Crash of a titan: The inside story of the fall of Lehman Brothers

One year ago, the assembled brains of the Fed and Wall Street sealed the fate of one of its oldest banks. In this gripping account of that weekend last September, Stephen Foley counts the cost of high finance's darkest hour

Monday 07 September 2009 00:00 BST

Go home. It's no one famous. You're just looking at a whole bunch of people who lost their jobs. Police shouted into the crowd, hastily erecting barricades, but New Yorkers and tourists were moth-like in the face of camera flashbulbs and the spotlights of television crews. Even in the neon-lit stampede of humanity that is Times Square, this was a sight to remember.

For the first time since it began crackling and fizzing in the obscurest corners of Wall Street more than a year before, the credit crisis finally had a human face. Many human faces. One by one, Lehman employees stumbled outside, carrying duffel bags stuffed with personal effects. As that Sunday ground on, more and more employees decided that they would not wait to find out the fate of the 158-year old investment bank. Hope had ebbed away that it had any future at all. Mid-afternoon, a rumour had shot round: maybe the bankruptcy would be so chaotic, so catastrophic, that the authorities would seal off the headquarters entirely. Even more came to grab what they wanted to save, just in case.

By the time darkness fell it was running on all the news channels: Lehman Brothers was filing for bankruptcy.

Few emerging from the building would speak to reporters, but those that did expressed disbelief. Anger that Lehman had been driven to the ground. Sadness at the careers derailed and the livelihoods lost. But most of all, shock. By September 2008, America had already entered the age of the bailout, and despite a week of insisting there would be no government money to save Lehman Brothers, no one could quite believe that Hank Paulson, Treasury secretary, and Federal Reserve chairman Ben Bernanke would let the bank go to the wall.

Lehman Brothers had 25,000 staff around the world, 4,500 at its European headquarters in Canary Wharf in London, where the scenes of bagging and boxing were repeated the next morning. It was the fourth largest of the Wall Street investment banks and the oldest. It had survived repeated financial panics around the turn of the 19th century and thrived during the Great Depression. It had over $600bn of assets and vast, untanglable trading relationships with every other major firm in finance. It was, almost everyone agreed, too big to fail.

And yet fail it did. In the small hours of the morning, on Monday, 15 September 2008, Lehman Brothers filed for bankruptcy, the biggest in American history by a factor of six.

It is no less extraordinary, one year on, to recall images from that weekend, probably the defining pictures of this great financial crisis. The NYPD officer shouting into the crowd was dead wrong. We weren't just looking at a bunch of people who lost their jobs. (And many, in the end, didn't.) We were looking at the symbolic end of a way of life on Wall Street and the start of very real economic horrors for the rest of us. We were looking – we can say this with confidence – at a terrible, terrible error.

"It's unconscionable what they did – or more accurately what they didn't do," says Joseph Stiglitz, Nobel prize-winning economist and professor at Columbia University. "They didn't do their homework. People were talking about the failure of Lehman Brothers from the moment of the failure of Bear Stearns in March, or before, and they didn't do a thing. If they knew there was systemic risk, why didn't they do anything about it?"

Paulson had been pushing Lehman to find a solution to its problems, to sell itself or to raise cash. He had not been preparing a government-sponsored contingency plan. There was none. That weekend, everyone was flying blind.

Lehman's fate was sealed not in the boardroom of that gaudy Manhattan headquarters. It was sealed downtown, in the gloomy grey building of the New York Federal Reserve, the Wall Street branch of the US central bank. Almost exactly 10 years previously, Dick Fuld, the scrappy Lehman boss, had sat in the Fed's wood-panelled conference room and hammered out with his fellow chief executives the deal that rescued Long-Term Capital Management (LTCM). On that occasion, when one of the largest hedge funds tottered and threatened to bring down the financial system, Wall Street's finest minds found a way to save it.

