The book, published today, describes in detail what happened on September
13 and 14 last year, when Hank Paulson, the US Treasury Secretary, his
successor Tim Geithner — then president of the New York Federal Reserve —
and Christopher Cox, chairman of the Securities and Exchange Commission,
were battling to prevent the fall of Lehmans. Their plan was for other banks
to underwrite its most toxic assets. The investment banking division, the
most attractive remaining asset, would then be sold — and Barclays quickly
emerged as the leading candidate to buy the business, but, as this exclusive
extract reveals, the Financial Services Authority and Alistair Darling had
other ideas.
”It looks like we may have the outlines of a deal around the financing!”
Steve Shafran, a senior adviser at the US Treasury, announced to Bart McDade
and the Lehman team at the NY Fed. Brandishing a huge smile, Shafran told
the Lehman bankers that the CEOs downstairs were close to agreeing to
funding the spin-off of Lehman’s real estate assets.
The men felt as if an unimaginable burden had been lifted almost
instantaneously from them. And McDade excitedly tapped out a message on his
BlackBerry to Michael Gelband, who was at Simpson Thacher’s offices.
Standing in a conference room uptown, Gelband read McDade’s message and
shouted. “We got it!” he said, a broad grin spreading across his face as he
let out a sigh of relief . . .
... Hector Sants, the deputy head of Britain’s Financial Services Authority,
was driving along the A30 from Cornwall on the southwestern tip of England
back to London on Sunday afternoon with his mobile phone clutched
precariously between his ear and his shoulder.
Sants had been on the phone for most of the weekend with his boss, Sir Callum
McCarthy, head of the FSA and a former Barclays banker himself.
McCarthy, at 64 years old, had only six days remaining in his tenure in the
post and was scheduled to step down that Friday.
Sants and McCarthy had spent hours trying to assess the state of affairs
between Barclays and Lehman. Sants had been in contact several times with
Varley (John Varley, Barclays’ group chief executive) that day, but
McCarthy’s efforts to contact Geithner, his counterpart in the United
States, were proving more difficult. They had spoken briefly on Saturday,
but he had heard nothing since.
“He hasn’t called me back,” McCarthy grumbled. “You can’t get hold of any of
these people.” They had no idea what Barclays’ (president, Bob) Diamond had
— or had not — communicated to the US Government about what conditions had
to be met to receive their blessing back in Britain. Indeed, McCarthy was
nervous that Diamond, an American who had never become part of Britain’s
gentlemen’s club, may have been a bit reckless in the negotiations, like any
aggressive Wall Streeter. Both men were especially concerned that Diamond,
in his zeal to sign a deal, might not have fully explained the requirements
that the British regulators would ask for before approving it. To them,
buying Lehman could put the bank and the British financial system as a whole
in jeopardy. Varley, who was supportive of pursuing Lehman but clearly less
enthusiastic than Diamond, had assured Sants during a call on Friday that
Barclays’ board would pursue the deal only if it could receive adequate help
from the US Government or another source.
“I would not recommend a transaction to my board unless I’m satisfied both in
terms of the quality of the assets we’re purchasing and in respect to the
funding positions,” Varley had said.
McCarthy and Sants also faced another looming problem, one that, in the grand
scheme of things, may have seemed minor but was nonetheless important at
that very moment: the London Clearing House, which clears many of the
derivative counterparty trades across Europe, was scheduled to do a software
upgrade that weekend that would switch all its transactions to a newer
system. They had instructed the London Clearing House on Saturday to hold
off on proceeding with the upgrade until they knew more about the fate of
Lehman and Barclays, but were now being badgered for a final answer, as
dozens of technicians had been engaged to handle the switchover.
