September 19, 2008 6:32AM

How Lehman Was Allowed to Die

By Alexis Glick

Yesterday I got the phone call that sent shivers down my spine. Never have I listened so intently to someone speak. I took my time writing this note. Lives were affected, jobs were lost and more tales will be told. I can only tell you what I was told. I have no agendas. My job is to report the news. This is what I am doing, based on an interview with a source who had an inside look at the week Lehman Brothers was allowed to die.

On Monday, September 8 Lehman Brothers had $40 billion in cash. One week before they filed for Chapter 11. They were in the process of doing two things: one, they were in the process of raising more cash, and two, they had opened up the books to Neuberger Berman and their investment management business to interested parties to bid on a percentage of that business. They did not want to sell the investment management business. They knew the value of the stand-alone business and that by selling that business they were giving up future earnings power. They explored the sale to formulate a price in the event that they needed to sell it, but they did not want to give it up. At best, as Dick Fuld mentioned on that conference call on the morning of Wednesday, September 9, they were willing to sell a majority stake.

In the days leading up to the earlier-than-expected earnings announcement, they thought they would be able to survive the turmoil. But in the course of hours, things began to unravel. Rating agencies began downgrading their debt that Tuesday, September 9. By the end of the day Tuesday, the bank’s stock was down 45%. Wednesday night September 10, Moody’s held a conference call in which they said Lehman needed to complete a transaction with a strategic partner that would have the “effect of calming the markets.” The $40 billion in cash, the additional equity investment they thought they were going to get, was gone.

As the credit default swaps (insurance purchased to hedge default risk of Lehman Brothers debt) began to widen as much as 135 basis points to 610 basis points, the highest level seen on Lehman paper, the shorts piled on and the counterparties demanded more. In simple terms, to insure $10 million of debt, the insurance cost $610,000 dollars to protect that investment. One bank, in the wake of the Fitch downgrade and subsequent Moody’s downgrade, required $5 billion of collateral to do business with them. Each of the counterparties was asking for more and more money and the well went dry.

I asked this source if we knew that Moody’s and others suggested, including Dick Fuld himself, that a deal was pending to sell a majority interest in the Investment Management business, why didn’t they do it in those final days? Why didn’t they announce a sale on that Thursday, September 11, or that Friday, the 12? At that point, sources tell me that the $3 billion for that 60% stake was meaningless. It would not have saved the bank. Remember that Thursday the stock was down another 41%, closing at $4.22. At the same time, Washington Mutual, the giant savings and loan bank was crumbling, down 30% on Wednesday and 21% on that Thursday.

Last weekend, September 13and 14, and the days leading up to that weekend, Lehman was in deep discussions to sell the bank to Bank of America or Barclays Bank. They were close to selling the bank to Barclays. A deal was all but done and the Fed would not help. Barclays did not want some of the residential and commercial portfolio (the problem assets). How much is unclear. At the time Lehman planned to spin off $30 billion dollars worth of these assets. How many of those assets Barclays was willing to take isn’t clear. Lehman needed the Fed to step in, agree to allow the Spinco deal to happen and authorize the deal. The Fed would not do it. Lehman needed a little help. If Spinco worked, they could spin off the problem assets from their residential and commercial portfolio into a separate company. Barclays would buy the bank and get the guarantee that they did not have to buy the assets that they did not want. The Fed would not step in.

Lehman did not know that Bank of America was simultaneously talking to Merrill Lynch. Reportedly word was starting to percolate that Merrill Lynch by Friday was out of cash and was going to be next. Merrill CEO John Thain pursued a deal with BofA’s Ken Lewis while Lewis courted both parties. Ken Lewis and Bank of America had the choice, and the Fed needed them to rescue one of these banks. Lewis had always shown interest in Merrill Lynch and the synergies made sense. The Lehman team did not know to what extent Bank of America was working with the Fed to get a deal done with Merrill Lynch.

On the Sunday before Lehman filed for Chapter 11, Sunday, September 14, the Fed told Lehman to file for Chapter 11. Lehman was given no choice, sources tell me. The Fed was the only one lending them money at that point. They knew they were doomed and it became clearer through that Sunday that Merrill and Bank of America were about to announce a deal. They were made to be an example. The Fed knew one investment bank needed to be rescued that weekend or more would fail and allowing Lehman to fail, which the markets had already priced in, would not have had huge ramifications for the market.

