How lehman fell....

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Nov. 10 (Bloomberg) -- It was the afternoon of Sept. 9, and tensions were rising in the 31st-floor office of Lehman Brothers Holdings Inc. Chief Executive Officer Richard S. Fuld Jr.

That morning news broke that the Korea Development Bank had pulled out of talks to buy a stake in the New York-based securities firm. By 1 p.m., Lehman's already battered stock had plunged another 43 percent.

Fuld was rat-a-tatting orders to associates seated at a table in his corner office, one wall of which featured photographs of lions taken by the boss himself in Africa. Herbert ``Bart'' McDade, installed as president in June, Vice Chairman Thomas A. Russo and Chief Financial Officer Ian T. Lowitt had been in and out of Fuld's lair all morning. Now the CEO was staring daggers at responses he deemed too slow or too fuzzy to help right his listing ship, said a person familiar with events that day. And he was lashing out at the injustice of it all.

``Here we go again,'' Fuld erupted at one point, the person recalled. ``Perception trumping reality once more.''

It was vintage Fuld, a man so physically imposing, so volcanically explosive that, even at age 62, he scared underlings and competitors alike. He was raging on the captain's bridge, while a storm engulfed the company he had willed into becoming one of Wall Street's finest. Couldn't the short-sellers see how much he had done to shed bad assets? Couldn't they understand what a great franchise it still was?

Fuld was grounded enough in reality to know one thing: ``We've got to act fast,'' he said, ``so this financial tsunami doesn't wash us away.''

Financial Armageddon

Six days later -- 158 years after its founding as a cotton brokerage in Alabama -- Lehman Brothers was gone. Treasury Secretary Henry M. Paulson Jr. said he didn't want to use taxpayer money to save Lehman, as the government had done in March when it pledged $29 billion to facilitate the sale of failing Bear Stearns Cos. to JPMorgan Chase & Co. Federal Reserve Chairman Ben S. Bernanke insisted there was nothing the government could have done in the end, even though Fuld had warned that Lehman's collapse could trigger a financial Armageddon.

Fuld's failure to save Lehman, after rescuing it three times before, is a story about how the most indomitable man on Wall Street became addicted to leverage and intoxicated with the power it brought. It is a tale about the inability to repair a financial model wrecked by a lack of limits and transparency, a story pieced together from interviews with former Lehman executives and outsiders familiar with the firm. Isolated, surrounded by acolytes and unaware of the rivalries tearing his firm apart, Fuld was too prideful to accept the fast-eroding value of the empire he had built, too slow to cut a deal.

Biggest Bankruptcy

The end came after months of frantic activity to find a solution -- reaching out to, then spurning an offer from Berkshire Hathaway Chairman Warren Buffett; meeting with executives of banks on three continents, devising a last-ditch plan to spin off Lehman's toxic assets; and pleading with government officials.

Then, on the morning of Sept. 14, after a series of weekend meetings at the New York Fed, a private deal to save the firm from bankruptcy was hatched. The government persuaded a syndicate of banks to backstop a new entity that would take over $55 billion to $60 billion of Lehman's troubled assets, and London-based Barclays Plc agreed to acquire the rest of the firm, according to people familiar with the negotiations.

When the U.K.'s Financial Services Authority refused to sign off on the Barclays purchase late that morning, U.S. officials refused to take any steps to save the deal. At about 2 a.m. on Monday, Sept. 15, Lehman filed the biggest bankruptcy in U.S. history.

`Guilty Firm'

``Wall Street was giving the impression that after some bloodletting the crisis would be over, and the government bought that line,'' said Charles R. Geisst, author of ``100 Years on Wall Street'' and a finance professor at Manhattan College in New York. ``The thought was to make an example of a guilty firm, and Lehman just happened to be the next one in line.''

