The Devil's Casino (19 page)

In early summer 2005, not long after the incident, McDade was moved from the position of head of fixed income to replace Shafir as the head of equities. Some saw the move as a demotion, but McDade was so successful in his new job that it simply increased his power base within the firm. Now two huge divisions respected him.

After McDade’s demotion, the wives realized that their husbands’ fates at Lehman would first become evident within their own circle: that, in fact, the social dynamics of the firm would initially play out among themselves. “The women can’t hide their disdain for someone they know is on the way out. It ‘s like the herd leaving someone with a broken leg behind,” one says.

One of the great things about our firm is that if one of our people wants to get something done, such as finding the best doctor in the world, Lehman Brothers is small enough and flat enough that people are accessible where that can happen.

—Steve Lessing

I
n the 1990s Dick Fuld tried to make sure that at least one person in his entourage was whip-smart and unafraid to tell him the truth. The only way to do this was to appoint someone near him who would be content to remain under him, and be docile with regard to the rest of the senior team. “Dick was clever about this,” says Tom Hill. “He found a young talent who wouldn’t jostle the rest.”

Until April 1996, Mike Odrich, Fuld’s chief of staff, had been that person. Odrich was immensely likable, very bright, and completely loyal. He had attended Stanford and Columbia Business School. He had a single-digit handicap in golf. He had suited Fuld perfectly. But it was time for him to move on and build up Lehman’s fledgling private equity division, which at that point consisted of little more than a merchant bank. Odrich ‘s last big job as Fuld’s chief of staff was to find his own replacement. Fuld asked Odrich to bring him the sharpest young brain in the firm.

Odrich sent him a redheaded graduate of Northwestern University with an
MBA
from the Kellogg School of Management named Scott Freidheim. At Northwestern, Freidheim had been the captain for the university’s soccer team. He had been hired by Odrich and Hill in 1991.

Scott was the son of Cyrus F. Freidheim, the former vice chairman of Booz Allen & Hamilton and
CEO
of Chiquita. Freidheim was 31 years old at the time of his hiring, and was a senior vice president working in banking. He was, in many ways, like Fuld: a good athlete and intensely competitive—ruthlessly so, if need be—but he could also be charming. And he was extremely loyal.

When Fuld offered him the job, Freidheim immediately accepted. “Why don’t you think about it overnight? ” Fuld asked him. “Sure. I’ ll humor you,” said Freidheim. “Then I’ ll come back tomorrow and say I want the job.”

Fuld looked at him quizzically. Most people didn’t speak to him like that. Fuld preferred it when people treated him like the scary gorilla.

Freidheim knew this promotion was putting him in a precarious but potentially life-altering position. Mary Anne Rasmussen, then director of human resources, met with him about the job and he mulled it over, and reportedly told her, “I suppose that if you want to let it rip, get close to the sun. But you had better be comfortable with knowing that it’s either going to work out spectacularly well or it’s going to blow up in flames. It will not be an average experience.”

Freidheim struggled to engage with his boss for a while, and Joe Gregory was reportedly far from helpful. Colleagues say he considered Freidheim an obstacle—that he got in the way of Gregory’s direct access to Fuld. But Fuld also wanted to test his chief of staff, and make sure he paid his dues and earned credibility. So Fuld never offered Freidheim a simple “How are you?” or “How was your weekend?”

Freidheim didn’t respond well to this, and Fuld was growing wary of his latest chief of staff. “Is this guy really the right person?” he reportedly asked Odrich.

“Give him a chance,” said Odrich. “You’ ll see.”

Two years into his tenure, colleagues recall, Freidheim felt he needed to make a breakthrough. He thought about who Fuld really was and what would appeal to him. Freidheim considered the things that mattered most to Fuld. “Dick adored his family,” he later told colleagues. “And he was just as passionate about work. When there was a problem, and when no one else could handle it, we’d wheel him in, and he’d take care of it.”

Freidheim remembered a documentary he’d seen,
Eternal Enemies: Lions and Hyenas
. He brought the video into his next meeting with Fuld. As the meeting ended, Fuld was becoming aggressive about something, and ordered Freidheim to repeat something he had just said. Freidheim said, “Okay, Ntwadumela. Whatever you want.”

Fuld leaned forward. “What?” he said.

