Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the FinancialSystem--and Themselves

CHAPTER FIFTEEN

At around 8:00 the next morning, Sunday, September 14, Wall Street’s groggy CEOs trudged back to the NY Fed.

Lloyd Blankfein and Russell Horwitz, his chief of staff, each of whom had had roughly four hours of sleep, entered the building together.

“I don’t think I can take another day of this,” Horwitz said wearily.

Blankfein laughed. “You’re getting out of a Mercedes to go to the New York Federal Reserve—you’re not getting out of a Higgins boat on Omaha Beach! Keep things in perspective.” Blankfein was making a not-so-subtle reference to John Whitehead, one of Goldman’s former CEOs and a company patriarch, who had written a book titled A Life in Leadership: From D-Day to Ground Zero, which Blankfein had made required reading at the firm.

A Fed staffer announced to all the CEOs that Paulson, Geithner, and Cox would soon be coming downstairs. When Jamie Dimon, dressed in tight blue jeans, black loafers, and a shirt showing off his muscles, wandered into the room, Colm Kelleher whispered to John Mack, “He’s in pretty good shape for his age.”

Paulson and Geithner appeared and announced that they had good news, which everyone in the room already seemed to know. Overnight, Barclays had put together a proposal to buy Lehman and was prepared to move ahead. The only stumbling block that remained was getting all the other banks to contribute enough money—some $33 billion—to finance Lehman’s “bad bank.” After instructing the group to finish working out all the details, Geithner abruptly left the room.

A document titled “Certain Deal Issues” was now circulated, identifying some of the more difficult questions the bankers would have to consider. Would the two parts of a split-up Lehman each have enough funding after the deal closed? And could Lehman’s bad bank be made “bankruptcy remote”—in other words, legally sealed off so that creditors couldn’t go after the healthy part later?

It was then that Dimon decided to play the role of John Pierpont Morgan, who helped rescue the nation following the Panic of 1907.

“Okay, let’s make this really simple,” he announced. “How many of you would kick in $1 billion—I don’t care what form it takes—to stop Lehman from going down?”

It was the question on everyone’s mind but the one that no one had dared to ask. It was the same question that Herbert Allison, then of Merrill Lynch, had posed a decade earlier in the same building when at stake was saving Long-Term Capital Management. Dimon, then at Citigroup, had had a seat at the table for that one, too. The only difference between then and now was that Allison had asked how many banks could put up $250 million; even factoring in inflation, $1 billion a bank was a steep request.

At the time, Jimmy Cayne, Bear’s chairman, had refused to take part. “What the fuck are you doing?” Merrill’s CEO, David Komansky, screamed at him.

Cayne shouted back: “When did we become partners?”

Everyone in the room today was well aware of that famous exchange between the two Wall Street kingpins.

Blankfein told the room that while he wasn’t convinced that Lehman actually posed a systemic risk, there was a larger issue of all the banks’ reputations and public perception to consider. “Bear Stearns did a lot of good things over the last decade, but the only thing they’re remembered for is, they didn’t step up when the industry needed them to.”

What went unspoken but was surely on the minds of many of the bankers in the room was the role that Dick Fuld had played in the rescue of LTCM. When it came time for him to contribute his $250 million share, he explained that he couldn’t afford to do so. Given the pressure on his firm—and the rumors then that Lehman was about to go out of business—he had contributed only $100 million.

Now, with a dozen banks represented around the table, Dimon kicked off the fund-raising effort.

“I’m in,” he said. One by one the bankers began to indicate what they might be willing to ante up as well. When the tally was added up, they were close to saving Lehman—or so they thought.

Peter Kraus and Peter Kelly of Merrill Lynch arrived at Goldman Sachs’ headquarters just after 8:00 a.m., rode the elevator up to the thirtieth floor, strode through the glass doors, and slipped into the virtually empty executive suite on their own. Kraus, having worked at Goldman for twenty-two years, knew his way around the place.

Gary Cohn and David Viniar of Goldman greeted them and escorted them to a conference room. Before the meeting, Cohn had privately told Viniar that if Goldman were to buy a stake in Merrill, the price was going to be a lowball one. “I’m going to be low single digits,” he asserted, a far cry from the $30 a share that Fleming had been hoping to get out of Bank of America. (Cohn didn’t say so at the time, but he was thinking the entire firm’s value might be just several billion dollars; Merrill’s market capitalization on Friday had been $26.1 billion.)

Kraus brought with him the same deck, or presentation, that he had taken to Morgan Stanley. He told the Goldman bankers that Merrill was looking to sell a 9.9 percent stake in the firm and also looking for a $20 billion credit facility.

Before the negotiating even began, Cohn, always blunt, told them: “I’m going to write down your mortgage portfolios to a place where I think they click.” In other words, he was going to value Merrill’s toxic assets at next to nothing.

“I know the way you think,” Kraus replied. “You could put a positive number on it,” he said, hoping that Cohn and Viniar would at least assign some value to the portfolio.

Just as Kraus began digging deeper into Merrill’s balance sheet, Kelly, the only non-Goldman-connected man in the room, stopped him. He was clearly anxious about providing Goldman with too much information. Kraus may have trusted his former colleagues, but Kelly was more circumspect. To him, the odds of pulling off a deal with Goldman were low, and given Cohn’s comments, if a deal did come together, Merrill would be sold for a song.

“Guys, nothing personal, but let’s just lay low here,” Kelly said. “If you want to do due diligence, let us talk to John and let’s figure out what we want to do.”

That was acceptable to Cohn and Viniar, who, in any case, had to get back to the NY Fed. They agreed they’d resume the talks once Kraus and Kelly could get their information in order.

As the meeting was breaking up, Kelly called Fleming to give him a progress report. He said that he and Kraus had made their pitch, but he acknowledged that simply getting a credit line in exchange for 9.9 percent might not be enough to save the firm.

“That’s not going to fill the gap if Lehman goes,” he told Fleming.

“It looks like we may have the outlines of a deal around the financing!” Steve Shafran, a senior adviser at Treasury, announced to Bart McDade and the Lehman team at the NY Fed. Brandishing a huge smile, Shafran told the Lehman bankers that the CEOs downstairs were close to agreeing to funding the spin-off of Lehman’s real estate assets.

The men felt as if an unimaginable burden had been lifted almost instantaneously from them. And McDade excitedly tapped out a message on his BlackBerry to Michael Gelband, who was at Simpson Thacher’s offices.

Standing in a conference room uptown, Gelband read McDade’s message and shouted, “We got it!” he said, a broad grin spreading across his face as he let out a sigh of relief.

Hector Sants, the deputy head of Britain’s Financial Services Authority, was driving along the A30 from Cornwall on the southwestern tip of England back to London on Sunday afternoon with his cell phone clutched precariously between his ear and his shoulder.

Sants had been on the phone for most of the weekend with his boss, Sir Callum McCarthy, head of the FSA and a former Barclays banker himself. McCarthy, at sixty-four years old, had only six days remaining in his tenure in the post and was scheduled to step down that Friday.

Sants and McCarthy had spent hours trying to assess the state of affairs between Barclays and Lehman. Sants had been in contact several times with Varley that day, but McCarthy’s efforts to contact Geithner, his counterpart in the United States, were proving more difficult. They had spoken briefly on Saturday, but he had heard nothing since.

“He hasn’t called me back,” McCarthy grumbled. “You can’t get hold of any of these people.”

