Steven Fenster’s nightmares came alive in the fall of 1983. In the capricious world of trading, the market suddenly turned bearish. Lehman’s profits began to shrivel, and analysts agreed: the trading engine, which had been driving Lehman’s profits, was stalling all over Wall Street. The dreary business outlook produced new converts to the belief that Lehman’s capital was inadequate. Among them was Roger Altman, who all that summer had been whispering to Glucksman that he was an ally in opposition to the sale of the firm. “I only came to the conclusion we were seriously undercapitalized during the budget process of October,” says Altman. “Because we had had five consecutive years of record growth and had been retaining 80 percent of earnings, our capital went up each year. We had been generating enough capital to finance the growth we were experiencing. I was of the view we could continue—until October 1983. Many people came to this conclusion earlier,” Steven Fenster and Peter Solomon among them. “What changed in 1983,” Altman continued, “was the business outlook. The business turned down all over Wall Street in the last quarter of 1983. I realized that whatever we would earn in fiscal 1984 was modest. Therefore, our retained earnings would be modest. Therefore, we wouldn’t increase our capital very much. At the same time, I was listening to our managers tell us of their plans to grow and the opportunities to grow if they had capital.”

But Roger Altman was not the type to lead a parade. Nor, as a former associate of Peterson’s, was Altman the right leader. Arrayed against the view that Lehman’s capital was inadequate were some internally powerful forces, including Bob Rubin, Dick Fuld, Jim Boshart and, at first, Lew Glucksman. The man who on October I officially became Lehman’s sole CEO, worried that an infusion of substantial outside capital would come about only through one of three means: merging the company into a larger entity, as Kuhn Loeb did when it married Lehman or Shearson when it linked with American Express; recruiting an outside investor to purchase some of Lehman’s stock, as Dillon Read had done when it recruited Bechtel; or taking Lehman public, as Merrill Lynch, Dean Witter and First Boston had done. Each of these options was unattractive to Glucksman, because each threatened Lehman’s traditional independence as well as Glucksman’s own newly acquired power base. Joining Glucksman’s core group in opposition to those who said Lehman’s capital was inadequate were two longtime members of the banking department, William Morris and Henry Breck (who had recently been placed in charge of money management). They believed the “capital issue” was really a subterfuge for partners who were either panicky about getting their own money out, or simply wanted to cash in and sell the firm at a premium.

The intellectual leader of those proclaiming the adequacy of Lehman’s capital was Bob Rubin. In late September, Glucksman and Rubin had arranged a $50 million loan from Prudential, which was added to Lehman’s subordinated debt, and thus became part of its capital base. “I don’t believe that we had a capital shortage,” says Rubin. “I believe partners were concerned about a lack of significant earnings. We augmented our capital by $50 million from Prudential in September. So if they were concerned about capital, they didn’t understand the numbers. We had more capital in September after Peterson was paid off than we ever had in our history.”

Rubin’s close friend Bill Morris made the same point another way: The only reason a firm requires capital, he says, is “to survive a one-hundred-year storm” of losses, to “satisfy the New York Stock Exchange’s capital requirements,” or as insurance. When a firm needs capital it borrows it, just as a homeowner does. So the question, he argued, was not whether Lehman’s capital was adequate but: “What was it the partners desired to get done? I don’t think getting more capital into the business was uppermost in their minds. Getting their capital out of the business to reduce their risk was.”

This group began to advance the argument that if partners were truly concerned about capital, there was a fourth alternative in addition to standing pat, selling the firm, or bringing in outside capital, and that choice was to shrink. Lehman didn’t have to be a supermarket, they said. Nor did it need an infusion of three times its current capital, as some partners argued. Instead of compromising the private partnership, they believed Lehman should concentrate on banking services and on those products—perhaps commercial paper, perhaps money management, perhaps M. & A.—where it was strong.

In the capital debate that raged in the fall of 1983, Lew Glucksman was indecisive. In his heart, he was with Rubin and Fuld and Boshart, who sensed that now that the traders enjoyed their place in the sun the bankers were greedily maneuvering to dilute their power. But Glucksman’s head told him something else. That is why he was the prime force behind the $50 million loan from Prudential. Nor did Glucksman believe Lehman could shrink without paying a terrible price, including revenues that might plunge faster than costs. Caught between his heart and his head, Glucksman was uncharacteristically ambivalent.

Into this vacuum stepped Shel Gordon, gingerly. “Shel Gordon could tiptoe through a beach and not leave a footprint,” says former Lehman associate Steven Rattner, who admires him. Gordon, the new head of the banking division, believed that Lehman had made the correct decision in the mid- to late seventies to become a full-service firm. He supported Peterson’s efforts over the last several years to nudge Lehman into more venture capital, leveraged buyouts, real estate deals and other activities where the risks—and the rewards—were vast. Because of the volatility of trading, Gordon also believed that partners would rest easier with a more ample capital cushion. As a manager, he saw new opportunities beckoning in Europe and Japan that required investment. “I always felt the size of our capital base was probably half of what it would have to be over a two to three year time period,” explains Gordon. “We faced the prospect of having a half dozen of our good clients—Chase Manhattan Bank, Philip Morris, D.E.C., Westinghouse, Caterpillar Tractor—wanting to come to market at the same time.”

Shel Gordon gently coaxed his partners. Those, like Solomon and Schwarzman, who felt estranged from Glucksman, were seduced by the open door they always found to Gordon’s office. Since Gordon was trusted by Glucksman, he was the perfect umbrella under which various factions could gather. Mergers and acquisitions specialist Eric Gleacher recalls how Gordon would instruct him in how “to maneuver Lew.” Gordon “does not recall” those words to Gleacher, but he does acknowledge the delicate diplomatic role he performed: “I was more concerned with getting people to focus on that issue than on the outcome of that issue. Not having the issue focused on risked destroying the firm in the long run.”

The ferment at Lehman was growing, as was the level of anxiety. From the day he arrived at Lehman that fall, Pete Dawkins put his back into the grind, as if he were back in boot camp. He was intent on mastering a new field, public finance. He didn’t partake in the capital debate or in the firm’s internal politics. Yet the erect former West Pointer remembers that from October I, the day he arrived, there was the sense that he had been parachuted into a minefield. “Sitting around the partners’ dining table,” he says, “you picked up part of this. But a lot of it was taking place in private meetings.”