Freidheim said again, “Whatever you want, Ntwadumela.”

Fuld tipped back in his chair, took off his glasses, and looked at Freidheim. “This better be good,” he said.

Freidheim described the documentary to his boss: Lions and hyenas go after a wildebeest, and in the confusion of the kill, one lioness finds herself on the wrong side of the territorial boundary, and she’s surrounded by hyenas.

“And the hyenas are slowly—there must be 40 of them—surrounding the lioness. She’s trying to fight them off, but they ‘re all keeping their distance. But one by one, they dart in and bite her, then dart away. It’s clear that they are winning, and she is going to die.

“Then, one of the two males—Ntwadumela—hears what is going on in the distance. He was sleeping, but he gets up, starts heading toward the hyenas at a trot. And then he starts running.

“As he gets close to the pack of hyenas, he picks up his pace, picks out the matriarch, and goes straight for her. The matriarch is the top dog in the pack of hyenas. Ntwadumela catches the matriarch, bites her on the back of the neck, throws her in the air, breaks her neck. She ‘s dead. Everyone goes home. Game over.”

Freidheim paused, then said: “
Ntwadumela
is Botswana for ‘He who greets with fire. ‘ And Dick, that would be you.”

From then on, Freidheim called Fuld Ntwadumela whenever he could. And Fuld loved it.

Freidheim rose to become one of Fuld’s most trusted confidants. Ten years later, he’d give Fuld a bust of a lion to put on his mantel.

The fact that Lehman’s strength was in fixed income--namely as a bond shop--now worked to its advantage. Wall Street was slowly being taken over by capital markets guys: the same guys advisory bankers of yore had looked down their noses at. By the mid -1990s, Morgan Stanley (where John Mack was president), Goldman Sachs ( Jon Corzine), and Lehman Brothers (Fuld) were all led by men who had started in capital markets. The high-stakes gamblers were now in charge of the casino.

“This was the time that people’s balance sheets grew significantly,” says Bob Steel, a retired vice chair of Goldman Sachs and former undersecretary of the U.S. Treasury. “I don’t believe these things are accidents.”

Leverage
became an important word. So did
mortgages
. As the housing market grew, mortgage-backed securities became the devil’s dice—and no one was more aggressive in this field than Lehman, under the leadership of its longtime real estate guru, Mark Walsh.

“Walsh had a lot of credibility because he had a very good long-term track record investing in commercial real estate,” John Cecil says. “And so when Dick and others decided to improve firm performance even further, by taking proprietary risk, he was one of the guys that they wanted to see go . . . and he did. Ramping up to the end, you probably see a rapid growth of the assets under Mark’s control.”

In 2000, Fuld rewarded Walsh for all the money he had been making in real estate by naming him co-head of a new private equity group that invested in real estate. Walsh raised $1.6 billion in pension funds and delivered an internal rate of return of more than 30 percent over the next few years. He raised $2.4 billion for a second fund, which generated 15 percent until it closed in 2005. Lehman owned just 20 percent of the funds, but if outside investors passed on a deal, the fund managers could use Lehman money.

If they won—and until 2006 they were winning big—they got huge bonuses. Walsh’s commercial real estate department was not the only one to rise within Lehman. So too did the residential housing, namely mortgages—which Lehman both originated and securitized (that is, diced up and sold off as financial pieces to clients) under its fixed income group. It was so prolific in this area that a senior member of the Federal Reserve would later say, “A lot of people thought of Lehman as a bond shop; but really it became a mortgage shop.”

Lehman was slowly transforming itself from an operation that survived deal to deal into a more streamlined, multifaceted shop. In 1999 it lead-managed Qualcomm’s $1.1 billion initial public offering (
IPO
); served as Olivetti’s adviser in the $34 billion acquisition of Telecom Italia—later hailed by
The Banker
magazine as “the deal of the year”; advised MediaOne in its $63 billion merger with AT&T (
Institutional Investor
‘s M&A deal of the year); and assisted US West in its $48 billion deal with Qwest Communications. The firm was also an adviser to Honeywell International in the acquisition of Pittway Corporation—the deal of the year for
Investment Dealers’ Digest
.