They had no idea what Barclays’ Diamond had—or had not—communicated to the U.S. government about what conditions had to be met to receive their blessing back in Britain. Indeed, McCarthy was nervous that Diamond, an American who had never become part of Britain’s gentlemen’s club, may have been a bit reckless in the negotiations, like any aggressive Wall Streeter. Both men were especially concerned that Diamond, in his zeal to sign a deal, might not have fully explained the requirements that the British regulators would ask for before approving it. To them, buying Lehman could put the bank and the British financial system as a whole in jeopardy. Varley, who was supportive of pursuing Lehman but clearly less enthusiastic than Diamond, had assured Sants during a call on Friday that Barclays’ board would only pursue the deal if it could receive adequate help from the U.S. government or another source. “I would not recommend a transaction to my board unless I’m satisfied both in terms of the quality of the assets we’re purchasing and in respect to the funding positions,” Varley had said.

McCarthy and Sants also faced another looming problem, one that, in the grand scheme of things, may have seemed minor but was nonetheless important at that very moment: The London Clearing House (LCH, Clear-net), which clears many of the derivative counterparty trades across Europe, was scheduled to migrate its entire energy futures business—worth over 100 billion pounds—to a completely new computer system that weekend. They had instructed the London Clearing House on Saturday to hold off on proceeding with the upgrade until they knew more about the fate of Lehman and Barclays, but were now being badgered for a final answer, as dozens of technicians had been engaged to handle the switch-over.

“We shouldn’t allow this to drag on,” Sants said to McCarthy, hoping they could get an answer back to the London Clearing House. “We ought to try to contact Geithner and just make our position very clear.”

They scripted out what McCarthy would say: “We feel as the regulator [sic], in the best interest of the global financial system, that it’s important you understand—we hope Barclays has already made this clear to you, but in the event Barclays has not made this clear to you—that we need the appropriate funding assurances both on the trading side and with regards to the asset issues if we’re going to allow this to go forward.”

McCarthy said he would try Geithner one last time.

On the thirteenth floor of the NY Fed, Hilda Williams, Geithner’s assistant, told him that Callum McCarthy was on the phone. Geithner finally took the call, explaining, brusque as ever, that he had been in back-to-back meetings trying to get a deal together for Lehman and apologizing for not returning his call sooner.

McCarthy stopped him, saying that he was very concerned that he didn’t know anything about the deal being contemplated. He had a list of questions that he needed answered.

“The capital requirements and, in particular, the transaction risk between the time of taking on the risk and the completion of the transaction leaves a very big open-ended exposure,” McCarthy said, keying in on his biggest problems with the deal. He explained that the FSA still needed to determine whether Barclays was properly capitalized enough to take on the risk of buying Lehman. And, he said, even if it was—which he suggested was a possibility—Barclays still would need to find a way to guarantee Lehman’s trades until the deal was completed. “I’m very doubtful Barclays can ever get to a position to fulfill the requirements, and it is far from clear that they will be able to do so,” he said.

Geithner had no idea that the FSA would take such an aggressive position and asked McCarthy directly whether the authority was formally saying it wouldn’t approve the deal.

“It is completely impossible for us to take a view on whether these risks are risks that we would accept,” McCarthy replied, unless “you bring a proposal forward.” But, he added, since it was so late in the day—about 3:30 p.m. in London—the chances were remote they’d be able to come to a conclusion within the next several hours.

McCarthy went on to present another problem: He said that Barclays could not guarantee Lehman’s trading obligations without a shareholder vote, which was a UK “listing requirement” for all publicly traded firms in Britain. However, not only was there insufficient time for such a vote, but he said that he wasn’t authorized to waive the vote requirement—only the government could do that.

Geithner explained that, based on his conversations with Barclays, he thought the British government had already indicated it would be supportive of the transaction.

“I have no indication that that is the case at all,” McCarthy said firmly, and then expressed anxiety, as Darling had to Paulson on Friday, about Barclays’ own health and that of the rest of the market.

“Look,” Geithner said impatiently, “we’re going to have to decide in the next half hour what we do. Time is running out.”

“Good luck,” McCarthy said curtly.

Geithner ended the call and rushed into Paulson’s office, where the secretary and Chris Cox were speaking, and recounted the conversation.

“I asked him if he was saying no,” Geithner said, “and he kept saying that he wasn’t saying no.” But clearly, Geithner complained, that’s exactly what he was saying.

Paulson was beside himself. “I can’t believe this is happening now.”

After a brief discussion of strategy, Paulson ordered Cox, who was the only regulator in the room with legal authority over Lehman Brothers, to call McCarthy. Cox, Paulson thought to himself with a sense of annoyance, was supposed to have prewired these very regulatory issues. “I don’t want to be left here holding Herman,” the Treasury secretary said, glancing at his zipper in case the joke wasn’t clear.

Cox reached McCarthy on his cell phone in the living room of his two-story home in Blackheath, across the Thames River. After the FSA head patiently reiterated the problems that the Barclays deal faced, Cox suggested they could try to work around them, adding, “You seem to be very unsympathetic to this.”

“No,” retorted McCarthy coldly, “I’m trying to establish the facts of life so that you understand them and approach this with some realism.”

“You’re being very negative,” Cox insisted.

“Look, you should understand, one of the great problems for us at this end is not actually being properly kept in the loop of what you’re up to,” McCarthy complained, growing increasingly agitated. “You must understand, we’re hearing things late in the day,” he said, ticking off a list of requirements that Barclays would need to meet. “We could have told you earlier which ones would run into problems and which ones wouldn’t.”

Five minutes later Cox returned to Paulson and Geithner, notepad in hand, deathly pale.

“They’re not going to do it,” he said. “This is a total reversal. They never said a word to us about this before!”

Tom Baxter, the NY Fed general counsel, who had just walked in, couldn’t believe what he was hearing. “We’ve come this far, the money’s on the table,” he said in disbelief. “Didn’t they know this when they took the plane over here?”

“I’ll call Darling,” Paulson said.

In Edinburgh, Scotland, Alistair Darling, Prime Minister Gordon Brown’s Chancellor of the Exchequer, was preparing to head to London for the workweek, as he did every Sunday.

It was about 4:00 p.m. local time, and Darling had been on the phone for much of the day with John Varley of Barclays, officials at the FSA, and Prime Minister Brown himself, trying to decide whether the U.K. government should approve the deal with Barclays.

Darling had deep misgivings about the transaction, especially after he had learned from one of his staffers that Bank of America had dropped out of the bidding. Was Barclays going to be left buying leftovers? He had read all the coverage of the deal in the papers that morning, including an editorial in the Sunday Telegraph:

Free things can still make expensive purchases. Investors should only get behind Diamond if he can prove two things: that he is retaining the kind of discipline that has been sadly lacking from the world’s leading banks in recent times; and that Lehman, as transparently as it is possible to prove, is a genuine bargain.

Darling thought it was impossible that Barclays could have done a deep enough examination of Lehman’s books to be satisfied that the bank wouldn’t be exposed to extreme markdowns of Lehman’s assets in the future. Even worse, Darling had other problems on his mind: HBOS, the United Kingdom’s biggest mortgage bank, was struggling; he also knew that Lloyds was interested in buying them. Between Barclays, Lloyds, and HBOS, the entire British banking system, he thought, was at risk.

As all these concerns ran through his mind, he answered the phone call from Hank Paulson.

“Alistair,” Paulson said gravely. “We’ve just had a distressing conversation with the FSA.”

Darling explained that he understood that they had been in touch and that there seemed to be numerous unanswered questions. “I have no objection in principle to the deal,” Darling said. “But you’re asking the government to take on a huge risk. We need to be sure what it is that we are taking on and what the U.S. government is willing to do. The questions we are asking are not unreasonable.”

“We’re at the end of the line here,” Paulson said, surprised at Darling’s position, and pressing him again about whether he was prepared to lift the requirement for a shareholder vote.

