[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]

                      PUBLIC POLICY ISSUES RAISED
                      BY THE REPORT OF THE LEHMAN
                          BANKRUPTCY EXAMINER



                               BEFORE THE


                     U.S. HOUSE OF REPRESENTATIVES


                             SECOND SESSION


                             APRIL 20, 2010


       Printed for the use of the Committee on Financial Services

                           Serial No. 111-124

57-742 PDF                WASHINGTON : 2010
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                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
WM. LACY CLAY, Missouri                  Virginia
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
JOHN ADLER, New Jersey
JIM HIMES, Connecticut

        Jeanne M. Roslanowick, Staff Director and Chief Counsel

                            C O N T E N T S

Hearing held on:
    April 20, 2010...............................................     1
    April 20, 2010...............................................   101

                        Tuesday, April 20, 2010

Bernanke, Hon. Ben. S., Chairman, Board of Governors of the 
  Federal Reserve System.........................................    15
Black, William K., Associate Professor of Economics and Law, 
  University of Missouri-Kansas City School of Law...............    73
Cruikshank, Thomas H., former Member of the Board of Directors 
  and Chair of Lehman Brothers' Audit Committee..................    71
Eshoo, Hon. Anna, a Representative in Congress from the State of 
  California.....................................................     1
Fuld, Richard S., Jr., former Chairman and Chief Executive 
  Officer, Lehman Brothers.......................................    69
Geithner, Hon. Timothy F., Secretary, U.S. Department of the 
  Treasury.......................................................    13
Lee, Matthew, former Senior Vice President, Lehman Brothers......    75
Perlmutter, Hon. Ed, a Representative in Congress from the State 
  of Colorado....................................................     4
Schapiro, Hon. Mary L., Chairman, U.S. Securities and Exchange 
  Commission.....................................................    17
Valukas, Anton R., Partner, Jenner & Block LLP, Court Appointed 
  Examiner, Lehman Brothers Bankruptcy...........................    48


Prepared statements:
    Eshoo, Hon. Anna G...........................................   102
    Kanjorski, Hon. Paul E.......................................   114
    Speier, Hon. Jackie..........................................   115
    Bernanke, Hon. Ben. S........................................   118
    Black, William K.............................................   122
    Cruikshank, Thomas H.........................................   149
    Fuld, Richard S., Jr.........................................   158
    Geithner, Hon. Timothy F.....................................   166
    Lee, Matthew.................................................   175
    Schapiro, Hon. Mary L........................................   179
    Valukas, Anton R.............................................   193

              Additional Material Submitted for the Record

Frank, Hon. Barney:
    Written statement of Hon. Christopher Cox, former Chairman, 
      U.S. Securities and Exchange Commission....................   209
    Written statement of the Financial Accounting Standards Board 
      (FASB).....................................................   217
    Written statement of Hon. Henry M. Paulson, Jr., former 
      Secretary, U.S. Department of the Treasury.................   223
Garrett, Hon. Scott:
    Memorandum of Understanding Between the U.S. Securities and 
      Exchange Commission and the Board of Governors of the 
      Federal Reserve System.....................................   226
Hensarling, Hon. Jeb:
    E-mail from Bart McDade regarding Repo 105...................   227
Schapiro, Hon. Mary L.:
    Written responses to questions submitted by Representative 
      McHenry....................................................   228

                      PUBLIC POLICY ISSUES RAISED
                      BY THE REPORT OF THE LEHMAN
                          BANKRUPTCY EXAMINER


                        Tuesday, April 20, 2010

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 11 a.m., in room 
2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Members present: Representatives Frank, Kanjorski, 
Gutierrez, Sherman, Meeks, Moore of Kansas, Lynch, Miller of 
North Carolina, Green, Wilson, Perlmutter, Donnelly, Foster, 
Speier, Minnick, Adler, Kilroy, Driehaus; Bachus, Royce, Jones, 
Biggert, Hensarling, Garrett, McHenry, Jenkins, and Lance.
    Also present: Representative Eshoo.
    The Chairman. The hearing will come to order. The 
photographers will drop out of sight. If you took a couple of 
journalists with you, nobody would mind.
    We will begin with two of our colleagues who represent 
public jurisdictions that were victims of the Lehman 
misbehavior, I believe it is fair to characterize, and we have 
public jurisdictions that have been left uncompensated. That 
was one of the consequences of the legal situation that the 
Bush Administration believed it confronted, that they had no 
choice, they could either fund everybody or nobody, and in the 
future that will be different.
    But we now deal with the situation; and both Representative 
Perlmutter, who is a member of this committee, and 
Representative Eshoo, as a strong advocate for the district in 
California, along with another member of the committee, 
Representative Speier, have consistently raised this issue. So 
Representative Speier will make an opening statement, but we 
will begin with testimony from our two colleagues.
    We will start with Ms. Eshoo, because Mr. Perlmutter is 
stuck here for the day. You can speak and leave, so we will let 
you go first.


    Ms. Eshoo. Mr. Chairman and members of the committee, thank 
you for inviting me to testify today. I particularly want to 
thank you for your extraordinary leadership in helping to steer 
our Nation out of the worst financial crisis since the Great 
Depression. This hearing on the public policy issues raised by 
the report of the Lehman bankruptcy examiner demonstrates your 
continued vigilance on behalf of the American people.
    Up until days before its declaration of bankruptcy, Lehman 
Brothers was considered one of the most trusted, reliable, and 
safest of firms to invest in. The examiner's report clarifies 
just how risky the practices and lack of transparency that sank 
Lehman really were. This behavior exemplifies Wall Street's 
reckless behavior which brought our economy to the brink of 
ruin. When we look at the case of Lehman, we are really 
examining the root causes of the crisis.
    We learned in the examiner's report on page 732: ``Lehman 
employed off-balance sheet devices known within Lehman as `Repo 
105' and `Repo 108' transactions to temporarily remove 
securities inventory from its balance sheet, usually for a 
period of 7 to 10 days, and to create a materially misleading 
picture of the firm's financial condition in late 2007 and 
2008. Lehman accounted for Repo 105 transactions as sales as 
opposed to financing transactions. By recharacterizing the Repo 
105 transaction as a sale, Lehman removed the inventory from 
its balance sheet.''
    On page 733: ``Lehman regularly increased its use of Repo 
105 transactions in the days prior to the reporting periods to 
reduce its publicly reported net leverage and balance sheet. 
Lehman's periodic reports did not disclose the cash borrowing 
from the Repo 105 transaction; i.e., although Lehman had in 
effect borrowed tens of billions of dollars in these 
transactions, Lehman did not disclose the known obligation to 
repay the debt.''
    Now, why did Lehman do this? Let me quote the examiner's 
report again.
    Page 735: ``Starting in mid-2007, Lehman faced a crisis. 
Marked observers began demanding that investment banks reduce 
their leverage. The inability to reduce leverage could lead to 
a ratings downgrade, which would have had an immediate, 
tangible monetary impact on Lehman.''
    On page 738: ``By engaging in Repo 105 transactions and 
using the cash borrowings, Lehman reduced its reported leverage 
    On page 739: ``In this way, unbeknownst to the investing 
public, rating agencies, government regulators, and Lehman's 
board of directors, Lehman reverse engineered the firm's net 
leverage ratio for public consumption.''
    Senior executives at Lehman were fully aware of this. The 
examiner's report further states on pages 742 and 743: ``A 
senior member of Lehman's financial group considered Lehman's 
Repo 105 program to be balance sheet `window dressing' that was 
based on legal technicalities. Other former Lehman employees 
characterized Repo 105 transactions as an accounting gimmick 
and a lazy way of managing the balance sheet.''
    The bottom line is that, despite senior management knowing 
full well the perilous situation they were getting themselves 
and their investors into, they kept moving.
    The examiner concludes on page 746: ``Repo 105 transactions 
were not used for a business purpose, but instead for an 
accounting purpose: to reduce Lehman's publicly reported net 
leverage and net balance sheet.''
    On page 853: ``In order for this off-balance sheet device 
to benefit Lehman, the firm had to conceal information 
regarding its Repo 105 practice from the public.''
    With Lehman Brothers engaged in such risky behavior, this 
begs the question: Where were the SEC, the Treasury, and the 
Federal Reserve? The examiner's report concludes that these 3 
agencies were monitoring the situation since early 2007. They 
were aware that Lehman was in trouble given their highly 
leveraged balance sheets. The agencies warned the firm about 
the risk of collapse if they didn't move to more conservative 
investments. However, the leadership at Lehman Brothers 
continued to maintain their pattern of deception.
    The examiner's report goes on to say, on pages 1,482 and 
1483: ``At the highest levels, each of these agencies 
recognized as early as 2007, but certainly by mid-March 2008, 
after the Bear Stearns near collapse, that Lehman could fail. 
Treasury Secretary Paulson, Federal Chairman Bernanke, the 
Federal Reserve Board New York Secretary Geithner, and SEC 
Chairman Cox all had direct communication with former Lehman 
CEO Fuld. The day after Bear Stearns Weekend, teams of 
government monitors from the SEC and the Federal Reserve Board 
New York were dispatched to and took up residence at Lehman to 
review and monitor its financial situation.''
    So we had one of the largest banks in our country teetering 
on the brink of bankruptcy and the executives of that bank were 
masking accounting gimmicks that inflated their quarterly 
earnings. The rest of the story we know all too well.
    The Chairman. We have a very full day, so you are going to 
have to wrap this up.
    Ms. Eshoo. I will just summarize.
    In my congressional district, San Mateo County and its 
public institutions were severe victims and still are of the 
Lehman bankruptcy. San Mateo County is required by California 
State law to hold operating funds, reserves, and bond proceeds 
in an investment pool. Their investment pool, which held funds 
on behalf of the county, local cities, school district, transit 
agencies, and the community college district were invested in 
the most highly rated conservative Lehman securities. When 
Lehman collapsed, San Mateo County lost $155 million.
    I will submit the rest of my testimony for the record, Mr. 
Chairman, and would also like to request that a Wall Street 
Journal article that outlined exactly what happened to San 
Mateo County be put into the record as well.
    [The prepared statement of Ms. Eshoo can be found on page 
102 of the appendix.]
    The Chairman. That will be put in the record. And all 
witnesses, I believe there will be no objection, will have the 
ability to put anything into the record which they wish to 
    Ms. Eshoo. I thank you again.
    The Chairman. Mr. Perlmutter?


    Mr. Perlmutter. Thank you, Mr. Chairman, Mr. Bachus, fellow 
    As we recall, the fall of 2008 was full of turmoil in the 
financial services sector; and the turmoil intensified on 
September 15, 2008, when Lehman Brothers Holding, Inc., filed 
the largest bankruptcy proceeding in this country's history. 
The Chapter 11 filing of Lehman Brothers rocked Wall Street, 
but it also severely affected small communities like those in 
Colorado who invested in Lehman Brothers. These were school 
districts and local governments who made investments that they 
believed were conservative in Lehman which was portraying its 
financial condition in a better light than it was in reality. 
They trusted that Federal regulators were keeping a watchful 
eye on companies like Lehman Brothers.
    In Colorado, a group of over 100 municipalities, school 
districts, and other local government entities invested in a 
State-sanctioned investment program for public monies known as 
the Colorado Surplus Asset Fund trust or CSAFE. CSAFE is a 
Triple-A rated fund that was adversely affected by Lehman 
Brothers filing when a money market fund in which CSAFE had 
invested known as the primary fund or the reserve fund 
announced that it broke the buck. CSAFE invested in the primary 
reserve fund for both security and liquidity purposes.
    Another group of 63 Colorado governments invested directly 
in Lehman Brothers commercial paper through the Colorado 
Diversified Trust pool known as CDT. CDT is a local government 
investment pool operated under Colorado statutes where the 
investments are held on behalf of the participants but 
registered in the name of the trust. After Lehman went under, 
CDT disbanded, and the $5 million Lehman investment is now held 
in their names, but we don't know what they are worth.
    The local entities that own Lehman Brothers provide core 
community services such as sewer, water, fire protection, 
public safety, and education. As many of you are also 
experiencing, these school districts and small community 
entities are already facing economic hardships and the losses 
suffered from Lehman are multiplying the local economic 
    As we consider the public policy implications highlighted 
in the report of Examiner Valukas, it is clear that many 
critical components for the House-passed Wall Street Reform 
bill are critical to ensuring that similar mistakes are not 
    The issue begins with the reliance on the credit rating 
agencies. These Lehman entities and Lehman investments were 
Triple-A rated investments, yet communities got clobbered.
    The importance of increased oversight and transparency in 
the derivatives market is also evident in the examiner's 
report. Information sharing and greater coordination between 
Federal regulators is critical.
    And it is clear from the examiner's report, and I just 
refer the committee to pages 1,488 and 1,489, the SEC, which 
was supposed to be the primary regulator, was overseeing a 
number of Lehman's activities. Whether it was valuation of its 
assets, whether it was reporting things properly, whether it 
was liquid or not, whether things were secured, Lehman Brothers 
at its end was acting like it was pawning its assets.
    It is as simple as that. It kept pawning its assets to its 
lenders on a faster and faster basis and got less and less for 
what it pawned. So one week, it pawned its gold watch and got 
$100. The next week, the secured creditor said, that watch is 
only worth $75; and pretty soon it was just running to keep 
    The regulators saw this happening, especially the SEC, but 
they didn't share it with the little guys. The communities in 
Colorado, the communities in California, my guess is everybody 
in this committee has entities and community governments which 
have suffered the same kind of fate. So we need to have better 
information sharing among the various government entities that 
are regulating this.
    There was this thing, as I said, this Repo 105. The 
repurchase agreement is just, in my--after you read this, is 
just another way of describing pawning, just trying to get 
assets today or get money today for your assets so that you can 
keep in business. This company was in serious shape over the 
course of 2007-2008, yet that disclosure wasn't made known to 
local governments like those in Colorado. We think that 
disclosure element, that reasonable regulation and reasonable 
disclosure, as we have outlined in our reform package that 
hopefully we will vote on this spring, needs to be done to 
avoid the kind of losses that school districts, hospital 
districts, and the like suffered in Colorado and elsewhere 
around the Nation.
    With that, I yield back.
    The Chairman. I thank the gentleman from Colorado.
    Are there questions for either of our two colleagues?
    If not, we will proceed to opening statements.
    The gentleman from Alabama.
    Mr. Bachus. Mr. Perlmutter, you mentioned central 
derivatives clearinghouses as one of the things suggested, and 
I agree with you that there needs to be some information on 
that. And you mentioned rating agency reforms, and both 
Republicans and Democrats propose some of those reforms.
    But, going past that, better information sharing between 
the agencies doesn't require legislation. And I totally agree 
with you that they did not share information among themselves, 
nor did they share it with the American people. But that is 
their statutory duty today. You wouldn't need new legislation.
    What I guess I am saying is that 95 percent of the failures 
here; there were regulations on the books which they simply 
didn't enforce. I am not sure about the call for more 
regulations and more powers, when they failed to do their job 
in the first place.
    Mr. Perlmutter. If I could respond?
    Mr. Bachus. Sure.
    Mr. Perlmutter. I think one of the things that I see in 
this report is that the Securities and Exchange Commission back 
in 2007-2008, maybe before that, may have been watching things 
but wasn't sharing much with the other regulators. So I agree 
with you. They ought to be sharing.
    There was also a question of, for instance, the SEC, there 
was a deposit of several billion dollars with Citigroup by 
Lehman Brothers. Lehman Brothers treated it as an asset when in 
fact it was held as collateral by Citigroup. The SEC knew that, 
but, quote--and this is on page 1,488--``the SEC did not, 
however, take any action to require Lehman to remove the 
deposit from the amount it continued to report publicly.'' So 
there were--each agency was making mistakes, and I think the 
SEC was at the heart of it.
    But your bigger question, and I think it is within the bill 
that we propose, is the oversight council, so that really there 
is a place where they are forced to talk about these major 
financial institutions. And if there is a systemic risk, and 
the report also talks about there being a void in dealing with 
a systemic risk after Gramm-Leach-Bliley, we have to move 
forward on that.
    Mr. Bachus. Right. In fact, I think both parties, and we 
proposed an oversight council, too, so I would agree with you 
on that. I guess what I am saying is the material 
misrepresentations, the laws are on the books today. They just 
didn't do their job. Their number one job is to protect 
investors; and, as you say, they concealed that information. 
The Federal Reserve--you talked about the SEC. The Federal 
Reserve was on site.
    Mr. Perlmutter. Both of them were.
    Mr. Bachus. They were either incompetent or they concealed 
the facts. I would agree with both of you that the facts were 
they did not share that information. And I think they knew. A 
lot of what Lehman was doing went back to 2005. They got away 
with a little, then they got away with a little more, then 
    But I am just saying that I think we ought to all really--
and what you kind of start with is, if you are going to fix 
something, you have to find out what caused it. And I think 95 
percent of the cause is they didn't do their job. That is the 
regulators. In fact, not only did they not do their job, in 
cases they actively failed to share with the American people 
the information they had. So there was not only nonfeasance, I 
think there was malfeasance.
    Mr. Perlmutter. And I will just respond. I agree with you. 
I think the SEC's job is to especially take care of the 
investors out in Denver, Colorado, and Lakewood, Colorado, 
those guys who aren't privy to all of the inside information. 
They are not JPMorgan Chase. They are not Citigroup. And so the 
SEC, by not really stepping up and saying to my communities, 
hey, you better watch these investments, they are not looking 
so good, we have concerns about them, I think that was a 
failure. And the regulator has to do a better job. We have to 
have reasonable regulation. Don't overreach, but when you know 
there is a problem, let people know that so they can make 
educated investment decisions.
    Mr. Bachus. Exactly. I agree totally with that.
    The Chairman. I will just recognize myself for a minute to 
say the gentleman from Colorado said to the counties and other 
local governments, you are not a sophisticated financial 
institution, and the answer is, don't try to invest like one 
either. I think a little more prudence going forward in the 
investment side would also be helpful.
    We will excuse our witnesses. We thank our colleagues. I 
know Mr. Perlmutter will join us. We will continue. I know 
there is ongoing legislative activity here.
    Our colleagues have been very diligent, along with Ms. 
Speier, in trying to pursue some relief for their constituents, 
and we will continue to cooperate with them.
    We will now begin with opening statements, and we need our 
witnesses to leave quickly. Thank you.
    We will begin with the opening statement of the gentleman 
from Pennsylvania, Mr. Kanjorski, the chairman of the Capital 
Markets Subcommittee.
    Mr. Kanjorski. Thank you, Mr. Chairman.
    We meet, again today, to examine yet another massive 
corporate failure. We have heard the sad song of corporate 
greed and regulatory breakdown one too many times in recent 
years in instances like the accounting misdeeds at Enron, the 
massive Madoff fraud, and the audacious bets of the American 
International Group. The events that led to Lehman's collapse 
add another verse to this troubling refrain in American 
    In the Lehman tune, it deeply troubles me that we must once 
again explore how reckless Wall Street titans profited at the 
expense of innocent shareholders on Main Street. I am also 
deeply disappointed in the performance of auditors and 
regulators who failed to uncover wrongdoing, mismanagement, and 
capital shortfalls even as they fiddled in Lehman's offices. 
The American people, those who invest their hard-earned savings 
and retirement nest eggs in our markets, deserve not only 
answers about what happened but also the enactment of real 
solutions to design--
    Mr. Bachus. Mr. Chairman, should the witnesses not be 
present for the opening statements?
    The Chairman. If the gentleman wants them to be, that is 
fine with me. Are the witnesses here?
    Mr. Bachus. We are waiting on Secretary Geithner.
    The Chairman. I would go ahead.
    Mr. Bachus. The statements are actually intended for the 
witnesses. I don't know how Mr. Kanjorski feels, but that is 
the regular order.
    The Chairman. I understand. I think they will hear what has 
been said. We have a large committee and a lot of questions to 
    Are the witnesses here? Let's get the witnesses who are 
here out here. Let's ask those two to be here. My guess is the 
Secretary is represented, and we will go forward. Let's wait 
until they come out.
    Mr. Bachus. I do hope that Secretary Geithner is here by 
the time we ask him questions.
    The Chairman. I will say that the Secretary has been very 
diligent in responding to requests. He has never ducked us. He 
has given us a great deal of time. And I think he was told that 
there would be statements from the members first. So no 
inference should be drawn about Secretary Geithner's 
willingness to be here. He has been a very cooperative witness.
    The gentleman from Pennsylvania will now proceed.
    Mr. Kanjorski. To reiterate, Mr. Chairman, I am deeply 
disappointed in the performance of auditors and regulators who 
failed to uncover wrongdoing, mismanagement, and capital 
shortfalls even as they fiddled in Lehman's offices. The 
American people who invest their hard earnings and retirement 
nest eggs in our markets deserve not only answers about what 
happened but also the enactment of real solutions designed to 
reform the way Wall Street functions.
    The Valukas Report also reveals that Wall Street executives 
continue to embellish the truth, tell half truths, and hide 
behind their power in the marketplace. Lehman's former managers 
claim not to recall transactions or not to have spent 
meaningful time examining those very transactions important to 
investors. I find their excuses difficult to believe, 
especially in the wake of the corporate accounting and 
attestation reforms mandated by the Sarbanes-Oxley Act.
    Moreover, Lehman's unscrupulous practices illustrate 
exactly why the Senate needs to quickly pass and the Congress 
needs to swiftly finalize the Wall Street Reform bill. The bill 
already passed by the House would force major participants in 
our markets to hold more capital and leverage less.
    Additionally, the House-passed legislation and the pending 
Senate bill would include provisions to end the era of ``too-
big-to-fail,'' like my amendment directing regulators to break 
up financial firms that have become too big, too 
interconnected, too concentrated, and too risky.
    The thoughtful Valukas Report additionally highlights the 
importance of my whistleblower reforms and tipster bounties 
contained in the House bill.
    Moreover, his report proves the need to fundamentally 
change the way the U.S. Securities and Exchange Commission 
operates. Among other things, the House bill doubles the 
Commission's budget over 5 years and requires comprehensive 
review and overhaul of the Commission's operations.
    In sum, today's hearing builds a case for Wall Street 
reform. Hopefully, this Lehman hearing will be one of the last 
arias of this all too gloomy opera about the dark side of 
American capitalism. The proverbial fat lady must begin to 
sing. We must now begin our work.
    The Chairman. The gentleman from Alabama is recognized for 
4 minutes.
    Mr. Bachus. Thank you, Mr. Chairman.
    In response to reading revelations of the accounting 
manipulations by the Lehman bankruptcy examiner last month, I 
called on Chairman Frank to hold this hearing. I want to thank 
him for his prompt response to my request.
    One has to ask the question, was Lehman too big or too 
interconnected to blow the whistle on? The court-appointed 
bankruptcy examiner, Anton Valukas, has provided us with an 
exhaustive report on Lehman's actions and the regulator's 
failures in that critical period between the rescue of Bear 
Stearns and Lehman's bankruptcy. As we consider how to reform 
our financial regulatory system his report serves as both a 
case study and a cautionary tale of what can only be described 
as a gross regulatory failure. The regulations and powers 
needed to address the misconduct were in place. They simply 
were not utilized.
    When Mr. Valukas released his report, he unveiled a 
troubling narrative that many had suspected but did not know to 
be the case. The report found that Lehman engaged in 
``materially misleading accounting and balance sheet 
manipulation.'' Had there not been a bankruptcy, and had Mr. 
Valukas not conducted his report as a result, the acquiescence 
of the New York Fed and SEC in Lehman's misrepresentations 
would have been swept under the rug and the American people and 
investors kept in the dark.
    Far more disturbing than the material accounting 
irregularities of Lehman were the actions or inactions of 
regulators, the New York Federal Reserve Bank and the SEC, who 
were on site at Lehman and had every opportunity and 
responsibility to observe the actions painstakingly described 
in Mr. Valukas' report. The report shows at best regulators 
failed to catch an accounting manipulation that permitted 
Lehman to give a misleading picture of its financial health to 
investors, creditors, rating agencies, and the financial 
markets. As a result, what would have been a bad situation, a 
failure of one of the Nation's large investment banks, was made 
far, far worse by the Fed's failure to plan and coordinate the 
response to Lehman's certain collapse.
    These regulators failed to share information with each 
other about Lehman's deteriorating liquidity position, and they 
failed to force Lehman to disclose that it was far less liquid 
than it was reporting itself to be.
    The New York Fed and the SEC administered three stress 
tests to Lehman, and Lehman failed them all. This alone is 
concrete evidence of a complicity of the Federal Reserve and 
the material misrepresentation of Lehman's financial condition. 
Regulators did not require Lehman to do anything in response to 
these failures. And, more importantly, they failed to disclose 
these failures to the financial markets.
    In conclusion, Mr. Chairman, the regulatory proposals that 
have been offered by this Administration, and are now being 
considered by Congress, double down on these same failed 
policies. The same regulators, in some cases the same 
individuals who failed us 2 years ago and made Lehman's 
collapse far more damaging than it should have been, are still 
with us. Lehman is gone, but the failures of the Fed and the 
SEC are still with us and should not be rewarded with new 
regulatory powers.
    I yield back the balance of my time.
    The Chairman. The gentlewoman from California, Ms. Speier, 
is recognized for 1 minute and 50 seconds; and she also 
represents areas affected by the failure. Ms. Speier.
    Ms. Speier. Thank you, Mr. Chairman.
    More than 18 months have passed since Lehman Brothers 
collapsed, but the repercussions of its failed and possibly 
criminal leadership continue. As was detailed by my colleagues 
on the first panel, State and local governments across the 
country who invested taxpayer dollars in supposedly safe Lehman 
investments have had to cancel important projects, lay off 
employees, and make other drastic service cuts to make up their 
losses. They lost, but others profited handsomely from Lehman's 
reckless actions.
    Lehman's CEO, Richard Fuld, is here today. He certainly 
profited handsomely. He made almost $500 million in salary, 
bonuses, and stock options since 2000. You note I did not say 
``earned.'' He has publicly stated he felt terrible about the 
failure of Lehman. I say that is not enough. I say give it 
back. Disgorge yourself of the money. It is time for those 
whose greed, arrogance, and fraud caused this crisis to be held 
    The bankruptcy examiner makes a compelling case that fraud 
took place and that Mr. Fuld is lying about his role in it. I 
guess that is to be expected, since he is trying to avoid 
    It is funny. Repo 105 is more like criminal procedure 101. 
The executives of Enron were held criminally and civilly liable 
for their responsibilities relative to fraud. Their accountants 
were held liable. We must demand the same here, not just for 
Lehman but for all those on Wall Street who have bought into 
the culture of greed and profit for themselves, no matter what 
the cost is to others.
    The executives are not the only ones responsible. 
Government regulators bear a large share of the responsibility. 
Mr. Fuld argues that Lehman could have survived had it been one 
of the clubs favored by the Fed and Treasury and provided a 
bailout just like Merrill and Bear Stearns and AIG. Instead, 
the government chose to let Lehman fail.
    I will submit the rest of my testimony for the record.
    The Chairman. Let me ask at this point if we can get 
unanimous consent for our colleague, Ms. Eshoo, who has been a 
leader in the effort to deal with the fallout here, to sit with 
the committee. Is there any objection?
    Hearing none, Ms. Eshoo will be welcome to sit with us.
    And the gentleman from California, Mr. Royce, is recognized 
for, I guess, 2 minutes and 10 seconds. The gentleman from 
Alabama gave back 20 seconds.
    Mr. Royce. Thank you, Mr. Chairman.
    As the Fed's Donald Kohn pointed out months prior to the 
bankruptcy, the question was not whether Lehman Brothers would 
fail, but the question was when it would fail and how it would 
fail. And since the crisis we have heard from advocates of the 
Dodd-Frank regulatory reform package that the regulators only 
had two options: bailout or bust. Hence, the need for 
resolution authority. This is a false choice.
    As the Lehman bankruptcy examiner puts it, what is clear is 
that the government--had it acted sooner, the government could 
have handled this. What is clear is that the markets might have 
been spared the turmoil of Lehman's abrupt failure. The 
regulators were not fully engaged, he said. They did not direct 
Lehman to alter the conduct we know in retrospect led Lehman to 
ruin. The government did not act soon enough. The regulators 
were not fully engaged. While regulatory consolidation and 
updating is necessary, the evidence from the Lehman collapse 
shows the regulators had the sufficient tools, they just failed 
to act to mitigate the impact of this failure.
    We are now on the brink of doubling down on this flawed 
approach with the Dodd-Frank regulatory reform, and we are on 
the verge of authorizing bailouts of the future which is going 
to create more moral hazard. Instead of moving away from a 
government-provided safety net under our financial system, the 
Dodd-Frank approach expands the size and scope of that safety 
net, thereby compounding the moral hazard problem that frankly 
not only contributed to the collapse but contributed to the 
collapse of a lot of other institutions.
    Instead of a strong commitment from the Federal Government 
to never again shield creditors and counterparties of failed 
institutions from losses, this approach in this legislation 
does just the opposite. It authorizes bailouts, and that will 
inevitably lead to the erosion of market discipline as the 
cornerstone of the well-functioning market.
    The Chairman. The gentlewoman from Ohio, Ms. Kilroy, who 
was the first to ask for a hearing on this subject, wrote to us 
and asked for a hearing, and I will--
    Mr. Bachus. Mr. Chairman?
    The Chairman. Yes?
    Mr. Bachus. My letter preceded her letter by one day.
    The Chairman. Oh, I am sorry. I hurt the gentleman. She was 
the first one who came to my attention. I apologize to the 
    While I am at it, I do want to say, because I want to give 
the gentleman's feelings full vent, Secretary Geithner, in your 
absence, there were 1\2/3\ opening statements. I hope you will 
read them, because members should not have been making opening 
statements that you didn't read. So you will not be tested on 
them, but we do ask you to read them.
    I trust I have taken care of everybody's feelings, and the 
gentlewoman from Ohio is now recognized for 1 minute and 50 
    Ms. Kilroy. Thank you, Mr. Chairman. I am more than happy 
to share credit for writing letters and calling for this 
hearing with Mr. Bachus.
    Today, we are looking at the practices of Lehman Brothers 
and the policy implications following the report of Anton 
Valukas, the court-appointed examiner of the Lehman bankruptcy. 
The report describes how Lehman frequently ignored the warnings 
of their own risk management system to pursue even greater risk 
and disguise their position by using an accounting practice 
known as Repo 105 to bolster their balance sheet and quarterly 
reports. Representative Perlmutter described that as pawning. I 
describe it as compulsive gambling, taking ever riskier bets 
and then disguising those losses through Repo 105.
    The subsequent fallout and its effect on Main Street were 
simply extraordinary. We heard from Colorado and California.
    Likewise, I asked the State treasurer of Ohio for public 
records regarding Ohio State pension funds, which had 
sophisticated advisors, about their investments with Lehman. I 
wanted to understand the impact on hard-working Ohioans whose 
pensions often represent their life savings. While the long-
term nature of these investments and the ongoing bankruptcy 
proceedings make it difficult to calculate the exact amount of 
economic damage incurred by Ohio's pension funds attributable 
to Lehman's bankruptcy, the information provided makes it clear 
that the losses are substantial. For the last quarter of 2007 
to September 2008, Ohio's public pension funds holding with 
Lehman declined in value a staggering $480 million.
    That is just Ohio. There are millions of hard-working 
Americans nationwide who watched their savings eroded by the 
reckless bets of Wall Street. If they were regulated the way 
that Ohio's community banks are regulated, I doubt this would 
    Thank you, Mr. Chairman, for your consideration and your 
strong leadership. I yield back.
    The Chairman. The gentleman from New Jersey is recognized 
for 2 minutes and 10 seconds. Mr. Garrett.
    Mr. Garrett. Thank you, Mr. Chairman. Thank you to all the 
witnesses as well.
    I had a chance to read the summaries of the Lehman 
bankruptcy report, and reading the testimony of some of the 
witnesses today and thinking back on some of the exchanges that 
we have had in this committee as well it seems as though a 
pattern does seem to be emerging here, and that same pattern 
basically emerges throughout other case studies that led to the 
current financial crisis. And the pattern that I speak of is 
where regulators who are basically put in place to protect the 
investors, the depositors, and the financial system itself 
basically have repeatedly been shown to be unable or unwilling 
to do the job that they are appointed to do.
    While during the current debate over the regulatory forum 
you hear a lot of calls for transparency of the institutions 
that they oversee, many times regulators seem to be having 
trouble living up to those same standards when it comes to 
their efforts. Now, in the case of point in Lehman bankruptcy, 
the Fed knew that Lehman would fail sooner or later. And I 
think the SEC probably knew all along that the number of 
employees that they had dedicated to the entire consolidated 
regulation of the major investment banks, only 24, was really 
completely inadequate to do the job. Likewise, with the Fed, 
which I think has disclaimed any responsibility for the only 
two folks that they had over there. Yet in both of these cases, 
the regulators led the public to believe that they were on the 
job and protecting investors, while in fact they were not being 
transparent about the true state of play at the time.
    Another angle on failed regulation that cries out for 
closer scrutiny, and one I hope that we get to today, is the 
regulated structure of the New York Fed. One is basically rife 
with conflict of interest where the institutions being 
regulated choose their own regulator.
    Now, over in the Senate, you have the Dodd bill, which is 
currently under consideration, would significantly increase the 
authorities of these same regulators. Like a lot of Americans, 
I don't have a lot of confidence in the regulatory regime we 
have; and, given their track record, giving these regulators 
more power will provide the market with a false sense of 
security while hampering the free markets.
    More people, for instance, should have been listening to 
the David Einhorns of the world, a hedge fund investor who 
actually figured out what Lehman was doing at the time and put 
less faith I think in the regulators that are supposedly 
watching out for investors on Main Street.
    Now, that is a lesson that I think, unfortunately, keeps 
coming through over and over again as we have these hearings 
and as we have studied events leading up to this financial 
    The Chairman. I will recognize myself for, I believe I have 
1 minute remaining.
    Before I do that, before the minute starts, I want to ask 
unanimous consent to insert into the record testimony of former 
SEC Chairman and member of this committee Chris Cox, who is out 
of the country, and former Secretary of the Treasury Henry 
Paulson--two men who obviously had a major role in dealing with 
this--and a letter from the Financial Accounting Standards 
Board, since we want to get that involved.
    I will now recognize myself a minute to say I am 
disappointed at the partisan tone.
    First, I have to say the gentleman from California stated a 
view of myself and Senator Dodd which has less relation to 
reality than the norm. We never said that there was only a 
choice throughout this between bankruptcy and a bailout. What 
we have said, and we have quoted Secretary Treasury Paulson on 
this, is that once the failure comes, you have to pay all or 
nothing. The notion that you do nothing to avert failure is, of 
course, the opposite of what we believe.
    As to the notion about the regulators having enough power, 
two President Bush appointees, Christopher Cox of the SEC and 
Henry Paulson as the Secretary of the Treasury, both said, no, 
we did not have enough authority.
    Now, I want to address briefly the false dichotomy between 
did they have enough authority to do it and, if they did, 
should we give them any more? Yes, if everybody had worked 
perfectly, they could have avoided it, but people don't work 
perfectly. And having more authority to make sure that you deal 
with potential failures is part of our job.
    We will now begin with Secretary Geithner and the 


