House of Cards (89 page)

The assembled bankers spent much of Saturday, Saturday night, and Sunday morning poring over Lehman's commercial real estate books to see if they felt comfortable putting together financing to facilitate Barclays's acquisition of the rest of Lehman, including its global fixed-income, equities, investment banking, and asset management businesses, which totaled some $600 billion of assets.

Fuld and Lowitt had announced on Wednesday that the commercial real estate assets would be marked down to $33 billion—from $40 billion—before being contributed to “SpinCo.” But on Saturday, as the bankers from Goldman Sachs, Credit Suisse, Citigroup, and Deutsche Bank—the subgroup assigned to work on the project of putting together financing for Barclays—analyzed Lehman's loan and securities portfolio,
they quickly realized, according to one participant, “the effective marks on the assets should probably be $12 billion lower,” or $21 billion, rather than $40 billion, almost a 50 percent discount to their marked value (notwithstanding the Wednesday revision). “There wasn't a disagreement among the group about what the write-down should be,” he said. “The reaction was one of considerable surprise but also tinged with the sort of skepticism that you would expect given the way in which the company shares had been trading…. The fact is the market clearly didn't believe their valuations, and when the team got in there to look at it they realized why.”

But there was some disagreement about the $21 billion valuation depending on whether some institutions would have to mark them to market. As a compromise, the four banks instead recommended to the other banks in the consortium that Lehman's real-estate portfolio be valued at around $25 billion. The hole the consortium of banks had to fill was closer to $15 billion, meaning that each one would need to provide around $1 billion to finance the commercial real-estate assets left behind by Barclays in what would remain of Lehman Brothers. They knew that they would have to take a write-down on their loans as the assets were sold into the market over time. But to facilitate the Barclays deal, they were willing to do it. “There was a real concern that the demise of Lehman would lead to real problems for everybody else,” one banker said. “When you've got a tsunami coming in, it starts to get pretty uncomfortable for everyone.”

W
HILE MOST OF
Wall Street was hunkered down at the New York Federal Reserve to review Lehman's books, Greg Fleming, the president of Merrill Lynch and a former financial institutions banker, had been urging his boss, John Thain, Merrill's CEO, to call Ken Lewis to talk about a deal between the two firms. Fleming had grown concerned during the week as Merrill's stock fell to $17.05 per share, from $28.50 per share. Fleming also knew that Lewis had long coveted Merrill Lynch and that Fleming's previous boss, Stan O'Neal, had no interest in such a deal.

“It's an iconic name,” Lewis told
Fortune
about Merrill Lynch and the “one company” he wanted “to round out” his strategic vision for Bank of America. He said owning Merrill Lynch “would give us a major presence in investment banking as well as wealth management.”

Thain, who had been at the Fed on Friday night, knew by Saturday morning that Bank of America was out of the hunt for Lehman, and he had also decided that Lehman was not going to be saved. If Lehman declared bankruptcy, he figured Merrill would be the next domino to fall.
He had watched the group of bankers “pummel” Bart McDade, Lehman's president, with questions about Lehman's assets “and decided he did not want to be next,” according to a banker there. “It became clear to me that it would make sense to explore options for us,” Thain said in the press conference after announcing the deal.

Thain got Lewis's cell phone number from Fleming, stepped out of the meeting and called the Bank of America CEO. “We began to talk about the opportunity over the phone,” Lewis said. “Then a few hours later, we were talking about it in person.” Rumors began circulating at the New York Fed that Thain and Lewis were talking about a deal. In the interim, Lewis flew up by private jet from Charlotte to New York. They agreed to meet secretly in a Bank of America corporate-owned apartment at the TimeWarner Center, at Columbus Circle. “It didn't take but about two seconds to see the strategic implications or [the] positive implications” of the deal, Lewis said. “It was obviously a fairly short period of time, very intense and we saw a lot of each other.” Following his call to Lewis, Thain said the two men “quickly” realized “the strategic combination made a huge amount of sense, and the opportunity to put this transaction together really was [so] unique that we both decided we wanted to take the opportunity.” The code name for the deal was “Project Alpha.”

At his side as an advisor Lewis had J. Christopher Flowers, the head of his own private-equity firm that specialized in financial services. Flowers, an ex-Goldman partner, seemed to have examined the books of nearly every Wall Street firm by September 2008, including Bear Stearns and Merrill Lynch. “[Flowers] had done quite an amount of due diligence on Merrill Lynch fairly recently,” Lewis said. “It was very, very extensive. They had looked at the marks very comprehensively. This allowed us to have him and his team as an advisor, and just update the information they already had. That was one of the key ingredients to being able to do this as quickly as we did.” Flowers was very complimentary of what Thain and his team had done in terms of shedding assets, including Merrill's 25 percent stake in Bloomberg and a $30.6 billion portfolio of troubled, mortgage-backed securities for 22 cents on the dollar.

Lewis determined he had to move quickly to win Merrill. Not only had he wanted to own the firm for years, he also was aware that Goldman Sachs and Morgan Stanley were in the mix. Merrill had reached out to Morgan Stanley about a deal. Morgan Stanley passed quickly—reportedly because the firm decided there simply was not enough time.

