``Perception trumping reality once more.'': A Philosphical Treatment By Richard Fuld

We just heard Liddy, now, from Bloomberg, let's listen to Fuld:

``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.''

Fuld's an epistemologist. Who knew? Oh dear, weather words. It's bad.

"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."

Why?

"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."

Still, some claim it wasn't a mistake. Go figure.

"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.''

Weather again. Here's my point: An actual human agent saw the problem and did nothing.

"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. "

He's a kind of Cassandra apparently, not the head of a business.

"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."

I thought that he'd predicted a bubble?

"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."

Objects in the mirror are bigger than they appear.

"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."

Sounds here like Fuld couldn't differentiate between perception and reality. It's Proustian, frankly. The problem you project onto others is actually your own.

"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."

Absolute gold. I've been waiting for it. Waiting for government intervention. Got it!

"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. "

I might work this into a novel.

"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."

It does appear that he's sitting on a weaker and weaker hand. Perhaps he playing a game none of us understand.

"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."

Perception and reality again. This article is making him sound like King Lear.

"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."

Now he's an alchemist.

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

Note to Paulson. Moral hazard only works when you enforce it from the beginning. If you don't, then your actions seem fickle and arbitary.

"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.''

I told you we'd learn a lot if we'd just listen. Fuld was right, and is just saying what I said people would say once you've ignored moral hazard. Actions are as important as words.

"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. "

What's he going to say? I'm an ass. He's too rich to admit that to himself.

"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."

He misheard Paulson, who told him to go sit in the corner. Mythology talk. That's bad as well.

"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."

He walked out into cold evening air, bumped into a man carrying a bag of groceries, and quickly apologized. The cars and buses roared past him, ignoring the dimensions of the harm his failings would cause to the world's financial system. A beautiful middle aged woman smiled at him, something that would usually cheer him up, but not today.

"Why did I risk so much on mortgage-backed securities?", he asked aloud to passing pedestrians, none of whom responded, either because they didn't know or didn't care. "Was is simply a matter of using the name 'Spinco'?", he mused. "Could it all boil down to choosing a laughable name sounding like one of the Marx Brothers?"

Time for me to end this narrative before I actually start writing a novel based on it.