    [House Hearing, 110 Congress]
    [From the U.S. Government Publishing Office]

            THE CAUSES AND EFFECTS OF THE LEHMAN BROTHERS BANKRUPTCY

    =======================================================================

                                    HEARING

                                   before the

                             COMMITTEE ON OVERSIGHT
                             AND GOVERNMENT REFORM

                            HOUSE OF REPRESENTATIVES

                           ONE HUNDRED TENTH CONGRESS

                                 SECOND SESSION

                                   __________

                                OCTOBER 6, 2008

                                   __________

                               Serial No. 110-207

                                   __________

    Printed for the use of the Committee on Oversight and Government Reform

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                  COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

                     HENRY A. WAXMAN, California, Chairman
    EDOLPHUS TOWNS, New York             TOM DAVIS, Virginia
    PAUL E. KANJORSKI, Pennsylvania      DAN BURTON, Indiana
    CAROLYN B. MALONEY, New York         CHRISTOPHER SHAYS, Connecticut
    ELIJAH E. CUMMINGS, Maryland         JOHN M. McHUGH, New York
    DENNIS J. KUCINICH, Ohio             JOHN L. MICA, Florida
    DANNY K. DAVIS, Illinois             MARK E. SOUDER, Indiana
    JOHN F. TIERNEY, Massachusetts       TODD RUSSELL PLATTS, Pennsylvania
    WM. LACY CLAY, Missouri              CHRIS CANNON, Utah
    DIANE E. WATSON, California          JOHN J. DUNCAN, Jr., Tennessee
    STEPHEN F. LYNCH, Massachusetts      MICHAEL R. TURNER, Ohio
    BRIAN HIGGINS, New York              DARRELL E. ISSA, California
    JOHN A. YARMUTH, Kentucky            KENNY MARCHANT, Texas
    BRUCE L. BRALEY, Iowa                LYNN A. WESTMORELAND, Georgia
    ELEANOR HOLMES NORTON, District of   PATRICK T. McHENRY, North Carolina
        Columbia                         VIRGINIA FOXX, North Carolina
    BETTY McCOLLUM, Minnesota            BRIAN P. BILBRAY, California
    JIM COOPER, Tennessee                BILL SALI, Idaho
    CHRIS VAN HOLLEN, Maryland           JIM JORDAN, Ohio
    PAUL W. HODES, New Hampshire
    CHRISTOPHER S. MURPHY, Connecticut
    JOHN P. SARBANES, Maryland
    PETER WELCH, Vermont
    JACKIE SPEIER, California

                         Phil Schiliro, Chief of Staff
                          Phil Barnett, Staff Director
                           Earley Green, Chief Clerk
                      David Marin, Minority Staff Director

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on October 6, 2008..................................     1
    Statement of:
        Fuld, Richard S., Jr., chairman and chief executive officer,
          Lehman Brothers Holdings...................................   205
        Zingales, Luigi, professor of finance, University of Chicago;
          Robert F. Wescott, president, Keybridge Research LLC; Nell
          Minow, chairman of the board and editor, the Corporate
          Library; Gregory W. Smith, general counsel, Colorado Public
          Employees' Retirement Association; and Peter J. Wallison,
          Arthur F. Burns fellow in Financial Policy Studies,
          American Enterprise Institute..............................    31
            Minow, Nell..............................................    70
            Smith, Gregory W.........................................    77
            Wallison, Peter J........................................   164
            Wescott, Robert F........................................    60
            Zingales, Luigi..........................................    31
    Letters, statements, etc., submitted for the record by:
        Davis, Hon. Tom, a Representative in Congress from the State
          of Virginia, staff analysis................................    11
        Fuld, Richard S., Jr., chairman and chief executive officer,
          Lehman Brothers Holdings, prepared statement of............   208
        Mica, Hon. John L., a Representative in Congress from the
          State of Florida, H.R. 4071................................   177
        Minow, Nell, chairman of the board and editor, the Corporate
          Library, prepared statement of.............................    72
        Smith, Gregory W., general counsel, Colorado Public
          Employees' Retirement Association, prepared statement of...    79
        Wallison, Peter J., Arthur F. Burns fellow in Financial
          Policy Studies, American Enterprise Institute, prepared
          statement of...............................................   166
        Waxman, Hon. Henry A., a Representative in Congress from the
          State of California, prepared statement of.................     5
        Wescott, Robert F., president, Keybridge Research LLC,
          prepared statement of......................................    62
        Zingales, Luigi, professor of finance, University of Chicago,
          prepared statement of......................................    34

            THE CAUSES AND EFFECTS OF THE LEHMAN BROTHERS BANKRUPTCY

                                  ----------

                            MONDAY, OCTOBER 6, 2008

                              House of Representatives,
                  Committee on Oversight and Government Reform,
                                                        Washington, DC.
        The committee met, pursuant to notice, at 10:09 a.m., in
    room 2154, Rayburn House Office Building, Hon. Henry A. Waxman
    (chairman of the committee) presiding.
        Present: Representatives Waxman, Maloney, Cummings,
    Kucinich, Tierney, Watson, Higgins, Yarmuth, Braley, Norton,
    McCollum, Cooper, Van Hollen, Sarbanes, Welch, Davis of
    Virginia, Shays, Mica and Turner.
        Staff present: Kristin Amerling, general counsel; Caren
    Auchman, press assistant; Phil Barnett, staff director and
    chief counsel; Jen Berenholz, deputy clerk; Alison Cassady,
    professional staff member; Brian Cohen, senior investigator and
    policy advisor; Zhongrui ``JR'' Deng, chief information
    officer; Greg Dotson, chief environmental counsel; Miriam
    Edelman, Jennifer Owens, and Mitch Smiley, special assistants;
    Earley Green, chief clerk; David Leviss, senior investigative
    counsel; Karen Lightfoot, communications director and senior
    policy advisor; Leneal Scott, information systems manager;
    Roger Sherman, deputy chief counsel; Lawrence Halloran,
    minority staff director; Jennifer Safavian, minority chief
    counsel for oversight and investigations; A. Brooke Bennett,
    minority counsel; Brien Beattie, Molly Boyl, Alex Cooper, Adam
    Fromm, Todd Greenwood, and Mark Marin, minority professional
    staff members; Larry Brady, John Cuaderes, and Nick Palarino,
    minority senior investigators and policy advisors; Patrick
    Lyden, minority parliamentarian and Member services
    coordinator; and Brian McNicoll, minority communications
    director.
        Chairman Waxman. The meeting of the committee will please
    come to order.
        On Friday, Congress passed a $700 billion rescue package
    for Wall Street. This was something no Member wanted to do. If
    Wall Street had been less reckless, or thorough regulators had
    been more tentative, the financial crisis could have been
    prevented. But we voted for the $700 billion rescue because the
    consequences of doing nothing were even worse.
        The excesses on Wall Street have caused a credit freeze
    that threatened our entire economy. The $700 billion rescue
    plan is a life-support measure. It may keep our economy from
    collapsing, but it won't make it healthy again. To restore our
    economy to health, two steps are necessary. First we must
    identify what went wrong, then we must enact real reforms for
    our financial markets.
        Over the next 3 weeks, we will start this process in this
    committee. We will be holding a series of five hearings on the
    financial meltdown on Wall Street. We'll examine how the system
    broke down, what could have been done to prevent it, and what
    lessons we need to learn so this won't happen again.
        Today's hearing examines the collapse of Lehman Brothers,
    which, on September 15th, filed for bankruptcy, the largest
    bankruptcy filing in American history. Before the Lehman
    Brothers bankruptcy, Treasury Secretary Paulson and Federal
    Reserve Chairman Bernanke told us our financial system could
    handle the collapse of Lehman. It now appears they were wrong.
    The repercussions of this collapse have reverberated across our
    economy. Many experts think Lehman's fall triggered the credit
    freeze that is choking our economy, and that made the $700
    billion rescue necessary.
        Lehman's collapse caused a big money market fund to break
    the buck, which caused investors to flee to Treasury bills and
    dried up a key source of short-term commercial paper. It also
    spread fear throughout the credit markets, driving up the costs
    of borrowing.
        Over the weekend we received the testimony, the written
    testimony, of Richard Fuld, the CEO of Lehman Brothers. Mr.
    Fuld takes no responsibility for the collapse of Lehman.
    Instead he cites a, ``litany of destabilizing factors,'' and
    says, ``in the end, despite all our effort, we were
    overwhelmed.''
        In preparation for today's hearing, the committee received
    thousands of pages of internal documents from Lehman Brothers.
    Like Mr. Fuld's testimony, these documents portray a company in
    which there was no accountability for failure. In one e-mail
    exchange from early June, some executives from Lehman's money
    management subsidiary Neuberger Berman made this
    recommendation: Top management should forego bonuses this year.
    This would serve a dual purpose. First, it would represent a
    significant expense reduction; second, it would send a strong
    message to both employees and investors that management is not
    shirking accountability for recent performance.
        The e-mail was sent to Lehman's executive committee. One of
    its members is George H. Walker, President Bush's cousin, who
    is responsible for overseeing Neuberger Berman. And here is
    what he wrote the executive committee. ``Sorry, team. I'm not
    sure what is in the water at 605 Third Avenue today. I'm
    embarrassed, and I apologize.''
        Mr. Fuld also mocked the Neuberger suggestion that top
    management should accept responsibility by giving up their
    bonuses. His response was, ``don't worry, they are only people
    who think about their own pockets.''
        Another remarkable document is a request submitted to the
    compensation committee of the board on September 11th, 4 days
    before Lehman filed for bankruptcy. It recommends that the
    board give three departing executives over $20 million in,
    ``special payments.'' In other words, even as Mr. Fuld was
    pleading with Secretary Paulson for a full rescue, Lehman
    continued to squander millions on executive compensation.
        Other documents obtained by the committee undermine Mr.
    Fuld's contention that Lehman was overwhelmed by forces outside
    of its control. One internal analysis reveals that Lehman saw
    warning signs, but did not move early/fast enough, and lacked
    discipline about capital allocation.
        In 2004, the Securities and Exchange Commission relaxed a
    rule limiting the amount of leverage that Lehman and other
    investment banks could use. As this chart--Lehman chart shows--
    and if we could have that posted, I would appreciate it--that
    proved to be a temptation the firm could not resist. So in
    2004, the SEC allowed greater leverage, and Lehman and other
    banks couldn't resist that and took on more leverage.
        At first Lehman's bets paid out. As Mr. Fuld's testimony
    recounts, Lehman achieved 4 consecutive years of record-
    breaking financial results between 2004 and 2007. These were
    lucrative years for Lehman's executives and Mr. Fuld. Lehman
    paid out over $16 billion in bonuses. And we do have the chart
    now on the screen. Lehman paid out over $16 billion in bonuses.
    Mr. Fuld himself received over $40 million in cash bonuses. His
    total compensation during these 4 years exceeded $260 million.
        But while Mr. Fuld and other Lehman executives were getting
    rich, they were steering Lehman Brothers and our economy toward
    a precipice. Leverage is a double-edged sword. When it works as
    it did in 2004 to 2007, it magnifies investment gains. But when
    asset failures decline as the subprime market did, leverage
    rapidly consumes a company's capital and jeopardizes its
    survival.
        Mr. Fuld's actions during this crisis were questionable. In
    a January 2008 presentation, he and the Lehman board were
    warned that the company's liquidity can disappear quite fast.
    Yet despite this warning, Mr. Fuld depleted Lehman's capital
    reserves by over $10 billion through year-end bonuses, and
    stock buybacks and dividend payments. In one document a senior
    executive tells Mr. Fuld that if the company can secure $5
    billion in financing from Korea, ``I like the idea of
    aggressively going into the market and spending 2- of the 5- in
    buying back lots of stock and hurting Einhorn bad. This action
    might have inflicted short-term losses on a short seller Lehman
    despised, but it would have burned through even more capital.''
    Mr. Fuld's response: ``I agree with all of it.''
        What is fundamentally unfair about the collapse of Lehman
    is its impact on the economy and taxpayers. Mr. Fuld will do
    fine. He can walk away from Lehman a wealthy man who earned
    over $500 million, but taxpayers are left with a $700 billion
    bill to rescue Wall Street and an economy in crisis.
        Risk taking has an important role in our economy, but
    Federal regulators are supposed to ensure that these risks
    don't become so large that they can imperil our entire economy.
    They failed miserably. The regulators had a blind faith in the
    market and a belief that what was good for Mr. Fuld and other
    executives on Wall Street was good for America, and we are now
    all paying a terrible price.
        We can't undo the damage of the past 8 years. That is why I
    reluctantly voted for the $700 billion rescue plan. But we can
    start the process of holding those responsible to public
    account and identifying the reforms we need for the future.
    These are the goals of today's hearing and the other hearings
    we will be holding this month.
        [The prepared statement of Hon. Henry A. Waxman follows:]

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        Chairman Waxman. I would now like to recognize Mr. Davis
    for his opening statement.
        Mr. Davis of Virginia. Thank you, Mr. Chairman. We have
    Members on this side who would like to make opening statements.
    What is the position to be today?
        Chairman Waxman. The rules of the committee provide that
    the chairman and the ranking member may make opening
    statements. We have many Members here. We have many witnesses
    that will also be here to--also here to make their
    presentations. So the Chair will stick by the rules. Opening
    statements only by the chairman and the ranking member.
        Mr. Davis of Virginia. Thank you, Mr. Chairman.
        Mr. Shays. I'd just like to ask unanimous consent that
    Members be allowed to make an opening statement. This is a
    hugely important hearing. It is the beginning of five hearings,
    and frankly there is some----
        Chairman Waxman. There is objection to that. The rules
    don't provide for it, and the committee will not give unanimous
    consent for it.
        Mr. Shays. I haven't finished my motion.
        Chairman Waxman. The Chair has recognized Mr. Davis for an
    opening statement.
        Do you wish to make a motion, Mr. Shays?
        Mr. Shays. I wish to make a unanimous consent motion that
    we be allowed to--because I believe there is a cover-up going
    on, and I'd like to make a statement.
        Chairman Waxman. We'll follow the rules. Mr. Davis is
    recognized for his opening statement.
        Mr. Davis of Virginia. Thank you, Mr. Chairman, for
    convening a series of hearings to examine the many complex and
    interlocking causes and effects of the economic paralysis
    gripping our Nation and most of the industrialized world.
    Today, tomorrow and in the coming weeks we'll ask some tough
    questions about the role of investment firms like Lehman
    Brothers Holding, insurers like AIG, hedge funds, credit-rating
    agencies, regulators and Congress in feeding the boom that has
    now gone so painfully bust.
        I particularly appreciate you calling Lehman Brothers up
    today before us. Mr. Fuld, a very active contributor to
    Democratic causes, along with Mr. Janulis, Mr. Demura, Mr.
    Collerton and others, have been bypassed by other committees,
    and I appreciate your having the courage to call him up here
    today.
        The scope of these hearings effectively rebuts the
    simplistic premise peddled by some that laissez-faire
    Republicanism and mindless deregulations alone caused the
    collapse of global capital markets. That's the political
    cartoon version of a very complicated life-and-death reality.
    Partisan fingerpointing adds nothing to serious oversight of
    the intricate web of individuals, institutions, market
    incentives and cyclical trends that have brought us to the
    brink of economic abyss.
        For more than a decade, all the Wall Street and Washington
    players engaged in an increasingly elaborate game of high-takes
    musical chairs driven by the mesmerizing siren song of
    perpetually rising housing costs. But when the music stopped,
    as it always does, many formally upstanding financial giants
    found themselves without a safe or a sound place to sit.
    Suddenly the phrase ``too big to fail'' measured only the
    limits of our foresight, not the size of the all too
    foreseeable failure.
        So today we start with the case of Lehman Brothers, a
    venerable investment house that sank into insolvency while
    others were being thrown Federal lifelines. One lesson from
    Lehman's demise: Words matter. Rumors and speculative leaks fed
    the panic and accelerated a flight of confidence in capital
    from that company.
        Words matter here as well. Look at the TV monitors. As we
    watch them, the markets are watching us. In this volatile
    environment, unsupported allegations, irresponsible disclosures
    can inflame fears and trigger market stampedes. As these
    hearings proceed, we should watch the pulse of Wall Street and
    choose our words with great care.
        But it must be said the driving factor in the loss of value
    and confidence in Lehman was the financial undertow created by
    falling home prices and resulting losses on mortgage-backed
    assets of all kinds. And central to that crisis in the $12
    trillion mortgage securities market were imprudent policies and
    cozy practices of the two government-sponsored housing finance
    giants, Fannie Mae and Freddie Mac. We have asked that former
    Fannie Mae CEO Franklin Raines be invited to testify at a
    future hearing because that company's failure offers Congress
    lessons that we dare not overlook. You can't have a complete
    analysis without looking at Freddie and Fannie.
        Many in Congress did turn a blind eye to clear warnings of
    impending danger sounded as early as 1998. They missed golden
    opportunities to treat localized problems before they
    metastasized throughout the economic system. Out of well-
    intentioned zeal to promote homeownership, Members from both
    parties and both Chambers not only tolerated, but encouraged
    the steady erosion of mortgage-lending standards. When an alarm
    sounded, Fannie and Freddie, holding low-income borrowers as
    political hostages, mobilized armies of expensive lobbyists to
    block calls for greater accountability and transparency. Using
    lobbying fees and campaign contributions, the mortgage giants
    bought their way around attempts by Senate and House Banking
    Committees to pierce their profitable pyramid scheme. The
    Clinton administration was rebuffed by a Republican Congress,
    and this administration had no more success with the Democratic
    Congress in advancing needed reforms.
        This committee cannot ignore that sad history in our
    inquiries into the causes and effects of the current economic
    crisis. But now that the $700 billion economic rescue bill has
    been enacted, the debate is no longer whether the Federal
    Government should intervene in the credit markets, but how that
    intervention should be managed to stabilize capital flows and
    protect taxpayers. Although it comes too late to help Lehman
    Brothers, the so-called bailout program will have to make
    wrenching choices, picking winners and losers from a shattered
    and fragile economic landscape.
        These hearings should help mark the land mines and potholes
    on the path to a restoration of trust and economic vitality.
    Trust. There is a moral dimension to economics we don't often
    want to confront. Economics is not an objective discipline, but
    a political art grounded in certain assumptions about human
    nature and civilized behavior. As the process of deleveraging
    unfolds, breaking the economy's delusional addiction to debt
    beyond our reasonable means to repay, the goal has to be a
    restoration of the moral bond between labor and capital. We
    need to restore faith in production, savings and investment
    over consumption, spending and speculation. Our witnesses today
    can help us do that. We appreciate their being there.
        Thank you, Mr. Chairman.
        Chairman Waxman. Thank you very much, Mr. Davis.
        Mr. Davis of Virginia. I also ask unanimous consent for our
    staff analysis to be included in the hearing record.
        Chairman Waxman. Without objection, that will be the order.
        [The information referred to follows:]
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        Mr. Shays. Mr. Chairman, a parliamentary inquiry.
        Chairman Waxman. The gentleman will state his parliamentary
    inquiry.
        Mr. Shays. Thank you.
        In my request for permission to have the Members give an
    opening statement, I'd like the Chair to please cite the
    provision of committee rules or House rules on which he relies
    for the proposition that only the Chair and ranking member may
    make opening statements.
        Chairman Waxman. The rule provides--in general the House
    and committee rules do not address the common practice of
    opening statements by Members at hearings and meetings. The
    only exception is House Rule 11, clause (2)(k)(1), which
    provides that the chairman at a hearing shall announce in an
    opening statement the subject of an investigation. Because
    there is no limitation on opening statements in the rule, every
    member of the committee has the right to--has a right to seek
    recognition, but that as a matter of House rules, the refusal
    of the Chair to recognize a Member for an opening statement is
    not appealable. As a practical matter, controversy relating to
    handling of opening statements are normally dealt with by
    consensus within the committee. The committee has always
    operated on the basis of the chairman and the ranking member,
    and that is the way we'll continue to do so.
        Mr. Mica. Mr. Chairman, parliamentary inquiry.
        Chairman Waxman. The gentleman will state his parliamentary
    inquiry.
        Mr. Mica. Mr. Chairman, I have been on the committee with
    you for 16 years. I had the opportunity to chair two
    subcommittees.
        Chairman Waxman. The gentleman will state his parliamentary
    inquiry.
        Mr. Mica. I am stating, but I have to have a preface for
    my----
        Chairman Waxman. The gentleman will state his parliamentary
    inquiry.
        Mr. Mica. During the entire tenure of my chairmanship, I
    afforded as a courtesy every Member on either side in every
    hearing the opportunity for an opening statement. Now, it may
    not be in the rules, Mr. Chairman, and you have the ability to
    now reject my request for an opening statement.
        Chairman Waxman. The chairman----
        Mr. Mica. I would ask you in fairness an opportunity for
    all sides to be heard on this important hearing, the
    opportunity--I'm asking you honor the ability of my--of the
    rules just stated to allow me to present a 5-minute opening
    statement.
        Chairman Waxman. Well, the chairman notes the presence of
    many, many Members. To allow you to make an opening statement
    and not others would be unfair. The rules do not provide for
    all Members to have the right to an opening statement. There
    are occasions when Members have been given that opportunity,
    especially when it is a small subcommittee, as you chaired. But
    we have too many Members here and too many witnesses to be
    heard. So the Chair did not hear a parliamentary inquiry, but a
    personal appeal, which the Chair denies.
        We have with us the following witnesses: Nell Minow,
    chairman of the board and editor of the Corporate Library;
    Gregory W. Smith, general counsel, Colorado Public Employees'
    Retirement Association; Robert F. Wescott, Ph.D., president of
    Keybridge Research LLC; Luigi Zingales, Ph.D., professor at the
    University of Chicago Graduate School of Business; and Peter J.
    Wallison, Arthur F. Burns fellow in Financial Policy Studies,
    American Enterprise Institute.
        And it is the policy of this committee that all witnesses
    that testify before us do so under oath, so I'd like to ask
    each of you to please stand and raise your right hands.
        [Witnesses sworn.]
        Chairman Waxman. The record will indicate that each of the
    witnesses answered in the affirmative.
        Your prepared statements will be in the record in full. We
    would like to ask each of you to be mindful that we have a
    clock that will indicate when 5 minutes is up. We'd like you to
    stay as close to the 5 minutes as possible. There will be a
    green light for 4 minutes, a yellow light for the last minute.
    And then when it turns red, the 5 minutes has expired.
        Dr. Zingales, am I pronouncing your name correctly? OK.
    There is a button on the base of your mic. Be sure it is in,
    and we'd like to hear from you first.

    STATEMENTS OF LUIGI ZINGALES, PROFESSOR OF FINANCE, UNIVERSITY
     OF CHICAGO; ROBERT F. WESCOTT, PRESIDENT, KEYBRIDGE RESEARCH
        LLC; NELL MINOW, CHAIRMAN OF THE BOARD AND EDITOR, THE
    CORPORATE LIBRARY; GREGORY W. SMITH, GENERAL COUNSEL, COLORADO
        PUBLIC EMPLOYEES' RETIREMENT ASSOCIATION; AND PETER J.
     WALLISON, ARTHUR F. BURNS FELLOW IN FINANCIAL POLICY STUDIES,
                     AMERICAN ENTERPRISE INSTITUTE

                      STATEMENT OF LUIGI ZINGALES

        Mr. Zingales. OK. Thank you. Chairman Waxman, Ranking
    Minority Member Davis, members of the committee, thank you for
    inviting me.
        The demise of Lehman Brothers is the result of a very
    aggressive leverage policy in the context of a major financial
    crisis. The roots of this crisis have to be found in bad
    regulation, lack of transparency, and market complacency
    brought about by several years of positive returns.
        A prolonged period of real estate price increases and the
    boom of securitization relaxed lending standards. The quality
    of these mortgages should have been checked by the capital
    market that bought them, but several problems made this
    monitoring less than perfect. First, these mortgages were
    priced based on historical records, which did not factor in the
    probability of a significant drop in real estate prices at the
    national level. Nor did they factor the effect of the changes
    in the lending standards on the probability of default.
        Second, the massive amount of issuance by a limited number
    of players, which Lehman was one, changed the fundamental
    nature of the relationship between credit-rating agencies and
    the investment banks issuing the securities. As a result,
    instead of submitting an issue to the rating agency's judgment,
    investment banks shopped around for the best ratings and even
    received handbooks on how to produce the riskiest security that
    qualified for a AAA rating.
        The market was not completely fooled by this process. AAA-
    rated asset-backed securities had a higher yield than corporate
    AAA, a clear indication of the higher risk.
        Unfortunately, regulatory constraints created inflated
    demand for these products. Fannie Mae and Freddie were allowed,
    even induced, to invest their funds in these securities,
    creating an easy arbitrage. They issued AAA-rated debt and
    invested in higher-yield AAA-rated debt.
        Another source of captive demand were money market funds.
    Being required to hold only highly rated securities, money
    market funds loved these instruments and satisfied the
    regulatory requirements and boosted their yields.
        Most managers of these firms were aware of the gamble they
    were taking, but could not resist taking it under an intense
    competition for yield-hungry customers. These managers were
    also hoping that if a shock occurred, all their competitors
    would face the same problem, thereby reducing the reputational
    costs and possibly triggering a government support. The
    September 19th decision to insure all money market funds
    validated this gamble, forever destroying money market
    managers' incentives to be careful in regard to the risks they
    take.
        The pooling of mortgages, while beneficial for
    diversification purposes, became a curse as the downturn
    worsened. The lack of transparency in the issuing process made
    it difficult to determine who owned what. Furthermore, the
    complexity of these repackaged mortgages is such that small
    differences in the assumed rate of default can cause the value
    of some tranches to fluctuate from 50 cents on the dollar to
    zero. Lacking information on the quality and hence the value of
    banks' assets, the market grew reluctant to lend to them for
    fear of losing out in case of default.
        In the case of Lehman and other investment banks, this
    problem was aggravated by two factors, the extremely high level
    of leverage and the strong reliance on short-term debt
    financing. While commercial banks cannot leverage their equity
    more than 15 to 1, Lehman had a leverage of more than 30 to 1.
    With this leverage, a mere 3.3 percent drop in the value of
    assets wipes out the entire value of equity and makes the
    company insolvent.
        In turn, the instability created by a leverage problem was
    exacerbated by Lehman's large use of short-term debt. Reliance
    on short-term debt increases the risk of runs similar to the
    ones bank face when they are rumored to be insolvent. The
    Lehman CEO will likely tell you that his company was solvent,
    and it was brought down by a run. This is a distinct
    possibility. The problem is that nobody knows for sure. When
    Lehman went down, it had $26 billion in book equity, but the
    doubts about the value of its assets combined with the high
    degree of leverage created a huge uncertainty about the true
    value of this equity. It could have been worth $40 billion or
    negative $20.
        It is important to note that Lehman did not find itself in
    that situation by accident. It was the unlucky draw of a
    consciously made gamble.
        Lehman Brothers' bankruptcy forced the market to assess
    risk. As after a major flood, people start to buy flood
    insurance. After the demise of Lehman, the market started to
    worry about several risks previously overlooked. This risk
    reassessment is crucial to support a market discipline. The
    downside is that it can degenerate into a panic.
        Chairman Waxman. Thank you very much, Dr. Zingales.
        [The prepared statement of Mr. Zingales follows:]
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        Chairman Waxman. Dr. Wescott.