    Secretary Geithner. Thank you, Chairman Frank, Ranking 
Member Bachus, and members of the committee.
    On September 15, 2008, Lehman Brothers became the largest 
bankruptcy in American history. In the days that followed, it 
helped push our financial system to the brink of collapse.
    Lehman's failures illustrate many of the fundamental flaws 
in our financial system. These problems are exposed with great 
care and force in the Valukas Report. The report tells a story 
of the ways in which our system allowed large institutions to 
take on excessive risks without effective constraints. In 
particular, this system allowed the emergence of a parallel 
financial system, what many have called the shadow banking 
system. This system operated alongside and grew to be almost as 
big as the regulated banking system, but it lacked the basic 
protections and constraints necessary to protect the economy 
from classic financial failures.
    Imagine building a national highway system with two sets of 
drivers. The first group has to abide by the speed limit, wear 
seatbelts, buy cars with anti-lock brakes. The second group can 
drive as fast as they choose with no safety features and 
without any fear of getting pulled over by the police. Imagine 
both groups are driving on the same roads. That system would 
inevitably cause serious collisions, and drivers following the 
rules of the game would inevitably get hit by drivers who 
    A system like that makes no sense. We would never allow it 
on the roads, so why do we allow it in our economy?
    Our financial system allowed risk to move toward areas 
where regulations were most lenient. And, as you would expect, 
when there is a lot of money to be made by avoiding regulation, 
there is going to be a lot of activity and risk moving to where 
the constraints are weak.
    In the lead-up to the crisis, we saw a breakdown in the 
basic, most fundamental, most important checks and balances in 
the system. Credit rating agencies failed to do an adequate job 
of assessing the risks in structured credit products and 
disclosing their ratings methodologies, boards of directors 
failed to exercise critical judgment and address critical 
weaknesses in risk management, accounting and disclosure 
regimes did not adequately inform investors of material risks 
in a timely fashion, and executive compensation practices were 
rewarded short-term gains with little attention to the risk of 
long-term loss. The derivatives market, operating largely in 
the dark without oversight, grew to enormous scale, with firms 
able to write hundreds of billions of dollars of commitments 
without the capital to meet those commitments.
    And, tragically, when we saw firms manage themselves to the 
edge of failure, the government had exceptionally limited 
authority to step in and to protect the economy from those 
failures. We did not have any ability, as we have had with 
banks for more than 3 decades, to step in, and in an orderly 
and safe way wind down major investment banks like Lehman or 
major insurance companies like AIG.
    Failure is inevitable in financial systems. The challenge 
for government is to design a system in which the failures of 
private firms cannot cause catastrophic damage to the economy.
    In our system, the Federal Reserve was the fire station, a 
fire station with important if limited tools to put foam on the 
runway, to provide liquidity to markets in extremis. However, 
the Federal Reserve, under the laws of this land, was not given 
any legal authority to set or enforce limits on risk-taking by 
large financial institutions like the independent investment 
banks, insurance companies like AIG, Fannie Mae and Freddie 
Mac, or the hundreds of nonbank financial firms that operated 
outside the constraints of the banking system.
    The sweeping financial reforms that this committee has 
passed, that the House has passed and that the full Senate is 
now about to consider are designed to deal with the 
vulnerabilities in this system, this financial system exposed 
by the crisis and illustrated by the Lehman example.
    First, with financial reform, investment banks like Lehman 
will not be able to escape consolidated supervision because of 
their corporate form. Large firms like Lehman would be subject 
to tougher prudential requirements such as higher capital, 
higher liquidity requirements, and more exacting oversight than 
other firms because of the greater risk they pose to the 
    With financial reform, we will bring derivatives markets 
out of the dark. We will establish transparency so that 
regulators can more effectively monitor the risks of 
derivatives players and financial institutions; and we will 
bring the standardized derivatives products into central 
clearinghouses and trading facilities, reducing the risk these 
markets can pose to the system.
    With financial reform, if a firm like Lehman is able to 
manage itself to the edge of failure, the government will have 
the ability to wind it down with no exposure to the taxpayer. 
This is bankruptcy for banks. It is essential to deal with 
moral hazard, the risk that investors and executives will take 
risks in the future in the expectation the government will step 
in to bail them out.
    And, finally, with financial reform, we will establish 
stronger protections for investors and for consumers, with 
clear rules enforced across the financial marketplace. We need 
a system in which regulators can act preemptively to protect, 
not be left to simply come in after the fact to clean up the 
    The failures in our system, of course, were devastating. 
When a conservative Republican President, a President with an 
abiding faith in markets, is forced by a financial crisis to 
put Fannie Mae and Freddie Mac into conservatorship, to ask 
Congress for $700 billion in authority to stabilize a financial 
system, and to invest taxpayers' money into banks that 
accounted for 75 percent of our financial system, to lend 
billions of dollars to two of our largest automakers--when a 
President, a conservative Republican President is forced to do 
all that, and he was right to do it, it is undeniable that the 
system is broken.
    The question we face is not whether to fix it but how best 
to fix the system. Any strategy that relies on market 
discipline to compensate for weak regulation and then leaves it 
to the government to clean up the mess is a strategy for 
    The best strategy is to force the financial system to 
operate with more transparency, with clear rules that set 
unambiguous limits on leverage and risk so that taxpayers never 
have to come in and protect the economy by saving firms from 
their mistakes. This is the strategy behind the reforms 
proposed last June by the President, the reforms passed in 
December by the House, and the reforms currently under debate 
in the Senate.
    Thank you very much.
    [The prepared statement of Secretary Geithner can be found 
on page 166 of the appendix.]
    The Chairman. Chairman Bernanke?


    Mr. Bernanke. Thank you.
    Chairman Frank, Ranking Member Bachus, and other members of 
the committee, I appreciate the opportunity to testify about 
the failure of Lehman Brothers and the lessons of that failure. 
In these opening remarks, I will address several key issues 
relating to that episode.
    The Federal Reserve was not Lehman's supervisor. Lehman was 
exempt from supervision by the Federal Reserve because the 
company did not own a commercial bank and because it was 
allowed by Federal law to own a federally insured savings 
association without becoming subject to Federal Reserve 
    The core subsidies of Lehman were securities broker-dealers 
under the supervisory jurisdiction of the SEC, which also 
supervised the Lehman parent company under the SEC's 
Consolidated Supervised Entity, or CSE, program. Importantly, 
the CSE program was voluntary, established by the SEC in 
agreement with the supervised firms without the benefits of 
statutory authorization.
    Although the Federal Reserve had no supervisory 
responsibilities or authorities with respect to Lehman, it 
began monitoring the financial condition of Lehman and the 
other primary dealers during the period of financial stress 
that led to the sale of Bear Stearns to JPMorgan Chase. In 
March 2008, responding to the escalating pressures on primary 
dealers, the Federal Reserve used its statutory emergency 
lending powers to establish the primary dealer credit facility 
and the term securities lending facility as sources of backstop 
liquidity for those firms. To monitor the ability of borrowing 
firms to repay the Federal Reserve in its role as creditor 
required all participants in these programs, including Lehman, 
to provide financial information about their companies on an 
ongoing basis.
    Two Federal Reserve employees were placed onsite at Lehman 
to monitor the firm's liquidity position and its financial 
condition generally. Beyond gathering information, however, 
these employees had no authority to regulate Lehman's 
disclosures, capital, risk management, or other business 
    During this period, Federal Reserve employees were in 
regular contact with their counterparts at the SEC; and in July 
2008, then-Chairman Cox and I negotiated an agreement and 
formalized procedures for information sharing between our 
agencies. Cooperation between the Federal Reserve and the SEC 
was generally quite good, especially considering the stress and 
turmoil of the period.
    In particular, the Federal Reserve, with the SEC's 
participation, developed and conducted several stress tests of 
the liquidity position of Lehman and the other major primary 
dealers during the spring and summer of 2008. The results of 
these stress tests were presented jointly by the Federal 
Reserve and the SEC to the management of Lehman and the other 
firms. Lehman's result showed significant deficiencies in 
available liquidity, which management was strongly urged to 
correct. The Federal Reserve was not aware that Lehman was 
using so-called Repo 105 transactions to manage its balance 
sheet. Indeed, according to the bankruptcy examiner, Lehman 
staff did not report these transactions even to the company's 
    However, knowledge of Lehman's accounting for these 
transactions would not have materially altered the Federal 
Reserve's view of the condition of the firm. The information we 
did obtain suggested that the capital and liquidity of the firm 
were seriously deficient, a view that we conveyed to the 
company and I believe was shared by the SEC and the Treasury 
    Lehman did succeed at raising about $6 billion in capital 
in June 2008, took steps to improve its liquidity position in 
July, and was attempting to raise additional capital in the 
weeks leading up to its failure. However, its efforts proved 
    During August and early September 2008, increasingly 
panicky conditions in markets put Lehman and other financial 
firms under severe pressure. In an attempt to devise a private-
sector solution for Lehman's plight, the Federal Reserve, 
Treasury, and the SEC brought together leaders of the major 
financial firms in a series of meetings at the Federal Reserve 
Bank of New York during the weekend of December 13th through 
15th. Despite the best efforts of all involved, a solution 
could not be crafted. Nor could an acquisition by another 
company be arranged. With no other option available, Lehman 
declared bankruptcy.
    The Federal Reserve fully understood that the failure of 
Lehman would shake the financial system and the economy. 
However, the only tool available to the Federal Reserve to 
address the situation was its ability to provide short-term 
liquidity against adequate collateral. And, as I noted, Lehman 
already had access to our emergency credit facilities.
    It was clear, though, that Lehman needed both substantial 
capital and an open-ended guarantee of its obligations to open 
for business on Monday, September 15th. At that time, neither 
the Federal Reserve nor any other agency had the authority to 
provide capital or an unsecured guarantee; and, thus, no means 
of preventing Lehman's failure existed.
    The Lehman failure provides at least two important lessons. 
First, we must eliminate the gaps in our financial regulatory 
framework that allow large, complex, interconnected firms like 
Lehman to operate without robust, consolidated supervision. In 
September 2008, no government agency had sufficient authority 
to compel Lehman to operate in a safe and sound manner and in a 
way that did not pose dangers to the broader financial system.
    Second, to avoid having to choose in the future between 
bailing out a failing, systemically critical firm or allowing a 
disorderly bankruptcy, we need a new resolution regime 
analogous to that already established for failing banks. Such a 
regime would both protect our economy and improve market 
discipline by ensuring that the failing firm's shareholders and 
creditors take losses and its management is replaced.
    Thank you, and I would be glad to respond to your 
    [The prepared statement of Chairman Bernanke can be found 
on page 118 of the appendix.]
    Mr. Kanjorski. [presiding] Chairman Schapiro?