This was precisely the template that Paulson, Bernanke and the New York Fed chairman Tim Geithner had in mind when they summoned Wall Street bosses again on the Friday of Lehman's final weekend. One by one they got the call: Be here at 6pm. Only this time, Fuld was not invited. He would be left to rattle around the Times Square boardroom, awaiting his bank's fate. How had it come to this?

In 1850, Henry, Emanuel and Mayer Lehman, Bavarian immigrants to Alabama, began bartering for cotton as payment from customers at their store, and within a few years these original Lehman Brothers were full-blown commodities traders. Subsequent generations of Lehmans would take the firm into investment banking, backing America's great retail enterprises, from Woolworth's to Macy's, and then funding the first television manufacturers and broadcasters in the Thirties.

Richard Severin Fuld, son of a well-to-do New York family, came to Lehman in 1969 as a trader of commercial paper, and quickly proved himself boisterous, even by the standards of a Wall Street trading floor. Colleagues named him The Gorilla, and his brutality was legendary. He ruled by intimidation, and he conceived of Wall Street as a war, his staff a great fighting force manning a battleship, its guns permanently trained on even bigger rivals. His "never surrender" attitude meant that he rejected offers from potential buyers for Lehman Brothers earlier in 2008, when outsiders were saying the bank was too weak to survive on its own. The great outpouring of anger against him has come not just from the public and politicians, but from Lehman staff. The New York artist Geoffrey Raymond set up camp outside the Lehman offices on the day after the bankruptcy, and handed green marker pens to employees to graffiti a portrait of Fuld. It is littered with sarcastic messages. "Nice trade," says one. Another: "Enjoy your old age, Prick Fuld."

Hauled before Congress in October, his only public outing since the fall of Lehman, Fuld blamed "rumours, speculation, misunderstandings and factual errors" for the collapse. "I want to be very clear. I take full responsibility for the decisions that I made and for the actions that I took based on the information we had at the time," he said, but there was nothing he would have done differently.

Like the bosses of other investment banks, Fuld had been salivating since the middle of the decade over the enormous profits on offer from slicing and dicing America's mortgages into securities for sale to investors around the world. Lehman rushed headlong into this business, ignoring warnings that the US housing market had become dangerously overheated and that mortgage brokers were doling out loans to people who could never repay them. The bank was also one of the biggest financiers of commercial property and had taken some pretty optimistic views of its portfolio's worth.

A reckoning was fast approaching and Lehman had put itself at more risk than most: to juice results and get ahead of the competition, it had pumped itself up on debt. The bank held less than a dollar in reserves for every $30 of its liabilities. As long as it had assets to match them, this was fine. But investors were increasingly sceptical about the value of the assets Lehman claimed.

In that final week, when Fuld announced a further $3.9bn loss, confidence collapsed. Clients fled. Jamie Dimon, head of the mighty JPMorgan Chase, another storied investment bank, phoned personally to demand that Lehman put up $5bn in collateral or he'd pull the bank's credit lines. Lehman scraped together the coin – just – and made it to the weekend, but it was clear it wasn't coming out the other side as an independent bank.


Henry Merritt Paulson, Hank to everyone, is a man of impeccable free market credentials. It is gobsmacking that he will go down in history as the Treasury secretary who ordered the biggest-ever government intervention in the US banking system. It is still gobsmacking to him, too.

Terrifying looking – totally bald, with the thick neck of the American football player that he was in college – Paulson had been both an obvious choice for Treasury secretary and an odd one. The $37m-a-year boss of Goldman Sachs had been wooed by President George Bush in 2006 with the promise of autonomy over economic policy, and he reluctantly accepted the call to service, becoming the latest in a long line of Goldman executives to pass through the revolving door into government. But he was not a natural politician, a tub-thumper in negotiation rather than a flatterer, and a tongue-tied mess in public speaking.