“If this were to go ahead, you know, what would the U.S. government be doing? What are you offering?” Darling asked in return.

Paulson reiterated that he was hoping the private consortium was coming together, but now Darling shifted the conversation and began peppering Paulson with questions about the United States’ contingency plans for Lehman’s bankruptcy. “Well, if Lehman is going into administration, we need to know because it will have implications over here,” Darling said before ending the call.

“He’s not going to do it,” Paulson told Geithner in amazement. “He said he didn’t want to ‘import our cancer.’”

For the next two minutes in Geithner’s office, a half dozen excited voices were speaking at once, until he finally quieted the group and asked, raising his voice for the first time the entire weekend, “Why didn’t we know this earlier? This is fucking crazy.”

Paulson began to wonder aloud if President Bush should call Gordon Brown personally, but almost before finishing the question, he answered it himself. “There’s no chance,” he said, explaining that he thought that Darling had implied he had already spoken to Gordon Brown about the situation. “He was so far away from, ah, wanting Barclays to do anything,” he remarked of Darling.

“Okay. Let’s go to Plan B,” Geithner said after a moment’s reflection.

In case it wasn’t clear what all of this meant, Shafran of Treasury spelled it out in simple terms in a text message to his colleagues: “We lost the patient.”

They agreed to assemble downstairs to relate the news to the bankers so that they could begin preparing for Lehman’s bankruptcy. Plan B was simple: Regulators would press the banks to unwind trading positions they had with Lehman and with one another in a way that minimized the impact on the markets.

And then there was the next critical issue to address, Geithner said: “We have to deal with Merrill.”

As they got up to leave, Paulson, clearly depressed, remarked drily: “If you’re going to ride the pony, sometimes you have to step in the shit.”

A NY Federal Reserve security guard who had been searching for Bart McDade and Rodgin Cohen eventually found them on the first floor. “Secretary Paulson would like to see you,” he announced before escorting them to Geithner’s waiting room.

Cohen was already uneasy, for while McDade had been sending out enthusiastic e-mails about the near-consummation of the deal, Cohen had overheard a number of government officials who seemed to be more circumspect about its prospects. McDade now also sensed that something was amiss and sent a message to Gelband while he was waiting, telling him, “There might be a holdup.”

The door to Geithner’s office opened and out walked Geithner, Paulson, and Cox, all looking alarmingly dour.

“We got the banks to agree to fund, but the U.K. government has said no,” Paulson announced.

“Why? Who?” Cohen asked, incredulous.

“It came from Downing Street. They don’t want U.S. problems infecting the U.K. system,” Paulson said.

While McDade just stood mutely in shock, Cohen, who was famous for his equanimity, virtually shouted, “I cannot believe this! You have to do something!”

“Look,” Paulson said sternly, “I’m not going to cajole them and I’m not going to threaten them.”

Cohen was not finished.

“I know a lever we can pull with the U.K. government,” Cohen offered. “I have a friend I can call.”

Paulson just stared at him, shaking his head. “You’re wasting your time. The decision was made at the highest levels.”

Cohen walked to a corner and dialed Callum McCarthy directly. They had known each other for years; Cohen had been Barclays’ lawyer in the 1990s when McCarthy worked there. But the look on Cohen’s face as he explained the situation told the story unequivocally: McCarthy was clearly not able to help his friend.

“You’ve really got this wrong if you don’t think this is going to infect you,” Cohen told McCarthy, nearly begging him to reverse his decision. “By not doing the deal, it’s going to infect you.”

Downstairs, Paulson, Geithner, and Cox entered the main conference room where the CEOs were still trying to coordinate funding of Lehman’s real estate assets. The mood in the room had been noticeably upbeat as they continued to make progress.

“Those of you who do not want to assist a Barclays deal can breathe a sigh of relief,” Paulson announced, somewhat awkwardly, and a number of bankers in the room did not understand what he was trying to convey until he formally announced that the deal was dead. “The British are not allowing for this type of guarantee; they can’t get it done by tonight; they need a shareholder vote.”

“But we have the money!” Jamie Dimon said.

“Isn’t this our closest ally in the world?” one of the bankers asked.

“Guys, trust me,” Paulson said. “I know how to be a tough guy. I’ve done everything I can. There is no deal.”

The general opinion in the room was that they had been blindsided; Paulson merely shook his head and declared that the British had “grinfucked us.”

Geithner steered the conversation to the necessity of setting up contingency plans. He said that Lehman’s holding company would file for bankruptcy that day. He also indicated that the government would open up an emergency trading session in the afternoon for all of the biggest banks to unwind positions with the firm.

Finally, Geithner broached the idea of creating a revolving credit facility, which would effectively serve to help the next bank in trouble. The proposal was for a $100 billion emergency fund, with each bank in the room putting up $10 billion: $7 billion funded and $3 billion unfunded. Any one bank could withdraw up to $35 billion from it in the case of an emergency.

At the end of the meeting, Paulson and Geithner pulled Thain aside and quietly told him, “We’ve got to talk to you.”

“John, you see where we are with Lehman Brothers,” Paulson told Thain once they had seated themselves in a conference room. “You’ve got to do something here. We don’t have the authority it’s going to take if you’re looking for the government to save you.”

“I’m working on it,” Thain said solemnly. “I’m trying to save myself.”

Thain explained that he was working on two parallel paths: one to sell a small stake in the firm to Goldman Sachs, and the other to sell the entire firm to Bank of America. He said that he had had coffee with Ken Lewis that morning and that Bank of America was much farther along, but that he expected Goldman could move quickly, too.

Geithner had heard enough; he had to brief Bernanke, so he got up and left.

Paulson could tell that Thain might be leaning toward the Goldman investment option—he knew Thain wanted to remain CEO of Merrill—but instructed him to push forward on the deal with Bank of America.

“John, you have to get this done,” he urged. “If you don’t find a buyer by this weekend, heaven help you and heaven help our country.”

So far, Paulson had been trying to show no sense of fear among his colleagues and CEOs, but, in truth, the moment was beginning to overwhelm him. He was getting increasingly anxious that the market could end up toppling.

Paulson stepped out of a meeting room and found a quiet corner to call his wife Wendy on his cell phone. His voice immediately betrayed his own panic. “What if the system collapses?” he confided in her. “Everybody is looking to me, and I don’t have the answers. I’m really scared.”

Wendy tried to allay his fears with encouragement and prayer. She immediately began reciting Timothy 1:7—“For God hath not given us the spirit of fear, but of power, and of love, and of a sound mind.”

“I understand it’s not going through,” Bart McDade told Bob Diamond when he reached him at his desk at Barclays’ headquarters.

“What do you mean?” Diamond replied, completely taken aback. “I haven’t heard that.”

“It’s off. The government says it’s not happening,” McDade told him, and recounted Paulson’s discussion with the British regulators.

Diamond immediately got off the phone and called Tim Geithner’s office.

“I just heard,” Diamond said, exasperated. “What happened?”

“You should talk to Hank,” Geithner told him.

When he finally managed to reach Paulson, he said, somewhat curtly, “I want to tell you that it was really difficult for me to get a call from someone else well after you did this.” He paused, trying to keep his voice level. “And what I’ve been told you said is very much against what I think the facts are, and I think I deserve an explanation.”

When he hung up after hearing Paulson’s account of the communications, Diamond was in turn deflated, furious, and embarrassed. He was livid with Paulson and dismayed by the British government. How could they have led him so far only to quash the plan at the last moment?

At 12:23 p.m., Diamond tapped out a message on his BlackBerry to Bob Steel, who had been trying to set the deal up for six months:

Couldn’t have gone more poorly, very frustrating. Little England.

