In Part 2 of a five-part series, Yalman Onaran and John Helyar chronicle the demise of investment bank Lehman Brothers and the fall from grace of its leader Richard Fuld.
The fall of Lehman Brothers isn't another tale about an overmatched or under-engaged chief executive.
For the 16 years Richard Fuld presided over Lehman, he was considered one of the industry's most skilled chief executives, boosting the firm's profit from US$113 million in 1994 to US$4.2 billion last year and multiplying its share price 20 times. Fuld was no E. Stanley O'Neal or Charles O. "Chuck" Prince, late of Merrill Lynch and Citigroup respectively, who had got top jobs without being steeped in their institution's businesses. Nor was he a James "Jimmy" Cayne, who played
bridge while Bear Stearns burned.
Fuld lived for and identified with his firm. It was his oxygen, a friend says. He had spent his entire career there, so his saga is also a story of Wall St over the past four decades. When Fuld began working at Lehman in 1969, messengers lugged bags of stock certificates between brokers' offices to complete trades. His rise embodied the triumph of the trader and of the outsize bonus - he took home about US$300 million over the past eight years.
Starting on Lehman's commercial-paper desk, Fuld became a formidable fixed-income trader. He maintained a reputation as a keen risk manager until it became clear Lehman had taken on too many bad mortgage-related assets.
The difference between risk management in the 1980s and in the new millennium was like the difference between playing draughts and three-dimensional chess. The instruments Lehman issued had become more complex than commercial paper, the stakes incomparably higher.
It was the same all over Wall St. While chief executives of Fuld's generation spent their days in top-floor offices taking meetings, the firms' numbers wizards were downstairs cooking up synthetic financial gizmos and mind-bending trading strategies. What they concocted might produce monster profits - or prove a Frankenstein's monster.
"Fuld took a franchise he'd built from almost nothing, brick by brick, and then trashed it in less than two years," said Sean Egan, of Egan-Jones Ratings. "His biggest mistake was in not understanding the risks that had evolved since he was last active in debt markets. And he relied on the support of others whose interests were aligned with him."
A chief executive needs good managers reporting to him to figure out the right risk-reward ratios and make the right decisions.
Increasingly, Fuld was not getting good dope. He became isolated in recent years, people familiar with the firm's operations said. He countenanced little debate and delegated more responsibility to Joseph M. Gregory, 56, who became president and chief operating officer in 2004.
An intimidating figure - he played in international squash competitions when he was younger and is still fit - Fuld was known around the office as "the Gorilla". His icy stare, people who worked at Lehman say, froze recipients with fear. No one wanted to tell Fuld something was wrong or to question how Lehman was run.
As it turned out, one of the lessons Fuld took away from Lehman's decline in the 1980s would contribute to its collapse in 2008.
The earlier crisis grew out of a power struggle between two senior partners: Lewis Glucksman, who headed trading and was Fuld's mentor, and Peter Peterson, who ran investment banking. Glucksman manoeuvred Peterson out of the chairmanship, setting off a rift between traders and bankers that so weakened the firm it wound up being acquired by American Express in 1984.
It was traumatic for the partners, since the dispute cost them their independence and considerable income. When Lehman was spun off in 1994, Fuld vowed that no one would ever do unto him as Glucksman had done unto Peterson. For Fuld, that meant not having a strong No 2.
Christopher Pettit, a longtime friend and ally of Fuld's, was forced out as chief operating officer when he balked at an executive reorganisation in 1996. (He died three months later in a snowmobile accident.) Six years would go by before Fuld installed another chief operating officer. In the meantime, Fuld pushed potential rivals aside, say people familiar with the operation. Michael F. McKeever, who ran investment banking, was stripped of his duties bit by bit and left in 2000.
John Cecil, chief financial officer until 2000, was demoted to an adviser because he dared oppose Fuld.
The man Fuld finally appointed chief operating officer was Gregory, a trusted lieutenant who had worked at Lehman since 1974. He would make it his mission to keep Fuld's life uncomplicated by debate.
Any meeting with Gregory, say people who worked with him, was a soliloquy. He delivered lectures on matters as minute as improving the look of sloppy dressers. Management-committee meetings were conducted without discussion, attendees say.
The same was true of executive committee meetings presided over by Fuld. While reviewing budgets for 2007, one committee member questioned the performance of a unit, according to a person who was in the room. Fuld stared at him coldly, then broke the silence: "You've got some balls to say that, knowing how much I hate that topic."
As Fuld returned to studying the papers in front of him, Gregory continued dressing down the committee member for his impertinence. He also upbraided him after the meeting, demanding that any objections be brought to Gregory privately and not voiced in front of the committee. Gregory did not return calls seeking comment.
Word on proper comportment spread through the ranks. Fuld conducted an employee webcast every three months. He would always end by asking if there were any questions. There rarely were.
The problem with this authoritarian climate was that when Lehman began to sputter, Fuld was cut off from dissenting opinion. Woe to the messenger who came to the 31st floor bearing bad news.
The refusal of fixed-income chief Michael Gelband to play the yes-sir game cost him his job - and Lehman one of its best risk managers. He was forced out by Gregory in May 2007, people familiar with the circumstances say. Four months later Gregory also shunted aside risk chief Madelyn Antoncic, when she fought for hedges on some of Lehman's investments. She was demoted to a peripheral government-relations job.
Gregory also set factions within Lehman against each other, the people say. New York executives, led by Bart McDade, then head of equities, jousted with those in London, who gathered around international operations chief Jeremy M. Isaacs and believed they deserved more power because the firm's top growth areas were outside the US. The intercontinental rivalry would prove a critical fault line for Lehman.
As cut off from information as Fuld may have been, it was not as if he didn't recognise the firm's problems. In November 2004, more than two years before the bull market reached its peak, Fuld was telling people around him that low interest rates and cheap credit would create a bubble that could one day pop.
"It's paving the road with cheap tar," he told colleagues in a meeting at the time. "When the weather changes, the potholes that were there will be deeper and uglier."
Fuld also warned against taking on too much risk, such as leveraged loans, which are used to finance buyouts of firms, as Lehman tried to compete with commercial banks that used their bigger balance sheets to support investment banking operations.
"We're vulnerable if we throw our balance sheet around," Fuld said, according to a person at the meeting.
As early as March 2006, Fuld approached Martin J. Sullivan, then chief executive of AIG, about a possible merger. Fuld saw Lehman becoming the investment banking unit of the insurer. A combination would have given Lehman a trillion-dollar balance sheet, funded by stable insurance premiums, which it could use to provide leverage to its clients, Fuld told his executive committee at the Fairmont Turnberry Isle Resort and Club near Miami, according to a person who attended
Sullivan was not interested, and the proposal did not go beyond the initial contact, the person said. Sullivan, who left AIG in June 2008, did not return calls seeking comment.
Tomorrow: "On March 17, a day after the sale of Bear Stearns, Lehman shares fell as much as 48 per cent in New York Stock Exchange trading on concern the firm would be Wall St's next victim.
To Fuld, the idea was outrageous. The hit was a matter of wrong perceptions, not weak fundamentals. So he got on the phone to the firm's biggest clients to tell them Lehman was no Bear Stearns, and he ordered other executives to do the same."