The best orator in the world would have had trouble explaining the Treasury's policy pirouettes as the credit crisis spiralled last year. In March, Paulson had orchestrated the sale of Bear Stearns to JPMorgan, financed with the loan of public money from the Federal Reserve. Just the weekend before Lehman collapsed, he had ordered the mother of all bailouts, the nationalisation of America's two mortgage finance giants, Fannie Mae and Freddie Mac, putting the Treasury on the hook for potentially hundreds of billions of dollars.

Yet in subsequent days, he had rediscovered his free market mojo. Capitalism must claim its scalps. Banks that take too much risk should be hoist on that petard. If the government were to guarantee nobody fails, then what's to stop bankers rolling the dice for higher and higher stakes – and higher and higher bonuses when the gambles pay off?

This was the line in the sand moment, Paulson figured. The time to "re-establish moral hazard". Lehman would get no money from the government. Wall Street would have to sort this one out itself. No bailout this weekend, he said.

It was a message delivered by the Fed's Tim Geithner, the quiet-spoken government apparatchik whose career was forged in the Asian debt crises of a decade earlier, when the chief executives piled in to the Fed that Friday evening. Some blame him for not delivering it forcefully enough. Paulson and Bernanke did deliver it forcefully, but all the way through that fraught weekend it hung there in the room: You did it for Bear Stearns. Few could really believe that there wouldn't somehow be taxpayer money, Fed loans or government guarantees – something – to smooth a rescue.

In a 48-hour blizzard of brainstorming and deal-doing, Wall Street was changed forever. But not in the way Paulson had hoped.

It was clear from that Saturday morning, when the titans of the industry reconvened, that Lehman was infinitely more complicated than LTCM before it. The chief executives were split into teams, some to examine how awful Lehman's property portfolio might be, others to try to untangle Lehman's trading relationships. No one doubted that the consequences of failing to do a deal could be catastrophic, but the bickering began immediately.

One plan was for the biggest banks to put up money to cover losses on the $85bn property portfolio, while freeing up the good bits of Lehman – its fiery bond trading business – for sale to one of the two suitors in the room, Bank of America or the UK's Barclays. John Mack spoke up against the idea. How was it fair that his firm, Morgan Stanley, should end up with a slice of a dodgy property portfolio while Barclays or BofA walks off with the Lehman jewels? Other firms pointed out that that, after the credit crisis, they couldn't afford to rescue of someone else.

Nonetheless, talks continued. Bob Diamond, who runs Barclays' investment banking division, had made no secret of his desire to turn it into a global powerhouse, but had previously argued it was better to poach staff from rivals, rather than buy competitors outright and be saddled with reluctant employees. This weekend, though, he scented the chance for a bold move. Barclays advisers crawled all over Lehman's books, as Diamond barked orders.

No less ambitious was Ken Lewis, the bespectacled banker from North Carolina, whose Bank of America has long been an also-ran in investment banking. The company's bright-red branches dominated retail banking, but Lewis's attempts to build an investment bank to rival Goldman Sachs and its peers were always something of a laughing stock. When bad bets by its Wall Street traders had wiped out the profits from the retail banking side in 2007, Mr Lewis said he had had "all the fun I can stand in investment banking". But Lewis saw an opportunity to change his fortunes with an audacious bid for Lehman, and his staff had been sniffing around all week. By Friday, though, they knew they couldn't make the numbers work. His team of advisers flew back to North Carolina empty-handed on Saturday morning, only to be told to get straight back on the plane to New York. Now Lewis was flying in with them. The mission had changed. There was a new target. They touched down around lunchtime.

Early Saturday morning, Lewis had taken a call from John Thain, a protégé of Paulson from his Goldman Sachs days, who now ran Merrill Lynch. Thain was brainy in a way that didn't quite add up to smart. He would later lose his job at Merrill and his reputation when it was revealed he had spent squandered $1.2m of shareholders' cash on redecorating his office with a $35,000 "commode on legs", an $8,000 rug and a $1,400 "parchment waste can".