“We shouldn’t allow this to drag on,” Sants said to McCarthy, hoping they
could get an answer back to the London Clearing House. “We ought to try to
contact Geithner and just make our position very clear.” They scripted out
what McCarthy would say: “We feel as the regulator [sic], in the best
interest of the global financial system, that it’s important you understand
— we hope Barclays has already made this clear to you, but in the event
Barclays has not made this clear to you — that we need the appropriate
funding assurances both on the trading side and with regards to the asset
issues if we’re going to allow this to go forward.” McCarthy said he would
try Geithner one last time.
On the thirteenth floor of the NY Fed, Hilda Williams, Geithner’s assistant,
told him that Callum McCarthy was on the phone. Geithner finally took the
call, explaining, brusque as ever, that he had been in back-to-back meetings
trying to get a deal together for Lehman and apologising for not returning
his call sooner. McCarthy stopped him, saying that he was very concerned
that he didn’t know anything about the deal being contemplated. He had a
list of questions that he needed answered.
“The capital requirements and, in particular, the transaction risk between the
time of taking on the risk and the completion of the transaction leaves a
very big open-ended exposure,” McCarthy said, keying in on his biggest
problems with the deal. He explained that the FSA still needed to determine
whether Barclays was properly capitalised enough to take on the risk of
buying Lehman. And, he said, even if it was — which he suggested was a
possibility — Barclays still would need to find a way to guarantee Lehman’s
trades until the deal was completed. “I’m very doubtful Barclays can ever
get to a position to fulfill the requirements, and it is far from clear that
they will able to do so,” he said.
Geithner had no idea that the FSA would take such an aggressive position and
asked McCarthy directly whether the authority was formally saying it
wouldn’t approve the deal.
“It is completely impossible for us to take a view on whether these risks are
risks that we would accept,” McCarthy replied, unless “you bring a proposal
forward”. But, he added, since it was so late in the day — about 3.30pm in
London — the chances were remote they’d be able to come to a conclusion
within the next several hours.
McCarthy went on to present another problem: he said that Barclays could not
guarantee Lehman’s trading obligations without a shareholder vote, which was
a UK “listing requirement” for all publicly traded firms in Britain.
However, not only was there insufficient time for such a vote, he said that
he wasn’t authorised to waive the vote requirement — only the Government
could do that.
Geithner explained that, based on his conversations with Barclays, he thought
the British Government had already indicated it would be supportive of the
transaction.
“I have no indication that that is the case at all,” McCarthy said firmly, and
then expressed anxiety, as Darling had to Paulson on Friday, about Barclays’
own health and that of the rest of the market.
“Look,” Geithner said impatiently, “we’re going to have to decide in the next
half-hour what we do. Time is running out.”
“Good luck,” McCarthy said curtly.
Geithner ended the call and rushed into Paulson’s office, where the secretary
and Chris Cox were speaking, and recounted the conversation.
“I asked him if he was saying no,” Geithner said, “and he kept saying that he
wasn’t saying no.” But clearly, Geithner complained, that’s exactly what he
was saying.
Paulson was beside himself. “I can’t believe this is happening now.” After a
brief discussion of strategy, Paulson ordered Cox, who was the only
regulator in the room with legal authority over Lehman Brothers, to call
McCarthy. Cox, Paulson thought to himself with a sense of annoyance, was
supposed to have prewired these very regulatory issues. “I don’t want to be
left here holding Herman,” the Treasury Secretary said, glancing at his
zipper in case the joke wasn’t clear.
Cox reached McCarthy on his mobile phone in the living room of his two-story
home in Blackheath, across the Thames. After the FSA head patiently
reiterated the problems that the Barclays deal faced, Cox suggested they
could try to work around them, adding: “You seem to be very unsympathetic to
this.”
“No,” retorted McCarthy coldly, “I’m trying to establish the facts of life so
that you understand them and approach this with some realism.”
“You’re being very negative,” Cox insisted.
