeding and high intellect; a dining room in which was served only the finest Bordeaux, and a boardroom where stimulating conversations abounded and great fortunes were created.

Much of the wealth of the United States owed its beginnings to the dazzling brilliance of financiers, all named Lehman, who had plotted and schemed on behalf of the firm. The roots of the place stretched back to the 1840s, to the fields of Alabama and the town of Montgomery, which had four thousand white citizens and two thousand black slaves. When cotton was king. To that thriving heart of the Old South, Henry, Emanuel, and Mayer Lehman, cattle merchants from Bavaria, had journeyed, and they made it their home. Since every other immigrant of the time headed like homing pigeons to New York, gateway to the New World, it was probably not a fluke that these three future financial t.i.tans made straight for the center of the cotton industry, the place that really counted in the world's shipping and trading operations. In 1850 they established their own trading and dry goods business and called it Lehman Brothers.

The Civil War devastated the South and caused tempestuous highs and lows in the cotton industry. By 1868 the Lehmans had moved to lower Manhattan, where they not only founded the New York Cotton Exchange but joined in boldly in the postwar expansion of trading stocks and bonds. In particular, they sold bonds to raise money for their home state of Alabama, which was almost bankrupt and desperately trying to build textile mills and railroads. They also helped found the Coffee Exchange and the Petroleum Exchange.

The Lehmans made their breakthrough into cooperation with the old Wall Street families by helping to build a couple of major banks, Mercantile National and Manufacturers Trust. By the turn of the century they were in heavy cahoots with Goldman Sachs and they raised money to help launch Studebaker (with the first pneumatic tires) plus the General Cigar Company and Sears Roebuck.

I looked around the walls as I walked through the third floor to meet Larry McCarthy. Everywhere there was evidence of one of the most ill.u.s.trious investment banking corporations in all of history: photographs, stern portraits of Lehmans past. This was the family that had sp.a.w.ned four generations to run their corporation, all the way from the cotton fields of Alabama in 1850 to the death of the immortal Bobbie Lehman in 1969. Almost 120 years of excellence.

During that time the firm had raised the capital, even invested their own wealth, in helping to start huge retail operations such as Gimbel Brothers, F. W Woolworth, and Macy's. They nurtured the airlines American, National, TWA, and Pan-American. They raised the capital for Campbell Soup Company, Jewel Tea Company, and B. F. Goodrich.

Bobbie Lehman personally was the driving financial force behind a new outfit that believed it could transmit moving pictures-RCA, the birth of television. Lehman, under his guidance, also backed the Hollywood film studios RKO, Paramount, and 20th Century Fox, plus the TransCanada pipeline and Murphy Oil, along with a giant of the oil service business, Halliburton, and the exploration and production newcomer Kerr-McGee.

Like his father, Philip, and his grandfather Emanuel, Bobbie led a corporation that was long on integrity, trusted and admired. Though the family's Jewish origins evoked mild hostility from social giants such as the Astors and the Morgans, the pure decency and efficiency of the Lehmans overcame all. Down the years many other partners from outside the family joined the corporation, and they were all men of stature and achievement. For almost a hundred years Lehman represented a business aristocracy, an organization all other New York investment banks secretly aspired to emulate.

I had obviously been reading up on the Lehman history in the days leading to my arrival. And the magazine articles about Bobbie were fantastic. He owned a string of racehorses and a $100 million art collection. The firm's longtime New York headquarters at 1 William Street was hung with paintings by old masters such as Botticelli, Goya, Rembrandt, and El Greco. There were works by Renoir, Matisse, Pica.s.so, and Cezanne, all part of his private collection. They were also part of an enormous gift of three thousand works he later made to the Metropolitan Museum of Art, a gift that the curators described as "one of the most extraordinary private collections ever a.s.sembled in the United States."

Bobbie was a close friend of some of the most powerful men in the country. He played on one of the great United States polo teams, with teammates such as Jock Whitney and Averell Harriman. He made the banker and car rental king John Hertz a senior partner in Lehman, and the two of them often went to the races together. Like Whitney, Hertz was a major owner-breeder of thoroughbreds, and owned the 1928 Kentucky Derby winner Reigh Count, sire of Hertz's 1943 Triple Crown winner, Count Fleet. Bobbie Lehman was a member of New York City's aristocracy. His cousin Herbert Lehman was governor of the state, and later became a U.S. senator.

