Too Big to Fail [70]
Each success bred hunger for more, leading to monstrous deals like Lehman’s partnership with SunCal Companies. A land speculator that bought property primarily outside Los Angeles, SunCal secured approvals for residential development and then sold them to home builders at a hefty markup. Lehman pumped $2 billion into what appeared to be its can’t-fail transactions. Walsh had virtually unlimited use of Lehman’s balance sheet and used it to turn the firm into an all-in, unhedged play on the U.S. real estate market, a giant REIT (real estate investment trust) with a little investment bank attached—a strategy that worked extraordinarily well right up until the moment that it didn’t.
At the very height of the market, Walsh concluded his last great deal, a joint transaction with Bank of America, committing $17.1 billion in debt plus $4.6 billion in bridge equity to finance the purchase of Archstone-Smith, a collection of premium apartment complexes and other high-end real estate. The properties were excellent, but the price was sky-high, based on projections that rents could be hiked substantially. Almost immediately, the proposition started to look dubious, especially when the credit markets seized up. But given a chance to back out of the deal, Fuld declined. The firm had made a commitment and it was going to stick with it. Gregory made a circuit to rally the troops. “This is going to be temporary,” he told Lehman colleagues. “We’re going to fight through this.”
As both Gregory and Fuld were fixed-income traders at heart, they weren’t entirely up to speed on how dramatically that world had changed since the 1980s. Both had started in commercial paper, probably the sleepiest, least risky part of the firm’s business. Fixed-income trading was nothing like Fuld and Gregory knew in their day: Banks were creating increasingly complex products many levels removed from the underlying asset. This entailed a much greater degree of risk, a reality that neither totally grasped and showed remarkably little interest in learning more about. While the firm did employ a well-regarded chief risk officer, Madelyn Antoncic, who had a PhD in economics and had worked at Goldman Sachs, her input was virtually nil. She was often asked to leave the room when issues concerning risk came up at executive committee meetings, and in late 2007, she was removed from the committee altogether.
In the presence of the trading executives, Gregory always tried to make an impression with his market savvy, to such a degree that it became a running joke. Traders eventually came to consider his tips as contrary indicators; if Gregory declared that a rally in oil prices had much further to go, for example, they’d short oil.
In recent years, though, a growing contingent of Lehman executives had begun to view Gregory as a menace. He just didn’t know enough about what was going on, they thought. The firm was making bigger bets than it would ever be good for and nobody in the executive office seemed to understand or care. To criticize the firm’s direction was to be branded a traitor and tossed out the door.
Among those who tried to sound the alarm was Michael Gelband, who had been Lehman’s head of fixed-income trading for two years and had known Gregory for two decades. In late 2006, in a discussion with Fuld about his bonus, Gelband remarked that the good times were about to hit a rough patch, for which the firm was not well positioned. “We’re going to have to change a lot of things,” he warned. Fuld, looking unhappy, said little in reply.
The fixed-income guys had been spending a lot of time talking about the train wreck that awaited the U.S. economy. In February 2007, Larry McCarthy, Lehman’s top distressed-debt trader, had delivered a presentation to his group in which he laid out a dire scenario. “There will be a domino effect,” he