“Look, you should understand, one of the great problems for us at this end is
not actually being properly kept in the loop of what you’re up to,” McCarthy
complained, growing increasingly agitated. “You must understand, we’re
hearing things late in the day,” he said, ticking of a list of requirements
that Barclays would need to meet. “We could have told you earlier which ones
would run into problems and which ones wouldn’t.”
Five minutes later Cox returned to Paulson and Geithner, notepad in hand,
deathly pale.
“They’re not going to do it,” he said. “This is a total reversal. They never
said a word to us about this before!”
Tom Baxter, the NY Fed general counsel, who had just walked in, couldn’t
believe what he was hearing. “We’ve come this far, the money’s on the
table,” he said in disbelief. “Didn’t they know this when they took the
plane over here?”
“I’ll call Darling,” Paulson said.
Alistair Darling was in Edinburgh, preparing to head to London for the working
week, as he did every Sunday.
It was about 4pm local time and Darling had been on the phone for much of the
day with Varley, officials at the FSA and Gordon Brown himself, trying to
decide whether the UK Government should approve the deal with Barclays.
Darling had deep misgivings about the transaction, especially after he had
learnt from one of his staffers that Bank of America had dropped out of the
bidding. Was Barclays going to be left buying leftovers? Darling thought it
was impossible that Barclays could have done a deep enough examination of
Lehman’s books to be satisfied that the bank wouldn’t be exposed to extreme
markdowns of Lehman’s assets in the future. Even worse, Darling had other
problems on his mind: HBOS, the UK’s biggest mortgage bank, was struggling;
he also knew requirements that Barclays would need to meet.
“Alistair,” Paulson said gravely. “We’ve just had a distressing conversation
with the FSA.”
Darling explained that he understood that they had been in touch and that
there seemed to be numerous unanswered questions. “I have no objection in
principle to the deal,” Darling said.
“But you’re asking the Government to take on a huge risk. We need to be sure
what it is that we are taking on and what the US Government is willing to
do. The questions we are asking are not unreasonable.”
“We’re at the end of the line here,” Paulson said, surprised at Darling’s
position and pressing him again about whether he was prepared to lift the
requirement for a shareholder vote.
“If this were to go ahead, you know, what would the US Government be doing?
What are you offering?” Darling asked in return.
Paulson reiterated that he was hoping the private consortium was coming
together, but now Darling shifted the conversation and began peppering
Paulson with questions about the United States’ contingency plans for
Lehman’s bankruptcy.
“Well, if Lehman is going into administration, we need to know because it will
have implications over here,” Darling said before ending the call.
“He’s not going to do it,” Paulson told Geithner in amazement. “He said he
didn’t want to ‘import our cancer.’” For the next two minutes in Geithner’s
office, a half-dozen excited voices were speaking at once, until he finally
quieted the group and asked, raising his voice for the first time the entire
weekend: “Why didn’t we know this earlier? This is ******* crazy.” Paulson
began to wonder aloud if President Bush should call Gordon Brown personally,
but almost before finishing the question, he answered it himself. “There’s
no chance,” he said, explaining that he thought that Darling had implied he
had already spoken to Brown about the situation. “He was so far away from,
ah, wanting Barclays to do anything,” he remarked of Darling.
“Okay. Let’s go to Plan B,” Geithner said after a moment’s reflection.
They agreed to assemble downstairs to relate the news to the bankers so that
they could begin preparing for Lehman’s bankruptcy. Plan B was simple:
regulators would press the banks to unwind trading positions they had with
Lehman and with one another in a way that minimised the impact on the
markets.
And then there was the next critical issue to address, Geithner said: “We have
to deal with Merrill.”
As they got up to leave, Paulson, clearly depressed, remarked drily: “If
you’re going to ride the pony, sometimes you have to step in the shit.”
An NY Federal Reserve security guard who had been searching for Bart McDade
and Rodgin Cohen eventually found them on the first floor.
“Secretary Paulson would like to see you,” he announced before escorting them
to Geithner’s waiting room.