The Dow Jones Industrial Average fell 504 points on the day Lehman collapsed, triggering an increase in bank borrowing costs and a run on money-market funds and financial institutions around the world. By Tuesday, Paulson and Bernanke had reversed course, agreeing to an $85 billion bailout of foundering American International Group Inc., at the time the world's largest insurer. The government has since decided to make $250 billion of capital infusions to bolster major U.S. banks. Only Lehman has paid the ultimate price of the financial meltdown to date -- obliteration by bankruptcy.

Reputation in Tatters

It's little comfort to Fuld that he was right to forecast Armageddon and regulators were wrong. His reputation is in tatters; his days are filled with lawyers; three U.S. attorneys are investigating whether he misled investors about the firm's financial condition; his anger is palpable.

Fuld declined to be interviewed for this article as did his lawyer, Patricia Hynes of Allen & Overy.

In October, he appeared before the House Committee on Oversight and Reform wearing his emotions on the sleeve of his dark blue suit.

When asked why AIG was saved and Lehman wasn't, he leaned into a microphone, scowled and slowly replied: ``Until the day they put me in the ground, I will wonder.''

Here's the kind of year it has been for the man who went from being the toast of Wall Street to toast. In January he was hobnobbing with the elite at the World Economic Forum in Davos, Switzerland. Nine months later he was heckled all the way to his limo after testifying at a congressional hearing.

Fuld's Career

The fall of Lehman isn't another tale about an overmatched or under-engaged CEO. For the 16 years Fuld presided over Lehman, he was considered one of the industry's most skilled chief executives, boosting the firm's profit from $113 million in 1994 to $4.2 billion last year and multiplying its share price 20 times. Fuld was no E. Stanley O'Neal or Charles O. ``Chuck'' Prince, late of Merrill Lynch & Co. and Citigroup Inc. respectively, who'd gotten top jobs without being steeped in their institution's businesses. Nor was he a James ``Jimmy'' Cayne, who played bridge while New York-based Bear Stearns burned.

Fuld lived for and identified with his firm. It was his oxygen, a friend says. He had spent his entire career there, so his saga is also a story of Wall Street over the past four decades. When Fuld began working at Lehman in 1969, messengers lugged bags of stock certificates between brokers' offices to complete trades. His rise embodied the triumph of the trader and of the outsize bonus -- he took home about $300 million over the past eight years.

Starting on Lehman's commercial-paper desk, Fuld became a formidable fixed-income trader. He maintained a reputation as a keen risk manager until it became clear Lehman had taken on too many bad mortgage-related assets.

Quant Concoctions

The difference between risk management in the 1980s and in the new millennium was like the difference between playing checkers and three-dimensional chess. The instruments Lehman issued had become more complex than commercial paper, the stakes incomparably higher.

It was the same all over Wall Street. While CEOs of Fuld's generation spent their days in top-floor offices taking meetings, the firms' quants were downstairs cooking up synthetic financial gizmos and mind-bending trading strategies. What they concocted might produce monster profits -- or prove a Frankenstein's monster.

``Fuld took a franchise he'd built from almost nothing, brick by brick, and then trashed it in less than two years,'' said Sean Egan, president and founder of Egan-Jones Ratings Co. in Haverford, Pennsylvania. ``His biggest mistake was in not understanding the risks that had evolved since he was last active in debt markets. And he relied on the support of others whose interests were aligned with him.''

`The Gorilla'

A CEO needs good managers reporting to him to figure out the right risk-reward ratios and make the right decisions. Increasingly, Fuld wasn't getting good dope. He became isolated in recent years, people familiar with the firm's operations said. He countenanced little debate and delegated more responsibility to Joseph M. Gregory, 56, who became president and chief operating officer in 2004.

An intimidating figure -- he played in international squash competitions when he was younger and is still fit -- Fuld was known around the office as ``the Gorilla.'' His icy stare, people who worked at Lehman say, froze recipients with fear. No one wanted to tell Fuld something was wrong or to question how Lehman was run.

As it turned out, one of the lessons Fuld took away from Lehman's decline in the 1980s would contribute to its collapse in 2008.

