The Devil's Casino_ Friendship, Betrayal - Vicky Ward [52]
After that deal, Walsh was awarded increasing autonomy. Fuld was so confident in him,
he often put the firm's balance sheet behind Walsh's deals. As interest rates declined and
all asset values inflated, the values of buildings he had stakes in increased. Firmwide,
Walsh was a hero. He seemed to have a knack for choosing properties that could be
improved and would make a killing for the firm when they sold.
The trouble was that in doing this Fuld was tying the firm's balance sheet to illiquid
assets. If something were to go wrong, the firm wouldn't be able to reduce its exposure.
But in the meantime, his unit grew until reports said it generated more than 20 percent of
Lehman's profits.
In 1997, the New York Times reported that Barry Sternlicht, the CEO of Starwood Hotels
and Resorts, remembered Walsh bringing Fuld to his living room. Sternlicht was so
impressed by the duo that he let them finance his $7 billion purchase of ITT Corporation,
the parent company of the Sheraton Hotel chain, usurping a deal he'd already had in place
with Goldman Sachs. From that moment on Fuld knew that Walsh was a key, if not the
key, to Lehman's prosperity.
On April 6, 1998, the environment on Wall Street changed forever: The $83 billion
merger of Citicorp and Travelers Group, which created the world's largest financial
services company, was a watershed moment. It led to the repeal of the Glass-Steagall Act
of 1933, which prevented bank holding companies from owning insurance companies and
brokerage firms. And it opened the doors for a host of mergers and consolidations within
the financial services industry.
Lehman's leaders could now entertain mergers with other houses, and they looked at
hundreds of potential merger targets, including the retail brokerage PaineWebber.
Lehman also looked at Prudential--again, in vain. Prudential didn't want to sell.
Lehman's real problem, however, was that its price -to-earnings (P/E) ratio was too low-around 11--while most booming Wall Street businesses had P/Es of 14. The P/E ratio is
used for valuation--the higher the P/E, the higher the stock price. In order for Lehman to
make a merger, it would have had to overpay to compensate for its low P/E, which would
have been detrimental to its shareholders.
But all such dreams of expansion were postponed on August 17, 1998, when the
pavement suddenly crumbled beneath Wall Street's feet, and all the securities houses
heard rumblings of potential doom. Russia had devalued the ruble and defaulted on its
government bonds--the first time any country had done this in the postwar era. Panicked
investors sold emerging markets securities, while also selling Japanese and European
bonds in favor of U.S. bonds, which were widely considered the safest currency and debt
in the world. This in turn led to a drop in worldwide markets.
Cecil says, "Initially, it was a nonevent for the firm." Fuld had always been wary of
investing in Russia. He often called the place "the world's biggest fucking crime
syndicate."
Cecil knew that Lehman had some exposure through a money management group, III
(Triple I) Offshore Advisors, which managed the High Risk Opportunities Fund (HRO).
Lehman, he said, had $300 million of principle in jeopardy. According to Cecil, $300
million was a headache for the firm, but not life -threatening.
Tom Russo--general counsel and head of public relations--tried to go on the offensive
and organize a collaborated response to the III crisis rather than let individual firms try to
cut deals or seize the fund's assets.
Things were complicated, however, by the Securities and Exchange Commission (SEC),
which decided to investigate Lehman's marks, or pricing.
Russo says the SEC alleged that Lehman's prices were higher than everyone else's,
although the General Accounting Office--later renamed the Government Accountability
Office (GAO)--would later show that Lehman's prices were accurate. In the meantime,
the rumor mill went berserk. Lehman's stock price fell 60 percent.
The first Cecil heard