by Susanne Craig, Carrick Mollenkamp, Deborah Solomon and Dan Fitzpatrick
Saturday, September 20, 2008provided by Wall Street Journal History has thrown a handful of men together this week with a task that they themselves might have brushed off as unthinkable just days ago: Give the U.S. financial system its biggest makeover since the 1930s. And do it quickly.
They hail from all parts of the financial world, a banker from North Carolina, a London financial executive, the U.S. Treasury chieftain who himself once ruled a Wall Street powerhouse. Along with small cadre of other men, they are struggling to shore up the foundations of Wall Street, on the fly.
It's too early to know whether the choices they've made -- rapid-fire acquisitions of Wall Street icons Merrill Lynch & Co. and Lehman Brothers Holdings Inc., government seizure of one of the world's biggest insurers, American International Group Inc. -- were the right ones. Rarely are decisions on the trillion-dollar scale made so hastily and with so little vetting.
Now, the government appears ready to embark on yet another attempt to stem the financial carnage. The Treasury Department and the Federal Reserve are considering ways to take bad assets off the balance sheets of financial institutions, according to a person familiar with the matter.
Here is a look at how this group was thrown together and the influences that have shaped their decisions to date. The account is based on interviews with numerous primary players, as well as individuals who witnessed the action.
Henry Paulson
Too Big to Fail
Since Alexander Hamilton first held the job 219 years ago, the position of Treasury secretary largely centered on advising the administration on economic and fiscal policy.
In a few short months, Henry Paulson has rewritten that job description.
Today he finds himself in a position of power unmatched by his predecessors. He decides whether Wall Street firms live or die, picking winners and losers with the power of the federal purse. It's a particularly unusual role, given the Bush administration's laissez-faire approach to markets.
Mr. Paulson, 62 years old, has used this expanded power to set a precedent that's now coming back to haunt him. In recent days he helped orchestrate government takeovers of insurer AIG and mortgage giants Fannie Mae and Freddie Mac. Prior to that, in March, he helped structure a rescue of Bear Stearns Cos., which included an agreement that the Federal Reserve would take on $30 billion in Bear Stearns's assets if J.P. Morgan Chase & Co. would buy the struggling investment bank.
In all of these cases, shareholders suffered huge losses. Still, these decisions raised the difficult issue of "moral hazard" -- the idea that government bailouts encourage more risk-taking, since financial firms assume they'll be thrown a lifeline if they get into trouble.
But are some companies simply too big to be allowed to fail? There's no way to be certain, without letting them fail. And that has risks of its own.
In recent days, the AIG matter presented precisely this conundrum. The immense company had more than $1 trillion in assets at the end of the second quarter, and insured everything from lives in India to cars in the U.S. to airplanes and oil rigs, operating in 130 countries.
The bailout question puts Mr. Paulson in an uncomfortable position. A Republican who came to Washington only in 2006, he once headed investment bank Goldman Sachs, a veritable icon of the free market.
As the financial crisis has deepened, Mr. Paulson's views on bailouts have evolved. A look at his actions in the past week illustrate this difficult balancing act.
With Lehman's shares plunging early last week, Mr. Paulson fielded phone calls from Wall Street executives. The message: They would consider buying the firm and saving it from possible collapse -- but only if they, too, got the benefits of the Bear deal.
Huddled with advisers in his office overlooking the White House, Mr. Paulson decided he had had enough. The government must stand pat: No bailout for Lehman.
He decamped to New York City, and on Friday evening, in a high-ceilinged conference room at the massive stone-and-iron New York Fed building in lower Manhattan, he tried to persuade Wall Street executives that it was their job, not the government's, to fix the unfolding mess at Lehman.
"You have a responsibility to the marketplace," he told them, according to a person who was there.
Saturday morning, in the same room, Mr. Paulson and Timothy Geithner, president of the New York Fed, ordered the assembled Wall Street titans to break into three groups and start cooking up some solutions.
One group included top brass from Morgan Stanley, Merrill and Citigroup Inc. It was dubbed the "LTCM Group," and its task would be to propose something modeled on the 1998 bailout of Long Term Capital Management, a huge hedge fund that collapsed and was bailed out when Wall Street firms contributed some $3.63 billion.
The second group, including executives from Goldman and Credit Suisse Group, began poring over Lehman's commercial real-estate business, which has caused huge losses. Their job: Figure out the assets' actual value.
The third group, dubbed "Lights Out," was charged with studying the fallout of a Lehman failure.
By midday Saturday, however, Mr. Paulson started thinking more closely about AIG. He started talking to executives at Goldman and J.P. Morgan Chase to see if they could help AIG, perhaps by pulling together private loans.
