Could Revamp Bill Have Averted Lehman Fallout?

WASHINGTON — Lawmakers attempted to put the pending regulatory reform bill to the test on Tuesday, debating whether it would have prevented the fall of Lehman Brothers if it had been enacted two years ago.

The Obama administration, House Democrats and regulators claimed that reform would have given the agencies expansive powers allowing them to detect problems earlier and seize and unwind the investment bank in an orderly fashion if needed.

But at a hearing on Lehman's collapse, Republicans attempted to turn that argument on its head, contending that regulators already had plenty of power that they failed to use in the lead-up to the investment bank's failure and that the bill would not have helped.

"The laws were on the books today, but they didn't do their jobs," said Rep. Spencer Bachus, the lead Republican on the House Financial Services Committee. "They were either incompetent or they concealed the facts."

Bachus said regulators failed to catch Lehman's accounting manipulation or to share information with one another about concerns over its liquidity, and gave a misleading picture of the investment bank's financial health.

Regulatory proposals offered by the Obama administration would only "double down" on the same failed policies already in place, Bachus said.

But regulators argued they had few good options when it came to reining in Lehman or preventing its collapse from harming the economy.

Federal Reserve Board Chairman Ben Bernanke said the central bank had urged Lehman to improve its liquidity position in the months leading up to its September collapse. It also provided the investment bank access to its emergency credit facility. But he said the Fed had little leverage over the firm.

"Our stick wasn't very good," Bernanke said. "In the case of Lehman, we only had the nuclear option of essentially letting it fail."

Had the reform bill been enacted, the Fed would have been able to force Lehman to take remedial action and prevented it from harming the economy if it still did collapse.

"We would have had more ability to force Lehman to take precautionary actions and plan the dismembership over a longer period of time with the guidance of living will and other tools," said Bernanke, referring to a provision that would require large firms to provide regulators with a plan to unwind them in a crisis. The reform bill would have "greatly reduced the impact" of Lehman's failure "on many of the parts of the economy."

He was backed by Treasury Secretary Tim Geithner, who argued that under the bill, large, complex firms would receive consolidated oversight by the Federal Reserve Board and would face higher capital and liquidity requirements.

"If these reforms become law, we will be far better situated to avoid the abuses that led to the crisis," Geithner said. "These regulatory loopholes will be closed, and opting out will not be an option."

He also said that the bill would create a resolution regime to safely dismantle, sell or liquidate major financial firms in an orderly fashion — a tool regulators lacked with Lehman.

"You want the system to be designed to in a sense draw a circle around the failing institution to make sure that the fire can't jump the fire break and infect the rest of the system," Geithner said. "That's the challenge."

Though Henry Paulson, Geithner's predecessor, did not appear at Tuesday's hearing, he wrote in prepared remarks that regulatory reform would have helped the government deal properly with Lehman.

"The government must have the authority to wind-down, and eventually liquidate, nonbank financial institutions in a manner that prevents harm to the system as a whole," Paulson wrote. "We sorely felt the need for this authority at the time of Lehman's failure, and, had we had it, I think the situation would have ended quite differently."

Rep. Paul Kanjorski, D-Pa., urged the Senate to quickly pass reform legislation, so that Congress could finalize a final bill. (The House passed its version in December.)

"The proverbial fat lady has begun to sing; we must now complete our work," Kanjorski said.

Much of the blame for Lehman's collapse fell on the Securities and Exchange Commission, which was the investment bank's primary federal regulator. According to Anton Valukas, a partner at Jenner & Block LLP who was assigned to examine the failure, the SEC had made a few recommendations from time to time but it did not try to direct the bank.

His 2,209-page report included interviews with more than 250 people and reviewed 35 million pages of documents.

"So the agencies were concerned," he said. "They gathered information. They monitored. But no agency regulated."

In response, SEC Chairman Mary Schapiro said the agency was never adequately staffed, with a maximum of 24 people tasked with examining the five largest investment firms.

"It was undermanaged and it lacked clarity in its mission," Schapiro said. "Were we prudential regulators? Or were we disclosure and enforcement regulators? Those two things came into conflict on multiple occasions."

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