                     STATEMENT OF ROBERT F. WESCOTT

        Mr. Wescott. Chairman Waxman and members of the committee,
    thank you for inviting me to testify today about the financial
    meltdown on Wall Street. I'll focus my comments on the main
    causes of the financial crisis. During questions, I'm also
    happy to discuss its economic effects and also the lessons we
    might draw about it for public policy. I'll give you an
    economist's perspective, drawing on my experiences in
    forecasting the U.S. economy, in participating in the national
    economic policymaking process at the National Economic Council
    of the White House, and in researching global and economic
    financial risks.
        In my opinion, there were three main contributors to the
    financial meltdown. The first was an environment of easy credit
    that existed in the first half of this decade. We simply left
    the monetary floodgates open too far and too long in the period
    2002 to 2005. During this period, mortgage rates got as low as
    2\1/2\ percent, and families got an inflated sense of their
    capacity to afford housing. This cheap credit quickly got
    capitalized in housing prices, and housing prices doubled and
    even tripled in some neighborhoods in the span of just a few
    years. This caused a housing frenzy, and many Americans
    developed unrealistic expectations and assumed that housing
    prices could only go up.
        The second key development was mortgage securitization, the
    bundling of pools of mortgages, their underwriting and their
    sale to institutional investors. This increased liquidity and
    made mortgage money cheaper than--because we could tap the
    savings of global savers. On the downside, however, it also
    meant that the mortgage originator was no longer going to hold
    the mortgage to maturity. So it did not have a strong incentive
    to perform due diligence on the loan.
        In this environment of easy credit, there was lots of
    competition. Lenders began loosening standards to win business
    and increase market share. This led to an easing of down
    payment requirements and a proliferation of unconventional
    mortgages, including teaser rate mortgages, no doc mortgages,
    option payment mortgages and so on. Eventually homebuyers were
    receiving 100 percent loan-to-value mortgages, a very dangerous
    predictor of default risk.
        The third key development was an increase in leverage by
    investment banks, as has just been stated. Whereas a
    traditional bank might have a leverage ratio of, say, four,
    meaning that the value of its obligations was four times the
    value of its shareholders' equity, investment banks increased
    their leverage ratios to 30 or 35 times in the past few years.
    Such high leverage ratios meant that there was much less
    cushion in hard times.
        Well, how did these ingredients mix? As long as house
    prices kept appreciating steadily, all players in the system
    had a strong incentive to keep going and keep doing what they
    were doing. It was good for existing homeowners because they
    had asset appreciation, and they had great opportunities for
    extracting equity out of their houses through cash-out
    refinancings and home equity loans. Basically families started
    using their houses as ATM machines. It was good for new
    homebuyers, including speculators, because they saw almost
    immediate price gains. It was good for mortgage brokers. They
    earned hefty origination fees. It was good for rating agencies.
    They had great business. And it was good for investment banks
    because they were earning large securitization fees.
        The system boomed this way for many years. The problem came
    when the U.S. housing sector simply reached saturation. By
    early 2006, almost every American who wanted a home was in one.
    The Fed started raising interest rates to fight inflation, and
    suddenly housing prices leveled off and then began to fall.
    Some borrowers, especially subprime borrowers, began to miss
    their monthly mortgage payments, and the value of subprime
    mortgage portfolios began to decline. Now, because of the high
    leverage in the investment banks, many simply did not have the
    cushion to fall back on.
        The problems were compounded by a rapidly weakening U.S.
    economy. As the housing sector weakened, overall U.S. economic
    growth was cut roughly in half, and the drying up of home
    equity loans and cash-out refinancings hurt consumption. By
    early 2008, 10 percent of all U.S. households were underwater
    with their mortgages, meaning that they owed more on their
    house than their house was worth. These events set the stage
    for the financial and liquidity crisis we have today.
        The cause of Lehman Brothers--basically the collapse of
    Lehman Brothers in September was effectively the pinprick that
    burst the bubble. Mr. Chairman, the collapse of Lehman shook
    the market's financial confidence and set off the liquidity
    crisis that has thrown sand into the gears of the U.S. economic
    engine.
        What lessons should we draw? Any time the price of a major
    asset class or commodity increases 200 percent or 300 percent
    in a matter of just a few weeks--in a matter of just a few
    years, whether it is home prices, timber, Dutch tulips, oil,
    gold, technology, stocks, we need to ask questions. Prudent
    regulators need--needed to ask whether the system they regulate
    could tolerate a rapid return of asset prices to the historical
    trading range, and private executives running investment banks
    who wanted to maximize their shareholders' value in the long
    term needed to ask whether their business model could tolerate
    a rapid return of asset prices to their historical range.
        Thank you.
        Chairman Waxman. Thank you very much, Dr. Wescott.
        [The prepared statement of Mr. Wescott follows:]
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        Chairman Waxman. Ms. Minow.

                        STATEMENT OF NELL MINOW

        Ms. Minow. Thank you very much, Mr. Chairman and Members.
    It is an honor to participate in this hearing. I appreciate it
    very much. And I would give anything if what I wasn't here to
    say was, ``I told you so.''
        I have testified before this committee before, and what I
    said then was that there is no more reliable indicator of
    investment--litigation and liability risk than excessive CEO
    compensation. CEO compensation is not just the symptom, it is
    actually a cause. It pours gasoline on the fire.
        With that in mind, I'd like to tell you what our ratings
    have been. My company, the Corporate Library, rates boards of
    directors, and in part we look at decisions they make, like CEO
    pay. We have given this company a C or a D since we started
    rating them, with one very brief exception of a couple of
    months where we gave them a B.
        Here is a quote from our analyst's note on the company:
    Although the CEO's 2007 salary is well below the median for
    companies of similar size, his nonequity incentive compensation
    of $4,250,000 exceeded the 85th percentile. While typical
    target bonus is two times base salary, Mr. Fuld's was more than
    five times his base salary. Additionally, his total annual
    compensation of $71,924,178 ranks in the top 3 percent for
    similarly sized companies.
        As I've mentioned before, this is the problem. When we pay
    people based on the volume of business rather than the quality
    of business, eventually it is like a game of musical chairs.
    And when the music stops, the people that don't have a place to
    sit are the investors.
        Pay that is out of alignment is one of the causes of poor
    performance, but it is also an important symptom of an
    ineffective board. Let's talk about this board for just a
    minute. They had a finance and risk management committee. I
    think that my economist colleagues here would agree, and my
    investor colleague, that the--in a company like this, the
    finance and risk management committee is a very important
    committee, and yet it only met twice in 2007 and twice in 2006.
    The crystal-clear explanations of Dr. Zingales and Dr. Wescott
    were--as brilliant as they are, were not unknown at the time.
    These were things that the risk committee should have been
    looking at.
        An additional indicator is the meaningful stock ownership
    by the board. It is a public statement of their confidence in a
    company and a powerful reminder and motivator for them as they
    deliberate issues like executive compensation and risk
    management. With the exception of the CEO who sold the
    significant percentage of his stock, and the lead director, and
    the 23-year veteran on the committee, given their tenure, these
    directors did not put their money where their mouths were.
        I'm really horrified by the effort by Mr. Fuld and other
    executives in these failing companies to absolve themselves of
    blame. It infuriates me when they talk about how efficient the
    markets are except when they are not efficient. All of a
    sudden, it is not their fault anymore. These are people who
    fight for deregulation, and now they're blaming the regulators.
        They talk about a litany of destabilizing factors. Let me
    tell you that the most important destabilizing factor was: an
    inefficient and ineffective board of directors and bad judgment
    by the executives. People make mistakes, but what we like to
    see is people accepting responsibility and participating in
    mitigating damages and preventing the recurrence. It is
    indispensable for the credibility of our capital markets to
    align the interests of executives with the investors, and we'll
    have an enormously increased cost of capital if we do not make
    that clear throughout the world.
        What we had was an executive compensation system that
    created an incentive for imagining derivative securities that
    exploited regulatory and accounting loopholes. I had a
    presentation at the Public Company Accounting Oversight Board
    where they told us that Paul Volker said he didn't understand
    these derivatives. I hereby propose the Paul Volker rule, that
    if he doesn't understand it, we shouldn't put it out on the
    markets. Even if executives are overwhelmed by forces beyond
    their control, I believe you've heard this expression before,
    that is why we pay them the big bucks.
        Thank you.
        Chairman Waxman. Thank you. No demonstrations. Thank you,
    Ms. Minow.
        [The prepared statement of Ms. Minow follows:]
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        Chairman Waxman. Mr. Smith.

                     STATEMENT OF GREGORY W. SMITH

        Mr. Smith. Thank you, Mr. Chairman. Thank you, Members, for
    having me here today to express the perceptions and perspective
    of a major institutional investor. One of the things that I
    want to address--you certainly heard some good diagnosis and
    comments from people much more qualified than I to assess why
    this has happened. I'd like to put a little bit of a face to
    this.
        We hear a lot in the media about the savior of Wall Street,
    and we hear a lot about major institutions and--throughout the
    country, Wall Street being saved. We think this is about every
    working American in the United States. It is about people that
    I work for every day. I work for a pension fund that represents
    420,000 current and former public employees, public servants in
    the State of Colorado. We represent every State trooper, every
    teacher in the State of Colorado, every State employee, every
    judge and over 400 employers, including all of our local
    divisions of government. These--the individuals are the ones
    that are being impacted in this crisis. It is the individuals
    who are having to face the questions of whether their college
    fund for their children is going to still be around when this
    is over. It is these individuals who are wondering how long is
    it until retirement now, how long do I have to go before I can
    recover from what Wall Street has done to me this time.
        And what it really has boiled down to is a complete
    collapse in investor confidence. And it is a complete collapse
    in investor confidence because they no longer believe in
    management, they no longer believe in the numbers, and they no
    longer believe in the regulatory framework for good reason.
        We don't claim to know, I certainly don't claim to be able
    to articulate, why this happened, and I certainly would not
    predict what the result of the blame game is going to be. There
    is certainly going to be one, and the lawyers are going to
    spend a lot of time on it. What we would like to urge you to
    consider is what the future needs to hold to regain confidence,
    and what it needs to consist of is an opportunity for
    shareholders to be heard in a meaningful way at a meaningful
    time in the process of running corporate America. We need
    access to the proxy. We need to be able to hold the directors
    accountable. If they're not doing a good job, we need to be
    able to get them out of the boardroom and get somebody else in
    that will represent shareholders.
        We need a regulatory framework that is aligned with the
    shareholder, not with corporate America, but with the
    shareholders, and a regulatory framework that is prepared to
    hold people accountable that breach their duty to the
    shareholder.
        That's where we need to go. We need to have say on pay, and
    we need to be able to regain confidence that this market is
    about the shareholder, it is about mom and pop, it is about
    small businesses, and it is about the individuals that I
    represent all over this country.
        One of the things that doesn't get talked about very much
    and that is really impacting the people that I work with is the
    credit crisis and the freezing of their accounts. People who
    have been the most conservative investors and who have thought,
    well, I don't want to get involved in these speculative things,
    I'm going to put my money in a money market, I'm going to fall
    behind inflation, I don't really worry about inflation, I want
    to make sure I have my money, those people don't have their
    money now.
        We manage our cash through those types of accounts. There
    were times last week and 2 weeks ago that our money was on the
    brink of being frozen. People in this country are not going to
    be able to make payroll. Small businesses are not going to make
    payroll because they are not going to be able to access their
    cash.
        These are the problems that we believe are yet to come.
    Some of them you've begun to see. But there is many more to
    come, and it is the working people of America that are
    suffering this crisis. It is not about Wall Street, it is about
    investor confidence, And that is what needs to be restored.
        Thank you.
        Chairman Waxman. Thank you very much, Mr. Smith.
        [The prepared statement of Mr. Smith follows:]
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        Chairman Waxman. Mr. Wallison.