Earlier on Saturday -- with Lehman executives also in the building seeking a bailout -- Mr. Paulson was disinclined to give AIG financial support until he knew more about the scope of the insurer's problems.
AIG's chief, Robert Willumstad, persisted. "I'm proposing a transaction, not a bailout," he told Messrs. Paulson and Geithner, according to a person familiar with the exchange.
By Sunday, however, with the potential for a private-sector solution collapsing, Mr. Paulson began realizing that government money would have to be involved.
He believed an AIG collapse could be disastrous to the global economy because AIG's financial tentacles extended so deeply into world financial markets. Officials were particularly concerned that AIG's troubles would spill over into the money-market mutual funds held by millions of Americans, given its role in insuring some of the investments popular among funds like these.
By Monday, things were moving too quickly: In the wake of a ratings downgrade of AIG, it now would take an $85 billion loan to avert possible collapse. Goldman and J.P. Morgan couldn't raise the money fast enough.
So on Tuesday, Mr. Paulson decided to support a government loan. "A disorderly failure of AIG," the Fed said, "could add to already significant levels of financial market fragility," boost borrowing costs and cut into household wealth while triggering "materially weaker economic performance."
John Thain
Get Ahead of the Tsunami
On Saturday, John Thain, Merrill's chief executive, was busy at the New York Fed working on Lehman's problems when a sudden realization hit him: If he didn't act fast, his own brokerage firm, Merrill, might not survive this crisis.
It occurred while listening to Lehman's president, Herbert H. "Bart" McDade III, give a sobering summary of Lehman's assets and liabilities. "This could be me by Friday," Mr. Thain thought, according to people who have spoken to him.
The stakes were high for Mr. Thain, a Goldman alum and former head of the New York Stock Exchange who had been Merrill's CEO only since December.
Over the past year, Merrill has written down more than $46 billion due to bad bets on real estate and other mortgage-related investments. Mr. Thain was brought in to clean up the mess. Still, Merrill's stock was getting hammered. It had fallen more than 12% on Friday alone.
The 53-year-old Mr. Thain ducked out of his meeting, called Kenneth D. Lewis, the CEO of Bank of America Corp., and asked him if he'd be interested in buying Merrill.
By 2:30 that afternoon, the two men were face to face in New York. The meeting set in motion a 36-hour marathon negotiating session.
Mr. Thain dispatched Merrill's president, Gregory Fleming, to meet with Bank of America's team so they could start combing through Merrill's books.
Saturday afternoon, another twist came: Two top Goldman executives were expressing interest in buying a 9.9% stake in Merrill.
Merrill Lynch, the biggest brokerage in the U.S., was officially in play.
By midafternoon Sunday -- only 24 hours after the first approach -- Merrill and Bank of America deal makers had agreed on a price: $29 a share. Merrill's top managers and directors hastily gathered for a special board meeting to approve the sale.
"When I took this job, this was not the outcome I intended," Mr. Thain said, according to people who were there. "But it is what is best for shareholders
Kenneth D. Lewis
Emerging on Top
The boldest gamble of Mr. Lewis's career started with the Saturday morning phone call from Mr. Thain.
Mr. Lewis didn't hesitate. Here was a chance for the Mississippi-born son of a soldier and night-shift nurse -- a man known among bankers for craving the respect of the Wall Street establishment -- to elevate Bank of America as rivals crumbled around him.
Bank of America is the only employer Mr. Lewis ever had. He started in 1969 as a credit analyst when the bank was called North Carolina National Bank.
He took over as CEO in 2001 and since then has engineered more than $162 billion in acquisitions. Bank of America now ranks as the biggest retail bank in the U.S.
Earlier this year, its purchase of Countrywide Financial Corp., the foundering mortgage giant, was thought to be Mr. Lewis's crowning moment. Buying Merrill, with its slogan of "bringing Wall Street to Main Street," would be far more significant.
Only days earlier, Mr. Lewis had considered buying Lehman. By Friday, he decided he couldn't do a deal without government financial support, something Mr. Paulson, the Treasury chief, was unwilling to offer.
So Saturday morning, Mr. Lewis had told his exhausted deal team to return to Charlotte. Then came Mr. Thain's call.
Mr. Lewis ordered his team straight back to New York. The prospective deal already had a code name: "Project Alpha."
Mr. Lewis himself rushed to the Big Apple that afternoon. He met with Mr. Thain for an hour inside Bank of America's corporate apartment, overlooking Central Park.
When Mr. Lewis returned home Monday, a voicemail awaited him. It was from his mentor, Hugh McColl, a buccaneering figure who had kicked off Bank of America's expansion efforts in the 1980s. Mr. McColl offered his congratulations.
Robert E. Diamond Jr.