Bart McDade, Alex Kirk, and Mark Shafir walked in silence through the underground garage at the NY Fed and piled into McDade’s black Audi A8 to drive back to Lehman headquarters. For at least five minutes nobody said a word as they all just tried to comprehend what had just happened. They had all come to accept that they were out of options.

As they drove up the West Side Highway, McDade dialed Fuld on the speakerphone.

“Dick, you’ve got to sit down,” he began.

“I’ve got bad news. Horrible news, actually,” he said. “Supposedly the FSA turned the deal down. It’s not happening.”

“What do you mean ‘not happening’?” Fuld bellowed into the phone.

“Paulson said it’s over. The U.K. government won’t allow Barclays to do the deal. Nobody’s saving us.”

Fuld, too, was speechless.

Across town, Greg Fleming of Merrill Lynch and Greg Curl of Bank of America were getting closer to formulating their own agreement, as lawyers began to draft the outlines of a deal document. The combined company would be based in Charlotte but would have a major presence in New York; the brokerage business would continue to use the iconic Merrill Lynch name and its familiar bull logo.

Fleming was working through some of the details when he took a call from Peter Kraus, who was on his way back to Goldman Sachs. He told Fleming that he needed part of the diligence team sent over to meet him there.

“I’m not sending anybody anywhere,” Fleming replied. “We’ve got a good deal in hand and we’re going to finish it.”

Fleming was worried that Kraus, who he felt had been unhelpful from the day he had arrived at Merrill just over a week earlier, was trying to undermine the agreement with Bank of America and that he was more interested in a deal with his old pals at Goldman. Fleming was also concerned that if Bank of America officials discovered that Merrill was talking to Goldman, they would simply walk.

“We need as many options as we can get,” Kraus told him. “You’re the president of the company, it’s your call, but you’re making a big mistake.”

“Well, it is my call,” Fleming agreed, “and I just made it.”

“John, we have to talk,” said Dick Fuld, almost begging, when he reached John Mack on his cell phone at the New York Fed. “There’s a way to make a deal work. Let’s set something up.” Mack was clearly devastated for his friend, but there was no way to do what he was asking. “I’m sorry, Dick,” he said sympathetically. “I’m really sorry.”

When he got off the phone, he strolled over to a group of bankers that included Jamie Dimon and recounted the conversation, lamenting Lehman’s fate.

Dimon furrowed his brow.

“I just had the most surreal conversation with a guy at Lehman,” Dimon said. “He seems to be in denial.”

Mack just shook his head. “This is bizarre.”

Over at AIG, Chris Flowers, taking a break from working with Bank of America, had stationed himself at one of the secretarial desks in the hallway, waiting to meet with Willumstad. Accompanying him was Dr. Paul Achleitner of Allianz; together they had prepared an offer for the company.

When they were invited into a conference room, they found Willumstad there with Schreiber and a group of his advisers, including Doug Braunstein from JP Morgan, Michael Wiseman from Sullivan & Cromwell, and several others.

“We have an offer,” Flowers announced, producing a one-page term sheet that he handed to Willumstad.

Flowers, who hadn’t yet heard about the additional $20 billion hole that JP Morgan’s bankers had discovered, explained that he had put together a deal that valued AIG at $40 billion. (The company’s actual market value on Friday had been about $31 billion.) Given the company’s problems, he asserted, it was the best estimate he could come up with quickly.

He then spelled out the rough terms: His own firm and Allianz would put up about $10 billion of equity—$5 billion each—and they planned to raise $20 billion from banks; they would also sell $10 billion of assets. The investment they’d be making would be directly in AIG’s regulated subsidiaries, but they’d gain control of the parent company. That condition was a move to protect Flowers and Allianz: If the parent company were to falter, they’d still own the subsidiaries. Finally, Flowers said they would have to be able to convince the Federal Reserve to turn AIG into a broker-dealer, so that it had the same access to the discount window that investment banks like Goldman Sachs and Morgan Stanley had.

Before ending his presentation, Flowers added that he had one other term that hadn’t been noted on the deal memo: “Bob, we would replace you as CEO.”

The silence that greeted the offer reflected the fact that Willumstad and his advisers thought the bid had to be a joke—not because Flowers had the audacity to tell Willumstad that he would be fired, but because the deal was also filled with potential pitfalls; Flowers was putting up scarcely any of his own money, and he hadn’t lined up 80 percent of the funds needed to do the deal. They also thought the price ludicrously low. In their minds the company was worth at least twice that.

“That’s fine,” Willumstad said calmly. “We have an obligation, we’ll take it to the board, but I have to tell you, you know, you’ve got contingencies in here that none of us can agree to,” he said, referring to the need for Flowers to still receive bank financing. “Thank you,” Willumstad said and stood, trying to get them to leave as quickly as possible. As soon as Flowers departed the room, Achleitner closed the door and took his seat again.

“I don’t approve of what he just did,” Achleitner said, almost whispering.

“Well, you read the letter before you came,” Willumstad said, his temper in check.

“No, no, no, that’s not how we do business,” Achleitner said apologetically.

“Okay. Whatever,” Willumstad responded. “Thank you very much.”

When the entire group had finally left, Willumstad turned to Schreiber and whispered, “Don’t let those guys back in the building!”

For a brief moment Dick Fuld allowed himself to smile. Ian Lowitt, Lehman’s CFO, had just gotten word that the Federal Reserve was planning to open the discount window even wider, a move that would enable broker-dealers like Lehman to pledge even more of their assets—including some of their most toxic assets—as collateral in exchange for cash.

“Okay, here we go!” Fuld said, believing they might be able to hang on a bit longer as they sorted out their options.

“This is great, great news,” Lowitt said, already tallying in his head the tens of billions of dollars of real estate assets he thought they might be able to pledge to the Fed. “We have enough collateral!”

“Lehman’s got to file immediately,” Paulson, leaning back in his chair, instructed Geithner and Cox. He made it clear that he didn’t want Lehman adding to the uncertainty in the marketplace by dragging the situation out any longer.

Paulson had another reason for insisting that Lehman file: If the Fed was going to open its discount window even wider to the remaining broker-dealers, he didn’t intend that Lehman be granted that access; doing so would represent another opportunity for moral hazard.

Cox said that he wanted to hold a press conference to announce the bankruptcy. As the sole regulator with formal authority over the firm, he felt he needed to communicate the news to the public before it crept out on its own and panic ensued.

He summoned Calvin Mitchell, the head of communications for the NY Fed, and Jim Wilkinson, Paulson’s chief of staff, into his temporary office and asked when a conference could be scheduled.

“Well, can’t you do it at the SEC office somewhere? Isn’t that more appropriate?” Mitchell asked, clearly uncomfortable about arranging a media event in the middle of such chaos.

“It’s easier to do it here; no one is there,” Cox insisted. “The journalists are here,” pointing out the window at the scrum of press lined up on Liberty Street.

“Okay, so, we could do it on this floor,” Mitchell said. “Or, if we do it on the main floor, we have a podium we can bring down.”

Cox liked the idea of holding the press conference downstairs and added, “That’s a good backdrop.”

As they began discussing the substance of what Cox would say at the conference about Lehman’s bankruptcy, Erik Sirri, the SEC’s head of markets and trading, pointed out a slight problem with the plan.

“We can’t announce this,” Sirri said. “We can’t say a company has filed for bankruptcy until they decide to file. And that’s a decision for Lehman’s board.”

Just after 1:00 p.m., Stephen Berkenfeld of Lehman called Stephen Dannhauser of Weil Gotshal, the firm’s bankruptcy lawyer, frantically explaining that a group of Lehman executives—led by Bart McDade—had just been ordered to appear at the New York Fed. “You’d better get down there,” he urged, and said nothing further.