    Ms. Schapiro. Thank you, Congressman Kanjorski, Ranking 
Member Bachus, and members of the committee. I appreciate the 
opportunity to testify regarding the Lehman Brothers examiner's 
report, and I want to thank Mr. Valukas for his thorough and 
invaluable work.
    The SEC supervised Lehman through a consolidated supervised 
entity program which was designed to fill a gap in the 
regulatory structure that was left when the Gramm-Leach-Bliley 
Act failed to require investment bank holding companies to be 
regulated at the holding company level. This program, while 
staffed with dedicated and hard-working professionals, was 
flawed in its design and never adequately resourced to meet the 
challenges of prudential supervision of some of the world's 
largest financial institutions. It reflected a profoundly 
different approach to oversight and supervision for the 
Commission, a move away from our traditional rules-based 
oversight of broker deals and securities products to a 
prudential model of consolidated supervision involving a vastly 
expanded array of entities and financial products. 
Participation in the CSE program by firms was voluntary. The 
program was seriously underresourced, understaffed, and 
undermanaged, and in some ways lacked a clear vision regarding 
its scope and mandate. The CSE program was discontinued in 
September of 2008 by former Chairman Christopher Cox.
    The examiner's report raises serious questions about the 
oversight of Lehman's liquidity pool, asset valuation, and its 
risk-related internal controls. Although firms are fully 
responsible for providing accurate information to their 
regulators, in certain instances it appears there was 
insufficient follow-up on issues that should have raised 
concern. In addition, the examiner's report identifies Lehman's 
use of Repo 105 transactions as a means for it to reduce its 
    Though the report concludes that the regulators, credit 
rating agencies, investors, and the Lehman board were unaware 
of these transactions, it nonetheless raises critical questions 
about the use of these transactions to manage Lehman's balance 
sheet at the close of financial reporting periods and also 
raises questions as to how widespread this practice may be.
    We have requested detailed information from multiple large 
financial institutions about their use of repurchase agreements 
or similar transactions and related accounting and disclosures 
and will take appropriate action when necessary.
    While the CSE program no longer exists, the SEC is taking 
steps to significantly bolster our oversight of larger broker/
dealers through improvements to broker/dealer reporting and 
monitoring, establishment of cross-divisional teams with 
dedicated responsibility for oversight of key financial firms, 
enhancements to our broker/dealer examination program, changes 
to the capital rules to reduce reliance on value at risk 
models, and consideration of increased capital requirements and 
explicit leverage requirements.
    The failure of Lehman also demonstrates the need for 
important legislative changes in supervisory resolution 
structures for large financial entities that can have a 
systemic impact. The bills passed in the House and being 
considered in the Senate, although different in many details, 
are designed to address key issues raised by the financial 
crisis and illustrated by Lehman's failure. The move toward 
central clearing and transparency of OTC derivatives can have a 
substantial impact on the soundness of our financial system. 
The creation of a systemic risk council, properly empowered, 
can be a force to improve standards across the industry. And 
the establishment of a credible resolution regime is vital to 
ending the problem of ``too-big-to-fail.''
    In light of the Lehman failure and the examiner's report, 
the SEC is determined to become a more effective regulator 
focused on capital adequacy and liquidity risk, committed to 
its core strengths in the areas of disclosure and enforcement 
and embracing meaningful functional regulation, active 
enforcement, and transparent markets.
    It is not clear that any action by the SEC could have saved 
Lehman Brothers, but we are determined to use the lessons of 
that experience to be more effective. More vigorous oversight 
and a new approach are essential, and I look forward to 
continuing to work with you as you consider ways to strengthen 
our financial system.
    Thank you for the opportunity to testify today, and I look 
forward to answering your questions.
    [The prepared statement of Chairman Schapiro can be found 
on page 179 of the appendix.]
    Mr. Kanjorski. Thank you very much, Madam Chairman.
    I am going to take my 5 minutes while the chairman is out 
of the room.
    I want to publicly announce that George Orwell lives. I 
have listened to my colleagues on the Republican side, and I 
really cannot believe--there are two conclusions I can come to. 
Either you all failed to read the bill that we passed here in 
this committee and in the House, or you are purposefully 
attempting to mislead the American people as to the real 
content of that bill.
    When you say that we do not have protections in there that 
never existed before, you are just dead wrong. And I call your 
attention to the amendment that I offered, the ``too-big-to-
fail'' amendment that passed this committee and is part of the 
House bill, that will prevent this in the future and give 
authority to these regulators and others the ability to stop 
institutions from growing so large that they will systemically 
challenge the American system. That is the first time in 
    Still, everyone on this side of the aisle seems--and 
particularly not only the members present at this committee, 
but I listened over to the weekend to these talking heads. I 
listened this morning to some of the Senators. Now, we have to 
get everybody together here to accept the basic facts or we are 
in trouble.
    Along with that, I will direct my questions. Mr. Secretary, 
we need a system, we really need a system. I have listened to 
your testimony very closely. I listened to Mr. Bernanke very 
closely and Ms. Schapiro very closely, and I did not hear you 
mentioning the ``too-big-to-fail'' amendment where we have 
authorized the appropriate regulators to move in, take control, 
and order large banks and institutions that challenge the risk 
to our system--either force them to break up, add capital, or 
take other actions that would reduce their risk. Is there a 
reason I am not hearing you mention that in this testimony?
    Secretary Geithner. Mr. Chairman, you are exactly right. 
Critical to any effective reform and at the center to the bill 
this committee passed are a set of authorities to limit risk 
taking across the financial system, and as part of that you 
proposed and the committee embraced a provision to give 
explicit authority to the Federal Reserve, to limit risks ahead 
of the crisis.
    I completely agree the best way to deal with ``too-big-to-
fail,'' the necessary part of reforms to deal with that, is to 
make sure there are people equipped with authority to put 
effective constraints on risk taking ahead of the crisis.
    Mr. Kanjorski. The question on that is--and it was raised 
by Mr. Volcker--have we been too nice to just say the 
regulators have that authority, or should we mandate the use of 
that authority?
    Secretary Geithner. Mr. Chairman, as you know, in the bill 
that Senator Dodd has proposed in the Senate, he takes an 
approach building on the model you laid out, which does impose 
actual limits and does require the Federal Reserve--would 
require the Federal Reserve, if passed, to design regulations 
that would apply those limits. So it includes your broad grant 
of authority, but accompanies that with an explicit requirement 
that clear limits be put in place.
    Mr. Kanjorski. I appreciate that. Mr. Bernanke, Mr. 
Chairman, I did not hear in your testimony any discussion of 
the ``too-big-to-fail'' amendment as proposed by this committee 
and passed into law in the House at least, and now part of the 
Senate bill in modification.
    Is there a reason why important elements of this 
Administration and the regulatory leadership of this company 
are not taking a public position on this issue?
    Mr. Bernanke. No, sir. I am very much in favor of 
addressing ``too-big-to-fail.'' I think it is a major concern, 
and the two lessons I drew on consolidated supervision and 
resolution are two big parts of the strategy.
    Mr. Kanjorski. I agree. They are. I did not hear your 
comment on the amendment that I offered in this committee as 
part of the House bill, and now part of the Senate bill, giving 
the authority to the regulators to intercede, require plans, 
require additional capital, break down organizations that are 
``too-big-to-fail.'' Is there a reason why you failed to 
address that?
    Mr. Bernanke. We were discussing Lehman, which was near the 
end. Prior to the crisis, you want to take actions necessary to 
limit risks, and I am very sympathetic to the view that through 
capital, through restrictions on activities, through liquidity 
requirements, through executive compensation, through a whole 
variety of mechanisms, it is important that we limit excessive 
risk taking, particularly when the losses are effectively borne 
by the taxpayer.
    Mr. Kanjorski. Mr. Chairman, you dance well.
    Mr. Bernanke. Thank you.
    Mr. Kanjorski. Are you going to answer my question? Are you 
or are you not in favor of the law as passed by the House and 
incorporated in the Senate bill authorizing the regulators with 
greater authority to break up organizations, if necessary, that 
are deemed to be ``too-big-to-fail?''
    Mr. Bernanke. I think it is something that would be on the 
whole constructive, and I am certainly, as a regulator, willing 
to work within its dictates.
    Mr. Kanjorski. Madam Chairman?
    Ms. Schapiro. Thank you. I would agree that having that 
authority for regulators is actually quite critical. I would 
point to the example of the CSE program to illustrate that, 
because that was a program that lacked a statutory basis and 
despite its many other flaws, which I am sure we will talk 
about further this morning, there was no authority on the part 
of the regulators based in statute to take dramatic or 
substantive action with respect to imposing requirements upon 
the investment bank holding companies. I think that was a huge 
flaw in the program.
    The Chairman. The gentleman from Alabama.
    Mr. Bachus. Thank you.
    Let me state, before I turn to questions, is where we 
disagree is injecting capital into those companies. The House 
passed $150 billion, what we continue to call a bailout fund. 
It is $50 billion in the Senate. I know Secretary Geithner has 
now called that it be removed, and I think that is an important 
    But we disagree that in a failing business like Lehman it 
is appropriate to put additional capital, particular by our 
governmental entities. That is where there is serious 
disagreement. Not that you don't need more resolution authority 
as they go into bankruptcy or a bankruptcy-like proceeding. 
There is no disagreement there, so I think we are getting 
closer together.
    Let me ask you this, Secretary Geithner. The examiner's 
report is replete with examples of the New York Federal Reserve 
and the SEC missing red flags that would have prevented 
Lehman's implosion from being as devastating to the markets and 
the economy as it ultimately was, and I am going to quote the 
    ``Had the government acted sooner on what it did or should 
have known, there would have been more opportunities for a soft 
landing. The markets might have been spared the turmoil of 
Lehman's abrupt failure.''
    Now, as harsh as that criticism is, for me it raises 
another question, and that is, why didn't the government act? 
Why didn't the regulators require Lehman to correct its 
misstatement and do something to prevent, as the examiner put 
it, billions of dollars of additional investments into Lehman 
by investors based on misinformation?
    I am wondering if the answer might be hinted at in your 
explanation to the examiner, that you feared the markets would 
figure out that Lehman had ``air in its marks,'' in other 
words, that Lehman was carrying assets on its books at inflated 
values, much-inflated values. I would ask you to respond to 
    Secretary Geithner. Thank you.
    Mr. Chairman, could I just begin with your first point, 
though, and then I will answer your question directly. The bill 
that this House passed and the Senate is considering would not 
give the Executive Branch of the United States the ability to 
go put capital into failed institutions. This is a very 
important point. You may be right that we may agree on the core 
provisions of this stuff, but it does not do that.
    What it does say is if a firm manages itself to the edge of 
the abyss, it can't survive without the government coming in, 
the only thing the government could do would be to step in and, 
in effect, put it into receivership so it could be broken up, 
sold off, unwound, without causing catastrophic risk to the 
economy as a whole and without the taxpayer being exposed to 
any risk of loss.
    Mr. Bachus. Mr. Kanjorski mentioned putting capital into 
the firm, and I know, Mr. Bernanke, you said you didn't have 
the right with Lehman to add capital. You wished you had that 
right. I think that is where we disagree, Chairman.
    Mr. Kanjorski. Will the gentleman yield? I just want the 
record to be correct. I never mentioned putting capital in, no.
    Mr. Bachus. You never mentioned capital?
    Mr. Kanjorski. Putting capital in, no.
    Mr. Bachus. All right. We will review the record. I thought 
you said, Mr. Chairman, that you didn't have the right to put 
additional capital into Lehman, not that you would have.
    Mr. Bernanke. In that context, we just had no tools. That 
might have been one possibility. But I am not advocating--
    Mr. Bachus. What I am saying is, you did say you didn't 
have the tools to put capital in, which to me would be an 
indication that you at least would like to put capital in. 
Maybe I misread that.
    Mr. Bernanke. No, sir, I do not.
    Mr. Bachus. You would agree with us that putting capital in 
is not appropriate?
    Mr. Bernanke. I would want the firm to die, but I would 
want to be able to break it up and sell off pieces and so on, 
very much like we do with a bank today.
    Mr. Bachus. Sure. Absolutely. And I don't know--we have 
proposed an enhanced bankruptcy for that, and I think giving 
you additional powers is appropriate, in that regard alone.
    Go ahead. Would you respond to the charge by the examiner 
that you could have avoided some of the harshness, that we 
could have had a softer landing had you acted sooner?
    Secretary Geithner. Mr. Bachus--
    Mr. Bachus. You were at the New York Fed.
    Secretary Geithner. I was president of the New York Fed at 
that time, and this is what I believe. At that point, beginning 
in March of 2008, two things were clear: One is we were on the 
edge of the verge of a financial crisis of enormous force, 
something that we hadn't seen in decades, and there were a 
series of institutions that had gotten themselves to the point 
where they were uniquely exposed to those risks. They were 
going to be terribly vulnerable to that gathering storm.
    Now, after Bear Sterns got itself into that mess, as you 
know we moved very quickly, the Federal Reserve, the Secretary 
of the Treasury, and the SEC moved very quickly to put in place 
a set of arrangements. It was a patchwork of arrangements, not 
an optimal set of arrangements, to try to encourage those large 
independent investment banks that remained to take actions to 
make themselves also stronger in the months that followed Bear 
Sterns. And we worked very closely together--
    Mr. Bachus. Let me--
    The Chairman. The gentleman's time has expired. We are 30 
seconds over already.
    Mr. Bachus. He did not--let me ask a yes or no question.
    The Chairman. No, the gentleman may make a concluding 
statement. We have a lot of members here.
    Mr. Bachus. I am going to point to the examiner's report, 
page 1510, ``The Federal Reserve Bank of New York was aware 
that Lehman was overstating its liquidity.'' Is that a true 
    Secretary Geithner. I don't know if that is a fair 
statement. What I would say, and I will echo what the Chairman 
said, is that there is nothing in that experience that did 
anything but confirm our judgment, Mr. Bachus, that Lehman was 
vulnerable to this gathering storm, both in terms of how much 
leverage it had and in terms of how it was funding itself. We 
were deeply concerned about that.
    Mr. Bachus. The Federal Reserve Bank was aware that Lehman 
was overstating its liquidity.
    The Chairman. I don't understand the gentleman from 
Alabama's approach here. He had plenty of time. He raised some 
other issues. It is my responsibility to try to give every 
member a chance. I asked one of my colleagues on the Democratic 
side to stop in a very important statement. We can't run the 
committee with people just talking whenever they want without 
regard to the time.
    Now, I will recognize myself for 5 minutes to add to my 
procedural dismay, frankly, some substantive dismay. I am 
disappointed at the partisan tone here.
    First of all, let's be very clear. The primary 
responsibility here is within the Securities and Exchange 
Commission, that is what Mr. Valukas says, despite Chairman 
Cox's statement, we believe it is clear that the SEC was 
Lehman's primary regulator. Page 6 of Mr. Valukas' testimony: 
``Mr. Cox was a Republican member of this committee appointed 
by President Bush to head the SEC partly because he thought his 
predecessor, whom he had also appointed, was too 
interventionist, Mr. Donaldson.''
    This effort to put it all on the Fed and diminish the role 
of the SEC is a fairly transparent partisan effort. It doesn't 
solve our purpose. We are here to try to make sure this doesn't 
happen again. That is our major role.
    Now, the other thing I have to respond to is this blatant 
mischaracterization that we are trying to put capital into 
these companies. The gentleman from Alabama began by saying he 
disagrees with us, I think he meant the Democrats, because we 
want to put capital into the company. He incorrectly imputed 
that statement to the gentleman from Pennsylvania, who made it 
clear he never said it.
    He then said, well, the Chairman said that was a tool they 
might have had back then. The Chairman is a very nice fellow. 
He doesn't speak for the Democrats, nor we for him.
    The bill that we have, as the Secretary made clear, is very 
explicit: No money can be spent in these cases until the 
institution is out of business. The notion that we inject 
capital into institutions is flatly wrong, flatly contradicted 
by the text of the bill.
    The point is that we put money in at the suggestion of the 
head of the FDIC, Ms. Bair, another Republican appointee whom I 
admire greatly, who says her experience is that when you are 
putting an institution out of business, as she does with banks, 
you need some money to do that in a way that does not cause 
greater systemic problems, and in fact, can minimize the cost 
to the government.
    That is what the money is there for. Whether it is there or 
after doesn't seem to me to be terribly important. What is 
important is none of that money can be spent to help the 
institution. So the suggestion, not the suggestion, the 
statement that there is an effort to inject capital into these 
institutions is simply flatly and clearly wrong.
    Now, the other point I want to make is this, to Ms. 
Schapiro, because we have been told, well, they had all the 
authority, etc. But I believe that there were a couple of 
decisions made by the SEC under Chairman Cox, whose statement 
we have put in the record. Chairman Cox and Secretary Paulson, 
by the way, both contradict my Republican colleagues. Those two 
appointees of President Bush said no, they didn't have all the 
authority they should have had, and they wanted to have more 
authority and they support efforts to give more authority here.
    But let me ask Chairwoman Schapiro, the SEC made a couple 
of decisions: one, to increase the amount of leverage that 
entities are allowed; and two, to give them a kind of voluntary 
regulatory approach. Would it be fair to say that contributed 
to the context in which this happened and that we have taken 
action to undo that?
    Ms. Schapiro. Mr. Chairman, the consolidated supervised 
entity program had to be voluntary because there was no 
authority in the statute for the SEC to bring investment bank 
holding companies under the regulatory umbrella. So when the EU 
directive required consolidated supervision for these 
institutions, the SEC, I believe at the time, felt it was 
stepping up to the plate to offer a consolidated supervisor so 
that they would be regulated.
    The Chairman. What would the current legislation, the 
pending legislation, do in regard to that?
    Ms. Schapiro. The current legislation would give a systemic 
risk regulator the tools to see all of the entities and 
affiliated entities across the institution, which I think is 
very important.
    In return for coming into this voluntary program and 
submitting to a holding company regulation by the SEC, the 
Commission permitted the broker dealers of these institutions 
to calculate their net capital in a different way, utilizing 
the alternative net capital rule, which took away the 
prescribed haircuts and instead allowed the firm to use value-
at-risk models.
    The Chairman. With the new authority you would get if the 
bill passed, would that still be allowed?
    Ms. Schapiro. The rules would still be allowed. Although 
there are no consolidated supervised entities any longer, 
presumably under the legislation they would be subject, these 
kind of entities, to the systemic risk regulator and the 
oversight of the council.
    The alternative net capital rules do still exist. They have 
been cut back, and it is a question we are debating right now 
within the agency to eliminate them in their entirety.
    The effect they had in 2004 was to allow firms by use of 
their models to support larger and larger positions against the 
same capital base that they had historically. To counterbalance 
that, though, they were required to hold $5 billion in early 
warning net capital and to have a liquidity pool--which raises 
all of its own issues--sufficient to cover their costs for a 
year if unsecured lending were unavailable.
    So there were trade-offs and balances. The agency felt it 
was bringing the holding companies into the regulatory sphere, 
but at the same time it loosened some of the ties on firms.
    The Chairman. The gentleman from California.
    Mr. Royce. Thank you, Mr. Chairman. I am going to raise a 
couple of issues here, not to point fingers at the regulators, 
but because Congress is on the brink of passing legislation 
that will fundamentally change our financial sector. And it is 
not just Members on this side of the aisle who are saying this.
    Over the weekend, I listened to one of our Democratic 
colleagues say that the Dodd bill would lead to permanent 
bailout authority and a fundamental change of our system. So 
there is that concern. And the underlying premise of the bill 
is the belief that despite the regulators' performance in 
recent years, regulators are going to always know here what to 
do to mitigate the next systemic shock. They are going to know 
    The case of Lehman Brothers, I think, proves that this is a 
shaky precedent upon which we are basing the future health of 
our capital markets. Because there is another way to look at 
this, and I remember an argument Mr. Geithner made that I 
thought was a profound one--you said that the top three things 
to get done are capital, capital, capital. It is the fact that 
we allowed these institutions to overleverage, right? The 
regulators allowed them to overleverage. I agree with that.
    I remember Mr. Greenspan said the reason the capital issue 
is so often raised is in a sense it solves every problem. And I 
remember Mr. Volcker saying the same thing, or essentially 
that. So that is where the reform efforts should be centered.
    Now, the wider presence of the Dodd bill, which, frankly, a 
lot of economists are raising issue with this concept of a 
permanent bailout authority, but let's go over the regulatory 
experience here.
    There is an expectation of regulatory competence in the 
market; counterparties, creditors, investors. They expect the 
Federal regulators to have a firm understanding of the solvency 
of an institution and whether or not that institution is 
basically accurately portraying their liquidity position; are 
those leveraged ratios really what they are supposed to be.
    So we are looking at the examiner's report here and it says 
the SEC deferred to the Federal Reserve Bank of New York. We 
mentioned these stress tests. You did three stress tests. You 
were chairman at the time, Mr. Geithner, of the Federal Reserve 
Bank of New York, you were president of the bank, and Lehman 
failed all three. And in the words of the bankruptcy examiner, 
it does not appear that any agency required any action of 
Lehman in response to the results of this stress testing.
    The New York Fed presumably had the authority under the 
memorandum of understanding with the SEC to require Lehman to 
take corrective action. Maybe you feel otherwise. But the 
bottom line seems to be that the Fed could have tightened terms 
and raised haircuts on collateral. Failure to use that leverage 
likely lulled the management of Lehman into believing that the 
government would save the day.
    And that is the moral hazard problem I have with all of 
this. I want to see more market discipline in this legislation. 
Let me allow you to respond. But I think it is a signal to 
market participants that a firm that the Fed privately knew to 
be failing should be treated as just as an another 
counterparty. That is my concern. Could I have your 
observations on that? And let's get back to the capital capital 
capital statement you made earlier.
    Secretary Geithner. Congressman, I really agree where you 
started. We cannot design a system that relies on the wisdom of 
regulators to act preemptively with perfect foresight, to come 
in and preemptively defuse pockets of risk and leverage in the 
system. That may be possible. We will do our best to do that. 
But you can't build a system that requires that level of 
preemptive exercise and perfect foresight. It is not possible.
    The only way I am aware of to design a more stable system 
is to use capital requirements, as you said, to enforce a set 
and enforce constraints in leverage on institutions that could 
pose catastrophic risks to the financial system. That is the 
centerpiece of the reforms that this committee embraced.
    To be able to do that on a consolidated basis for 
institutions exposed to systemic risk is the essential 
necessary reform that we all have to support. Now, it is not 
sufficient, but it is necessary.
    You also, to make credible the possibility of allowing 
failures in the future, have to make sure that the system can 
manage those failures without collateral damage to the 
innocent. And, again, that is what the bill does.
    Mr. Royce. Yes, I understand that. But under the Dodd bill, 
the creditors of any company that is resolved under the Dodd 
bill will have will a chance to be bailed out. If the creditors 
are not to take most of the losses as they did in Lehman, a 
fund isn't necessary. It is counterintuitive.
    The Chairman. The gentleman's time has expired.
    The gentleman from California, Mr. Sherman.
    Mr. Sherman. Thank you, Mr. Chairman.
    I was listening carefully to Mr. Kanjorski and I join with 
him in talking about the importance of his amendment. I think 
that we should go further and not just allow, but require 
regulators to break up firms that have reached a certain size.
    Mr. Kanjorski put forward the idea that either our 
Republican friends had failed to read the House bill or were 
deliberately mischaracterizing it. In an effort at 
bipartisanship, let me put forward a third possibility, and 
that is perhaps our Republican friends have read the Senate 
bill, which is unfortunately much closer to their 
characterizations than the House bill.
    As for reading bills, I know the Secretary of the Treasury 
has stated that under the bill under consideration in the 
Senate, ``the taxpayer will not be exposed to any risk of 
loss.'' I would refer the Secretary to sections 210 and 1155 of 
the Senate bill, in which the taxpayer clearly does take 
enormous risks, and that is similar to the risk they would take 
under section 1204 of the legislative proposal he made last 
    Under that legislative proposal, it is true that taxpayers 
don't take risks to bail out a failing institution for the 
benefit of its shareholders and management, but the taxpayers 
take tens of billions, perhaps hundreds of billions of dollars 
of risk, for purposes of taking care of the counterparties and 
the general creditors of these failed firms.
    Mr. Bachus shares my passion for avoiding bailouts, but he 
says the way to do that is to strip from the Senate bill the 
$50 billion fund there or the $150 billion fund that this House 
makes available to provide for the creditors of a resolved 
institution. I would point out that the amount available under 
either the Senate or the House bill for taking care of 
creditors and counterparties is not just the $50 billion or the 
$150 billion; it is that, plus borrowings from the Treasury.
    So if you eliminate the $50 billion or $150 billion fund, 
but you allow the borrowings, then the borrowings start with 
dollar one. I would think the ultimate, total victory for Wall 
Street would be to tell them they don't have to pay into the 
$50 billion or $150 billion at the present time, but that they 
are available for the FDIC to borrow money and to bail out 
their creditors and counterparties.
    Mr. Bachus. If the gentleman will yield, if I could respond 
very briefly, what I said in bankruptcy, then the taxpayers 
wouldn't be exposed at all. So I am saying that one of the 
things that this bailout is not putting taxpayers--
    Mr. Sherman. Reclaiming my time, I am more concerned with 
Senator McConnell's remarks where he seems to take aim at the 
$50 billion and $150 billion and leave the borrowing capacity.
    Secretary Geithner, we are here to discuss Lehman Brothers. 
We are doing an autopsy to learn how to treat future patients, 
and one of the possible treatments is either the House or the 
Senate bill.
    So let me take you back to September 1, 2008. It was too 
late, I would think at that point, to save Lehman Brothers, but 
it was not too late for an orderly resolution. The purpose of 
this bill is to give you and the other regulators the tools for 
an orderly resolution.
    How much money would you need from outside the Lehman 
Brothers carcass to take care, in an orderly way, of the 
counterparties, say the County of San Mateo, which had put 
money in, seems relatively blameless. Would you tell them that, 
well, we will sell off Lehman Brothers assets and hope to give 
you a few cents on the dollar? Or would you use the tools of 
these bills to go into the $50 billion, the $150 billion, the 
borrowed funds, in an orderly way to provide more to the 
general creditors and to San Mateo County than the carcass of 
Lehman Brothers would provide?
    Secretary Geithner. Congressman, you are a very thoughtful 
critic in many of your approaches in this area and I respect 
your views on this. So let me just describe again the basic 
idea underpinning the bill that passed the House and it is 
still in the Senate bill in this basic context.
    The idea is to take a model that has existed for more than 
3 decades for small banks. We have a lot of experience with 
that model over many recessions, many financial crises. That 
model allows the government to come in--
    Mr. Sherman. Mr. Secretary, I have such limited time. Could 
you just answer my question of what you would do with Lehman 
    Secretary Geithner. I want to get to your question. Your 
question is an excellent question.
    With this authority we are proposing, the government would 
have been able to come in, put Lehman into receivership to wipe 
out equity holders, to replace management in the board, and to 
manage that institution's unwinding in a way that maximizes 
return to the taxpayer and minimizes risk of losses for the 
    Mr. Sherman. Mr. Secretary, how much money would you need?
    Secretary Geithner. As you know, it is an unanswerable 
question. You can't know in advance how much.
    Mr. Sherman. Tens of billions.
    The Chairman. The gentleman's time has expired.
    The gentlewoman from Illinois.
    Mrs. Biggert. Thank you, Mr. Chairman, and thank you for 
holding this hearing, and thank you all for being here. I 
really wish we had had this hearing a long time ago, and I wish 
we had had the report from Mr. Valukas. I think it really is a 
document that is very important to our work here in this 
committee, and I think that we are sitting--it is getting kind 
of, I don't want to say political, but there are a lot of 
arguments here that I think that if we had had this before, 
that we would have had maybe a better discussion.
    And I know the questions that I have always had are about 
the regulators and did they do the right thing, and now we are 
talking about did you all have the authority.
    I think that one of the reasons, and I know I have asked 
Secretary Geithner so many times about having a council rather 
than having it through the Federal Reserve, and the reason for 
that is, and it seems apparent to me here, is the fact that the 
regulators in the report says you didn't really discuss this. 
Maybe at an early time where more action could have been taken. 
The regulators didn't meet and talk about it. And I would 
imagine that if there was such a crisis coming up, that it 
would have come to the committee, they would have come to the 
Financial Services Committee and say we have a problem here, 
and we don't think we have the authority. What can we do? How 
can this be solved? And that didn't happen.
    So we are looking back on an a really serious issue, and 
now we are talking about maybe we have to take care of the 
risk, take care of a bank that maybe it is going to fail, but 
before the crisis. So we have to have the working together of 
everyone to solve these problems.
    I kind of see that I don't want to see this get into back 
and forth and being kind of negative about all of this. But if 
we had the council, and I was thinking, I did FLAK where we 
actually wanted to bring all of the agencies together when 
there was a problem, and we did that with Hurricane Katrina, 
and found out there was a lot of duplication within the 
    What we need here is the authority for the regulators. But 
if we had a council and that was to discuss it, and somebody 
comes up with an issue and somebody else in another area has 
the same thing, that we would know ahead of time without so 
much government intrusion into these areas.
    I look at this as saying we have the big banks. We are 
going to tell them they are going to fail. And yet are we 
going--is the next step going to be companies that we are going 
to tell them they can fail, what their compensation will be?
    I think we are walking a really fine line here, and I hope 
there is more discussion on this, so that we really can find 
some answers. What is the difference between bankruptcy for 
Lehman Brothers and then having other ones that we are going to 
tell them that they are going to fail, but they don't go 
through bankruptcy?
    What about a small company? We see these small businesses 
going out of business every single day because they can't 
operate within the barriers that either the State or the 
government has put up. I think we have a much huger problem 
here than just this.
    But I really think that the examiner has done a really good 
job to highlight these, and I hope all of you who have worked 
on this would take this. I know, Chairman Schapiro, you have 
worked a lot on this and came in at a time when it was very 
difficult, and all of you have lived through this, and I just 
hope--we really have to come up with the right answers. So I am 
not going to ask any questions. Thank you.
    The Chairman. The gentleman from New York.
    Mr. Meeks. Thank you, Mr. Chairman.
    I guess I want to direct my questions first to Secretary 
Geithner, but I can't resist the comment of saying that in 
prior Congresses, this question about power that was had, we 
were in the climate where I think the other side, all they were 
talking about was we had too much regulation, we needed to 
deregulize, deregulize, deregulize. Now that we have this 
problem, I hear some other things that are going on. And there 
need to be some changes, and it seems they are resisting those 
changes that obviously are so importantly needed.
    But let me ask you first, Secretary Geithner, my colleague, 
Dennis Moore, and I had an amendment that passed this committee 
to require all systemically significant firms to run quarterly 
stress tests in accordance to standards and scenarios 
established by the Fed and to make the rules of these stress 
tests public. It also required the Fed to run similar stress 
tests every 6 months and to make their results public also. If 
a firm breaches the critically undercapitalized requirement 
under any of those scenarios, it must prepare and make a public 
and credible restructuring or dissolution plan which meets 
standards set by the Fed.
    If this had been required as early as 2000, we believe red 
flags would have been raised about Lehman well before it 
failed. Would the capital market have limited the firm's 
additional growth and exposure of the firm, and therefore, if 
this was in place likely limited the likelihood and impact of 
an eventual failure as took place in Lehman Brothers? I would 
like to get your opinion on that.
    Secretary Geithner. Congressman, I completely agree with 
you. I think you are in exactly the right place. I think 
requiring systematic stress testing on a regular basis and 
disclosing the results is a necessary, important thing and it 
would provide just the benefits you described. It would allow 
the market to make a better assessment of who is strong, who is 
less strong, about their potential capital needs, and give the 
regulators tools to force firms to raise capital earlier in the 
process. So I very much agree with you.
    Mr. Meeks. I hope we can get it in the Senate bill, because 
unfortunately it is not there now. I know there are some 
Senators who are going to make that amendment over the next 
couple of days. But any help that we can get that in the Senate 
bill would be deeply appreciated.
    Let me go to Chairman Schapiro. Recent reports indicate 
that large financial institutions are engaged in the repo 
process today, that is still continuing. In fact, the Wall 
Street Journal reported that over the last 5 quarters, leverage 
ratios are 42 percent lower at the end of the quarter than from 
their peak for several financial suggestion institutions. It 
appears investment banks are temporarily lowering risk when 
they have to report results, and they are leveraging up with 
additional risk right after.
    So my question is, is that still being tolerated today by 
regulators, especially in light of what took place with 
reference to Lehman?
    Ms. Schapiro. That is a great question. We have sent a 
letter and demanded information from the largest financial 
institutions to explain to us exactly how they are using repos, 
how they are accounting for and disclosing repos, and the 
impact on their balance sheet, whether they have changed their 
accounting models over the past 3 years, and, importantly, what 
have been their average debt balances over the period, so that 
we don't just have them dress up the balance sheet for quarter-
end and then have dramatic increases during the course of the 
    So we are collecting all of that information. It was due to 
the agency last week. We are analyzing it. We will make those 
comments public before terribly long.
    Then, on a parallel track, we are considering whether under 
SEC rules, we need new rules to prevent this sort of masking of 
debt or liquidity at quarter-end, as we saw Lehman do with the 
repo 105 transactions.
    Mr. Meeks. Let ask you, because you are the expert, you are 
a great securities lawyer, would you say that the failure to 
disclose leverage ratios over the course of the quarter 
constitutes intent to defraud investors, or is it a failure to 
disclose material information to investors? What would it be?
    Ms. Schapiro. Without concluding, because we obviously have 
an ongoing review of specifics in the Lehman area, I would tell 
you that current rules do require disclosure of off-balance 
sheet financial information and material trends in liquidity. 
And disclosure would be required if transactions are engaged in 
to present a better liquidity or leverage picture as of the 
reporting date.
    So we think the disclosure requirements are quite robust 
here. The question for us is whether Lehman complied with those 
disclosure requirements as well as the accounting requirements.
    The Chairman. The gentleman from New Jersey, Mr. Garrett.
    Mr. Garrett. I thank the Chair.
    As we begin, let me associate myself with some of the words 
of Chairman Schapiro as far as your position on the cause of 
this situation and the work that was a failure in the past and 
the good work you are attempting to do at this period of time.
    I associate also, I think you referred a little bit to the 
CFC situation, and as you know, the inspector general pointed 
out that there were problems with that program, and I think 
that is right on the mark.
    To Secretary Geithner, I didn't write it down exactly, but 
you said something, I got the first part of it, we can't rely 
on regulation to preemptively, I think it was dispel every--
    Secretary Geithner. On the wisdom and foresight of 
regulators to act preemptively.
    Mr. Garrett. That is it, and I agree with that assertion. 
The question that comes up with this, that the market does 
however is going to--should be able to rely upon the proper and 
adequate execution by the regulators so they can make their 
investments and what-have-you appropriately.
    Now, I know that you have been one who has been calling for 
a change in the system and supporting more transparency and 
disclosure, and basically the Senate bill and the like which 
characterizes changes in the markets, the derivatives markets 
and exchange programs, and putting things on the exchange and 
    But I have to say that after looking at the report, and 
again, under the other testimony, it seems that you are in a 
hard place to try to make that pitch for adequate transparency, 
light of the New York Fed's, not in your current capacity, but 
in the New York Fed's lack of disclosure during the period of 
time in question.
    It is almost like that old movie line, ``You want the 
truth? You can't handle the truth.'' And so the New York Fed 
decided that perhaps we would not disclose all of the truth 
going along.
    The reason that we are hearing this, we are getting this 
pushback or some of that sort of statement, is because we are 
hearing, well, it is not the Fed's responsibility, it was not 
the New York Fed's responsibility to disclose all of this 
    But I remind you, I don't know if we have it up on the 
screen, you have the memorandum of understanding between the 
Board and Commission. It reflects the Board's and the 
Commission's intent to collaborate, cooperate, and share 
information in areas of common regulatory and supervisory 
interests to facilitate their oversight of financial service 
    That tells me that back during this period of time, and 
even going back earlier than that, when I think the New York 
Fed put out a pamphlet that talked about who is responsible for 
all this as far as oversight, the New York Fed put out a 
pamphlet explaining that as a condition of obtaining access to 
the facility, primarily credit facility, investment banks would 
also be subject to supervision by the Federal Reserve. Since 
March 2008, standalone investment banks supervised exclusively 
by the SEC at that point have now come under the regulatory 
authority of the Federal Reserve as well.
    So the responsibility, the overall responsibility for 
regulation there and supervision, was with the New York Fed 
during the period of time when you were there. Now, was it 
being done is what the market--the market should assume that it 
is being done properly, correct? The question is, was it?
    In the report, it says the Federal Bank of New York was 
aware that Lehman was overstating its liquidity. This goes to a 
point that Ms. Schapiro was raising earlier, the necessity of 
making sure that the information is correct on Lehman's 
liquidity pool. In it, it says the New York Fed raised concerns 
with the SEC--strike that. The New York Fed did not raise 
concerns with the SEC about what it found because the New York 
Fed examiner said, ``they did not perceive,'' this is your New 
York Fed, ``did not perceive any duty to volunteer liquidity 
information to the SEC.'' Witnesses from the Fed also explained 
that its failure to take action and report this discrepancy 
stemmed from the fact that the Fed was not Lehman's primary 
    So my question initially is, during this period of time, 
you had regulatory authority; your examiner--was your pamphlet 
then not correct saying, when you set it out in March of 2008, 
that it is since March 2008, stand-alone investment banks 
supervised exclusively by the SEC have come under the 
regulatory authority of the Federal Reserve as well?
    Mr. Bernanke. The authority, they became bank holding 
companies, and that is when the real authority came over. The 
MOU that you are quoting states in numerous places, including 
in the section you just quoted, that nothing should be 
construed as saying anything other than that the primary 
responsibility remains with the SEC and the Fed is not 
responsible as a primary regulator.
    Mr. Garrett. So was there not a responsibility to exchange 
    Mr. Bernanke. There was excellent information exchanged. We 
had three phone calls every day between the SEC, the Fed, and 
Lehman Brothers. The couple of examples cited by the bankruptcy 
examiner are relatively minimal, and in each case, both parties 
had all the access to information independently that they 
    Mr. Garrett. So you knew about the problem--
    The Chairman. The gentleman's time has expired.
    The gentleman from Kansas.
    Mr. Moore of Kansas. Thank you, Mr. Chairman.
    Chairman Bernanke, Fed Governor Daniel Tarullo gave a 
recent speech noting the benefits of publicly releasing results 
from stress tests. Mr. Meeks asked a question about the 
amendment that we both offered to require release of this 
    If we had had regular and transparent stress tests starting 
in 2000, wouldn't those stress tests become more effective over 
time? Wouldn't they help investors and regulators identify 
potential areas of unhealthy risk taking and improve market 
    Mr. Bernanke. Again, we are talking about bank holding 
companies and the Fed's authority, not Lehman Brothers. We 
found the stress tests last year were extremely helpful; they 
provided a lot of information to the markets and increased 
confidence. We already use stress tests on a regular basis to 
try to validate and evaluate a bank's capital positions. But 
making them public is certainly something worth looking at.
    Mr. Moore of Kansas. Thank you, sir.
    Secretary Geithner, did the on-site examiners not know what 
questions to ask? Do you think you deployed enough people to 
properly oversee the large financial firm? Did these examiners 
get to know the people at Lehman? Do you have any retrospective 
thoughts about this?
    Secretary Geithner. Again, in that period of time, as 
Chairman Schapiro said, the Federal Reserve had no legal 
authority to act as Lehman's regulator or supervisor. We were 
very careful in designing the memorandum of understanding to 
make it clear to the public that this cooperative arrangement 
we put in place, where we were putting people in these firms to 
make sure we had a better sense of the risks we might be 
exposed to as a potential lender to Lehman Brothers and the 
other investment banks, did not come with or did not confer 
authority on us to act as their supervisor and regulator. We 
did not have that authority.
    So we established a very limited presence with a limited 
purpose, and that limited purpose was to make sure that we were 
in a better position to assess the risks we might be exposed to 
in the event that Lehman and these other firms took advantage 
of the primary dealer credit facility. But, again, we were very 
careful to make it clear that we had no supervisory authority, 
no authority as regulator, and that was an important 
    Mr. Moore of Kansas. Chairman Schapiro, the same question 
to you. Do you have a comment on that, please?
    Ms. Schapiro. Yes. I think that the issue for the 
consolidated supervised entity program was that it was never 
adequately staffed. There were no more than 24 people at the 
peak in the program responsible for the 5 largest investment 
bank holding companies and their affiliates.
    It was somewhat flawed in its design. It was a volunteer 
program. There were few mechanisms for the staff to require or 
mandate changes in risk management or other procedures. It was 
undermanaged, in my view, and it lacked clarity in its mission. 
Were we a prudential regulator or were we a disclosure and 
enforcement regulator? And those two things came into contact 
on multiple occasions, I think. So it was quite different than 
our historical approach to broker dealer regulation.
    It is one reason I think the legislation is really 
critically important, because these investment bank holding 
companies as systemically important institutions would come 
under genuine mandatory comprehensive regulation that the SEC 
was trying to bootstrap itself into through the CSE program.
    But, again, I have studied the examiner's report very, very 
carefully. I have looked at all of the flaws in the CSE program 
that are outlined there, and there are a number of ways where 
we either lacked authority or resources to do the kind of job 
that the American people had a right to expect.
    Mr. Moore of Kansas. Thank you very much.
    Mr. Chairman, I yield back.
    The Chairman. The gentleman from Texas, Mr. Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman. I am glad the 
discussion is a little less contentious now than it was 
earlier. But I would point out to my colleagues on the other 
side of the aisle who chose to impugn motives for people on 
this side of the aisle, that perhaps if there was not a bailout 
fund in the House bill or a bailout fund in the Senate bill, 
perhaps people would not be confused about the ultimate purpose 
of those funds. Perhaps those funds with the best of intentions 
are perhaps designed to ensure that no taxpayer funds are used. 
But, unfortunately, some of the people who designed them are 
the very same people who told us that Fannie and Freddie would 
never have a taxpayer bailout. We see what has happened there.
    Chairman Schapiro, my first question is for you. I 
understand many of your criticisms of the Consolidated 
Supervision Entity Program. But I guess my question goes to, 
what did the SEC have the authority to do and not do?
    As I read the language, it would appear that, number one, I 
am reading from title 17, chapter 2, part 240, that the 
Commission can impose additional conditions on a broker dealer, 
including restricting the broker dealer's business on a 
product-specific, category-specific or general basis; two, 
submitting to the Commission a plan to increase the broker 
dealer's net capital; and if the Commission finds it necessary 
or appropriate, it may impose ``additional conditions on the 
broker dealer or the ultimate holding company.''
    I know that Chairman Cox had previously testified before 
the Senate Banking Committee that, ``The SEC had authority to 
monitor for and act quickly in response to financial or 
operational weaknesses in a CSE holding company or its 
unregulated affiliates that might place regulated entities or 
the broader financial system at risk.''
    I think the General Counsel has said similar words, as did 
the Deputy Director of the Division of Market Regulation of the 
SEC in testimony before this committee.
    Is it not true that under this program, the SEC did have 
the authority to have caused Lehman to add additional capital?
    Ms. Schapiro. Congressman, my understanding is, and I 
wasn't there at the time, obviously, when the CSE program was 
in effect, the voluntary nature of the program related to the 
regulation and the supervision of the holding company and the 
affiliates of the broker dealers. The SEC does, as you point 
out, have broad and comprehensive authority with respect to the 
regulation of U.S. broker dealers.
    Mr. Hensarling. I am not sure if that answered the question 
or not. Under this voluntary program, I admit it was voluntary, 
could the SEC have required Lehman to post additional capital?
    Ms. Schapiro. With respect to the broker dealer, I believe 
they could have. With respect to the holding company, that is a 
question I don't think we really know the answer to. My view 
would be that we could have pushed the limits of our authority 
in this program much more than we did. That is because, while 
the program is voluntary, leaving the program meant being 
regulated by another regulator, in this case, likely a European 
regulator. So we had more leverage over these firms and than 
perhaps the staff thought they were free to exercise.
    Mr. Hensarling. So I think it is an important point, 
because as a practical matter, what would have happened had 
Lehman chosen to pick up their toys and go home, ultimately 
that sends a very strong signal to the market, or as you put it 
in all probability the EEU would have provided a regulator for 
    Okay. So you say that certainly you could have required 
more capital at the dealer broker level. How about the 
disclosure as far as what was posted into their liquidity pool 
and what was actually there, and at what point does the SEC not 
just have the authority to direct Lehman, say, to properly 
disclose, but to tell the public?
    Ms. Schapiro. My understanding is that with respect to the 
liquidity pool encumbrances, the staff knew of some, but did 
not know of others. With respect to the ones they knew about 
and knew about in a timely way, they directed Lehman to remove 
some of them from the liquidity pool for purposes of the 
prudential oversight program.
    There was not communication to Lehman that they needed to 
recalculate or provide new disclosure with respect to the 
public of what their liquidity pool assets were and whether the 
number had been changed by the removal of some assets.
    Mr. Hensarling. And is the same true with respect to Repo 
105? Could you have required--
    The Chairman. The gentleman's time has expired.
    Let me just explain--I don't think members ought to be able 
to start a new conversation after the red light. That has been 
my principle. I try and let things come down, but not have a 
new one.
    The gentleman from Massachusetts.
    Mr. Lynch. Thank you, Mr. Chairman. I want to thank the 
witnesses as well for helping the committee with its work,
    I do think that Lehman's example in their participation in 
the derivatives market could be instructive going forward. 
Secretary Geithner, you actually lay it out very, very clearly 
in your testimony. You say rightly that Lehman was a major 
participant in the over-the-counter derivatives market, and as 
of August 2008, Lehman held over 900,000 derivatives positions 
worldwide, and the market turmoil following Lehman's bankruptcy 
was in large part attributable to the uncertainty surrounding 
the exposure of Lehman's derivatives counterparties. Also, you 
note correctly that the derivatives market went from $2 
trillion in 2002 to $60 trillion at the end of 2007.
    So we are trying to get at this in the House and the Senate 
bills by requiring a couple of things. One is clearing of 
derivatives trades, and you also are talking about reporting. 
Secretary Geithner, you and I have had this conversation 
    I am concerned on two levels: One, right now in the United 
States, 97 percent of the clearinghouse ownership is in just 5 
firms, five banks. So I am worried about the concentration of 
ownership in the clearinghouse community.
    Two, and maybe Chairman Schapiro, you could address this, 
the fact that we are requiring reporting may not be enough. It 
depends on what they are required to report. Many of the 
failings that we had and many of I think the misinvestments in 
CDOs stemmed from the fact we couldn't find out what was inside 
a CDO, and there was a lot of difficulty for investors to do 
    So if you could just maybe, Secretary Geithner, you could 
talk about the clearinghouse problem, and then maybe, Chairman 
Schapiro, you might speak about the report.
    Secretary Geithner. Congressman, you are exactly right 
about what these bills tried to do. It is not just forcing 
central clearing of standardized products and bringing more 
transparency, but our view is standardized products that are 
centrally cleared should be traded on exchanges or on 
electronic trading platforms, and that the major participants 
in these markets have to be subjected to oversight to make sure 
they hold enough capital against these risks and we need to 
have more authority for the regulators to make sure they can 
police fraud.
    Now, on your question about the clearinghouse concentration 
risk, in encouraging central clearing you concentrate risk--
    Mr. Lynch. Just to be clear though, we have an exemption 
there for very complex derivatives to be traded bilaterally, so 
that compounds the problem.
    Secretary Geithner. You are exactly right. And our view is 
to make sure you can force people to hold enough capital in 
margin against the more complex products that can't be 
essentially cleared as a check and balance against the risks 
that people use that exception to evade the basic protection 
and benefits of central clearing.
    Now, when you concentrate risk in a clearinghouse, you are 
concentrating risk, so it is very important that the 
clearinghouse be run in a way where it has a sufficient 
financial cushion against the risk of default by its 
participants. So we will have a strong interest in making sure 
that the clearinghouses, and there will be many that will 
exist, are managed very conservatively, so we are effectively 
managing a system where we are going to concentrate the risk in 
those clearinghouses.
    Mr. Lynch. Thank you.
    Ms. Schapiro. I would agree that the utilization of 
clearinghouses can make an enormous difference in this 
marketplace in the reduction of counterparty risk. Coupled with 
that is we really need high levels of transparency, both to 
regulators and very much also to the public.
    With respect to the assets that underlie a variety of 
asset-backed securities, whether they are commercial real 
estate or home mortgages or auto loans, the SEC has recently 
proposed very extensive rules that would require detailed loan 
level disclosure in a very accessible, usable way for investors 
so that he they don't have to rely on rating agencies, but they 
can actually utilize their own analysis to determine what the 
quality of the assets are in those asset-backed securities.
    We have also proposed a retention requirement that would 
hopefully better align the interests of issuers of asset-backed 
securities to hold higher quality assets in those pools.
    Mr. Lynch. I know time is getting short, but I am worried 
about these very complex derivatives that are bilateral. How do 
you get at that? How do you let an investor know what is behind 
these? Because they are extremely complex. I just don't know 
what the reporting requirements are.
    Ms. Schapiro. Our rule proposal, if it is ultimately 
adopted by the Commission, would provide investors with all of 
that information in the public markets as a condition of using 
shelf registration, and actually proposes to allow very much 
the same kind of disclosure in the private markets.
    Mr. Lynch. Thank you.
    The Chairman. The gentleman's time has expired.
    The gentlewoman from Kansas.
    Ms. Jenkins. Thank you.
    Madam Chairwoman, I had a question for you. I just wanted 
to follow up and clarify a small detail that you touched on 
with one of my colleagues' questions. It is my understanding 
that the accounting standard that governed the repo 105 
transactions when Lehman was still around was Financial 
Accounting Standard 140, but it has recently been updated by a 
new standard, FAS 166. Is that true?
    Ms. Schapiro. Yes, FAS 166 and 167, which just went into 
effect in January, updated that accounting.
    Ms. Jenkins. And 166 changed the disclosure requirement 
such that a repo 105 type of transaction, one that accounted 
for the sale, would be required to be disclosed under the new 
standard, is that correct?
    Ms. Schapiro. The standard sets out particular criteria for 
what can be accounted for as a financing versus as a sale, and 
really goes to the heart of what a true sale is so these assets 
can be held off the balance sheet.
    Ms. Jenkins. Okay. But it requires reporting?
    Ms. Schapiro. Yes.
    Ms. Jenkins. And as you said, it would just really take 
effect for reports that are just now coming out?
    Ms. Schapiro. I believe the standard took effect in January 
of this year. So we will be watching very closely to see the 
effectiveness of this standard while we continue to look at the 
data I mentioned earlier that is coming in from the 19 
financial institutions on all of their repo accounting and 
    Ms. Jenkins. Thank you. I just think it is important for 
the committee to have an understanding as to how these 
standards have changed since this happened.
    The Chairman. If the gentlewoman would yield, I think it 
would be useful if all of those are submitted for the record. 
Let's get the actual text of all of the standards as part of 
the testimony.
    [The standards referred to can be accessed at www.fasb.org/
    Ms. Jenkins. Thank you, Mr. Chairman. We haven't seen a lot 
of media coverage on those standards and when they took effect. 
I appreciate that. I yield back. Thank you.
    The Chairman. The gentlewoman made a very important point 
that should have been raised. Let's make sure we have the old 
and new standards in the record here.
    The gentleman from North Carolina.
    Mr. Miller of North Carolina. Can I pass and come back? I 
am reviewing something now.
    The Chairman. All right. The gentleman from Texas.
    Mr. Green. Thank you, Mr. Chairman, and I thank the 
witnesses for appearing.
    I don't think that we can overstate the value of confidence 
in our system going forward. As a matter of fact, we want to 
make sure that we have confidence in our system at all times, 
and probably our system has functioned as well as it has, 
especially the FDIC insured system, because there is confidence 
in the system. Confidence is really a cornerstone of the 
system. And as we move forward, the question really isn't 
whether a large institution that poses a systemic risk should 
be allowed to fail if it is not properly managed, the question 
is, how do you allow that to happen and not create systemic 
risk? How do you allow that to happen and not have public 
confidence become a part of a crisis such that the public 
responds, if you are talking about banks, the public will 
respond by demanding the deposits.
    And when that happens, you have what is known as a run, and 
with a run, we find that the institutions themselves become at 
risk. That is a broader problem that we are trying to resolve, 
not the institution that is failing, but more how does that 
happen without causing other institutions to become a part of 
the failure that is developing?
    So with that said, I would like to start with Mr. Geithner. 
This plan that has been proposed to allow these institutions to 
fail, ``too-big-to-fail,'' right size to separate, eliminate, 
this plan to do this, if the plan were in place, how would it 
have impacted a facility, an institution like Lehman, please?
    Secretary Geithner. If this authority had been in place, 
then the government would have had the ability to step in early 
and effectively put Lehman Brothers or AIG into a form of 
receivership, into a form of bankruptcy, and again manage the 
unwinding sale dismemberment of that firm without risk, with 
less risk that would spread to healthy institutions.
    What you said at the beginning is exactly right: you want 
the system to be designed to, in a sense, draw a circle around 
the failing institution to make sure that the fire can't jump 
the fire break and infect the rest of the system. That is the 
    Mr. Green. Chairman Bernanke, if you would respond as well?
    Mr. Bernanke. The Secretary put it very well. In this case, 
you would want to isolate the broker-dealer which remained 
healthy. You would want to unwind the derivatives positions.
    A lot of discussion here has been on why didn't the SEC and 
the Fed insist on Lehman doing this, that, and the other thing. 
We were very insistent. We talked a lot to Lehman about raising 
capital and raising liquidity, but our stick wasn't very good. 
With a bank, you can seize a bank and say it is 
undercapitalized and break it apart. In the case of Lehman 
Brothers, you only had the nuclear option of essentially 
letting it fail. So with that tool, we would have had more 
ability to force Lehman to take precautionary actions and then 
we would have been able to plan the dismemberment over a longer 
period of time with the guidance of a living will and other 
types of tools. So I think it probably would not have 
completely insulated the system from the impact of failure, but 
it would have created an impact on many of the parts of the 
    Mr. Green. Madam Chairwoman, if you would like to respond?
    Ms. Schapiro. Thank you. As the non-bank regulator in the 
group, we look at building confidence a little bit differently. 
We create confidence through transparency and honest disclosure 
in the belief on the part of investors that they can rely on 
the information that is contained in the financial statements 
of the company whose stock they may want to buy. And that is 
really the fundamental underpinning of confidence in the 
securities market. But we also do it through tough rules that 
level the playing field so that institutional and retail 
investors have as many of the same opportunities in the 
marketplace as possible. We do it through hands-on supervision, 
and we have to do it through rigorous enforcement when the 
rules are violated. And I think those are all components of 
building confidence in our securities markets as compared to 
our depository institutions.
    The Chairman. The time of the gentleman has expired. The 
gentleman from Colorado.
    Mr. Perlmutter. Thank you, Mr. Chairman.
    Thank you, members of the panel for your testimony today. 
Before I get going, I would like to thank Chairman Schapiro 
specifically. One of the funds I spoke about earlier in my 
testimony called CSAFE was sort of an indirect investor in 
Lehman Brothers, and the SEC took very strong action in a 
number of lawsuits that had been filed in New York against the 
primary fund and the reserve fund and Lehman Brothers. And as a 
consequence, that fund that had lots of money from different 
entities in Colorado has received most of its money back. So I 
just want to say thank you on that.
    I do want to compare really how the SEC is being handled 
now versus how it was handled under the Bush Administration and 
under Chairman Cox, and I am going to use some of the language, 
Mr. Bernanke, that you used in your interview with Mr. Valukas 
where on page 1497 of his report, in your interview, first 
there were interviews of various staff, and they said the 
primary weakness of the CSE program was SEC understaffing and 
the lack of higher level skill sets.
    So that came from the testimony, I believe, of Thomas 
Baxter. Then in that same footnote, you say: ``Those views 
peculated to the top. Mr. Bernanke observed that the Fed had 
some skepticism and concern about the SEC's capacity going back 
to Bear where they were blindsided to a significant extent 
there as well.'' Then you said, Mr. Bernanke was careful not to 
assign blame or fault, but observed that the SEC was ``in over 
its head.''
    So, Mr. Chairman, sitting here having listened to a lot of 
testimony from you and other folks as we went through this 
hurricane in the fall of 2008, what appears from this testimony 
and this report and what I saw I believe firsthand was the SEC 
being an observer and not a regulator, kind of watching, 
monitoring, and then entities like those that I represent in my 
area in Colorado, the school districts, the hospital districts, 
and the fire protection districts, got clobbered.
    You described the relationship and the communication in the 
testimony as tricky between the SEC and the Federal Reserve. 
Describe what was going on between the Federal Reserve and the 
SEC in that last year with respect to Lehman Brothers to try to 
get it under control.
    Mr. Bernanke. First, on that quote, like Chairman Schapiro, 
I had no concerns about the confidence of the SEC staff, but it 
was a voluntary program which limited authorities and the SEC 
came to it with an enforcement culture rather than an 
examination culture, which I think was a problem in some 
    Contrary to the impression given by the examiner's report, 
with very few exceptions, I think the communication between the 
Fed and the SEC was really quite good during the very short 
period from April through September when Lehman failed. We 
worked together designing those liquidity stress tests. We had 
multiple calls a day, not me personally, but staff. Secretary 
Geithner may speak for himself.
    Mr. Perlmutter. So you would disagree with this statement 
by the examiner: ``Although the SEC and the Federal Reserve 
Bank had equal access to the same data on Lehman, the personnel 
of the two agencies did not necessarily share their conclusions 
and analyses with one another; indeed, because of what Bernanke 
described as tricky issues, he and Cox became directly involved 
in the negotiation of a formal memorandum of understanding that 
would allow the exchange of information between the two 
    Mr. Bernanke. There are some tricky legal issues which you 
don't want to take your time for me to explain, but we came to 
a very amicable agreement in July when we signed the MOU. So 
that was not an issue. Throughout the process, information 
exchange was good.
    Mr. Perlmutter. I will yield back.
    The Chairman. I am going to take 30 seconds. Chairman 
Bernanke, I greatly admire you; but please, don't ever tell the 
committee of jurisdiction that there are legal issues that we 
don't want to get into. We would like to have that choice.
    Mr. Bernanke. I apologize.
    The Chairman. The gentleman from North Carolina.
    Mr. Miller of North Carolina. Thank you, Mr. Chairman.
    Chairman Schapiro, you said a moment ago that the 
accounting rules have now changed, and the transactions that 
Lehman Brothers used to avoid reporting their liabilities, the 
repo 105 transactions, I think also the R-3 hedge fund 
investment. There were press reports at the time of the 
bankruptcy findings that suggested that other financial 
institutions may have used the same transactions for the same 
purposes. Have you determined if other institutions did that?
    Ms. Schapiro. First of all, I should say, we are 
scrutinizing very carefully in the Lehman context whether 
characterizing their repos as sales for their accounting 
treatment was proper given the very strict criteria around 
sales accounting there. And we are obviously looking very much 
at the truthfulness of the disclosure that was in public 
    We have sent a letter to the CFOs of 19 of the largest 
financial institutions and asked them to provide us with very 
detailed information, as we are currently reviewing their 10-Ks 
that goes to all of their accounting for repos and securities 
lending, and any other transactions that involved the transfer 
of financial assets with an obligation to repurchase in the 
    We are reviewing that information right now. It has been 
coming in over the last 2 weeks. We expect it to be quite 
detailed. It will cover the accounting as well as the 
disclosure, and any changes they may have made to their 
accounting in the last several years, and we will make that 
information public.
    Mr. Miller of North Carolina. Thank you. One of the 
findings of the Lehman bankruptcy examiner was that it would 
have been better, if an institution is going to fail, it is 
better it to do it sooner rather than later. Life is much more 
complicated if all of the assets are pledged as collateral. It 
becomes more expensive and more disruptive to the economy.
    I introduced an amendment in the financial reform bill 
along with Mr. Moore that Sheila Bair first recommended that 
would limit the priority, the preference that repo transactions 
get upon resolution. You can make the same argument with 
respect to derivative transactions and the collateral grabs by 
any creditor in a position to do it when a firm is obviously in 
a death spiral.
    Given what we know about Lehman and the collateral grab 
there and at AIG, and the liquidity run that created, would it 
not impose more market discipline, useful market discipline, 
that was Chairman Bair's argument for that amendment to limit 
the preference that repo transactions get or that collateral 
provided for derivative transactions get?
    Chairman Schapiro, do you have an opinion on that or have 
you given any thought to that?
    Ms. Schapiro. I haven't been involved in that, and I don't 
have a deeply held opinion, but I think it would impart useful 
market discipline.
    Secretary Geithner. I would not want to alter the claims 
established in bankruptcy without enormous care and thought 
because of the risks that would cause enormous uncertainty to 
markets that are hugely important to the way our system works.
    But you are exactly right that the risks that accumulated 
in repo and in derivatives were hugely consequential. I think 
the best way to limit those risks is to make sure that those 
markets are run with much tighter constraints through margin 
requirements and capital requirements, and I think that is the 
best way ahead of the storm, ahead of the boom, ahead of the 
crisis, to limit the risk. You see leverage build up in those 
markets as well.
    So I think you are exactly right about the risks. The 
question is about the means to confront them, and I would do it 
through margin and capital.
    Mr. Miller of North Carolina. One thing I am determined to 
come out of this, if I can, is that the same rules applies to 
the financial industry as apply to everyone else. It is very 
clear that repo transactions and collateral provided for 
derivative transactions get a very different treatment on 
bankruptcy. Given what we saw happen with Lehman Brothers, and 
I think the injustice that it works to other creditors who are 
not in a position to demand collateral, in those kinds of 
transactions, those kinds of preferences are set aside in 
bankruptcy routinely, but not with respect to these 
transactions. Do you think that the different treatment is 
    Secretary Geithner. Again, I believe it is. I think there 
should be a difference between how you treat creditors who are 
unsecured and those who are secured. But I completely agree 
with you about the risk posed by a system that allows people to 
take enormous leverage in these products. And I think the right 
way to deal with this preemptively to reduce the risk of future 
crises is to make sure that you can set margin and capital 
requirements in these transactions ahead of the boom.
    The Chairman. Our witnesses have to leave at 1:30. I can't 
speak for the other side, but if there are there any other 
Democrats, don't bother to come, because our dance card is 
    The gentleman from Indiana.
    Mr. Donnelly. Thank you, Mr. Chairman.
    Chairman Schapiro, have you looked to see who else has repo 
105 type transactions?
    Ms. Schapiro. Yes, we have. As I mentioned earlier, we sent 
a letter to the major financial institutions and asked them for 
a very detailed explanation of their use of repo and securities 
lending transactions, how they are accounting for them and how 
they are disclosing them. We are in the process of analyzing 
that information in the context of reviewing their 10(k) 
filings, and we will make that information public.
    Mr. Donnelly. Thank you very much.
    Secretary Geithner, it is probably over a year ago where I 
talked about naked credit default swaps, and I mentioned that 
the only difference between that and a bet on my Chicago Bears 
was that if one side didn't pay up, everybody just left town, 
nobody got paid. These synthetic CDOs, when you look at Lehman 
Brothers and the exposure they already had and then you put the 
CDOs created throughout the other companies, it was like 
pouring additional gasoline on a fire.
    They were made up of bonds from other bonds, and so, in 
effect, created out of whole cloth. One of the things that was 
mentioned at that time was that well, these products help 
mitigate risk. And in looking back on this now, it seems to me 
that all these synthetic CDOs did was tremendously increase the 
risk and the danger, and then we found out that besides being 
incredibly risky, the game is somewhat rigged. So I ask again, 
what possible value do instruments like this have?
    Secretary Geithner. Congressman, that is a very good 
question. It is the heart of the dilemma we create in facing 
    There will always be products that some people like. They 
deem them innovation; they seem to prove some use. Our 
challenge is to make sure that the system is strong enough to 
withstand the risks that might come when those innovations go 
astray. Again, I think the best way to protect the system 
against the possibility in the future, people pile these kinds 
of risk upon piles of leverage is to make sure again that we 
are bringing the derivatives market out of the dark, giving the 
cops the tools to defer fraud and manipulation, force people to 
hold margin and capital against those commitments.
    I think that is the best way to do it because again, we 
will never know soon enough in the future what particular 
innovation might pose catastrophic risk. The best thing we can 
do is make sure the system runs with the kind of shock 
absorbers that can allow it to withstand those mistakes in 
    Mr. Donnelly. But unless I am looking at these wrong, these 
were basically fake instruments? They were made up from other 
products so it wasn't really that these were the original 
mortgage bonds, these were selectively picked by putting a team 
together and there are really no players there. When you look 
at this, I understand laying off risk for Southwest Airlines 
and for people who have obligations on one side on housing, but 
these were created almost out of whole cloth to in effect 
become betting instruments. How do they have any value?
    Secretary Geithner. You are exactly right. These were 
derivatives on derivatives on derivatives, and they were 
designed to enable people to take huge leveraged bets on 
particular outcomes. In this case, and this was the 
catastrophic mistake, they were bets on a world in which people 
assumed house prices would rise indefinitely. So the products 
were complicated. They had fancy names, but the underlying 
misjudgment and miscalculation at the heart of all of this was 
a judgment that house prices would rise in the future and 
therefore people would not be exposed to a risk of default on 
anything like the scale we saw.
    Mr. Donnelly. And I guess the biggest concern was these 
transactions had nothing to do with mitigating risk. What they 
did was, in effect, bet the casino, one side against the other, 
and the American people were the losers?
    Secretary Geithner. I believe derivatives come with 
enormous risk. It is a searing, painful lesson for the American 
economy. But they do provide still a very useful economic 
function. Our job is to make sure that we can get the benefits 
of hedging without exposing the taxpayer and the American 
economy to catastrophic risk and loss.
    The Chairman. The gentleman from Illinois.
    Mr. Foster. Thank you, Mr. Chairman.
    The line of questioning I would like to pursue has to do 
with contingent capital requirements, and how they would have 
been useful when the Lehman crisis hit, and how they would have 
been useful in preventing a Lehman-like situation from 
developing in the first place.
    As you probably know, I was the author of the amendment 
that passed through this committee and through the House that 
was supported also by Representative Minnick and Representative 
Himes which authorized the incorporation of contingent capital 
into the capital structure of systemically important firms. I 
was gratified to see when The Wall Street Journal convened its 
panel of experts on how to reform our financial system, that 
recommendation number one was better capital requirements, 
including the incorporation of contingent capital. And I was 
gratified also to see the Senate proposal also included 
contingent capital.
    My first question is, how would a contingent capital 
requirement have played out during the final crisis, both to 
limit systemic risk and counterparty panic and also in terms of 
keeping taxpayers off the hook, providing the shock absorber 
you just referred to, and I will start with Secretary Geithner 
    Secretary Geithner. The benefit of contingent capital is 
that it provides a tool that can be used in crisis to in effect 
create more capital right when firms need it. So if designed 
appropriately, and put in place on top of the required minimum 
capital requirements, in terms of common equity in particular, 
it can play a very useful stabilizing role as firms and 
financial institutions slip toward the edge of a crisis.
    Mr. Foster. Chairman Bernanke, do you have anything to add?
    Mr. Bernanke. Yes, I think it is a very interesting idea 
and we are looking at it carefully. There are some design 
issues; for example, what would trigger the conversion. That is 
a very important issue that we are thinking about. There are 
some other ways to approach the issue. One is the resolution 
regime. Say if it required that all capital instruments, 
including say subordinated debt had to take losses, then that 
would effectively make subordinated debt into a contingent 
capital form, for example. So there are different ways to do 
it. But I think it would have helped considerably during the 
    Mr. Foster. My second question is, how would contingent 
capital requirements have discouraged Lehman-like situations 
from coming up in the first place? Simply the requirement to go 
and continuously market the contingent would provide a very 
strong market-based signal of which firms the market viewed as 
    Secretary Geithner. I agree with you. If designed 
appropriately, they could provide a very useful market signal 
early on of a firm that is facing the risk of losses that are 
large relative to its capital. Again, the virtue of capital is 
that it provides a cushion to absorb losses. You need more of 
it earlier to constraint leverage, and you want more of it in 
the capacity to mobilize it as firms slip toward financial 
    Mr. Bernanke. It is critical to make clear that whatever 
the instrument is, it will not be protected under any 
circumstances so there is no moral hazard or lack of market 
discipline. If you have an instrument like that, then its 
pricing or the requirement that you have to go out and sell 
that instrument is a very useful form of discipline.
    Mr. Foster. It effectively requires firms to carry 
privately funded bailout insurance in some sense and makes the 
price for that insurance public so hopefully some of the CEOs 
would drive to work every day worried that they might fail a 
stress test than trigger the conversion of this debt rather 
than actually face the insolvency. Or worry simply about having 
a story in the Wall Street Journal that says hey, the last time 
we had an auction for our convertible debt, they got a very bad 
price. And why is it that the market thinks this firm is shaky. 
So it has a very powerful, to my mind, has a very powerful 
benefit of warning firms away from the cliff before they 
actually approach it. That was the point I wanted to make.
    And one last thing, is there a baseline implementation that 
you have or would be willing to give us just in terms of your 
thinking on what the contingent capital would look like?
    Mr. Bernanke. We are still looking at it in the Fed and the 
Basel Committee is looking at it. There are some design issues 
that are not resolved, notably the trigger issue.
    Secretary Geithner. To add one thing, Mr. Chairman, with 
your permission, the timeframe that the Basel Committee is 
working with is to reach broad agreement around the world on a 
new global capital standard by the end of this year, and part 
of that will be not just setting the new ratios, but deciding 
what forms of capital will be most appropriate in that context. 
That is the broad timeframe we are working on.
    The Chairman. The gentlewoman from California.
    Ms. Speier. Thank you, Mr. Chairman.
    We have been discussing today the failure of Lehman and 
this is to you, Chairman Schapiro. There is no question in Mr. 
Valukas's report that the SEC was in charge of regulating 
Lehman. The report says the SEC did not learn of all of the 
precise facts until September 12th, but months earlier had 
learned of critical information that put it on notice. The SEC 
did not act on its knowledge. It simply acquiesced.
    The SEC disapproved of Lehman's inclusion of the amount in 
its liquidity pool. It took no action to require Lehman not to 
do so.
    The SEC knew that Lehman was in repeated and persistent 
breach of its own risk limits; yet, the SEC simply acquiesced.
    The SEC knew that Lehman's internal stress tests excluded 
untraded positions, including commercial real estate; the SEC 
simply acquiesced. It goes on and on and on.
    So would you just admit, it was not under your watch, but 
just admit that the SEC failed to do its job in regulating 
    Ms. Schapiro. The SEC didn't have the staff, the resources, 
or quite honestly, in some ways the mindset to be a prudential 
regulator of the largest financial institutions in the world. 
It was such a deviation from our historic disclosure-based and 
rules-based approach to regulation, to come in and be a 
prudential supervisor. The staff was never given the resources. 
This program peaked at 24 people for the entire universe of the 
five largest investment banking firms in the world. They didn't 
have the technology to support them. They didn't have the 
management leadership, in my view, to support them to do a good 
    Was it a success story? I don't think any of us would claim 
that the oversight of Lehman was a success. But this is also an 
agency that has learned and is learning from all of these 
mistakes and understands the importance of doing this right 
going forward.
    Ms. Speier. Let me ask you this question. We are all 
talking about transparency, that to protect the investor, this 
has to be a transparent process. How can any of us sit here and 
suggest that repo 105s should be allowed to be operational in 
this country at any time? I would like to ask you all, isn't it 
time to ban repo 105 by the SEC?
    Ms. Schapiro. It is not at all clear that what Lehman was 
doing satisfied any of the then-current accounting and 
disclosure requirements. That is obviously very much a subject 
of our ongoing investigation. But if there is an accounting 
loophole here, if there is no reason to ever allow a sale where 
there is a repurchase in the future, we will look very 
carefully at that, having worked with the accounting standards 
setters, to see if that is something that should be absolutely 
cut off and prohibited.
    Under current accounting, assuming that the asset is truly 
isolated, not available and so forth, there are limited 
circumstances where it is permitted to be accounted for as 
    Ms. Speier. But that is the same strategy.
    Ms. Schapiro. I have profound questions about it. I agree 
with you.
    Ms. Speier. Mr. Bernanke, should they been banned?
    Mr. Bernanke. If they are not a true sale, then it 
shouldn't be treated as a true sale. I would make two comments: 
one, Lehman went to the U.K. to get this approval; two, 
recognizing concerns about so-called ``window dressing'' and 
the quarter, the Federal Reserve for our bank holding companies 
reports quarterly averages to the public of assets held, etc., 
which should help, I think, in this regard.
    Ms. Schapiro. If I may just add, as I said earlier, we are 
looking at the possibility of requiring that kind of quarterly 
average disclosure by public companies in their quarterly 
reports so that the public would have a much better view of 
whether they are window dressing.
    Ms. Speier. My last question is to you, Secretary Geithner. 
We have been in conversation now for months about Lehman's 
failure. We now have ample evidence that our regulators did not 
act. Why not now utilize your authority to try and make these 
cities and counties whole or at least partially whole because 
they are the only ones that have been impacted like this?
    Secretary Geithner. You are exactly right, not just in the 
Lehman losses, but on a range of other losses. The 
municipalities across the country suffered enormous damage from 
this crisis, caused incredibly damaging falls in revenue and 
deep damage to critical services that we all depend on. So I 
completely agree with you. That is why in the Recovery Act, we 
put so much money into support for State and local governments. 
I don't believe I have the authority under TARP. As you know, 
we have talked about this many times to directly compensate 
municipal authorities for their losses on their Lehman 
    Ms. Speier. If we give you the authority, will you do it?
    Secretary Geithner. If Congress writes authority for me to 
do it, of course, I would do that.
    The Chairman. The time of the gentlewoman has expired. The 
gentlewoman from Ohio.
    Ms. Kilroy. Thank you, Mr. Chairman, and I thank the 
witnesses for their time here this morning. We are learning a 
lot about Lehman Brothers from the report of the bankruptcy 
examiner, and also learning a lot about the role of regulatory 
agencies. We want to make sure, as Secretary Geithner said, 
that the cops have the tools so we don't get in this position 
    One of the questions that I had was with respect to the 
stress testing that you talked about as being one of the tools 
that would help to get an early warning of a situation like 
Lehman. In the bankruptcy examiner's report, he indicated that 
Lehman's stress test suffered from significant flaws, like they 
put the repo 105s into play to disguise the true condition of 
the balance sheet. Apparently, the stress test excluded real 
estate investments and other risky holdings that Lehman had 
accumulated. How will we be assured that kind of situation will 
not happen again, that the true picture of the holdings will be 
revealed in the stress testing?
    Ms. Schapiro. Congresswoman, I think that rigorous, honest 
stress tests on a regular basis can be very, very important 
risk management tools. And they were thought to be an important 
component of the CSE program. But as we know from the 
examiner's report, they were not conducted, frankly, in an 
honest way. They did exclude commercial real estate. They also 
excluded private equity investments, and in some cases, 
leveraged loans. And we, unfortunately, did not demand real 
rigor from Lehman Brothers in conducting their stress test. So 
it is something that we obviously are very focused on right 
now. We recently, for example, required that money market funds 
undergo regular stress testing of their portfolios. It is 
something that we are looking at as part of our overhaul of our 
examination program, whether there should be a much more 
rigorous, routine requirement of stress testing for broker-
    Ms. Kilroy. Are you intending to issue further regulations 
in this regard?
    Ms. Schapiro. Certainly, as we go through the overhaul of 
our exam program, and we did issue regulations with respect to 
money market funds, it is possible that we will, yes.
    Ms. Kilroy. One of the other functions that should give 
some warning of a perilous financial situation is the risk 
management function, and I am very concerned with respect to 
Lehman that they repeatedly, despite the warnings of their risk 
managers, exceeded their risk management limits or then simply 
made them higher. That seemed to mean they had no risk 
management function at all. And when key personnel left, that 
should have been a big warning signal as well about something 
going amiss with that risk management function. What was the 
responsibility of those who were keeping an eye on Lehman 
Brothers, the regulators and the board, with respect to making 
sure that they heard from the risk managers?
    Ms. Schapiro. My view is that a best practice in the 
evolving world of risk management best practices is that risk 
management should report to the board, and that the board 
should have responsibility to understand and agree to the risk 
appetite of the institution, they should check the portfolio 
against that risk management appetite, that risk oversight 
functions have to be independent, and there is lots of good 
literature now articulating a number of requirements for risk 
    In fact, at Lehman, they did have risk appetite levels 
across the entire institution. They had concentration or 
transaction limits, and they had balance sheet limits. We 
already know the balance sheet limits were evaded by repo 105, 
and the other limits, as you correctly point out, were either 
just raised or blown through.
    My understanding is that the staff and the Commission at 
the time thought that they should not substitute their judgment 
about risk management at the firm for the judgment of 
management; that their responsibility was to ensure that any 
changes to risk management levels or risk limits should be 
escalated within the firm's management and ultimately to the 
board, but that they should not substitute their judgment. 
That's my understanding of what happened at the time.
    Ms. Kilroy. One of the other things that has been discussed 
is pay structure and how pay structures relay into taking 
excessive risk. At Lehman, they had policies that were 
supposedly intended to prevent that; yet again, it seems those 
policies weren't followed. Are we now taking measures to 
address the issue of compensation structures and how they play 
into excessive risk?
    Ms. Schapiro. A quick answer is the SEC just put new rules 
in place for this proxy season that require boards to disclose 
how compensation structures incentivize risk taking, have a 
board oversee risk, and I think those will be very beneficial 
and provide a lot of transparency in this area.
    The Chairman. The time of the gentlewoman has expired. 
Anyone on the committee who wishes to submit further questions, 
those will be incorporated into the record. The witnesses are 
thanked for their testimony. We will take a 10-minute break, 
and we will then resume with Mr. Valukas, the Lehman Brothers 
bankruptcy examiner.
    Mr. Kanjorski. [presiding] The committee will reconvene 
with our next witness, Mr. Valukas.


