The Devil's Casino (27 page)

Fuld arrived in Hong Kong ignorant of all this. The night before their meeting, Min called Fuld at his hotel and dropped three bombs: First,
KDB
was working in a consortium with, among others, the South Korean Hana bank as well as an assortment of other players, all of which would have to support the deal. Second, the South Korean government was involved, and wanted the aforementioned study of the deal before approval. Due to this, there was no way there could be any announcement of a deal before August 22. Further, should a deal take place, it would have to be structured so that if Lehman underperformed and the merged entity started to suffer massive drops in share price, there had to be a way the South Koreans could transform their minority stake into a controlling majority stake—they would take over Lehman’s management. (Structuring an investment like this—allowing a minority shareholder to assume control of a company without paying a control premium to the shareholders—could be illegal.)

Fuld was shocked. He thought he’d come to finalize the deal; now he was practically starting over.

Min was being advised by three parties: C. K. Lee, the president of South Korea’s Hana investment bank; Victor Lewkow of the New York law firm Cleary Gottlieb Steen & Hamilton; and a tall dark-haired American banker from the New York boutique advisory firm Perella Weinberg. His name was Gary Barancik.

Fuld asked Min if they could at least announce they were in discussions to do a deal. When Min made it clear that his government approval process wouldn’t allow an announcement prior to August 22, Fuld asked whether
KDB
would at least be willing to announce the following week that discussions between the parties were taking place. Min, though he had initially indicated that he would consider this, subsequently concluded that it would be “unwise” to announce discussions before receiving the government’s blessing. He told Fuld no.

Nonetheless, arrangements were made for talks to continue in New York City on August 5, in order to hammer out a term sheet and begin the due diligence on Lehman’s business units, though some on the Lehman team were beginning to doubt that this deal was viable. “It was just too complicated; it had too many parts,” one member of the executive committee said later.

Min was also starting to have doubts. When the South Koreans landed in New York on the night of August 2, Min’s concern about Lehman’s real estate portfolio had grown exponentially—he wouldn’t proceed with the deal until those assets were shipped elsewhere. As a result, Min turned the proposed agenda for the New York meeting on its ear, asking that the time be spent reviewing Lehman’s real estate assets on the first day, rather than doing the planned term sheet negotiations and general due diligence. He’d proceed only if what they found satisfied him.

A representative from
KDB
called McGee and asked if the Lehman team could bring Mark Walsh to the next day ‘s meeting to walk Min’s team through the valuations.

Walsh obliged. Min, however, was not satisfied. He expressed his concern about the real estate marks to market at the end. Fuld was not present during this meeting, but Bart McDade suggested a way around Min’s objections. What if Lehman offered him a stake in a “CleanCo” that had none of Lehman’s commercial or residential real estate? Min liked this idea. He even said that
KDB
would pay 1.25 times the book value, so long as the real estate was removed.

The two groups planned to meet again, at 6 P.M.—without Walsh—and go over a term sheet for such a deal. That afternoon, however, Fuld called Min twice. Both times he told him that the original deal was better, that it made more sense for Min to keep the businesses together. He said, in effect: “There’s tremendous opportunity here, given how depressed market prices are for these assets right now. If you invest now and buy the whole thing, you’ re going to look like a hero.”

Min was put off by Fuld’s calls, and was alarmed at his continued insistence on dumping the toxic assets on him, but nonetheless showed up for the 6 P.M. meeting, along with his bankers and lawyers.

Fuld kicked off the conversation by reiterating that he believed
KDB
was missing an opportunity by not taking on the whole company, all real estate included. It was the third or fourth time that day he had tried to persuade Min, and the pitch was wearing thin.

One person in the meeting says, “Everyone in the room other than Dick looked increasingly concerned” as Fuld talked. “Dick’s going through this whole thing, trying to sort of key up the same exact deal again to buy the whole company. And E.S. kept raising objections, politely reminding Fuld that
KDB
was uncomfortable with the amount of exposure, and Dick kept arguing with him. It was sort of incredible.

“
KDB
had already met with the whole Lehman team earlier about CleanCo, and had reached a conceptual agreement. The Koreans thought they were all there to talk about, ‘ Are you prepared to accept our offer and move forward on a CleanCo deal?’ Dick comes in and tries to change tack.”