Glucksman vs. Peterson

The earlier crisis grew out of a power struggle between two senior partners: Lewis Glucksman, who headed trading and was Fuld's mentor, and Peter Peterson, who ran investment banking. Glucksman maneuvered Peterson out of the chairmanship, setting off a rift between traders and bankers that so weakened the firm it wound up being acquired by American Express Co. in 1984.

It was traumatic for the partners, since the dispute cost them their independence and considerable income. When Lehman was spun off in 1994, Fuld vowed that no one would ever do unto him as Glucksman had done unto Peterson. For Fuld, that meant not having a strong No. 2.

Christopher Pettit, a longtime friend and ally of Fuld's, was forced out as chief operating officer when he balked at an executive reorganization in 1996. (He died three months later in a snowmobile accident.) Six years would go by before Fuld installed another chief operating officer. In the meantime, Fuld pushed potential rivals aside, say people familiar with the firm's operation. Michael F. McKeever, who ran investment banking, was stripped of his duties bit by bit and left in 2000. John Cecil, chief financial officer until 2000, was demoted to an adviser because he dared oppose Fuld, the people say.

Gregory's Role

The man Fuld finally appointed chief operating officer was Gregory, a trusted lieutenant who had worked at Lehman since 1974. He would make it his mission to keep Fuld's life uncomplicated by debate.

Any meeting with Gregory, say people who worked with him, was a soliloquy. The COO delivered lectures on matters as minute as improving the look of sloppy dressers. Management-committee meetings were conducted without discussion, attendees say.

The same was true of executive-committee meetings presided over by Fuld. While reviewing budgets for 2007, one committee member questioned the performance of a unit, according to a person who was in the room. Fuld stared at him coldly, then broke the silence: ``You've got some balls to say that, knowing how much I hate that topic.''

Authoritarian Climate

As Fuld returned to studying the papers in front of him, Gregory continued dressing down the committee member for his impertinence. He also upbraided him after the meeting, demanding that any objections be brought to Gregory privately and not voiced in front of the committee. Gregory didn't return calls seeking comment.

Word on proper comportment spread through the ranks. Fuld conducted an employee webcast every three months. He'd always end by asking if there were any questions. There rarely were.

The problem with this authoritarian climate was that when Lehman began to sputter, Fuld was cut off from dissenting opinion. Woe to the messenger who came to the 31st-floor bearing bad news.

The refusal of fixed-income chief Michael Gelband to play the yes-sir game cost him his job -- and Lehman one of its best risk managers. He was forced out by Gregory in May 2007, people familiar with the circumstances say. Four months later Gregory also shunted aside risk chief Madelyn Antoncic, when she fought for hedges on some of Lehman's investments. She was demoted to a peripheral government-relations job.

`Cheap Tar'

Gregory also set factions within Lehman against each other, the people say. New York executives, led by McDade, then head of equities, jousted with those in London, who gathered around international operations chief Jeremy M. Isaacs and who believed they deserved more power because the firm's top growth areas were outside the U.S. The intercontinental rivalry would prove a critical fault line for Lehman.

As cut off from information as Fuld may have been, it wasn't as if he didn't recognize the firm's problems. In November 2004, more than two years before the bull market reached its peak, Fuld was telling people around him that low interest rates and cheap credit would create a bubble that could one day pop.

``It's paving the road with cheap tar,'' he told colleagues in a meeting at the time. ``When the weather changes, the potholes that were there will be deeper and uglier.''

AIG Approach

Fuld also warned against taking on too much risk, such as leveraged loans, which are used to finance buyouts of firms, as Lehman tried to compete with commercial banks that used their bigger balance sheets to support investment banking operations. ``We're vulnerable if we throw our balance sheet around,'' Fuld said, according to a person at the meeting.

As early as March 2006, Fuld approached Martin J. Sullivan, then CEO of AIG, about a possible merger. Fuld saw Lehman becoming the investment banking unit of the insurer. A combination would have given Lehman a trillion-dollar balance sheet, funded by stable insurance premiums, which it could use to provide leverage to its clients, Fuld told his executive committee at an offsite at the Fairmont Turnberry Isle Resort & Club near Miami, according to a person who attended the meeting.