I am also told that Lehman Brothers NEVER had a firm bid from the Korea Development Bank or any other party in the months leading up to the bankruptcy filing. The rumors, the articles, the stories about what Fuld did not do with the KDB were not true.

As you have read in countless articles or witnessed in the days leading up to that weekend, federal officials did not want any more public funds used in the wake of the Fannie Mae and Freddie Mac plan and the rescue of Bear Stearns. AIG at the time had to raise between $30 and $40 billion, according to rating agencies. The wheels were coming off the bus. Hindsight is 20/20, but one will never know. What if all these events didn’t collide on the same weekend? Would Lehman Brothers still be around? Was Lehman made to fail in the weeks leading up to the bankruptcy? Were they the blood on the street that I talked about in past blogs? The Government was taking on too much taxpayer risk and they needed to send a signal, Lehman may have very well been that signal.

I report this now not because I am defending Dick Fuld. I still can’t help but think about what he could have done to sell this company and rescue these lives. He will be the poster boy for excess and the demise of one of the greatest financial institutions in the world. What he was thinking, we may never know. But, what this story tells you is that short sellers, credit default swap markets, rating agencies and fear have taken over asset quality, earnings, history and pedigree. Just knowing what happened to Lehman in that last week explains what is happening to John Mack at Morgan Stanley and why he is fighting for his life. People will say the SEC changed the short-sale rules to accommodate Goldman Sachs and Morgan Stanley while they profited the most from naked short selling but would leaving the rules in place have been better? Mack is lobbying because he knows that the shorts, the swaps and the rating agencies have been dictating his fate. The more he loses his equity, as he has seen erode in the past four days, the more he loses the power to pay his counterparties to stay in business. This is how far we have allowed traders and short sellers to unwind our multi-billion dollar Wall Street investment banks.

15 Responses to “How Lehman Was Allowed to Die”

Comment by DanW

September 19th, 2008 at 8:20 am

I am not an investor by trade, just an ordinary citizen and I did my own research on this subject to find that it was a multi faceted demise over several years.

In short what I uncovered, and it may only be part of the story, is that the investment banks on Wall Street disregarded the risk of the sub prime mortgage assets that some unscrupulous lenders made. This paper was bundled in an attempt to spread the risk and presented as a viable investment option. Moody’s and other credit ranking firms simply applied the credit risk rating of the institution presenting the bundle, so investors had no real idea how bad the risk was. This fact was hidden by greed on Wall Street and perpetuated into the massive scale we have seen unfold. Even AIG, who wrote most of the insurance against this paper, did not seem to really understand the associated risks.

I am not a proponent of rescuing companies that stretched and manipulated the rules for the sole purpose of greed. As a tax payer, I do not want to rescue these institutions, however, because this was let to spread to financial institutions around the world, I understand the need for the Fed to do something. I also applaud the bi-partisan congress actually trying to do the right thing.

So the silver lining in this cloud of doom is one; Wall Street has been put on notice and two; our government may actually start working for the people again!
Comment by lehman dependent

September 19th, 2008 at 9:25 am

precisely. perhaps some of the knee jerk posters of crowing invective against the deposed employees of lehman might reconsider their targets. as the fat cat hedge fund guys sip their bollinger maybe the rank and file should spare a thought for the average joe employees of lehman who worked their health and happiness into the ground just to buy a moderate level of comfort for their families who are now facing personal bankruptcy.

the sacrificial lamb of wall street hides many a tale of personal pain.
Comment by Jeff Priore

September 19th, 2008 at 9:27 am

Lives were affected, jobs were lost and more tales will be told but the top managers at Lehman Brothers will still be wearing $1,000 suits, driving $200,000 cars and snacking on caviar. The rich will still be rich even though we’re asked to pine for their suffering. The poor employed by Lehman Brothers cleaning their offices and holding their doors open? They’ll find other minimum wage jobs for other fancy people. had Lehman Brothers been propped up by Uncle Sam the taxpayers (which does not include the rich and famous) would have shelled out the billions to keep the excess going.
Comment by grwe

September 19th, 2008 at 9:58 am

The Fed. assisted in getting a deal done for Bear Stearns. It then bailed out Fannie/Freddie. It came time for Lehman and they just let them fail. Days later, they are devising a plan to help out everyone else. I don’t understand this. I believe Dick Fuld was trying to save his company, but it was out of his hands. Panic, short seller, rating agencies, I think, had more control over his company than he did. Most I. Banks and many C. Banks are in the same position that Lehman was in, in that they have these bad assets too, yet, Lehman was left to fail. Lehman just filed on Monday and they are now going to help. How is this fair? Could Lehman not have been saved had they thought about this last Friday?
Comment by LarryS