Bobbie focused the firm on venture capital. And he had an inspired touch at spotting new businesses, leading his family firm into an undeniable golden age. There should have been a crystal ball on his desk. Over and over he listened to people, helped them develop their ideas, and then backed them either with the firm's money or by raising it for them. "I bet," he once said, "on people."

And now I walked the hallowed floors of this bank, and it's still difficult for me to explain what it meant on that first morning. I knew the place had made a twenty-first-century move from its famous old headquarters in the financial district, but so far as I was concerned it was like moving a cathedral. The real estate was different, but the holiness remained.

G.o.d knows what Bobbie Lehman would have thought if he'd known the real reason why Lehman had paid $700 million for this 1,000,000-square-foot office building. Because the real reason was the terrorism of 9/11, when Lehman had occupied three floors of One World Trade Center, with another 6,500 employees in Three World Financial Center, amidst the carnage and the debris.

Bobbie died two years before the Twin Towers were completed. He never saw them rise to their heights, and he'd been gone 32 years when the gleaming Boeing 767, owned by the airline he had helped to create, smashed into the 84th floor of the North Tower.

Larry McCarthy took me down to the trading floor, which looked a lot like that at Morgan Stanley. There were well over a hundred people already there, all standing up in front of banks of computer screens-and, it seemed to me, all shouting. The temperature was around sixty degrees, which felt freezing even on this hot July morning. Larry told me it was kept that way even in the winter: cool, with oxygen being pumped in to give everyone as much energy as possible. I knew a lot of casinos in Las Vegas and even the Mohegan Sun complexes followed that policy, just to keep the gamblers energetically hurling their cash at a system geared to stop them from winning. That was not the objective at Lehman Brothers.

My opening day was spent meeting and spending time with two top female operators with whom I would be in constant touch every day. The first was Christine Daley, who was in her thirties at the time and head of distressed-debt research. Christine was a vulture's vulture. They say she could tell you to the penny what General Motors was worth at any given moment in the week, even in the auto giant's darkest days-particularly in the auto giant's darkest days. in the auto giant's darkest days.

Christine was a beautiful, slim, immaculately dressed Italian-American. I heard she earned over $2 million a year. She was watchful, and very skillfully set out to find out precisely what I knew. And she was no pushover, not the kind of person to whom I could easily have sold a couple hundred pork chops. And she had a towering reputation as a researcher who could slice and dice any big corporation, and swiftly come up with an eye-wateringly correct valuation. Unsurprisingly, she had graduated magna c.u.m laude from the College of New Roch.e.l.le with departmental honors in all semesters. At New York University's Stern School of Business she graduated number one in her cla.s.s, which was doubtless no shock to anyone.

Her second-in-command was a corporate brainiac, Jane Castle, thirtyish, a pet.i.te woman whom Larry described with undiluted admiration as "one hundred pounds of h.e.l.l." She was married to another big-hitter at Lehman, Joe Castle. Their double-barreled income had provided them with an apartment in the city and a summer house at the Jersey sh.o.r.e. Jane was reputed to be Christine's equal at a.s.sessing the value of a corporation down to the minutest detail. Larry had told me, "Jane can tell you what Delta Air Lines is serving for lunch in first cla.s.s on their morning flight from JFK to Berlin, and what it cost them. There's nothing she doesn't know about that company."

Jane came from Queens, a borough of New York City. She should have been from Missouri, because she accepted nothing at face value. No statement by any executive of any corporation, large or small, was good enough for her, because it might have been inaccurate or careless. She had to know know the truth. I knew I would have to earn her trust in the weeks to come. It wasn't just there for the asking, even though I was one of Larry McCarthy's oldest friends. the truth. I knew I would have to earn her trust in the weeks to come. It wasn't just there for the asking, even though I was one of Larry McCarthy's oldest friends.

I knew from the first moments I spent with Christine and Jane that this was the major leagues. I was in the presence of greatness with these two. I might be shorting major corporations in the near future, with millions of Lehman dollars on the line. But I had access to these two steel-trap minds. And right from the start my confidence was high.

The only thing that was not high about my situation was the floor I worked on-the third. But I quickly learned this was not a permanent state of affairs. Lehman moved their departments up and down in the building all the time, trying to ensure no one became too comfortable in their environment. They already made sure no one became warm either, with that chilly air they kept pumping through. The day I arrived the elevator order was: second floor, equities; third floor, fixed income (high grade and high yield); fourth floor, mortgages; fifth floor, capital markets investment banking; sixth floor, CDO and CLO structuring; seventh floor, munic.i.p.als and investment management. Within weeks that would change.