Sullivan wasn't interested, and the proposal didn't go beyond the initial contact, the person said. Sullivan, who left AIG in June 2008, didn't return calls seeking comment.

False Comfort

Lehman used its balance sheet to finance leveraged buyouts anyway. So did other Wall Street firms forced to compete with commercial banks, which were allowed to practice investment banking after the 1999 repeal of the Glass-Steagall Act.

Leveraged loans weren't Lehman's undoing, though. Fuld saw the dangers they posed and rid the firm of the riskiest ones in the fourth quarter of 2007, according to company filings.

What Fuld failed to do is take advantage of a rebound in the prices of fixed-income assets at the time to sell some of Lehman's $84 billion mortgage portfolio. He took false comfort in having hedged the firm's mortgage positions at the end of 2006. Because of the hedges, insiders say, Lehman executives were sanguine after the July 2007 implosion of two Bear Stearns hedge funds that had invested in subprime securities. Fuld even loaded up on mortgage-backed securities at the beginning of 2008, not seeing how vulnerable the firm would be when the subprime cancer metastasized to other asset classes.

Davos Predictions

The disconnect was on display at the World Economic Forum in Davos in January. On the one hand, Lehman Vice Chairman Russo, 65, presented a paper entitled ``Credit Crunch: Where Do We Stand?'' predicting the reset of interest rates on $550 billion of subprime mortgages in the next 12 months would trigger foreclosures and economic woe. On the other hand, Russo said it was no big deal for Lehman. ``Dick Fuld is very conscious of risk,'' he said in a Bloomberg TV interview. ``He's created a culture that's enabled us to do fine.''

Others weren't so sure. A Lehman employee of more than 20 years says she sat her subordinates down in January and told them to start considering options outside the firm.

By the end of the fiscal first quarter in February, after New York-based rivals Citigroup and Merrill had taken about $45 billion in writedowns, Lehman's mortgage portfolio had increased by 2 percent from the previous quarter. Associates say Fuld had concluded the market for mortgage-backed securities had hit bottom, and he didn't have people around him to warn about the spread of subprime troubles to so-called Alt-A mortgages --those made to borrowers without full documentation -- and the commercial real estate market.

Callan Appointment

Roger Nagioff, 44, a London equities trader who succeeded Gelband as fixed-income chief, was struggling to learn the business as the subprime rout began. He quit in February 2008 after realizing he couldn't get his head around Lehman's mortgage-related positions, people close to Nagioff said.

Lehman also had a rookie chief financial officer. Erin M. Callan, a 43-year-old investment banker, had been elevated to the job in December by Gregory, although she had no experience in the company's treasury, a typical training ground for CFOs. Fuld went along with the appointment and allowed her to become the public face of Lehman because he trusted Gregory and didn't get involved in staffing decisions, people say.

On March 17, a day after the sale of Bear Stearns, Lehman shares fell as much as 48 percent in New York Stock Exchange trading on concern the firm would be Wall Street's next victim.

Counter-Punching

To Fuld, the idea was outrageous. The hit was a matter of wrong perceptions, not weak fundamentals. So he got on the phone with the firm's biggest clients to tell them Lehman was no Bear Stearns, and he ordered other executives to do the same.

This was pure Fuld: When bloodied, counter-punch. That's how he turned things around in 1998, when Wall Street rumors had Lehman over-exposed to the Russian currency collapse and the ``Asian flu.'' His jawboning with clients, regulators and others pulled Lehman's stock out of a spiral from $21 to $6.

This time around Fuld also reached out to Omaha billionaire Buffett, the man who had ridden to the rescue of Salomon Inc. in 1987, according to two people with knowledge of the approach. He asked investment banking chief Hugh ``Skip'' McGee, 49, to call David L. Sokol, chairman of Berkshire Hathaway-owned MidAmerican Energy Holdings Co., and see if Buffett might be interested in a stake in Lehman.

