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when Bruce Lakefield, then the head of Lehman Europe, called during the second week

of September to say there was a rumor swirling that Lehman had big exposure problems.

Cecil told him not to worry.

While Lehman was being buffeted by this mess, a bigger one was unfolding for all of

Wall Street.

In mid-September, the hedge fund Long-Term Capital Management (LTCM) fell apart,

throwing the entire financial system into a panic.

LTCM was founded by John Meriwether--the former head of bond trading at Salomon

Brothers--and led by a group of academics, including Nobel Prize-winning economists

Robert Merton and Myron Scholes, who had, with Fischer Black, originated the Black -

Scholes option pricing model. The complex mathematical equation proves, after a series

of assumptions about the market, that "it is possible to create a hedged position,

consisting of a long position in the stock and a short position in [calls on the same stock],

whose value will not depend on the price of the stock," according to Black 's paper about

the topic. LTCM also included the highest paid trader at Salomon Brothers, Larry

Hilibrand, and David Mullins Jr., a former Harvard professor and vice chairman of the

Federal Reserve.

The fund was leveraged at 50 to 1, and until 1998 it had generated massive returns,

supposedly because its mathematical geniuses had made these bets based on the historical

relationships between various fixed income securities, such as U.S. Treasury bonds and

risky corporate or emerging markets bonds. Almost every Wall Street firm was an

investor, and even in a down year--1997--LTCM returns were 17.1 percent after fees.

But by July 1998, things had started to go wrong--and they only got worse once Russia

defaulted and investors started to pull out of seemingly safe investments. On September

2, LTCM disclosed that the value of the fund's holdings, once $1.8 billion, had dropped

by 44 percent.

Meriwether approached Goldman Sachs co-CEO Jon Corzine for help. Could they be

partners? Corzine said he'd think about it, but only if the fund would be willing to accept

risk controls and oversight. Meanwhile, the stock prices of all Wall Street banks sank

because the market feared that securities firms would have to close out their LTCM

positions at fire -sale prices.

Lehman stock plummeted from the mid-40s in August to the low 20s in September.

Warren Buffett agreed to put up $3 billion to shore up LTCM, and Maurice "Hank"

Greenberg, the CEO of insurance giant American International Group (AIG), put up $700

million. Corzine led the Wall Street rescue by pledging that Goldman Sachs would put up

$300 million--something his co-CEO, Henry Paulson Jr., disagreed with.

Corzine prevailed--at least for the moment.

On September 22, while LTCM was organizing a bankruptcy meeting, Todd Jorn--then

Lehman's sales manager responsible for hedge funds--joined Fuld, Russo, Gregory, and

Vanderbeek at the New York Federal Reserve at 33 Liberty Street in downtown New

York, where each of the investment houses was asked to put in $250 million to shore up

LTCM.

Jorn says Fuld didn't think much of the bailout idea, and was even "abrasive" about it. He

had reason to be: Lehman was one of the very few houses to have turned down offers to

invest in LTCM.

Earlier that summer Meriweather and some associates had come to see Fuld and Cecil

and asked them to take 20 percent of the company for $1 billion. Cecil remembers that

after the LTCM guys left, Fuld frowned at him and said, "Those guys look scared." To

Jorn, Fuld growled, "I want to know what the fuck is going on, and I want to know

yesterday." Jorn turned to analyst Ming Xu, who called every trading desk and every

sales manager in the United States to try to assemble the firm's entire exposure to LTCM.

"Dick didn't feel like he should put in any goddamned money," Jorn says of the proposed

bailout of LTCM. "One, because he didn't have exposure in LTCM, and two, because he