Andrew Sorkin - Too Big to Fail - The Inside Story of How Wall Street and Washington Fought to Save the FinancialSystem--and Themselves

“This is bullshit,” Wieseneck exclaimed after the initial session ended, having served little purpose other than to make introductions. Even as the talks progressed, the Lehman team could hardly tell to whom they were speaking. At one point Russo engaged in what he thought was a productive exchange with an individual who turned out to be an outside accountant. “Relying on Kunho is like bottom of the ninth, two outs, in the World Series,” Shafir complained to his American colleagues the first night in the bar, “and you send up a guy to the plate who hasn’t gotten a hit all year.”

Lehman had wanted to start discussions at $40 a share, but by the end of the first day the stock was at $30. Nobody—not even this group of deal-hungry Koreans—was going to pay a 33 percent premium. The whole affair became increasingly unreal.

No food was served at the meetings, so the Lehman bankers were starving by the time they got back to their hotel, where the meals were generally dreadful. The only palatable item they could find on the menu was tuna, which most of them ate every day of their stay.

But neither the subpar accommodations nor the Koreans’ erratic behavior could dent Russo’s enthusiasm: He was going to make this happen. “They’re going to do this deal,” he told his colleagues, supported by Kunho and Bhattal. “They’re going to put in $10 billion. They’re going to make their balance sheet available for loans.”

No, they aren’t, thought Shafir. They aren’t going to do anything of the kind.

Sitting on a hotel room bed crowded around the speakerphone, the group called Fuld back in New York, with Russo leading the conversation. “Dick, I’m feeling very good about it,” Russo enthused. “I think we have a 70 percent chance of getting something done with these guys.”

Fuld’s delight at the news, however, was short-lived. The group returned to New York empty-handed on June 5; efforts to come up with even a rudimentary term sheet had completely failed. The Koreans had obviously been deterred by Lehman’s cratering stock and simply may not have had the wherewithal to bring about such a major piece of business. Even Russo had lost confidence. “We’re not going to get a deal with these yoyos,” he told Fuld.

Moments after hearing the news, Fuld, frustrated as ever, screamed down the hall at Steven Berkenfeld, a member of the firm’s executive committee.

“Were you the one who said you can’t trust the Koreans?” he asked.

“I don’t think I phrased it that way,” Berkenfeld said.

“Yes, you did,” Fuld said. “And you were right.”

The Korean deal wouldn’t go away quietly, though. A few days later, Min called Fuld and insisted he still wanted to get something done. Fuld figured the only way it was remotely possible was if the Koreans hired a real adviser. So he called up Joseph Perella, the mergers and acquisitions guru who had recently started a new firm, Perella Weinberg Partners.

“Listen, I’ve got something for you,” Fuld told Perella. “You’re going to get a call from ES. Do you know him? He used to work for me.”

Fuld was explicit about what he needed out of the deal. “We’re trading at about $25. Our book value is $32. We need a premium, so we’d take $35 to $40.”

Perella, who assigned the project to his colleague Gary Barancik, didn’t think the odds were good. KDB was a national institution with what seemed to him to be a local charter. They had no business branching out with a risky international deal. “It’s like the Long Island energy utility trying to buy something in Russia,” he told Barancik.

But they promised to do the best they could.

Fuld was also dealing with another problem: a potential whistle-blower.

One of Lehman’s employees, Matthew Lee, a senior vice president in the finance division whom Fuld scarcely even knew existed, had just weeks earlier sent a letter to the company’s senior management in which he claimed to have uncovered a series of accounting and management problems at the firm.

Fuld’s inner circle dutifully forwarded the letter to the firm’s auditors and the board, but weren’t overly concerned by it. To them, Lee had always been something of a troublemaker. Because they had recently demoted him and were planning to fire him, they viewed the letter as more of an extortion attempt by a disgruntled employee looking for a severance agreement than anything they should worry about.

However, during a meeting with the firm’s auditors, Ernst & Young, Lee raised a serious red flag about one of the firm’s practices that was also quietly being questioned in other parts of company: an accounting trick known as Repo 105.

What the public did not know—nor did some of Lehman’s top executives, including Fuld—was that Lehman had been artificially lowering its quarterly leverage ratio by using an accounting sleight of hand. At the end of every quarter, Lehman’s government securities business would “sell” securities to a counterparty in exchange for cash, which they’d use to pay down debt. But days after the quarter ended, Lehman would turn around and take the securities back onto their balance sheet and return the cash.

Instead of accounting for these deals in the traditional manner as “repurchase agreements” or “repos,” in which the firm would lend securities in exchange for cash, classifying them as “sales” had the effect of making the firm’s leverage look lower in than it really was: Lehman had managed to move $49 billion off of its books in the first quarter of 2008 and $50 billion in the second quarter.

Within certain parts of the firm, Repo 105 was an open secret. In early June Michael McGarvey, a finance controller, sent an e-mail to his colleague Jormen Vallecillo explaining the accounting practice as “basically window dressing. We are calling repos true sales based on legal technicalities.” Vallecillo replied, “I see … so it is legally doable but doesn’t look good when we actually do it?”

Lehman’s London-based law firm, Linklaters, had blessed the practice, but that didn’t keep other senior executives from being anxious about it. Back in April Hyung Lee, global cohead of fixed income, e-mailed Bart McDade, “Not sure you are familiar with Repo 105,” he began. McDade shot back, “I am very aware… . It is another drug we r on.” In early June McDade issued an edict that the firm would cut its use of Repo 105 by half.

Lee, as expected, was dismissed and was paid $300,000 in cash to leave the firm. As part of his severance agreement, he agreed “not to make any remarks now or at any time in the future to any third party, such as a client, a competitor, or the media, that could be detrimental or adverse in any way to Lehman.”

With Lee gone, Fuld and the firm had bigger things to agonize about, or so they thought.

Skip McGee, a forty-eight-year-old Texan, commuted to New York every week from Houston to run Lehman’s investment banking operations. He’d board a private plane using the firm’s NetJets account every Sunday evening around 7:30, land in New York around midnight, and take a car to his rental on the Upper West Side. Come Thursday night he’d be on a first-class flight back to Houston on Continental.

McGee, a classic, old-school, back-slapping banker, was clearly ambitious. After graduating summa cum laude from Princeton and getting a law degree, he had spent nearly two decades at Lehman, first as a banker for wildcatters in the oil patch of his backyard and then moving up the ranks until he became the head of the entire investment banking division and joined Fuld’s vaunted executive committee.