    Mr. Valukas. Mr. Chairman and Ranking Member Bachus, I 
appreciate the opportunity to appear before you today in 
connection with my role as the examiner in the Lehman Brothers 
    Your letter dated April 14, 2010, inviting me to appear 
before this committee requested that I address six specific 
topics, and I have responded to each of those in my written 
testimony that I previously submitted to you.
    I would like to briefly address two major points this 
afternoon before taking questions. First, although the public 
had a right to expect that firms like Lehman were being 
regulated in a meaningful way, in reality, they were not.
    Second, because there was a failure of genuine cooperation 
in certain areas, and lack of cooperation in certain areas 
between government agencies, opportunities were missed all 
through Lehman's conduct before the situation reached the point 
of no return.
    By at least 2007, various agencies of the United States 
Government were concerned at the highest levels with the 
prospects for Lehman's survival. The concerns did not translate 
into action. Governing agencies gathered information, they 
monitored, but no agency effectively regulated or compelled 
Lehman to alter its conduct. The Federal Reserve Bank of New 
York gathered and analyzed information from Lehman, but it 
viewed its role as a potential lender and not as a regulator, 
and it deferred to the SEC. The SEC was Lehman's primary 
regulator under its CSE program. It made a few recommendations, 
but in general, it collected information but it did not direct 
    For example, the SEC knew in 2007 that Lehman persistently 
exceeded its internal risk limits, limits that they had been 
told initially were hard limits and that would not be exceeded. 
But the SEC's limited response to assuring itself that Lehman 
had an internal process, which they did, for senior management 
to review these regions. The SEC never required that Lehman 
take steps to reduce its risk profile nor did it require Lehman 
to disclose that it was in breach of its limits.
    So that was never publicly disclosed to rating agencies or 
anyone else. The inability of Lehman to liquidate some of these 
same assets in 2008, the assets which they acquired in breach 
of these risk limits, was, in fact, a contributing factor to 
Lehman's demise.
    The SEC knew as early as June of 2008 that Lehman was 
reporting sums in its liquidity pool that the SEC determined 
were not, in fact, appropriately within that pool because they 
were encumbered, but the SEC did not require any action by 
Lehman, nor did they make any public disclosure of that. The 
SEC did not know that Lehman was manipulating its balance sheet 
to make its leverage appear better than it was by using repo 
105 transactions that I describe in detail in my report. The 
SEC did not know this because it did not ask the right 
questions. Its failure to ask about off-balance sheet 
transactions in this post-Enron era is hard to understand.
    Significantly, the SEC and the Federal Reserve Bank of New 
York failed to share certain information with each other about 
Lehman's liquidity and Lehman's inclusion of encumbered assets 
in its liquidity pool. Each agency had knowledge not possessed 
by the other. Had they combined that knowledge, they would have 
realized earlier the severity of Lehman's liquidity position 
when there was still possibly time to do something to at least 
to soften the fall.
    The agency, with the skill sets to regulate a financial 
institution like Lehman, which might be the Fed, did not have 
the authority, and the agency with the authority, the SEC, may 
not have possessed the skill set. The two agencies were unable 
to smooth out the gaps in this critical area because they 
failed to have a full and open sharing of information in 
connection with this particular area.
    I must emphasize, as I attempted to set out in the report, 
that Lehman's failure was the result of many factors. There is 
no single cause or actor involved here. There is no bright line 
action that can be said in retrospect, had the government done 
this, Lehman would not have failed. It is far from clear that 
the most engaged regulator could have saved Lehman from its 
fate. But what is clear is had the government acted sooner on 
what it did know or should have known, there would have been 
more opportunities to spare the markets and the American people 
the turmoil of Lehman's abrupt failure. What is clear is that 
the regulators were not fully engaged and did not direct Lehman 
to alter the conduct which we now know in retrospect led to 
Lehman's ruin.
    [The prepared statement of Mr. Valukas can be found on page 
193 of the appendix.]
    Mr. Kanjorski. Thank you very much, Mr. Valukas.
    I guess we will start with my questions.
    Listening earlier today to some of the testimony, and 
particularly to the speakouts of individuals as to who was 
responsible or totally responsible, I think one of my 
colleagues on the other side said that 95 percent of the 
problem with Lehman Brothers' failure was a result of the 
    Mr. Bachus. If the gentleman would yield, what I said was 
95 percent of the things that they needed to do, they could 
have done under the present regulations.
    Mr. Kanjorski. I stand corrected, if that is what you said 
or intended to say, but it struck me not too humorously; it was 
like Willie Sutton blaming the guards for allowing him to rob 
the bank. I think we have to get our hands around the 
proportions. The proportions were that Lehman Brothers took 
extraordinary liberty in dealing irresponsibly with their 
positions and their clients' positions which led to their 
downfall, and subsequently, its effect on the entire system; 
would you say that is correct?
    Mr. Valukas. In substance, yes. Lehman made a conscious 
business decision in 2006 in connection with how they believed 
the market was going to operate and what was going to happen, 
particularly in areas involving real estate.
    They, as one high-ranking individual described it to me, 
decided to double-down in terms of those investments.
    Those investments, they were using their business judgment. 
They had in place risk matrixes which should have told them 
when they were exceeding those risk matrixes in these 
particular areas. They, in fact, had those in place and, in 
fact, they exceeded those. The regulators observed those 
exceedances, and acquiesced in those exceedances, taking the 
position that as long as senior management knew about it, there 
was nothing more that needed to be done. So the regulators did 
not prevent Lehman from doing what it intended to do.
    Lehman had a right under those circumstances, having 
disclosed this information to the regulator, to pursue its own 
business judgment, which it did. It turned out that judgment 
was clearly faulty. But the regulators were kept apprised of 
those risks. The regulators were kept apprised of the 
exceedance, and did nothing to stop those from taking place.
    So when you say Lehman's decisions, they were clearly 
Lehman's decisions and judgments. No one told them to make 
those investments. Did the regulators do anything to prevent 
that from taking place, the answer is no. Were they fully 
apprised of it, yes.
    Mr. Kanjorski. Does that not that bring up the question as 
to what we should do in the future in reforming regulations so 
that this would never happen again. Paul Volcker has made a 
very strong point to me on a number of occasions that there are 
some times when Congress should enact in statute and mandatory 
requirements as opposed to just giving authority for things to 
occur, and that is why under the Volcker Rule, he is asking us 
to make it statutorily mandatory that proprietary trading not 
be allowed because he fears that perhaps the regulators or the 
businesses will pursue the course of trading if it is an option 
or if it is open, and that forces the regulator to be very 
    His comment on that is--quoting Mr. Volcker--``I have been 
a regulator before, and it is very difficult to always remain 
stern in enacting activities from those who are regulated.'' So 
in the Volcker Rule, he wants it to be mandatory.
    You know I am the author of an amendment that occasionally 
gets referred to as the ``too-big-to-fail'' amendment. It 
originated in the House, was attached in the bill that came 
through the committee, and ultimately, was passed on the Floor. 
That is a very encompassing amendment that basically gives 
unusual powers to the regulators using the systemic risk 
council to evaluate the largest financial institutions in the 
country, and if they look, even though they are sound at the 
moment, that they are doing things that are unusual or 
systemically, potentially systemically risky, they can give 
them orders to cease and desist.
    They can require them to file better plans of equity and 
other positions that would lessen their risk. Do you think that 
amendment should still be allowed in the context that is in now 
to be an authority that the regulators could impose, or should 
we attempt to reduce that down to a mandatory role?
    Mr. Valukas. Mr. Chairman, I don't feel qualified to answer 
that question, in all candor.
    Mr. Kanjorski. You are more qualified than we are.
    Mr. Valukas. I can say, and what we can take away from this 
investigation and review, what we didn't have here was an 
agency, the SEC, that either acted or believed that it had the 
authority to make changes at the time they were making changes, 
and that was a problem. I think Chairperson Schapiro addressed 
that. So however that should be addressed, I don't know. But I 
think that is a problem that needs to be addressed.
    Mr. Kanjorski. Thank you very much. My time has expired, 
and I now recognize the gentleman from Alabama.
    Mr. Bachus. I want to commend you, Mr. Valukas, on an 
outstanding job as bankruptcy examiner. I think that had there 
not been a bankruptcy, we would not have known a lot of this. 
In your written testimony, you make the point that what is 
clear is had the government acted sooner on what it did know or 
should have known, there would have been more opportunities for 
a soft landing. Markets may have been spared the turmoil of 
what was Lehman's abrupt failure, which I think did catch the 
markets somewhat unaware.
    Chairman Bernanke, however, has testified before this 
committee that, ``The trouble at Lehman had been well known for 
some time and investors and counterparties had had time to take 
precautionary measures.'' Your assessment of this statement 
appears inconsistent with Chairman Bernanke's. Do you believe 
that the actions of the regulators helped mask the extent of 
Lehman's troubles and were investors fully aware of the 
    Mr. Valukas. I think that it was well known by the spring 
and summer of 2008 that Lehman had significant problems. It was 
widely reported in the press that if there was another bank 
that was going to have a failure, it was likely to be Lehman. 
Those issues were clearly known, and Lehman's massive 
investments in the real estate areas which were becoming 
increasingly illiquid were certainly known.
    What was not known by the public was at that same time, 
Lehman, as part of its explanation as to why it was okay was, 
for instance, reporting its liquidity pool at very record 
    What was not known and could not have been known by the 
investing public but was known and could have been known by the 
regulators was that in fact that liquidity pool was 
increasingly becoming encumbered. By August of 2008, 17 to 20 
percent of that liquidity pool that was being reported publicly 
was in fact, in the estimation of Federal regulators, 
encumbered, and should not have been included. There was no 
disclosure of that to anyone. Would that have precipitated 
people being more concerned and taking up more affirmative 
action, I could speculate, but I would speculate that it would 
be a hash warning that people might look at.
    Similarly, the regulators could have known that Lehman was 
using repo 105 to indicate better leverage than they actually 
had. And they were announcing that at a time when the rating 
agencies, as well as the analysts, thought these were critical 
issues. Had the regulators said tell us about all of your off-
balance sheet transactions, how you are getting these leverage 
numbers, which after Enron you would think was a possible 
question, that would have been disclosed. What would that 
impact have been.
    So my view on this was that there were things that the 
regulators should have known that would have triggered concerns 
earlier which would have given them time to deal with this 
issue rather than trying to cram it in on a weekend in 
    Mr. Bachus. Okay, thank you. In your written testimony, you 
note that because neither the SEC nor any other agency directed 
Lehman to correct its misleading and incomplete public 
statements, the public did not know there were holes in 
Lehman's liquidity pool, nor did it know that Lehman's risk 
controls were being ignored and that reported leverage numbers 
were artificially deflated. Billions of Lehman shares traded on 
misinformation. In your view, does this point to a problem with 
the regulations or the regulators?
    Mr. Valukas. It certainly points to the problems of the 
regulators not having done the regulation they should have done 
in those areas.But it also points to a larger problem which I 
think needs to be thought of, which is that, in an institution 
as large as Lehman, as we tried to get our arms around this 
institution, which is a monster, that you need to have an 
agency or agencies or people who truly understand the scope of 
the issues, the scope of the agency, and the problems that 
could exist. And what we found is that neither of these 
agencies independently had that expertise. They had some but 
not all. And so you could say is that a problem with regulation 
or the regulators. I don't know. I do know that those were two 
problems, and you need to handle both of those.
    Mr. Bachus. As you said, if they had combined their skill 
sets, communicated, and shared information, they would have 
been much more at least successful or had an ability to be more 
    Mr. Valukas. That is correct. Now, whether that would have 
solved everything, I can't say that, but it would have 
certainly solved some of these problems.
    Mr. Bachus. And I would agree with you and others that the 
Fed does have some special abilities with these large holding 
companies. And I think--
    Let me ask you this as a follow-up to that. The public may 
have seen that memoranda of understanding between the SEC and 
the New York Fed that the New York Fed was going to come in and 
do certain things. And they did stress tests, and Lehman failed 
those stress tests. To your knowledge, as a result of those 
stress tests, was Lehman asked to do anything to remedy the 
situation or address their failures?
    Mr. Valukas. No. They were encouraged to raise more capital 
and do something with regard to their liquidity, but no one 
directed them to do anything in particular. So as a matter of--
pardon me, I didn't mean to cut you off. So as a matter of 
talking to them about the need to do something better in this 
situation but not directing them to do anything.
    Mr. Bachus. And, as you mentioned, that $45 billion that 
they said they had record liquidity, which turned out to be a 
material and blatant misrepresentation.
    Mr. Valukas. At some point, that became--by the time--as of 
September 10th, Lehman was reporting $41 billion in their 
liquidity pool which was being cited by analysts as a good 
reason why Lehman was still viable. Internal documents show 
that maybe as much as $15 billion or more of that was, in fact, 
encumbered and should not have been included in the poll. That 
information was not disseminated to the American public.
    Mr. Bachus. Thank you.
    Mr. Kanjorski. The gentleman from Massachusetts, Mr. Lynch.
    Mr. Lynch. Thank you, Mr. Chairman.
    Thank you, sir, for your willingness to come before the 
committee and help us with our work.
    I wanted to ask you about the role of the auditor in this 
case for Lehman, Ernst & Young. You stated in your report that 
you thought there may be the possibility of a colorable claim 
against Ernst & Young for failing to disclose affirmatively the 
use of Repo 105 and other practices here. Would that be 
something normally that Ernst & Young or a firm in that place 
would report on?
    Mr. Valukas. What we found, what I concluded, was there 
were colorable causes of action we believed against Ernst & 
Young, which means simply that someone could bring the suit and 
we thought that there were sufficient facts to support a 
malpractice case, not that it would necessarily be successful.
    We laid out both sides. The two issues that we focused on 
with regard to Ernst & Young were the following:
    An individual came forth and reported that there were $50 
billion of off-balance sheet transactions which he thought were 
inappropriate. Ernst & Young, the audit committee of Lehman 
Brothers, had previously ordered or directed Ernst & Young and 
Lehman to review allegations of problems in the balance sheet. 
Ernst & Young was supposed to be conducting that investigation. 
In the course of that time, the allegation about the $50 
billion of off-balance sheet transactions came to their 
    They thereafter met with the board. The board told us that 
they never disclosed--Ernst & Young never disclosed to them 
about the $50 billion worth of off-balance sheet transactions 
which turned out to be Repo 105, nor did they do a follow-up. 
In our opinion, that is a colorable cause of action against 
them for malpractice for failing to advise the board and 
failing to follow up.
    In terms of the disclosure of the Repo 105, the financial 
statements which were in fact reviewed by Ernst & Young 
affirmatively state in a footnote that Repo transactions are 
accounted for as finances. In fact, these Repo transactions 
were accounted for as sales. And that, to us, a fact finder 
could find that was affirmatively misleading to the public.
    Mr. Lynch. Sure. Thank you. That is a very clear answer.
    Let me ask you about, as was pointed out in your earlier 
testimony, at the time that they went under Lehman had 900,000 
different derivative positions globally, 900,000; and yet you 
point out that these risk limits that prevented Lehman both 
systemwide and per transaction to have certain limits that they 
could not exceed, and looking at some of these CDOs and some of 
the obligations on many of these positions, they almost have 
limitless risk that Lehman was sitting on. How do you reconcile 
the fact that there was a limit, at least on paper, for Lehman 
and yet in practice 900,000 open positions on derivatives 
globally, many of them very, very complex that had almost 
bottomless risk? I can't seem to reconcile those two positions.
    Mr. Valukas. I am not sure I can for you, because I am not 
sure I can--I can tell you this--and the answer is, I am not 
sure I can do that now, but I would certainly be pleased to 
submit something to you subsequently.
    I can tell you this. Lehman had, by the estimation of the 
SEC and others, a very robust risk analysis system in place, 
something which would identify for them the nature, scope, and 
volume of their risk. And I would have to look back, and it is 
a very detailed thing, as to all that was covered by that risk 
analysis, but it was a very complete and very thorough 
analysis. Through 2007, they consistently exceeded those risks, 
identified the fact that they were exceeding those risks, and 
the response to that was simply to raise the risk limits so 
that they were no longer in exceedence.
    As to specifically how the derivatives played in, I just 
can't give you that answer now, but I will get you that answer.
    Mr. Lynch. Is there any question in your mind, Mr. Valukas, 
that the purpose of the Repo 105 was simply to doctor up the 
quarterly reporting so that they would increase their cash and 
lower their debt limit?
    Mr. Valukas. The internal documents of Lehman Brothers, 
which were contemporaneous with the time that this was 
occurring--put aside the testimony after the fact--but the 
contemporaneous documents describe this practice, the purpose 
of this practice is to adjust the balance sheet so as to affect 
the leverage numbers. That was the purpose of this transaction, 
specifically in a quarter end so that this would be the 
reported numbers.
    Mr. Lynch. Thank you, sir. I yield back.
    Mr. Kanjorski. Thank you, Mr. Lynch.
    Now, we will hear from the gentleman from California, Mr. 
    Mr. Royce. Thank you, Mr. Chairman.
    Getting back to this idea about a bailout fund, just a 
couple of hours ago, Majority Leader Steny Hoyer mentioned that 
the bailout fund was not central to the financial overhaul, in 
his words; and I think this is a step in the right direction. 
But I point out to the members here Mr. Sherman's comments to 
the previous panel, because I share Brad Sherman's worries 
about this, the permanent bailout authority concept that he and 
I have been warning about.
    Let me just point out that if you take the fund out, but 
leave the line to the Treasury in place, you don't solve the 
problem. You still have that moral hazard problem. And when we 
talk about rewarding risky behavior, rewarding creditors and 
counterparties of a failed firm, and that basically is 
compounding the moral hazard problem, it is because it is the 
availability of the funds outside of the given failed 
institution that creates the problem and the implication here. 
And that is why some of us think this should be done with 
enhanced bankruptcy authority.
    But, anyway, also, Mr. Geithner again compared the 
resolution authority that they are requesting to the authority 
that the FDIC uses to close commercial banks. And I was 
thinking about this. This is like comparing apples and oranges. 
Commercial banks are overwhelmingly made up of insured deposits 
and very small, straightforward loans, for the most part. In 
fact, 98 percent of the liabilities of banks and thrifts that 
have been unwound by the FDIC in the last couple of years, 
those were insured deposits.
    But here this is in stark contrast with what we are talking 
about in the bill. Because many of the non-deposit-taking 
institutions that would be covered under a resolution authority 
are institutions like Lehman Brothers which doesn't have 
insured deposits, no depositors of any kind, and have complex 
assets and liabilities that did not look anything like the 
simple small loans and residential and commercial mortgages 
that the FDIC has any familiarity with or deals with.
    So the FDIC model works well for small, straightforward 
financial institutions. But applying that model to large, 
complex institutions will create a perception of a government 
safety net under those institutions likely to be resolved 
through the resolution authority, and for that reason you have 
all the problems then that come with a moral hazard and the 
implied government bailout and the lower cost of capital for 
these firms, so it is not the right approach.
    I want to go back--and I am going to ask you a question. I 
am going to go back to Chairman Bernanke and Secretary 
Geithner's comments. They stated that neither the Federal 
Reserve nor the Federal Reserve Bank of New York was Lehman's 
primary regulator. In fact, both have been quick to disavow any 
regulatory responsibility for Lehman, claiming instead that the 
Fed's only relationship with Lehman was that of a lender and 
that any monitoring they did was purely to ensure that any sums 
that were loaned to Lehman would be paid back. Do you agree 
with this assessment?
    Mr. Valukas. I agree that, as among the regulators, that 
all three of the regulators with whom we spoke took that 
position, including the position that the SEC also ascribed to 
that position as being that they were the primary regulators 
and that the Federal Reserve was not the primary regulator. And 
as I read the MOU, I am not sure that the MOU confers upon them 
regulatory authority that is held by the SEC. I am not sure 
they can do that. So I understand their point of view. We left 
it at that.
    Mr. Royce. But it seems that during the spring of 2008, 
there was a general consensus that Treasury and the Fed, not 
the SEC, were in control of that situation. There doesn't seem 
to be any other interpretation from what was happening in terms 
of the market perception. The Fed appeared to be in control of 
the Lehman situation in the spring of 2008. I think that is the 
way the market read it. I think that is the way you assumed it 
when you were doing your report.
    And, along those lines, do you believe there was a false 
sense of security in the market that Lehman was being 
supervised by the New York Federal Reserve and that Lehman 
would be bailed out, given that it was bigger and more 
interconnected than Bear Stearns? Bear Stearns had been bailed 
out. Do you think there was that market perception out there?
    Mr. Valukas. I honestly don't feel qualified to answer that 
question because I do know that as that summer went on--and I 
am just speaking as a citizen who read what was going on at 
that time--there were those who said there will never be a 
bailout, there were those who said there might be a bailout, so 
I don't know what the market perception was at that time.
    Mr. Royce. I am one who was very worried there was 
certainly going to be a bailout, and I am afraid there is going 
to be more if this bill passes.
    Thank you very much.
    I yield back, Mr. Chairman.
    Mr. Kanjorski. The gentleman from North Carolina, Mr. 
    Mr. Miller of North Carolina. Thank you, Mr. Chairman.
    The word of the day appears to be making parts in speeches 
completely unrelated to Mr. Valukas' testimony or expertise, 
but I would like to break from that for a moment.
    Mr. Valukas, your report concludes that we would be better 
off if Lehman had become--had gone into insolvency, if they 
failed sooner rather than later. What difference would it have 
made if they had failed about the time that Bear did?
    And there were certainly published reports then that Lehman 
was almost certainly next, that Lehman was certainly on very 
uncertain footing at that point. That would have just been, I 
guess, 7 years, 3 months, into a Republican Administration 
instead of 7 years, 8 months, into an Administration, but how 
much difference would that have been in the kind of disruption 
of the financial system?
    Mr. Valukas. Let me--and I hope the report didn't convey 
the impression that we thought that if Lehman had failed 
earlier, things would have been better. What I tried to convey 
in the report was that had certain of these things taken place, 
and the focus been on the fact that they were in a more extreme 
position than they actually showed themselves to be, there 
might have been more affirmative action to soften the fall, 
possibly to push harder on Lehman executives to effect a sale, 
to push harder as it related to financing, to look for 
    What it boiled down to is that when it came to the last 
weekend, if you read the various accounts, the numerous books, 
the television shows about what happened, is over a period of 3 
days, everybody is frantically trying to do something about 
this. And the point is that a more orderly process, maybe 
spelled out over weeks or even a month, might have prevented 
the precipitous fall off the cliff which occurred. That is the 
    And the issue is, if you had known more, if you had known 
that the liquidity pool was being increasingly tied up, it was 
not as it was being portrayed, if you had known about the 
leverage not being where it is, might that have precipitated 
more dramatic action in an earlier time which might have 
softened the fall? That is the possibility to which we--that is 
what we are talking about.
    Mr. Miller of North Carolina. Mr. Valukas, obviously, 
Lehman continued to get a great deal of credit from those in 
the financial sector when everyone thought they were probably 
in a death spiral because of the preferred position that secure 
creditors got. If there were--to what extent was that a factor, 
the apparently limitless credit that was available so long as 
they had access to pledges collateral?
    Mr. Valukas. You are talking about their ability to 
continue to do business. It disappeared overnight.
    When you get to the end of September, the middle of 
September, that ability to do business, the loss of confidence 
had the people on the other side of the Repo transaction, the 
financing transaction, simply say we are not going to do 
business anymore and that ended it. That is what took place.
    As of that point when you come to that September weekend, 
the understanding was that the market was now beginning to 
refuse to do business with Lehman. They didn't have the 
resources to be able to continue to do business because they 
didn't have the dollars necessary in their liquidity pool or 
otherwise to keep it going.
    I hope that answers the question.
    Mr. Miller of North Carolina. It does.
    I yield back, Mr. Chairman.
    Mr. Kanjorski. Thank you very much.
    The gentleman from New Jersey, Mr. Garrett.
    Mr. Garrett. I thank the gentleman from Pennsylvania for 
continuing on with this hearing; and, to the witness, thank you 
for being here. Thank you also for all the extensive work that 
went into this report.
    I am going to just give you a couple of examples taken out 
of the report in general, to just get your sense of this.
    In your report, you describe how Thomas Baxter, who is the 
general counsel of the New York Federal Reserve, became aware 
of allegations that short sellers were unfairly insuring Lehman 
and how he came to believe that the short sellers may have been 
correct regarding the potential fraud at Lehman. And, according 
to your report, the New York Fed Reserve did not follow up on 
these allegations, even though one of the short sellers, as I 
mentioned previously, David Einhorn, called upon Chairman Cox 
and Chairman Bernanke and Secretary Paulson to ``pay heed to 
the risk of the financial system that Lehman is creating and 
that will guide Lehman towards the problems that they had.'' So 
that was in your report.
    And if I can find the other memo, there was a--Moody's came 
out--I think the second point was that Moody's came out in the 
spring or June--here it is. On June 13th, Moody's reported that 
Lehman's liquidity management and standalone liquidity position 
remain robust in June of that year; and Lehman ended with a 
record $45 billion of liquidity available to a holding company.
    So that information, obviously, of Moody's is out there in 
the public domain. So that information is saying things are 
good as far as the public is concerned.
    And then, as you may have heard me indicate previously, in 
your report you say, when the examiner questioned Lehman's 
executives and other witnesses about Lehman's financial health 
and reporting, I think a recurrent theme in response was that 
Lehman gave full and complete financial information to 
government agencies. And then he continued, the government 
agencies never raised significant objections or directed Lehman 
to take corrective action.
    So everything I am reading so far is you have out in the 
public domain from Moody's and otherwise that things are going 
okay as far as their quarterly reports are concerned, as far as 
the liquidity situation, that the Fed, the New York Fed was 
aware of what the public information was about that. But, even 
if they weren't, in their primary supervising capacity they had 
the information at hand to say that really wasn't the case. Is 
that your understanding? Maybe you need like a timeline on that 
as well.
    Mr. Valukas. Let me be specific, because this is a 
    In June 2008, the SEC learned that Lehman had made a $2 
billion comfort deposit with Citibank--Citicorp and had 
included that in their liquidity pool. Initially, their staff 
was concerned about it when it was elevated to a senior person. 
He specifically felt that it should not have been included in 
the pool. That was not disclosed to the Fed.
    In July 2008, the Fed found out that Lehman had made a 
pledged $5 billion worth of collateral to JPMorgan Chase. They 
learned in August that had in fact been included in the 
liquidity pool.
    So the SEC knew about the $2 billion. The Fed knew about 
the $7 billion--or the $5 billion. The Fed did not tell the SEC 
about that $5 billion until September 12th. So the SEC learned 
on September 12th that $5 billion which had been pledged to 
JPMorgan Chase had in fact been included in the liquidity pool. 
Both parties agreed it should not have been.
    So the answer is, no, the public was not given the 
information that the Federal Government had about this 
liquidity pool; and the public pronouncements that were made 
about that liquidity pool, if you listened to the witnesses, 
were not accurate.
    Now, did Lehman withhold any of that information from the 
Federal Government? To the best of my knowledge, no. When asked 
the question, they provided the information.
    Mr. Garrett. And the take that I had from the previous 
panel was: (A) neither one of them was the primary regulator; 
and (B) that there was lots of sharing of information, and that 
the points that are made in your report they are just merely 
aberrations as far as sharing of information, that, they didn't 
say this, but 99 percent of the time they are sharing 
information, but you are just picking on some of the 
aberrations as far as information not being shared. That was my 
takeaway. Is that a correct understanding of what was going on 
or was information truly not being shared?
    Mr. Valukas. Let me say this. I have no reason to dispute 
what was said by Chairman Bernanke about the sharing of 
information, the agreement he made with Chairman Cox. I believe 
in fact they made that agreement.
    I also know at the staff level, at least in this instance, 
which I consider to be a critical area, the view of the staff 
was it was, in part, if they asked a question, I would give 
them the answer, but they weren't volunteering. So, no, I don't 
think across-the-board that word filtered down.
    And I don't know about all the other instances of sharing. 
I know when they did the stress test that was jointly done by 
the SEC and the Federal Reserve, so there was a sharing in 
connection with that, and that was done in connection with 
Lehman Brothers. So I can't dispute the fact that there was a 
sharing agreement, that at least at the top they instructed 
people to share. I can dispute the idea that sharing occurred 
in this particular instance.
    Mr. Garrett. Thank you.
    Mr. Kanjorski. Thank you very much, Mr. Garrett.
    The gentleman from Texas, Mr. Green.
    Mr. Green. Thank you, Mr. Chairman; and thank you, sir, for 
appearing today.
    You indicated that--I am saying approximately. I think you 
used the number $50 billion was off the balance sheets, is that 
    Mr. Valukas. That is correct.
    Mr. Green. Is it also true that there was a company that 
received these off-balance sheets books? Is that a way to put 
    Mr. Valukas. The transactions--the Repo 105 transactions 
were done with essentially the same banks or institutions that 
they did regular repos with. So there were several 
counterparties, different counterparties, but they were 
typically the same counterparties.
    Mr. Green. Was there a business made up of former Lehman 
employees who received these investments?
    Mr. Valukas. Not to my knowledge.
    Mr. Green. No reports of that?
    Mr. Valukas. Let me double-check for a second.
    I am not aware of any.
    Mr. Green. You indicated that the disclosures were 
incorrect and misleading, is that true?
    Mr. Valukas. Yes.
    Mr. Green. Who does your report go to when you are 
finished, completely finished?
    Mr. Valukas. During the course of this investigation--the 
short answer is that we have provided all the information we 
have to the United States Attorney's Office in the Southern 
District of New York, the Eastern District of New York, and the 
District of New Jersey, and to the SEC. During the course of 
the investigation, we cooperated with them completely and kept 
them apprised of what we were finding as we went along, and we 
have continued to do so.
    Mr. Green. While this is not on all fours with the Madoff 
case, there are some similarities. You have a whistleblower, 
you have the appearance of assets that do not exist, and my 
concern is that no one to date has been arrested, no one has 
been charged. Are these fair statements, to the best of your 
    Mr. Valukas. I am not aware of anybody being charged.
    Mr. Green. And the concern really is this: How can this 
kind of thing--and you are not qualified to answer--but how can 
this go on and no one suffers some sort of criminal 
investigation to the extent that the public is aware of it?
    This is just amazing. When I read this information, I was 
thunderstruck. Because I couldn't believe that all of this 
information is available and we haven't seen anyone arrested. 
The public at some point has to see some sort of effort to 
bring to justice people who do this and that take advantage of 
so many others with these misleading and incorrect documents.
    You don't say that they were intentionally done, but it 
concerns me that we have all of this information and we don't 
have the criminal investigation that I am aware of either 
taking place such that at some point we would know whether or 
not a crime was committed, I suppose. There is no indication so 
far of a crime. But if this isn't fraud, it will do until fraud 
shows up. That is about as close as you can get to fraud, if it 
isn't fraud, and not have fraud. It really is quite 
disconcerting to see this kind of thing happen and not see the 
    But I thank you for what you have done to help us at least 
get some insight as to what was going on there. Thank you.
    Mr. Valukas. Thank you.
    Mr. Green. I yield back.
    Mr. Kanjorski. Thank you, Mr. Green.
    The gentleman from California, Mr. Sherman.
    Mr. Sherman. Thank you.
    I would like to start by kind of clarifying your role. 
Because when I first saw that you were making a report I 
thought, here is somebody brought in from the neutral world, no 
allegiance to anybody involved, going to give us a report. I 
think you have a good report, but it is my understanding that, 
in effect, you work for the creditors of Lehman Brothers. They, 
of course, would like to find some deep pockets that can help 
supplement what they are otherwise going to receive and that it 
is not your job to throw away or ignore any colorable claim 
that they might have. Do I understand your role?
    Mr. Valukas. No, that is not my role. My role as the 
examiner was to answer questions that were put to me by a court 
by court order.
    I am by training an attorney. I was a former U.S. Attorney 
in Chicago and chairman of a law firm. And my role as examiner 
was to try to determine what the facts were, as I like to say, 
put the cards face up on the table; and to the extent that the 
facts--from those facts I could draw a conclusion as to whether 
there was a colorable claim to lay that out. And as I undertook 
this responsibility that also included to lay out all of the 
defenses that might exist for those colorable claims so that 
anybody reviewing the report could know what actually had taken 
place as best we can determine it and what might be possible 
causes of action. I did not report to, nor was I responsible 
for, nor did I find myself in any way indebted to the creditors 
committee, the debtors or anyone else.
    Mr. Sherman. I stand corrected.
    I want to move on to something else. Matthew Lee will be 
testifying later, and his written testimony states that on May 
16th, he sent a letter to Lehman management raising issues 
about the scope of--within the scope of his responsibility. His 
letter is referenced in your report which was made public 
recently, and the letter that is in your report makes no 
reference to Repo 105.
    In his testimony that he is going to give to this 
committee, he says that he prepared another writing--I will 
call it a second letter--that was sent to a Lehman officer 
addressing matters outside the immediate scope of his 
responsibility and that second letter did identify Repo 105.
    Now, that second letter was not in your report. Are you 
aware of this second communication that Mr. Lee mentions in his 
    Mr. Valukas. There was an e-mail that was sent by his 
lawyer. There was then a discussion about that, and I remember 
we went and interviewed the individuals from Ernst & Young who 
had in their notes the information that was imparted to them 
which included the information that there had been off-balance 
sheet transactions of $50 billion, the purpose of which was to 
accomplish a goal.
    Mr. Sherman. So there was this e-mail. Is that referenced 
in your report?
    Mr. Valukas. I think the e-mail is referenced in the report 
yes. I will double-check that, but there was in fact an e-mail.
    Mr. Sherman. Now, at about the time this e-mail was sent, 
was Mr. Lee trying to negotiate a severance package with 
    Mr. Valukas. That is my understanding, that he had been 
terminated and was trying to negotiate a package. But if he is 
here, he will explain that.
    Mr. Sherman. So this second communication, is it in your 
report or do you have a copy of it that you could provide to 
the committee?
    Mr. Valukas. I will look back. If we have the e-mail, I 
will provide a copy for you.
    Mr. Sherman. To your knowledge, who did Mr. Lee provide 
this e-mail to? Who did he send it to?
    Mr. Valukas. I think the e-mail came from his lawyer, the 
one I am thinking of.
    Mr. Sherman. I yield back.
    Mr. Kanjorski. Thank you very much, Mr. Sherman.
    And now the gentleman from Ohio, Mr. Wilson.
    Mr. Wilson. Thank you, Mr. Chairman.
    Thank you for coming in today, Mr. Valukas. Your report 
provided some very interesting reading.
    I only have 5 minutes, so I hope I can run through my 
questions as quickly as I can.
    I know that Thomas Baxter told you in no way was the idea 
to make Lehman a poster child for a moral hazard. But do you 
believe that is not true?
    Mr. Valukas. I don't know how to respond to that question. 
I apologize.
    I did not find any evidence--nothing was said to me which 
indicated that somebody was deliberately trying to subvert 
Lehman's ability to survive. We did not find any 
communications. We went through 23 million or 25 million e-
mails, documents, things such as that. There was nothing in 
there to suggest any of that. In the interviews that we had 
with individuals, nobody gave us any testimony suggesting that.
    Mr. Wilson. What do you think was so much more saveable 
about Bear Stearns, for example, than Lehman?
    Mr. Valukas. What we were told was that--in connection with 
Lehman--that the opportunity to lend to Lehman was dependant 
upon Lehman's ability to have collateral which could stand, 
which was sufficient to justify the loans; and they did not, as 
of that date, September 15th, have that type of collateral.
    Mr. Wilson. I get the sense that the Fed thought that 
something could be done about this. However, since they weren't 
the regulator in charge, they stepped back. How do you feel 
about that?
    Mr. Valukas. I am not sure that I am qualified to answer 
that question in terms of what we were trying to do. All I know 
is that over that weekend, there were all of these efforts that 
were being made. It would appear, on their face, at least, to 
be good-faith efforts to salvage Lehman or salvage some aspect 
of Lehman. I can't really comment beyond that.
    Mr. Wilson. In your report, you cited many times the risk 
that Lehman was taking was far and above what their model was.
    Mr. Valukas. Yes.
    Mr. Wilson. So that was a building crescendo to what really 
came in September of 2008?
    Mr. Valukas. What happened was they took on increasingly 
what turned out to be illiquid assets. They had in place or 
they told the SEC they had in place a risk matrix which limited 
the amount of risk to take in individual transactions. They 
exceeded that 30 times in a row by taking on more and more of 
    What they did at the end of the year was then they looked 
back and they said, we have exceeded--they had all these risk 
exceedences. They simply raised the level of risk which they 
were qualified to take. So that is the way they addressed it.
    Now, as I said before, many of those assets, and some in 
particular, Archstone, were assets which later became in 2008 
more or less an anchor around them and became a significant 
problem in their ability to survive.
    Mr. Wilson. I found that a real contrast in your findings 
in some of the testimony that was given by, for example, Mr. 
Cruikshank, is there an opportunity to be able to compare those 
and match them up?
    Mr. Valukas. I am not sure how I could do that. If you 
wish, I could read Mr. Cruikshank's testimony, if that is what 
you are asking.
    Mr. Wilson. I think it is sort of implied that part of it 
was doing business. What really isn't implied is the fact that 
it was risky business, and that is how we got the report of the 
    Mr. Valukas. What happened, as I said before, was they made 
a decision to increasingly take on these types of risks. These 
were business decisions which under the law they were entitled 
to make. They were escalated up, and people concurred in those 
decisions about the risk that they should take in making their 
business judgments.
    What the regulators did not do is prevent them from doing 
so or say, no, you can't take on that risk or we prevented you 
from doing so. And under our system and the law basically 
businessmen are permitted to take risk and make judgments as to 
how much risk they take as long as it is not irrational. And in 
this situation, it was not irrational. It may have been 
excessive, ultimately, but we concluded that it was in the 
business judgment rule.
    Mr. Wilson. Thank you for your answers.
    Thank you, Mr. Chairman. I yield back the balance of my 
    Mr. Kanjorski. Thank you, Mr. Wilson.
    And we will now hear from the gentleman from Texas, Mr. 
    Mr. Hensarling. Thank you, Mr. Chairman.
    Mr. Valukas, please forgive me. I missed some of your 
testimony. I had a different appointment. So if we plow some 
old ground, I apologize.
    The first question I have concerns the Repo 105 practice, 
which I am sure you discussed in some detail.
    I see on page 13 of your testimony: ``I express no view on 
whether, as a technical matter of GAAP accounting, it is 
permissible to treat transactions as sales which are by all 
other measures financings.''
    So I assume it says what it means. You don't have an 
opinion on whether or not as a pure technical matter of GAAP 
accounting this violated the standard or not?
    Mr. Valukas. I have no--we did not need to and we didn't 
express an opinion as to whether accounting for Repo 105 this 
way complied technically with that aspect of GAAP.
    We did have a view which was that, even if you account 
technically, that this is technically correct. If it does not 
accurately reflect the entire balance sheet, the truth of what 
is there, then that is not compliant with GAAP. Because GAAP 
says it should be a fair picture of your financial situation. 
So you could technically have some portion which complies with 
FAS 140 and still make that balance sheet or that financial 
    Mr. Hensarling. To use a fairly nontechnical phrase, the 
way it was used by Lehman in your opinion doesn't pass the 
smell test. Is that a fair assessment?
    Mr. Valukas. I am sorry. You will have to repeat that to 
    Mr. Hensarling. I said, using a nontechnical phrase, is it 
fair to say that in your opinion the way Lehman used Repo 105 
does not pass the smell test?
    Mr. Valukas. I concluded that there were colorable causes 
of action against Lehman executives for filing false--filing 
financial statements which were false and incorrect based on 
their use of Repo 105.
    Mr. Hensarling. In your opinion, under the CSE program, 
could the SEC have compelled more complete disclosure of these 
Repo 105 transactions?
    Mr. Valukas. Absolutely.
    Mr. Hensarling. There seemed to be some confusion on the 
earlier panel about that.
    In your opinion, could the SEC have required them to set 
aside more capital against--to decrease their leverage and to 
increase their capital? Did the SEC have that ability?
    Mr. Valukas. I understood the CSE program, the focus there 
was liquidity, capital, leverage. Those were areas in which, at 
least in the testimony before Congress, they were going to 
address because of the concerns of what would take place in 
those areas and the systemic risk that might occur in the event 
of a failure.
    So I am presuming that meant--and I am in part presuming 
that based on the testimony of Chairperson Schapiro--that, yes, 
they could have mandated certain changes or said these are 
risks that either need to be disclosed or limited actions like 
that under the CSE program. Voluntary as it was, Lehman had the 
right then to step away from that program, but I doubt that 
they would have.
    Mr. Hensarling. I don't have at my fingertips the portion 
of your testimony where you talk about in some respects--I 
don't want to put words in your mouth--that the failure of, I 
guess, in some respects that the SEC and the Federal Reserve, 
to bring some of these matters to light, that there were 
literally millions of trades that were--uninformed trades that 
might otherwise have not taken place. Again, I don't have that 
passage at my fingertips. Is that a fair assessment?
    Mr. Valukas. Yes. We conclude in the report that the 
failure to--that subsequent to the publishing of those 
financial statements which excluded the information about the 
Repo 105, that there were literally billions of dollars worth 
of shares of Lehman Brothers that were traded by the American 
    Mr. Hensarling. So you don't see this at all as a lack of 
authority by the SEC to act upon these matters. It might have 
been a lack of competence, some would maintained a lack of 
resources, lack of will, but you have concluded that it was not 
a lack of authority with respect to them compelling increased 
disclosure or lessening their leverage?
    Mr. Valukas. With regard to disclosures, there is not even 
a--I have no question about their authority to order that 
    And in terms of the leverage information, to the extent it 
was disclosure about leverage, I have no question about that.
    Mr. Hensarling. I see I am out of time. Thank you, Mr. 
    Mr. Kanjorski. The gentleman from Colorado, Mr. Perlmutter.
    Mr. Perlmutter. Thank you, Mr. Chairman.
    Thank you, Mr. Valukas, for your testimony today. Thanks 
for putting this report together.
    I feel obligated to respond to a couple of things Mr. Royce 
said about a bill that is pending on reforming Wall Street. And 
following up on Mr. Hensarling's questions, whether or not the 
regulations were in place, it was clear that the SEC, in my 
opinion, under the Bush Administration, no regulation was good 
regulation. That was a principle. That was a Bush doctrine. And 
based on what I hear my friends from the Republican side say, 
they don't want to do anything and want to allow Wall Street to 
run amuck.
    Now, one of the things that you said--and I think it is on 
page 1,484--is that after Gramm-Leach-Bliley was passed, there 
was a void, I think your language is. The Gramm-Leach-Bliley 
Act of 1999 created a void in the regulation of systemically 
important large investment bank holding companies. Neither the 
SEC nor any other agency was given statutory authority to 
regulate such entities. So we are passing--we are hopefully 
going to pass a reform bill that reigns in Wall Street and 
these systemically large companies.
    Now, Mr. Royce also was talking about enhanced bankruptcy 
authority. In connection with the Lehman Brothers case--and I 
don't know if you were charged as an examiner with this--but 
you did say it couldn't do any business anymore after 
September. It just didn't have the liquidity. What do you mean 
by that?
    Mr. Valukas. I meant that what caused the failure 
ultimately was the lack of liquidity. They didn't have the cash 
resources, the money necessary to continue their business. They 
couldn't open up in the morning and continue to trade because 
they didn't have those resources.
    Mr. Perlmutter. And they are a financial services business.
    Mr. Valukas. In order for them to survive, they needed to 
do repo transactions to gather cash against collateral; and as 
of that weekend, that was over.
    Mr. Perlmutter. What kind of bankruptcy are they in right 
now, Mr. Valukas?
    Mr. Valukas. Chapter 11.
    Mr. Perlmutter. Chapter 11? So are they doing business, or 
are they still liquidating Chapter 11?
    Mr. Valukas. They are liquidating at this point.
    Mr. Perlmutter. One of the issues that we have in front of 
this committee is whether or not a financial services 
organization should be allowed to reorganize or whether they 
should be liquidated as in a Chapter 7. And so the Republicans 
think they ought to be able to reorganize. The Democrats think 
they ought to be put out of their misery. We think they should 
be liquidated.
    Now, one of the things that we have seen here, I am 
curious, did you look to see if there are any assets left for 
payment of creditors? You may have heard my area had some local 
governments that were hit hard by the Lehman Brothers 
bankruptcy. Is there something for them to collect against?
    Mr. Valukas. I am not a bankruptcy lawyer, and I am not a 
bankruptcy lawyer in this particular case, but I do know from 
the reports that I have seen filed by the debtors' counsel, I 
think there are several billions of dollars left in the estate 
to which there are--and maybe more than several--for which 
there are numerous claims far in excess of those dollars.
    Mr. Perlmutter. Mr. Royce and Mr. Garrett were sort of 
focusing on, while it is the Federal Reserve's responsibility, 
maybe it was the SEC's responsibility. One of the things that 
you found when you looked at these CSEs--and I think you said--
page 1,512 of your report, you recite from the MOU, which says: 
``As the primary supervisor of CSEs, the SEC will provide the 
Federal Reserve on an ongoing basis with requested 
information.'' Did you look at the SEC as the primary 
supervisor, primary regulator in this, in the Lehman Brothers 
    Mr. Valukas. Yes.
    Mr. Perlmutter. And I think your testimony was that they 
took on more of a role of just an observer than an actor.
    Mr. Valukas. My view on it was they acquiesced in this 
area. They acquiesced--when the risk exceedences occurred, they 
acquiesced in some of these other areas; and they were not 
directing them to do things which ultimately were issues that 
they should have directed them.
    Mr. Perlmutter. Thank you. Nothing further.
    Mr. Kanjorski. Thank you very much, Mr. Perlmutter.
    And now we will hear from--
    Mr. Bachus. Mr. Chairman, I appreciate Mr. Perlmutter 
clearing up a lot of my confusion as to where we were going.
    Mr. Kanjorski. I think you made it very clear.
    The gentlelady from California, Ms. Speier.
    Ms. Speier. Thank you, Mr. Chairman.
    Mr. Valukas, I just want to thank you publicly for an 
outstanding report. Your testimony--your statement here this 
afternoon could not be clearer as to who was responsible.
    What is kind of humorous to me is how on many statements 
that we have before us today, they are attempting to rewrite 
history. One of them appears to be Mr. Fuld, who has said in 
his testimony, which you will be getting later, that he had 
absolutely no recollection whatsoever of hearing anything about 
Repo 105 transactions while he was CEO of Lehman. Do you 
believe that statement could be true?
    Mr. Valukas. I don't know that it is appropriate for me to 
comment on Mr. Fuld's credibility.
    We concluded in the report that a fact finder could 
conclude that in fact he did know and acted upon information he 
knew or should have known. There was at least one witness who 
testified that he discussed Repo 105 transactions with him. In 
the magnitude of those transactions, there were documents that 
were sent to him by e-mail and otherwise which reflected the 
Repo 105 transactions which were dealing with balance sheet 
which were a great issue and concern to Lehman Brothers at the 
    The two presidents of Lehman Brothers acknowledged they 
knew about Repo 105. The three CFOs during that period of time 
claim they knew about Repo 105 and numerous other executives. 
Mr. Fuld's position was that he did not know about it. If an 
action is brought, someone will determine whether that is or is 
not credible.
    Ms. Speier. You also referenced in your statement that you 
found that there were colorable claims against Lehman for 
violating regulation S-K, which requires a registrant to 
discuss known trends involving its capital resources, 
specifically including off-balance sheet financing 
    Mr. Valukas. Yes.
    Ms. Speier. So Lehman did not in its actual notification to 
investors talk about the off-balance sheet financing 
    Mr. Valukas. They did not. And we asked executives of 
Lehman Brothers who were involved in the preparation and they 
told us that a sophisticated investor reviewing the balance 
sheets--reviewing the financial statements would never be able 
to observe anything which disclosed the Repo 105 transactions.
    Ms. Speier. In your opinion, are Repo 105s potentially a 
very dangerous instrument that can be used as Lehman used it to 
create the impression that it was leveraged less than it 
actually was?
    Mr. Valukas. I don't think there is anything inherently 
wrong with the Repo 105 transaction. It is simply another repo 
transaction, no different than any other, just putting 
additional collateral and securing the opinion of a lawyer in a 
different jurisdiction that it would qualify as a true sale. 
But it is in all other respects a repo transaction. It was a 
failure to disclose to the public and the regulators what they 
were doing and that they were using this to shift assets off 
balance sheets in order to affect their leverage at quarter end 
that we found to be the misstatement, not Repo 105 inherently 
as a bad instrument, because it is simply neutral. It is how we 
say it was used and, more importantly, not disclosed.
    Ms. Speier. So do you think the issue would be resolved 
somewhat of all Repo 105 transactions had to be disclosed so 
there was the transparency that didn't exist in these?
    Mr. Valukas. Yes. At that point in the instance of the 
Lehman situation, there would have been no reason to do a Repo 
105 transaction if you are going to disclose it.
    Ms. Speier. And then you also referenced that, as part of 
their CSE--being granted CSE status, they advised the SEC that 
they had robust procedures to calculate and set risk limits as 
a ``binding constraint on its risk-taking that could not be 
exceeded under any circumstances.'' So they make this 
statement, and then they go right ahead and violate it by 
lifting the limits on the risk that they can take, is that 
    Mr. Valukas. That is correct. And they fully disclosed that 
to the SEC as they were doing it.
    Ms. Speier. So they fully disclosed it. While we were 
granted CSE status because of the statement, we are now going 
to violate the statement, and they informed the SEC, and the 
SEC took no action.
    Mr. Valukas. The SEC acquiesced. The SEC started--while 
they stated in that written position that it was a hard limit, 
they subsequently took the view that it was a soft limit. The 
SEC's position was, as long as they disclosed it to senior 
management, which they did, that the SEC and senior management 
reviewed it, which they did, that they would--that satisfied 
the SEC. So Lehman--when Lehman said they made full disclosure 
to the SEC in this area, they did in fact do that.
    Ms. Speier. Thank you. My time has expired.
    Mr. Kanjorski. The gentlelady from Ohio, Ms. Kilroy.
    Ms. Kilroy. Thank you, Mr. Chairman.
    And thank you, Mr. Valukas, for being here today. Like my 
colleagues, I very much appreciate your report. It is very 
useful in performing the sort of autopsy to find out more of 
what was going on and, from our point of view, what are the 
policy implications.
    There are certainly some very real-world implications of 
what happened with Lehman Brothers. People in Ohio, people in 
California, people in Colorado, and people in other States as 
well had invested, worked their lives, had pension funds.
    In my case, Ohio public employees, teachers, police 
officers--their pension funds were invested in offerings by 
Lehman. And we have learned that there is a substantial 
decrease in value, although I can't sort it all out entirely 
yet, but a substantial decrease in value between December of 
2007 and September of 2008. So although the high-risk strategy 
may have been a business decision, that high-risk strategy 
certainly had consequences far beyond the Lehman boardroom.
    One of the things that I gleaned from your report was that 
some of the reasons that you found some actions not to have 
violated or be a violation of fiduciary or other standards was 
because of the standard articulated by the court in Caremark; 
and I was wondering if you would advise us to take actions in 
legislation to tighten down those standards and to put more 
responsibility on corporate officers, boards, CEOs, and others 
who are engaged in high-risk gambling but maybe not telling the 
people financing it that they are on the way to the casino.
    Mr. Valukas. You are asking me a policy question, and I am 
not sure that I am qualified to answer that question. So I am 
not comfortable answering it.
    I can say this. Lehman had in place a process of reporting 
matters up. And in fact, we found that matters were reported 
up. For instance, they are elevated to the board. So the 
process that was in place at Lehman on its face was a good 
    The business judgment rule pretty much says that if you 
have this process in place and you are acting--you are making 
rational decisions, you are permitted to do so. So it is not 
just--I would say that the issue wasn't necessarily just within 
Lehman as to what Lehman was doing so much as it might have 
been with regard to the regulators who need to be able to say 
to a businessperson, that might be a business judgment you are 
prepared to make, but we are not prepared to let you make that 
judgment. And that is where I see it. I don't necessarily see 
it is inherently an issue of internal regulation. Because, as I 
said in my testimony, they had those processes in place, and to 
some extent, I thought they were following them.
    Ms. Kilroy. To some extent, they were followed. Certainly, 
in other critical areas, they weren't followed. And some 
people--Mr. Gelband, Dr. Ancitick, Mr. Lee--made known their 
position inside the company that they were engaged in behaviors 
that were far too risky, they were overleveraged, that they 
were exceeding the risk management levels. And those people no 
longer work for the company, lo and behold.
    In my opinion--I don't know if you share this opinion or 
not--that kind of activity with the key people who have spoken 
up being removed from the company or resigning from the company 
after speaking up has a chilling effect on the ability of other 
people to become whistleblowers.
    So I guess the other question is, do you have any 
recommendations for us whether whistleblowers deserve or should 
have additional protection so that they can speak up when 
behaviors are risky and make sure that the appropriate people 
know it, not maybe just the next one up in the chain, but 
sometimes all the way up to the board?
    Mr. Valukas. This is outside of my role as an examiner, but 
I believe that it is critical in corporations that 
whistleblowers be heard at the highest levels so that in fact 
their concerns, such as they are, should be responded to, and 
so that the highest officers to whom they respond--to whom they 
report are held responsible if they don't respond. So I think 
it is not simply to your superior. And I think my own 
experience is that with Sarbanes-Oxley and some of the other 
laws that have passed that it has gotten better within 
corporate America, significantly better.
    Ms. Kilroy. In this instance, the risk management function 
did not have a direct line to the board.
    Mr. Valukas. That is correct.
    Ms. Kilroy. We also have learned that not only were Repo 
105s moved off balance sheet at quarters end and presentations 
made to potential investors that make things look better than 
they actually were but that also when stress tests were 
undertaken that certain risky investments were also not 
included in those stress tests.
    Mr. Valukas. That is correct. And we didn't find that it 
was deliberately excluded, but we did find that the stress 
tests in fact were not testing the things which were going to 
be the most significant problem for Lehman and ultimately 
turned out to be the most significant problem for Lehman. So 
that the items which were tested might account for $4 billion 
worth of potential losses, the items that were not being tested 
accounted for as much as $12 billion to $14 billion worth of 
potential losses. So the greatest problem that they might face 
was not being tested for.
    Ms. Kilroy. It seems that I might come to agree with one of 
the employees who has stated that everyone saw the train was 
coming, but no one got out of the way.
    Mr. Valukas. That is to some extent true, yes.
    Ms. Kilroy. I think I am out of time, Mr. Chairman. I yield 
    Mr. Kanjorski. Thank you very much.
    Mr. Valukas, I just have to tell you that your testimony 
has been outstanding, and my great respect goes out to you. 
Anybody who can work on 25 million e-mails--
    Mr. Valukas. I didn't look at them myself.
    Mr. Kanjorski. I trust you did not, but just to have that 
volume of material, and then to be able to so directly recall 
as much as you have today, certainly has helped us on the 
committee to get a grasp of at least what happened and the 
complications of this thing, so we thank you. I guess all 
Chicago lawyers are your caliber.
    Mr. Valukas. Thank you.
    Mr. Bachus. Mr. Valukas, I think this gives us some 
valuable insight into anytime you want to fix the system, or at 
least you want to have regulatory reform, you first want to 
determine what went wrong and why. So I think this will help 
us, because it is one of the clearest pictures I think of lack 
of regulation. And I don't mean the laws. I mean lack of 
regulators enforcing the regulations or really also conveying 
to people or failing to convey information they knew to the 
general public even though it is their duty to protect 
investors and to withhold that information. And so I think it 
would be very valuable to us as we determine what to do in 
    Mr. Valukas. Thank you. It is an honor to be here.
    I know what you are struggling with, but, as a citizen, we 
are all hopeful that you are going to help us get through this. 
It is critically important. So thank you very much for having 
me here.
    Mr. Kanjorski. Thank you very much, Mr. Valukas. Thank you.
    I think we have had the feeding frenzy, if that is 
    We now have the final panel. And our first witness on that 
panel will be Mr. Richard S. Fuld, Jr., former chairman and 
chief executive officer of Lehman Brothers.
    Mr. Fuld?