                     STATEMENT OF PETER J. WALLISON

        Mr. Wallison. Thank you, Mr. Chairman and members of this
    committee. I'm really pleased to have this opportunity to
    address the question of regulation and its role in the current
    financial crisis.
        There are cases where regulation is necessary and cases
    where it is harmful. It was necessary in the case of Fannie Mae
    and Freddie Mac. These two companies were seen in the market as
    backed by the Federal Government. As a result, investors did
    not worry about the risks of lending to them since Uncle Sam
    would bail them out if the companies got into financial
    trouble. Investors have been proved right. In cases where
    investors see themselves as bearing no risks lending to a
    private, shareholder-owned company, strong regulation is
    essential. That is the only way that government can protect
    itself against loss. Yet Congress resisted----
        Chairman Waxman. Mr. Wallison, could you pull the mic a
    little closer? Some Members are having----
        Mr. Wallison. Oh, I'm sorry.
        Yet Congress resisted reforming regulation of Fannie Mae
    and Freddie Freddie until it was too late. And even then the
    reform legislation wouldn't have been passed unless it had been
    attached to a housing bill that Congress wanted to adopt before
    going home for the August recess.
        The failure by Congress had serious consequences. An
    article in yesterday's New York Times makes clear that reckless
    buying of junk loans by Fannie Mae and Freddie Mac bears a
    large part of the responsibility for the financial crisis we
    are now in. Voters, justifiably angry about the $700 billion
    rescue plan just adopted by Congress, should recognize who is
    responsible and act accordingly.
        Incidentally, since some issues of compensation have come
    up, I ought to mention that Fannie was very generous in its own
    compensation. Franklin Raines, who was its chairman for several
    years, 4 or 5, made $90 million during the time he was there,
    and there was little outrage expressed in Congress at that
    time.
        Bad or weak regulation is often worse than no regulation at
    all. Another article in the New York Times on Friday of last
    week recounted the SEC's failure to devote sufficient resources
    to the regulation of the major investment banking firms that
    have now all collapsed, been taken over, sold themselves to big
    banks or sought shelter under the Federal Reserve's wings as
    financial holding companies. According to the article, the SEC
    assigned a pitifully small staff to regulating these huge
    investment banks, and as a result they took imprudent financial
    risks that ultimately led to their losses.
        A chart accompanying the article shows that these
    institutions took increasing risks every year from the time
    they entered the SEC's supervisory regime. This is important.
    It demonstrates the effect of regulation in creating moral
    hazard. Immediately after the SEC took over the supervision of
    their safety and soundness, the market discipline to which they
    had previously been subject began to relax. Investors thought
    the SEC was minding the store, but it wasn't. That is why weak
    regulation can be worse than none.
        Regulation itself is no panacea. Even strong regulation may
    not be effective. Regulation of commercial banks in the United
    States is a case of strong regulation failing. Congress imposed
    a strong regulatory regime on commercial banks when it adopted
    FDICIA in 1991. Still, even though IndyMac, WAMU, Wachovia and
    dozens of smaller commercial banks were regulated by one or
    another agency of the Federal Government under strict FDICIA
    requirements, they all failed or had to be taken over just like
    the weakly regulated investment banks.
        Calling for more regulation as a solution to the financial
    crisis is, therefore, somewhat simplistic. Regulation's track
    record is ambiguous. There is no question that it is the only
    protection we have when the government is exposed to risks
    created by companies it backs, like commercial banks, which
    have deposits insured by the FDIC, and like Fannie Mae and
    Freddie Mac, which were seen as backed by the Federal
    Government without any limit.
        But the regulation of the investment banks by the SEC was a
    mistake. They were not seen as backed by the government in any
    way until the SEC was given authority to supervise their safety
    and soundness. Then their risk-taking took off. If they had
    been left free of government oversight, they would not, in my
    view, have been able to borrow the funds that created their
    extraordinary leverage.
        If our solution to today's crisis is to regulate hedge
    funds, private equity funds, finance companies, institutional
    lenders, pension funds, leasing companies and insurance
    companies and anyone else who participates in the capital
    markets without any government backing, we will simply be
    assuring ourselves of many more financial crises in the future.
        Many thanks, Mr. Chairman.
        Chairman Waxman. Thank you, Mr. Wallison.
        [The prepared statement of Mr. Wallison follows:]
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        Chairman Waxman. I want to thank all of the members of the
    panel for your presentation. We'll now recognize Members to ask
    questions for a 5-minute period. We'll start with Mrs. Maloney.
        Mrs. Maloney. Thank you, Mr. Chairman and Ranking Member
    Davis and all of the panelists.
        We are facing what has been called the most serious
    financial crisis since the 1930's. And the potential cost to
    taxpayer is staggering: $29 billion to J.P. Morgan to buy Bear
    Stearns; $85 billion to AIG; $200 billion to Fannie and
    Freddie; $700 billion rescue package; $300 billion to the Fed
    window opening it up to investment banks; $50 billion to
    stabilize the money market funds. A staggering $1.7 billion
    potential cost to taxpayers.
        Now, Professor Zingales, you seem to believe that this may
    have been caused by the staggering leverage that was put in
    these firms, but others see it as the deregulation that has
    taken place in Congress over the past decade. In 1990, Congress
    passed the Financial Stabilization Act, which took away the
    protections of the Glass-Steagall Act that had served and
    protected our economy for 80 years. This allowed the banking a
    safety and soundness standard to be able to merge and be
    lowered, with risky speculative activities. And then during
    this period, Congress prohibited the regulation of risky
    derivatives. The SEC loosened rules governing the amount of
    leverage that investment banks could use, and Federal
    regulators were defunded and defanged, and they were reluctant
    to use the authority they had to protect taxpayers and
    investors.
        Some believe that the root cause of the credit cost of this
    crisis was not only the leverage, but the excessive
    deregulation. And I would like to ask first, Dr. Wescott, and
    then others, if you'd like to comment. What do you think were
    the biggest mistakes or missed opportunities for regulators?
    And going forward, what do you think we should regulate? Do you
    think all of this deregulation that I listed was a mistake for
    protection for our taxpayers and our economy?
        Mr. Wescott. Regulation is a--as Mr. Wallison said, is an
    extremely complicated matter, and it is very important that it
    be handled and that we get the incentives properly lined up
    here.
        There is no question that the regulators did make a
    decision. The SEC made a decision in 2004, in April 2004, to
    relax the leverage standards that the large $5 billion-plus
    investment banks would be allowed to operate under. And in my
    opinion, this decision did end up making the situation worse.
    And so I do----
        Mrs. Maloney. What about Glass-Steagall, Dr. Wescott? That
    is not complicated. It merely says financial institutions, bank
    safety and soundness should not mingle with risky activities.
    That is not complicated at all. It is very clear. Was that a
    mistake to roll that back, do you believe? Or I'd ask any other
    panelist to talk.
        Mr. Wescott. I don't have a strong opinion on Glass-
    Steagall. I do think that there were risks involved in the
    mortgage-lending business that were greater than were
    appreciated by regulators and obviously by many of the
    investment banks themselves. The key thing was that they
    assumed there was going to be plenty of business, and that they
    could keep getting additional borrowers, and that they would
    not suffer credit quality loss as we went further and further
    down the list of applicants for mortgages.
        Mrs. Maloney. Thank you very much. My time is very limited.
    I'd just like to go down the line, starting with Dr. Zingales.
        Do you think repealing Glass-Steagall, allowing banks to
    mix with risky investment banks that were leveraged in hedge
    funds, in some cases 1 to 30, 10 to 60, do you think rolling it
    back was a mistake, yes or no?
        Mr. Zingales. No. I don't think it was a mistake.
        Mrs. Maloney. Yes or no. Mr. Wescott, you don't think it
    was a mistake?
        Mr. Wescott. No at this point.
        Mrs. Maloney. Ms. Minow.
        Ms. Minow. I do think it was a mistake.
        Mrs. Maloney. You do.
        Mr. Smith.
        Mr. Smith. It appears to be from this angle. I'm sorry. It
    appears to be from this angle.
        Mrs. Maloney. Mr. Wallison.
        Mr. Wallison. Not a mistake.
        Mrs. Maloney. OK. So we're divided on that.
        If the Fed and Treasury had not allowed Lehman to fail in
    default on its obligations, would this have prevented runs on
    other firms, and especially the money market funds, the run
    that began on that? Again, down the panel quickly. My time has
    expired. Quickly now.
        Mr. Zingales. I think no. The proof is if we look at what
    happened when Bear Stearns was bailed out, I think that, for
    example, the price of the credit default swap was--an insurance
    on default as a measure of how risky borrowers are considered--
    went up the same amount it went up after the Lehman default. So
    I don't think that bailing out sort of Lehman would have--would
    solve the situation.
        Mr. Wescott. I think that regulators in retrospect would
    now understand that there was more Lehman paper out there in
    money market accounts, and they might have made a different
    decision on that account.
        Ms. Minow. I think it would not have made an enormous
    difference.
        Mr. Smith. I think it was one piece of a much bigger
    puzzle.
        Mr. Wallison. It has no significant difference, I think.
        Chairman Waxman. Thank you, Mrs. Maloney.
        Mr. Davis.
        Mr. Davis of Virginia. Thank you.
        This concerns the SEC. Both the chairman and I were
    instrumental in shepherding through legislation that removed
    the Civil Service pay ceilings on the SEC employees because
    they were losing employees like crazy. They lost a third of
    their senior management because of the pay. We raised that, but
    we also held hearings on IT and their IT capacity. What were
    the limitations if SEC had wanted to do something? Were their
    systems up? Could they have done the appropriate job? Or are
    there limitations on their IT and personnel that probably
    limited their abilities? Does anybody have any thoughts on
    that?
        No. OK.
        Ms. Minow, let me just ask you. You rated the corporate
    boards at Lehman. Did you ever rate the board in salaries at
    Freddie and Fannie?
        Ms. Minow. I'm sorry. Freddie and Fannie? Yes. We did give
    a high grade to Fannie Mae after they were--in 2002, when we
    began rating after they were cleared by the SEC and OFHEO. We,
    however, from the beginning gave poor ratings to Freddie.
        Mr. Davis of Virginia. We should have seen this coming;
    don't you agree? I mean, I don't know if any of you are
    familiar with the Superior Bank. I just was looking at one--
    Superior Bank, the inspector general report. This was a Chicago
    bank owned by--the chief owner was Penny Pritzker, who happens
    to be, as I think many of us know, Senator Obama's finance
    chairman. But more importantly, when you look at the inspector
    general's report, it says that the bank became associated with
    the subprime lending business in 1992. Beginning in 1993,
    Superior embarked on a business strategy marked by rapid and
    aggressive growth into subprime home mortgages. Federal bank
    regulators warned them in 1993, 1994, 1995, 1997 and 2000 to
    rein in their risky subprime lending businesses.
        According to an independent investigation by the Department
    of Justice, the bank used improper accounting procedures to
    cover up their bad debts. Fifteen hundred of the bank customers
    lost large sums of money. But this was years ago. I mean,
    didn't--all the warning signs were there that these subprimes
    were a mess, wasn't there?
        Ms. Minow. Yes, there were. That's why one of my primary
    concerns is the obstacles to what I would consider the
    essential market oversight from institutional investors like
    the Colorado pension fund, if they could have responded as I
    think they would like to have. If the corporate community
    hadn't lobbied for so many restrictions on the ability of
    shareholders to respond to these indicators, then I think we
    would not need a lot of new regulation.
        Mr. Davis of Virginia. Mr. Wallison.
        Mr. Wallison. Well, I would say that this is a very good
    example of the faith in regulation that is often misplaced. The
    regulators had the responsibility for looking at the risks that
    were being taken by these institutions, and they did not
    effectively do that. And I think that is an important lesson
    for our Congress to understand, because regulation is not a
    solution to many of these problems, especially when the
    regulators have a great deal of difficulty understanding what
    is happening in these institutions.
        The Superior Bank case is a perfect example of something
    that was starting in 2001 and beginning to build at that point
    with subprime loans. But I'm afraid that if a congressional
    committee or a regulator--let's put it this way: If a
    congressional committee had looked over the shoulder of the
    regulators and said, will you stop that from happening, I think
    the regulator would have been reluctant to do it. The
    institutions were making money from this. And once more, they
    were afraid of some of the political backlash that would come
    if they did try to stop this kind of lending.
        There is a strong feeling in the United States that many
    people should have access to housing. And the question is, do
    you allow the regulators to interfere with a strong housing
    market, especially involving----
        Mr. Davis of Virginia. Lower-income people were getting
    housing, so nobody wanted to stop that.
        Mr. Zingales. I think that the problem is not subprime per
    se, it is a risky lending. But as Mr. Wallison said, it has
    beneficial effects.
        Second, in some situations, a risky--might be profitable. I
    think that the problem is that the level of securitization this
    took place was not probably monitored. We have sort of an
    enormous market that has completely sort of unregulating type
    of disclosure. I think we should have more disclosure, because
    today we don't know who owns what. And out of that, a lot of
    the problems we observe in the credit market is because banks
    don't know the losses of other banks. If they don't know the
    losses, it is because they don't know what is in their
    portfolio. And if they don't know what is in the portfolio--
    because if you look at the issuances, you cannot trace back
    easily what is in that package of loans. We don't know whether
    they are loans from California, we don't know whether they are
    from Florida. We don't know who has these loans. And this lack
    of transparency is one of the roots of the problem. It is not
    subprime, It is the lack of transparency.
        Mr. Wescott. Just on the question of whether we should have
    known or did we know, I will just say that in looking at a full
    range of economic statistics in the summer of 2005, looking at
    the value of houses divided by median income and by many other
    measures, we knew that the housing prices were set for a fall.
    We were beginning to tell our clients in the autumn of 2005
    that housing prices were set for a fall and the housing sector
    was ready for a decline. We were not alone. Many other
    economists were also giving similar warnings.
        Chairman Waxman. Thank you, Mr. Davis. Mr. Cummings.
        Mr. Cummings. Thank you very much. Ms. Minow, when I went
    to church yesterday, it is interesting that almost everybody
    who came up to me afterwards was very upset. And it seemed like
    the thing they were most upset about was the compensation for
    these executives. As part of the committee's investigation the
    committee asked for copies of the e-mails that Mr. Fuld sent
    and received over the last 6 months. I want to read to you from
    an e-mail an exchange that involves Mr. Fuld, his executive
    committee, and senior executives at Neuberger Berman, a money
    management subsidiary of Lehman Brothers.
        The first e-mail is sent in early June of this year. It is
    sent from Neuberger Berman executives to Mr. Fuld's executive
    committee. The e-mail begins, ``as long-term employees and
    former partners of Neuberger Berman, we feel compelled to
    express our views on several matters to members of Lehman's
    executive committee.'' In the e-mail, the Neuberger Berman
    executives write that Lehman had made, ``management mistakes,''
    and that, ``a substantial portion of the problems at Lehman are
    structural rather than merely cyclical in nature.''
        The e-mail then recommended two actions. And let me read
    from the e-mail. It says top management should forego bonuses
    this year. This would serve a dual purpose. First, it would
    represent a significant expense reduction. Second, it would
    send a strong message to both employees and investors that
    management is not shirking accountability for recent
    performance. And then it goes on to say, too, and this is a
    direct quote, do a partial spinout of NB. A partial spinout
    could be an attractive source of capital for Lehman at a time
    when the company needs capital. The officials also suggested
    that a partial spinout of Neuberger Berman would allow some
    employees to receive their equity compensation in the new
    Neuberger Berman shares instead of Lehman shares, which would
    reassure the Neuberger employees of their funds.
        Question: Ms. Minow, what do you think of the
    recommendations made in this e-mail? And was the
    recommendations that senior management forego bonuses a sound
    one?
        Ms. Minow. Yes, it was.
        Mr. Cummings. And why is that?
        Ms. Minow. Because in my opinion, management gets paid
    last. You know, you pay the shareholders, you pay the
    employees, and then if there is any money left over you take
    it. But when the company is doing poorly, management should--
    management compensation should reflect that.
        Mr. Cummings. Yeah, because when I talk to the people in my
    block, they tell me--you said something that was very
    interesting. You said paying people based on volume as opposed
    to quality is just the wrong way to go. And the people in my
    block in Baltimore, if they perform poorly, they get fired.
        Ms. Minow. Yeah.
        Mr. Cummings. They certainly don't get a bonus.
        Ms. Minow. That is how it works in my company.
        Mr. Cummings. And Mr. Fuld is going to come in here in
    about an hour, and you know what he is going to say? He is
    going to say it is everybody's fault but mine, but he was the
    chief guy, is that right?
        Ms. Minow. He was. He was the captain of the ship. And you
    are familiar with the expression ``the buck stops here.'' You
    know, unfortunately it did stop with him. He took all the
    bucks.
        Mr. Cummings. One of the recipients of that e-mail was
    George W. Walker. Mr. Walker was Lehman's global head of
    investment management at the time. And if the name sounds
    familiar, that is because Mr. Walker also happens to be
    President Bush's cousin. Within 15 minutes, Mr. Walker writes a
    followup e-mail to the other members of the executive
    committee. And let me read that to you, because it is extremely
    interesting. He said sorry, team. I am not sure of what is in
    the water at 605 Third Avenue today. The compensation issue she
    raises is hardly worth the EC's--executive committee's that
    is--time now. I am embarrassed and I apologize. Mr. Fuld also
    mocked the Neuberger executives. And his response was don't
    worry. They are only people who think--listen to this--they are
    only people who think about their own pockets.
        Ms. Minow, I see you shaking your head. What do you think
    of Mr. Fuld's response? I can imagine what you are going to
    say, because it is clear that he was thinking about his own
    pockets as he made millions upon millions.
        Ms. Minow. You are exactly right, Congressman. I am
    horrified by that. I am absolutely horrified. And I am thinking
    about--I am thinking about what you could possibly say to him
    when he arrives here to make him understand his responsibility.
        Mr. Cummings. I wonder how he sleeps at night. Mr. Smith,
    do you have a comment on that? I see you shaking your head,
    too. You talked about all the employees you represent.
        Mr. Smith. Well, it is of interest to me that nowhere in
    that conversation, nowhere even in their way of thinking does
    the shareholder have any role whatsoever. And that is who their
    duty is to.
        Mr. Cummings. Thank you very much. I see my time is up.
        Chairman Waxman. Thank you, Mr. Cummings.
        Mr. Mica.
        Mr. Mica. First of all, I think it is very important that
    our committee investigate how we got into this financial mess.
    I believe Americans want to know who caused this outrage, how
    it happened, and who will be held accountable. If it is
    wrongdoing by AIG or Lehman, in fact I saw one of these signs
    out here with Code Pink, and they said no bail, jail. And which
    I agree with. In fact, at the conclusion of these hearings I
    intend to consult with my colleagues to ask for a special
    counsel to investigate this matter. The announced hearings,
    however, today and the ones that we have before us selected by
    the chairman only cover Lehman, AIG, and several regulators.
    Unfortunately, I think this is a clever sequencing of these
    hearings, which is obviously organized to deflect attention
    from government-backed financial institutions, and also deflect
    from Congress any blame, and put it on Wall Street, or blame it
    on executive compensation.
        Any hearing or real oversight that does not start with
    Fannie Mae, Franklin Raines, who walked away with over a
    hundred million dollars in executive compensation and bonuses,
    and also hearing from his accomplices, any hearing will be a
    sham. This is like investigating the Great Train Robbery and
    only talking to the dining car stewards. Instead of a balanced
    panel today, we will take testimony from academics, and no one
    from Fannie Mae or Freddie Mac. Rather clever.
        The fact is that our Nation's current financial crisis
    began back in 1992, with the concerted effort to expand
    government-sponsored enterprises Fannie Mae and Freddie Mac to
    include loans to marginally qualified borrowers and get into a
    whole host of speculative investments. Last week Speaker Pelosi
    incorrectly and partisanly attributed the responsibility to the
    Bush administration's failed economic policies. Chairman Waxman
    in his opening statement is trying today to direct focus on
    Wall Street and regulators. Last time I checked, none of those
    folks had a vote in Congress.
        In fact, it was in 1999, and we heard some reference to
    this already, I have a copy of the vote here which we will put
    in the record later, the Congress voted to repeal the Glass-
    Steagall Act, allowing banks to engage in speculative ventures.
    And Wall Street followed. In fact, long before Bush took
    office, the stage was set for the current financial meltdown of
    the housing and finance industry. In fact, in 1999 the Clinton
    administration and Fannie Mae Director Raines lowered policy
    standards and increased subprime loans to new, more dangerous
    levels.
        As quoted in the New York Times that year, Raines said,
    ``Fannie Mae has expanded home ownership for millions of
    families in the 1990's by reducing down payment requirements,
    yet there remain too many borrowers whose credit is just a
    notch below what our underwriting has required who have been
    regulated to paying significantly higher mortgages in the so-
    called subprime market. Wall Street followed.''
        The New York Times article continued, ``in moving even
    tentatively into this new era of lending, Fannie Mae is taking
    on significantly more risk, which may not pose any difficulty
    during flush economic times, as we saw, but the government-
    subsidized corporation may run into trouble in an economic
    downturn, prompting a government rescue similar to that of the
    savings and loan associations.''
        In fact, in 2004, Raines and Freddie Mac CEO Richard Syron
    told an ABA meeting, ``we push products and opportunities to
    people who have lesser credit. In fact, testimony before the
    House Financial Services Committee on Capital Markets and
    Insurance and Government Sponsored Enterprises on October 6,
    2004, Raines termed some of these loans riskless.'' That is his
    quote.
        In fact, Raines by rule change lowered Fannie Mae's cash
    reserve requirements from 10 to 2.5 percent. In fact, after
    fraudulently cooking Fannie Mae's books so Raines and Jamie
    Gorelick and others could boost earnings to rob millions in
    bonuses, congressional Democrats chose to ignore the findings.
    During a House Financial Services hearing on September 10,
    2003, the top Democrat at the time, Barney Frank, said the more
    people in my judgment exaggerate a threat of safety and
    soundness, the more people conjure up the possibility of
    serious financial losses to the Treasury, which I do not see. I
    think we see entities that are fundamentally sound and
    withstand some of the debt disaster scenarios. Representative
    Maxine Waters demanded to know why if it ain't broke, why
    anybody would want to fix Fannie Mae. More incredibly----
        Chairman Waxman. Thank you, Mr. Mica.
        Mr. Mica [continuing]. Frank said a few days later, I want
    to roll the dice a little bit more in this situation.
        Chairman Waxman. Mr. Mica, you can put the rest of the
    statement in the record, but your time has expired.
        Mr. Mica. Well, since our side is gagged from either giving
    a statement or----
        Chairman Waxman. Mr. Kucinich, it is your turn to ask the
    questions.
        Mr. Mica [continuing]. Having the opportunity to not ask
    questions, I won't get to ask my questions.
        Chairman Waxman. I thought you asked a lot of brilliant
    questions here. Mr. Kucinich, your turn to ask questions.
        Mr. Kucinich. I thank the gentleman. Mr. Wallison, in your
    testimony you said voters are justifiably angry about the $700
    billion rescue plan just adopted by Congress. Why?
        Mr. Wallison. Because much of the problem that----
        Mr. Kucinich. You want to speak closely to the mic?
        Mr. Wallison. Because much of the problem that this plan is
    intended to address was caused by a lack of regulation of
    Fannie Mae and Freddie Mac.
        Mr. Kucinich. OK. Thank you, sir.
        Mr. Wallison. The bad assets that are now on the books of
    banks and securities firms all over the world came from a
    market that they stimulated between 2005 and 2007.
        Mr. Kucinich. Thank you, sir. Thank you for your answer. I
    am going to go on with the rest of my questions.
        I want to say that I agree with you that the American
    people are angry. I voted against this bailout. And I think
    that I have to say that, with all due respect to our Chair, who
    really was given a mandate to hold hearings after the fact, I
    am sorry that these hearings are taking place after we voted on
    the bailout. I mean how much better we would have been, how
    much better informed we would have been if we had had these
    hearings before the bailout. And I think that it would have--
    that takes nothing away from Mr. Chairman, who I have the
    greatest admiration for, but this is a decision that was made
    by our congressional leaders. We should have had these hearings
    first and then taken a vote on a bailout later.
        Now I want to get into the questions of why didn't
    Secretary Paulson save Lehman. We all know about the
    implications of the collapse. That is what we are here to
    discuss. But you know, my question is why Secretary Paulson
    decided to bail out AIG and other companies but not Lehman.
        Gretchen Morgenson in the New York Times wrote a column
    about the decision to rescue AIG. She said that Secretary
    Paulson, a former CEO of Goldman Sachs, made this decision
    after consulting with Lloyd Blankfein, the current CEO of
    Goldman Sachs. She also wrote that Goldman Sachs could have
    been imperiled by the collapse of AIG because Goldman was AIG's
    largest trading partner. She said Goldman had a $20 billion
    exposure to AIG.
        Now I would like Professor Zingales, when you hear about
    that, you know, a decision was made to let Lehman go down.
    Goldman Sachs is still standing for sure. Are you concerned,
    given these facts, that there is an apparent conflict of
    interest by the Treasury Secretary in permitting a principal of
    a firm that he was a CEO with to be involved in these
    discussions about the survival of Lehman?
        Mr. Zingales. Yes. I am certainly concerned by that. But I
    have to say that I think that the reason--and I am not saying
    it wasn't the right decision--I think the reason to go to the
    AIG bailout is that AIG was a major player in the credit
    default swap market. And I think that not only Goldman was very
    heavily involved with that, J.P. Morgan, to the best of our
    ability, J.P. Morgan has a notional amount of $7 trillion in
    the credit default swap market. Most of that is hedged. And
    since they buy and sell insurance at the same time, so if
    everybody is holding up, there is no risk. But if AIG went
    under, all of a sudden J.P. Morgan would have found itself
    probably on edge for a significant fraction of that sort of a
    $7.1 trillion. Now----
        Mr. Kucinich. Let me ask you this. You throw Lehman
    Brothers overboard. Does that help what competitive position
    may remain with respect to Goldman Sachs?
        Mr. Zingales. I think it is clear that Goldman Sachs
    benefits from Lehman Brothers going under, yes.
        Mr. Kucinich. I want to ask Ms. Minow to answer the
    question that I asked. Is there an apparent conflict of
    interest here?
        Ms. Minow. Yes, there was.
        Mr. Kucinich. You want to elaborate on that?
        Ms. Minow. You know, that is part of the problem of
    regulating and deal making and bailing out in the financial
    sector. You know, we do regressions about the relationships
    between the various boards of directors. And overwhelmingly,
    that is the most tightly knit.
        Mr. Kucinich. I want to thank you for that. Because see,
    what we are confronted with is that bailout legislation gives
    Secretary Paulson the ability to direct assets over the entire
    economy, changing forever the idea of a free market and putting
    him in a direct position where he can benefit the people that
    he worked with while he was CEO of Goldman Sachs. Does that
    concern you?
        Ms. Minow. It concerns me greatly, Congressman. And that is
    why I think it is very important, even though the legislation
    was already passed, to have these hearings right now, because
    as you well know, the implementation is going to tell the story
    here. And even though the legislation is now significantly
    longer than the original proposal sent over by the
    administration, there is still a lot of room to make it right
    or make it wrong. And I think it is going to need a lot of
    oversight.
        Mr. Kucinich. Thank you very much.
        Chairman Waxman. Thank you, Mr. Kucinich.
        Mr. Turner.
        Mr. Mica. Mr. Chairman, I have a unanimous consent request.
        Chairman Waxman. The gentleman will state his unanimous
    consent request.
        Mr. Mica. I would like to ask unanimous consent to submit
    for the record the final vote results of roll call 570, which
    is the Glass-Steagall repeal, which you actually and I voted no
    on.
        I would like unanimous consent to insert in the record H.R.
    4071, which Mr. Shays asked me to cosponsor as a cosponsor, to
    register and regulate the Federal securities laws to include
    housing-related government-sponsored enterprises in March 20,
    2002.
        And I would like unanimous consent to submit into the
    record the legislation entitled Federal Housing Finance Reform
    Act of 2005, sponsored by Richard Baker, voted for by myself
    and others--you weren't with me on that one--that would have
    resolved this. And also the vote of that I think are important
    to include in the record.
        Chairman Waxman. Without objection, that will be the order.
        Mr. Mica. Thank you.
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        Chairman Waxman. Mr. Turner.
        Mr. Turner. Thank you, Mr. Chairman. I also voted against
    the bailout package. And I voted against the bailout package
    because I believe that it did nothing to prohibit the types of
    practices we are going to discuss today. It provided no real
    relief to communities or homeowners who are impacted as a
    result of these practices. And I believe it does no real
    understanding of what the requirements will be for
    administering such a program as we look to the underlying
    mortgages and the number of housing and house units that is
    there. And I also don't believe that the value is ultimately
    going to be there when they take a look at the mortgages and
    the mortgage-backed securities that they are going to be
    acquiring.
        Dr. Wescott, you said that--you gave us about four or five
    points as to how this happened. Easy credit, housing prices
    escalating, securitization of mortgages, houses becoming ATMs.
    And Ms. Minow, you indicated also excessive CEO compensation.
    Well, I am from Ohio, and we are one of the leaders,
    unfortunately, in the area of foreclosures. And I want to tell
