The bankruptcy examiner assigned to the Lehman Brothers bankruptcy case published a 2,000+ page report yesterday, which reads like the modern-day equivalent of a Greek tragedy. Many things went wrong on Lehman's road to collapse, a collapse that appears to have been preventable had Lehman executives owned up to the company's dire situation. Lehman chief Richard Fuld let slip away several opportunities to shore up Lehman's capital base, most notably an opportunity to cut a deal with Warren Buffett of Berkshire Hathaway (NYSE:BRK.A). Such a deal would have put an important "stamp of approval" on Lehman, likely giving it much-needed time and credibility.The Role of Warren Buffett and David Sokol
Here are some passages that mention Warren Buffett's contacts with Lehman as it was trying to raise capital:
pp. 613-614: After the near collapse of Bear Stearns, Lehman moved to raise additional capital. Lehman initiated work on an equity offering and restarted efforts to locate candidates willing to make a strategic investment in Lehman. In late March , Lehman undertook discussions with Warren E. Buffett, CEO of Berkshire Hathaway. However, those discussions did not result in any investment by Buffett, Berkshire Hathaway, or any of its affiliates. Instead, at the beginning of April 2008, Lehman completed a $4.0 billion convertible preferred stock offering. Other offerings to bolster Lehman’s capital followed in May and June.
pp. 640-642: The SpinCo idea was a variation on a good bank/bad bank structure. Among
Lehman’s strategic options, SpinCo had a longer time horizon than other options, because substantial advance work would be needed. By early August 2008, Lehman anticipated completing the spin‐off in the first quarter of 2009. Lehman intended SpinCo to accomplish four interrelated purposes. The first and primary purpose of SpinCo was to relieve Lehman’s balance sheet of its “outsized” commercial real estate exposure that had become a source of increasing market concern and pressure. Second, by moving those assets to a separate entity, Lehman hoped to avoid the necessity of having to continue marking down those assets as the market continued to deteriorate. That process had exposed Lehman to criticism in the press and by analysts in what Hugh “Skip” E. McGee, III, the head of Lehman’s Investment Banking Division, referred to as the “are we marked correctly game.” Third, by spinning off those assets, Lehman would avoid a “fire sale for the vultures” that would have locked in its paper losses. Instead, SpinCo would allow Lehman to manage those assets on a value‐maximizing basis for the benefit of Lehman’s shareholders, either by selling the SpinCo assets or holding them to maturity. Fourth, once Lehman had purged its balance sheet of “toxic” commercial real estate assets, it hoped that the post‐spin “clean” or “core” Lehman (a.k.a. “CleanCo”) could achieve returns on equity in the low teens, twelve times net leverage, and maintain an A rating. However, SpinCo faced substantial structural and execution issues that led some observers to question its feasibility. Paulson told the Examiner that he expressed great skepticism about SpinCo to Fuld and advised him to abandon the plan. James L. “Jamie” Dimon, JPMorgan’s CEO, told the Examiner that he did not believe that SpinCo would work, thinking that the proposal was too leveraged, too complex, and involved too much real estate. When the concept was described to Buffett, he dismissed it. Ultimately, Lehman was not able to carry out the SpinCo plan prior to its bankruptcy.
p. 651: In March 2008, Lehman had approached Buffett concerning a private investment. In mid‐July 2008, Lehman again considered approaching Buffett about investing in SpinCo debt. In late August or early September 2008, McGee called MidAmerican Energy Holdings’ President David L. Sokol, hoping to entice Sokol either to have MidAmerican Energy Holdings invest in the SpinCo plan or to advocate the plan to Buffett. McDade and McGee showed Sokol Lehman’s “Gameplan”
presentation, explaining that Lehman was ready to execute the plan if Lehman had an investor. Sokol was not interested in investing, but relayed the basic premise of the SpinCo plan to Buffett. During that discussion, Buffett dismissed the idea as unrealistic.