Spurning Buffett

The answer was yes, Sokol told McGee. So Fuld called the 78-year-old Buffett. Berkshire Hathaway would buy preferred shares that would pay a dividend of 9 percent and could be converted to common at the then-market price of $40, the people said. That was costlier than what other investors demanded, Fuld was told by associates, and he spurned the offer. A few days later, on April 1, Lehman sold $4 billion of convertible preferred stock to public investors with a 7.25 percent interest rate and a 32 percent conversion premium.

That meant those buying the convertibles were willing to pay one-third more than the market price for Lehman's shares if and when they wanted to convert. Buffett was willing to pay only the going price at the time, which would have meant more dilution for existing shareholders. A spokeswoman for Buffett declined to comment.

Fuld had saved some money, yet he rebuffed a Buffett stake, considered to be corporate America's Good Housekeeping seal of approval. Although that might have helped Lehman in the short run, it wouldn't have solved the firm's fundamental problem: Fuld needed to sell the entire mortgage-related portfolio at whatever price he could get and raise enough capital to cover the losses incurred in such a sale.

`Huge Brand'

Six months later Goldman Sachs Group Inc., the most profitable investment bank, agreed to even harsher terms with Buffett -- paying him a 10 percent annual return on a $5 billion investment. Yet the market had deteriorated so much by then that even the billionaire's blessing wasn't enough. Goldman's shares fell 36 percent in the two weeks after the deal was announced, only to recover after the government stepped in to buy stakes in the biggest U.S. banks.

Lehman's April 1 stock sale sent a signal that the firm continued to have access to capital and the confidence of investors and the government. Its shares rose 26 percent in the following three weeks. At a dinner at the Treasury Department on April 11, where Fuld chatted with Paulson, he came away with the impression, as he wrote in an e-mail to Russo that night, that we ``have huge brand with treasury'' and that Paulson ``loved our capital raise.'' The e-mail was later made public by U.S. Representative Henry A. Waxman, chairman of the House Committee on Oversight and Government Reform.

Finding a Buyer

Paulson would complain, in interviews with the New York Times and Charlie Rose after Lehman's demise, that he couldn't get Fuld off the dime in finding a buyer for Lehman. Brookly McLaughlin, a Treasury spokeswoman, said Paulson ``spoke to Fuld quite often'' between April and September. She wouldn't divulge the frequency or substance of their conversations. Fuld took Paulson's request to mean he should find a strategic partner to buy a stake in Lehman, which he was already searching for, according to people close to the CEO.

Why Fuld was unable to find a buyer for all or part of Lehman remains a matter of dispute. It was not for want of trying, although some people familiar with those efforts throughout the spring and summer say he was unwilling to accept the rapidly falling valuation of his firm.

``Dick was so proud of Lehman that he was slow to recognize that others didn't share that belief,'' said George L. Ball, chairman of Houston-based investment firm Sanders Morris Harris Group Inc. and a friend of Fuld's.

`Hurting Einhorn'

One obstacle, say people close to Fuld, is that he was more of an inside man. He didn't like to mingle with the Wall Street elite on the black-tie circuit. He didn't go in much for the genteel game of golf, preferring the sweaty game of squash, often on his own home court in Greenwich, Connecticut. He didn't care for public speaking.

Throughout the crisis, Fuld was too quick to blame his detractors for his own mistakes. David Einhorn, president of Greenlight Capital Inc., a New York-based hedge fund, became enemy No. 1 on May 21, when he went public with his analysis that Lehman was propping up its numbers with aggressive valuations and challenged CFO Callan's credibility.

The short-seller put pressure on Lehman's stock and aroused Fuld's ire. A May 26 e-mail to Fuld from Lehman executive David Goldfarb, released by Waxman's committee, suggested that the firm should use capital it was hoping to raise to buy back Lehman stock, ``hurting Einhorn bad!!'' Fuld's response: ``I agree with all of it.''