    you a little bit about what our experience is. And I would like
    to get your thoughts on this.
        In 2001, I was serving as mayor for my community. And then
    city commissioner Dean Lovelace, who was a leader in our
    community of trying to advocate for people who were victims of
    predatory lending, brought to the attention of the city
    commission and ultimately legislation, which we passed but were
    not able to enforce, attempting to prohibit predatory lending
    practices in our community. We then began working with the
    Miami Valley Fair Housing Center in our community to work
    directly with people who were impacted. And our community in
    the past 2 years has had 5,000 foreclosures on an annual basis
    in a county of about 500,000 people. The State of Ohio I
    believe is clipping along at about 80,000-plus foreclosures.
        And Dr. Wescott, we are not seeing the housing price
    escalation as the problem. Ohio is not a State that saw wild
    fluctuations in housing values. In fact, the Miami Valley Fair
    Housing Center, Tim McCarthy, the director there, tells me that
    this is what we experienced. Houses that are probably valued
    between $75,000, $80,000, people who found the American dream,
    who got a traditional lending product, were convinced to
    refinance their house by unscrupulous lenders, predatory
    lenders, subprime lenders, convinced that the property value
    was worth a hundred thousand, many times capitalizing the fees,
    giving the ultimate homeowner a small portion of the cash in
    the refinancing, the homeowner then facing many times interest
    rates or payment schedules that they are either not familiar
    with or not prepared to make; in any event, finding perhaps
    hard economic times or other circumstances where they realized
    that the value of the property is below the actual mortgage
    value. And ultimately, this property going through foreclosure
    becomes abandoned in my community. Sitting with a leaking roof,
    broken windows and many times is now worth $20,000, requiring
    tens of thousands of dollars for it even to be habitable. We
    are seeing that scourge around our community. And when I see
    that, I don't see bad loan choices, I don't see people who just
    were stretching for the American dream but could not afford it.
    I see someone having stolen the American dream, where there was
    a homeowner and a family that were sitting there that were
    convinced to them what they thought was the most regulated
    transaction in our country, protected by the Federal Government
    and rules and regulations, caught in a cycle of refinancing.
        But there is someone who knew. The person who originated
    this loan knows that the value of the property isn't there.
    They know that this homeowner is not going to be able to make
    it. And ultimately, as we now know, they take that loan,
    securitize it, and sell it back likely to the bank that had the
    first mortgage to begin with that wouldn't have given them a
    loan like that. Again, I believe these people stole. And I
    believe it was systematic stealing at such an unbelievable and
    grand scale that it is going to be very difficult for us to
    unwind this.
        In those circumstances, I would like your thoughts on that
    very process.
        Mr. Wescott. Mr. Turner, you described very eloquently a
    second type of housing problem that we are having in this
    country. We really have two housing problems. We have the
    credit-oriented problem that is heavily focused in Florida,
    California, Las Vegas, and so on. And because this part of the
    economy, because the housing sector of the economy started
    weakening, we have actually eaten into real disposable income.
    We have hurt consumer spending across the country. And what
    that has done is that has lowered demand for automobiles, for
    industrial goods, and so on. And that is the core part of the
    problem in the State of Ohio. It is the same in Michigan. These
    are regions that have lost hundreds of thousands of industrial
    jobs, as you well know. And so the fundamental problem in Ohio
    is the loss of jobs and the fact that many people just don't
    have the income they did 2 years ago or 4 years ago.
        Ms. Minow. Mr. Turner, I want to repeat that one of the
    most important factors in creating this problem was pay plans
    that rewarded the executives on the basis of the number of
    transactions rather than the quality of transactions. And as I
    said the last time I spoke to this committee, of course we
    could never pay Congress what you are worth, but if we were
    paying you based upon the number of laws rather than the
    quality of the laws, I think you see what the result would be.
    And when we created these pay packages so that they were
    benefited by just generating as many transactions as possible,
    chopping them up, sending them all over the place in a form
    that could no longer be valued accurately, to me that is one of
    the key sources of this problem.
        Mr. Turner. As we talk many times about falling housing
    prices, it is going to be interesting when we actually get into
    these mortgage-backed securities and look at these mortgage
    transactions, because I think we will find that many of these
    loans were given on housing prices where the value wasn't there
    to begin with.
        Ms. Minow. I agree. And I understand that in some cases
    even the title searches were not completed.
        Mr. Turner. Thank you, Mr. Chairman.
        Chairman Waxman. Thank you, Mr. Turner.
        Mr. Tierney.
        Mr. Tierney. Thank you, Mr. Chairman. I want to thank all
    of our panel for testifying today. I know we are going to have
    this hearing and about four other hearings trying to understand
    the process that got us into this situation. And today we are
    focusing on Lehman Brothers. Over the weekend we all got a
    chance to look at Mr. Fuld's proposed testimony for today. And
    in looking at that, it appears that he blames just about
    everyone and everything except himself and the other executives
    for the downfall of Lehman.
        So I wanted to begin by asking this panel for a full
    diagnosis of just what went on. What were the factors that went
    into this? Mr. Fuld said it was a litany of destabilizing
    factors: Rumors, credit agency downgrades, naked short attacks.
    He says ultimately lack of confidence, and in the end he was
    overwhelmed. So I want to ask each of you whether or not you
    agree with that, that Mr. Fuld was a victim of the
    circumstances or whether or not he and his fellow executives
    made mistakes, causing the collapse of the company and
    eventually putting all of us in jeopardy.
        Ms. Minow, if I could begin with you. Do you agree with Mr.
    Fuld's diagnosis?
        Ms. Minow. No. I think it is horrific. I can't believe that
    he would have the chutzpah to say something like that. I hold
    him completely responsible. I hold him responsible and his
    board responsible for the foreseeable consequences of the
    decisions they made.
        Mr. Tierney. Professor Zingales, what are your views on
    that?
        Mr. Zingales. I think he is definitely responsible for
    having a too aggressive leverage policy, too much short-term
    debt that makes the firm sort of at risk of a background that
    is exactly what happened, and to have not controlled the risk
    that the firm was taking during this boom period.
        All this said, it is also true that we are in exceptional
    circumstances, and I think that the system is suffering of lack
    of liquidity. And so it is possible that a lot of banks and
    firms that in normal times would not be insolvent today find
    themselves insolvent. The example is suppose that we had no
    mortgages, what would be the price of your house? And we are in
    the situation right now. The banks are not lending. And if the
    banks are not lending, we don't know what the prices of
    anything is. And at those prices it is very easy that a lot of
    firms, a lot of banks are insolvent.
        Mr. Tierney. Thank you. Mr. Smith, you are the only
    investor on the panel. What are your views?
        Mr. Smith. Well, certainly I hold him responsible, but I
    think it goes beyond that.
        Chairman Waxman. Is your mic on?
        Mr. Smith. I am sorry. I certainly hold him responsible. I
    certainly think they made conscious decisions to take risks
    that went far beyond the interests of the shareholder. But I
    also look at the directors, and I look at their responsibility
    for overseeing management. And I look at the regulatory system
    that denies investors the opportunity to hold directors
    accountable. So there are multiple pieces to the puzzle. But I
    don't believe that he has any safe ground to stand on.
        Mr. Tierney. Thank you. Professor Zingales and Ms. Minow,
    if I were to put you or you were to put yourself in Mr. Fuld's
    position, in 2007 Lehman Brothers paid out nearly $5 billion in
    bonuses. He himself got a $4 million bonus. But at the same
    time they did that, they spent over $4 billion buying back
    shares of stock. They paid out $750 million in dividends. Were
    those actions, almost $10 billion of capital dissipated in that
    sense, were those wise decision under the circumstances?
        Ms. Minow. No. I don't think they were. And I will say that
    I am a real radical on the subject of CEO stock sales. He was
    also selling a lot of his stock at that time. And I don't
    believe that CEOs should be allowed to sell stock while they
    are still with the company.
        Mr. Tierney. Dr. Zingales.
        Mr. Zingales. No, it was not a wise decision. He should
    have increased the equity base, not reduce it at that moment.
        Mr. Tierney. I noticed that in June 2008 the Lehman
    Brothers had a $2.8 billion loss on their books, and that sent
    everything--stunning the markets, sent everything spinning. If
    they had that $10 billion that had gone to bonuses and to
    dividends and buybacks, it certainly seems that they might have
    avoided that situation as well.
        Do you know, Dr. Zingales, what the amount of money that
    Mr. Fuld was seeking from the Korean Development Bank toward
    the end?
        Mr. Zingales. No, I don't know the exact amount.
        Mr. Tierney. Do you, Ms. Minow?
        Ms. Minow. No, I do not.
        Mr. Tierney. I believe it was probably $6 billion or less.
    And my point was again, if you take that $10 billion off the
    books, you lost that opportunity to do something substantial in
    terms of saving that company and saving our economy on that.
    But we can explore that further with Mr. Fuld.
        But I do want to just cover an e-mail exchange between Mr.
    Fuld and one of his top executives, David Goldfarb, that was
    dated May 26, 2008. In that, Mr. Goldfarb reports that a
    possible deal with the Korean Development Bank would provide
    several billion dollars worth of new capital to Lehman. Mr.
    Goldfarb describes what he would like to do with the money, and
    he writes as follows. It feels like this could become real. If
    we did raise $5 billion, I like the idea of aggressively going
    into the market and spending two of the five and buying back
    lots of stock and hurting Einhorn bad. Now, in the e-mail Mr.
    Goldfarb was referring apparently to David Einhorn, who at the
    time was publicly critical of Lehman and was shorting its
    stock. Mr. Fuld wrote in a short response, I agree with all of
    it.
        So here is how I read this e-mail. Lehman was dangerously
    low on capital, and possibly found an investor willing to give
    them billions of dollars. And what they wanted to do with it,
    however, was buy back stock and punish a short seller. Mr.
    Smith, what are your views about that e-mail exchange, being an
    investor?
        Mr. Smith. Well, horrified. When you know that you are low
    on cash, when you know that you have exposed your company to
    what I have heard as ranging from 35 to 70 times leverage, and
    you are giving away your cash with a motive of punishing
    someone rather than benefiting your shareholders, that is the
    ultimate breach.
        Mr. Tierney. Thank you.
        Chairman Waxman. Thank you, Mr. Tierney.
        Ms. Watson.
        Ms. Watson. I really think this is the most important
    hearing we have had in this particular Congress. I thank the
    experts for coming out this morning. I just returned from
    California, the largest State in the Union, 38 million people.
    It was a turnaround for me. And I tell you, they followed me
    out of church, they followed me at several dinners, political
    dinners. Everyone was outraged over the $850 billion of their
    moneys to bail out people who have shown nothing but corporate
    greed. And I am hoping that as a result of the six hearings we
    are going to have that we can come out with a policy that will
    really curtail this greed out of control.
        Now, looking at Lehman Brothers and trying to get to the
    bottom of what caused this economic crisis that we are in, the
    makeup of the board may provide some insight with what went
    wrong. Seven of the 10 board members were retired. Many of them
    lacked Wall Street experience. And the Lehman board members
    included the former head of Telemundo, who was a retired Navy
    Admiral, and a theater producer.
        And so I am directing this to Ms. Minow. You are an expert
    on corporate governance. Do you have concerns about the
    effectiveness of the Lehman board? And let me just mention one
    board member, Mr. Roger Berlind, the theater producer. He has
    been on the board for 20 years, and sits on the audit and the
    finance and risk committees. What are your concerns about
    having a board full of people like Mr. Berlind?
        Ms. Minow. Thank you, Ms. Watson. As I said in my
    testimony, we rank boards based on the decisions they make, and
    not on their resumes. And I will say in fairness to Mr. Berlind
    that yes, he is a theatrical producer, he does have a
    background in finance, and was the co-founder of a Wall Street
    firm at one time. However, I think it is clear that the members
    of this board had no clue about the kinds of securities and
    other issues, the derivative securities and the credit default
    swaps that we have heard about today. And the fact that the
    risk committee met only twice 2 years in a row I think tells
    you everything you need to know.
        So I rank this board very, very poorly. They currently get
    an F from us.
        Ms. Watson. I see one of the biggest problems in corporate
    governance is how entrenched the board can become. And under
    current law, there is no effective way for shareholders to
    challenge an incompetent or negligent board. And in the bailout
    bill, Chairman Barney Frank tried to address the problem of
    these entrenched boards. And he said that shareholders should
    be able to propose their own candidates for the board. The
    theory behind this reform is that if the board gets too close
    to management, as the Lehman board did, the shareholders can
    vote in a new board with more independence and oversight.
    Unfortunately, Secretary Paulson insisted that this corporate
    governance reform be dropped from the bill.
        So I would like to ask you first, Ms. Minow, was this an
    important reform? And then Mr. Smith, do you have a view on
    this? And Mr. Zingales, what you think. In that order, please.
        Ms. Minow. This is a crucial reform. Mr. Smith mentioned it
    in his testimony. I have it in my written remarks. At this
    point, you know, I always love bringing this up when I am
    speaking to the committee because one thing that you all
    understand very, very well here, very intimately is the concept
    of an election. And yet we call it an election for a corporate
    board, and only one person runs, no one runs against them, and
    management counts the votes. It is a pretty good system. We
    have to have some way--this is exactly what I am talking about
    when I say we need to remove the impediments to oversight from
    investors so that we can remove directors. There are currently
    more than 20 directors serving on boards today who did not
    receive a majority vote from their shareholders. Shareholders
    did everything they could to say we don't want you and they are
    still serving. So we definitely need to improve that system.
        Thank you.
        Mr. Smith. Yes, that certainly is one of the biggest
    reforms I would like to see. It is the only place I have ever
    seen where----
        Chairman Waxman. Is your mic on?
        Mr. Smith. Pardon me?
        Chairman Waxman. Is your mic on?
        Mr. Smith. Yes, it is. Who are our representatives, the
    shareholders' representative is not picked by the shareholders
    and the shareholders have nothing to say about who they are,
    and they are not accountable to the shareholders. Their
    presence in the board room is dependent upon management and
    whether or not management puts them on the slate. That is not a
    good connection for the shareholders to have their voice heard
    in a board room, and it has failed us.
        Mr. Zingales. I completely agree with you. In fact, there
    are very few things that the United States can learn from
    Italy, but Italy has a law that allows representatives of
    institutional investors to be elected on board. And I happen to
    be one of those. I sit on the board of one of the largest
    companies in Italy, Telecom Italia, as representative of
    institutional investors. And I sit on their compensation
    committee, and I can actually argue about their compensation.
    And I can tell you that last year I wasn't particularly polite
    in some of the conversation. And if I was appointed by
    management, I would not have been renewed. But I was renewed
    because I am appointed by institutional investors and I
    represent shareholders on that board.
        So I think that would be a very important reform that we
    could pass.
        Chairman Waxman. Thank you, Ms. Watson.
        Ms. Watson. Thank you so much.
        Chairman Waxman. Mr. Higgins.
        Mr. Higgins. Thank you, Mr. Chairman. Just a couple of
    thoughts. Virtually every recession or severe economic downturn
    originates in excesses in the financial economy. And then they
    go on to ruin the real economy. I think the recent financial
    crisis is consistent with that. And I find in my review of the
    facts four basic abuses: A lack of transparency, excessive
    leveraging, conflicts of interest, and most egregious, the
    probability of dishonesty and deceit.
        Lehman Brothers didn't just collapse on September 15th. Its
    financial situation has been getting increasingly dire with
    each passing quarter. But Lehman's executives kept telling
    shareholders and public investors that its finances were in
    great shape. In September 2007, Lehman's chief financial
    officer told investors, ``our liquidity position is stronger
    than ever.'' In December 2007, CEO Richard Fuld said, ``our
    global franchise and brand have never been stronger.'' In March
    2008, Lehman fired its chief executive officer and hired a new
    one. The new chief financial officer told investors, ``I think
    we feel better about our liquidity than we ever have.'' In June
    2008, CEO Richard Fuld told shareholders, ``our capital and
    liquidity positions have never been stronger.'' And on
    September 10th, 5 days before Lehman filed for bankruptcy
    protection, Lehman made upbeat comments to investors and
    research analysts.
        Mr. Smith, you represent a State pension fund. Your fund
    manages retirement assets of public employees in the State of
    Colorado. What do you think about these statements by Mr. Fuld
    and others at Lehman? Were they giving you an honest assessment
    of what was going on inside the company?
        Mr. Smith. Well, clearly, they were not giving us an honest
    assessment of it. And unfortunately, neither were the books,
    neither were the auditors. There was no piece of the puzzle
    that allowed us--we are big boys and girls. We invest billions
    of dollars. We understand how to invest. We understand how to
    do due diligence. But you have to have the tools to do that.
    And you have to have people who are going to be honest enough
    to tell you the facts, or at least have you have the ability to
    go mine the facts yourself. And in today's situation, and for
    many years now we have been unable, we have been impaired in
    our ability to do that.
        Mr. Higgins. Professor Zingales, what is your view? Could
    Mr. Fuld have been truthful when he said in June 2008 that our
    capital and liquidity positions have never been stronger?
        Mr. Zingales. It is hard to imagine that it was never
    stronger than that. I think that it is clear that was a moment
    of crisis, and it is clear that he didn't have a good
    understanding of what the situation was. If it is true, as was
    said, that he was indicating that they would buy back stocks in
    order to punish the analysts, I think--I am sorry, the short
    sellers, this is a typical situation of overconfidence by a CEO
    that doesn't see the problems as they should be. And he thinks
    that the responsibility is all on the market that gets it
    wrong. It is all on the short sellers, the short sellers of
    stocks, and they don't see the problem coming.
        Mr. Higgins. Mr. Fuld had a vested interest in painting a
    rosy picture at Lehman. If he had disclosed its precarious
    situation it could have put more pressure on the company. That
    is why I believe the disclosure rules are so important.
    Investors shouldn't have to rely on the rosy assessment of
    corporate executives. They should be able to verify those
    statements in reviewing public filings of the company. Mr.
    Smith or Dr. Wescott, what are your views about disclosure
    rules?
        Mr. Smith. Well, I was just mentioning I should have hit
    transparency a little harder in my answer. I appreciate the
    loop back, because that is what we believe was lacking with the
    off balance sheet opportunities, with the loosened accounting
    rules, with the obfuscation of the leverage that they were
    actually imposing on the assets of the organization that were
    in large part undetectable by an investor. Didn't have much of
    a fair shot at assessing our risk when we got into that.
        Mr. Wescott. A quick comment. Basically, there are two ways
    you can go if you are going to regulate an industry. You can
    have very, very tight regulation. At the limit, you can imagine
    a regulator basically working full-time in the institution
    looking at every number every day. And that is one way you
    could go. The other way is to back off and to allow--to have
    less day to day, minute to minute regulation. If you are going
    to go that way, though, you have to--the key building block is
    disclosure and transparency. And that is--if you don't have
    this very minute level of regulation, you have to have
    disclosure and transparency.
        Chairman Waxman. Thank you, Mr. Higgins.
        Mr. Higgins. Thank you, Mr. Chair.
        Chairman Waxman. Ms. McCollum.
        Ms. McCollum. Thank you, Mr. Chairman. I want to go back to
    September 10th, because that is 5 days before the bankruptcy
    filing. It is my understanding that the chief financial officer
    held a conference call for investors. And that was reported in
    the Wall Street Journal. And in fact, some of the bankers even
    advised them not to hold this call because there were going to
    be too many open questions. And I would like to know from the
    panel, to your understanding is this accurate?
        Ms. Minow. I don't have any information about that, sorry.
        Ms. McCollum. My understanding is at the time that they
    were making this call they were trying to raise capital through
    new investors or by off selling assets. Dr. Wescott, Dr.
    Zingales, any comment on that?
        Mr. Wescott. Unfortunately, I don't know the details of
    what was going on.
        Mr. Zingales. Neither do I.
        Ms. McCollum. One of the concerns that I had, Dr. Zingales,
    from your testimony, you talked about how there were three
    issues kind of involved to Lehman's collapse. One of them that
    we haven't spoken about very much was the whole idea of the
    credit market swap that was involved in here. So irrespective
    of whether or not they were making good investments, and they
    definitely were not in the home mortgage securities, could you
    elaborate on Lehman Brothers' role in the credit swap?
        Mr. Zingales. Actually, the role of Lehman in the credit
    default swap market is relatively limited. There is a table in
    my long testimony, I think it is table 5, that reports the best
    numbers we have regarding sort of the amount of credit default
    swaps in place. And Lehman is 25th in the list. So they
    definitely had some sort of play in the market, but not a huge
    play in that market.
        Ms. McCollum. But when there is lack of confidence in the
    market, to what degree did these--I mean they were out there
    hustling for cash, looking for something. They knew that they
    had problems with the loans that they had accrued. The fact
    that they got even involved in doing this credit swap, does
    that bring any--from my research, that does not bring any
    stability to a company. In fact, it adds to destability.
        Mr. Zingales. It depends what position they take, because
    if they were hedging their risk by taking insurance along the
    way, this should in principal have reduced their risk. Of
    course if they were selling insurance, that would have been
    crazy, but I don't think at that time people would have bought
    the insurance because they were sort of rumored to be in
    difficulty. So you don't want to buy insurance from an
    insurance company that you are not sure is going to be around
    to pay when your house is in trouble, for example.
        Ms. McCollum. Could I ask each one of the panelists, there
    was great discussion about privatizing Social Security. And as
    we have heard from the gentleman from Colorado, a lot of
    pensions had their security assets in fact involved in these
    types of products. Could you tell me what, in your opinion,
    privatizing Social Security would have meant for Americans
    today had that plan gone through?
        Mr. Smith. Well, the beauty in our view as a pension
    system, and particularly a hybrid defined benefit pension
    system is that we are able to pool at least some of these
    market risks for our members. The members in our system who
    were within a year or so of retiring and faced this crisis
    probably still have the ability to retire, because we have a
    long-term ability to provide those benefits. If they were on
    their own and they were in individual accounts that were under
    their control and their responsibility, they would be left with
    only that, and that would be inadequate to provide for them in
    these times. And this cycle would have caused them to go back
    to work for years into the future. So it would be devastating
    to have individuals--in my view, to have individuals and
    individual accounts out there trying to survive in what is a
    market that lacks transparency.
        Mr. Wescott. Just there are many different proposals of how
    to do a privatization of Social Security. There is carve out,
    there is add on, and so on. So it is difficult to know exactly
    which type of plan we would be talking about. The key for
    insuring safe retirements for Americans is diversification, a
    blend of income, some coming from Social Security, some coming
    from company plans, some coming from private 401(k) plans or
    individual plans. What we really want is to have a blend of
    money so that you have multiple sources, each of them subject
    to different risks.
        Chairman Waxman. Thank you very much. Did anyone else wish
    to respond to the question? Thank you, Ms. McCollum. Mr. Van
    Hollen.
        Mr. Van Hollen. Thank you, Mr. Chairman. I thank all of the
    witnesses for being here today. I just want to pick up on a
    point that Ms. Minow raised in her testimony regarding the link
    between executive compensation and overall performance. We are
    looking at Lehman Brothers as a case study today. We have AIG
    tomorrow. And then we will go on to some of the more systemic
    issues. But I think what we are seeing today, just looking at
    Lehman Brothers, is a good case study of the fact that you
    don't have this alignment between pay and performance. In fact,
    as my colleague Mr. Cummings was saying, unlike the rest of
    America, where pay for performance means you get rewarded when
    you do well, but you actually get--there are disincentives, you
    get cut in pay when you do poorly, the fact of the matter is on
    Wall Street you do well when they do well, and you do well when
    they are doing poorly. And that clearly is a mismatch. And I
    think it is important to look at this to make the
    recommendations you have talked about in terms of what we can
    do legislatively to better align stockholders' interests with
    those of the executives who are making decisions. And one
    problem I think is the fact that people are urged to take big
    risks to maximize short-term pay and bonuses at the expense of
    longer term well-being of the company and the stockholders. And
    I think one of the reasons that happens is because people think
    that when they make bad decisions they are going to still get
    bailed out.
        I want to talk to you briefly about a memo that was written
    at Lehman Brothers by the compensation committee on September
    11th. That is 4 days before Lehman Brothers declared
    bankruptcy. And it is a recommendation from Lehman Brothers to
    the compensation committee of the board. It discusses a number
    of the separation payments, including one of them to Andy
    Morton. Mr. Morton was the head of Lehman's global head of
    fixed income. He was the person who was responsible for the
    leveraged investments that were a good part of what drove
    Lehman into bankruptcy. Another was Mr. Benoit Savoret, a
    member of Lehman's executive committee. It says that they both
    had been involuntarily terminated. They have been fired. And so
    you would think, you know, when you get fired, bad performance,
    no pay. But it goes on to recommend giving them cash separation
    payments combined of $20 million, $16.2 million for Mr.
    Savoret, and $2 million for Mr. Morton. And it calls--in the
    memo they describe these as special payments. And they come up
    with a rationale for providing these kind of last minute
    bailouts to these guys. Is this part of the mentality of sort
    of an insatiable, you know, insatiable sense of entitlement on
    Wall Street that suggests that even when you do badly someone
    is going to be there to bail you out?
        Ms. Minow. I couldn't possibly have put it as well as you
    did, Congressman. That was perfect. I had to laugh, though,
    when you said this was a good case study. I wish it was the
    only case study. It is just replicated over and over and over
    and over again. And you are right, they are so completely out
    of touch, that on the upside they always say I am responsible,
    it is a market test, I am Michael Jordan, I am A-Rod, I deserve
    this. But on the downside, it is never their fault. And if we
    don't have better shareholder oversight, if we don't have
    better market response to them, then they are never going to
    get the message.
        Mr. Van Hollen. Let me just read to you their description
    of why these are apparently justified in their view. They say
    these executives are, ``very experienced senior executives with
    valuable business skills and experience that the corporation
    may wish to leverage.'' Again, these are the guys who helped
    obviously contribute to the downfall. It also says, ``the
    corporation would face significant impacts if the terminating
    executives should fail to provide appropriate transition
    assistance, solicit clients, or engage in other behavior that
    may be detrimental to the corporation.''
        Now that you have heard the rationale, does that pass the
    common sense smell test?
        Ms. Minow. Not at all. But this goes back to a point that I
    made earlier where I said I take a very hard line. I don't
    believe they should be allowed to sell their stock until after
    they leave their company. And if that doesn't motivate them
    adequately, then they are not paying attention. But I think it
    is hilarious that they use the term ``leverage.'' Because one
    thing we have learned about this company is they didn't
    understand leverage at all.
        Mr. Van Hollen. Mr. Smith, as somebody who entrusts these
    individuals with lots of decisions, is that the kind of pay for
    performance that you would want to see?
        Mr. Smith. Certainly not, and certainly highlights our
    desire to have say on pay as a shareholder, to be able to be in
    the board room or have a representative in the board room that
    actually is looking at those payments and saying how is this
    going to bring value to my shareholders? And I would contend
    that there is categorically no way those payments could bring
    value to the shareholders.
        Mr. Van Hollen. Thank you. Thank you, Mr. Chairman.
        Chairman Waxman. Thank you, Mr. Van Hollen.
        Mr. Cooper.
        Mr. Cooper. Thank you, Mr. Chairman. I would like to
    explore the role of excessive leverage in the downfall of
    Lehman Brothers. Professor Zingales starts his whole testimony
    by saying the downfall of Lehman Brothers is the result of its
    very aggressive leveraging policy. Could you help the public
    understand how leverage magnifies gains or losses?
        Mr. Zingales. Sure. Let me make sure that you all
    understand what we are talking about. When you buy a house and
    you put a 10 percent down, you are basically buying something
    that is worth 10 times what you put down. So your ratio is 10
    to 1. That is the leverage. What Lehman was doing was 30 to 1.
    So it was much more than what most people do in buying their
    house. And this exposes you enormously to fluctuations in the
    value of the underlying assets.
        As I said in my testimony, if you have a drop of only 3.3
    percent in the value of your assets, your entire value of the
    equity is wiped out, and so you are insolvent. And this system,
    as was mentioned by the chairman, is very rewarding on the
    upside, so that when things go well you have very high sort of
    earnings, you have very high return on capital, and this allows
    you to pay very large bonuses. On the downside, this is very
    dramatic. And so especially given sort of the situation in
    which we were, the risk on their assets and the risk of a
    downturn in the housing market, it was not sort of not
    foreseeable, I think their leverage policies should be much
    more cautious. But also it is not only the leverage, it is also
