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




                               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

  Available via the World Wide Web: http://www.gpoaccess.gov/congress/


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                 HENRY A. WAXMAN, California, Chairman
EDOLPHUS TOWNS, New York             TOM DAVIS, Virginia
PAUL E. KANJORSKI, Pennsylvania      DAN BURTON, Indiana
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
    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

                     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

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



                        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 
    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 
    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 
    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 
    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 
    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 
    Mr. Mica. Mr. Chairman, I have been on the committee with 
you for 16 years. I had the opportunity to chair two 
    Chairman Waxman. The gentleman will state his parliamentary 
    Mr. Mica. I am stating, but I have to have a preface for 
    Chairman Waxman. The gentleman will state his parliamentary 
    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 
    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.



    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 
    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.


    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 
    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.


    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 
    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 
    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 
    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.


    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 
    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 
    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 
    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 
    Mr. Smith. I think it was one piece of a much bigger 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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, 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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.
    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 
    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.


    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 
    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 
    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 
    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' 
    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 
    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 
    Mr. Fuld. I myself did not lobby for the increased 
    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 
    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, 
    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 
    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 
    Mr. Cummings. That would be June 9, 2008. You remember that 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    Mr. Kucinich. Indeed. Indeed.
    Chairman Waxman. Mr. Tierney.
    Mr. Tierney. Mr. Fuld, thank you for joining us here this 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    Mr. Fuld. Mr. Felder's presentation was when, January you 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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, 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    [Whereupon, at 2:45 p.m., the committee was adjourned.]