Bear Stearns Precedent

Meanwhile, the company's financial situation continued to deteriorate. The value of Lehman's residential-mortgage portfolio and commercial real estate assets kept declining as the prospect of recession grew. Nobody wanted to buy into Lehman -- at least not for the moment.

Even interested parties figured the price would keep coming down, as real estate valuations fell and Lehman got more desperate for cash. The Bear Stearns precedent, in which the government stepped in to facilitate a deal, also gave prospective buyers a reason to wait.

Lehman sold $16 billion, or about one-fifth, of its mortgage assets during the second quarter of 2008. Selling assets that nobody wanted meant taking significant losses. Market volatility had also rendered many of the hedges ineffective during the quarter. That led Lehman to announce a $2.8 billion second-quarter loss on June 9, its first since being spun off from American Express. Lehman also reported that it had raised another $6 billion in capital from investors.

Strategic Partner

The loss led Fuld to panic, say some people who interacted with him at the time. For the first time, he started worrying that he might lose the firm. McDade, 49, who as head of equities was instrumental in raising capital from trading clients, persuaded Fuld to promote him to president, ousting Gregory. Callan was also pushed aside, replaced by Lowitt, 44.

One of the first things McDade did was to bring back Gelband, 49, to help him sort out the mess. He also asked investment banking chief McGee to redouble efforts to find a strategic partner who would buy a stake of at least 10 percent.

While the firm had been in talks with potential partners in the previous three years -- including Japan's Mizuho Financial Group Inc. and China's Citic Group and Ping An Insurance (Group) Co. -- they were always with the intention of cooperation in Asia, where Lehman was weaker than most of its rivals.

GE, Citic, KDB

Now, as summer began, the stakes were higher. Talks began in July with executives at Bank of America Corp. One Lehman proposal was to merge with the investment banking unit of its Charlotte, North Carolina-based rival, which would own about 40 percent of the new entity. While CEO Kenneth D. Lewis wasn't keen on that idea, talks continued on other possible combinations, people familiar with the discussions said.

Fuld also reached out to General Electric Co. CEO Jeffrey R. Immelt, a fellow board member of the New York Fed. He said no. An overture to London-based HSBC Holdings Plc went nowhere. And Fuld came up empty after meeting in August with executives from Citic, China's biggest state-owned investment firm.

Only the Korea Development Bank seemed eager to make a deal. The bank's chief executive officer, Min Euoo Sung, had run Lehman's operations in Seoul until May. In early August, according to Lehman executives involved in the talks, KDB offered to buy 25 percent of the firm for $22 a share, about where the shares were trading at the time. Then talks bogged down on issues like how much management say the Korean bank would have and how Lehman's mortgage positions should be valued. By early September, Min was only willing to pay about $8 share, the executives said.

Codename Spinco

``The gap in assessing the size of potential writedowns was just too big,'' Min told reporters in Seoul on Sept. 16.

Some involved with the negotiations say Fuld and McDade didn't want to cede any management control and that Min grew concerned about further Lehman writedowns. Others say Min never had approval from his government to do a deal, so he kept lowering the price to make sure it wouldn't happen. Min told legislators in Seoul on Sept. 18 that Lehman was unwilling to accept less than $17.50 a share.

Meanwhile, worried that his lieutenants wouldn't be able to fetch a fair price from an investor, Fuld was pursuing another strategy. The plan his associates devised would offload Lehman's toxic commercial-mortgage portfolio to an independent company, codenamed Spinco. The new company's stock would be owned by Lehman shareholders, and its startup capital would be provided by the firm. While Lehman would have to raise fresh capital to replace what it transferred to Spinco, investors would be buying into an investment bank with a scrubbed balance sheet.

Management Shift

The U.S. Securities and Exchange Commission gave the plan initial approval, Lehman executives said. There was only one hitch: It would take at least three months to meet SEC requirements. Lehman didn't have three months.