Separately, on Saturday morning at the Fed, representatives of Goldman Sachs reached out to former Goldman partner Peter Krause, Merrill's newly recruited head of strategy, to see whether Merrill would
consider allowing Goldman to make a 9.9 percent minority investment in Merrill. This set off a heated debate—according to someone who witnessed it—between Krause and Fleming about whether Merrill should pursue the Goldman deal or the Bank of America deal.

For Goldman, the idea was to save a rival and to keep the fury of the looming storm at bay. “I think about it in terms of the Great Barrier Reef,” one Goldman executive said. “If you think of Bear as being an outlying piece of coral at the far eastern extremity of the reef, then Lehman is a bit closer in and then Merrill is a bit closer. Then Morgan Stanley and Goldman Sachs are on the beach but still pretty close to the water. When you have a tsunami coming in, it's getting to be pretty uncomfortable.”

Merrill and Bank of America executives were closing in on an all-stock deal, in which Merrill shareholders would receive $29 per share in Bank of America stock, which valued Merrill at $50 billion, a 70 percent premium to where Merrill's stock had closed the previous Friday.

M
EANWHILE, BACK AT
the Fed, tempers started to flare. The assembled bankers were still wrestling with how to value the Lehman real-estate assets that Barclays wanted to leave behind. “It was a question of how much equity we needed to put up,” one banker said, “to make the Barclays deal fly.” This led to increasing tensions on all sides. At one point, late Saturday night, Gary Shedlin, a M&A banker at Citigroup, faced off against his old boss, Michael Klein, who was there representing Barclays and his client, Archibald Cox Jr., who was appointed chairman of Barclays Americas in April 2008.

“How much equity do you need to raise to do the deal?” Shedlin asked Klein.

“Why is that important?” Klein shot back. “Why do you need to know that?”

“You're making an offer for this company and we've got to know how you're going to finance it,” Shedlin countered.

“We will not have to raise any incremental capital as part of this transaction,” Klein said definitively. The two men glowered at each other before turning to less confrontational matters.

Bankers worked most of the night to put together a term sheet for how they would all agree to support Barclays's acquisition of most of Lehman Brothers. Some banks—such as BNP-Paribas and Bank of New York— were not so sure they wanted to participate, causing Jamie Dimon, the CEO of JPMorgan Chase, to admonish them. “You're either in the club or you're not,” he said, according to one banker. “And if you're not, you'd better be prepared to tell the secretary why not.” Still, a deal seemed close.

On Sunday morning, the executive group reassembled at the Fed at nine o'clock. “Everything was ready to go on Sunday morning,” one participant said. “People were happy with the term sheet, so there was a doable deal on the table.” Steve Shafran, a senior advisor to Paulson and a former Goldman Sachs partner, told a group of Lehman Brothers executives at the Fed that morning, “It looks like we may have the outlines of a deal around the financing.” After which, the Lehman bankers thought they had saved their firm.

The Barclays deal required the blessing of the Financial Services Authority, in London—the UK equivalent of the SEC. So Paulson spoke with his UK counterpart, Alistair Darling, the Chancellor of the Exchequer, and to the FSA. He then summoned McDade, Lehman's president, to the New York Fed and told him at around 9:45
A.M.
, “Deal's off. The FSA has turned it down.” At roughly 10 o'clock, Paulson and Geithner briefed the bankers at the Fed. The FSA would not comment on its decision, but a number of the participants at the Fed on Sunday morning said the reasons given to them by Paulson for the FSA's rejection ranged from “the overall size of the potential exposure that Barclays was taking on and whether Barclays was in good enough shape to do it” to the fact that the “FSA was looking for some kind of a cap to avoid U.K. contagion, and the Fed had just said, ‘No assistance for Lehman.' The FSA then concluded based on the amount of diligence, the risk profile, and the lack of any assistance from the U.S. that they were not going to let it proceed.”

There was also the suggestion made that Barclays “wasn't really that serious about getting FSA approval” going into the weekend knowing that there might be an opportunity to buy what it wanted from Lehman later at a lower price. (Barclays did not make its senior officials involved with the Lehman deal available for comment.)

T
HE
L
EHMAN TEAM
was devastated by the news. “We thought we had a trade and felt good about it and thought we were in the right place,” explained one Lehman banker, “and then to have the rug pulled out from under us after we were led to believe that the Street was there on the financing, it was just horrifying from our perspective.” The stunned Lehman team returned to 745 Seventh Avenue to plot its next moves. Paulson then told the remaining bankers, according to one, “Let's start talking about what the world will look like if Lehman goes under. Let's focus on a solution for stabilizing the markets.” Among the people still present for Paulson's Sunday morning speech was John Thain. After Paulson and Geithner left the executives to contemplate what they could do as a consortium to keep the world's markets from collapsing completely, the assembled
alpha males began talking about Merrill Lynch in front of Thain, as if he weren't there.