September 19th, 2008 at 11:37 am

There is an interesting side note that no one seems to be talking about when it comes to Lehman Brothers. 30% of the company was owned by its employees. I am former employee whose role was providing administrative support. At year end EVERYONE received a performance bonus, that included secretarys, and clerical workers, and they were pretty generous as a percentage of one’s salary. If one received a bonus of $10,000 or more (and many many did) your bonus included a percentage of restricted stock (restricted in that you could not sell it for three years), and the bigger your bonus the more of it was paid in restricted stock. (I believe that top bonuses were paid with 60% restricted stock)

Now I am not saying that there were not excesses and greed in the running of Lehman. But I just wonder why the only financial institution that was allowed to fail was the one that had significant employee ownership.
Comment by bbbeauti

September 19th, 2008 at 1:06 pm

I think the fed. should not have helped one company (the deal with bears sterns) and not helped anyone else. but then if you look at the top management of Lehman and what they received as bonuses last year, that in itself would have been enough to keep the company going for a bit more. and when it states “bonuses for the employees” like one article said I saw, I can guarantee you very, very, very! little if NONE made it down to the real employees below upper management level.

We keep blaming the sup-prime market, and yes that is a big factor and the brokers who qualified these poor suckers with the first payments and not the increased ARM payments are the biggest instigators…but there are other factors like multi billion dollar bonuses in times where no bonus should be given.
Comment by Walter

September 19th, 2008 at 1:12 pm

One can not help but ask “Would Lehman still be around if todays Fed annoucement would’ve been made 1 week ago ?? Would Merrill still be independent ??” Why was Lehman the scape goat as opposed to the
other candidates ?? I don’t have any idea. Seems that most of the investment banks had
risky assets that they probably shouldn’t of had.

I am happy that “shorting” is being evaluated. I find it a very dangerous practice,
and many of the Wall Street firms that employ the strategy to make money are now
getting burned by it. Perhaps its poetic justice ??

I would like to see shorting banned altogether. It is not fair that only the financial companies get this protection. What happens if “shorters” start targeting high tech companies ?? Would we sit there and watch the shorters drive them out of business. Will the Treasury and Fed be there to bail them out ??

We need to get back to a long term investing mentality. If you believe a company is poorly run, don’t buy the stock, or sell the stock you have,
or if you own the stock simply buy some puts as downside protection. The whole idea
of making a quick buck is damaging our financial system. Lets get back to the basics
of building good strong companies with a financial marketplace that wants to support
them
Comment by Richard Korsgren

September 19th, 2008 at 2:00 pm

No one seems to understand what is happening. The taxpayer will not bail out this bailout and this not good. We should be paying for our debts as we go. This 1-2 trillon bailout money will go onto our national debt, which is now running wild. One day, the rest of the world will lose faith in the US Government (because of this huge debt) and not buy this debt. Inflow of money will slow and stop. We have abused our financial system and now we are trying to buy our way out with money we do not have. We will be sorry one day but who really cares? Actually, I have heard no one this day even discussing it. We just do not get it!

Richard Korsgren
M
Comment by Lehman's foreign victim

September 19th, 2008 at 2:26 pm

I agree with grwe and LarryS. Why the Fed had such an unfair treament to Lehman? Only two real reasons I can think of. One, Dick Fuld had alienated himself with the Fed in whatever the issues before. Two, Lehman has most of his bundled portfolio sold to other developing countries (I know many in Aisa), so the Fed doesn’t care. A lot of people in developing countries, they poured in all their savings, retirment money to buy just “American” products thinking these are from the most powerful country where if anything goes wrong, the U.S. government will protect their rights. Now their money with Lehman is forzen for 120 days without knowing how small the percentage of their money can be returned to them. Many livies will be affected there too, not just the employee of Lehman (who have been in the top of the pyramid for all these years, so I don’t too worry about them). What role the USA going to play in the world going forward? I can only see the super power world police fighting human rights role is quickly fading away!

Fed, please save Lehman (with tear)!
Comment by Dave, TX

September 19th, 2008 at 4:02 pm

Alexis

I appreciate your reporting.

I have a question and possible indication of what has happened. I would appreciate your response.

I was a Real Estate Broker for three years and I got out of the business three years ago because I saw this coming.