The firm's announcement of another management shuffle on Sept. 7 hardly buoyed confidence. Isaacs, the international operations chief and former rival of McDade's, was out, as was Andrew J. Morton, global head of fixed income. Isaacs had actually resigned in June, although the announcement was delayed for three months at Fuld's request. His decision to leave the firm after McDade's ascension, at a time when he could have been instrumental in negotiating a foreign deal, only served to widen the rift between the London and New York offices.

Hedge Fund Squeeze

The beginning of the end came two days later when the KDB talks fell apart.

``The possibility of a Lehman deal wasn't big from the very beginning,'' Jun Kwang Woo, chairman of South Korea's Financial Services Commission, said after the collapse. Still, by Sept. 9, it was all Lehman investors had to pin their hopes on. With shares trading at $7.79 a share, below what KDB had been willing to pay a few days earlier, Lehman had a market value of $5.4 billion, one-sixth of what it had been a year earlier.

The cost of insuring Lehman's debt surged by almost 200 basis points after the KDB news, rising to 500, still not as high as where Bear Stearns's credit-default swaps were trading before its collapse. (A basis point equals one-hundredth of a percentage point.)

That caused Lehman's hedge fund clients to pull out, and short-term creditors cut lending lines. New York-based JPMorgan, Lehman's clearing agent for trades, demanded additional powers to seize cash and collateral in the firm's accounts.

$3.9 Billion Loss

The next day, Sept. 10, Fuld pre-announced quarterly results -- a $3.9 billion loss, after $5.6 billion of writedowns. He also said Lehman would auction off a majority stake in its asset-management division, and he revealed his Spinco plan. He was still talking defiantly.

``We have a long track record of pulling together when times are tough,'' Fuld said on a conference call with investors. ``We are on track to put these last two quarters behind us.''

Once again, Fuld was a step behind events. Before the day was out, Moody's Investors Service said it was reviewing Lehman's credit ratings and that it would downgrade the firm unless it made a deal with a strategic partner. Lehman's shares fell another 42 percent the next day to $4.22.

As things were spinning out of control, Fuld turned to the federal regulators with whom he had been talking since the demise of Bear Stearns.

He had approached Timothy F. Geithner, 47, president of the Federal Reserve Bank of New York, in July to see whether Lehman might become a bank-holding company, which would allow it to widen its funding base. Geithner was cool to the idea, according to a person familiar with the discussions, saying it wouldn't solve the problem of Lehman's troubled assets. Fuld never made a formal application.

Fed `Haircuts'

Now, Fuld went back to Geithner. With Lehman running out of cash -- it had only $1 billion left by week's end -- it had to borrow money from the Fed's broker-dealer facility by Monday if it wanted to stay in business. Again the New York Fed, on whose board Fuld sat until the day before, was of no help. He was told Lehman's assets didn't fit the criteria for collateral, Bernanke would later say. The Fed also raised its ``haircuts,'' or collateral requirements, a person familiar with the discussions said, making it harder for Lehman to borrow from the facility.

Meanwhile, Paulson was putting out the word there would be no more federal bailouts, that the government couldn't rescue every failing investment bank.

With the clock running out, Lehman executives reached out again to Bank of America. They also called Barclays, the second- largest U.K. bank by market value, and Nomura Holdings Inc., Japan's biggest brokerage. The message went out: Fuld was ready to sell.

Paulson's Pledge

On Sept. 12, one team of Lehman executives was camped out at the Lexington Avenue offices of New York-based law firm Simpson Thacher & Bartlett LLP, showing the firm's books to Barclays. Another group was at the Park Avenue office of Sullivan & Cromwell LLP doing the same for Bank of America. CEO Lewis agreed to the talks after Paulson urged him to consider a deal, a person with knowledge of the discussions said.

Two other Lehman executives -- McDade and Alexander Kirk, global head of principal investing -- were dispatched to the New York Fed on Liberty Street, where Geithner and Paulson had gathered a group of Wall Street leaders. There, Paulson reiterated that no taxpayer money would be used to save Lehman. He challenged the group to find a private solution to rescue the firm, saying it was in their own best interests.

