About halfway into the question-and-answer portion of the call, Michael Mayo, the prominent analyst with Deutsche Bank, addressed the capitalization issue with blunt directness: “To the extent you might need $7 billion to capitalize that entity,” his voice boomed over the speakerphone, “and you’ll get $3 billion with the spin of part of IMD [the more viable investment management division], how would you get the other $4 billion?”
Lowitt paused as he recalled the explicit instructions, given the conversation the firm had had the night before with the JP Morgan and Citigroup bankers: Don’t get pinned down talking about any specific numbers. You will be crushed. He was now being asked the one question that he didn’t want to answer.
“Well, we don’t feel that we need to raise that extra amount to cover the $7 billion,” he replied, trying to sound confident about the firm’s capital position, “because you will have less sort of leverageable equity in core Lehman than in, you know, where you are at the end of this quarter.”
In other words, the plan was essentially an accounting gimmick: Lehman would be smaller and less leveraged as a result of the spin-off, and would therefore need less capital.
Mayo responded that he had his doubts about Lehman’s plan, but in adherence to Wall Street protocol, he left it at that. This was not the place for a showdown.
For a few moments it almost appeared as if Fuld would be able to claim victory: Shares of Lehman Brothers opened that morning up 17.4 percent. The rise might give him the breathing room he needed.
Across the Atlantic a group of senior executives from Barclays in London were likewise intently listening in on the call, taking meticulous notes as they sat in a conference room at the firm’s headquarters, known as “The Bungalow,” in Canary Wharf. They had registered for the call under an assumed name. Bob Diamond, Barclays Capital’s CEO, had been mulling buying Lehman for months, ever since he had received the call from Bob Steel, when he was still at Treasury in April. In June, Diamond had broached the idea with Barclays’ board, which had been discussing possible expansion plans in the United States. The group ultimately decided against pursuing Lehman—unless, as John Varley, the firm’s chairman, put it, “the firm could be bought at a distressed price.” Diamond had in turn communicated that message directly back to Steel.
But the timing now seemed ripe for a deal. “I’m surprised, given how shaky this is, that I actually haven’t had a call from Treasury, because it knows that we would be willing to do this at a distressed price, and it’s not that far off,” Diamond had told Varley only a day earlier. Diamond had been in the middle of giving a recruiting presentation at Wharton, the elite business school at the University of Pennsylvania, on Tuesday, when his cell phone vibrated. Seeing that it was Varley, he abruptly stopped his presentation and walked off the stage. “If we’re going to meet with the board, we’re going to meet with the board tomorrow,” Varley told him. Diamond found one of the only three direct overnight flights to Heathrow from Philadelphia.
He took the last-minute overnight return flight to London to resolicit support to buy Lehman. He would have to win over Varley and the board—and do so quickly.
Varley was a model of the conservative Englishman and had married into one of the bank’s founding Quaker families. Soft-spoken and courtly, he wore suspenders every day, listed table tennis and fishing as his hobbies, and had far less tolerance for risk than Diamond. Whatever his own professional predilections, however, Varley had always given Diamond a long leash, even if he did maintain a quiet uneasiness with his colleague’s appetite for deal making.
The two men had long had a complicated relationship, having both vied for the top job in 2003. Although Varley won the position, Diamond was paid nearly six times what Varley, his superior, made. (In 2007, Diamond earned $42 million to Varley’s $8.4 million.) For years, Diamond had avoided taking a seat on the Barclays’ board to avoid disclosure of his compensation agreement, which would have landed him squarely in the pages of the British tabloids as a “Fat Cat.” Despite his title, Diamond was to many the de facto CEO. In 2006 a Dresdner Kleinwort analyst wrote a report provocatively titled “Bob Diamond 3, John Varley 0.”
As soon as the Lehman call came to an end, the Barclays executives discovered they were in agreement: They’d make a play for the firm. But only—Varley reiterated the point—if they could get it for a song.
Diamond went back to his office and phoned Bob Steel at his new number at Wachovia. “Remember our conversation about Lehman?” he asked.
“Of course,” Steel answered.
“Well, we’re now interested.”
Lehman’s stock may have temporarily stabilized after the earnings call, but only hours later Fuld was faced with a new problem: Moody’s Investors Service announced that it was preparing to place Lehman’s credit rating on review, warning that if the firm did not soon enter into “a strategic transaction with a stronger financial partner,” it would cut its rating.
Fuld decided to call John Mack, CEO of Morgan Stanley; he needed options. And, unlike his relationships with Ken Lewis and Lloyd Blankfein, he actually trusted Mack.
“Listen, I really need to do something,” Fuld told him. “Let’s do something together.”
Mack had always genuinely liked Fuld and was concerned by the stress he could now hear in his voice. But he had no interest in entering into a deal and wondered if Fuld was deluding himself by even making the call.
“Dick, I want to help, but it just doesn’t make any sense. We’ve talked about this before,” Mack said, reminding him of the meeting they had had at his house over the summer. “There’s so much overlap.”
After getting off the phone, however, Mack continued to think about the possibility of a deal with Lehman and found that he was intrigued. His initial impulse about its unfeasibility may have been correct when Lehman’s stock was trading at $40 a share, but given its current price, a deal might well be financially attractive.
“I’ve been thinking,” he said, after calling Fuld back. “I agree with you. We should talk.”
After Fuld thanked him for reconsidering, Mack paused a moment and then said firmly, “Dick, I’m a very straightforward guy. I really like you, but let’s be clear, this is not a merger of equals. Only one person can run this. We have to get that up front now.”
After an awkward silence, Fuld finally responded, “I wasn’t thinking that way,” and then, after another brief hesitation, added, “Let me think about it. I’ll call you back.”
Twenty minutes later Fuld was back on the phone.
“Look, you’re right,” he said, the toll that recent days had taken shading his voice. “I want to do the right thing. Let’s see what can be done.”
Fuld suggested that they set up a meeting between the senior managements of both firms, without Fuld or Mack present; let them be the ones to decide if it was a good or bad idea.
The gathering was arranged for that night at the apartment of Walid Chammah, Morgan Stanley’s co-president.
Bob Diamond drummed his fingers on the desk as he waited on hold for Tony Ryan at Treasury, whom Bob Steel had suggested he call. “Tony,” Diamond began, “do you recall the conversation I had with Steel?”
For a moment, Ryan was confused.
“Which?” he asked, trying to act as if he knew what Diamond was talking about.