    how much of that leverage is short term. Because when you have
    a problem, the short term lenders can leave you and create a
    situation of insolvency, which is exactly where Lehman was. And
    before the beginning of the crisis, 50 percent of that leverage
    was made of short-term debt, which is very profitable in the
    short term because short-term debt, especially in the current
    environment, is much cheaper than long-term debt but exposes
    more to a risk of a run, and that is exactly what happened.
        Mr. Cooper. So Lehman was levered I think at the start of
    Dick Fuld's tenure at 27 times, and then it went to 37 times.
    And now that there are no major investment banks left on Wall
    Street, even Goldman Sachs and Morgan as I understand are down
    to about 10 times leverage. So it has been a substantial
    contraction of the leverage ratios.
        Dr. Wallison, could you tell us what you think an
    appropriate leverage ratio would be for investment banks,
    assuming we have major investment banks return to America one
    day?
        Mr. Wallison. I don't think, Congressman, that you can give
    a number. It depends very much on the risks that they are
    encountering in the market at a given time. It is obvious, it
    should have been obvious to the management of Lehman and any
    other management that when things can't continue, as Herb Stein
    once said, they will stop. And as a result, a provision should
    have been made for a downturn. But there isn't a number that is
    the right number under any circumstances.
        Mr. Cooper. But it is sounding today, since no firm, major
    firm left in the country is leveraged at 30 to 40 to 1, that
    must be too much, right? Another point about leverage is the
    fulcrum on which the lever rests, the capital, the equity that
    Lehman thought it had on its balance sheet. And Professor
    Zingales, didn't you say in your testimony on the day they went
    bankrupt it supposedly had $26 billion on its balance sheet?
        Mr. Zingales. Yes, $26 billion in book value of equity. The
    problem is the market value of the equity depends crucially on
    the value of its assets; and the uncertainty that was created
    in the value of the assets in part by lack of transparency, in
    part by the liquidity crisis made it impossible to know exactly
    what it was. And when the market becomes nervous, that is the
    moment they pull out their money. That is the reason why adding
    a lot of short-term debt is not wise, because in that situation
    you can have literally a bank run, and that is what happened.
        Mr. Cooper. So a contraction in credit because of excessive
    leverage crushed $26 billion in capital, which we question the
    value of anyway, because, apparently, mark-to-market rules
    didn't necessarily apply quickly enough in this case. And I
    think that leaves a lot of folks back home wondering whether
    this is Wall Street or a casino.
        Because, as you conclude your testimony, Professor
    Zingales, you say Lehman did not find itself in this situation
    by accident. It was the unlucky draw of a consciously made
    gamble. That doesn't sound like an investment. That sounds like
    gambling.
        Mr. Zingales. I think, as I said in my testimony, they were
    too aggressive in their leverage; and that is the reason why I
    think they should not have been bought out. My major concern is
    that if we bail out everybody who took those gambles, we are
    going to create incentives to have more gambles down the line.
    And I think that there is a strategy on Wall Street to sort of
    take a lot of gambles on the outside and then walk away when
    things don't work out. And if you don't get punished when
    things don't work out, everybody will play that gamble over and
    over again. So I think we have to be very careful on what we do
    now, because I think that what we are doing now will define
    incentives for a generation to come.
        Chairman Waxman. Will the gentleman yield? Just for me to
    point out that the regulation of commercial banks is that the
    leverage is no more than four to one. So I guess every--all the
    banks are now commercial banks. But there is a spelling out of
    it--of a leverage number.
        The next person to question would be Mr. Sarbanes.
        Mr. Sarbanes. Thank you, Mr. Chairman.
        Of course, we have all alluded to the fact that there is a
    lot of people who are angry out here in the country. I expect
    that when we are done with these five hearings they are going
    to be a lot angrier, because they had deep suspicion about this
    culture of greed and recklessness on Wall Street. Now they are
    going to have plenty of proof positive of it once we are done
    with these hearings.
        I don't think there is any surprise to be found in the huge
    either golden parachute packages or compensation or salaries
    that these folks got used to thinking they should have. When
    you look at the amount of money they are playing with--and I
    use the phrase ``play with'' rather than ``manage'' because
    that's where it seems things seemed to get. So you put it in
    that context, and they lose all perspective. They are not
    living really in the same world that everybody else is living
    when they are dealing with these kinds of dollars under these
    sorts of conditions.
        And I have to go back to what Congressman Higgins was
    asking about before. Because if you're Richard Fuld, I mean,
    how do you lose all commonsense? I'm looking at these
    statements that he made. Late in the game, like right before
    this thing falls apart, our global franchise and brand name--
    our brand have never been stronger. In June 2008, still in this
    year, our capital liquidity positions have never been stronger.
    This is a no-win statement from him. Because either he has lost
    all perspective and is completely clueless in a statement like
    that or he is quite savvy but he is deceiving people
    affirmatively.
        You could pull anybody out of any coffeehouse anywhere in
    this country who are small businessmen and you could lay out
    for them the basic metrics of what was happening to this
    company at that moment in time and they would say, are you
    kidding me? Are you kidding me that this was a strong position?
    I mean, anyone would recognize that.
        So here is my question. How does this happen? Talk to me a
    little bit about the culture, the external culture--in other
    words, if you're Richard Fuld, you've got your company's
    culture that you're dealing with, and then you have the larger
    culture. So what happens that makes him lose such perspective?
    Or, if you want to look at it another way, think he can get
    away with this kind of public pronouncement. Is it the parties
    you're going to? Is it the fact that the analyst division of
    your own company suddenly evaporates and stops doing its job? I
    mean, what is happening to get you to this point? Anybody. Yes.
        Mr. Wescott. Let me take the first cut at this.
        Think of the--you're having a monthly management meeting of
    your management team, you have the heads of your profit units
    there, and you're giving--if you're the CEO, you're giving them
    their profit targets, let's say, for the quarter. This trading
    desk, you're expected to have $100 million of profit; that
    trading desk, $50 million; and so on. In the room, you have the
    corporate risk officer; and these companies--all of the
    investment banks have risk officers. Their job is to be looking
    at the financial developments, at the trends of housing prices,
    subprime loans and so on. And when you're sitting around the
    table, the profit managers are explaining what their prospects
    are for hitting that profit target.
        Presumably, the risk officers there are saying, we are
    getting kind of nervous here, because we're now pushing the
    envelope in this area. I think maybe we need to cut back the
    profit target for that--let's say, that trading activity or
    whatever activity, because it is starting to feel risky.
        Ultimately, that is what the CEO is being paid for. He is
    being paid for that judgment, hearing the debate that is going
    on. And probably in many of these cases, the risk officers were
    not speaking up quite loudly enough.
        Ms. Minow. Mr. Sarbanes, I always say when I look at boards
    of directors, more than being a financial analyst, more than
    being a lawyer, I'm an anthropologist. Because I think you have
    to look at kind of the anthropology of the board room. And when
    you have a CEO who picks his board to make sure that it is a
    bunch of retirees who barely know what a derivative is and have
    a risk committee that meets only twice in a year, you have kind
    of an emperor's new clothes problem. Nobody wants to tell him
    the truth, and he intentionally surrounds himself with people
    who are complicit.
        If you look at the part of my testimony where I talk about
    the related party transactions, these are people who were
    getting side payments from the company. They had no incentive
    to provide any kind of independent oversight, and that is why
    it is so important to let shareholders like Mr. Smith throw
    some of these people out.
        Mr. Sarbanes. Well, they called Mr. Fuld the gorilla,
    right? So maybe they should have had Jane Goodall in there
    doing an analysis from an anthropol--thank you, Mr. Chairman.
        Chairman Waxman. Thank you, Mr. Sarbanes.
        Mr. Welch.
        Mr. Welch. Thank you. Thank you, Mr. Chairman. I thank the
    witnesses.
        Mr. Wallison, I happen to agree with some of your criticism
    about Fannie Mae and Freddie Mac and the walk-away bonuses to
    the folks who ran that company, those public enterprises, into
    the ground are pretty despicable. And, you know, frankly it is
    mystifying to me why somebody would get over $100 million for
    essentially buying and selling mortgages. It is not that
    complicated.
        They, as a public entity, are now prohibited from lobbying.
    I have a question of you. Do you believe that, in view of the
    fact that the taxpayers now have $700 billion in the game, that
    restriction on lobbying should apply to banks or other agencies
    that choose, choose to participate in the benefit of this
    taxpayer bailout?
        Mr. Wallison. No. The restriction on Fannie Mae and Freddie
    Mac from lobbying comes from the fact that they are now
    controlled by the Federal Government. There isn't any need for
    them to come to Congress and inform Congress in particular.
    Lobbying serves a very valuable function, in my view, of
    informing Congress of what the legislation will actually do.
        Mr. Welch. Let me just clarify it. The distinction between
    a paid lobbyist and then representatives on the actual payroll
    of Fannie Mae and Freddie Mac coming in, for which I have no
    objection.
        Mr. Wallison. I don't see a difference, really, between
    those two, whether you are salaried by the company or whether
    you are retained outside. Lobbyists have a valuable function;
    and Congress should consult with, listen to lobbyists. You have
    to discount them appropriately, listen to both sides. But it is
    a very dangerous thing for Congress or anyone else to wall
    yourself off from the information that the companies themselves
    can provide about the effect of your legislation.
        Mr. Welch. All right. Let me rephrase the question a little
    bit. I do agree with you that lobbying is a very valuable
    activity for people that come in and petition. My question is
    whether taxpayers should help pay for it.
        Mr. Wallison. Sure. Of course. For individual companies--
    Mr. Congressman, if I can just finish the question--this is
    very important for them to make sure that Congress people who
    are making decisions on legislation that could affect them
    substantially are well informed and that directly affects the
    shareholders.
        Mr. Zingales. I agree with you, Congressman.
        Mr. Welch. And the question--I just want to rephrase it,
    because I don't want to turn this into lobbying or not. But the
    question really has to do with the fact that there is $700
    billion of taxpayer money in this bailout effort. And should
    any of that money be allowed to be used for lobbying
    activities?
        Mr. Zingales. Yeah. I think that you are right. It should
    not be used for lobbying. But, most importantly, I think that
    lobbying does serve a useful purpose, but it is also true that
    it is an unfair game. Because clearly sort of financial firms
    have much more power than the public interest. So the public
    interest always loses out in lobbying.
        Mr. Welch. OK. I mean, we've heard--I'll ask Ms. Minow. You
    look like you want to weigh in on this.
        Ms. Minow. Thank you very much, Congressman. There is one
    point that I would like to make.
        I would hope that the committee would take a look at
    Bethany McLean's article in Fortune Magazine about Fannie Mae.
    Because it wasn't just the lobbying. It was the fact that their
    foundation had events in all of the congressional districts
    that--for their Oversight Committee that I think played a very
    big role in it. So it is more than just lobbying.
        Mr. Welch. All right. Mr. Smith, do you think if we had
    stronger shareholder representation on the board so that the
    policies that were then being advocated by the company, if we
    had those stronger shareholder representatives on the board of
    governance, that would help address this issue?
        Mr. Smith. Absolutely. I think that is the key to--it is
    really the solution. Because I think to cutoff lobbying does
    isolate you. And what we need to have is a balanced opportunity
    to be heard by the interested parties, and I think that is the
    piece that is lacking or has been lacking.
        Mr. Welch. OK. Dr. Wescott, do you have anything to add to
    this?
        Mr. Wescott. No.
        Mr. Welch. You know, we have been asking a little bit about
    this corporate pay an awful lot because it is the symbol of
    outrageous excess and abuse.
        Mr. Prince was in here before. He got $38 million when he
    walked away, lost about $20 billion in two quarters.
        Mr. Mozilo of Countrywide, another great American
    entrepreneur, was given $120 million; and he ran his company
    into the ground.
        Mr. O'Neal from Merrill Lynch got a walk-away package of
    $161 million. Also, in the last two quarters before he left,
    they lost about $20 billion for the shareholders.
        And all of us think that is a bit odd. Do you believe there
    should be a right of the taxpayers to have whatever rights
    would be available to the company to claw back some of that
    rip-off walk-away money in the event those companies choose to
    participate in this bailout?
        Mr. Zingales. Yes.
        Mr. Welch. Mr. Zingales. Mr. Wescott.
        Mr. Wescott. Yes. If the government is part owner of the
    firm, it should have the rights of a part owner.
        Mr. Welch. OK. Mr. Wallison, how about you?
        Mr. Wallison. Yeah. If the compensation was, in fact, not
    properly earned, the shareholders, the company should be able
    to get it back.
        Mr. Welch. Yeah. And would we all basically agree that
    these guys got out of dodge before the house of cards
    collapsed?
        Ms. Minow. Yes.
        Mr. Welch. But it put in place the rot in the beams that
    led to its falling down.
        Ms. Minow. Congressman, if a private entity were
    participating in some kind of a transaction of owning
    distressed securities, they would insist on those rights and
    the taxpayer should certainly insist on them as well.
        Chairman Waxman. Thank you, Mr. Welch.
        Mr. Welch. Thank you, Mr. Chairman.
        Chairman Waxman. Mr. Shays.
        Mr. Shays. Thank you, Mr. Chairman.
        I want to apologize. I'm going to make some reference to my
    statement. I had been hoping that I could do that earlier,
    because it has context to the questions that I want to ask. I'd
    like to know your response to what I'm about to say.
        At the center of our financial crisis is the collapse of
    the housing market. So it is surprising to me we are not taking
    a close look at Fannie Mae and Freddie Mac. But what is also
    glaringly missing from these hearings is an intense
    investigation about the role of Congress in this disaster,
    particularly as it relates to Fannie Mae and Freddie Mac.
    Together, these two giant financial institutions scrutinize
    half of our Nation's $12 trillion mortgage market.
        Clearly, Wall Street bears significant responsibility for
    this crisis. The leaders of these financial institutions need
    to explain how overleveraging, undercapitalization of peak
    accounting and minimal investor disclosure ever seemed like
    sound business practices. Every part of the financial market
    broke down. Wall Street accumulated far too much debt;
    consumers lived on credit, often refinancing their homes to get
    it; lenders lured buyers into houses they couldn't afford;
    investment firms did not disclose the risks associated with
    their products; the rating agencies seemed oblivious to shaky
    financial instruments and the companies that bought and sold
    them; and the Federal Government, including Congress, failed to
    properly regulate. The regulatory structure was failing, and we
    in Congress refused to do anything about it.
        In the interest of truth, it must be said we are not
    confronting the 800-pound gorilla in the room. What we're not
    confronting is the role of Fannie Mae and Freddie Mac in this
    debacle. Combined, these two companies not only scrutinized
    half of the Nation's mortgage market but one train alone in
    subprime loans. Yet they are not required to disclose the risk
    these mortgages posed to the solvency of their balance sheets.
        Why? Because we in Congress have not required the same
    registration reporting requirements of Fannie and Freddie as we
    do with all other publicly traded companies.
        The efforts of a few of us in Congress to address this
    situation are a matter of public record. Our efforts can be
    found in legislation, in hearings and debates and votes in
    committee and on the floor of the House.
        When it came to Fannie and Freddie, lobbyists effectively
    manipulated both sides of the aisle. Fannie and Freddie hired
    lobbyists to advocate for their position and kept countless
    lobbyists on retainer to prevent them from arguing against
    their position. Congress stood idly by as Fannie and Freddie
    played with trillions of dollars under a different set of rules
    with little capital to protect their balance sheets from sudden
    losses.
        There is no way to explain it. The reason--there is no
    other way to explain it. The reason we haven't scheduled
    hearings on these two institutions and haven't requested
    documents from either is because their demise isn't someone
    else's fault, it is ours; and we don't want to own up to it.
        Mr. Chairman, the alarm bells were sounded more than 4
    years ago. I requested transcripts of these public discussions.
    I request that the transcripts of the following committee and
    House debates be placed in the record for today's hearing:
        July 23, 2002, Financial Services Committee hearing, OFHEO
    Risk-Based Capital Stress Test for Fannie Mae and Freddie Mac.
        July 23, 2003, Financial Services Committee markup, H.R.
    2420, the Mutual Funds Integrity and Transparency Act.
        September 25, 2003, Financial Services Committee hearing,
    H.R. 2573, the Secondary Mortgage Market Enterprises Regulatory
    Improvement Act and the Administration's Proposals on GSE
    Regulation. That was September 25, 2003.
        October 6, 2004, Financial Services Subcommittee hearing,
    the OFHEO Report: Allegations of Accounting and Management
    Failure At Fannie and Freddie.
        April 6, 2005, Financial Services Committee hearing,
    Additional Fannie Mae Failures.
        October 26, 2005, floor debate, consider Mr. Royce
    amendment to H.R. 4161 to strengthen the OFHEO regulator.
        Getting to the bottom of this--that's my motion, that we
    introduce these into the record.
        Chairman Waxman. If the gentleman would permit, I would
    suggest that we make reference to all of those, and people then
    can link into those, rather than spend taxpayers' money to
    reproduce all of those records, if that is acceptable.
        Mr. Shays. That is acceptable.
        Chairman Waxman. Then, without objection, that will be the
    order.
        Mr. Shays. Getting to the bottom of this, whatever that
    takes, is our obligation but requires us not to just look at
    CEOs of Lehman or AIG but at ourselves and the wretched
    manipulation by Fannie Mae and Freddie Mac of the Congress of
    the United States.
        With the limited time I have left, I would like--I have no
    time left.
        Chairman Waxman. If the gentleman would permit and yield to
    me, we have five hearings scheduled on the issues of where we
    are in the economy and what has happened with Wall Street, and
    the gentleman raises issues about Freddie Mac and Fannie Mae.
    Our staff is already looking into some of the documents
    relating to them, and we may well add additional hearings. We
    are not restricted to those five hearings, and I appreciate the
    concern that has been raised.
        Mr. Shays. Will the gentleman yield?
        Chairman Waxman. Yes, sir.
        Mr. Shays. Given that the housing market is what brought
    down everyone else, why wouldn't we start with Fannie Mae and
    Freddie Mac, given they were exempted from the 1934 law, the
    1933 law and given that we all know that they hired lobbyists
    to work their will in Congress? Why would we not be looking at
    Congress? Why are we looking at everyone else but Congress?
        Chairman Waxman. Well, I have no reason not to look at
    Congress. We'll be happy to look at Congress. It has been
    controlled by the Republican party for a 12-year period; and
    during the 2 years the Democrats have been in control, it has
    been controlled by a Republican administration. We ought to
    look at the politics of why we haven't gotten further.
        But trying to understand where we have been and where we
    are now and what the causes were and what reforms are necessary
    is the objective of this committee. And you can't do everything
    all at once. We'll start with the first hearing today, and
    we'll go on to the next one tomorrow, and we'll go on from
    there.
        We have completed all of the members who sought
    recognition. Mr. Mica----
        Mr. Mica. Mr. Chairman, given the importance of this
    hearing and again asking for fairness for both sides, I would
    ask unanimous consent that each side be given an additional 10
    minutes to be distributed by the Chair and the acting ranking
    member for additional questions of this panel.
        Chairman Waxman. The Chair is going to object to that. We
    have had a very long time with this panel, and we have Mr. Fuld
    waiting. But the Chair will note that there are many more
    Democratic Members here than Republican Members, and I will
    allocate 5 minutes to the Republicans between the two of you to
    ask any further questions that you wish to pursue of this
    group. Who should control that time?
        Mr. Shays. I will control it and yield to my colleague 3
    minutes. Thank you, Mr. Chairman.
        Chairman Waxman. OK.
        Mr. Mica. Well, actually, I'm quite disappointed. I was----
        Mr. Shays. I'd be happy to yield my colleague 5 minutes.
        Mr. Mica. I was berated by the Chair in the bipartisan
    matter in which I conducted my subcommittees. I'm the ranking
    member of the largest committee in Congress. I chaired the
    subcommittee--Aviation Subcommittee for 6 years, never once
    denied a single Democrat or Republican the opportunity to fully
    participate in offering an opening statement or asking a
    question. I'm really--I'm really saddened by the way this is
    being conducted, because this is an important hearing and there
    are important questions that the people want answered. And if
    he wonders why people aren't on this side, if you can't
    participate, why the hell should you be here? But that's
    another matter.
        I have a couple of questions of my remaining time.
        So now that we have no major investment banks, Mr.
    Wallison, what do we do in regulating them?
        Mr. Wallison. Well----
        Mr. Mica. That's a rhetorical question.
        Mr. Wallison. Nothing to regulate at the moment--firms,
    incidentally, all of which could become investment banks over
    time.
        Mr. Mica. Yeah. Well, I think that some of the things that
    were raised here, transparency, leveraging, would you say that
    by Fannie Mae reducing its reserves from 10 percent to 2.5
    percent, that others in the private sector--people don't
    understand that we had a government-backed securities
    operation, which was Fannie Mae, and they were backed by the
    U.S. Government. Lehman, AIG and the others are private--were
    private investment activities; is that correct?
        Mr. Wallison. Yes, it is.
        Mr. Mica. OK. Not that they should be precluded. But when
    you have ones reduce their reserves, then what happens? Wall
    Street follows usually to compete. Isn't that what happened?
        Mr. Wallison. No. Actually, Congressman----
        Chairman Waxman. Is your mic on?
        Mr. Wallison. Sorry. The capital of Fannie and Freddie were
    set by statute. That was one of the regulatory problems that
    are associated with those two enterprises.
        Mr. Mica. My point, though, is that, in most of this, Wall
    Street followed.
        Now, of course, Raines only took off with $100 million in
    compensation, and we have--and that was a government-sponsored
    activity. That is absolutely outrageous. Mr. Shays tried to
    bring that under control. He introduced legislation. I was a
    cosponsor in 2002.
        And then people in Congress--and we don't have anyone from
    Fannie Mae here to start this out. This is ridiculous. Fannie
    Mae--who was the biggest private mortgage lender in the
    country? Wasn't it Countrywide, Mr.----
        Mr. Wallison. Countrywide, yes.
        Mr. Mica. Countrywide. OK. How is this, Mr. and Ms.
    America? Franklin Raines received a 5.1 percent loan for 10
    years for almost a million dollars in refinancing. Jamie
    Gerlach received 5 percent for a $960,000 refinancing, both
    employees. This is a government activity, outrageous. And they
    walked away with millions of dollars, and we are not looking at
    that.
        Then the guy that writes the bailout package in the Senate
    gets--he got one of these VIP Countrywide mortgages for
    himself, and we are just trying to blame Wall Street. Is that
    fair? I want everyone to----
        Mr. Wallison. There has been greed all around, I would say.
    Greed all around.
        Mr. Mica. OK. Was it greed, Mr. Smith, or just a good deal
    for the few elected officials and somebody behind a government
    mortgage company who was ripping folks off?
        Mr. Smith. I would certainly say it is not actions in the
    best interest of the shareholders.
        Mr. Mica. Ms. Minow.
        Ms. Minow. Sorry. I think there are profound conflicts of
    interests, and I hope that there is oversight of Fannie and
    Freddie and Congress.
        Mr. Mica. Doctor.
        Mr. Wescott. There is plenty of blame to go around. The
    truth is that Fannie actually lost market share in some of
    these mortgage areas in the years in question.
        Mr. Mica. To the private sector competing with trying to
    keep up with what the government was doing.
        Mr. Wescott. Right.
        Mr. Mica. What government-backed activity was doing. Thank
    you.
        Mr. Zingales. Conflict of interests are always dangerous,
    whether they are in Wall Street, in Congress or in a political
    opposition. It is always dangerous.
        Mr. Mica. How again do you bring this under control--and go
    down the panel--given the cards that we are currently dealt?
    That is my question.
        Mr. Wallison. Well, there was an excellent bill that came
    out of the Senate Banking Committee in 2005. That bill would
    have allowed a regulator to control their capital which would
    have immediately reduced their risks and controlled their
    portfolios, which are a major source of their risks. That was a
    partisan vote. All Republicans voted for it; all the Democrats
    voted against it.
        Mr. Mica. And then who was chairman and--who was chairman
    and then who blocked it as the ranking member?
        Chairman Waxman. The gentleman's time has expired.
        Mr. Mica. Excellent.
        Chairman Waxman. The chairman will now take his 5 minutes.
    And I don't think we ought to use these hearings as an
    opportunity to be partisan, because Freddie and Fannie had
    people in charge when Clinton was President that got excessive
    salaries and bonuses, but so did Mr. Mudd, who was appointed by
    President Bush.
        But what we're starting to look at in these series of
    hearings of how we got into this mess is what has happened with
    one of the companies that has actually gone bankrupt and for
    which many people have told us this started in a direct line to
    the $700 billion that the Congress has now approved to give to
    the Treasury to help stabilize our economy. To start off with
    Lehman I think is perfectly appropriate. To look at Freddie Mac
    and Fannie Mae is also appropriate. And we should look at all
    of these issues.
        But what struck me from your presentation today--and I
    thank the panel very much for what you had to tell us--is that
    there seems to be almost no accountability to the people who
    own the corporations. They are the ones who own it, and they
    are the ones who take the loss when the company goes bankrupt.
    There seems to be no transparency in what is going on.
        It appears that the CEO controls the decisions with a board
    that is hand picked in many circumstances, and it certainly
    appears to be the case with Lehman Brothers. And the CEO can
    play with other people's money. And not just play with other
    people's money, he can borrow a lot of money to leverage the
    money he has to play with. And if times are good, that leverage
    can bring in enormous amounts of profit. But if times are bad,
    then he can lose his footing for his corporation very, very
    quickly.
        It does seem to me that ordinary people play by a different
    set of rules than they do on Wall Street because ordinary
    people in this country--many of them have lost their jobs, have
    lost their homes. Everyone has seen their health care costs go
    up, if they're lucky enough to have health care insurance. And
    if they're not, when they go to see a doctor to access the
    system, they know how expensive it all is, especially if they
    buy drugs. And if they fail in their jobs, they are held
    accountable. They don't get the promotions. They don't get the
    bonuses. And, in fact, they get fired. Even if they have done a
    good job they get fired if the corporations run into troubles.
        But the CEOs seem to always come out on top. They win when
    the corporation wins, and they win when the corporation tanks.
    And there is something that is fundamentally troubling about
    that, because there is no accountability and there is no
    consequence.
        So as we look at how to reform the system, I think we--we
    need more transparency on Wall Street. We have a vast explosion
    in new investments, complex financial instruments like credit
    default swaps, derivatives, collaterized debt obligations.
    There is no way for an investor to discipline firms that invest
    in these derivatives because there is so little disclosure. And
    as I heard you, Mr. Smith, it is hard for you to do anything--
    as representing a good number of investors to do anything about
    what a corporation's actions are because the corporation is so
    closed. Is that an accurate statement?
        Mr. Smith. Yes, it is.
        Chairman Waxman. So I think as we look at how we got into
    this situation. We have to recognize that there have been
    people who have been able to play games with other people's
    money and never had to face the consequences themselves or
    failure. There is not enough transparency as to what they are
    doing, there is not enough control by even their shareholders,
    and the regulators are toothless either because the laws don't
    allow them to regulate or they are just not regulating because
    they are short on their budget or short on their commitment.
        So maybe we can say everybody is responsible, everybody is
    to be blamed. But I know one thing. The $700 billion is now
    going to be paid for by taxpayers in hopes that we stabilize
    our financial markets.
        There is no guarantee that we are going to return to health
    right away. We hope we can do that. But what this committee is
    trying to do is to understand how we got into this situation
    and give some recommendations. Not that we have the
    jurisdiction--out of our legislation--but to those committees
    that do have the jurisdiction, to think through whether there
    ought to be a limit on the amount of money that they can
    leverage, there ought to be limits in transparency, there ought
    to be limits on shareholder--limits on CEO pay, and whether
    there ought to be a lot more openness to shareholder influence
    in the companies that they presumably own.
        I thank you all very much for your presentation; and we are
    going to now move onto the second panel, which will be Mr.
    Fuld. Thank you.
        Let's take a few minute recess while this panel leaves, and
    then we are going to have Mr. Fuld take his place. Let's have a
    3-minute break.
        [Recess.]
        Chairman Waxman. The committee will come back to order.
        We have Richard S. Fuld, Jr., chairman and CEO of Lehman
    Brothers. He has been the chairman and CEO of Lehman Brothers
    since 1993, and we are pleased to have Mr. Fuld here to
    testify.
        Mr. Fuld, it is the practice of this committee that all
    witnesses that testify do so under oath. So if you would please
    stand and raise your right hand.
        [Witness sworn.]
        Chairman Waxman. The record will indicate that Mr. Fuld
    answered in the affirmative.
        We are anxious to hear from you. We have your prepared
    statement. It will be in the record in its entirety, and we
    will--we'll give you whatever time you want. But be mindful of
    the fact that your whole statement is already in the record. So
    go ahead with your oral presentation.
        We usually ask witnesses to stay to 5 minutes, but I don't
    want to limit you to 5 minutes if you feel you need more time.
    There is a button on the base of the mic. Be sure it is pressed
    and pull it close to you.

