All the Devils Are Here [215]
“From March to September,” says a former Treasury official, “the big question was, how would we attempt to deal with the next shoe dropping?” Nobody doubted another shoe was coming.
With his antennae so attuned to Wall Street, Paulson had long thought the next shoe could be Lehman Brothers, the second smallest of the big five. When Bear Stearns started its downward spiral, Paulson had called Lehman CEO Dick Fuld, who was on a business trip in India. “You better get back here,” Paulson told him, according to Too Big to Fail, Andrew Ross Sorkin’s book about Wall Street during the financial crisis.
Fuld was an aloof, stubborn executive who had run Lehman since 1994 and had seen his firm through crises before. He felt certain he could do it again. But he was playing a dangerous game. Instead of getting “closer to home,” like Goldman Sachs, Lehman had decided to double down, in large part by financing and investing in big commercial real estate deals at the very height of the real estate bubble. Between the fourth quarter of 2006 and the first quarter of 2008, Lehman’s assets had increased by almost 50 percent, to some $400 billion. Its leverage ratio was 30 to 1. “Pedal to the metal,” is how David Goldfarb, Lehman’s chief strategy officer, described the firm’s growth, according to Lehman’s bankruptcy examiner.
All that risk on its books was taking a toll, however. The market was starting to ask questions, just as it had with Bear. The stock was declining. And starting in 2007, according to one well-placed observer, Lehman had begun to lose access to unsecured funding, so it was increasingly dependent on the repo market. But repo lenders had begun to steadily increase the “haircut” they demanded from Lehman. On March 26, Eric Felder, Lehman’s U.S. head of global credit products, sent an e-mail to Bart McDade, the head of Lehman’s equity capital markets group. “I’m scared that our repo is going to pull away . . . We need to be set up for [commercial paper] going to zero and a meaningful portion of our secured repo fading (not because it makes sense but just because).... The reality of our problem lies in our dependence on repo and the scale of the real estate related positions. . . .”24
Ian Lowitt, who was then Lehman’s co-chief administrative officer, wrote back, “People are on it. Agree there will be another run, but believe it will be industry wide not Lehman specific. You are not Cassandra, cursed by Apollo to be able to see the future but have no one believe you!!!”
That the government knew Lehman Brothers was playing with fire—and did nothing about it—would become clear in the aftermath of the crisis. The SEC, for instance, would later tell the Lehman bankruptcy examiner that it was well aware that the bank had repeatedly violated its own internal risk limits. But, the agency added, it “did not second-guess Lehman’s business decisions so long as the limit excesses were properly escalated within Lehman’s management.”
The Federal Reserve developed rigorous stress tests for Lehman that were supposed to determine its ability to withstand a run on the bank. The Fed devised two scenarios, which they called Bear and Bear Stearns Lite. Lehman Brothers failed both. The Fed came up with an additional round of tests; Lehman failed those, too. Lehman did pass stress tests of its own devising. “It does not appear that any agency required any action of Lehman in response to the results of stress testing,” the examiner later wrote.
And there was strong suspicion that Lehman’s marks were inflated. Indeed, Tim Geithner would later tell the Lehman bankruptcy examiner that a fire sale of assets might have revealed that Lehman “had a lot of air in [its] marks.”
What bothered Hank Paulson, though, was that Fuld just didn’t seem to share his urgency. Although Fuld did raise