Seconds later, Dannhauser grabbed three senior partners—Harvey Miller, Thomas Roberts, and Lori Fife—and dashed to the street to find a cab. As the four sat sweating in gridlocked traffic, Roberts took a call from a partner back at the Weil Gotshal office who told him that Citigroup had just asked about the firm’s availability to represent it as a creditor in a Lehman bankruptcy.

“That doesn’t make any sense,” Roberts told the partner. “We’re on our way to discuss a deal with Barclays.”

An hour after leaving the General Motors Building, the cab finally approached the New York Federal Reserve Building. News camera crews were still camped outside, watched over by uniformed Fed security. As the lawyers finally entered the building, they encountered Vikram Pandit of Citigroup hurrying out, looking as if he was late for another appointment.

Bart McDade and other Lehman representatives had already arrived upstairs and were sitting across from several rows of government officials and lawyers. Baxter, the general counsel for the New York Fed, was clearly running the meeting, as were lawyers from Cleary Gottlieb, representing the Securities and Exchange Commission.

McDade was just then telling Baxter, “You don’t understand the consequences. You don’t understand what is going to happen!”

Baxter, on noticing the arrival of the Weil Gotshal team, politely stopped the conversation to explain what was going on. “Harvey, we have had a great deal of deliberations and we’ve been thinking about this a lot, and it’s clear now that there isn’t going to be a Barclays transaction. We’ve come to the conclusion that Lehman has to go into bankruptcy.”

Incredulous, Miller leaned forward until he was inches from Baxter. “Why? Why is bankruptcy necessary?” Miller demanded. “Can you explain, can you please elaborate on this?”

“Well, I’m not sure it’s really necessary, given all the circumstances,” Baxter responded, sheepishly. “But, ah, there’s not going to be any kind of bailout, so we think it’s appropriate that Lehman go into bankruptcy.”

Miller looked at his colleagues. “I’m sorry, Tom, but we don’t understand.”

Alan Beller, a lawyer at Cleary Gottlieb, cut in peremptorily. “You need to do this, and it should be done before midnight tonight. We have a program to calm the markets.”

Miller raised his voice. “Oh, you have a program to calm the markets, do you? Could you possibly tell me what that program is?”

“No, it’s not necessary for your decision making,” Baxter shot back.

“Tom,” Miller persisted, “this makes no sense. Yesterday, no one from the Fed was talking to us about bankruptcy, and now we have to have a filing ready before midnight. And what is the magic of midnight? The only way we could ever file, and it won’t be by midnight, is with a skinny Chapter 11 petition. What will that accomplish?”

“Well, we have our program,” Baxter repeated.

Miller stood up, his six-foot-two frame looming over the other lawyers.

“What,” he slowly bellowed, “is this program?”

Baxter just stared uneasily, offering no immediate answer.

“If Lehman goes into bankruptcy, totally unprepared, there’s going to be Armageddon,” Miller warned. “I’ve been a trustee of broker-dealers, little cases, and the effect of their bankruptcies on the market was significant. Here, you want to take one of the largest financial companies, one of the biggest issuers of commercial paper, and put it in bankruptcy in a situation where this has never happened before. What you’re going to do now is take liquidity out of the market. The markets are going to collapse.” Miller waved his finger and repeated, “This will be Armageddon!”

Baxter looked at the SEC lawyers, and, considering for a moment, finally said, “Okay, I’ll tell you what we’re going to do, we’re going to caucus.”

“This is insane,” Miller said to Roberts as soon as the Lehman team was alone in the conference room. “They’re telling us to fucking file. The government is telling us to file.”

“I don’t even know what to say,” Roberts replied. “This has got to be illegal.”

About a half hour later, Baxter and the other government lawyers returned to the room, and the meeting resumed. “Well,” Baxter announced, “we’ve considered everything you said, and it hasn’t changed our position. We are convinced that Lehman has to go into bankruptcy, but what we are prepared to do is keep the Fed window open for Lehman so that the broker-dealer can continue operating the business.”

Baxter was making the case for compromise, that there could be a way for an orderly winding down of Lehman. The Fed would loan money to Lehman’s broker-dealer unit, but not indefinitely, only as part of a bankruptcy.

Sandra C. Krieger, executive vice president at the NY Fed, asked, “How much cash are you going to need us to provide you tomorrow to fund yourself on Monday night?”

“It’s impossible to know the answer to that,” Kirk told her.

“Well, that seems highly irresponsible!” she replied edgily.

“Really?” Kirk said, growing angry. “You want to tell me on the $50 billion of trades selling tomorrow how many of our counterparties are going to send us the money when we file for bankruptcy?”

Seeing that the conversation was quickly devolving, Miller jumped in and asked again why this measure was necessary.

“We’ve listened to your comments and we have concluded that our decision is correct, and we don’t have to discuss this any further,” Baxter said.

Miller still persisted. “You are asking this company to make a very momentous decision. It is entitled to all the information it can get.”

“You’re not going to get that information,” Baxter replied.

Alan Beller interrupted to say, “Look, we will have a series of releases that we are fairly confident will calm the markets tomorrow.”

“I’m sorry,” Miller responded sardonically, “you’re talking to me about press releases?”

At that the meeting was brought to a close.

Greg Fleming saw Peter Kelly in the hallway at Wachtell Lipton and gave him a big bear hug. As he did, he whispered into Kelly’s ear: “It’s done. Twenty-nine dollars. You owe me a beer,” he said with a big smile.

Fleming had just gotten off the phone with Thain, who had given him the green light to go ahead with the deal at $29 a share.

After an afternoon of haggling with Greg Curl, Fleming had persuaded him not only to accept the agreement but to fund Merrill’s bonus pool, up to the amount paid out in 2007. Nobody would get an employment contract, including Fleming and Thain—a point that Curl admired. To ensure that the deal would be completed, Fleming had convinced Curl to agree to a virtually airtight MAC agreement—meaning that even if Merrill’s business continued to deteriorate, Bank of America couldn’t later wiggle out of the transaction by claiming a “material adverse change” had occurred.

By Curl’s thinking, as he explained to Ken Lewis before agreeing to the price, “We might be able to get it for cheaper later, but if we don’t do the deal today, we could lose the opportunity entirely.” For Curl, a journey-man dealmaker, this was his crowning achievement.

Bank of America scheduled a board call for 5:00 p.m., while Merrill set up a board meeting at the St. Regis hotel at 6:00 p.m. to approve the deal. In a matter of hours, Merrill Lynch, with a history of nearly one hundred years as one of the most storied names on Wall Street, would be sold to Bank of America for the biggest premium in the history of banking mergers. It was, as one newspaper later put it, as if Wal-Mart were buying Tiffany’s.

At the NY Fed the banks had just finished trying to unwind their Lehman positions, an effort that had not gone particularly well. The Fed had passed out a memo to the CEOs earlier in the day explaining the program, which would be an extraordinary two-hour trading session in New York and London, during which firms that had opposing trades with Lehman tried to pair up and cut out the middleman.

The process was based on the assumption that Lehman was going under: “All trades conducted will be done on a contingency basis, contingent on the filing of bankruptcy of the Lehman parent,” the Fed memo said. “Trades will ‘knock in’ if the Lehman Brothers Holding Inc. files for bankruptcy before 9am ET on Monday.” The memo was intentionally never distributed to anyone at Lehman.

However neatly laid out the Fed proposal might have been, the various banks struggled to find matching trades that could remove Lehman from the picture. When frustrated traders left their desks at 4:00 p.m. in New York, many of them faced as much exposure to Lehman as they had on Friday afternoon.