That morning, though, Thain had seen an important pattern in the credit crisis. With markets panicking, investors and clients were sucking their money away from whichever bank looked the most dangerous. After Bear Stearns in March it had been Lehman. After Lehman, it would be Merrill. Thain was determined not to do a Dick Fuld – fight the market and lose. To salvage what he could of the 94-year old firm, he was willing to sell it. The next day, Merrill agreed to be taken over.

It is time to "spray foam on the runway", Tim Geithner told his sleep-deprived officials on Sunday afternoon. Lehman was going to crash.

Only then did the truth dawn. Paulson, Geithner and Bernanke had not been negotiating. There really would be no government guarantees, no taxpayer bailout. Bob Diamond at Barclays had come closest to a deal, but even he had come back to the Treasury demanding that it backstop Lehman's trading positions until he could arrange a vote of Barclays shareholders. When Barclays received a "no", the game was over for Lehman.

Dick Fuld, pacing uptown, had come to the same realisation by the middle of Sunday. Geithner was not returning his calls. He had telephoned Ken Lewis's home in North Carolina so often that Donna Lewis had to tell him to stop. If her husband wanted to call him back, he would.

Spraying foam on the runway meant doing whatever was possible to keep markets happy while the unpredictable consequences of Lehman's failure played out. The Fed promised to pump money into the markets. The terrified Wall Street chief executives agreed to pay for a $70bn insurance fund that they could draw on if any turned out to have big exposure to Lehman losses. Meanwhile, Geithner shifted his attention to the insurance giant AIG, where he was trying to orchestrate another private-sector rescue.

There was not enough foam. When Lehman crashed, pieces flew off in all directions. On the Monday morning, an exhausted-looking Paulson began a tense press conference with an attempt at levity. "I hope you all had a good weekend," he said. He insisted that markets had had a long time to prepare for Lehman's collapse, and the banking system was "safe and sound". But it wasn't. Investment funds that had promised their savers they were the safest place for their money came forward to say they had lost money on Lehman, sparking panic.

The private sector pulled away from AIG, leaving the Fed no alternative but to nationalise it, and worry about untangling its vast sub-prime mortgage trades later. By Wednesday, the credit markets had seized up entirely. Big corporations were reporting difficulty getting funding to pay wages and invoices. The economy appeared in grave danger. By the middle of the week, Paulson would complain: "I feel like Butch Cassidy and the Sundance Kid. Who are these guys that just keep coming?"

On Thursday night, the Treasury went literally down on his knees before Nancy Pelosi, speaker of the House of Representatives, begging her to agree taxpayer money to bail out the financial system. Bernanke, a scholar of the financial panic that caused the Great Depression, told fearful lawmakers there wouldn't be a banking system in place by Monday morning if they didn't act. Paulson talked openly about planning for martial law, about how to feed the American people if banking and commerce collapsed. Despite this, it would take almost two weeks before Congress agreed – at the second attempt.


The best defence of the decision to let Lehman fail is that it shocked Congress into providing funds to recapitalise the banking system – something it might not have done without the scenes of Lehman staff carrying their boxes into the street. If the credit crisis had continued to play out slowly, largely hidden from public view, America's sclerotic political system may never have mustered the energy to react. But the consequences of those 48 hours, when Paulson's laissez-faire capitalism briefly reasserted itself, were severe. Ben Bernanke admits that Lehman's demise had consequences for the rest of the economy. "It was that shock to the financial system that led to the global recession that began last fall, which was probably the worst one since World War Two," he told public television. "When Lehman Brothers failed, the financial markets went into anaphylactic shock, basically."

"People argue that if it wasn't Lehman Brothers it would have been something else," says Alan Blinder, the former Federal Reserve board member and professor at Princeton University. "I don't buy that. I don't mean everything would have been great if we had bailed out Lehman. We were in a financial crisis before Lehman. But it had a shock value that just caused everything to fall off a cliff. If you look at data on almost anything – consumer spending, investment spending, car sales, employment – it just drops off the table at Lehman Brothers and I don't think we needed to have that."