p. 664-667: In late March 2008, McGee suggested that Lehman reach out to Buffett. McGee had a pre‐existing banking relationship with Sokol of MidAmerican Energy, which is majority‐owned by Buffett’s Berkshire Hathaway. Either McGee or Joseph G. Sauvage, LBI Vice‐Chairman, called Sokol to ask if Buffett would take Fuld’s call. Jerry A. Grundhofer, who was about to join Lehman’s Board, also asked Buffett if he would take Fuld’s call. Buffett agreed. Before calling Buffett, Fuld called Sokol on March 27, 2008. That same day, Lehman prepared a draft of a letter, to be sent by Fuld to Lehman employees, outlining a $3.5 billion investment from Buffett in Lehman’s preferred stock at a $54 per share conversion price. Fuld told the Examiner that he did not know how that letter came to be prepared, and it does not appear that Fuld saw the draft. Fuld also did not recall Buffett indicating a willingness to invest $3.5 billion. Buffett was surprised that Lehman had prepared a draft letter announcing the deal, because he never got close to a deal with Lehman. Fuld and Buffett spoke on Friday, March 28, 2008. They discussed Buffett investing at least $2 billion in Lehman. Two items immediately concerned Buffett during his conversation with Fuld. First, Buffett wanted Lehman executives to buy under the same terms as Buffett. Fuld explained to the Examiner that he was reluctant to require a significant buy‐in from Lehman executives, because they already received much of their compensation in stock. However, Buffett took it as a negative that Fuld suggested that Lehman executives were not willing to participate in a significant way. Second, Buffett did not like that Fuld complained about short sellers. Buffett thought that blaming short sellers was indicative of a failure to admit one’s own problems. Following his conversation with Buffett, Fuld asked Paulson to call Buffett, which Paulson reluctantly did. Buffett told the Examiner that during that call, Paulson signaled that he would like Buffett to invest in Lehman, but Paulson “did not load the dice.” Buffett spent the rest of Friday, March 28, 2008, reviewing Lehman’s 10‐K and noting problems with some of Lehman’s assets. Buffett’s concerns centered around Lehman’s real estate and high yield investments, lending‐related commitments, derivatives and their related credit‐market risk, Level III assets and Lehman’s securitization activity. On Saturday, March 29, 2008, Buffett learned of a $100 million problem in Japan that Fuld had not mentioned during their discussions, and Buffett was concerned that Fuld had not been forthcoming about the issue. The problems Buffett saw in the 10‐K along with Fuld’s failure to alert Buffett to the issue in Japan cemented Buffett’s decision not to invest in Lehman. At some point in their conversations, Fuld and Buffett also discovered that there had been a miscommunication about the conversion price. Buffett was interested only in convertible preferred shares. Buffett told Fuld that he was willing to agree to a $40 conversion price per share, while Fuld thought Buffett was offering to buy in at “up‐40,” or 40% above the current market price, which would have been about $56 per share. On Friday, March 28, 2008, Lehman’s stock closed at $37.87. Fuld spoke to Lehman’s Executive Committee and several Board members about his conversations with Buffett. Lehman recognized that an investment by Buffett would provide a “stamp of approval.” However, Lehman already had better offers for its April capital raise, and Lehman did not think it could give a better deal to Buffett at the same time it gave a less attractive deal to others. On Monday, March 31, 2008, before Buffett could tell Fuld that he was not interested, Fuld called Buffett to say that Lehman could not accept his terms.
p. 667-668: McGee contacted Sokol again in late August or early September 2008 and outlined Lehman’s “Gameplan” for survival, specifically SpinCo. During a subsequent telephone call with Sokol, McGee explained the “good bank/bad bank” scenario and stated that Lehman would need an investor. Sokol believed the e‐mail and call were intended to induce Sokol to pass that information on to Buffett, so Sokol briefed Buffett on SpinCo. Buffett thought the idea would not solve Lehman’s problems. Sometime during the week prior to Lehman’s bankruptcy, McGee again reached out to Sokol with what both Sokol and McGee described to the Examiner as a “Hail Mary” pass. McGee asked, “Do you have any ideas to save us?” Sokol, who was bear hunting in Alaska at the time, told McGee that he did not.
p. 708: On Saturday, September 13, 2008, Barclays reached out to Buffett to ask whether Buffett would guarantee Lehman’s operations until a Lehman‐Barclays deal closed. Barclays and Buffett discussed a scenario in which Buffett would provide $5 billion of protection. Buffett expressed interest in that possibility, but Barclays did not pursue it.
p. 709: Lehman’s management had scheduled a Board meeting for noon on Sunday, September 14, 2008, but delayed the meeting until 5:00 p.m. in order to try to come to some resolution at the FRBNY meetings. At some point on Sunday, Fuld was told that the FSA would not waive the requirement that a guaranty of Lehman’s obligations required the approval of Barclays’ shareholders, and therefore the FSA would not approve the Barclays deal. Fuld asked Paulson to call Prime Minister Gordon Brown, but Paulson said he could not do that. Fuld asked Paulson to ask President Bush to call Brown, but Paulson said he was working on other ideas. From that, Fuld inferred that Paulson was going to call Buffett, although Paulson never mentioned Buffett’s name. Fuld brainstormed about other means to contact and convince the FSA to permit the deal, including having Jeb Bush, a Lehman advisor, ask President Bush to call the Prime Minister.