    Mr. Fuld. Mr. Chairman, Ranking Member Bachus, and members 
of the House Committee on Financial Services, you have invited 
me here today to address a number of public policy issues 
raised by the Lehman Brothers bankruptcy report filed by the 
    Since September of 2008, I have given much thought to the 
financial crisis that forced Lehman into bankruptcy. The idea 
of the superregulator that monitors the financial markets for 
systemic risk, I believe is a good one. This new regulator 
should have actual experience and a true understanding of the 
business of financial institutions, the capital markets, and 
risk management.
    The new regulator should also have access on a real-time 
basis to all information and data from all market participants 
regarding all transactions and positions and have clear 
standards for capital requirements, liquidity, and other risk 
management metrics. The job of the new regulator can only be 
done with the creation and utilization of a master mark-to-
market capability that has the responsibility for determining 
valuations and capital haircuts on all assets, commitments, 
loans, and structures.
    As to the Fed and the SEC, officials from both were 
physically present in our offices seeing everything in real 
time, monitoring and reviewing our daily activities of 
liquidity, funding, capital, risk management, and mark-to-
market processes.
    After an extended investigation into Lehman's bankruptcy, 
the examiner recently published a lengthy report stating his 
views. Despite popular and press misconceptions about Lehman's 
mortgage and real estate, asset valuations, liquidity, and risk 
management, the examiner found no breach of duty by anyone at 
Lehman with respect to any of these.
    The examiner did take issue, though, with Lehman's Repo 105 
sale transactions. As to that, I believe the examiner's report 
distorted the relevant facts, and the press, in turn, distorted 
the examiner's report. The result is that Lehman and its people 
have been unfairly vilified.
    Let me start by saying that I have absolutely no 
recollection whatsoever of hearing anything about or seeing 
documents related to Repo 105 transactions while I was the CEO 
of Lehman. Therefore, what I will say about Repo 105 
transactions is based on what I have recently learned.
    As CEO, I oversaw a global organization of more than 28,000 
people, with hundreds of business lines and products, and with 
operations in more than 40 countries spread over 5 continents. 
My responsibility was to create an infrastructure of people, 
systems, and processes all designed to ensure that the firm's 
business was properly conducted in compliance with the 
applicable standards, rules, and regulations.
    There has been a lot of misinformation about Repo 105. 
Among the worst were the completely erroneous reports on the 
front pages of major newspapers claiming that Lehman used Repo 
105 to remove toxic assets from its balance sheet. That simply 
was not true. And, according to the examiner, virtually all of 
the Repo 105 transactions involved highly liquid investment-
grade securities, most of them government securities. Some of 
the newspapers that got it wrong were fair-minded enough to 
print a correction.
    Another piece of misinformation was that Repo 105 
transactions were used to hide Lehman's assets. That also was 
simply not true. Repo 105 transactions were sales, as mandated 
by the accounting rule FAS 140.
    Another misperception was that Repo 105 transactions 
contributed to Lehman's bankruptcy. That also was just totally 
untrue. Lehman was forced into bankruptcy amid one of the most 
turbulent periods in our economic history, which culminated in 
a catastrophic crisis of confidence and a run on the bank. That 
crisis almost brought down a large number of other financial 
institutions, but those institutions were saved because of 
government support in the form of additional capital and 
fundamental changes to the rules and regulations governing 
banks and investment banks.
    As to Repo 105, the examiner himself acknowledges: first, 
Repo 105 transactions were not inherently improper; second, 
Lehman vetted those transactions with its outside auditor; and 
third, Lehman properly accounted for those transactions, as 
required by GAAP.
    Repo 105 transactions were modeled on FAS 140. In 2000, the 
accounting authorities wrote rules which expressly provided for 
them, described them, and dictated how they should be accounted 
for. In 2001, Lehman's written accounting policy incorporated 
those accounting rules. E&Y, the firm's independent outside 
auditor, reviewed that policy and supported the firm's approach 
and application of the relevant rule, FAS 140. As I said, that 
rule mandated that those transactions be accounted for as a 
sale, and that is exactly what I believe Lehman did. Lehman 
should not be criticized for complying with the applicable 
accounting standards.
    My job as the CEO was also to put in place a robust process 
to ensure that Lehman complied with all of its obligations to 
make accurate public disclosures. I had hundreds of people in 
the internal audit, finance, risk management, and legal 
functions to ensure that we did, in fact, comply with all of 
our obligations.
    That process had a number of components: first, E&Y's role 
in auditing our financial statements and reviewing our 
quarterly and annual SEC filings; second, a rigorous 
certification process before every annual and quarterly SEC 
filing, involving hundreds of people who had firsthand 
knowledge of the firm's day-to-day business and the 
responsibility to review and certify for accuracy the firm's 
SEC disclosures before they were filed; and third, an all-
hands, in-person, mandatory meeting chaired by Lehman's chief 
legal officer, including me and more than 30 other senior 
officers with responsibility for all parts of Lehman.
    I relied on this certification process because it showed 
that those with granular knowledge believed the SEC filings 
were complete and were accurate. And I never signed an SEC 
filing unless it was first approved by the chief legal officer.
    In conclusion--actually, given all that has been said, I 
would like to add that I am very much aware that one day we had 
a firm; the next day we did not. And a lot of people got hurt 
by that. I have to live with that.
    So I thank you, Mr. Chairman.
    [The prepared statement of Mr. Fuld can be found on page 
158 of the appendix.]
    Mr. Kanjorski. Thank you.
    We will next hear from Mr. Thomas Cruikshank, a former 
member of the board of directors and chair of Lehman Brothers' 
audit committee.
    Mr. Cruikshank?


