McDade and McGee couldn’t believe what they were witnessing. They had spent the past two days orchestrating a deal based on spinning off the real estate assets, and now Fuld was trying to retrade on their work. Worse, a look of horror crossed Min’s face. Min pulled Barancik aside and whispered, “I’m not comfortable with this,” and in response, Barancik spoke up on behalf of KDB. He said they would only negotiate on the basis of 1.25 times the book value valuation, and then, as his aggravation mounted, started questioning Lehman’s accounting. “I don’t believe that you’ve taken all the write-downs,” he said, reiterating why they weren’t interested in the real estate assets.
“Okay,” Fuld said, his frustration showing. “What do you think our real estate portfolio should be marked at?”
Before Barancik could answer, McDade piped up. “Well, we have a term sheet,” he interjected, trying to steer the conversation back in a more productive direction. “Why don’t we look at that?”
“Look, I just think we need to take a break,” Barancik said, sensing the tension could topple the talks.
As they stepped into the hallway, Fuld, having misread Min’s mood, approached him and again started promoting the idea of selling him the real estate.
McGee, who was standing behind Min and could see this conversation was only antagonizing him, tried to signal Fuld , slicing his finger across his throat to urge him to stop badgering the Korean.
Finally managing to break free of Fuld, Min took Barancik to a small room to study the term sheet—which was more a list of broad principles than a formal agreement. As they reviewed it, Min nodded at each bullet point until he reached the final one, which stipulated that KDB would provide credit to Lehman to help support it. To Min that was an instant red flag. Was Lehman seeking an open-ended credit line, hoping to leverage KDB’s balance sheet to bolster its own standing?
Min, looking pained, grabbed Kunho Cho, his friend when they worked at Lehman together, and asked to talk with him privately. Even before Min spoke a word, Cho could tell it wasn’t going to be good.
“There is a serious credibility problem here,” he said in Korean. “All of this time we have negotiated in good faith consistently, and we were moving toward the goal we all wanted, and now, all of sudden, it’s a new picture.”
Clearly frustrated, Min continued, “Look, it’s not about 1.25 versus 1.5 times book, or a $2 billion versus a $4 billion credit line. It’s none of that. It’s the way you conducted the meeting. I just feel uncomfortable about the way this whole thing has been conducted by Lehman senior management. I cannot continue on this basis.”
Cho, who had helped persuade Min to fly to New York for the meeting, was devastated.
When Min returned to the main conference room he looked apologetically at Fuld, and then at the rest of the bankers assembled around the table. “I’d like to thank you all, but I don’t think we have a structure that works,” he said, and got up to leave. “Gary Barancik can continue the dialogue.”
A dolorous look came over Fuld’s face. “So, you mean, that’s it?” he asked, raising his voice. “You’re just going back to Korea?”
Steve Shafran was at a gas station in Sun Valley, Idaho, one brisk morning in August when Hank Paulson called. Shafran, one of Paulson’s special advisers at Treasury, was on vacation. “Give me an update on Lehman,” Paulson instructed.
Shafran, who turned off the engine of his fifteen-year-old Land Rover, recognizing that this might take some time, had been assigned by Paulson earlier in the summer to a special project: to act as a coordinator between the SEC and the Federal Reserve to begin contingency planning for a Lehman Brothers bankruptcy. The original assignment had actually been to ascertain systemic risk in the banking system and to make sure the various government agencies were talking to one another, but it had soon morphed into focusing almost exclusively on Lehman.
It was by its very nature a secret undertaking, given that he wasn’t allowed to let anyone—least of all Lehman Brothers—know that the government was even thinking about the possibility, no matter how improbable it might be. If the stock market caught even a whiff of it, Lehman’s shares would plunge. But Paulson, who had been speaking to Fuld almost every day, had become convinced that Lehman was going to face a struggle in its attempts to raise capital, and they needed to prepare for the very worst.
Indeed, Paulson had become so frustrated with Fuld’s various plans that he had assigned Ken Wilson to be Fuld’s personal liaison. “I’m going to tell Dick that he’s talking to you,” Paulson told Wilson. “It’s just a waste of time. I’ll talk with him when he’s got something really important to say to me.”
Paulson wasn’t the only one worried about Lehman. Shafran’s assignment followed a series of e-mail exchanges within the Federal Reserve back in June between Bernanke and his colleague, Donald Kohn, the Fed’s vice chairman. Kohn had written to Bernkane to say that he had spent time “thinking about options” for Lehman “ in the event the slow erosion of confidence turns into a rout and liquidity fled quickly. None are good, given the lack of interest by a purchaser.” He followed up with second e-maiclass="underline" “One of the hedge fund types on Cape Cod told me that his colleagues think Lehman can’t survive—the question is when and how they go out of buinsess not whether.”
For Shafran, dealing with other government agencies was something of a novelty. He had moved himself and his children to Washington only a year earlier, after his wife of twenty-four years, Janet, was killed in a plane accident. They had been living in Sun Valley, where he had gone after retiring from Goldman Sachs. Shafran had worked at the firm for fifteen years, serving as Paulson’s point person in Hong Kong, helping him in his efforts to gain entrée to China. He had come to Washington to start over.
For Shafran the Lehman project was even more awkward than it would be for other Treasury staffers because he was a casual friend of Fuld’s. They knew each other from Sun Valley, where Shafran had become a city councilman in Ketchum and Fuld owned ninety-seven acres in the area (worth some $27 million), with a main home on a private road across the Big Wood River and a cabin on the shore of Pettit Lake, right near Shafran’s. They played golf together at the Valley Club and socialized occasionally. Shafran liked Fuld and admired his intensity.
But now, as Shafran was sitting in the gas station parking lot on the phone, he gave Paulson a progress report. He said he had held some conference calls with the Fed and SEC, and while they thought it was impossible to truly estimate the systemic risk, he felt that they were finally at least paying attention to the challenge. “They are on it,” he said. “I’m comfortable.” He explained that they had identified four risks within Lehman: its repo book, or portfolio of repurchase agreements; its derivative book; its broker dealer; and its illiquid assets, such as real estate and private equity investment.
Paulson knew he couldn’t do much for Lehman himself. Treasury itself did not have any powers to regulate Lehman, so it would be left to the other agencies to help manage a failure. But that made him anxious.
Earlier in the summer, David Nason had held a meeting with the SEC and told Paulson they were not on top of the situation. With streams of spreadsheets of Lehman’s derivative positions splayed before them in the Grant conference room, he had questioned Michael A. Macchiaroli, an associate director at the SEC, about what they would do if Lehman failed.
“There are a lot of positions,” Macchiaroli said. “I’m not sure what we’d do with the positions, but we’d try to net them out, and we’d go in there, and SIPC would come in,” he added, referring to Securities Investor Protection Corporation, which acts in a quasi-FDIC capacity but on a much smaller scale.