    STATEMENT OF RICHARD S. FULD, JR., CHAIRMAN AND CHIEF EXECUTIVE
                   OFFICER, LEHMAN BROTHERS HOLDINGS

        Mr. Fuld. Chairwoman Waxman, Ranking Member Davis and
    members of this distinguished committee, today there is
    unprecedented turmoil in our capital markets. Nobody, including
    me, anticipated how the problems that started in the mortgage
    markets would spread to our credit markets and our banking
    system and now threaten our entire financial system and our
    country.
        Like many other financial institutions, Lehman Brothers got
    caught in this financial tsunami. But I want to be very clear.
    I take full responsibility for the decisions that I made and
    for the actions that I took. Based on the information that we
    had at the time, I believed that these decisions and actions
    were both prudent and appropriate.
        None of us ever gets the opportunity to turn back the
    clock. But with the benefit of hindsight, would I have done
    things differently? Yes, I would have.
        As painful as this is for all of the people affected by the
    bankruptcy of Lehman Brothers, this is not just about Lehman
    Brothers. These problems are not limited to Wall Street or even
    Main Street. This is a crisis for the global economy.
        We live in a world where large investment--large
    independent U.S. investment banks are now extinct, where AIG
    and Fannie Mae and Freddie Mac are under government control and
    where major institutions are being rescued and where regulators
    are engaged in a daily struggle to stabilize the financial
    system. In this environment, it is not surprising that the
    media coverage of Lehman's demise has been rife with rumors and
    inaccuracies. I appreciate the opportunity to set the record
    straight for this committee and to be as helpful as possible in
    explaining why we ultimately could not prevent a bankruptcy
    filing. And then I want to respond to your questions.
        I'm a Lehman lifer. I joined as an intern in 1966 and got a
    full-time job as a commercial paper trader while earning my
    business degree at night. In 1994, when Lehman Brothers was
    spun out of American Express as a separate company and I became
    the CEO, we were a small domestic bond firm. By 2007, we had
    built Lehman into a diversified global firm with 28,000
    employees. I feel a deep personal connection to those 28,000
    great people, many of whom have dedicated their entire careers
    to Lehman Brothers. I feel horrible about what has happened to
    the company and its effects on so many, my colleagues, my
    shareholders, my creditors and my clients.
        As CEO, I was a significant shareholder; and my long-term
    financial interests were completely aligned with those of all
    the other shareholders. No one had more incentive to see Lehman
    Brothers succeed. And because I believed so deeply in the
    company, I never sold the vast majority of my Lehman Brothers
    stock and still owned 10 million shares when we filed for
    bankruptcy.
        As I said, following the spin-off of Lehman Brothers from
    American Express, our business was almost exclusively at a
    fixed income. We recognized the need for diversification, and
    over the subsequent 14 years we built and acquired significant
    equity and asset management businesses. We established a
    presence in 28 countries. We also continually strengthened our
    risk management infrastructure.
        Lehman Brothers did have a significant presence in the
    mortgage market. This should not be surprising, though. U.S.
    residential mortgages are an $11 trillion market, more than
    twice the size of the U.S. Treasury market and a serious
    participant in the fixed-income business, had a significant
    presence in the mortgage market.
        As the environment changed, we took numerous actions to
    reduce our risk. We strengthened our balance sheet, reduced
    leverage, improved liquidity, closed our mortgage origination
    businesses and reduced our exposure to troubled assets. We also
    raised over $10 billion in new capital. We explored converting
    to a bank holding company. We looked at a wide range of
    strategic alternatives, including spinning off our commercial
    real estate assets to our shareholders.
        We also considered selling part or all of the company. We
    approached many potential investors, but in a market paralyzed
    by a crisis in confidence none of these discussions came to
    fruition. Indeed, contrary to what you may have read, I never
    turned down an offer to buy Lehman Brothers.
        Throughout 2008, the SEC and the Federal Reserve conducted
    regular and at times daily oversight of our business and our
    balance sheet. They saw what we saw in real time as they
    reviewed our liquidity and our funding, our capital risk
    management and our mark-to-market process.
        As the crisis in confidence spread throughout the capital
    markets, naked short sellers targeted financial institutions
    and spread rumors and false information. The impact of this
    market manipulation became self-fulfilling as short sellers
    drove down the stock prices of financial firms, the rating
    agencies lowered their ratings because lower stock prices made
    it harder to raise capital and reduced financial flexibility.
    The downgrades in turn caused lenders and counter parties to
    reduce credit lines and then demand more collateral, which
    increased liquidity pressures.
        At Lehman Brothers, the crisis in confidence that permeated
    the markets led to an extraordinary run on the bank. In the
    end, despite all of our efforts, we were overwhelmed.
        However, what happened to Lehman Brothers could have
    happened to any financial institution and almost did happen to
    others. Bear Stearns, Fannie Mae, Freddie Mac, AIG, Washington
    Mutual and Merrill Lynch all were trapped in this vicious
    cycle. Morgan Stanley and Goldman Sachs also came under attack.
        Lehman's demise was brought on by many destabilizing
    factors: the collapse of the real estate market, naked short
    attacks, false rumors, widening spreads on credit default
    swaps, rating agency downgrades, a loss of confidence by
    clients and counter parties and buyers sitting on the sidelines
    waiting for an assisted deal.
        Again, this is not just a Lehman Brothers's story. It is
    now an all-too-familiar tale. It is too late for Lehman
    Brothers, but the government has now been forced to
    dramatically change the rules and provide substantial support
    to other institutions.
        I greatly appreciate the opportunity to speak with you
    today; and if I can be helpful to this committee in any way to
    understand how we got here and what our country can do to move
    forward, I am happy to do so. Thank you, sir.
        Chairman Waxman. Thank you very much, Mr. Fuld.
        [The prepared statement of Mr. Fuld follows:]
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        Chairman Waxman. Without objection, the Chair and the
    ranking member will control 10 minutes which they can use or
    reserve and use at a subsequent time. Hearing no objection,
    that will be the order.
        The Chair will recognize himself.
        Mr. Fuld, the committee--our committee requested all the
    documents relating to your salary, bonuses and stock sales; and
    the committee staff put together a chart, which I hope will
    come up on the screen. This chart will show your compensation
    for the last 8 years. It shows your base salary, your cash
    bonuses and your stock sales.
        In 2000, you received over $52 million. In 2001, that
    increased to $98 million. It dipped for a few years. And then,
    in 2005, you took home $89 million. In 2006, you made a huge
    stock sale; and you received over $100 million in that year
    alone. Are these figures basically accurate?
        Mr. Fuld. Sir, if those are the documents that we provided
    to you, I would assume they are.
        Chairman Waxman. OK. The bottom line is that, since 2000,
    you have taken home more than $480 million. That is almost half
    a billion dollars, And that is difficult to comprehend for a
    lot of people. Your company is now bankrupt, our economy is in
    a state of crisis, but you get to keep $480 million. I have a
    very basic question for you. Is this fair?
        Mr. Fuld. Mr. Chairman, your first question was about this
    slide: Are those numbers accurate? They are accurate the way
    you have put them up on that slide, but--I believe your number
    of cash and salary bonuses are accurate. The option exercises--
    the way you have them portrayed here I believe represent the
    full option without the strike price. And the only reason I
    exercised those options is because they came due at maturity.
    If I had not exercised those, I would have lost it. There was
    that stock sale----
        Chairman Waxman. Well, I will leave the record open for you
    to give me any changes in that list.
        Mr. Fuld. What I would say to you----
        Chairman Waxman. But, basically, didn't you take home
    around $400 to $500 million as the head of Lehman Brothers for
    the last--since 2000 to now?
        Mr. Fuld. The majority of my stocks, sir, came--excuse me--
    the majority of my compensation came in stock. The vast
    majority of the stock that I got I still owned at the point of
    our filing.
        Chairman Waxman. The stock is in addition to the numbers
    that I have indicated. Because those were your salary and your
    bonuses. Now, you had bonuses; and, in addition to that, you
    had some stock sales. You have lost some money of the stock
    that you have received as compensation, which you received as
    compensation on top of these other figures. So you have been
    able to pocket close to half a billion dollars. And my question
    to you is, a lot of people ask, is that fair for the CEO of a
    company that is now bankrupt to have made that kind of money?
    It is just unimaginable to so many people.
        Mr. Fuld. I would say to you that the 500 number is not
    accurate. I would say to you that, although it is still a large
    number, I think for the years that you're talking about here, I
    believe my cash compensation was close to $60 million, which
    you have indicated here. And I believe the amount that I took
    out of the company over and above that was, I believe, a little
    bit less than $250 million. Still a large number, though.
        Chairman Waxman. Still a large amount of money. You have a
    14 million ocean front home in Florida. You have a summer
    vacation home in Sun Valley, Idaho. Yet you and your wife have
    an art collection filled with million dollar paintings. Your
    former President, Joe Gregory, used to travel to work in his
    own private helicopter.
        I guess people wonder if you made all this money by taking
    risks with other people's money, you could have done other
    things. You had high leverage, 30 to 1 and higher. You didn't
    pay out billions of dollars in dividends. And you didn't have
    to pay out these millions of dollars in dividends and bonuses.
    You could have saved some of these funds for lean times, but
    you didn't.
        Do you think it is fair and do you have any recommendations
    on fundamental reforms that would bring a new approach to
    executive compensation? Because it seems that the system worked
    for you, but it didn't seem to work for the rest of the country
    and the taxpayers who now have to pay up to $700 billion to
    bail out our economy.
        We can't continue to have a system where Wall Street
    executives privatize all the gains and then socialize the
    losses. Accountability needs to be a two-way street. Do you
    disagree with that? And do you have any recommendations of what
    we ought to be doing in this area?
        Mr. Fuld. Mr. Chairman, we had a compensation committee
    that spent a tremendous amount of time making sure that the
    interests of the executives and the employees were aligned with
    shareholders. My employees owned close to 30 percent of our
    company; and that was because we wanted them to think, act and
    behave like shareholders. When the company did well, we did
    well. When the company did not do well, sir, we did not do
    well.
        Chairman Waxman. Well, Mr. Fuld, there seems to be a
    breakdown. Because you did very well when the company was doing
    well and you did very well when the company wasn't doing well.
    And now your shareholders who owned your company have nothing.
    They have been wiped out.
        I'm going to reserve the balance of my time, and we are
    going to go on to other Members. Mr. Shays.
        Mr. Shays. If you'd yield me 2 minutes.
        Mr. Fuld, I'd like to ask you first, who appoints the
    compensation committee?
        Mr. Fuld. The compensation committee is now appointed by
    the corporate governance committee of the board.
        Mr. Shays. But did you have a major role in appointing the
    compensation committee?
        Mr. Fuld. I believe I had more of a role in the early or
    mid-'90's. Clearly less of a role these last number of years.
        Mr. Shays. And then, finally, of the 10 million shares that
    you had in the company--that is what you have right now, 10
    million shares?
        Mr. Fuld. No. I don't have the exact amount. I think it is
    closer to 8 million shares, and that does not include the
    options that expired that are worthless. Well, actually, they
    haven't expired--that are still there with a longer term
    vesting but with a much higher strike price than, obviously,
    where the stock is today.
        Mr. Shays. Thank you.
        Thank you, Mr. Chairman.
        Chairman Waxman. Thank you, Mr. Shays.
        I want to recognize Mrs. Maloney for 5 minutes.
        Mrs. Maloney. Thank you, Mr. Chairman.
        We are in a financial crisis, and we lost four major
    investment banks in a week, and taxpayers have been called upon
    to assume a potential $1.7 billion in taxpayer liability to
    backstop our financial institutions. During this hearing today,
    we have seen a long list of examples of deregulation and we
    have heard about the net capital rule, which was eliminated so
    that Lehman and other investment banks could ramp up their
    leverage to very dangerous high levels, putting their
    institutions at risk. And for almost 30 years this rule kept
    investment banks from taking on debt more than 12 times the
    value of the banks' investments. Firms were required to stop
    trading if their debt exceeded that ratio. As a result, most
    investment banks did not take on excessive debt.
        Yet this report in the New York Times--and I'd like
    permission to have it referenced or put in the record----
        Chairman Waxman. Without objection.
        Mrs. Maloney [continuing]. Last Friday, called the Agency's
    2004 Rule Let Banks Pile Up New Debt. And many people feel that
    this was a major cause of the crisis, and they reference a
    meeting in April 2004.
        And I'd like to ask you, were you at that meeting? Did you
    lobby for this change? Why did Lehman want to increase its
    leverage? And, in hindsight, do you think the SEC rule--that
    changing this SEC rule was appropriate for protecting safety
    and soundness, the stability of our markets and taxpayers'
    money?
        Mr. Fuld. Congresswoman, I was not at that meeting, I
    believe, in 2004. And I do not recall if any other of my people
    were there. I had a chance to--while I was sitting in the
    waiting room, I saw, I would assume, almost all of the first
    panel. The information about leverage I think has been grossly
    misunderstood.
        There are two numbers. One is gross leverage, and one is
    net leverage. Gross leverage includes--excuse me if I get
    technical. If I get too technical, please stop me. Close to
    half of our balance sheet, if not more, was what we called the
    matched book. The matched book was predominantly government
    securities and agencies that we took on our balance sheet to
    finance for our clients. We were one of the top U.S. Treasury
    Government traders and financiers, meaning financing the U.S.
    Government debt. And we supplied a tremendous amount of
    liquidity to institutional investors that owned U.S. Government
    debt and agencies. At times, that was as high as $300 to
    probably more, $300 billion. I heard some of the earlier
    remarks about if you lost 3 or 4 percent of that. For the
    matched book, you do not--those are government securities. So
    the real number, the effective number is net leverage.
        Mrs. Maloney. So did you lobby for this capital rule
    change, and do you think it contributed to the financial
    instability and loss of safety and soundness in financial
    institutions such as your own that allowed this increased
    leverage?
        Mr. Fuld. I myself did not lobby for the increased
    leverage.
        Mrs. Maloney. Did Lehman Brothers lobby for it?
        Mr. Fuld. I am not aware of that.
        Mrs. Maloney. I would like to ask you, now that we have the
    opportunity of looking back, and we want to look forward on
    what needs to be done, if you had to give government advice on
    how we could strengthen the safety and soundness of our
    institutions and the accountability and transparency that all
    of us want, what would you recommend to change the system?
        Mr. Fuld. In my written testimony, I spoke about the need
    for additional regulation and new regulation; because when the
    original regulations were written, it was a very different
    environment. I believe there were 10 million shares a day
    traded, and today there are close to 5 billion shares traded.
    The electronic connectivity today, not only within this country
    but country to country; investors today, given that electronic
    connectivity, have the right to move their money to the highest
    returning asset, and money moves very quickly and freely. So it
    is not just about regulation within the United States. I
    believe it is also about more of a matrix regulation that is
    more global in nature.
        I would focus also on capital requirements, capital
    requirements meaning more capital for less liquid assets, and a
    more robust understanding of mark to market, which I believe is
    one of the pillars of the new plan. Mark to market during
    periods of stress create one set of numbers and obviously, in a
    functioning noncredit crisis environment, produce another set
    of numbers.
        Chairman Waxman. Thank you.
        Your prepared statement, which has these recommendations,
    are in the record. And we want to move on to other questioners.
    Did you want to add one last point?
        Mr. Fuld. Yes, please. And the other is, something I
    strongly believe in, is the creation of what I call a master
    netting system, where all capital market counterparties
    download each night all their transactions to one local spot,
    first in the United States and then eventually hopefully make
    that be global. That is about all transactions and trades. It
    is about positions. It is about capital. It is about leverage.
    And it would give whatever regulator is then in control of that
    master netting system a complete view of the financial
    landscape, the available capital to each and every asset class,
    flexibility within those asset classes and vulnerability within
    those asset classes and vulnerability of one institution versus
    the next. What I am proposing is clearly expensive, costly, but
    by comparison to the unprecedented regulation this Congress has
    just passed, it is a fraction and, I believe, money well spent.
        Chairman Waxman. Thank you.
        Mr. Mica for 5 minutes.
        Mr. Mica. Thank you, Mr. Chairman.
        And looking at, first, your comment on Lehman Brothers
    primarily dealing in some, for most of its history----
        Mr. Fuld. Sir, I apologize, I cannot hear you.
        Mr. Mica. Can you hear me now?
        Mr. Fuld. Yes.
        Mr. Mica. Again, when you opened your statement, you said
    that Lehman Brothers, and it was around for what, 150 years,
    dealt in some pretty hard assets and some secure investments.
    You have been around a while. What turned the corner for you to
    get into some of the more speculative ventures like subprime
    and some of the other, again, riskier investments?
        Mr. Fuld. As I said in my verbal testimony, our
    participation in the mortgage-related businesses was clearly a
    natural for us given our dominance in fixed income. That was
    something that went back a number of years. And even as I
    listened, as I say, to the panel before me, they correctly
    pointed out that this was a goal of the government, to provide
    funding and mortgages to a number of people that typically
    would not or could not have received a mortgage.
        Mr. Mica. And one of your big--well, one of the big
    packagers or the competitors so to speak was Fannie Mae, which
    was deep into this. And you were dealing in some of the paper I
    think for secondary markets and other securitized mortgage
    paper to basically package it and make money off it. Is that
    right?
        Mr. Fuld. Yes, sir.
        Mr. Mica. What was Lehman Brothers' exposure to the debt of
    Fannie Mae and Freddie Mac, and what role did their collapse
    play in precipitating some of your financial troubles? If it
    didn't matter----
        Mr. Fuld. Our exposure to both Fannie Mae and Freddie Mac
    was both de minimis, sir.
        Mr. Mica. OK. But their collapse, did that help precipitate
    any problems with your firm?
        Mr. Fuld. It certainly set the stage for an environment, as
    I talked about loss of confidence and credit crisis mentality,
    that permeated our market; clearly set the stage for investors
    losing confidence, counterparties asking for additional
    collateral, and clearly an environment that lost liquidity,
    which is the life blood of a capital market system.
        Mr. Mica. I noticed some questions were asked about your
    political participation. I pulled Lehman Brothers'
    contributions to Federal candidates for the last 10 years.
    Fortunately, I didn't find my name there. Not like some of the
    other Members of Congress. I added some of this up, it is about
    $300,000 that you gave to influence Members of Congress. I also
    got your personal, which wasn't much, you probably bet a little
    bit too much on Hillary, too. But this is pretty much the
    extent of your financial contributions? To Members of Congress,
    to lobby.
        Mr. Fuld. I believe that was a result of Lehman's PAC----
        Mr. Mica. Right.
        Mr. Fuld [continuing]. Which was not corporate moneys.
        Mr. Mica. Right. I am just telling you. But wait until you
    hear this one. And if you haven't discovered your role, you are
    the villain today. So you have to act like the villain here.
        But guess what Fannie Mae did in the same period of time?
    $175 million in lobbying contracts over 10 years. Does that
    surprise you? You were outlobbied. It sounds like rather than
    just some greed on Wall Street, we had a little greed in
    Washington. What would you say to that?
        Mr. Fuld. I think that is more a matter for your committee,
    sir.
        Mr. Mica. I hope we get to it.
        Thank you.
        Chairman Waxman. The gentleman's time has expired.
        We now go to Mr. Cummings.
        Mr. Cummings. Thank you very much, Mr. Chairman.
        Mr. Fuld, I really appreciate that you began your testimony
    by taking full responsibility for the company's downfall, which
    occurred on your watch.
        But there are some concerns that I want to get to. As you
    know, the American taxpayer, many of them our constituents, we
    just passed legislation giving $700 billion to rescue Wall
    Street. One complaint I have heard over and over again from my
    constituents was that there seems to be a complete lack of
    accountability. They see Wall Street executives like you
    walking away with millions of dollars.
        And it is very interesting when you were talking about the
    chart that Mr. Waxman showed you on the board, you said that it
    was inaccurate. But I am going to discount it for you, and
    instead of $448 million over 8 years, let's say $350. How about
    that? $350? Is that OK? Can we discount it a little bit? You
    said it was not accurate. What would you say is accurate?
        Mr. Fuld. I would say that is closer, sir.
        Mr. Cummings. OK. I want to ask you about one of the e-
    mails obtained by the committee. On June 9, 2008, a former top
    Lehman executive--can you hear me OK?
        Mr. Fuld. Yes, sir.
        Mr. Cummings. Benoit D'Angelin sent an e-mail to Hugh
    McGee, who was the global head of investment banking at Lehman.
    The e-mail says that many bankers have been calling in the last
    few days, and the mood has become truly awful. It warns that,
    ``all the hard work we have put in could unravel very
    quickly.''
        And it offers the following advice. It says, ``some senior
    managers have to be much less arrogant and internally admit
    that major mistakes have been made. We can't continue to say we
    are great, and the market doesn't understand.''
        Mr. McGee forwarded this e-mail to you on the same day and
    explained that it was representative of many others. When you
    read the e-mail, and this is interesting, what was your
    reaction? I am just curious.
        Mr. Fuld. I am sorry, sir, what was the date of that? I am
    sorry.
        Mr. Cummings. That would be June 9, 2008. You remember that
    e-mail?
        Mr. Fuld. I do not----
        Mr. Cummings. Let me try to refresh your recollection a
    little bit. Let me tell you what you did, since you don't
    remember the e-mail. Here is what happened. You didn't take any
    personal responsibility. Instead, 3 days later, Mr. Fuld, on
    June 12th, you fired Erin Callan, your chief financial officer,
    and Joseph Gregory, your chief operating officer, but you
    stayed on and admitted no mistakes. You were CEO. Why didn't
    you take responsibility?
        Like today, you said you took full responsibility, why
    didn't you take responsibility for Lehman's mistakes? Why did
    you continue to say, ``we are great, and the market doesn't
    understand?''
        In your testimony today, right here, right now, you
    continue to deflect personal responsibility. You cite what you
    call a litany of reasons for Lehman's bankruptcy.
        Mr. Fuld, I want to ask you about your personal
    responsibility, since you have taken it. Do you agree that
    Lehman took on excessive leverage under your leadership? Please
    answer yes or no.
        Mr. Fuld. It is not that easy. I will say to you, our
    leverage at times was higher, but as we entered this more
    difficult market over this last year, we continued to bring our
    leverage down so that even at the point, Congressman, on
    September 10th, when we announced our third quarter results, we
    had grossly reduced our balance sheet by close to $200 billion,
    specifically around residential mortgages and commercial real
    estate and leverage loans.
        Mr. Cummings. Mr. Fuld, I have only got about less than a
    minute. I have to get this question in. I assume your answer is
    no. I am just giving you the benefit of the doubt.
        Mr. Fuld. At the end of the day, we worked hard; our
    leverage was way down. One of the best leverage ratios on the
    street. And our tier one capital was one of the highest.
        Mr. Cummings. So you feel comfortable with what you did. Is
    that right? That is not one of the things that you said your--
    --
        Mr. Fuld. Yes, sir.
        Mr. Cummings. OK, fine. Do you regret spending $10 billion
    in Lehman's cash reserves on bonuses, stock dividends, and
    stock buybacks as your firm faced a liquidity crisis? Do you
    regret that now?
        Mr. Fuld. I heard some of that while I was in the other
    room. I think that is a misunderstanding which I would like to
    clear up.
        Mr. Cummings. Well, let me go back to--you go ahead, I am
    sorry.
        Mr. Fuld. Because it is important that this committee
    understands exactly what that was. When I talked about my
    employees owning close to 30 percent, what is typical of Wall
    Street is you take a percentage of your revenues and you pay
    your people. We asked our employees to take a big percentage of
    their compensation in stock. And so what that $10 billion was--
    we had close to $19 billion of revenues--what most of that $10
    billion was, was compensation to our employees that they
    received in stock with a 5-year forward vest. So they didn't
    get that stock until 5 years, which aligned our interests,
    ``our'' being employees, with the interests of shareholders. To
    avoid dilution, because we took that $10 billion, gave it to
    the employees in stock, we had to take the $10 billion that
    they didn't get and go back into the open marketplace and buy
    back that stock so that we did not dilute our shareholders. And
    we did it each and every year. From where you sit, it looks
    like we just spent an extra $10 billion. That is not, sir, what
    we did.
        Mr. Cummings. Thank you very much, Mr. Chairman.
        Chairman Waxman. It sounds like, though, and I yield myself
    time here, that you were trying to not to dilute the payment to
    those employees while you were in a liquidity crisis. Wouldn't
    it have made more sense to use that money to pay off the debts
    that were heavily on your shoulders at that point and you knew
    that you were in a difficult situation?
        Mr. Fuld. At that time, at the end of the year, last year,
    I didn't believe that we had that problem.
        Chairman Waxman. You didn't believe you had a liquidity
    problem.
        Mr. Fuld. And we did not have a liquidity problem at the
    end of last year. We had just completed a record year, none of
    which, by the way, came from mortgages. And we paid our people
    fairly and what we thought was competitive with the rest of the
    Street.
        Chairman Waxman. OK. I accept your answer that you didn't
    think you had a liquidity problem, so you were trying to make
    sure that your employees were fully compensated.
        Mr. Fuld. Yes, sir.
        Chairman Waxman. OK. Thanks.
        Mr. Turner.
        Mr. Turner. Thank you, Mr. Chairman.
        Mr. Fuld, in looking at your written testimony, you say
    ultimately what happened to Lehman Brothers was caused by a
    lack of confidence.
        I have a different view, and I have a couple questions for
    you about what it really comes down to is we are hearing that
    the subprime crisis, the predatory lending crisis, the mortgage
    foreclosure crisis. You said you listened to the first panel
    and their testimony. I am going to summarize it for you
    briefly.
        Mr. Fuld. I heard most of it, but yes, sir.
        Mr. Turner. They said there was a period of easy credit;
    that housing prices were escalating and then declined; that
    there was securitization of mortgages; that houses became like
    ATMs where people withdrew their equity; and excessive CEO
    compensation.
        That is not necessarily our experience in Ohio.
        Mr. Fuld. I am sorry, that is not what?
        Mr. Turner. That is not necessarily our experience in Ohio.
    In 2001, my community held a series of hearings on then
    subprime lending, predatory lending at the behest of City
    Commissioner Dean Lovelace. And we found that, in many
    instances, what we were seeing in the escalation of
    foreclosures was a result of inflated property values at the
    time of loan origination. In fact, we then turned to the Miami
    Valley Fair Housing Center in our community, an agency that was
    helping people who were in the foreclosure crisis, and Jim
    McCarthy from there reports that over 90 percent of the people
    that they were dealing with were actually refinances and that
    many of them had issues of the original value of the property
    at the time of refinancing where the property values were
    inflated.
        Now, clearly, we are in a period now of decline or slow
    growth in some areas which is compounding the problem, but I
    think people are getting off too easy when we say that
    declining property values are the problem. And I want to tell
    you what my concern here is. I believe that if you issue a loan
    at origination where the loan value exceeds the property value
    and that you then issue securities based upon that loan and you
    don't disclose that gap that existed at loan origination, that
    you are in fact, I believe, stealing.
        I believe that we are in a series of situations where
    people aren't disclosing that at loan origination, in fact,
    there was already a gap between value and loan amount, and that
    the declining house values really just emphasize it and
    compound it.
        So I have two questions for you. The first is, do you
    believe that if mortgage-backed securities are issued and they
    do not disclose at origination that the original loan amount
    exceeds the property value, that it is stealing? And second,
    would you please describe Lehman Brothers' role in both issuing
    subprime loans and mortgage-backed securities?
        Mr. Fuld. I do not believe that any of the original
    mortgage securitizers knowingly at the point of origination
    would have taken a mortgage whose value was in excess of the
    value of the home. I find that very difficult to either
    understand or believe.
        Mr. Turner. And if it occurred?
        Mr. Fuld. If it did occur, I would say it was lack of
    understanding of what the real value was. But I don't think--I
    can't talk for the world in general, clearly, but highly
    unlikely that anybody would do that purposely.
        Mr. Turner. Then could you go to the role of your company
    in actually issuing original loans and then mortgage-backed
    securities?
        Mr. Fuld. We actually owned a number of what we called
    origination platforms. But those were more wholesale, where we
    went around to individual groups or companies of brokers that
    did in fact originate loans. When we bought them, we changed
    management, we changed underwriting standards to make them much
    more restrictive, to improve the quality of the loans that we
    did in fact originate so that those loans that we did then put
    into securitized form would be solid investments for investors.