    Mr. Cruikshank. Thank you, Mr. Chairman. Thank you, 
Congressman Bachus. I would like to thank the committee for 
inviting me to appear at today's hearing.
    No one can deny that the bankruptcy of Lehman Brothers has 
had a disastrous impact on the company, its employees, its 
investors, and even on our country and its economy. As a 
director of the firm, Lehman's collapse weighs on me personally 
each and every day. It is vital that we learn from Lehman's 
history so we do not repeat it.
    The day Lehman filed for bankruptcy was probably the 
darkest day of my professional career. Looking back, I am sure 
there are things Lehman could have done differently, but what 
may seem crystal-clear today was much less so 3 years ago. 
Indeed, even after Bear Stearns nearly collapsed in March 2008, 
the then-Treasury Secretary stated that the worst was likely 
behind us. If only he and other financial leaders had been 
    Still, even in retrospect, the examiner found that there 
are absolutely no colorable claims against the independent 
directors in connection with our work on behalf of the company. 
This conclusion comports with our own belief that we did our 
absolute best to try and help navigate Lehman through what was 
the greatest financial tsunami since the Great Depression.
    Between 2007 and Lehman's bankruptcy filing, our board and 
its committees convened on more than 80 occasions. We received 
detailed reports from management on Lehman's financial 
performance and other important issues. Board meetings were an 
active affair, as we probed management and demanded and 
received detailed, cogent answers.
    One issue that management spent a great deal of time 
discussing with the board was risk. As directors, we took great 
comfort from their reports regarding Lehman's extensive risk 
management system.
    In performing its oversight role, Lehman's board of 
directors relied upon the expertise of a variety of 
outstanding, outside professionals, including Ernst & Young. At 
no time during our numerous substantive discussions throughout 
2007 and 2008, did they raise any red flags regarding Lehman's 
risk management valuation or the firm's certified filings.
    As a board of directors, we also had confidence in what we 
understood to be Lehman's close working relationship with 
government regulators. Even before the financial crisis, Lehman 
voluntarily subjected itself to the scrutiny of the SEC. Lehman 
continued to work intimately with the SEC and the New York Fed 
as the financial crisis deepened.
    Lehman took numerous steps to adjust to the worsening 
economic climate. They shut down the subprime mortgage lending 
unit, substantially reduced mortgage and asset-backed 
securities exposure by many billions of dollars, raised more 
than $15 billion in new capital, and pursued a number of 
strategic alternatives in order to help stabilize the firm.
    The examiner's report has raised questions about certain 
transactions now known as Repo 105. As the examiner has 
concluded, this issue was never brought to the attention of the 
board. If there were any questions whatsoever about Lehman's 
accounting or disclosures, I believe our firm's auditors would 
have promptly raised it, and I would have expected them to do 
so. They did not.
    Now, I am not so presumptuous as to say I know precisely 
why Lehman collapsed. I believe that there were many 
contributing factors, including the firm's real estate 
exposure, which was exacerbated by the rules from applying 
mark-to-market accounting; the short sellers who were fueling 
rumors; the tightening of the short-term credit market; and a 
loss of confidence in Lehman that led to a run on the bank.
    That said, I was dismayed when the SEC and the New York Fed 
essentially told the board that Lehman needed to file for 
bankruptcy. I do not understand why the government did not help 
finance the sale of Lehman to Barclays, like it did in the case 
of Bear Stearns, or expand access to the Fed's primary dealer 
credit facility to Lehman, like it did for other major 
investment banks, or expedite Lehman's conversion to a bank 
holding company, as was done for Goldman Sachs and Morgan 
Stanley. There may be good and reasonable explanations for all 
of these distinctions, but I do not know what they are.
    While we cannot rewrite history, had the government acted 
to stabilize Lehman so that it could have been sold or unwound, 
our country's financial crisis might not have been nearly as 
severe and widespread.
    My thanks to the committee for the opportunity to speak 
with you today. And, while I may not have the knowledge and 
expertise of the other witnesses before you, I am happy to 
address any questions you may have.
    Thank you.
    [The prepared statement of Mr. Cruikshank can be found on 
page 149 of the appendix.]
    Mr. Kanjorski. Thank you, Mr. Cruikshank.
    And now, we will hear from Mr. William K. Black, associate 
professor of economics and law at the University of Missouri-
Kansas City School of Law.
    Mr. Black?