Finally, Barancik spoke up, and tried to make it clear that
KDB
was concerned that the real estate had not been appropriately marked to market. “
KDB
has already made the decision that the only basis on which it is prepared to move forward is on the CleanCo structure,” he said bluntly.

Fuld fired back: “Have you really looked at this real estate and what it’s valued at?” he asked, incredulous. “If our marks aren’t accurate, what should they be?”

Barancik said he was not commenting on the marks or drawing any conclusions. He simply wanted to concentrate on the deal his client wanted to do: CleanCo.

To everyone’s relief, McDade leaped in and produced a term sheet drawn up by the lawyers.

“Look, Dick, we do have
this
term sheet—let’s talk about the deal that we came here to talk about,” he said, and the term sheet was passed around.

Min looked at it and was surprised. It was a one-page document. And it was selling a different CleanCo than the one they’d agreed to buy.

A person on Min’s team recalls, “CleanCo wasn’t totally CleanCo. In fact, CleanCo was going to have some amount of assets . . . between, like, $5 billion and $15 billion of real estate assets, that would be chosen by mutual agreement, some of which would remain with CleanCo because they were nontransferable, and some of which the Lehman team proposed be cherry-picked as providing attractive value to CleanCo.”

The tension in the room was palpable. Fuld sat silent but scowling. Min was confused. There were small clauses to haggle over, but the main problem was the elephant in the room: namely, that CleanCo was no longer CleanCo. Until this was resolved, negotiations could not continue.

Min and his advisers asked if they could step out for a minute to confer. In private, Min made it clear that he’d had enough, that he felt Lehman was hiding something and attempting to pass its problems to him. He said he was getting on the next plane to South Korea. As far as he was concerned, the deal was dead.

But Barancik persisted: Would Min be willing to proceed with a deal that was truly clean? One that resembled the deal discussed earlier in the day with McDade and McGee?

Min said he was, then reentered the room and told Fuld and the others that he was flying home, but that Barancik had been instructed to work with Lehman on coming to terms on a deal.

Min rose to leave the table. Fuld was, at this point, slumped in his chair. He didn’t try to hide his anger. He said to his former employee, “So what do you mean, E.S.? You mean you’ re just walking out? You’ re going to give up now? After all the work we’ve done and after all the time we’ve been talking? You’ re just going to walk out the door?”

There followed an excruciating pause. Would Min walk out in a huff? He didn’t. As the group disbanded, he chatted with Fuld at the door. Min politely stuck to his position and Fuld seemed to calm down.

The Lehman team decided to exclude Fuld from further talks. From that point on, Lehman became far more cooperative—perhaps out of desperation. With the Perella team, they modeled spin-off structures, and sent newly furnished financial information to
KDB
to encourage a definitive proposal.

In late August, KDB drew up a term sheet offering to invest approximately $6 billion into a CleanCo Lehman. Lehman would be paid 1.25 times book value but at a significantly written -down book value. The offer worked out to $6.40 per share. At the time, Lehman stock was trading around $13. The Koreans demanded two board seats and control if Lehman didn’t meet performance targets in terms of stock price and return on equity. Lehman would also have to keep its single-A credit rating.

In Lehman’s eyes, the offer was untenable. According to its valuations of the real estate, the stock should be priced at $17 or $18 a share. The South Koreans countered that they might be prepared to pay more if after 18 months it looked like they had undervalued the company. But Lehman wasn’t interested. In fact, no one seems to know if Fuld even showed the term sheet to the Lehman board. Tom Russo, under whose purview such matters fell, said he “could not recall” if Fuld ever produced the document.

Given Lehman’s ultimate fate, such an omission would have been a grave deviation from standard operating procedure.

On September 1, Barancik asked McGee what Lehman’s reaction to the term sheet was. McGee said it had been rejected, but that Min was welcome to come to New York and talk further. In the meantime, Kunho Cho, a member of the Lehman team requested that
KDB
not reveal that there had ever been any talks. A leak like that would negatively impact Lehman’s already depressed stock price.