        Mr. Turner. So then would it be your testimony that none of
    those original loans that were issued by your company exceeded
    the property value at origination?
        Mr. Fuld. Congressman, in all fairness, I did not review
    each and every loan. I must tell you the truth on that, I did
    not. And it would be a misstatement for me to say that----
        Mr. Turner. I thought I had heard you say that no one would
    do that. And I tell you the experience in Ohio is that is
    exactly what was being done.
        Mr. Fuld. I would say no one would do it knowingly.
        Mr. Turner. Since you were at the top of the organization,
    I really wanted to get your perspective of how something like
    that could be happening. As I go through neighborhoods in Ohio
    and see abandoned house after abandoned house, where so many
    times the American dream of having a home have been stolen from
    people in refinancing where they did not understand the
    transaction they were in, and where the value at origination
    was inflated, making them captive to the house, ultimately
    leading to foreclosure.
        Mr. Fuld. Let me clarify that if I can. I said nobody would
    knowingly do that.
        Mr. Turner. Thank you, Mr. Chairman.
        Chairman Waxman. Thank you, Mr. Turner.
        Mr. Kucinich.
        Mr. Kucinich. Thank you. I want to associate myself with
    the remarks and questions of my colleague from Ohio.
        Mr. Fuld, I have here a copy of a memo from April 12, 2008,
    that you sent to--it is an e-mail that you sent to Thomas
    Russo. It says you just finished the Paulson dinner. This is a
    memo--did you have dinner with Mr. Paulson back in April?
        Mr. Fuld. I very easily could have, sir.
        Mr. Kucinich. This memo references it.
        Mr. Fuld. I don't believe it was just the two of us.
        Mr. Kucinich. But did you meet with him?
        Mr. Fuld. You are asking me specifically on that date?
        Mr. Kucinich. Did you talk to Mr. Paulson on a regular
    basis?
        Mr. Fuld. We had a number of conversations, sir.
        Mr. Kucinich. OK. Now, would you tell me, this memo says,
    that you sent to your colleagues, that we have a huge brand
    with Treasury. Speaking of Treasury, loved our capital raise.
    Do you feel at any time in this process that Mr. Paulson misled
    you?
        Mr. Fuld. I am sorry, sir, in response to this----
        Mr. Kucinich. Do you feel at any time in these
    conversations--we have your telephone logs--that you were
    misled by the Treasury Secretary?
        Mr. Fuld. No, sir, I do not.
        Mr. Kucinich. And do you feel then--you know, on September
    10th, you had a conference call with your investors. During the
    conference call, your investors were told no new capital would
    be needed; that Lehman's real estate investment property--
    investments were properly valued. Five days later, you filed
    for bankruptcy. Did you mislead your investors? And I remind
    you, sir, you are under oath.
        Mr. Fuld. No, sir. We did not mislead our investors. And to
    the best of my ability at the time, given the information that
    I had, we made disclosures that we fully believed were
    accurate. And I should--and I should----
        Mr. Kucinich. I want to go back to something here. You
    know, you have a memo here where you say that Secretary Paulson
    wanted to implement minimum capital standards, leverage
    standards, and liquidity standards. These seem to be some of
    the things that got your company in so much trouble. Now, did
    he ever tell you in all the conversations you had with him that
    he decided not to implement any of the proposals he discussed
    with you last April? And does any part of you feel that you
    were double crossed by the Secretary and he was playing you off
    against let's say Goldman Sachs?
        Mr. Fuld. I would sincerely hope that was not the case.
        Mr. Kucinich. And what about these things that he said to
    you about minimum capital standards, leverage standards,
    liquidity standards? Did he ever tell you he decided not to
    implement any of these things? You talked to him on a regular
    basis. What can you tell this subcommittee to enlighten us
    about where Secretary Paulson was? And you, as the head of
    Lehman Brothers, did you rely on anything that he told you that
    could have put Lehman Brothers down?
        Mr. Fuld. We instituted ourselves our own plan for reducing
    leverage, our own plan for increasing liquidity. And I will
    note that, on September 10th, when we pre- announced our
    earnings, we had $41 billion of excess liquidity.
        Mr. Kucinich. Let me ask you this, when did you know that
    J.P. Morgan was going to make a $5 billion collateral call?
    When did you first know about that?
        Mr. Fuld. I know that they had had conversations with our
    Treasury people.
        Mr. Kucinich. When?
        Mr. Fuld. I am not sure of the date. But it was----
        Mr. Kucinich. Mr. Chairman, if I may--thank you, sir, you
    are not sure.
        Mr. Chairman, this is a central question here, because with
    J.P. Morgan making a $5 billion collateral call, and on
    September 10th, they were telling investors they didn't have
    any more need for capital, that the real estate investments
    were properly valued, this puts us in a position where one of
    two things is possible. Either they were lying to their
    investors or they were misled by Secretary Paulson as to what
    could be done to help you, because after that $5 billion
    collateral call, that is what led directly to Lehman Brothers
    going down. Isn't that correct? Didn't you go down right after
    you understood that they were not going to remove that
    collateral call?
        Mr. Fuld. When you say collateral call, that is not the
    same thing as a margin call.
        Mr. Kucinich. I am talking about a collateral call.
        Mr. Fuld. No, I know. But the collateral call was not to
    meet a deficit in collateral that they were holding to offset
    risk. The collateral call, I believe, was because, as our
    clearing bank, they just asked for additional collateral to
    continue to clear for us.
        Mr. Kucinich. Thank you.
        Thank you, Mr. Chairman.
        Thank you, Mr. Fuld.
        Chairman Waxman. The gentleman's time has expired.
        Mr. Tierney.
        Mr. Fuld. Excuse me, I should clarify also, sir, I didn't
    mean to cut you off there. This is probably a subject for
    litigation, and it is probably appropriate that I leave it to
    that. I believe the creditors and J.P. Morgan are having a
    conversation.
        Mr. Kucinich. Indeed. Indeed.
        Chairman Waxman. Mr. Tierney.
        Mr. Tierney. Mr. Fuld, thank you for joining us here this
    afternoon.
        Just before Lehman went into bankruptcy, you were in
    conversations with the Korean Development Bank, which I believe
    is a South Korean lender. What amount of money were you looking
    for them to contribute to Lehman?
        Mr. Fuld. Congressman, our conversations with KDB, as one
    of five banks in a consortium, stretched over a number of
    months.
        Mr. Tierney. Can you tell me the amount that you were
    looking for from the consortium?
        Mr. Fuld. It wasn't so much that we were looking from them.
    Their original proposal was they wanted to buy in the open
    market close to 50 percent of our stock. It was not about
    giving us new capital. They wanted to buy close to 50 percent.
        Mr. Tierney. And was that type of arrangement something
    that you were looking for at that time?
        Mr. Fuld. I would have welcomed that transaction, yes, sir.
        Mr. Tierney. OK. Now, at about that time, in looking for
    that kind of transaction, you knew, because you had known for
    some time that you were already in a precarious situation. And
    I say that because there were reports that as far back as
    Christmas of 2006 that you were telling people that you had a
    cautious outlook for the year ahead. The next month in January,
    when you were in Davos at the World Economic Forum, you were
    reportedly telling people that you were really worried about
    the risks inherent in the property valuations and excess
    leverage and the rise in oil and commodity prices. Would that
    be fair to say you were of that mind around January 2007?
        Mr. Fuld. I was clearly focused on oil, yes, sir.
        Mr. Tierney. Then I think we go back to the situation where
    we know you were in that stage in December 2007. At the end of
    that year, there were payments made out, both cash and stock
    bonuses to your employees. They totaled about $4.9 billion. So
    is there any thought given at that point in time to say to your
    employees, this isn't the time to be handing out $4.9 billion
    in cash. We have a liquidity issue here. We have been seeing it
    coming for all year long. And we are going to keep that money
    in the company liquidity for the benefit of our shareholders,
    for the benefit of the public with whom we deal, and for the
    economy.
        Mr. Fuld. At the end of 2007, I did not believe at the time
    that we had a liquidity problem. And our most important assets
    in the firm are clearly our employees. They are the ones that
    touch the clients every day and do business every day.
        Mr. Tierney. I understand. I am a little shocked. I mean, a
    lot of other people thought that you had a very precarious
    position. At the end of 2007, you thought everything was fine?
        Mr. Fuld. We had just completed a record year, sir.
        Mr. Tierney. And if you want to cover that for a second,
    the record year that you just completed and the reports on that
    had some, according to one account, had some rather aggressive
    and bizarre accounting practices on that. They list out four or
    five things that they thought were strange. You listed a $722
    million paper profit on level three equity holdings, stock that
    doesn't trade publicly; there aren't liquid markets out there.
    You claimed a 9 percent profit on them. At the same time,
    Standard and Poor's index on publicly traded stocks fell by 10
    percent. That was what made you seemingly have a record year.
    One of your short sellers, Mr. David Einhorn, said he was told
    by your chief financial officer that $400 to $600 million came
    from writing up the value of electric generating plants in
    India. He thought the value was somewhere around $65 million,
    not $400 to $600 million. He also said Lehman showed some $600
    million of profit because of the decline in the market value of
    your own debt obligations and sort of assimilated that to the
    fact that it is permissible accounting surely enough, but it is
    like the profit that you make when your house is foreclosed for
    a value that is lower than your mortgage. Last, he said another
    $176 million was on your books by almost doubling, to some $365
    million, the value ascribed to certain mortgage servicing
    rights; in other words, the value you get paid for servicing
    mortgage holders' collection of payments and doing their
    paperwork, which are sort of tricky things to value.
        So I know that at the end of the year maybe your books
    looked like they were good, but if those were the reasons for
    that, then I think it is questionable why $4.9 billion is going
    out to the employees in bonuses, cash and stock, and why you
    are spending another $4 billion buying some of that back. And I
    think one of your investors here today clearly said he was
    horrified to find out you were doing that. That is why I raise
    the question.
        Thank you, Mr. Chairman.
        Chairman Waxman. I would just note, Mr. Fuld, that in
    January 2008, there was a presentation to your board, on which
    you serve, by Eric Felder. And he said very few of the top
    financial insurers have been able to escape damage from the
    subprime fall out. And a small number of investors, accounting
    for a large portion of demand liquidity, can disappear quite
    fast. So I just want that to be on the record.
        I would now go to Ms. Watson.
        Ms. Watson. Thank you so much.
        And Mr. Fuld, we are so pleased that you are willing to
    come and sit on the hot seat and admit that you take full
    responsibility.
        We heard from the first panel's view on what caused this
    financial crisis. And one key factor was deregulation or
    inadequate regulation of big financial entities like yours,
    Lehman Brothers. I would like to get your view on this topic,
    because as a publicly owned broker-dealer investment bank,
    Lehman was subject to a number of SEC regulations. The company
    was required to report important financial information to
    shareholders, and you were required to meet the basic SEC
    requirements to make sure that you were adequately capitalized.
    Is that correct?
        Mr. Fuld. Yes, Congresswoman.
        Ms. Watson. And in your written statement, you explain that
    the SEC and Fed conducted oversight of your balance sheet. As
    you stated, they were privy to everything that was happening.
    Is that correct?
        Mr. Fuld. Yes, Congresswoman.
        Ms. Watson. But, Mr. Fuld, Lehman Brothers went bankrupt.
    Your investors and your creditors lost hundreds of billions of
    dollars. And the failure has had a widespread impact for the
    rest of the economy. Would you agree that the current
    regulatory framework and the way they were implemented in your
    case failed?
        Mr. Fuld. Are you asking specifically about the SEC?
        Ms. Watson. Yeah. The regulatory framework.
        Mr. Fuld. Specifically about the SEC?
        Ms. Watson. Yes.
        Mr. Fuld. Because I had said in my written testimony that I
    thought the overall regulatory system had to be redone.
        Ms. Watson. You will agree that they failed.
        Mr. Fuld. But specifically to the SEC, we had extensive
    dealings with the SEC. They actually had dedicated and
    knowledgeable people actually in our firm overseeing a number
    of our daily activities. I went to them, our firm went to them
    specifically talking about naked short selling. They were
    constructive and positive. We went to them with an idea of
    creating something that we call Spinco. Spinco was the--was a
    new independent entity into which Lehman would place some
    number of commercial real estate assets, along with a piece of
    capital, and then spin that, which means give that to our
    shareholders, which we believed would have created true
    shareholder value over a longer period of time. This actually
    was a model that I believe could have been very helpful and
    instructive.
        Ms. Watson. Yeah, I am watching our timer there. So let me
    just say that we have learned how Lehman Brothers relied on an
    unregulated bond rating agency, whose conflict of interest gave
    him every incentive to rate your company's risky bonds as safe
    investments. We have heard how housing and banking regulators
    failed to curb the predatory lending abuses in the subprime
    market. And we have heard about how the net capital rule was
    implemented so Lehman and other investment banks could ramp up
    their leverage to dangerously high levels. And we heard that
    the SEC is underfunded, understaffed, and led by a chairman who
    either was unable or unwilling to enforce even the basic laws
    on the books. Do you think this deregulation and lack of
    oversight contributed to the melt down on Wall Street?
        Mr. Fuld. I cannot talk to what----
        Ms. Watson. Do you think it contributed--my time is almost
    up--to the melt down on Wall Street?
        Mr. Fuld. I cannot talk to what the SEC did with the other
    firms.
        Ms. Watson. Do you think it contributed, or are you wholly
    and solely responsible for the melt down on Wall Street?
        Mr. Fuld. I actually gave the SEC high marks for trying to
    be constructive.
        Ms. Watson. No--OK. Here is my bottom line question. If all
    the things that I just spoke of you think were just fine and
    worked like they should, the regulations, then it is your total
    responsibility for the failure of Lehman Brothers in
    bankruptcy?
        Mr. Fuld. In retrospect, it is easy to go back----
        Ms. Watson. Yes or no? Yes or no? My time is up.
        Mr. Fuld. If you are asking me, do I----
        Chairman Waxman. The gentlelady's time is up, and Mr. Fuld,
    you will be permitted to answer the question.
        Mr. Fuld. Thank you, sir. If you are asking me, did the
    regulatory framework contribute, or the lack of regulatory
    framework, contribute to where we are today? I would say yes.
    And that is why I think we need to redo----
        Ms. Watson. Thank you. Thank you. That is the answer I was
    trying to get to.
        Mr. Fuld. That is why I think we need to redo the
    regulatory framework.
        Chairman Waxman. Thank you, Ms. Watson.
        Mr. Higgins.
        Mr. Higgins. Thank you, Mr. Chairman.
        Mr. Fuld, there appears to be inconsistencies between your
    public statements and the private information you were
    receiving internally. Let me read you some of these
    inconsistencies and ask you to respond. In January of this
    year, Eric Felder, one of your top executives, made a
    presentation to you and the board of directors. He talked about
    the company's finances, and observed that, ``very few of the
    top financial issuers have been able to escape . . .''----
        Mr. Fuld. I am sorry, I didn't hear that. I am sorry. After
    Felder, I didn't hear that.
        Mr. Higgins. Yeah, he talked about the company's finances.
    He observed that, ``very few of the top financial issuers have
    been able to escape damage from the subprime fall out.'' He
    then warned you explicitly that in the current environment,
    ``liquidity can disappear quite fast.''
        But that is not what you were telling the public. In
    December 2007, in a press release, you said, ``our global
    franchise and brand have never been stronger.''
        My question is, why didn't you say publicly what you were
    being told internally, that you had to be careful because your
    liquidity could disappear quickly, which was in fact what
    happened?
        Mr. Fuld. Mr. Felder's presentation was when, January you
    said?
        Mr. Higgins. December 2007, January 2008. This year.
        Mr. Fuld. We actually listened very carefully to Mr.
    Felder. And I believe the record book will show that we reduced
    our balance sheet. We reduced our leverage. We raised capital.
    We increased liquidity. So we did listen.
        Mr. Higgins. Let me show you another internal document.
    This document is a document that your attorneys produced to the
    committee. It is from June 2008, 6 months later. This is a set
    of talking points describing what happened over the past year
    and why your company posted record billion dollar losses. This
    is an internal document that was never made public. And it
    seems to admit the truth about what was going on. It asks, this
    is your internal document, why did we allow ourselves to be so
    exposed? And then it spells out the reasons. ``Conditions
    clearly not sustainable. Saw warning signs. Did not move early,
    fast enough. Not enough discipline in our capital allocation.''
        But that is not what you told the public that month. Here
    is what you said during an earnings call with investors on June
    16th: Let me discuss our current asset valuation on those
    remaining positions. I am the one who ultimately signs off and
    am comfortable with our valuations at the end of the second
    quarter. Because we have always had rigorous internal process,
    our capital and liquidity positions have never been stronger.
        Mr. Fuld, I don't see how you could say that. Your internal
    documents said that conditions are clearly not sustainable and
    that you did not move early or fast enough. But you told the
    public Lehman had never been in a stronger position. How do you
    reconcile your public statements with the company's internal
    assessments?
        Mr. Fuld. Was this my document?
        Mr. Higgins. These are documents that your attorneys
    provided the committee.
        Mr. Fuld. I didn't mean that. Is this my document? Is this
    a presentation that I gave?
        Mr. Higgins. These are documents internally that went past
    your desk in the past 6 months.
        Mr. Fuld. This document does not look familiar to me. And
    if it was an internal document, it was--I really can't speak to
    that, because this document is not familiar to me.
        Mr. Higgins. Well, these documents were made----
        Mr. Fuld. But if you tell me it is mine, I believe you.
        Mr. Higgins. And ultimately, you are responsible. And this
    inconsistency with public statements made conveying a strong
    position and internal documents showing a direct contrast to
    that assertion, I think, is very troubling with respect to the
    issue of trust and confidence. According to your lawyers----
        Mr. Fuld. I am looking very carefully at this----
        Mr. Higgins [continuing]. This is a document that you
    either wrote or you reviewed.
        Mr. Fuld. I am looking at this very carefully, sir. It does
    not look like my document. Nor does it look like a speech that
    I gave. Nor does it look like anything that I reviewed.
        Mr. Higgins. These are your documents.
        Mr. Fuld. Excuse me, sir?
        Mr. Higgins. These are your documents.
        Chairman Waxman. The gentleman's time has expired.
        Mr. Shays, you wish to yield 2 minutes to Mr. Mica.
        Mr. Mica. Let me get down to some of the heart of this. I
    guess a lot of the collapse occurred on September 9th and 10th.
    You were trying to find $5 billion to back up your
    transactions. I recommend to everybody the Wall Street Journal
    today. They did an excellent job, better than the committee, of
    going through some of the public and private statements. I
    wouldn't necessarily pay for it. Maybe you could get it online.
    It is two bucks.
        But it does outline what you were going through. One is
    J.P. Morgan asked you for the $5 billion. Lehman executives
    claimed that they had a restructuring plan. And then you had
    discussions that night. You wanted to go into a conference
    call. Your counsel said not to go into a conference call. Maybe
    you could tell us about that.
        On the 10th, however, you told investors, we are on the
    right track to put these last two quarters behind us. Now,
    people want to know if you defrauded investors--I mean, I am
    going to be blunt here--by coming out and saying that as
    opposed to what happened on the 9th, and you knew or were told
    you weren't going to get the money.
        Mr. Fuld. As I said before, I am not--I am not really sure
    when that conversation----
        Mr. Mica. Yeah, but you had to know at some point you
    weren't going to get the $5 billion. I mean the Korea--the
    attempt to get the money from Korea was----
        Mr. Fuld. I am sorry, I thought you were talking about J.P.
    Morgan. I apologize.
        Mr. Mica. OK. But you were trying to get the money--well,
    J.P. Morgan wanted the money, and you were trying to find the
    $3 billion to $5 billion, right, to keep the ship afloat.
        Mr. Fuld. Two very different things. Very different things.
        Mr. Mica. Well, this is on the 9th.
        Mr. Fuld. Well, J.P. Morgan, as I said before, in answering
    one of the other questions----
        Mr. Mica. On September 9th, you needed $5 billion to keep
    the ship afloat. You were told, and your counsel told--also
    advised you not to go ahead with the conference call to
    disclose this internally. But you came out on the 10th and
    said, we are on the right track to put these last two quarters
    behind us. That is what you said. Again, I am just reporting--
    --
        Mr. Fuld. Correct. In our September 10th analysts call, I
    firmly believed that we put the last two quarters behind us. We
    had done a tremendous amount--I don't want to go through the
    whole thing all over again--but lowered our leverage, raised
    capital; you heard it all before. I am not going to go through
    it again.
        Mr. Mica. Were you told the night before you weren't going
    to get--be able to cook the deal?
        Mr. Fuld. I don't know what that refers to.
        Mr. Mica. Getting the money to keep the Lehman ship afloat.
        Mr. Fuld. What we said on September 10th was that we had
    adequate capital. We talked about a plan that involved spinning
    off those commercial real estate assets and that we were going
    to have to put capital into that. On the call, people talked
    about, how are you going to fill that? We talked about the
    sale, potential sale of IMD, either all or some, which would
    have created $3 billion of tangible equity. I think if you go
    back and look at the third quarter announcement, you will see
    that. Possibly more if we had sold it for a higher price. We
    had plans at the time to go to some of our preferred holders
    and convert some of those preferreds to equity. Because we had
    to prerelease because of the rumors about our company, we
    didn't obviously have a chance to complete some of those plans.
    We didn't know how much capital we were going to need to
    equitize Spinco. We didn't know how much of the commercial real
    estate assets would be sold. But that was all 3 months out. On
    that Wednesday, we had $41 billion. We had plenty of capital to
    operate. All conversations about additional capital were about
    what we were going to do when we took capital and put it into
    the new Spinco. That was all 3 months out. And that was obvious
    to shareholders. That is what we were talking about. And there
    were a number of questions from analysts at that time about
    that. So there was disclosure about where we were and, I
    believe, understanding. And there certainly was no attempt to
    mislead anyone.
        Mr. Mica. Again, again, before the committee, under oath,
    the night before September 10th, when you made that statement,
    did you in fact know that you weren't going to get the
    estimated $3 billion to $5 billion to keep the ship afloat?
        Mr. Fuld. Congressman, again, I say I am sorry, those are
    two very different numbers. One is additional collateral for
    our clearing bank. I know you are looking for an answer here.
    That is not capital. That is collateral. Two very different
    things. We believed we were going to raise, ``that $5 billion,
    by either selling all or part of Investment Management or the
    sheer fact that we were going to spin those assets off, then we
    didn't need that much capital.'' The $5 billion was additional
    collateral that J.P. Morgan was asking for.
        Chairman Waxman. The gentleman's time has expired.
        The Chair now recognizes Ms. McCollum.
        Mr. Fuld. Did I answer that, though, for you, sir?
        Ms. McCollum. Mr. Chair, a point of personal privilege.
        Chairman Waxman. Yes.
        Ms. McCollum. How I would go about yielding to the
    gentleman from Tennessee so he could make a flight?
        Chairman Waxman. I didn't hear you.
        Ms. McCollum. How I would go about allowing time for the
    gentleman from Tennessee to go ahead of me so he could catch a
    plane?
        Chairman Waxman. Then why don't I just recognize him now?
        Mr. Cooper. I thank the Chair.
        Mr. Fuld, in your testimony, on page 8, you say what
    happened to Lehman Brothers could have happened to any firm on
    Wall Street and almost did happen to others. But it didn't
    happen to the others. There is a difference. And you cite many
    factors in your testimony about how it could have been
    different, you know, if regulators had behaved differently or
    different things had happened. What could you have done
    differently personally that might have changed the fate of
    Lehman Brothers?
        Mr. Fuld. With the benefit of hindsight, sir, going back a
    couple of years, I would have made some changes to how we
    looked at and thought about our mortgage origination
    businesses, our commercial real estate business, and probably
    our leveraged loan business. Those were three of the areas that
    over the second and third quarter created some losses. And I
    believe in my verbal testimony I said, given the opportunity to
    look back, I would have done things differently. Should I have
    closed those businesses down then, I think people would have
    looked at me and said, that's irrational to have done that. But
    knowing what I know today, that clearly could have been a smart
    move. But given the information that I had, that is not the
    decision I made.
        Mr. Cooper. Well, that was a decision you could have made 2
    or 3 years ago. Given your book of business in 2007 and 2008,
    were there decisions you could have made to have changed the
    destiny of Lehman Brothers just in the immediate past?
        Mr. Fuld. We did make aggressive decisions to close some of
    the mortgage origination businesses. We had substantial hedges
    on our residential mortgage positions. In retrospect, I think
    we were slower on commercial real estate. I, like a number of
    other people, thought the mortgage crisis was contained to
    residential mortgages. There were a number of people, many
    experts included, that also thought that. And I was wrong.
    Looking back now at that information, I thought it was
    contained. We thought it was contained. And experts thought it
    was contained.
        Mr. Cooper. You mentioned being, ``slow on commercial real
    estate.'' Does that mean correctly valuing the portfolio of
    commercial real estate properties?
        Mr. Fuld. No, sir, it does not mean anything about
    valuation. It means about how quickly we thought about
    disposing those assets. And I think the record book will show
    that we went from $50 billion of those assets to $30 billion,
    keeping the remaining--I shouldn't say keeping, but ending up
    with $30 billion that would go into--either 30 or less,
    depending upon how much of the remaining 30 we sold in the
    fourth quarter, the remaining piece going to Spinco to be spun
    to our shareholders, which we firmly believed had real value.
        Mr. Cooper. You had a committee, the finance and risk
    management committee, which I believe was chaired by the once
    legendary Henry Kaufman, a previous panel said that this
    committee only met twice a year in 2007 and 2006. Were they
    giving you advice on these long-term strategic directions?
        Mr. Fuld. Let me just clarify one thing, if I may. I
    believe they did meet twice in 2007, but they met four times
    this year so far. Well, it is over now, so it is four times
    this year.
        Mr. Cooper. Were they giving you advice on changing
    strategic direction for the firm?
        Mr. Fuld. We talked about assets, and not just at the risk
    and finance committees, we talked about it at the board. We
    talked about how we were bringing down our exposures on
    residential and on commercial and on leveraged loans at almost
    each and every board meeting. Whether it was the risk committee
    or finance committee, we talked about it. It was clearly a
    subject on everybody's mind. Keep in mind that this was a board
    that did have a lot of financial experience. This was a strong,
    independent board. I was the only Lehman person on the board.
    These people--some of these people ran banks, IBM, other
    companies, Celanese. These were experienced people. And they
    had never any reservations about giving me advice and having a
    view about the markets.
        Chairman Waxman. Thank you, Mr. Cooper. Your time has
    expired.
        Ms. McCollum.
        Ms. McCollum. Thank you, Mr. Chairman. And I thank the
    committee for allowing Mr. Cooper to move forward.
        My constituents in Minnesota understand that you don't have
    to do something illegal to do something wrong. Imperfect
    Federal regulation isn't a license for unethical behavior,
    especially when it puts taxpayers at risk. In our current
    regulatory framework, there is a gray space between legal
    activity and illegal activity. And in that space, financial
    firms can make a choice to either obey the letter of the law
    but not to honor the spirit of the law. 12 years ago, and you
    have been with the firm for 42 years according to your
    testimony, Lehman Brothers Holding, Inc., sent a vice president
    to California to check out First Alliance Mortgage. Lehman was
    thinking about tapping into First Alliance Mortgage's lucrative
    business of making subprime loans. The vice president, Eric
    Hibbert, wrote in a memo describing First Alliance as a
    financial sweat shop, specializing in high pressure sales for
    people who are in a weak state. First Alliance, he said, the
    employees, ``leave their ethics at the door.'' The big Wall
    Street investment bank, that was Lehman Brothers, decided First
    Alliance wasn't breaking any laws, and Lehman went on to be, to
    lend the mortgage company--they needed about $500 million worth
    of sells and more than $700 million worth of bonds. In other
    words, Lehman Brothers is an example of how Wall Street's money
    and experience could have been used to prevent us being in this
    subprime mortgage crisis. History: We should learn from it.
    You, in your statement, on page 5, you said, ``we did
    everything we could to protect the firm.'' So I go back to this
    memo that Mr. Bishop had up and ask you if you agree with the
    spirit of the memo. Why did we allow ourselves to be so
    exposed? Did you ask those questions? Did you reflect that
    conditions were clearly not sustainable? Did you see warning
    signs? Did you move fast enough?
        And I ask that because of two things that have come to my
    attention, that the Federal Bureau of Investigation has
    launched preliminary inquiries as to whether or not Lehman or
    its executives committed fraud by misrepresenting the firm's
    condition to investors. So, sir, I want to ask you some
    questions. On September 10th, 5 days before your bankruptcy
    filing, you and your chief financial officer, Ian Lowitt, held
    a conference call for investors. According to the Wall Street
    Journal, you were advised by your bankers not to hold this call
    because there were too many open questions. It is my
    understanding that at the time you did make the call, and that
    you were frantically trying to raise capital either through new