Cohen was already uneasy, for while McDade had been sending out enthusiastic
e-mails about the near-consummation of the deal, Cohen had overheard a
number of government officials who seemed to be more circumspect about its
prospects. McDade now also sensed that something was amiss and sent a
message to Gelband while he was waiting, telling him: “There might be a
hold-up.” The door to Geithner’s office opened and out walked Geithner,
Paulson and Cox, all looking alarmingly dour.
“We got the banks to agree to fund, but the UK Government has said no,”
Paulson announced.
“Why? Who?” Cohen asked, incredulous.
“It came from Downing Street. They don’t want US problems infecting the UK
system,” Paulson said.
While McDade stood mutely in shock, Cohen, who was famous for his equanimity,
virtually shouted: “I cannot believe this! You have to do something!”
“Look,” Paulson said sternly, “I’m not going to cajole them and I’m not going
to threaten them.”
Cohen was not finished. “I know a lever we can pull with the UK Government,”
Cohen offered. “I have a friend I can call.”
Paulson just stared at him, shaking his head. “You’re wasting your time. The
decision was made at the highest levels.”
Cohen walked to a corner and dialed Sir Callum McCarthy directly. They had
known each other for years; Cohen had been Barclays’ lawyer in the 1990s
when McCarthy worked there. But the look on Cohen’s face as he explained the
situation told the story unequivocally: McCarthy was clearly not able to
help his friend.
“You’ve really got this wrong if you don’t think this is going to infect you,”
Cohen told McCarthy, nearly begging him to reverse his decision. “By not
doing the deal, it’s going to infect you.”
Downstairs, Paulson, Geithner and Cox entered the main conference room where
the CEOs were still trying to co-ordinate funding Lehman’s real estate
assets. The mood in the room had been noticeably upbeat as they continued to
make progress.
“Those of you who do not want to assist a Barclays deal can breathe a sigh of relief,”
Paulson announced, somewhat awkwardly, and a number of bankers in the room
did not understand what he was trying to convey until he formally announced
that the deal was dead. “The British are not allowing for this type of
guarantee; they can’t get it done by tonight; they need a shareholder vote.”
“But we have the money!” Jamie Dimon said.
“Isn’t this our closest ally in the world?” one of the bankers asked.
“Guys, trust me,” Paulson said. “I know how to be a tough guy. I’ve done
everything I can. There is no deal.” The general opinion in the room was
that they had been blindsided; Paulson merely shook his head and declared
that the British had “grin-****** us”. Geithner steered the conversation to
the necessity of setting up contingency plans. He said that Lehman’s holding
company would file for bankruptcy that day. He also indicated that the
Government would open up an emergency trading session in the afternoon for
all of the biggest banks to unwind positions with the firm ...
... “I understand it’s not going through,” Bart McDade told Bob Diamond when
he reached him at his desk at Barclays’ headquarters.
“What do you mean?” Diamond replied, completely taken aback. “I haven’t heard
that.” “It’s off. The Government says it’s not happening,” McDade told him,
and recounted Paulson’s discussion with the British regulators.
Diamond immediately got of the phone and called Tim Geithner’s office.
“I just heard,” Diamond said, exasperated. “What happened?”
“You should talk to Hank,” Geithner told him.
When he finally managed to reach Paulson, he said, somewhat curtly: “I want to
tell you that it was really difficult for me to get a call from someone else
well after you did this.” He paused, trying to keep his voice level. “And
what I’ve been told you said is very much against what I think the facts
are, and I think I deserve an explanation.” When he hung up after hearing
Paulson’s account of the communications, Diamond was in turn deflated,
furious and embarrassed. More than anything else he was dismayed by the
British Government. How could they have led him so far only to quash the
plan at the last moment? At 12.23pm, Diamond tapped out a message on his
BlackBerry to Bob Steel, who had been trying to set the deal up for six
months:
“Couldn’t have gone more poorly, very frustrating. Little England.”
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