That year Lehman also announced an agreement with Fidelity Investments to offer its research and a host of products to the company, a leading force in the mutual fund industry. It acquired Delaware Savings Bank to leverage online technology by providing a consumer bank. In 2000, to bolster one of its top moneymaking divisions, Lehman hired ex-Salomon Chief Equity Strategist David Shulman as the senior real estate investment trust (
REIT
) analyst.

On the UK banking side it hired John Williams, the sought-after investment banker who led the demutualization of Abbey National—transforming it into a joint stock company—and was an adviser to National Westminster Bank. It also hired Will Draper, a widely respected analyst from
HSBC
Bank, to strengthen Lehman Europe.

Another notable hire that year was Holly Becker, from Salomon Smith Barney, who was brought in to cover Internet equity research. At 43, Becker was the top-ranked Internet research analyst on Wall Street, according to
Institutional Investor
, and was married to Michael Zimmerman, one of the rising stars at Steve Cohen’s hard-charging hedge fund,
SAC
Capital.

With all its new hires, Lehman continued to prosper. One person who worked at Lehman then says employees who had been asked to buy stock in 1998 made eight or nine times their investment “within three years.”

By the end of 2000, Lehman had opened offices in Rome, Stockholm, Amsterdam, and Munich. The firm brought in revenues of $7.7 billion—and a net income of $1.78 billion. It even joined forces with nemesis Goldman Sachs to lead a $3 billion global bond offering for the World Bank, the first international bond offering to be marketed, sold, and traded through the Internet to both retail and institutional investors.

On July 16, 2001,
BusinessWeek
wrote a laudatory piece under the headline: “Lehman Brothers: So Who Needs to Be Big?” Lehman was proving that despite its smaller size, it could compete with the titans of Wall Street--as Pettit had once dreamed. According to an in -house history, senior management believed that Lehman’s size was a chief selling point: All aspects of the bank could service a client without conflict. The bankers didn’t contend with the traders. The “one firm” motto translated into profits. A corporate video made that year shows an unusually relaxed Fuld boasting, “There are no walls here.”

That year, as Lehman celebrated its 150th anniversary at a black-tie gala in the Museum of the City of New York, it joined the S&P 500 index and its stock price rose above $100 for the first time.

Like the rest of the country, Lehman was prospering, and feeling mighty good about itself.

When you’ re in one of these tragedies, people just do what they have to do, whatever that is. Some are brave; some are not—they just do what they’ve got to do.

—Joe Gregory, “The Modern History”

J
oe Gregory, watching the markets at his desk, thought he saw a plane streak across the sky. He looked again out the window of his office and across the Hudson River, and saw nothing but the glint and glare of the Hoboken skyline in the morning sun. Then the floor beneath his feet shook with a terrible boom. It was 8:47 A.M.

Down the hall, on the 10th floor of 3 World Financial Center, Scott Freidheim’s assistant, Marna Ringel, rushed to the window in the offices of Lehman’s headquarters and screamed: “It’s a bomb!”

Paul Cohen, a senior vice president who had been at Lehman longer than just about anyone else, was in an office facing the Twin Towers. He went straight to Gregory and said he thought a plane had hit the World Trade Center, maybe a twin-engine Cessna. Dick Fuld’s assistant, Marianne Burke, sat slumped at her desk, doing her best to remain calm. As the phones began to ring all around her, Burke went to the window and saw a terrifying confetti cloud of metal and dust rising from the ground.

Her boss was five miles away in midtown, having a Tuesday breakfast with clients.

When American Airlines Flight 11, a Boeing 767 that was supposed to be en route from Boston to Los Angeles, slammed into 1 World Trade Center on September 11, 2001, Brian J. Bernstein was at his desk on the 38th floor. The tall building shook violently, and Bernstein jumped out of his chair. He went to the window and saw a sheet of paper, metal, and glass debris raining down. Bernstein was one of Lehman’s 780 employees who worked in the North Tower. The firm’s technology development group occupied floors 38, 39, and 40.

Bernstein grabbed his wallet, keys, and Palm Pilot and headed for the fire escape stairwell—already filling with panicked people fleeing the building, and by the time he reached the 20th floor the stairs were so jammed that no one was moving. Smoke was filling the elevator shafts and the stairwells. The people on the stairwell started moving again, slowly. At the landing of the ninth floor, firemen rushed by, heading up.