A Second Chance
Robert E. Diamond Jr., on a plane to New York from London last Thursday, napped for four hours. He knew he'd get little sleep the next few days.
The 57-year-old president of Barclays PLC, the U.K.'s third-largest bank by market value, was thinking of buying Lehman. It represented a golden opportunity to set up a big shop on Wall Street. For the past dozen years, he had helped expanded Barclays from a middling London bank into a broad-based European investment house.
But he felt a deal would be unlikely without some support from the U.S. government or from other big Wall Street firms.
On Friday Mr. Diamond -- using a freight elevator to avoid the media at Lehman's office -- met with Lehman's chief, Richard Fuld. But the structure of the deal he proposed would require funding help from other Wall Street firms, as well as an assist from the U.S. government to cover the value of Lehman's assets.
By late Sunday morning, Mr. Diamond was told his idea was a no-go. Barclay's withdrew. It appeared Lehman would file for bankruptcy.
Then, on Sunday evening, it suddenly looked like Mr. Diamond might get a second chance. As he walked to Smith & Wollensky steakhouse in midtown Manhattan, Mr. Diamond's thoughts had turned to a cool beer, when his cellphone rang. It was Mr. McDade, Lehman's president, raising the possibility that a bankruptcy filing might actually open another path to a deal.
"Is there any chance that if this goes into receivership, we can try and do something?" Mr. McDade asked, according to a person familiar with the call.
Within hours, Lehman had filed for bankruptcy protection. Mr. Diamond then plowed headlong into bankruptcy law to see if he could quickly swoop in and cut a deal. He knew he would have to move quickly before Lehman started losing its employees, one of the firm's key assets.
On Tuesday, Barclays agreed to buy the bulk of Lehman's North American business, which won't include the firm's risky holdings and liabilities, for $1.75 billion.
Richard Fuld Jr.
Down and Out
Lehman colleagues long marveled at Mr. Fuld's knack for winning, at bond trading and on Wall Street. One Lehman partner once told an associate: "If Dick Fuld were in front of you on line to buy a lottery ticket, hand him your $2 because that bastard is going to win."
That luck ran out Sunday. After repeatedly insisting that he would never sell 158-year-old Lehman -- a firm he worked at for 41 years -- Mr. Fuld was forced to try to do just that.
Mr. Fuld, 62, spent much of the weekend holed up in his 31st-floor executive suite overlooking midtown Manhattan. With Lehman employees angry at the firm's precarious condition, Mr. Fuld was given extra security detail.
As he and other Lehman executives scrambled to find a deal, Mr. Fuld told a top adviser: "I just want my people to survive."
A lot was riding on this for Mr. Fuld, who was credited with almost singlehandedly rebuilding Lehman in the mid-1990s after it was spun off from American Express. But in the past two fiscal quarters the firm has rung up losses of $6.7 billion on bad real-estate bets.
He arrived at work at 7 a.m. on Saturday, wearing a blue suit and tie. Exhausted from the week's events, he tried to take a quick nap around 10 a.m., but it was a short one., Almost immediately, Mr. Paulson, the Treasury secretary, called to get a status report, according to a person familiar with the matter.
When Bank of America withdrew from takeover talks with Lehman Saturday afternoon, Mr. Fuld phoned Mr. Lewis several times to make another appeal, according to a person familiar with the matter. Mr. Lewis didn't return the calls.
What Mr. Fuld didn't know was that, by then, Bank of America was already deep in talks to buy rival Merrill.
Sunday, in a last-ditch effort to find a buyer, Mr. Fuld called John Mack, Morgan Stanley's chief, and asked him if a deal was possible.
The answer was no.
With that, Lehman's fate was effectively sealed, and it filed for bankruptcy early Monday.
It was a remarkable fall for an executive who relished control. Under Mr. Fuld, there never were casual Fridays. His signature look included crisp, white, hand-tailored shirts. Employees routinely referred to him as "The Chairman."
Outside Lehman headquarters on Monday, a painter offered angry employees an outlet. He exhibited a large portrait of Mr. Fuld and asked people to sign it. One employee scrawled: "Nice trade, Dick!"
Also on Monday, according to regulatory filings, Mr. Fuld sold more than two million Lehman shares at about 20 cents a share. The sale netted him almost $525,000, filings show.
Those same shares were valued at more than $145 million at the beginning of 2008.
Then, on Tuesday, a quick turnabout: Barclays agreed to buy Lehman's U.S. brokerage unit. That move salvaged, at least for now, part of the once-proud securities firm.
In a letter to employees announcing that deal, Mr. Fuld wrote: "I know that this has been very painful on all of you, both personally and financially. For this, I feel horrible."
-- Jon E. Hilsenrath contributed to this article.