“The extraordinary trading session held today to facilitate a partial unwind of these positions saw very little trading—perhaps $1 billion total—but at much wider spread levels for corporate bonds,” Bill Gross, head of PIMCO, told reporters that afternoon. “It appears that Lehman will file for bankruptcy and the risk of an immediate tsunami is related to the unwind of derivative and swap-related positions worldwide in the dealer, hedge fund, and buy-side universe.”

Word was also starting to spread that Merrill was about to be sold to Bank of America, a rumor that Gross, one of the nation’s most respected investors, said that he heavily discounted. “To some extent, the rumored bid for Merrill by Bank of America lends some confidence to all markets, although I am skeptical that BofA would pay such a premium on such short notice,” he said.

Ruth Porat, a Morgan Stanley banker who was present at the Fed, also doubted the speculation, especially the price. She called Jonathan Pruzan, Morgan Stanley’s banking industry expert, to tell him the latest buzz.

“The rumor is $29 a share, and it’s going to get announced in the morning,” she told him. “I can’t believe it, because they didn’t have time to do due diligence. It’s an absurd price.”

Without missing a beat, Pruzan replied, “Then it’s absolutely Ken. It’s true. That’s what Ken does.”

“Are you getting all this?”

Gary Lynch, the chief legal officer of Morgan Stanley, was barking into the phone as Paul Calello, the chief executive of Credit Suisse’s investment bank, paced nearby. With no access to a computer at the New York Fed, Lynch was in the process of dictating the text of an important press release to Jeanmarie McFadden, a Morgan Stanley spokeswoman, who was typing frantically to keep up.

The plan was to let the markets know that while Lehman might fail, Wall Street banks were cooperating to keep the whole financial system from imploding.

The release would open: “Today, a group of global commercial and investment banks initiated a series of actions to help enhance liquidity and mitigate the unprecedented volatility and other challenges affecting global equity and debt markets.”

It would go on to say that the world’s biggest financial institutions were creating a $100 billion borrowing facility for themselves—over and above what the Federal Reserve was providing through its Primary Dealer Credit Facility. Any one bank would be able to borrow up to $35 billion from the pool.

So far, ten banks were lined up to provide $7 billion each, for a total of $70 billion. The individual banks were a Who’s Who of the global financial system: Goldman Sachs, Merrill Lynch, Morgan Stanley, Bank of America, Citigroup, JP Morgan, Bank of New York, UBS, Credit Suisse, Deutsche Bank, and Barclays. In normal times, many of them were the fiercest of rivals.

The press release ended by stating assuredly that “the industry is doing everything it can to provide additional liquidity and assurance to our capital markets and banking system.”

Panic was starting to build within the Lehman ranks. George H. Walker IV, head of the firm’s investment management unit, sat in his office at 399 Park Avenue, scrambling to find a way to save the division. He had received bids for it on Friday from two separate private-equity firms, Bain Capital and TPG, and was in the middle of trying to bring them together when he received a telephone call from Eric Felder, one of McDade’s traders.

Felder was talking so fast that it sounded as if he were hyperventilating.

“You have to call your cousin,” he insisted. “If there was ever a time to call the president, now is the time.”

Walker, a second cousin to President Bush, was hesitant about using his family connections.

“I don’t know,” he said.

“You’ve got to do it, George,” Felder said to him. “The whole fucking firm is going down. Someone’s got to stop this!”

He placed the call but ended up leaving a message with the White House operators. The call would go unreturned.

With bankruptcy seemingly less than hours away, a new problem suddenly confronted Steven Berkenfeld, Lehman’s managing director: $18.5 million in unpaid bills from Weil Gotshal, the law firm he had hired to work on the bankruptcy filing. The debt, which was for previous legal work, was minuscule compared to the billions of dollars Lehman owed all over Wall Street. But it would prevent Weil and Harvey Miller from representing Lehman in Chapter 11. Since Weil was officially a creditor of Lehman, it would constitute a conflict of interest that a judge could use to throw Weil off the assignment.

To Berkenfeld, it was critical that Weil be involved in the case. After all, its lawyers knew the firm the best, and Lehman’s filing was due in almost record time. For Stephen Dannhauser, Weil’s chairman, the assignment was also of paramount importance: Judging from the size and complexity of the Lehman filing, which promised to be even bigger than Enron’s, the fees were likely to be well over $100 million.

Dannhauser had instructed Berkenfeld to pay Weil immediately, in advance of the bankruptcy, with cash sent by wire directly into the law firm’s accounts. Even this approach had risks: Being on the receiving end of such a payment could result in a law firm’s being disqualified from a case.

Still, with all of the pressure Lehman was under, Berkenfeld made the effort.

Because it was Sunday, there was only one place that the firm had cash available to wire——JP Morgan—and Berkenfeld had accordingly called over and made the request.

But now Dannhauser had called to say that the transfer hadn’t gone through: JP Morgan had frozen Lehman’s account, a decision that, Dannhauser was told, “came from the top.”

Berkenfeld immediately dialed JP Morgan’s general counsel, Stephen Cutler, and furiously demanded what it meant that the decision had “come from the top.”

“Look, I don’t know what that means,” Berkenfeld said, his voice rising. “I don’t know if that’s Jamie Dimon or someone outside of the firm. But one day, we’ll take your deposition and find out what happened.”

Cutler agreed he would try to make the payment.

When Bob Diamond got back to his room at the Carlyle Hotel, tired and deflated, he had a surprise waiting for him. His wife, Jennifer, and daughter, Nellie, a sophomore at Princeton, were there. Nellie, who had been scanning the news wires on her laptop, gasped when she read that the deal her father had been trying to broker had fallen apart and headed for New York.

They decided to go for dinner at the Smith & Wollensky steak house. Just as they were approaching the restaurant Diamond’s cell phone rang. He looked down at the caller ID and saw that it was McDade.

“I can’t answer it,” he told his daughter, who was puzzled by his uncharacteristic timidity. “I can’t do it anymore.”

“Dad, answer your phone!” she insisted.

Reluctantly, he took the call.

“I’ve got a question,” McDade said immediately when he picked up. “If we go into bankruptcy, would you consider taking the U.S. broker-dealer out of bankruptcy?”

Diamond whispered to Jennifer and Nellie, “I have to take this for a second.”

As the women entered the restaurant, he asked, “Is that what’s going to happen? Is this going to be Chapter 11?”

“We don’t know for sure,” McDade replied, “but if it goes into Chapter 11, if that’s the result, would you consider taking the U.S. broker-dealer?”

“Bart,” Diamond told him, “that’s exactly the part we want. So absolutely. We would consider it. But I have to tell you, I know nothing about bankruptcy law and I don’t know where to start. I have to talk to my board, I have to talk to John, but I’m pretty sure our answer would be yes.”

“Why don’t we do this,” Diamond continued. “I’ll get up early and get my team together, and we’ll meet you at five a.m. But leave me an e-mail if you haven’t declared bankruptcy. You get your team, and we’ll get our team.”

Bob Willumstad, with his advisers from JP Morgan, returned to the Fed on Sunday night to offer the latest update.

After Paulson, Geithner, and Jester took their seats around a conference table, Willumstad told the group somberly, “We’re in the same place, actually maybe a worse place than before.” He explained that the hole had since grown to $60 billion and detailed what they considered to be the “shenanigans” of Chris Flowers’s bid, to everyone’s amusement.

Jester, taking notes, started to grill Willumstad and Doug Braunstein about the numbers. Jester didn’t understand why they kept talking in ranges; he wanted to know how much money AIG needed to the last decimal point.

Braunstein sighed. “I can’t give you an exact figure. It’s difficult to get clear numbers,” he said, describing the antiquated systems at AIG.