Paulson's initial defence of letting Lehman fail, that he believed the market had had time to prepare, gave way to the one he uses today, echoed by Bernanke. This is that there was simply no way the Fed or the Treasury could have intervened. There was no legal mechanism to provide funds to an insolvent company. It's an argument that still perplexes many. "That's their second line," says Joseph Stiglitz. "When their first line looked incredible, they decided they didn't have the legal authority. It should be viewed as an unacceptable. They didn't have legal authority to do Lehman Brothers, but two days later they had legal authority to do AIG, an insurance company? Nobody thought they had legal authority to do Bear Stearns, but they found a legal authority."

The Treasury – now run by Geithner, appointed by Barack Obama to succeed Paulson in January – and the Fed are pushing Congress for precisely the formal powers they say they need to seize and sort out future Lehmans. The proposal is part of a wider set of reforms designed to ensure Wall Street is never again allowed to run wild, gamble with so much borrowed money, or to allow firms to grow so big they can hold the economy to ransom when they get into trouble. But these reforms are bogged down in Congress, in the teeth of a resurgent lobbying effort from the finance industry.

One year older, one year wiser, and yet we still can't say with any certainty: never again.

The cast of a financial drama: Where are they now?

Dick Fuld

The last CEO of Lehman Brothers has made one public appearance since that fateful weekend, telling a Congressional hearing that the pain will stay with him for the rest of his life. Friends report he feels betrayed by Hank Paulson, and mystified by what he could have done differently, but he is now personally besieged by lawsuits from shareholders claiming he misled them.

Ken Lewis

The Bank of America chief executive has lived to rue that whirlwind weekend of dealmaking – the acquisition of Merrill turned out to be pure poison. Spiralling losses forced Lewis to go cap in hand for a government bailout, and shareholders revolted, stripping him of the additional title of chairman. His days at the helm are numbered.

Hank Paulson

The former Treasury secretary had longed for retirement, a return to his loves of bird-watching and rearing wildlife on his farm in Illinois, but he has instead been fighting to salvage his reputation. Assailed by Congress, which believed he was more interested in helping his friends at Goldman Sachs than saving the real economy, he is writing a self-justificatory book, out in the New Year.

Bob Diamond

The Barclays investment banking chief is the only undisputed winner: his bank's logo now scrolls across the façade of 745 Seventh Avenue. Diamond refuses to be cowed by public revulsion against Wall Street pay, and continues to poach bankers with high bonuses.

John Mack

The Morgan Stanley chief kept his cool as panic threatened to engulf even his firm. He persuaded regulators to ban speculation against his shares and then became one of the first to pay back the government bailout. Slated to retire next year.

Jamie Dimon

This smooth son of Greek immigrants is now the King of Wall Street. JPMorgan Chase absorbed not just Bear Stearns, but also the giant Washington Mutual. One of the few CEOs who pulled out of sub-prime in time, his cockiness is at new highs.

Ben Bernanke

Obama prevaricated over reappointing the Republican academic to the Fed chairmanship, but an overwhelming number of economists advised that Bernanke – despite his mistakes – should be rewarded for preventing the crisis becoming, in his words, "Depression 2.0".

Lloyd Blankfein

Proving that bankers can make money in any market, Goldman Sachs has soared back into the black this year, but Blankfein, its CEO, has become a lightning rod for criticism of Wall Street. He faces the tricky question of what to do about his bonus. At the current rate, he is on course to get a package worth $50m this year. Will he have the balls to take it?

Timothy Geithner

With markets still in panic mode in January, Obama believed that promoting the New York Fed chairman to Paulson's old job would bring continuity. It almost backfired, when it was revealed Geithner had failed to pay $35,000 in back taxes and his first bank rescue plan as Treasury secretary sent markets plunging. But he is growing in stature.

John Thain

The Merrill boss went from hero to zero in four months. He got $50bn from Bank of America, but his relationship with BofA's Ken Lewis was a disaster. Merrill's losses spiralled out of control and Lewis blamed Thain for keeping him in the dark. When Thain asked for a multi-million-dollar bonus, it was the last straw, and he was fired by Lewis in January in a 15-minute meeting.