    Mr. Black. Members of the committee, thank you.
    You asked earlier for a stern regulator. You have one now 
in front of you. And we need to be blunt, and you haven't heard 
much bluntness in hours of testimony.
    We stopped a non-prime crisis before it became a crisis in 
1991 by supervisory actions. We did it so effectively that the 
people had forgotten it even existed, even though it caused 
several hundred million dollars in losses, but none to the 
taxpayers. We did it by preemptive litigation and by 
supervision. We broke a raging epidemic of accounting control 
fraud without new legislation in the period 1984 through 1986. 
Legislation would have been helpful; we sought legislation, but 
we didn't get it. And we were able to stop that because we 
didn't simply continue business as usual.
    Lehman's failure is a story in large part of fraud. And it 
is fraud that begins at the absolute latest in 2001, and that 
is with their subprime and their liar's loan operation. Lehman 
was the leading purveyor of liar's loans in the world for most 
of this decade. Studies on liar's loans show incidence of fraud 
of 90 percent. Lehman sold this to the world with reps and 
warranties that there were no such frauds.
    If you want to know why we have a global crisis, in large 
part, it is before you. But it hasn't been discussed today, 
amazingly. Financial institution leaders are not engaged in 
risk when they engage in liar's loans. Liar's loans will cause 
a failure. They lose money. The only way to make money is to 
deceive others by selling bad paper, and that will eventually 
lead to liability and failure as well.
    When people cheat, you cannot as a regulator continue 
business as usual. They go into a different category, and you 
must act completely differently as a regulator. What we have 
gotten instead are sad excuses. The SEC--we are told there are 
only 24 people in their comprehensive program. Who decided how 
many people there would be in their comprehensive program? Who 
decided the staffing? The SEC did. To say that we only had 24 
people is not to create an excuse, it is to give an admission 
of criminal negligence--except it is not criminal because you 
are a Federal employee.
    In the context of the FDIC, Secretary Geithner testified 
today that this event pushed the financial system to the brink 
of collapse. But Chairman Bernanke testified we sent two people 
to be on site at Lehman. We sent 50 credit people to the 
largest savings and loan in America. It had $30 billion in 
assets. We had a whole lot less staff than the Fed does. We 
forced out the CEO. We replaced the CEO. And we did that not 
through regulation, but because of our leverage as creditors.
    Now, I ask you, who had more leverage as creditors in 2008; 
the Fed, compared to the Federal Home Loan Bank of San 
Francisco 19 years earlier? Incomprehensibly, greater leverage 
in the Fed, and it simply was not used.
    So let's start with the Repos. We have known since Enron in 
2001 that this is a common scam in which every major bank that 
was approached by Enron agreed to help them deceive creditors 
and investors by doing these kind of transactions. And so what 
happened? There was a proposal in 2004 to stop it, and the 
regulatory heads--it was an interagency effort--killed it. They 
came out with something pathetic in 2006 and stalled its 
implementation to 2007, but it is meaningless.
    We have known for a decade that these are frauds. We have 
known for a decade how to stop them. All of the major 
regulatory agencies were complicit in that statement in 
destroying it. We have a self-fulfilling policy of regulatory 
failure because of the leadership in this era.
    We have the Fed, the Federal Reserve Bank of New York, 
finding that this is three-card Monte. What would you do as a 
regulator if you knew that one of the largest enterprises in 
the world, when the Nation is on the brink of collapse, 
economic collapse, is engaged in fraud, three-card Monte? Would 
you continue business as usual?
    That is what was done. Oh, they met a lot. They say, we 
only had a nuclear stick. It sounds like a pretty good stick to 
use if you are on the brink of collapse of the system.
    But that is not what the Fed has to do. The Fed is a 
central bank. Central banks, for centuries, have gotten rid of 
the heads of financial institutions. The Bank of England does 
it with a luncheon. The board of directors are invited; they 
don't say no. They are sat down. The head of the Bank of 
England says, ``We have lost confidence in the CEO of your 
enterprise. We believe that Mr. Jones would be an effective 
replacement.'' And by 4:00 that day, Mr. Jones is running the 
place, and he has a mandate to clean up all the problems.
    Instead, every day that Lehman remained under its 
leadership, the exposure of the American people to loss grew by 
hundreds of millions of dollars on average. Aurora was pumping 
out up to $3 billion a month in liar's loans. Losses on those 
are running roughly 50 cents to 85 cents on the dollar. It is 
critical not to do business as usual, to change.
    We have also heard from Secretary Geithner and Chairman 
Bernanke, ``We couldn't deal with these lenders because we had 
no authority over them.'' The Fed had unique authority since 
1994 under HOEPA to regulate all mortgage lenders. It finally 
used it in 2008. They could have stopped Aurora. They could 
have stopped the subprime unit of Lehman that was really a 
liar's loan place, as well, as time went by.
    Thank you very much.
    [The prepared statement of Mr. Black can be found on page 
122 of the appendix.]
    Mr. Kanjorski. Thank you very much, Mr. Black.
    And now, our last witness--I probably should reiterate that 
we ask our witnesses to confine themselves to 5 minutes to 
summarize your testimony--Mr. Matthew Lee, former senior vice 
president of Lehman Brothers.
    Mr. Lee?


