The Devil's Casino_ Friendship, Betrayal - Vicky Ward [54]
thought by putting the money in, it would guarantee that everyone thought he had
exposure."
David Komansky, then the CEO of Merrill Lynch, later told people that Fuld had said to
him, "I'd rather reach into my pants, take out my dick and cut it off" before he would give
anything to LTCM.
But Fuld did, eventually, fold. Lehman agreed to put in $100 million, while the others
agreed to put in $250 million and formed an oversight board. Bear Stearns argued that
since it was LTCM's clearing bank it was already overexposed. Bear Stearns put in
nothing.
Jorn recalls: "After the first 24 -hour session with the Fed, I went up to Joe Gregory and
said, 'Joe, there is this consortium board. We've agreed to put in the $100 million
investment. . . . Who is going to be our board member?"
According to Jorn, Gregory replied: "Why don't you just go hang out [at the Fed] and tell
me what's going on."
Jorn says, "For such a serious, nearly cataclysmic event, there was a kind of cavalier
attitude about it at Lehman."
Lehman actually emerged from this crisis stronger and richer. David Einhorn, the 40year-old founder of the hedge fund Greenlight Capital, says that in 2008 he tried to figure
out how Lehman had done so well in the bleak conditions of 1998. "I went back and I
read their 10-Qs from May and August and November of 1998," he says, "and research
reports from that period. And what struck me was that Lehman, who was rumored to be
insolvent during that period, actually got through the entire period without booking any
kind of a loss. How had they done it? They 'd increased their bets as things got worse.
And when the market came back, they made record profits in 1999."
Jorn says he believes that Einhorn is right.
He and Ming had suggested a series of hedges that Lehman could make if LTCM went to
zero and was no longer a creditworthy counterparty. They calculated that Lehman had
460 trades (Merrill Lynch, by comparison, had around 5,000) and that this left them
vulnerable.
They needed to buy $4 billion worth of 10-year notes, $4 billion of 10-year Treasuries,
and options on another $1 billion of 10-year Treasuries to cover themselves. The
purchase would be scaled out on a declining interest rate path, because Jorn reckoned that
if LTCM collapsed, the Federal Reserve would inject liquidity and lower interest rates.
Jorn never knew if the trade--which he presented to the head of fixed income, Jeffrey
Vanderbeek--got executed, but he believes it was. Events came to pass exactly as he and
Ming had bet, and Lehman finished the year ahead.
The cruel twist is that Lehman's success in 1998 may have led to its spectacular failure a
decade later. Einhorn explains how this experience hurt the firm in 2008: "Based on what
they were saying publicly [in 2007], they thought the crisis would only last a couple of
months. . . . The idea was in August 2007 not to take the write -down, to double down,
and that way when the market comes back, they would make even more money."
In layman's terms: Lehman Brothers doubled down once, and made a killing. It doubled
down again 10 years later, and got killed.
Despite coming through two harrowing crises with banner profits, Lehman was still
getting hammered on the Street by rumors that fall. Gossip varied from the absurd to the
sinister. One story said that the firm had invested $1 billion in a Russian satellite that had
exploded in outer space; another claimed that the Federal Reserve was looking through
the books and was about to take Lehman over; a third had it that Lehman was going to
declare bankruptcy at exactly 11.30 P.M. on such and such date--and so forth.
" 'Wounded' Lehman Looks Like Next Merger Target" read the New York Post in
November 1998. "The omens are ugly," a Lehman banker in London told the New York
Times.
Cecil recalls that Rumor Storm lasted for about six weeks, and he noticed that the nasty
bits of gossip usually appeared on Fridays. "We were now kind of in the Land of Shorts.
And a classic trick, if you'