It was clear to everyone in the room that AIG was now, as Willumstad expressed it, “in a bind”——though no one had as yet spoken of bankruptcy.

Willumstad suggested, again, that the Federal Reserve loan AIG just enough money to avoid being downgraded by the ratings agencies.

Geithner, again, said that that was out of the question. Given that Lehman was being left to die, Willumstad knew that Geithner’s refusal was serious. Still, he persisted.

“I’m proposing a transaction, not a bailout,” Willumstad said. “If we just get the Fed’s backing in exchange for collateral, I give you my word I’ll sell every asset needed to pay you back.”

Paulson repeated with exasperation that it wasn’t going to happen.

Once the AIG team had left, Geithner told Paulson that they needed to start thinking about what they could do to rescue the company—perhaps via another private consortium?

“I don’t know, I don’t know,” Paulson said wearily. He was still preoccupied with the fates of Lehman Brothers and Merrill Lynch, and now he was supposed to find a solution for AIG?

Jim Wilkinson, Paulson’s chief of staff, trying to keep his boss’s spirits up, marveled, “This would be extremely interesting from an analytical perspective if it wasn’t happening to us.”

Neither Treasury nor the Federal Reserve had oversight over AIG, but if it was going to fall to someone, it would be Geithner, who seemed closest to the situation. But before Paulson washed his hands of the situation, Geithner asked him if he could “borrow” the services of Dan Jester, who had proved to be quite helpful over the weekend working through many of the practical issues around Lehman and Merrill. As a former deputy CFO of Goldman, Jester understood financial services companies better than virtually all of them, Paulson said. And he was one of the few people among them who appreciated the complexities of the problem that lay ahead of them: When he was at Goldman, one of his clients back in the 1990s was none other than AIG.

As the evening wore on, Jamie Dimon, now back at JP Morgan’s headquarters, rang Doug Braunstein for an update on AIG.

“It’s not good,” Braunstein told him, referring to AIG’s growing hole as a “snowball.”

Dimon understood that AIG might have immediate problems because of a “liquidity crisis,” but he continued to believe that there was enormous value in its underlying business. For a moment, he started to daydream. “Maybe we should be taking a look at it. There’s got to be value there. Got to be.”

“What do you mean? For us?” Braunstein asked in disbelief.

“Yeah,” Dimon replied.

“No, no, no,” Braunstein insisted, trying to talk Dimon out of it. “They don’t seem to have a handle on their own numbers.”

“I don’t know,” Dimon mused, still unconvinced that AIG could really be worthless. “It could be a good idea.”

Paulson checked his watch and saw that it was past 7:00 p.m., which meant the Asian markets were opening, and Lehman still hadn’t filed for bankruptcy.

“Has Cox talked to them yet?” he barked at his chief of staff, Jim Wilkinson.

Wilkinson said that he had been trying to get Cox to call Lehman directly, but that he had been resistant.

“He hasn’t done shit,” Wilkinson said dismissively. “I went in there and repeated what you said, and it’s like he’s frozen. Like a fucking deer in the headlights.”

Cox, for whom Paulson had had very little respect to begin with, was proving how over his head he really was. Paulson had assigned him the task of coordinating Lehman’s filing by, well, now. “This guy is useless,” he said, throwing his hands in the air and heading over to Cox’s temporary office himself.

After barging in and slamming the door, Paulson shouted, “What the hell are you doing? Why haven’t you called them?”

Cox, who was clearly reticent about using his position in government to direct a company to file for bankruptcy, sheepishly offered that he wasn’t certain if it was appropriate for him to make such a call.

“You guys are like the gang that can’t shoot straight!” Paulson bellowed. “This is your fucking job. You have to make the phone call.”

The Lehman board had already begun its meeting when the bankruptcy lawyers from Weil Gotshal, towing wheeled suitcases stuffed with documents, finally arrived. Speaking in a subdued voice, McDade gave the directors a detailed account of what had happened at the New York Fed. He was answering their questions when Fuld’s assistant came in and handed a slip of paper to her boss, who began to slump in his chair as he read it.

“Hold on a minute—sorry, Bart,” he blurted. “Chris Cox is calling and he wants to address us.”

The board members looked at one another, their surprise etched in their expressions. No one could recall a time when the chairman of the SEC had asked to address a corporate board. One director questioned whether they should even take the call, but he was overruled. What did they have to lose? The lawyers, however, cautioned that if there were any questions, only the directors themselves should speak.

Fuld leaned in toward the speakerphone and said in a weary voice, “Ah, Chris, this is Dick Fuld. We got your message, and, ah, the board is in session here, everyone is here, all the directors and the firm’s counsel.”

A Lehman bankruptcy, Cox argued deliberately, stiffly, as if he were reading off a script, would help calm the market. It would be in the best interests of the nation, he said. He then introduced Tom Baxter, general counsel of the Federal Reserve of New York, who told the directors that the Fed and the SEC were in agreement that Lehman should file for bankruptcy.

One of Lehman’s outside directors, Thomas Cruikshank, who had led the oil services company Halliburton through the 1980s oil bust before anointing Dick Cheney his successor as CEO, was the first to speak.

“Why is it so important,” he asked, with a slight air of umbrage, “for Lehman to be in bankruptcy?”

Cox repeated that the markets were in turmoil and that the government had taken everything into consideration. Others followed up with variations of that same query, but Cox and Baxter stayed on message. The directors grew increasingly and visibly frustrated by the vagueness of the two men’s answers.

Finally, Cruikshank stated point-blank: “Let me see if I understand this. Are you directing us to put Lehman into bankruptcy?”

For several moments there was silence on the other end. Then Cox said, “Ah, give us a few moments, and we will get right to you.”

After one of the lawyers reached over the table and pushed the mute button on the speakerphone, the Lehman directors erupted with questions. Is the SEC telling us to file? Is the Fed? What the hell is going on here? To the best of anyone’s knowledge, the government had never ordered a private firm to declare bankruptcy, essentially hanging the Going Out of Business sign on the door itself.

Ten minutes later, Cox, clearing his throat, got back on the line. “The decision on whether to file for bankruptcy protection is one that the board needs to make. It is not the government’s decision,” Cox said in the same steady, methodical tones. “But we believe that in your earlier meetings with the Fed, it was made quite clear what the preference of the government is… .”

John Akers, the former chief executive of IBM, interrupted. “So you’re not actually directing us?”

“I’m not saying anything more than what I just said,” Cox replied before ending the conversation.

The directors looked around at one another dumbfounded as Fuld sat impassively, his head buried in his hands.

Tom Russo, Lehman’s chief legal officer, stood and outlined the board’s responsibilities under securities laws. As he spoke, some directors talked quietly among themselves. Bankruptcy seems inevitable. Do we file now? Next week?

The government, they all knew, had plenty of leverage. If they did not do what Cox wanted, who knew what the consequences could be? The Fed, which had agreed to lend money to Lehman’s broker-dealer unit to allow it to fund trades, could just as easily close it and force Lehman into liquidation. There was a motion to vote on filing for bankruptcy.

Henry Kaufman, an eighty-one-year-old former Salomon Brothers economist who headed the Lehman board’s risk-management committee, haltingly stood up to speak. Known as “Dr. Doom” for his downbeat outlooks in the 1970s, Kaufman had been sharply critical of the Fed earlier in the year, accusing the central bank of “providing only tepid oversight of commercial banking.” Now he again took aim at the government for pushing Lehman into bankruptcy.

“This is a day of disgrace! How could the government have allowed this to happen?” Kaufman thundered. “Where were the regulators?” He went on for another five minutes without stopping, and when he finally slumped into his seat the other directors could only look on in sadness.