What did I see? I saw the typical home buyer trying to get a mortgage for their dream home.

Realtors and Mortgage Brokers encouraged homebuyers to buy as much home as they could possibly afford. Was that a hard sale? No.

The typical scenario was a homeowner who had credit card debt and needed to sell their current home to pay off their credit cards. By eliminating the credit card payments they could qualify for a larger mortgage. Millions of home owners have been doing this for years and years.

Then a few years ago President Bush signed into law the new law that prohibited bankrupting on credit card companies and allowed the credi card companies to raise the minimum payment from 2% to 4%. I believe that law created a minefield in the housing market. Some home owners would be able to manuver through the minefield but many would not be so lucky.

So how did we get to the place where there is hundreds of thousands of forclosures?

Yes, the mortgage industry made many bad loans. But in my opinion, the new credit card law changed thousands of marginal home loans into bad home loans. More and more homebuyers failed to qualify for a loan and the law of supply and demand simply operated as usual. Fewer homebuyers - housing prices drop. Housing prices dropped and homeowners were pushed over the edge by their credit card debt and unable to bankrupt against the credit card companies. Thousands of homeowners are left with no other choice but to let their homes fall into forclosure.

When will we learn that credit is not an asset?

I think everybody is going to reap what we have sowed over the years.

Dave
Comment by Cal

September 19th, 2008 at 5:30 pm

I’m sorry, but most of America will not feel sorry for any of these guys or gals. Aren’t they supposed to be the smartest people in the room with their Ivy League educations? What, now their kids won’t be able to go Upper East Side private schools or they can’t afford their second or third homes? Or move to Scarsdale or Greenwich?

Heads should roll. There had better not be any mention of bonuses in the next couple of months. I want to hear Blankfein’s and Mack’s compensation. It should be $1.

They sold crap, they knew it was crap. And we go on and on to other countries about “free-market capitalism”. What a joke! And the funny thing is this stuff crops every ten years. The crash of ‘87, LTCM in ‘98 and now the credit debacle of ‘07/’08.

This better be fixed. I’d hate to see another Civil War in this country. I don’t trust this rally. If it peters out, what is next? They have already thrown the kitchen sink at it.
Comment by Credit rating victim

September 20th, 2008 at 5:20 am

When Lehman filed for Chapter 11 on Sunday,September 14, the long-term Lehman bonds in my portfolio had A+ credit rating issued all the rating agencies that are out there. Why? When was the last time a bank at the edge of collapse was allowed to carry an A+ (long term) and AA (short term) credit quality? Arent’t rating agencies supposed to inform the investors with CORRECT credit quality of a bond issuer in order to give investors opportunity to flee or stay invested?

As for my Lehman bonds : They bit the dust on Monday, September 15, just 7 days before the annual interest pay day (22 Sept.). Alive for 51 weeks, then dead on the final, 52nd week. Thank you! Thanks to FED, Fuld, Fitch, Moody’s, S&P’s, the US Treasury, BOfA, the system, thanks to you all. Now I know you better!
Comment by Jonathan

September 20th, 2008 at 9:42 pm

Great article, Alexis. I agree with most of what you have written, however, i don’t quite understand what you mean when you say “this is how far we have allowed traders and short sellers to unwind our markets”. Really? So it is the fault of the traders for the demise of these companies. Really? These companies were buying and selling junk, and they knew it. These CEO’s are just upset that traders (and yes i am one) knew it all along as well. It is not the fault of the traders that these CEO’s cannot understand or execute simple math skills. They screwed up their own balance sheets, not us. Lehman and the rest of them are just upset because we made money off of them when they could no longer continue. They did the same thing to their counterparties for years. By the way, traders who make money are efficient in risk management, so perhaps the highly compensated CEO’s could learn a little from us. Don’t feel sorry for them, they would break any trader to earn a dollar. As usual, always the fault of the traders. Funny thing is, knowone complains when traders drive up the equity. The investment banks all love that. I don’t like to see anyone lose their job, but nobody guarentees a traders employment either. We are in the results business, and Lehman and the others cannot gain the results. They got exactly what they asked for at Lehman when they levered themselves into the red.
Comment by Andy

September 21st, 2008 at 2:23 pm

Welcome to the United Socialist States of America.

Blatant manipulation in the markets, before a very important election in the country..hmmm
Comment by Veronica M Reimann

September 27th, 2008 at 8:09 pm

Why do we have to pay for Illegal aliens who have bought homes here they should not have been allowed morgages.