Five days later, on September 6, Freddie Mac and Fannie Mae imploded. The U.S. government had to seize the two mortgage giants and pledge as much as $200 billion of taxpayer money to save them. On Monday, September 8, there were press leaks that the deal between Lehman and the South Koreans had fallen apart. It was widely assumed within Lehman that the South Koreans were the ones responsible for the leaks, terrified that their involvement in talks would be made public. In any case, the leaks spelled disaster. They further undermined the credibility of the firm, and reinforced the idea that—for all the rumblings—Lehman was just blowing smoke about having a buyer.

By Tuesday, Lehman stock had dropped 45 percent, to $7.79.

Barancik called McGee and asked if Lehman would be willing to reconsider KDB’s offer. McGee, staring into the abyss, said Lehman would consider it.

But he was too late.

On September 10 a South Korean government official told Reuters they were walking away from the deal. The stock fell 9 percent to $7.25. Hours later, a
KDB
official told the news agency the two were still in talks and that the bank had made an offer—only to concede a few hours later that prospects looked grim. Lehman stock fell another 60 percent the next day to $4.22.

Bob Steel summed up those failed negotiations this way: “It takes nine months to make a baby, and they didn’t have nine.”

The trouble was that by the end they believed their own press.

They were in la-la land. They really did believe they were

omnipotent. It just never occurred to them they couldn’t get

away with that balance sheet.

—Former senior Lehman executive

F
annie Mae and Freddie Mac, the two teetering giants that kept the multitrillion -dollar housing market churning with cheap loans, officially collapsed on September 7, 2008. Although the two companies were technically publicly traded capitalist entities, they had been founded by the government during the Depression and were still called government-sponsored enterprises. They were also flat broke. After warning Congress that they might need government assistance in July, Hank Paulson officially nationalized them six weeks later, estimating that the cost of bailing them out would run around $200 billion.

It was finally clear even to the most casual observer that the housing and asset bubble had burst—and that the damage would in no way be, as Federal Reserve chairman Ben Bernanke had predicted a year earlier, “contained.”

Observers had initially feared for Main Street’s smaller community banks, but Fannie and Freddie were also massive buyers and sellers of the mortgage-backed securities weighing on the balance sheets of every Wall Street firm. If the two firms could go from getting a clean bill of health from regulators in July to needing $200 billion six weeks later, what did that foretell for everyone else with billions of dollars in mortgages on its books?

The question spooked James L. “Jamie” Dimon, the 53-year-old CEO and chairman of JPMorgan Chase. Dimon learned first -hand the type of risk his more aggressive competitors had piled on when he took over Bear Stearns in March. As the leader of Lehman’s official clearing bank--meaning cash and securities exchanges arranged by Lehman actually took place at JPMorgan Chase--he was also partially privy to Lehman’s books.

Dimon had two disturbing conclusions: One, that Wall Street was so dependent on short -term financing that any one of them could become the next Bear Stearns, and Two, that he didn’t have any more room on his balance sheet to rescue the next victim.

On Tuesday, September 9, right after the government seizure of Freddie and Fannie was announced, Dimon reportedly sat down to lunch with Bernanke and warned him that he was done bailing out banks. Dimon wanted to know if the Fed was ready to step in to save Lehman.

“We’ re working on a number of initiatives,” Bernanke said vaguely. “We’ re just trying to stay ahead of this thing.”

Dimon took the hint. If Lehman were to fail, JPMorgan would be stuck with those securities and a massive loss of cash. So as a precautionary measure, it was going to need to ask for more collateral from Lehman Brothers.

Dimon understood that any potential acquirer of Lehman would want at least some of the potential losses subsidized by the Fed--what had come to be known as a “Jamie deal” since he had gotten the central bank to guarantee $30 billion in Bear’s bad loans back in the spring. What few on Wall Street realized was that another Jamie deal would be impossible to put together. The hole in Lehman’s balance sheet was vastly bigger than Bear’s, and while the criticism of Paulson and Bernanke over the Bear Stearns deal had largely come from the populist left, the Fannie-Freddie bailout had won them the enmity of the right. (Their role in housing policy has long associated them with left -leaning advocacy groups like ACORN.)