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

Fannie and Freddie were still reeling from the accounting scandals when in March 2008, just days after the rescue of Bear Stearns, the Bush administration lowered the amount of capital the two companies were required to have as a cushion against losses. In exchange, the companies pledged to help bolster the economy by stepping up their purchases of mortgages.

But by that Wednesday, July 10, 2008, with investors unloading the stocks in droves, it was all coming undone. That afternoon William Poole, the former president of the Federal Reserve Bank of St. Louis, said unambiguously, “Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer .”

“Unfuckingbelievable!” Dick Fuld exclaimed to Scott Freidheim as he sank deeper into his office chair.

Lehman’s stock had opened Thursday morning down 12 percent, to an eight-year low, in response to a rumor that Pacific Investment Management Company, the world’s biggest bond fund, had stopped trading with the firm. Another piece of speculation was swirling that SAC Capital Advisors, Steven Cohen’s firm, was also no longer trading with Lehman.

“I know it’s not true, you know it’s not true,” Fuld said to Freidheim. “You’ve got to call these guys and get them to put out a statement.”

It had been an excruciating week. With the continued market jitters over Fannie and Freddie—the result of Lehman’s own analyst’s report, no less—investors were also taking it out on the firm. Fuld couldn’t understand it; Lehman had taken its lumps in its previous quarter and raised new capital. Its balance sheet, he thought, was in better shape than it had been in a long time, reflecting Lehman’s decision to deleverage its investments—that is, reduce the amount of debt it used to make those investments.

To Fuld, it was the shorts who kept driving down the stock price, spreading false information about Lehman’s health. Fuld had been told by several people that the “whisper campaign” against the firm was emanating from one place: Goldman Sachs. It made Fuld sick. His son, Richie, worked at Goldman as a telecommunications banker.

He decided the time had come to call Lloyd Blankfein personally.

“You’re not going to like this conversation,” Fuld began. He said he had been hearing “a lot of noise” about Goldman’s spreading misinformation. “I don’t know that you’re not ordering this,” he said menacingly, as if trying to intimidate Blankfein into admitting it.

Blankfein, offended that Fuld would even attempt to bully him, said he knew nothing about the rumors and ended the call.

These conversations became almost daily occurrences. Days later, Fuld heard rumors that Credit Suisse was spreading rumors about Lehman. He jumped on the phone to Paul Calello, CEO of Credit Suisse’s investment bank. “I feel like I’m playing whack-a-mole,” Fuld told Calello.

The constant stream of bad news was not only affecting Lehman’s stock but was hampering Fuld’s efforts to raise more capital. Skip McGee’s investment banking team had been reaching out to at least a dozen prospects—Royal Bank of Canada, HSBC, and General Electric among them—but was coming up empty. The only suitor with any real interest continued to be the Korea Development Bank’s Min Euoo Sung, and though many executives on the thirty-first floor still had doubts about him, Fuld had directed the bankers to keep working on the Koreans. Indeed, he was even thinking about taking a trip to Asia himself to see Min in person to try to seal a deal.

Then it struck him: What about his old friend John Mack at Morgan Stanley, the second-largest investment bank in the country after Goldman Sachs? The firm had had an ugly second quarter, reporting a 57 percent decline in earnings from a year earlier, but it still had enough cash and buoyancy in its stock price to be able to make a deal.

Fuld and Mack had come up on Wall Street together, with Mack joining Smith Barney’s training program in 1968 before moving to Morgan Stanley in 1972, when it had just 350 employees. Like Fuld, Mack had begun his career in bond sales and trading. And again like Fuld, he had quickly made a name for himself. He was an effective salesman and someone who could be both charming and physically intimidating. Mack would stride through the trading floor and, seeing a chance to make big profits, would yell, “There’s blood in the water, let’s go kill someone!” Coming across a trader reading the Wall Street Journal at 8:00 a.m., he was known for saying: “I see that again, and you’re fired.” But, again like Fuld, he was also fiercely loyal to his people, once physically barring entry to the trading floor by upper management when he was still a trader.

Fuld called Morgan Stanley in New York and was transferred to Paris, where Mack was visiting with clients in the firm’s ornate headquarters, a former hotel on the rue de Monceau.

After some mutual disparagement of the markets, the rumors, and the pressure on Fannie and Freddie, Fuld asked candidly: “Can’t we try to do something together?”

Mack had suspected the reason for Fuld’s call, and while he didn’t believe there was much chance that he’d be interested in such a prospect, he was willing to hear Fuld out. There might at least be some assets that he would be interested in; he doubted he would want to buy the entire firm. Mack told him he would be flying back to New York on Friday and suggested they see each other on Saturday.

Fuld, clearly anxious to set up the meeting, said, “We’ll come over to your offices.”

“No, no, that makes no sense. What if someone sees you coming into the building?” Mack asked. “We’re not going to do that. Come to my house, we’ll all meet at my house.”

A harried Hank Paulson walked into room 2128 of the Rayburn House Office Building and took his seat. Today’s House Financial Services Committee hearing was scheduled to discuss “financial market regulatory restructuring,” but it was really just about Fannie and Freddie. Paulson also wanted to start laying the groundwork for obtaining authority from Congress to wind down these government-sponsored enterprises—if it became necessary, which he didn’t anticipate. Paulson had visited Barney Frank, the chairman of the hearing, earlier in the week and had been encouraged “to ask for what you need.” Frank had pledged to support him.

Now, as Paulson appeared before the committee with Ben Bernanke beside him, he made his case: “We’re going to need broader emergency authorities too—for the resolution or wind-down of complex financial institutions that don’t have federal deposit insurance,” he explained. “But that’s where we need to get. That’s what we’ve got to drive toward.”

Representative Dennis Moore, a Democrat from northeast Kansas, asked, “Do you still believe the GSEs pose a systemic risk to the economy?” Paulson replied: “I would say, Congressman, in today’s world I don’t think it is helpful to speculate about any financial institution and systemic risk. I’m dealing with the here and now.”

But by the time the market closed that day, the “here and now” had grown even worse, with more than $3.5 billion in the combined market value of Fannie and Freddie wiped out. Concerns were mounting about Fannie’s and Freddie’s debts and the rocky state of the mortgage-backed securities that the agencies had guaranteed. The markets were testing Washington’s resolve. How much chaos would the government tolerate before it stepped in?