    investors or selling off assets.
        So when you and Mr. Lowitt spoke to your investors and said
    that you did not need more capital, and that Mr. Lowitt said to
    investors when asked whether Lehman would need to raise $4
    billion, I am paraphrasing, ``we don't feel that we need to
    raise that extra amount. Our capital position at the moment is
    strong.''
        So, sir, is this accurate? Were you told not to hold the
    call? Were you trying to raise capital during the week before
    you filed bankruptcy? Is it an accurate statement that your
    capital position was strong on September 10th?
        Mr. Fuld. It is correct that our capital position on
    September 10th was strong.
        Ms. McCollum. Did anyone tell you, advise you against
    holding the conference call I referred to? That should be a yes
    or no, sir.
        Mr. Fuld. Well, you are asking me did anyone.
        Ms. McCollum. So that's a pretty big call that was made----
        Mr. Fuld. Yes.
        Ms. McCollum [continuing]. Five days before filing
    bankruptcy, and your chief financial officer was present on the
    call.
        I ask you, did any of your outside bankers or other
    advisers warn you against making, holding this call?
        Mr. Fuld. I had so many conversations, I would never say to
    you that no one----
        Ms. McCollum. Well, sir, maybe you remember. Were you
    trying to raise capital during the week before you went
    bankrupt?
        Mr. Fuld. The week before, 2 weeks before, 3 weeks before.
        Ms. McCollum. Sir, I asked you a week before. I was just
    asking you for the week before this.
        Mr. Fuld. I am saying yes to all.
        Ms. McCollum. You are saying yes to all. When you were
    raising that capital, no one in your firm----
        Mr. Fuld. Yes. No, no, let me finish. I would like to
    finish because there's a different piece to that. What we were
    looking to do was to raise capital after we completed----
        Ms. McCollum. You were raising capital.
        Mr. Fuld. Excuse me, please.
        --after we completed the spinoff, which would probably have
    been January. After we had completed the spinoff of the
    commercial real estate assets.
        On September 10th, we had a strong capital position. We
    were trying to anticipate how much capital we were going to put
    into Spinco, how much capital we were going to use. We were
    trying to anticipate how much we would sell the investment
    management division for.
        So there were a number of moving pieces. But on September
    10th, given the business that we had, we had sufficient and
    strong capital and liquidity.
        Mr. Tierney [presiding]. Thank you, Mr. Fuld. Thank you,
    Ms. McCollum.
        Mr. Van Hollen, you are recognized for 5 minutes.
        Mr. Van Hollen. Thank you, Mr. Chairman.
        Mr. Fuld, you said earlier in your testimony that at Lehman
    Brothers when things were going well then people would do well.
    When things weren't going so well, then people would have
    cutbacks.
        I have to say that I think people looking in have
    concluded, based on the compensation structure, that when
    things went well people did really well. When things didn't go
    well, they still did very well.
        I would like to call your attention to a memo that was
    written on September 11, 2008, just 4 days before Lehman
    Brothers declared bankruptcy. And I hope someone can provide
    you with a copy of the memo.
        It's a proposal from the compensation committee, you are
    cc'd on the memo. It talks about compensation for two employees
    of Lehman Brothers. One was Andy Morton, I assume you recognize
    that name.
        Mr. Fuld. I do, sir.
        Mr. Van Hollen. He was the previous global head of fixed
    income. It said, the document here says he was involuntarily
    terminated. The memo here proposes to give him an additional $2
    million cash payment.
        The other official mentioned in the memo is Benoit Savoret.
    I assume you know him as well, is that right?
        Mr. Fuld. I do indeed, sir.
        Mr. Van Hollen. He used to be Lehman's chief operating
    officer of Europe and the Middle East until he was terminated.
    He was also, according to this memo, involuntarily terminated.
    Yet this memo proposes to give him a $16 million cash payment,
    again, just days before Lehman Brothers declared bankruptcy.
        These are two individuals who were involuntarily
    terminated. I think the normal sort of parlance is fired. Yet
    they are being given, combined, about $20 million in additional
    compensation, despite the obvious poor performance at this
    point, which nobody can deny.
        I ask you, is that appropriate? I mean, we are here having
    this conversation with you and the American people. Is that
    appropriate that 4 days before Lehman Brothers declares
    bankruptcy, that two individuals who have certainly been part
    of the decisionmaking that led to the decline would be given
    $20 million in additional compensation?
        Mr. Fuld. There were two pieces to that, clearly, Andy
    Morton and Benoit Savoret. Andy Morton was given, I think it's
    $2 million.
        Mr. Van Hollen. Yes.
        Mr. Fuld. We felt that was--or, more importantly, the
    compensation committee felt that was appropriate for his years
    of service.
        The $16 million, $16.2 million, was not a severance
    payment. The $16.2 million was a contractual obligation that
    the firm had made to Mr. Savoret, I forget when it was, but it
    was earlier in the year.
        That contract said that at any time if terminated he was
    due the items of the contract. So that's what that was. That
    was not a severance payment, sir.
        Mr. Van Hollen. Regardless of his performance, he would be
    due that amount of money is what you are saying, under the
    contract?
        Mr. Fuld. Unless he was fired for----
        Mr. Van Hollen. Let me ask you this. You would agree, would
    you not, that people can make decisions that in the short term
    maximizes profits and bonuses but are bad decisions for the
    long term? I mean, there are decisions that can maximize short-
    term profits, but people would also agree that they might not
    be the best long-term interests in the company; isn't that
    right?
        Mr. Fuld. If you are referring to this gentleman?
        Mr. Van Hollen. No, I am just referring as a general
    proposition. You would agree that there are times when you can
    maximize short-term profits, but if you looked at over the
    longer term, people would agree it's not a good, long-term
    decision. You would agree that there are some decisions that
    fall into that category?
        Mr. Fuld. Certainly not by design, but in retrospect,
    clearly.
        Mr. Van Hollen. Let me ask you about clawbacks. I am not
    talking about anything with respect to Lehman Brothers, but
    just as a proposition. Wouldn't you agree that it's appropriate
    that if somebody makes a decision that raises short-term
    profits and, therefore, bonuses, but then it's later shown that
    those same decisions resulted in harm to the company, that on
    behalf of the shareholders and certainly in cases where the
    public is now involved, that the shareholders or the public
    should be able to go back in and get a clawback and take those
    bonuses or additional payments back that are proven, with the
    benefit of hindsight, to have been bad decisions for a company
    and the shareholders?
        Mr. Fuld. That was actually one of the things I spoke about
    when I said interesting way to go forward is a long-dated
    compensation system. In our case, that's exactly what we had.
    We had a long-dated compensation system.
        Look, I am not proud of the fact that I lost that much
    money. But it does show that the system, our compensation
    system, did work.
        I left 10 million shares plus a whole number of options. I
    say, I am not proud of that. But when the firm did not do well,
    I was probably the single largest individual shareholder. I
    don't expect you to feel sorry for me. I don't mean that.
    That's not my point. My point, though, is that the system
    worked.
        Mr. Van Hollen. Mr. Chairman, if I could, you are now
    referring to shares that you owned which, obviously, when the
    company went bankrupt, went down. I am also referring to bonus
    payments that may have been made in previous years to
    executives, including yourself, when, now that the company has
    gone bankrupt, wouldn't it make sense to have provisions to
    protect shareholders, not just to--clearly, when the shares go
    down, the value of the company goes down, the share values do.
        But wouldn't it make sense to have clawback provisions with
    respect to bonus payments, cash payments? The shareholders
    could recover those moneys that were bonuses for what clearly
    proved to be bad decisions?
        Mr. Tierney. If you could answer that briefly, Mr. Fuld.
    Then we will move on.
        Mr. Fuld. I am sorry, sir.
        Mr. Tierney. If you want to answer that briefly, you may,
    but we have to move on.
        Mr. Fuld. Our compensation system was specifically set up,
    even for me. In 19--I am sorry, in 2007, 85 percent of my
    compensation was in stock. I lost that. All stock that I got
    for the last 5 years, I lost that.
        Actually, compensation that I received back from 1997, 1998
    and 1999, I went to the compensation committee and said I
    believe we should extend the vesting on this. I could have
    gotten it 7 years ago. I went to the compensation committee and
    said this should be extended to a 10-year vest. I lost all of
    that.
        I would like also for this committee to know that before
    the end of our second quarter, I went to my board, and I said,
    I think we are going to have a tough quarter. We were talking
    about how we were going to pay the troops, as I called it. I
    said I want you to take me out of it. I believe, given this
    performance, my recommendation to you, is that I do not get a
    bonus.
        I would like this committee also to know, I got no
    severance, I got no golden parachute. I had no contract. I
    never asked for a contract. I never sold my shares. That's why
    I had 10 million, because I believed in this company.
        I believed that this company--and that's why I said, I am
    glad I got these last two quarters behind us. I believe we are
    on the right track. I could have sold that stock. I did not,
    because I firmly believed that we were going to return back to
    profitability and get back on the road.
        Mr. Tierney. Thank you, Mr. Fuld. Thank you, Mr. Van
    Hollen.
        Mr. Sarbanes, you are recognized for 5 minutes.
        Mr. Sarbanes. Thank you, Mr. Chairman.
        I believe that you believed in this company, but I also
    believe that your belief in the company at a certain stage
    began to cloud your judgment.
        Let me ask you this first off. When you say to the public,
    our capital and liquidity positions have never been stronger,
    that is intended to convey the overall strength of the firm and
    the company, is it not? In other words, you can't assert that a
    company is not strong if you are asserting that its capital and
    liquidity positions are strong?
        Mr. Fuld. Our capital position was strong, our liquidity
    position was strong. We had completed a whole number of things
    that we did to protect the firm.
        Mr. Sarbanes. So the firm was strong, is what you were
    intending to communicate with a statement like that?
        Mr. Fuld. We had--I will go through it again with you if
    you would like, sir. We reduced our leverage.
        Mr. Sarbanes. Was the firm strong, was the firm strong? Was
    that the intended communication in saying our capital and
    liquidity positions have never been stronger? It was to convey
    that the firm was strong, right?
        Mr. Fuld. My----
        Mr. Sarbanes. I am going to assume that is what it was
    intended to convey. I think that the problem that we have had
    here is that statements of this kind, at the time they were
    made, were simply implausible. So it then raises a question of
    whether your perspective on the health of the firm was clouded
    or whether there was something else going on. I am going to
    leave that aside, because I want to move to a different
    question.
        You talked about how Lehman got into the originating
    business, and, I gathered, did business with a number of other
    originators, First Alliance was one, for example, for some
    period of time, before you then actually took an equity stake
    in those businesses; is that correct?
        Mr. Fuld. We took an equity stake in BNC Mortgage and also
    Aurora. A group in Europe called Elk, yes, sir, we did.
        Mr. Sarbanes. But those were firms or companies that you
    have been doing business with for some period of time before
    you then took the next step of taking an equity position? I
    mean, you did some business with them, so you knew how they
    operated?
        Mr. Fuld. We did some business with them.
        Mr. Sarbanes. You then said earlier that at the time you
    bought them you changed management, changed underwriting
    standards and took other actions designed to pull back on the
    very risky nature of the way they were conducting business,
    which I respect, although there's some evidence that the
    practice has continued nonetheless. I guess that's an admission
    by Lehman that the standards that were being used up to that
    point, in other words, by those companies, when you were doing
    business with them but had not yet bought into them, were not
    adequate standards.
        Now, your, one of your vice presidents, this was mentioned
    briefly, went to California to kick the tires on First Alliance
    and came back with a memo saying these sorts of things. First
    Alliance is a financial sweat shop specializing in high
    pressure sales for people who are in a weak state.
        Let me just mention, my primary concern with all of this,
    and Lehman is an example, it's not the only example, it's an
    example, is that what was happening was the thirst for more
    originated loans upon which you could build an empire of
    derivatives and slice and dice up the chain to make more money,
    the thirst for those got pushed down the chain and encouraged
    people to look the other way in terms of standard conventional
    underwriting standards, and so forth, which then created a
    culture and atmosphere in which predatory lending could
    flourish. I think that's what ended up happening to the
    detriment of millions of homeowners across this country.
        So sweat shop was one description. You said First Alliance
    was the ``used car salesman'' of blemished credit lending. They
    made loans where the borrower had no real capacity for
    repayment. At First Alliance it is a requirement to leave your
    ethics at the door, and in spite of this Lehman went ahead,
    invested in the company, and there's other evidence--I may run
    out of time, because I want you to respond to this--there's
    other evidence that these sorts of practices and ethics
    continued even after First Alliance was purchased, or you took
    some kind of ownership stake in First Alliance.
        How could you consort with this kind of an operation, given
    how lax those standards were?
        Mr. Fuld. I am not sure if we took an equity stake in First
    Alliance, but that doesn't answer your question at all. We
    actually spent some time with First Alliance. I believe that
    was in the mid-1990's, and I think in the late 1990's we
    extended financing to them. We worked with them to change
    underwriting standards.
        In the case of the ones that we bought after BNC and
    Aurora, we acted more as a conduit. That means we went to them
    and bought their production, and their production of mortgages.
    In that, we began to understand their business practice, our
    name became associated with them. We realized the best way to
    handle that was to buy them. If our name was going to be
    associated with them, buy them, change the management and
    change the underwriting standards, and that is what we did, and
    that is why we did it.
        Mr. Sarbanes. Thank you. Mr. Chairman, there's some
    evidence that it didn't change, but I will accept that answer.
        Chairman Waxman [presiding]. The gentleman's time has
    expired.
        Mr. Welch, before you start your questions, I want to, just
    for housekeeping purposes, ask unanimous consent that all the
    documents that have been referred to in this hearing be made
    part of the record. We will certainly leave the record open for
    questions for Members and responses.
        Without objection, that will be the order.
        Mr. Welch.
        Mr. Welch. Thank you. Thank you, Mr. Chairman.
        Thank you, Mr. Fuld, for being here today. This is a
    tragedy unfolding all across America, and we are only beginning
    to feel the pain.
        I know you sit here as the chief executive of a company
    that has a proud history of 158 years, did some tremendous
    things, and I have known some employees at your company and
    they are terrific, and 28,000 employees now don't work at
    Lehman Brothers. You had accounts, $700 billion, I guess. I am
    not going to beat you up about your salary here, but I want to
    ask you a couple of questions.
        No. 1, it seems that Wall Street and Lehman, along with
    others, turned what was a basic, simple transaction that was a
    step in reaching the American dream, and that is a family
    buying a house and being able to do that by borrowing money on
    a mortgage. It was a straight-out transaction oftentimes
    between a neighbor who was a community banker and a just wide-
    eyed young couple oftentimes being able to afford the first
    house.
        That got to be turned into a commodity. It got put on
    steroids with these subprime mortgages. It then got
    securitized. As long as the real estate values in this country
    were going up, fueled by low-cost credit, it was a house of
    cards that would stand until the first whiff of a downturn.
        In retrospect, do you believe that this process of
    securitization, of easy credit, of convincing people who
    couldn't afford a mortgage, particularly when the rates were
    retriggered, was a house of cards that was bound to fail in
    retrospect?
        Mr. Fuld. Seeing it as I see it now----
        Mr. Welch. Is that a yes?
        Mr. Fuld. I am not sure I would say it was a house of
    cards. It was--none of us ever expected housing prices to
    decline with the depth of violence that it did.
        Mr. Welch. So, I mean, what I understand the problem you
    had is that you didn't get out fast enough and delever fast
    enough, and the market went faster than you were able to make
    the adjustments.
        Mr. Fuld. You know, actually, Congressman, that was not the
    case. Residential mortgages were not our problem at the end. We
    had----
        Mr. Welch. Let me ask you a couple of questions. Thank you.
    I don't mean to interrupt, but I only have 5 minutes.
        I want to ask you a little bit about AIG. I mean, there was
    a whole series of bailouts. Then Mr. Paulson made the decision
    that when it came to Lehman there was going to be no
    governmental assistance. So, in fact, Lehman Brothers was
    treated differently than some other financial industry giants
    that were in similar circumstances. Obviously, the Treasury
    Secretary made a decision for reasons that he can explain.
        But let me ask you this, my understanding is that you did
    have pretty regular contact, telephone contact with Mr. Paulson
    and probably some individual meetings. I also understand from
    reports in the New York Times that Goldman Sachs in fact was a
    major trading partner of AIG, about $20 billion on the other
    side of contracts.
        Did you have any concerns that there may be some arbitrary
    reasons why Lehman Brothers, facing similar predicaments as
    AIG, was allowed to fail, whereas AIG was the beneficiary of an
    $85 billion bailout sponsored by the Treasury Department?
        Mr. Fuld. Well, I clearly would have loved to have been
    part of the group that got that.
        Mr. Welch. Well, do you have any views on that or thoughts
    on that, why you were allowed to fail, you, Lehman Brothers,
    were allowed to fail and AIG was bailed out?
        Mr. Fuld. That was a decision that was made that Sunday
    afternoon.
        Mr. Welch. I know that.
        Mr. Fuld. And I was not there.
        Mr. Welch. You have to be wondering. You are the head of
    this company. You want to keep it going. I understand from you
    everybody knew you were dedicated to the survival of Lehman.
        Mr. Fuld. Until the day they put me in the ground.
        Mr. Welch. Exactly.
        Mr. Fuld. I will wonder.
        Mr. Welch. You got an e-mail, as I understand it, from
    someone in your office, Mr. Humphrey, I think, about the
    Jarrett Waite situation, telling you that Mr. Waite had stopped
    by and commented in just a few weeks on the buy side it's very
    clear that GS, Goldman Sachs, is driving the bus with the hedge
    fund cabal and greatly influencing downside momentum, Lehman
    and others; thought it was worth passing on.
        What was the meaning of that, as you understood it? This
    was from a business associate ally of yours; correct? By the
    way, I don't blame you for asking the question. That's what we
    are asking.
        Mr. Fuld. What Mr. Waite was talking about was that,
    obviously, Goldman Sachs was involved with the hedge fund
    community.
        Mr. Welch. Well, that's the short selling, right?
        Mr. Fuld. Greatly influencing the downside momentum of
    Lehman and others.
        Mr. Welch. And that refers to short selling?
        Mr. Fuld. I have no proof of that at all.
        Mr. Welch. I will just ask you your opinion. Do you think
    that there was any justified reason why Lehman was treated one
    way; namely, allowed to fail, and AIG, just as another example,
    was given $85 billion in taxpayer assistance to bail it out?
        Mr. Fuld. I do not know why we were the only one.
        Mr. Welch. Is there any rational business decision why
    there would be a distinction made between the predicament that
    Lehman faced and the predicament that AIG faced?
        Mr. Fuld. I, actually, I must tell you, Sunday night or,
    more importantly, that weekend, we walked into that weekend. I
    firmly believed we were going to do a transaction. I don't know
    this for a fact, but I think that Lehman and Merrill Lynch were
    in the same position on Friday night, and they did a
    transaction with Bank of America.
        We went down the road with Barclays. That transaction,
    although I believe we were very close, never got consummated.
        Mr. Welch. Well, I thank you. You know, I feel bad, I know
    you do, for those folks at Lehman and your investors and your
    shareholders.
        Mr. Fuld. Let me just speak to that for a second, because,
    you know, we talk about what happened at Lehman, and we talk
    about whose fault, and why wasn't I on it, and my employees, my
    shareholders, creditors, clients have taken a huge amount of
    pain. Again, not that anybody on this committee cares about
    this, but I wake up every single night thinking what could I
    have done differently. And this has been going on, what could I
    have done differently. In certain conversations, what could I
    have said, what should I have done.
        I have searched myself every single night. I come back to
    at the time--and that's why I said this in the beginning--at
    the time I made those decisions, I made those decisions with
    the information that I had. Having said all of that, I can look
    right at you and say this is a pain that will stay with me for
    the rest of my life, regardless of what comes out of this
    committee, regardless of what comes out of when the record book
    gets finally written.
        That's all.
        Chairman Waxman. Thank you, Mr. Welch.
        Mr. Shays.
        Mr. Shays. Thank you very much, Mr. Chairman. Mr. Fuld, I
    know it's been a long day, but we are coming to a close.
        I have a variety of questions. Let's see how well we can
    get through them.
        First off, what we are doing is we are trying to see what
    happened. We are trying to see who is responsible, and to
    determine who is responsible, and that includes Congress,
    ultimately it must, and what being responsible means.
        So I am going to end my question, and I will tell you now,
    by having you tell me the significance of the fact that you
    take full responsibility. That's going to be my last question.
        But I need to know what that means, and I don't want it
    now, because I want to ask a few other questions.
        Then we are going to look at what do we do to change the
    system. We are the oversight committee. I am also on the
    Financial Services Committee that will come up with solutions.
        Now, we had Enron and WorldCom and every part of the system
    broke down. The directors didn't direct, the managers didn't
    manage. The employees didn't speak out. One spoke out
    privately, didn't speak out publicly.
        The law firm was duplicitous and part of the problem. The
    accounting firm was part of the problem. You had the rating
    agencies, everybody, every part of the system failed. So we
    passed Sarbanes-Oxley.
        Amazingly, Fannie and Freddie were not under that, because
    they are not under the 1933 and 1934 act; therefore, they
    weren't under Sarbanes-Oxley. So two huge organizations were
    never under the very system we put in place with Sarbanes-
    Oxley, much less all the other laws that were required. But
    that's just a footnote.
        What I want you to speak to is the highly leveraged. It
    strikes me that Wall Street was incredibly blase about risk,
    including yourself, that 30 to 1, you didn't leave yourself
    enough to deal with the potential run on a bank, and that when
    you gave these bonuses you just made it less likely that you
    would have the kind of reserves you needed, which strikes me,
    obviously in hindsight, as reckless. But people were saying, as
    we were going through the system, we have too much leveraging.
        I kind of responded, well, you know, the hedge fund folks
    will tell me, you know what? It's the really wealthy people,
    and they can absorb the risk. They know what the risk is. They
    know it's huge leveraging. But what we know now is Wall Street
    can bring down Main Street. Frankly, I am going to tell you,
    it's a little scary, because we don't even know all the folks
    that have been impacted by Lehman Brothers going down. I mean,
    we know stockholders, shareholders, clearly, employees, but all
    the different folks who had resources held by your company.
        So what I want you to do is speak about risk. Why did we
    get into this position of having such high leverage, and was it
    just too easy to make money that way, and so we just said the
    risk be dammed?
        Mr. Fuld. We certainly did not say risk be damned. I
    believe Lehman Brothers had a robust risk process. As far as
    the leverage, and I spoke about it earlier, there's a very big
    difference between the 30 times and where we were when we
    finished in the third quarter at 10\1/2\. A big piece of what
    that 30 was, again, was the match book, which was governments
    and agencies. So that should not be considered as an additional
    piece of risky leverage.
        Again, I will say that on September 10th we finished with
    the best or one of the best leverage ratios on the street and
    one of the best tier 1 capital ratios on the street. And, even
    to your question, that's how I viewed the company, and that's
    why I viewed it as strong, Mr. Congressman.
        Those were the metrics. Those were the metrics that the
    regulators used. Those were the metrics that all of us in the
    industry used, and ours were one of the best.
        Mr. Shays. Let me ask you about the rating agencies. What
    kind of relationship do you have with the rating agencies? You
    end up having to pay them to determine your value. Describe to
    me, do you have any financial relationship with the rating
    agencies?
        Mr. Shays. Yes, sir, we do.
        Mr. Shays. OK. Tell me that relationship.
        Mr. Fuld. On securitizations, for example, we go to them
    with the components of a potential securitized deal, the
    mortgages, valuation, loan to value, geography.
        Mr. Shays. Right, and you pay them for that?
        Mr. Fuld. They charge us a fee for a rating.
        Mr. Shays. How can we feel comfortable that the very people
    who are paying them are the very people they are evaluating?
        Mr. Fuld. That was one of the things on my list of things
    that should be included in, hopefully, tomorrow's reform.
        Mr. Shays. Let me just quickly go to executive
    compensation. I mean, this is the largest irritant, frankly, to
    the general public. When I got my MBA at NYU, I read a book,
    the 5,000 people that run America are the 1,000--I forgot what
    it was, but it was the people who run a company are on the
    board of three other companies or two other companies. So they
    help decide the compensation of someone else, and someone else
    helps decide the compensation of them.
        Do you really feel comfortable that the compensation
    committee can objectively evaluate what you and others should
    get when in fact you have some real say in who they are and--
    well, I don't need to say more.
        Mr. Fuld. There was nothing shy about my or the firm's,
    more importantly, the firm's or the board's compensation
    committee. They had access to outside experts, and they used
    it. They had access to other firms' competitive data. They were
    independent, and I find no--I was not on that board or on that
    group.
        Mr. Shays. Let me just end by saying to those of us on the
    outside, it seems a little screwed up, and it doesn't seem to
    us subjective, and that's my closing comment.
        I appreciate you being here today. Thank you.
        Chairman Waxman. Thank you, Mr. Shays.
        Mr. Sarbanes wanted additional time, and the Chair still
    has additional time. So I yield you 2 minutes.
        Mr. Sarbanes. Really, this is just to add something to the
    record, Mr. Chairman, getting back to the First Alliance issue,
    because you talked about how once you took an equity stake and
    the evidence is that you did do that, that you put new
    management, that the practices ceased and so forth.
        But the record is that even after you put hundreds of
    millions of dollars in there Mr. Hibbert, the same vice
    president who warned you about these practices before,
    indicated that First Alliance was still violating the Truth-in-
    Lending Act.
        In 2000, First Alliance went bankrupt. In 2002, the Federal
    Trade Commission charged First Alliance with systematically
    cheating elderly homeowners. The next year, more than 7,500
    homeowners sued Lehman and First Alliance for these same
    tactics. Where most lenders were charging fees of 1 or 2 points
    for a loan, your company was charging 25 points.
        The jury delivered a $50 million verdict against First
    Alliance and specifically found that Lehman Brothers
    ``substantially assisted First Alliance in perpetrating the
    fraud.''
        In light of that, it's just difficult to conclude that
    Lehman didn't know what was going on in terms of this subprime
    activity. I just wanted to add that to the record, Mr.
    Chairman. Thank you.
        Chairman Waxman. The gentleman's statement is part of the
    record.
        Mr. Fuld, we have completed the questioning by the Members,
    but I want to thank you for being here. I know this wasn't easy
    for you to be here, and I accept the fact that you are still
    haunted every night, as you said, by the wondering whether you
    could have done something different, whether this could have
    had a different ending.
        But I must say that statement you made that the system
    works because you lost the value of some of your shares really
    doesn't sound right to me. Because the system that you lived
    under gave you a very, very generous reward when your company
    was highly leveraged and everything was going up, and that's
    the American way. But when the leverage meant that you were
    taking huge losses, when the values were not holding up, you
    still got substantial compensation.
        I just would say that most Americans don't understand, even
    if--we thought you made $500 million, you said you only made
    around $350 million. That just seems to me an incredible amount
    of money.
        We have held hearings on executive compensation, and we
    found some conflicts of interest with these compensation
    committees. We are going to hold a hearing on the ratings, the
    groups that do the ratings for these bonds, because we think
    that ought to be explored more fully. But if you walked away
    with even $350 million and your shareholders got nothing, and
    the taxpayers have a system now where we put up $700 billion,
    and the American people are looking to see, are they going to
    come out of this?
        This is another day with a deep loss on Wall Street. We are
    just completely battered by the failure of our economic system
    as has shown up on the Dow and the ability to get credit. So
    something is just not right to say that the system worked as it
    should. That system didn't seem to be the system that makes
    sense. I still think that we have to look for ways to change
    it.
        Mr. Shays, do you want to make any closing comments?
        Mr. Shays. Just to say that I look forward to the next four
    hearings, and I do hope that we do get right in the thick of
    Fannie Mae and Freddie Mac.
        Thank you.
        Chairman Waxman. What I didn't hear from you, Mr. Fuld, you
    took responsibility for the decisions you made. In retrospect,
    you think you should have done some things different, but you
    don't seem to acknowledge that you did anything wrong. That, I
    think, is also troubling to me.
        Thank you very much for being here.
        That concludes our hearing for today, and we stand
    adjourned.
        [Whereupon, at 2:45 p.m., the committee was adjourned.]