Barclays Deal

One of the attendees, Merrill CEO John A. Thain, 53, took stock of his own company's best interests and initiated merger talks with Bank of America. Lewis had concluded on Friday that he couldn't do a deal with Lehman without government backing, which he thought would be forthcoming. After Paulson made it clear to Lewis that a government role wasn't in the cards, the Bank of America CEO pulled his team out of the Lehman talks.

That left only Barclays, since Nomura told Lehman it was unable to move fast enough. Fuld, who rarely left his office that weekend -- working the phones, fielding calls from deputies, talking to Barclays executives -- thought he had a deal Saturday night. Barclays was willing to buy Lehman for about $5 a share if it could leave behind the most troublesome assets, the ones Lehman had proposed spinning off into a separate company as well as some others Barclays didn't want.

Sunday morning brought a false dawn. Geithner and Paulson had talked a syndicate of banks into backstopping the creation of a new entity that would take over $55 billion to $60 billion of Lehman's problem assets, according to people with knowledge of the negotiations.

No Lifeline

Everyone was basking in what seemed a done deal until word came at 11:30 a.m. in New York that the U.K.'s FSA, which regulates that country's banks, refused to waive normal shareholder-approval requirements or to allow Barclays to guarantee Lehman's debts until obtaining that approval. The reason, people familiar with the decision say, was that Barclays lacked sufficient capital to absorb Lehman.

``The only reason it didn't happen,'' Leigh Bruce, a Barclays spokesman said today, ``is that there was no guarantee from the U.S. government, and a technical stock-exchange rule required prior shareholder approval for us to make a similar guarantee ourselves. We didn't have that approval, so it wasn't possible for us to do the deal. No U.K. bank could have done it. It was a technical rule that could not be overcome.''

At that point, the only way to save the deal would have been for U.S. regulators to make the temporary debt guarantee. They didn't. Paulson, who told the New York Times he didn't have the authority to rescue Lehman, didn't answer questions about Sunday's events submitted by Bloomberg. Nor did Geithner.

Failure's Furies

Fuld thought Paulson was in his corner, he told a person familiar with events, even as the Treasury secretary publicly resisted spending taxpayer money to help Lehman. Fuld was stunned, the person says, when Paulson didn't throw him a lifeline at the end.

It was McDade who called Fuld from the Fed meeting on Sunday afternoon, not Paulson. Far from helping Lehman, Paulson, Geithner and other officials, including SEC Chairman Christopher Cox, began pressing Lehman to declare bankruptcy. McDade told them that would have serious repercussions for other firms. Wall Street executives gathered at the Fed said a bankruptcy wouldn't be the end of the world. Goldman Sachs and Morgan Stanley both had war rooms with charts detailing Lehman's subsidiaries and their exposure to each one, and they thought their potential losses would be limited.

No one, not even Lehman, knew what furies the firm's failure was about to unleash.

Restless Nights

The end came at about 2 a.m. Sept. 15, when Fuld, out of running room, filed for bankruptcy. That day the Standard & Poor's 500 Index had its biggest daily drop since the September 2001 terrorist attacks, and bank-lending rates soared. Paulson, who was poised to let AIG fail, quickly re-thought the wisdom of that decision and approved an $85 billion bailout. He and Bernanke also went to Congress to push for a $700 billion federal bailout to buy bad assets from troubled banks.

Only Lehman ended up in the wrong place at the wrong time.

Fuld was hard-pressed to explain his fate when he appeared in front of Waxman's committee on Oct. 6. To many of the congressmen's hostile questions and accusations, he had no answers. ``I wake up every single night,'' Fuld said, ``thinking, `What could I have done differently?'''

It might have ended differently had Fuld not risked so much on mortgage-backed securities. It might have ended differently had Fuld been willing to acknowledge Lehman's falling valuations. It might have ended differently if Fuld had made a deal in June, or July, or August.

That would have required acknowledging that time had run out on Wall Street's over-leveraged, overpaid gilded age. Instead, in his stubbornness and isolation, Dick Fuld failed to save the firm he lived for.