The Role of David Einhorn
Greenlight Capital's David Einhorn is also mentioned in the report. Here are the excerpts:
p. 205-206: ...David Einhorn of Greenlight Capital, who at the time held short positions in Lehman, stated in an April 8, 2008 speech: "There is good reason to question Lehman’s fair value calculations. . . . Lehman could have taken many billions more in write‐downs than it did. Lehman had large exposure to commercial real estate. . . . Lehman does not provide enough transparency for us to even hazard a guess as to how they have accounted for these items. . . . I suspect that greater transparency on these valuations would not inspire market confidence." Einhorn’s skepticism was also reflected in the financial press. On March 20, 2008, Portfolio.com published an article titled “The Debt Shuffle,” which asked: “What actually happened to Lehman’s balance sheet in the first quarter? Assets rose. Leverage rose. Write‐downs were suspiciously miniscule. And the company fiddled with the way it defines a key measure of the firm’s net worth.” Lehman’s Head of U.S. Global Credit Products, Eric Felder, forwarded this article to Ian Lowitt, Lehman’s Co‐Chief
Administrative Officer, with the note, “bunch of people looking at this article,” to which Lowitt replied, “[d]oesn’t help.” Firms such as Lehman required the confidence of the market to assure its sources of short term financing that they would be repaid; and the market’s confidence in Lehman was publicly questioned.
p. 661: SpinCo was seen by some as validation of their suspicion that Lehman’s assets were not properly valued. David Einhorn, President of Greenlight Capital, told the Examiner that the creation of SpinCo supported his contention that Lehman had not been marking down its commercial assets. Einhorn believes that Lehman’s efforts to spin out its commercial real estate into a company where the assets did not have to be marked to fair value revealed that Lehman had not been marking those assets to fair value.
p. 713: After Bear Stearns nearly collapsed, short sellers began to focus on Lehman and other banks. On March 20, 2008, Russo contacted Linda Thomsen, the SEC’s Head of Enforcement, regarding rumors of hedge funds “taking another run at Lehman.” On April 1, 2008, at Lehman’s prompting, Erik R. Sirri, head of the SEC’s CSE program, made a statement at an annual conference regarding the SEC’s view of the seriousness of rumors and stock manipulation in the context of short sales. At the April 15, 2008 Board meeting, Lehman’s management discussed Lehman’s concerns regarding short selling. On May 21, 2008, at the Ira Sohn Conference, one day after the comment period for the SEC’s proposed rule concluded, Einhorn gave a presentation on Lehman, analyzing Lehman’s Form 10‐Q, filed April 9, 2008.2767 Einhorn announced that he was shorting Lehman’s stock based on his belief that the stock was over‐valued. Before that presentation, Einhorn had corresponded with Callan in mid‐May 2008, as part of what he described as fact‐checking in advance of his presentation at the Ira Sohn Conference. Einhorn focused on four major issues in his correspondence with Callan and in his May 21, 2008 speech: (1) Lehman’s disclosures regarding CDO exposure and related write‐downs; (2) the difference between the amount of Level III assets disclosed in the Form 10‐Q filed in February 2008 and during Lehman’s first quarter 2008 earnings call; (3) Lehman’s disclosure and valuation of its stake in KSK Energy; and (4) Lehman’s write downs of its CMBS assets. On the day of Einhorn’s speech, Lehman’s stock closed down $2.44, with its highest volume of the entire month of May 2008. Einhorn’s criticism of Lehman and Callan is commonly cited as the reason for Callan’s replacement less than three weeks later. Following the near collapse of Bear Stearns, Einhorn published a book, Fooling Some of the People All of the Time, which focused on Allied Capital. Thomas C. Baxter, Jr., General Counsel to the FRBNY, said that reading Einhorn’s book made him think that the FRBNY should pay more attention to short sellers’ concerns. However, Baxter did not reach that conclusion for the reason that Lehman would have wanted, namely to persuade the Government to regulate short sellers, but rather because it appeared to Baxter that Einhorn may have been shorting Lehman for good cause. Baxter was unable to say, however, whether anyone at the Federal Reserve followed up on Einhorn’s criticism of Lehman in his speech.
The following are links to the Report of the Examiner in the Chapter 11 proceedings of Lehman Brothers:
Disclosure: No positions