Right off the bat, I was placed next to Larry, the best place to learn the ropes fast. On my other wing was a twenty-eight-year-old big-league bond trader named Joe Beggans, whom I already knew from trips on Larry's fifty-two-foot Viking powerboat. Joe was a gutsy operator, still recovering from the battering he'd taken during the dot-com uproar and from trading Enron and Adelphia bonds. That was like standing under a falling chain saw. And that was how Big Joe had learned his trade.

He stood about six foot six and had been the number three quarterback on the University of Pennsylvania football team. We all knew that meant not a whole lot of playing time, but only Larry took it to its humorous limit. With Joe in full cry about some bond issue, Larry would solemnly get down on one knee and stretch both arms out in front of him, palms facing each other, ready for the snap in the dying moments of the game. After a few seconds, without a smile, he would return to his screen having made a charade of what he claimed was Joe's entire quarterback career: about two minutes. Of course, everyone fell over laughing, which was why Larry performed the ritual in the first place. But Joe really liked Larry and took it in good humor, chuckling at the hysterical sight of his diminutive boss down on one knee ready for the snap in the middle of Lehman's bond-trading floor.

Another member of our team was Peter Sch.e.l.lbach, whom we called Sch.e.l.l. A calculating and somewhat skeptical bear, he was our senior bank-debt man, specializing in power plants, making sure of our first claims when anything went wrong. Sch.e.l.l bought distressed power-plant bank debt at 40 cents on the dollar, but he always worked on the innate value of a power plant, and often correctly a.s.sessed it would go back to 70 or even 90 cents once the corporation cleaned house and got rid of the excesses. He told me he was hugely helped in these ventures by Christine and Jane. They made a h.e.l.l of a team, the ladies' academic caution allied to his aggressive trader mentality. One year they made profits for Lehman of well over $100 million.

Sch.e.l.l was a very good golfer and owned a house in the Hamptons. He was married with two sons, and played in a rock band that gigged at the Red Lion in New York once a month. He played the electric guitar, stuff from the Grateful Dead and the Who-cla.s.sic rock. He was a fantastic musician, and a whole group of us used to go and watch him.

Alex Kirk was probably one of the most respected men at Lehman, and he was only about six years older than I was, still in his mid-forties. Wall Street legend has it that he was one of the biggest distressed-debt traders on the dot-coms and telecoms, and made about $250 million for the firm when they all crashed. That put him on the map-h.e.l.l, it would have put anyone on the map. He'd gone to Trinity, the private liberal arts college in Hartford, Connecticut. His job t.i.tle was global head of high-yield and leveraged loan businesses. He wasn't a real bear's bear. He was just a calculated skeptic. He and Larry were big pals.

My new desk among the traders faced the salespeople. I spent the first month learning, watching, doing the research, particularly in subjects I knew a lot about-convertible bonds, airlines, energy, technology. But I was blown away by my new colleagues' depth of knowledge and the intricate types of modern debt instruments they worked with.

There were times when I did not know how the h.e.l.l I'd gotten in here, especially since Lehman was famous for recruiting battalions of the best young minds in the country, highly educated Ivy League types, magna c.u.m genius, born and bred for Wall Street from the time they were infants, and then sent to private schools such as Choate, St. Paul's, Exeter, Tabor, Andover, and St. John's. Almost everyone I met at Lehman had attended Harvard or Harvard Business School, MIT or the Sloan School, Yale, Princeton, Penn or Wharton, Northwestern, Stanford, North Carolina, or Duke. It should have been downright intimidating, but I'd been through the mill by now. I'd founded a million-dollar corporation, I'd worked at Merrill Lynch, Smith Barney, and Morgan Stanley. My resume would stand up to anyone's.

My own mantra was close to that of Mike Douglas in Wall Street: Most of these Harvard MBA types, they don't add up to dog s.h.i.t-give me guys that are poor, smart, hungry, and no feelings. You win a few, you lose a few, but you keep on fighting Wall Street: Most of these Harvard MBA types, they don't add up to dog s.h.i.t-give me guys that are poor, smart, hungry, and no feelings. You win a few, you lose a few, but you keep on fighting. Didn't impress Lehman, though. Every year they sent out their best and brightest to talk to and lecture these kids, take them out to dinner, take them to events, have them as interns in the summer, even at Christmas. They paid them well as interns, nurtured them. I could not believe the coddling, the opportunities they were given. Perfect lives, blessed at birth.