The act that made crisis inevitable

By Larry McDonald, a former Lehman Brothers vice-president

Sometimes I lie awake at night trying to place all the if-onlys in some kind of order. Sometimes the order changes, and sometimes there is a new leader, one single aspect of the Lehman collapse that stands out above all others. But it's never clear. Except when I stand right here and look up at the great glass fortress which once housed Lehman, and focus on that 31st floor. Then it's clear. Boy, is it ever clear. And the phrase if only slams into my brain.

If only they had listened – Dick Fuld and his president, Joe Gregory. Three times they were hit with the irredeemable logic of three of the cleverest financial brains on Wall Street – those of Mike Gelband, our global head of fixed income, Alex Kirk, global head of distressed trading research and sales, and Larry McCarthy, head of distressed bond trading. Each laid it out, from way back in 2005, that the real estate market was living on borrowed time and that Lehman Brothers was headed directly for the biggest subprime iceberg ever seen, and with the wrong men on the bridge. Dick and Joe turned their backs all three times. It was probably the worst triple since St Peter denied Christ.

Beyond that, there were six more if-onlys, each one as cringemakingly awful as the last. If only Chairman Fuld had kept his ear close to the ground on the inner workings of his firm – both its triumphs and its mistakes. If he had listened to his generals, met people who formed the heart and soul of Lehman Brothers, the catastrophe might have been avoided. But instead of this, he secluded himself in his palatial offices up there on the 31st floor, remote from the action, dreaming only of accelerating growth, nursing ambitions far removed from reality.

If only the secret coup against Fuld and Gregory had taken place months before that clandestine meeting in June 2008. If the 11 managing directors who sat in ostensibly treasonous but ultimately loyal comradeship that night had acted sooner and removed the Lehman leaders, they might have steadied the ship, changing its course.

If only the reign of terror that drove out the most brilliant of Lehman's traders and risk takers had been halted earlier, perhaps in the name of common sense. The top managers might have marshalled their forces immediately when they saw giants such as Mike Gelband being ignored.

If only Dick Fuld had kept his anger and resentment under control. Especially at that private dinner in the spring of 2008 with Hank Paulson, secretary of the United States Treasury. That was when Fuld's years of smouldering envy of Goldman Sachs came to the surface. Could that perhaps have been the moment Hank decided he could not bring himself to bail out the bank controlled by Richard S Fuld?

If only President George W Bush had taken the final, desperate call from Fuld's office, a call made by his own cousin, George Walker IV, in the night hours before the bank filed for Chapter 11 bankruptcy. It might have made a difference. If only ... if only. Those two words haunt my dreams. I go back to the fall of Lehman and what might have made things different. For most people, victims or not of this worldwide collapse of the financial markets, it will be, in time, just water over the dam. But it will never be that for me, and my long background as a trader and researcher has prompted me many times to burrow further to the bedrock, the cause of the crash of 2008. I refer to the repeal of the Glass-Steagall Act in 1999.

If only President Clinton had never signed the bill repealing Glass-Steagall Act of 1933, the post-Wall Street crash legislation that prevented commercial banks merging with investment banks, thus eliminating the opportunity for high-rolling investment guys to get their hands on limitless supplies of depositors' money. Glass-Steagall was nothing short of a barrier, and it stayed in place for more than 60 years, but the major US banks wanted it abolished. I remember my concern as I watched the television news on November 12, 1999. The action on the screen was flying in the face of everything my dad had told me. I was watching President Clinton step up, possibly against his better judgment, and sign into law the new Financial Services Modernisation Act, repealing Glass-Steagall. In less than a decade, this act would be directly responsible for bringing the entire world to the brink of financial ruin. Especially mine.

From "A Colossal Failure of Common Sense" by Larry McDonald (Ebury). To order a copy for the special price of £7.59 (free P&P) call 08430 600 030, or visit

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