As midnight approached, the resolution to file was put to a vote and passed. Some of the directors had tears in their eyes. Fuld looked up and said, “Well, I guess this is good-bye.”

One of the bankruptcy lawyers, Lori Fife, laughed. “Oh, no. You’re not going anyplace,” she said. “The board will be playing a pivotal role going forward.”

Miller elaborated on her point: “You’re going to have to decide what to do with these assets. So it’s not good-bye. We’re going to be seeing each other for a while.”

Fuld looked at the lawyers for a moment, dazed. “Oh, really?” he said softly, and then slowly walked out of the room, alone.

Warren Buffett, just back in Omaha from Edmonton, had received word of Lehman’s pending bankruptcy before he arrived at the Happy Hollow Country Club for a late dinner with Sergey Brin, the co-founder of Google, and his wife, Anne.

“You may have saved me a lot of money,” he said to the Brins with a laugh in the grand dining room. “If it wasn’t for getting here on time, I might have bought something.”

Mayor Michael Bloomberg, who had been on the phone with Paulson, called Kevin Sheekey, his deputy mayor for government affairs, from his brownstone. “I think we have to cancel our trip to California,” he told Sheekey, who was already packing his bags for a high-profile event with Governor Arnold Schwarzenegger that he had been planning for months.

“The world is about to end tomorrow,” Bloomberg explained, without a hint of sarcasm.

“Are you sure you want to be in New York for that?” Sheekey deadpanned.

Peter G. Peterson, co-founder of the private-equity firm the Blackstone Group and the CEO of Lehman in the 1970s before being ousted by Glucksman, was watching television with his wife, Joan Ganz Cooney, when she passed him the phone. It was a New York Times reporter asking him to comment on the day’s events.

After pausing for a moment to take it all in, he said: “My goodness. I’ve been in the business thirty-five years, and these are the most extraordinary events I’ve ever seen.”

Christian Lawless, a senior vice president in Lehman’s European mortgage operation in London, still at the office, e-mailed his clients Sunday night with a final sign-off:

Words cannot express the sadness in the franchise that has been destroyed over the last few weeks, but I wanted to assure you that we will reappear in one form or another, stronger than ever.

At Wachtell Lipton, Ken Lewis, of Bank of America, had a wry smile on his face. “Wow!” he exclaimed.

The deal with Merrill had been concluded—both boards had approved it—and he was waiting to share a champagne toast.

But reaching the deal was not what he now found so amusing. Out of the blue, Stan O’Neal, Merrill’s former CEO, had sent an e-mail message to Herlihy that he read aloud: “I deeply regret my inability to convince the Merrill board a year ago,” O’Neal wrote, referring to their secret talks last September. Then he followed up: “While I would expect the answer is no, I would offer my advice and counsel to Ken Lewis Re: Merrill.”

That e-mail was perhaps the only moment of levity in an atmosphere that had grown increasingly sour. Lewis had grown frustrated waiting around for the lawyers to finish with the deal documents so that he could sign them.

Lewis himself hadn’t gotten involved in the specific details, but the merger agreement contained a handful of “side letters” and separate agreements covering compensation that seemed to be taking some extra time for the lawyers to hammer out. Fleming had convinced Curl to agree to pay as much as $5.8 billion in “incentive compensation,” which was considered an unusual arrangement, given that that was the amount Merrill had paid out a year earlier, before the market downturn. But both Curl and Fleming felt the sum was necessary to make certain they could retain the firm’s employees.

It was growing late, and the Federal Reserve was still trying to get a reading of where the Bank of America-Merrill deal stood. The Federal Reserve Bank of Richmond, which had been overruled by Bernanke and Geithner earlier in the week about Bank of America’s capital ratios, was particularly concerned.

At 9:49 p.m., Lisa A. White, assistant vice president at the Federal Reserve Bank of Richmond, concluded a conversation with Amy Brinkley, Bank of America’s chief risk officer. White immediately sent out an e-mail to her colleagues titled “BAC Update”:

Just got off the phone with Amy Brinkley. She says that a deal with Merrill is solidified except for a few legal details that need to be worked out. Both boards have approved the deal, and once the legal issues are finalized, they will make an announcement … .

Amy indicated that BAC management feels a much higher level of comfort with Merrill than it did with Lehman, specifically with the value of the franchise and the marks on the assets. While Amy acknowledged that it may look to the outside world as if BAC is paying a bit of a premium for Merrill, BAC’s estimates of Merrill’s asset values indicate they are getting the firm at a 30-50% discount. Chris Flowers, the prominent private equity guru, has done extensive due diligence on Merrill over the past few months for potential equity investors, and I got the impression that BAC is at least partially relying on this work.

Will pass along more details as we get them.

After Chris Flowers left AIG, heading for a walk around Trinity Church at the intersection of Broadway and Wall Street, he decided to check in with Jamie Dimon, hoping to get some insight about the status of his bid for AIG, which he had left with Willumstad in the afternoon.

“What are you hearing?” Flowers asked. “Willumstad hasn’t told us shit.”

“You know, I think you pissed them off,” Dimon told him.

“Okay. I don’t know why, but I guess we did,” he said, and hung up.

As he walked back to 70 Pine Street, he took a moment to marvel at the huge takeover of Merrill on which he had just worked. With all the time he had been spending on AIG, it seemed almost like an afterthought. In the end, he hadn’t gotten a piece of the Merrill deal, but that hardly mattered. During the weekend’s insanity, his firm and Fox-Pitt Kelton, a boutique investment bank, had each been paid to write BofA a “fairness opinion.”

A fairness opinion is usually touted as an independent, unconflicted seal of approval for a deal. But on Wall Street, they are often seen as little more than paid rubber stamps. In this case the situation was even more complicated, not only because Flowers himself had considered taking part in the Merrill deal, but because Flowers’s firm also owned Fox-Pitt Kelton.

For their troubles, Flowers and Fox-Pitt would earn a combined $20 million in fees, $15 million of which was contingent on the conclusion of the deal. Not bad for less than a week’s work.

Ruth Porat of Morgan Stanley had gone over to the apartment of a friend, a Lehman executive, to console her. Just as they were pouring a glass of wine to commiserate, she took a call from Dan Jester, her pal from Treasury, with whom she had just worked for over a month on Fannie and Freddie.

“I need your help,” he told her. “You’re not going to believe this, but we think AIG may go into bankruptcy this week. I’m wondering if we can reconvene the team to focus on AIG.” In this case, the assignment would be to work on behalf of the Federal Reserve. He told her that he’d like Morgan Stanley to pull a team together and be down at the Fed in the morning.

“Hold on, hold on,” Porat said in disbelief. “You’re calling me on a Sunday night saying that we just spent the entire weekend on Lehman and now we have this? How the fuck did we spend the past forty-eight hours on the wrong thing?”

The drive home was excruciating; Fuld sat in the backseat feeling paralyzed. Gone was the bluster, the gusto, the fight. He was still angry, but really, he was just sad. For once, it was completely quiet except for the hum of the engine and the tires rolling down the highway. He had stopped looking at his BlackBerry.

By the time his Mercedes rolled into his driveway, it was 2:00 a.m. His wife, Kathy, was waiting up for him in bed. He slowly walked into his bedroom, still in a state of shock. He hadn’t slept in days; his tie was undone and his shirt wrinkled. He sat down on the bed.

“It’s over,” he said mournfully. “It’s really over.”

Looking on solemnly, she said nothing as she watched his eyes well up. “The Fed turned against us.”

“You did everything you could,” she assured him, rubbing his hand.

“It’s over,” he repeated. “It’s really over.”