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

As he leaned into his jog, CNBC reported that Lehman Brothers had just announced its earnings ahead of its conference call. The firm, the reporter elaborated, had also described its extraordinary spin-off plans in its press release. When Fleming returned to his room, he got a colleague to send him the announcement, which included an important headline buried at the bottom: “The firm remains committed to examining all strategic alternatives to maximize shareholder value,” which meant that it was open to just about anything. He knew the company had been quietly shopping pieces of itself, but that statement effectively made it official, at least to those paying attention. Lehman, the entire firm, was up for sale.

From his days as a merger banker focusing on financial services, he knew that if Lehman was on the auction block, Bank of America would be the likely buyer. But if Lehman was sold to Bank of America, the implications for his own firm, Merrill Lynch, would be enormous. He had long believed that Bank of America was the natural buyer for Merrill; at a Merrill board meeting just a month earlier, Bank of America had been listed in a presentation as just one of a handful of compatible merger partners.

Fleming began trying to figure out whom he knew who might be working on a deal with Bank of America. Ed Herlihy of Wachtell, a longtime friend and one of the legal deans of banking M&A, immediately came to mind. Herlihy had worked on nearly every deal Bank of America had orchestrated over the past decade.

“This is getting ugly,” Fleming told Herlihy when he reached him on his cell. “How are my friends in Charlotte?”

Herlihy could see where this conversation was heading and took steps to deflect it immediately. “Let’s not go there, Greg,” he replied.

“Just tell me. If you’re thinking about Lehman, you have to tell me. We could be interested in talking at some point. You and I both know that would be a much better deal.”

Herlihy, clearly uncomfortable, said, “We’ve been down this road before. We’re not going to do anything unless we’re invited in. If you are serious, now would be a good time to get moving on that.”

That was all the confirmation Fleming needed to be convinced that Bank of America was indeed bidding for Lehman.

Fleming had one more call to make before his first meeting that morning. He wouldn’t contact John Thain just yet—Thain, he suspected, wouldn’t be interested at this point, for whenever Fleming had tried previously to discuss contingency plans to sell the bank, he had been dismissive. Instead he phoned Peter Kelly, Merrill’s deal lawyer, and recounted his conversation with Herlihy.

“Look, you have to make sure Bank of America is there for us,” Kelly instructed him after the two had discussed the ramifications. “You have to convince John.”

“That’s a high bar,” Fleming said. They both knew that he and Thain had a fundamentally antagonistic relationship.

“I know,” Kelly said, “ but that’s why you get paid the big bucks.” Before hanging up, he made one last point: They might have to go over Thain’s head. “If you can’t convince John—and I know this is subversive behavior, but this is in the interest of the shareholders—you need to reach out to the board.”

The conference room on the thirty-first floor of Lehman Brothers was more crowded than usual for an earnings call, but what was typically a fairly routine affair had lately begun to be perceived as something more akin to an impeachment trial. Lehman was taking the situation seriously enough to have stocked the room with additional lawyers. Lehman technicians, meanwhile, were scrambling to ensure that the conference call and Webcast would go off without a major hitch. The firm had ordered hundreds of extra phone lines to keep up with the demand. The press release issued that morning forecast a third-quarter loss of $3.9 billion—the firm’s biggest ever.

Fuld strode in assuredly, as if nothing was out of the ordinary. Everyone in the room, however, knew that for years he had always let his chief financial officer handle these calls, as he had never been truly comfortable participating in them. As he took his seat at the head of the table, Fuld looked around the room with his trademark disarming glare, trying to settle in with his script and papers. He knew what the stakes were. Moments earlier he had taken a quick glance at the Bloomberg terminal to see if U.S. stock index futures might be higher on the hopes that he, Dick Fuld, would be able to ease fears about Lehman. But overnight, Asian stocks had slid, and Europe was even lower. There was a lot riding on what he would say today; millions of dollars would either be made or lost on exchanges the world over depending on how his presentation was received.

Shaun Butler, the head of investor relations, looked over at her boss. “Are you ready?”

“Yeah,” answered Fuld, faintly growling.

As the call was engaged, he slowly lowered his head and launched into his script, intoning deliberately: “In light of these last two days, this morning we prereleased our quarterly results. We are also announcing several important financial and operating changes that amount to a significant repositioning of the firm, including aggressively reducing our exposure to both commercial real estate and residential real estate assets.

“These will accomplish a substantial de-risking of our balance sheet and reinforce the emphasis on our client-focused businesses. They are also meant to mitigate the potential for future write-downs, and to allow the firm to return to profitability and strengthen our ability to earn appropriate risk-unadjusted equity returns.”

The executive summary: Lehman Brothers will be just fine. We appreciate your concern, but we have the situation under control.

“This firm has a history [of facing adversity] and delivering,” he continued. “We have a long track record of pulling together when times are tough and then taking advantage of global opportunities… . We are on the right track to put these last two quarters behind us.”

Fuld now handed off to his CFO, Lowitt, who, in his clipped South African accent, outlined what Lehman billed as its “key strategic initiatives.” The firm would seek to sell a 55 percent stake in its money-management business, which included Neuberger Berman, and it would spin off much of its commercial real estate holdings—otherwise known as “the bad stuff.”

Shifting as much as $30 billion of Lehman’s commercial real estate holdings, including its investments in Archstone-Smith, the owner of 360 high-end apartment buildings, and SunCal, a property developer, was no small undertaking. One thing that would be changing immediately was how Lehman valued its real estate assets.

Lowitt continued: “The real estate held-for-sale portfolio, consisting of assets across the capital structure, is booked at lower of cost or market as we take write-downs on this book, but do not reflect market value gains until a sale event occurs. REI Global”—the new entity’s infelicitous acronym—“will account for its assets on a held-to-maturity basis and will be able to manage the assets without the pressure of marked-to-market volatility. REI Global will not be forced to sell assets below what it believes to be their intrinsic value.”

On the surface the spin-off appeared to be a clean, elegant solution. It removed the troubled assets from Lehman’s balance sheet, leaving a stronger firm, just as Fuld had indicated that it would. But what was left unsaid was precisely what had concerned the bankers at the meeting with JP Morgan and Citi the night before: The new company would likely need to be funded. Where was Lehman going to come up with the money to accomplish that when it needed to retain as much capital as possible?