    Mr. Lee. Thank you, Mr. Chairman, Ranking Member Bachus, 
and the other members of the committee. Thank you for inviting 
me here today to answer questions about my story. I provided a 
written statement. I will give an even briefer oral statement.
    Many people don't know me. I was born and educated in the 
United Kingdom. I have an undergraduate and postgraduate degree 
from the University of Edinburgh in Scotland. In 1977, I joined 
the Arthur Young London office in the U.K. I was transferred in 
1981, 29 years ago, to the New York office of Arthur Young.
    I have three accountancy qualifications, one of which is 
certified public accounting. I am registered in the State of 
New York. At Arthur Young, I specialized in financial services 
companies. I attained the position of principal, and I 
specialized in financing products, repo, reverse repo, 
securities lending. I also specialized in international 
securities and U.S. trust banks.
    I made my career out of understanding internal control, 
identifying issues, figuring out potential issues, and 
resolving issues. That is what I did for a living. I was kind 
of like a professional whistleblower, if you would. Typically, 
my business was transacted by word of mouth. If you have a 
problem, you fix it--people usually fix it. I very rarely 
reduced my issue resolution to writing.
    I joined Lehman Brothers just as it went public in 1994. I 
was hired in. I didn't answer an ad. I was approached because 
of my skill set as an issue identifier/resolver. They had an 
issue in their equity finance business at the time. I became 
global product controller, equity finance, in 1994. I held that 
position twice. I also held my final position twice, which was 
the global product controller of the global balance sheet--I am 
sorry, not global product controller--global financial 
controller of the firm's balance sheet and global legal 
    There were a number of issues over the years at Lehman. If 
I fast-forward to the end of 2007, beginning of 2008, I had my 
normal load of issues, which were discussed regularly with my 
peers, with my boss. Those included the first five items in my 
May 16th letter, which I will get to in a second. They also 
included issues in the second e-mail that was talked about 
earlier that I am sure we will talk about later.
    My own personal issues were not being addressed at all in 
the 6 months in 2008. Other issues were not being addressed. 
There was very little communication, between people senior to 
me and myself, giving me some kind of pacification as to why 
these issues weren't being resolved.
    So, on May 16th, which was 2 weeks before the end of the 
second quarter, I hand-delivered my letter to the four 
addressees. And I will give a quick timeline of what happened. 
May 16th was a Friday. On the Monday, I sat down with the chief 
risk officer and discussed the letter. On the Wednesday, I sat 
down with general counsel and the head of internal audit and 
discussed the letter. On the Thursday, I was on a conference 
call to Brazil; somebody came into my office, pulled me out, 
and fired me on the spot without any notification.
    I stayed another 2 weeks. I had other meetings with 
internal audit. I realized that nothing was being done about my 
letter. I was so mad that nothing was being done that I said, 
okay, I am going to write down some issues that were outside my 
domain. I drafted a second letter. I sent it to my attorney, 
who decided not to issue it. Instead, he wrote the meat of the 
letter in two paragraphs in an e-mail that was discussed 
    Sorry, I have gone over. I will keep going.
    The Repo 105 issue was included in there. I mentioned that 
was outside my domain. That e-mail was issued on June 10th. On 
June 12th, I met with Ernst & Young for the first time. In 
attendance also was the general counsel of Lehman Brothers and 
the head of internal audit. At one point, the general counsel 
and head of internal audit left. I was left alone with Ernst & 
Young, two partners.
    As I said, I started out life, I worked several years for 
Ernst & Young. I have a loyalty to them. I said, well, if 
Lehman Brothers is not going to address this--they had already 
dismissed my e-mail through my attorney--that they were having 
nothing to do with my issues and other people's issues. So I 
told the contents of that e-mail--I didn't have the e-mail with 
me--to Ernst & Young, which is where they learned about Repo 
105 and a couple of other issues. There was an audit committee 
the next day. I think we next--sorry, I am just ending now.
    The only other point of note is on page 960 of the 
examiner's report, there is a reference to a presentation to 
the audit committee about my May 16th letter, some of the 
points. It does not have any content of the e-mail in it. I was 
not asked to give any input to that presentation or to the 
audit committee.
    Sorry, I have overrun my time. I will accept any questions. 
Thank you.
    [The prepared statement of Mr. Lee can be found on page 175 
of the appendix.]
    Mr. Kanjorski. Thank you very much, Mr. Lee.
    I am going to take my 5 minutes to start with.
    I thought, when the first two witnesses started, it was 
going to be a boring session. Then, I heard the next two 
witnesses, and I wondered why we didn't provide baseball bats. 
There seems to be a material disagreement as to whether there 
is any responsibility at Lehman, or whether or not any rules or 
regulations were violated. Certainly, that is obviously the 
conclusions we draw from the latter two witnesses.
    Let me just simply try and classify your testimony, Mr. 
Fuld. As I heard you testify, you did nothing wrong, you 
performed to the standard one would expect from the chief 
executive officer, and the termination of Lehman Brothers was 
just something that happened. Is that a relatively correct 
summation of your testimony?
    Mr. Fuld. Mr. Chairman, I wish it were that easy.
    Mr. Kanjorski. I did not hear you take any responsibility.
    Mr. Fuld. I have testified before where, at that time, I 
said both in my written and oral testimony that I take full 
responsibility for the decisions that I made. And all I can say 
to you is that I made those decisions, I had the information at 
the time that I thought was accurate and, with that, made a 
prudent decision.
    Mr. Kanjorski. What caused the demise of Lehman Brothers?
    Mr. Fuld. A number of factors.
    Mr. Kanjorski. What are they?
    Mr. Fuld. A little bit of history. I am not going to go 
back for a whole 150 years, because that is not appropriate. 
Lehman started as a public company in 1994. We were 
predominantly a fixed-income house. We grew over time, added an 
equity capability, added a strong investment banking 
capability, built out Europe, built out Asia. We eventually 
built out to an organization that had 28,000 people, hundreds 
and hundreds of business lines and products, as I talked about, 
40 countries, five continents.
    Mr. Kanjorski. I am not sure I understand. You became too 
large? Is that the point you are making?
    Mr. Fuld. No. I think there were other organizations that 
were larger than ours.
    Mr. Kanjorski. I agree. But what happened? Can you 
succinctly tell us just why did Lehman Brothers fail?
    Mr. Fuld. There were a number of initiatives that we 
undertook as we grew. Please understand that the last 5 years 
of our operation were all record years. We had grown from an 
organization that went from net income of about $100 million to 
an organization that had $4 billion. We went from an 
organization that had equity of about a billion to about $28.5 
billion. We had been known for strong risk management. We had 
been known for, ``when in doubt, fall back and do the right 
thing.'' We had been known for strong culture.
    I am trying to put in place, though, the pieces of what 
were the bases upon which we made decisions. You are asking me 
specifically where did we go wrong.
    Mr. Kanjorski. Very simply, what caused your demise? I do 
not think it is hard--did you over-invest in risky obligations? 
Did you have a less than adequate staff hired and executive 
execution? There have to be some fundamental reasons. I can 
agree that you will not give us one cause. But do not give me 
an advertisement of 25 years or 20 years of the company.
    Mr. Fuld. Mr. Chairman, I didn't mean to do that. I was 
trying to lay a foundation, though, for the mentality of the 
place from which we were coming.
    Mr. Kanjorski. You heard the testimony earlier that you had 
reserve funds that were inadequate because they were pledged in 
two different categories.
    Mr. Fuld. That we had what? I am sorry.
    Mr. Kanjorski. You had capital reserve funds, but that 
they, in fact, had been pledged in different directions so they 
were not adequate and should not have been exposed on your 
balance sheet as reflecting the standard of equity that you 
had. Is that true or not true?
    Mr. Fuld. I am not sure of what you meant by that, but--
    Mr. Kanjorski. There was testimony earlier, I think by the 
examiner, that in one instance, you had $2 billion on the books 
and in another instance, you had $5 billion on the books, 
neither of which should have been on the books because they 
were encumbered in some other transaction.
    Mr. Fuld. You are talking about liquidity; I am sorry.
    Mr. Kanjorski. Yes.
    Mr. Fuld. We built a strong liquidity base from the mid-
20s, 30s, to the low 40s. We had a series of stress tests with 
the Fed. I went, personally, to all three of those. Not once 
did I hear any feedback that led me to believe that we were 
    Mr. Kanjorski. How about the day when they told you that 
you had to go down? Do you mean to say that nobody ever told 
you that you were insufficient or you did not realize you could 
not cover your obligations on that famous Sunday?
    Mr. Fuld. There was a facility in place where Lehman had 
access to the Federal Reserve borrowing window--
    Mr. Kanjorski. So you were looking for a bailout?
    Mr. Fuld. I did not say that.
    Mr. Kanjorski. No, well, let us say it. When you were 
looking at the Federal Reserve access to funds, if you cannot 
get that, what was your methodology to stay in business and 
where were you going to get the sufficient collateral to do so?
    Mr. Fuld. My meaning for saying that was that facility had 
been in place. We had never needed it. We had not used it. We 
financed ourselves that Friday night. When the Fed opened the 
window for all the investment banks for additional collateral, 
we all turned to each other and said, ``We are fine. We will 
get through this.'' We then learned that window was denied to 
    Mr. Kanjorski. Yes, that was not quite correct, was it, 
because obviously you went down?
    Mr. Fuld. The window was closed to us that night.
    Mr. Kanjorski. Let me ask the question: Did you falsely go 
down? Were you able to survive, and the Federal Government 
forced you to go into bankruptcy in some way? Then, we have a 
whole different--
    Mr. Fuld. I can just tell you the facts. The facts are 
    Mr. Kanjorski. My time has expired, so I am going to pass 
along to my friend from Alabama. But--
    Mr. Bachus. Let me ask unanimous consent--
    Mr. Fuld. You hit on a good question. I would love to--
    Mr. Kanjorski. Unfortunately, we do not have all afternoon 
for an answer. I was hoping we would get a simple response.
    The gentleman from Alabama?
    Mr. Bachus. Before my time starts, if you will, could we 
have an additional 3 minutes on our side too?
    The Chairman. To make up for that, I would certainly have 
no objection.
    Mr. Bachus. I will divide it as a minute between the three 
gentleman who are here presently on this side. Thank you. Thank 
you, Mr. Chairman.
    My first question, Professor Black, both Secretary Geithner 
and Chairman Bernanke, in answer to my question about the 
failure of the Federal Reserve and Federal Reserve New York to 
require Lehman to correct its material misrepresentations on 
the grounds that they said they didn't because they weren't 
Lehman's primary regulator, do you find that explanation 
    Mr. Black. No. I think I have it word for word that 
Secretary Geithner said that this pushed the financial system 
to the brink of collapse. I don't follow business as normal 
when I was a regulator when that happens.
    Mr. Bachus. Right.
    Mr. Black. I insist that the problem be fixed. And the Fed 
had astonishingly large leverage, all the leverage that it 
needed, if it had exerted it. And, of course, Chairman Bernanke 
was the one who should have been excerpting it.
    Mr. Bachus. Right. And they ignored what the examiner has I 
think correctly said, material misrepresentations on the 
grounds that they weren't acting in a regulatory capacity.
    Is it ever appropriate for a government regulator to look 
the other way because he is not the regulator?
    Mr. Black. It is worse than that. We have a duty as 
regulators--we swear an oath to protect. We have a duty to make 
a referral to the Securities and Exchange Commission when we 
find any evidence of securities fraud. We always did that as 
regulators. And we have a duty to make criminal referrals. I 
didn't hear anything about criminal referrals, except from the 
bankruptcy examiner.
    Mr. Bachus. Right. They were also a creditor and a 
counterparty, and they are obviously an agency of the U.S. 
Government and the taxpayers.
    Mr. Black. That makes it even more bizarre. As I said, we 
had a staff at the Federal Home Loan Bank of San Francisco, a 
far smaller place, of 50 going through the credit files. If we 
were going to take exposure to something like Lehman, which was 
vastly more complicated and had far more problems, we would 
have had a staff--the equivalent staff would be sending 300 
people from the Federal Reserve Bank of New York. Instead, they 
did a pittance.
    Nothing squares. You can't believe that the whole global 
system is about to come down and then say, ``Well, sorry, we 
can't do anything, and we won't try.''
    Mr. Bachus. Right. Also, the bankruptcy examiner described 
Secretary Geithner's fear that if Lehman had tried to reduce 
its leverage by selling assets, the markets would have 
discovered air in the marks in those assets. In other words, 
the markets would have discovered they were grossly overvalued.
    What do you make of Secretary Geithner's comments about the 
air in the marks of Lehman assets and the fact they didn't 
disclose that to the investing public?
    Mr. Black. Well, he was asked about it twice that I recall, 
and he didn't answer either time.
    Mr. Bachus. Right. I asked him once.
    Mr. Black. Yes, but another Member brought it up. He didn't 
respond either time.
    It is, of course, the most obvious reason why the Fed 
wouldn't require honesty in accounting. Because honesty in 
accounting would have shown that the problem was not liquidity 
at Lehman. That was a symptom of the underlying problem that it 
was massively insolvent, which is, of course, what the 
bankruptcy examiner commented to someone when he said that the 
liabilities are grossly in excess. And those are Secretary 
Geithner's own words. That is not any of us creating a 
    Mr. Bachus. Thank you.
    Mr. Fuld, did you ever, in 2008, mention oversight by the 
SEC or the Fed in an effort to convey the impression that 
Lehman was sound or in good financial shape?
    Mr. Fuld. Did I ever mention it?
    Mr. Bachus. Yes, as a reason why people should consider 
Lehman as financially sound.
    Mr. Fuld. I don't recall that I did.
    Mr. Bachus. Okay. What about Andrew Sorkin in his book, 
``Too Big To Fail,'' where he quotes you as telling Jim Cramer, 
``I am on the Board of the Federal Reserve of New York. Why 
would I be lying to you? They see everything.'' And you were 
explaining to him that you all were sound by saying the Fed and 
the New York Fed and the SEC are in there every day, they are 
watching everything we are doing, and we are financially sound. 
What did you mean by the statement, ``They see everything?''
    Mr. Fuld. I don't recall that comment specifically. But, in 
all fairness, the Fed and the SEC were on premises, they saw 
our liquidity, they saw our capital positions, they saw our 
mark-to-market processes. And I believe they saw everything 
that we were doing real-time.
    Mr. Bachus. Yes. And I could agree that would convey a 
sense of confidence by them at least that you were doing things 
    Did they ever question what you were doing? Did the SEC or 
the Fed ask you to do something different? Did they ever ask 
you to change something you were doing for safety and soundness 
    Mr. Fuld. Not that I am aware of. But I do recall 
conversations, less so with the SEC, more so with President 
Geithner, where we talked about potential capital providers and 
potential structures. I believe I discussed with him the vast 
number of people with whom we had conversations about 
additional capital, potential investors, about a structure for 
commercial real estate. And I actually thought those 
conversations were strong and productive.
    Mr. Bachus. Did they lead you to believe that they might 
interject capital into Lehman or bail you out as they had done 
Bear Stearns?
    Mr. Fuld. No.
    Mr. Bachus. All right.
    My final question is this. You said you were on the board 
of directors of the New York Fed. If you said that to Mr. 
Cramer, what would--and you don't recall that conversation at 
all, is that what you are saying?
    Mr. Fuld. I do recall having lunch with him, but 
specifically that comment, no.
    Mr. Bachus. All right. If you said that, what would you be 
trying to convey, that you were on the board of directors of 
the New York Fed?
    Mr. Fuld. As I think about it now, my conversation--I don't 
know. In all fairness, you have asked me a question, so I will 
try to answer that. If they had something to say, they would 
have said it to me.
    Mr. Bachus. Who is ``they?''
    Mr. Fuld. If the Fed had something to say to me regarding 
our position or condition that needed to be corrected, 
modified, or changed, I had enough conversations with Fed 
officials that they would have said it to me. And that is why, 
at the third quarter, in my announcement, I actually said, I 
believe these last two quarters are behind us.
    Mr. Bachus. Okay, that is fair enough. Thank you.
    Mr. Miller of North Carolina. [presiding] The gentleman's 
time has expired.
    The Chair recognizes Chairman Frank for 5 minutes.
    The Chairman. Thank you.
    I wanted to pick up on something Mr. Black said as I was 
coming in. I apologize for the fact that I had to be elsewhere. 
And it was a very important point referencing the fact that in 
1994, this Congress passed the Homeowners' Equity Protection 
Act. It was actually largely led by my predecessor as the 
senior Democrat, John LaFalce, who was not the chairman at the 
time. Chairman Gonzalez was the chairman; the Democrats were in 
the majority.
    But that bill was passed in 1994, and it was then 
explicitly ignored by Mr. Greenspan. And that is really very 
important, because there has been a lot of discussion about 
what happened and why we had the subprime mortgages.
    And, as Mr. Black also noted, the Federal Reserve 14 years 
later used that authority. And that is important to note, 
because the authority that Mr. Bernanke used to regulate 
subprime mortgages was exactly the authority that Mr. Greenspan 
had had, it ought to be clear. Some have said, ``Well, the 
authority was deficient.'' But what Mr. Bernanke invoked in 
2008 was exactly the same statutory authority that Mr. 
Greenspan refused to use.
    And that is important because there has been this debate. 
And some have argued--and I think this is an important one--
that the Federal Reserve is responsible for the housing bubble 
because it failed to deflate the entire economy, or that it 
allowed interest rates to be set by other considerations. 
Frankly, I was supportive of those decisions. I think to have, 
in effect, added to unemployment to deal with the housing 
bubble would have been excess.
    The Fed had an alternative, and I appreciate Mr. Black 
making it clear. There was a way to deal with the subprime 
problem under Federal Reserve authority other than deflating 
the whole economy or restraining growth, to be more neutral, in 
the whole economy. It was to use the specific authority that 
was given by the Congress in 1994 to Mr. Greenspan. And there 
were efforts to get it used.
    My colleagues, the gentleman from North Carolina, Mr. 
Miller, who is now presiding, the gentleman from North 
Carolina, Mr. Watt, working with the Center for Responsible 
Lending and others in North Carolina who identified this 
early--first we tried to get Mr. Greenspan to use that 
authority. When he refused to do it, there was an effort in the 
Congress specifically to mandate what didn't happen. We were 
frustrated. It became an ideological dispute. We were then in 
the minority.
    In 2007, when Congress again changed hands, we did pass 
such a bill in the fall of 2007 to mandate what the Fed had 
been permitted to do but didn't do. The bill did not pass the 
    There is a phrase on the recorder's word processor that 
says, ``The bill did not pass the Senate.'' He only has to hit 
one key to get that printed. It saves a lot of time.
    But the Federal Reserve, to its credit, then acted. Now, I 
say that in part to note--and this becomes relevant--when we 
deal with the consumer agency, people have pointed to actions 
taken by the Federal Reserve under Mr. Bernanke, and that is 
accurate. But in every single case, action by the Federal 
Reserve came after this committee had initiated some action, or 
the whole House. But I did want to just thank Mr. Black for 
that point.
    Let me now--just one question to Mr. Lee. When you raised 
these issues, what was the general response you got?
    Mr. Lee. From within Lehman, annoyance. From Ernst & Young, 
they knew it. They knew the points.
    The Chairman. They knew it, but were they supportive? Did 
they say, ``Oh, yes, but that is okay?'' Did they defend it? 
What did Ernst & Young say?
    Mr. Lee. They certainly didn't support it. On the Repo 105 
issue, they knew about it. They did not appear to know the 
number was so large. It had risen from 25 sometime in 2007 to 
over 30 by November 30, 2007, to 49 at the end of the first 
    The Chairman. Let me ask you, to the extent there was any 
ambiguity, do you think the FASB's subsequent revisions have 
improved the situation?
    Mr. Lee. I can't really comment on that. FAS 140 needs to 
be killed, if it is not already.
    The Chairman. They have replaced it. All right, I 
appreciate it. I guess there is a certain historical sense of 
justice in that Lehman Brothers went to the United Kingdom to 
get their opinion, and so the United Kingdom sent you back to 
get even. So I think that at least you have sort of made us a 
little bit more whole vis-a-vis the United Kingdom in this.
    Thank you, Mr. Chairman.
    Mr. Miller of North Carolina. Thank you.
    The Chair recognizes the gentleman from California, Mr. 
    Mr. Royce. I am going to defer to the gentleman from Texas, 
Mr. Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman.
    Mr. Fuld, I assume you were here for Mr. Valukas' testimony 
earlier. Yes or no?
    Mr. Fuld. I did hear a good piece of it, yes, sir.
    Mr. Hensarling. On page 3 of his testimony, he represents 
that Lehman represented to the SEC in writing that its firm-
wide risk appetite limit was a ``binding constraint'' on its 
risk-taking that ``could not be exceeded under any 
circumstances,'' but management did not observe the limits.
    Do you agree or disagree with that assertion?
    Mr. Fuld. We set up risk appetite with a lower-level hurdle 
of 8 to 10 percent. That was the level below which we were not 
allowed to go, as an internal standard.
    Mr. Hensarling. But what did you represent to the SEC?
    Mr. Fuld. What we represented to the SEC was that, given 
our--actually, the same thing. But given our level of 
revenues--let me explain first what risk appetite was, if I 
may, just to put it in context. I don't mean to be too 
technical, but it is important that you understand it.
    Risk appetite was the amount that the firm could lose in a 
year and still pay all of its expenses and create an after-tax 
ROE of 8 to 10 percent. Now--
    Mr. Hensarling. Mr. Fuld, I understand that. Here is the 
bottom line, and my time is limited. Mr. Valukas says that 
Lehman made a representation to the SEC that they were binding 
limits, but yet the limits were breached. So do you agree or 
disagree with that assertion?
    Mr. Fuld. The binding limit was at 8 to 10 percent. Our 
risk appetite was set at $4 billion. It changed, in all 
fairness, between $3.6 billion, $4 billion, $4.2 billion. Had 
we, in fact, lost $4 billion, that would have triggered a 12 to 
12.5 percent ROE. So the risk appetite was set with a huge 
    Mr. Hensarling. I understand that. It is just a simple 
question. Do you agree or disagree with the assertion?
    Mr. Fuld. The assertion was that at 8 to 10 percent, we 
were not supposed to go below that internal standard.
    Mr. Hensarling. On page 4 of Mr. Valukas's testimony, he 
states that Lehman had in place a stress-testing program 
designed to assess whether Lehman could survive a series of 
both hypothetical and historical stress scenarios, but Lehman 
did not include many of its riskiest assets in its stress 
testing, such as commercial real estate.
    Again, a simple question: Do you agree or disagree with 
that assertion?
    Mr. Fuld. That was the case until, I believe, towards the 
end of 2007. The day-to-day marking of commercial real estate 
was an impractical exercise. But then again, that was--the risk 
committee and the executive committee said, regardless of that 
we will include commercial real estate because it is becoming 
more an important part of our portfolio.
    Mr. Hensarling. So, at some point it was included. Is that 
what you are saying, Mr. Fuld?
    Mr. Fuld. I am sorry, I didn't hear--
    Mr. Hensarling. At some point, you are saying the 
commercial real estate was added to the stress test? Is that 
what I am understanding from you?
    Mr. Fuld. Yes, sir, it was. Yes, sir.
    Mr. Hensarling. Okay.
    Let's talk about the Repo 105 transactions. Mr. Bart McDade 
is the former president and COO of Lehman; is that correct?
    Mr. Fuld. Yes, sir.
    Mr. Hensarling. So he would have answered to you. I assume 
you were there contemporaneously, served at the same time; is 
that correct?
    Mr. Fuld. Yes.
    Mr. Hensarling. Okay. Are you familiar with the e-mail 
exchange between himself and a Mr. Lee, not the Mr. Lee at the 
panel--it is exhibit 7, if we could get if it up on the chart--
where we had Mr. Lee asking Bart, ``I am sure if you are 
familiar with Repo 105, but it is used to reduce net balance 
sheet in our government's business around the world.'' The 
answer from former president and COO: ``I am very aware it is 
another drug we are on.''
    Are you familiar with this e-mail exchange, Mr. Fuld?
    Mr. Fuld. Yes, sir, I am.
    Mr. Hensarling. Do you have an opinion on what your former 
president and COO meant by, ``it is another drug we are on?''
    Mr. Fuld. No, I do not. As I said before, I clearly was not 
aware of Repo 105.
    Mr. Hensarling. How about Mr. Michael McGarvey? I am led to 
believe he was a senior member of Lehman's finance group. Are 
you familiar with Mr. Michael McGarvey?
    Mr. Fuld. Michael McGarvey?
    Mr. Hensarling. You are unfamiliar with this gentleman? He 
had an e-mail exchange with another Lehman employee, ``So what 
is up with Repo 105?'' Answer from Mr. McGarvey, ``It is 
basically window dressing. We are calling Repos true sales 
based on legal technicalities.''
    I was informed that Mr. McGarvey was a senior member of the 
finance group. You are unaware of his existence? You are not 
familiar with the gentleman of this particular exchange?
    Mr. Fuld. I am not.
    Mr. Hensarling. I see my time has expired.
    Mr. Miller of North Carolina. Thank you.
    The Chair recognizes Mr. Moore for 5 minutes.
    Mr. Moore of Kansas. Thank you, Mr. Chairman.
    Mr. Fuld, in your written testimony dated April 20, 2010, 
you say, ``Let me start by saying,'' and this is a quote, ``I 
have absolutely no recollection whatsoever of hearing anything 
about Repo 105 transactions while I was CEO of Lehman.''
    Is that correct, sir?
    Mr. Fuld. Yes, sir.
    Mr. Moore of Kansas. Were your employees hiding this from 
    Mr. Fuld. No, they were not.
    Mr. Moore of Kansas. Then why would you not know about 
this? Did they not know about it?
    Mr. Fuld. It was nothing about hiding. These transactions 
were sale transactions of government securities that occurred 
on the government trading desk--let me try to put this in some 
context, if I can, for you.
    Mr. Moore of Kansas. Well, please do.
    Mr. Fuld. On any given day, Lehman moved through its system 
over a trillion dollars. On any given day, Lehman traded 
between $50 billion and $100 billion of governments. We were 
probably one of the largest government dealers in the world. 
That is $50 billion to $100 billion a day. There is no reason 
why I would have known about a sale of governments, there is no 
reason why I would have known about these Repo 105 
transactions, because there was inherently nothing wrong with 
    As CEO, I ran more of a ``what do I really need to be 
focused on'' mentality. I was focused on less liquid assets, 
commercial real estate, residential mortgages, leveraged loans. 
I was not focused on the most highly liquid securities, I was 
not focused on government securities day to day that could vary 
between, as I say, $50 billion and $100 billion a day.
    My focus was more about, what could impact our capital? 
Governments very rarely, if ever, impacted our capital. Less 
liquid assets, they impacted our capital position. Over the 2 
years of 2007 and 2008, Lehman wrote down close to $25 billion 
that were essentially tied to our less liquid asset position. 
That was my focus.
    Mr. Moore of Kansas. Let me stop you there, sir. You say 
your focus was on what impacted our capital, correct?
    Mr. Fuld. Yes, sir.
    Mr. Moore of Kansas. Was the fact that your firm was 
offloading $50 billion worth of assets at the end of each 
quarter to cover up how overleveraged its balance sheet had 
become, was that not important to you at all?
    Mr. Fuld. These government securities were sold. They were 
gone. On any given day, another 50 could be sold.
    Mr. Moore of Kansas. I know $50 billion might not seem a 
lot to Wall Street, but shouldn't a CEO be aware of 
transactions involving that kind of money, sir?
    Mr. Fuld. Whether it is Wall Street or anywhere, $50 
billion is a lot. It is always a lot. And I do not want to 
leave the impression that $50 billion, regardless of any 
industry, is an insignificant number.
    But I must say to you that, with the focus of less liquid 
assets, whether our balance sheet, which is an indication of 
one point in time, was up or down $50 billion or $100 billion 
of governments, I will say to you, sir, that was not my focus.
    Mr. Moore of Kansas. In view of what has happened, should 
it have been your focus?
    Mr. Fuld. I wasn't involved in those transactions or the 
    Mr. Moore of Kansas. You are the CEO, aren't you, sir--
weren't you?
    Mr. Fuld. I was very much the CEO, sir.
    Mr. Moore of Kansas. Okay. Shouldn't you have been focused 
on some of that, then, in what you know now?
    Mr. Fuld. In what I know now, we had a thorough process 
around us, our auditors approved it, legal counsel signed off 
on disclosure. And, as I have come to understand this, there 
was nothing wrong with the Repo 105 transaction.
    Mr. Moore of Kansas. And looking back now, your testimony 
is there was nothing wrong with what happened at Lehman 
    Mr. Fuld. That is a different question.
    Mr. Moore of Kansas. Answer that question for me, if you 
would, sir.
    Mr. Fuld. Which goes back to the earlier question of, what 
did we do wrong?
    What we did wrong is I believe that we did not understand 
the contagion of one security, one asset class to the next. I 
believe that we did not--and I take responsibility for this--I 
did not see the depth and violence of this crisis. I believe 
early on we had too much commercial real estate. I believe we 
corrected that; we went from $50-some-odd billion down to $32 
billion. We corrected our residential positions; we went from 
30-some-odd down to 17. We corrected our leverage loan 
positions; went from 45 in mid-2007 down to less than 10. We 
raised capital and--
    Mr. Moore of Kansas. Let me stop you, sir. I am about out 
of time here. Mistakes were made, correct?
    Mr. Fuld. I would say that bad judgments were made 
regarding the market, yes.
    Mr. Moore of Kansas. And I hope that other CEOs of other 
companies can learn from the mistakes that Lehman Brothers and 
you made, sir. Would that be a worthwhile goal here?
    Mr. Fuld. Yes, sir, it would.
    Mr. Moore of Kansas. Thank you.
    I yield back my time.
    Mr. Miller of North Carolina. Thank you, Mr. Moore.
    Mr. Royce of California for 5 minutes.
    Mr. Royce. Thank you, Chairman.
    I want to return to an argument made earlier by the 
chairman of the committee that the policies at the Fed on 
inflation could have been offset by the regulatory oversight, 
proper regulatory oversight. And perhaps that is true, but it 
was Chairman Bernanke who argued for setting the Fed funds rate 
in 2002, June of 2002, at a negative level, below inflation. 
Fed fund rates for 4 years running was negative.
    And the argument that Congress was making at the time to 
put everybody in a home, regardless of whether they had means 
for a downpayment, we were allowing over at Fannie and Freddie 
the types of overleveraging that also introduced that on top of 
the bubble.
    So, for the record, I would make the observation that 
running negative interest rates for 4 years running doesn't 
help unemployment. In fact, it guarantees that when the bubble 
bursts, there is going to be much higher unemployment because 
you have made money so cheap that basically you have 
misallocated capital. You have sent to the market the wrong 
signals, and you have misallocated capital.
    And I think it is important, at some point, that be 
understood as one of the contributors to this besides the kinds 
of malfeasance--in addition to the malfeasance that we are 
talking about that occurred in the boardrooms.
    And, as for the boardrooms, I want to go into a couple of 
questions here. Given this ongoing presence--I will ask Mr. 
Fuld--of the Fed and the SEC mentioned in your testimony, and 
the fact that your much smaller competitor, Bear Stearns, which 
was far less interconnected, received government assistance 
just months, by the way, prior to your situation, were you 
working under the assumption that Lehman would be bailed out?
    Mr. Fuld. No, sir, I was not.
    Mr. Royce. You were not? Or a similar arrangement, perhaps, 
as to what happened with Bear Stearns, the diamond deal? You 
weren't working under the assumption that might happen in your 
situation, as well?
    Mr. Fuld. No, sir, I was not.
    Mr. Royce. So, in your view, these bailouts do not create a 
moral hazard that, at least in your instance, created the 
anticipation that you might get the same workout as other 
    Mr. Fuld. I--
    Mr. Royce. Okay. With respect to the firms you did business 
with, your creditors and your counterparties, do you believe 
that there was the presumption that Lehman should be treated as 
just another counterparty, or do you think they assumed that, 
like Bear Stearns, there might be the government behind it?
    Mr. Fuld. You have touched on a very interesting piece 
which I would like to talk about.
    There were two claims at the end of--or September 15th 
after Lehman. One was that there was a huge capital hole. Some 
said $30 billion; some said some other numbers. One thing that 
the examiner's report pointed out was that, as you went through 
the different asset classes, there were some pluses and 
minuses, some reasonableness, some unreasonableness, but at the 
end of the day, it was somewhere between an immaterial 
difference of $500 million and, let's say, $1.7 billion, 
rounded off to $2 billion. That would have lowered our equity 
from 28.5 to, let's say, 26, positive.
    The world believed that we had a capital hole. So for those 
who thought it was 30--
    Mr. Royce. Well--
    Mr. Fuld. This is important, though, sir--
    Mr. Royce. It is important, and we have your answer for the 
record. From my standpoint, what I think the world believes is 
that once we have done bailouts, we are going to do future 
bailouts. I voted against the bailouts. I thought it was a very 
bad precedent.
    But I will just go back to, Hayek won the Nobel Prize in 
1974 by explaining exactly how government intervention in these 
cases helps cause this boom-bust cycle in the economy. And I 
can't for the life of me see why people can't understand why 
running interest rates that are negative for 4 years in a row 
and then failing to control the overleveraging, and then 
Congress' culpability in terms of going in and allowing further 
leveraging, wouldn't have this impact.
    And I don't want to see those who are CEOs have the ability 
in the future to get a bailout at the expense of the taxpayers. 
And this underlying legislation is the wrong approach to 
prevent it.
    Thank you. I yield back.
    Mr. Miller of North Carolina. Thank you.
    The Chair now recognizes himself for 5 minutes.
    I want to pursue the line that Mr. Royce just raised about 
the role of Fannie and Freddie. I understand that you were 
direct competitors with Fannie and Freddie. You did the same 
thing they did. You bought mortgages, you created pools, you 
sold securities based upon those.
    Only, unlike Freddie and Fannie, you did not have a dual 
mission. Your only mission was making money, not making money 
and supporting affordable housing. Isn't that right? You were 
just about making money; there was no affordable housing goal 
for Lehman Brothers. The Treasury or HUD wasn't setting 
affordable housing goals for you, right? You were just under a 
requirement to your shareholders to make money, to make 
profits. Isn't that right?
    Mr. Fuld. I believe all of us had a clear-minded view that 
the Administration wanted everybody in the industry to extend 
themselves to fulfill the American dream.
    Mr. Miller of North Carolina. But you were also making a 
very tidy profit from securitizing mortgages, isn't that right? 
You spoke earlier, in response to Mr. Kanjorski's questions, 
about how much you grew largely as a result of your 
participation in the residential mortgage real estate market. 
Isn't that correct?
    Mr. Fuld. We did in the early years. The latter years, we 
did not.
    Mr. Miller of North Carolina. Okay. Did Freddie and Fannie 
have anything to do with Lehman's failure or with your buying 
subprime mortgages and selling securities based upon them, or 
Alt-A, what Mr. Black called liar's loans, and selling 
securities based upon them? It didn't have anything to do with 
Fannie and Freddie, did it?
    Mr. Fuld. Not the way you are asking that question. But the 
events of the weekend before did impact us, yes, sir. Different 
question, but--
    Mr. Miller of North Carolina. Your business over the course 
of the last decade, your participation in the subprime market, 
your participation in the Alt-A market, at the liar's loan 
market, didn't have anything to do with Fannie and Freddie, did 
it? You were competitors with them, were you not?
    Mr. Fuld. Sometimes, we were competitors, and sometimes, we 
sold into their conduit. So we were both a client and a 
    Mr. Miller of North Carolina. All right.
    Now, Mr. Fuld, you just said in response to Mr. Royce's 
questions that you never expected a bailout. That is different 
from other accounts--Andrew R. Sorkin's account, Secretary 
Paulson's account. They have both written books so far. All of 
the published accounts say that you assumed until the very end, 
until that weekend, that, in fact, you would be rescued.
    And Mr. Valukas, what he said earlier about the kind of 
things that could have been done earlier that would have made 
the collapse a little less catastrophic for the entire economy 
were, in fact, passed on. There was an opportunity to sell 
Lehman, all or part of Lehman, to a Korean firm, the Korean 
Development Bank, to sell half of it to a Chinese bank, Citic. 
There were apparently discussions about selling your assets 
management unit that never happened; selling your headquarters 
that never happened.
    Mr. Fuld and also Mr. Cruikshank, as a member of the board, 
what do we have to do to impress upon CEOs and boards of 
directors that they will be allowed to fail and they will not 
be rescued?
    Mr. Fuld. Let me go first, if I may, because you mentioned 
me first.
    We got to that fateful weekend. Looking at the asset 
valuations, we had strong capital. We had lost $30 billion of 
liquidity in 2 days. There was another claim we had no 
collateral. We had plenty of collateral, as evidenced by the 
fact that on that Monday we put up $50 billion of collateral to 
get a loan from the New York Federal Reserve Bank--all of 
which, by the way, was paid back 100 percent.
    So we had collateral, we had capital. We did not need a 
capital bailout; we needed a liquidity bridge so that we could 
consummate the sale to a potential buyer. That is what we 
needed. Or we needed the window to be extended to us as it was 
extended to the other investment banks and banks that Sunday 
    To be even more clear, when we heard that the bank was 
being opened, that the Federal Reserve window was being opened 
that Sunday night, we all said, ``We are fine. We are going to 
get this done.'' We then heard it was not being opened to us, 
    Mr. Miller of North Carolina. But, Mr. Fuld, that really 
isn't at all responsive to my question.
    Mr. Fuld. Then I apologize. I must have missed that then.
    Mr. Miller of North Carolina. Mr. Cruikshank, what can we 
do to convey to boards of directors and CEOs that they are 
going to be allowed to fail, that there is no safety net? That 
if they become insolvent, they will be taken into a 
receivership, that CEOs will lose their jobs, top management 
will lose their jobs, boards of directors will lose their jobs, 
shareholders will lose everything, creditors will not get paid, 
and taxpayers are not going to be on the hook? What do we need 
to do to convince you that is what the future holds?
    Mr. Cruikshank. Frankly, Mr. Chairman, I was convinced at 
the time that there would not be a bailout. And don't 
misinterpret my statement, because what I was saying was that I 
think we could have avoided a lot of disruption by putting into 
place now what they say they don't have. I wondered if some of 
these actions that they took with others would have gotten us 
to a much softer landing. I am not talking about a bailout. I 
thought right up to the end that, after the flak that had been 
received by the Fed and the Treasury after Bear Stearns, that 
it would be highly unlikely they would want to do that again.
    Mr. Miller of North Carolina. The Chair recognizes Mr. 
    Mr. Lance. Thank you, Mr. Chairman.
    And good afternoon to you, gentlemen.
    Mr. Cruikshank, to follow up, in your remarks, do you 
believe there were corporate governance failures at Lehman?
    Mr. Cruikshank. No, I don't. I think our governance 
procedures were really very good.
    I have stated in my statement that I believe the major 
problems with Lehman were just what I said. Basically, if you 
will remember, in 2006, we had had years of very profitable 
real estate operations in this country. Real estate was thought 
to be pretty much gilt-edged.
    Then the market was going up, we had had record earnings, 
we were getting bigger, and the business decision was made to 
expand our proprietary investments. And part of that was going 
into real estate. I think it ended up that real estate was one 
of our major problems, obviously.
    The other thing was that an investment bank cannot continue 
to exist once confidence is lost and there is a run on the 
bank. You can hardly have enough capital for that. And that 
occurred for a lot of reasons, some of which I have also 
outlined in that statement.
    Mr. Lance. But it is your opinion that you did not think 
you would be bailed out simply because there had been a bailout 
earlier in the year regarding another entity?
    Mr. Cruikshank. I would certainly not have counted on that.
    Mr. Lance. Thank you.
    Mr. Lee, in your opinion, were the executives at Lehman 
Brothers hiding the true nature of the firm's global balance 
sheet from either the SEC or the Federal Reserve or both?
    Mr. Lee. I think on the basis of disclosure, the answer is 
    Mr. Lance. And could you elaborate on that?
    Mr. Lee. I am not an accounting financial disclosure 
expert, but based on the knowledge I have gained over the 
years, I think that the public was misled as to the true 
leverage of Lehman Brothers, at least during fiscal 2008.
    Mr. Lance. Thank you, Mr. Lee.
    And, Professor Black, both Secretary Geithner and Chairman 
Bernanke have excused the failure of the Fed and of the Federal 
Reserve Bank in New York to require Lehman to correct its 
material misstatements on the grounds that they were not 
Lehman's regulators.
    Do you find that explanation convincing? And is it ever 
appropriate for a governmental regulator to ignore wrongdoing 
on the grounds that it is not acting in a regulatory capacity?
    Mr. Black. It is never correct. You have a responsibility. 
And if the Fed does not have rules mandating that its employees 
make referrals to the SEC and to the Justice Department, they 
should change that today. There is still a little bit of time 
to do that.
    But I believe that you will find that they have guidelines 
in place that require those kinds of referrals. And, 
unfortunately, it was hit with complete indifference. This is 
the quotation from the report from the Federal Reserve Bank of 
New York official: ``How Lehman reports its liquidity is 
between Lehman, the SEC, and the world. We have no 
responsibility to deal with a violation of law that we found.''
    Mr. Lance. Thank you, Professor.
    And finally, Mr. Fuld, you indicate in your testimony that, 
beginning in March of 2008, the SEC and the Fed conducted 
regular, indeed daily, oversight of Lehman. You have answered 
questions from other members of the committee regarding this, 
but do you think that management at Lehman was given a false 
sense of security that the government might ultimately bail you 
    Mr. Fuld. I don't believe that to be the case.
    Mr. Lance. Thank you.
    Thank you, Mr. Chairman. I yield back the balance of my 
    Mr. Miller of North Carolina. Thank you.
    The Chair recognizes Mr. Green of Texas for 5 minutes.
    Mr. Green. Thank you, Mr. Chairman.
    I do believe that fraud is important, because I think the 
American public would like to know if fraud was committed.
    And, Mr. Black, you have indicated that you think fraud was 
committed. Is this with reference to the Repo 105?
    Mr. Black. That is one of--
    Mr. Green. That is the one I would like to focus on.
    Mr. Black. Certainly.
    Mr. Green. Explain to us how you contend that fraud was 
committed with the Repo 105.
    Mr. Black. Because the Valukas examination report shows--
and several of the things were quoted in this hearing--that the 
purpose of the transactions was to produce an artificially 
deflated idea of the exposure, the leverage of the corporation. 
That is important, that is material, to securities investors. 
So, if you deliberately create a deceptive representation that 
is material to investors, that is securities fraud. That is 
actually a felony.
    Mr. Green. And are you of the opinion that this was 
committed at Lehman with the 105s?
    Mr. Black. Repeatedly.
    Mr. Green. I will come back to you if time permits. I will 
go to Mr. Lee.
    Mr. Lee, you indicated that you delivered a message, hand-
carried a codified message. You didn't say exactly what it was. 
Are you indicating to us that you were trying to tell the 
auditors that something improprietous was taking place?
    Mr. Lee. Sir, I delivered my May 16th letter by hand. The 
auditors I never gave anything to. I verbalized what was in an 
e-mail. And, as I said--
    Mr. Green. Let's talk just for a moment about the content. 
Were you trying to indicate that something improprietous was 
taking place?
    Mr. Lee. In my mind, yes.
    Mr. Green. And were you trying to indicate that this act 
could be harmful to investors?
    Mr. Lee. That was underlying it, yes.
    Mr. Green. Did you ever have an opportunity to communicate 
    Mr. Lee. What does ``this'' mean?
    Mr. Green. The fact that there was something improprietous 
taking place that may be harmful to investors with reference to 
Repo 105s?
    Mr. Lee. All my knowledge of Repo 105 was well-known in the 
firm. The other factors were well-known in the firm. I only--
    Mr. Green. Excuse me. I would like to know how they became 
well-known. Did you tell some specific person or did you give 
it to someone in writing that these Repo 105s were in some way 
improprietous and may harm, at some point, investors?
    Mr. Lee. At only one stage, did I put it in writing. But 
for months, years, it was--
    Mr. Green. Is your answer yes, that you did convey this?
    Mr. Lee. Yes, I did.
    Mr. Green. And did you convey this to the audit committee?
    Mr. Lee. I have never attended any audit committee.
    Mr. Green. Did you convey it to an auditor?
    Mr. Lee. I did, to two auditors.
    Mr. Green. To two auditors?
    Mr. Lee. Yes.
    Mr. Green. Did you receive a response with reference to 
what you conveyed?
    Mr. Lee. No, I did not.
    Mr. Green. There was simply nothing said to you after you 
passed this on?
    Mr. Lee. There was just acknowledgement that they knew 
about the issue. As I said earlier, they didn't know the 
amount, I don't think.
    Mr. Green. Now, you have heard Mr. Black. He has used the 
term ``fraud.'' Are you of the opinion that there was fraud?
    Mr. Lee. I am not a lawyer. I can't comment.
    Mr. Green. I will accept your answer.
    Mr. Black, I do have enough time to come back to you. In 
your opinion, based on what you have said, it seems that you 
think that there was not only fraud in a civil sense but also 
fraud in a penal sense. Is this a correct statement?
    Mr. Black. Yes. The elements are the same; there is simply 
a higher burden of proof of establishing those elements. So, if 
there is civil fraud, there is, in fact, criminal fraud, as 
    Mr. Green. Have you conveyed what you are sharing with us 
and perhaps other information to some authority that has the 
authority to investigate fraud?
    Mr. Black. If you are familiar with my writings, I do this 
on a weekly basis.
    Mr. Green. I would like it for the record. We have a record 
that we are trying to establish.
    Mr. Black. Right. It is in my prepared testimony.
    Mr. Green. Is your answer yes?
    Mr. Black. Yes.
    Mr. Green. And have you received a response with reference 
to what you called to the attention of these authorities?
    Mr. Black. The SEC has never contacted me about any of the 
things I have attempted to alert the SEC about.
    Mr. Green. My final question to you will be simply this: 
Name the authorities that you took evidence of fraud to.
    Mr. Black. No, I took them public. I didn't take them 
simply in some secret letter to them. I wrote saying, the 
following things are frauds and need to be prosecuted.
    Mr. Green. If you just write and publish it in the 
newspaper, how are you to assume that the proper authorities 
will know? I am sure that everybody reads your writing, but 
maybe someone might miss it who is in a position to do 
    Mr. Black. The SEC is, I can guarantee you, aware of the 
fact that I have been writing these things. And, this is 
something I have been doing for several decades.
    Mr. Green. I will have to relinquish my time now. Thank 
you, Mr. Chairman.
    Mr. Miller of North Carolina. Thank you.
    The Chair recognizes Mr. Wilson for 5 minutes.
    Mr. Wilson. Thank you, Mr. Chairman.
    My questions, gentlemen, are to Mr. Fuld and to Mr. 
    The report finds that you made a deliberate and decisive 
move to embark on an aggressive growth strategy, to take on 
even greater risk. And when this strategy seemed to slow, 
instead of pulling back, you made the conscious decision to 
double down. Is that correct?
    Mr. Fuld. No, sir, it was not.
    Mr. Wilson. Okay. Were there models of risk that you had 
that you were to go by and you were above them on numerous 
occasions most of the time. Is that true?
    Mr. Fuld. The model of risk for us--or the model of growth, 
I should say, for us was more about a wallet share of clients. 
It was a client-focused business. So it wasn't about taking on 
more risk.
    The second piece of your question, though, is, if I heard 
it correctly, there were risk levels, we ignored them. Is 
that--or did I make that up?
    Mr. Wilson. My understanding was you had models of risk 
that you were to go by and that you were consistently above the 
amount those models called for.
    Mr. Fuld. Those were internal guides that we set. I had 
this conversation with the examiner. I thought I explained it. 
And what I said was, we would look at these levels and 
understand why we tripped above a certain trigger. Some might 
have been volatility, some might have been because the hedge 
didn't work, some might have been because change of 
    One of the biggest moves in our risk appetite was our 
changing our own diversification benefit. We took exactly the 
same portfolio, gave a lower weighting to the diversification 
benefit, which moved our risk appetite, I forget the specific 
numbers but let's just say for example, from $3.6 billion to $4 
billion. That was all our doing. It wasn't that we had bought 
    And, in all fairness, given the market, the way it was, you 
could have the same position from one day to the next, and 
because of volatility and triggers and interaction of hedges, 
that, in itself, exactly the same position, could change your 
risk appetite.
    And, in response to that, we reacted in a very strong, 
aggressive way and brought down those vulnerable securities--I 
won't take your time with it, but, again, commercial real 
estate, residential mortgages, leveraged loans. That was our 
    Mr. Wilson. A lot of risk and a really increasing gamble. 
Do you gamble, Mr. Fuld?
    Mr. Fuld. Not the way you are asking, no.
    Mr. Wilson. Because some would say the behavior that went 
on at Lehman was more that of a gambler than an executive on 
Wall Street.
    Mr. Fuld. I think that those who don't have the information 
and the accurate information might say that.
    Mr. Wilson. You feel that, with the information that you 
have provided, that it wouldn't look like as much of a gamble; 
is that correct?
    Mr. Fuld. The information that I provided today is a tiny 
microcosm of who we were. Please understand--I hesitate to say 
this because you will--whatever. We were risk-averse. 
Commercial real estate--I know, I know, I--
    Mr. Wilson. How can you say that?
    Mr. Fuld. --walked right into that one.
    Commercial real estate was an area where, over the last 7 
to 8 years, a terrific team, very talented, smart decisions. 
And I will tell you that the decisions that we made on the 
properties that we bought in commercial real estate--strong 
management teams, strong properties, strong locations. I will 
look at you, though, and tell you: terrible timing, bad timing. 
No, terrible timing.
    Mr. Wilson. I have a couple other questions I would like to 
get in.
    Before the Lehman bankruptcy, Treasury Secretary Paulson 
and Federal Reserve Chairman Bernanke told us our financial 
system could handle the collapse of Lehman. It is clear that 
was not true. And, from this report, it appears to me that the 
company knew that. Why? Do you agree with that?
    Mr. Fuld. I am sorry, you say ``the company,'' meaning?
    Mr. Wilson. Yes, Lehman.
    Mr. Fuld. We told Secretary Paulson on that fateful weekend 
that if--because we had been mandated, we didn't choose, we had 
been mandated by the Fed to declare bankruptcy. We told 
Secretary Paulson, ``If you do that, there can be no orderly 
wind-down. There will be massive repercussions in the swaps and 
derivative markets that you will not be able to control, and 
this will be a disaster.''
    Mr. Wilson. Do you believe that there were people inside 
the Lehman organization fighting for government help, besides 
your conversation that you had with Mr. Paulson?
    Mr. Fuld. Not that I am aware of, sir.
    Mr. Miller of North Carolina. The gentleman's time has 
    Mr. Donnelly for 5 minutes.
    Mr. Wilson. Thank you, Mr. Chairman.
    Thank you, Mr. Fuld.
    Mr. Donnelly. Thank you, Mr. Chairman.
    Mr. Lee, at the end of every quarter, transactions were 
temporarily removed from the balance sheet. When were they put 
back on?
    Mr. Lee. It is a continuous process which peaked at the end 
of a reporting period. So if you read the examiner's report, it 
is like a 10-day stretch. There is not a set number of days. 
And there was always a level base of Repo 105 that was on all 
month long.
    Mr. Donnelly. So, Mr. Fuld, when you were talking about any 
given day there were a number of sales transactions, is it fair 
to say that at the end of the quarter with Repo 105 it was 
completely different than the rest of the quarter?
    Mr. Fuld. I will say that the examiner's report had a very 
interesting chart which showed that it spiked on the quarters.
    Mr. Donnelly. Do you know why it spiked on the quarters?
    Mr. Fuld. On the quarters' ends, I should have said. I 
    Again, I will say I was not there for the structure or the 
creation of these. But I will say that these transactions were 
not created by Lehman Brothers. They were created and modeled 
after FAS 140. I do not believe that FAS 140 created this rule 
to give firms the ability to create a gimmick or mislead--
    Mr. Donnelly. Let me ask you this: Do you think that the 
use of Repo 105 transactions, do you think when you use those 
it fairly reflected the condition of Lehman Brothers?
    Mr. Fuld. I do, because there was, in fact--and this is a 
piece that was said before, which I did not have a chance to 
respond to. Given what I said of our ability to sell, not 
monthly or weekly, but daily, $50 billion--
    Mr. Donnelly. Right, but--
    Mr. Fuld. If I may, sir, please.
    Mr. Donnelly. I am just trying to save as much time as 
possible. Go ahead.
    Mr. Fuld. I am usually pretty quick.
    Mr. Donnelly. Okay. Go ahead.
    Mr. Fuld. I apologize.
    We really could have sold $50 billion a day, and we did. 
The reason that we took these back, there had to have been a 
business purpose. And the examiner himself talks about a 
business purpose, because even in the sale transaction there 
was an implied spread. The examiner talks about it himself. 
There would have been no other reason to buy these securities 
back. They could have sold 50, 50, and another 50.
    Mr. Donnelly. Let me ask you this. Did the chief financial 
officer or the chief risk officer or the head of capital 
markets product control, did any of those folks tell you about 
the existence of Repo 105?
    Mr. Fuld. As I said before, not to my recollection at all 
did I have any conversations.
    Mr. Donnelly. Okay.
    Mr. Cruikshank, when did you first become aware of Repo 
105? Just a quick when did you find out?
    Mr. Cruikshank. During the examiner's investigation when he 
interviewed me.
    Mr. Donnelly. Okay.
    Mr. Fuld, in talking about risk-averse, at 30:1, did you 
think that was risk-averse, a leverage figure? Is there any 
leverage figure that crossed your risk-averse concern?
    Mr. Fuld. I think the 30:1 is a misconception. Fifty 
percent of our balance sheet was a matchbook. Not to get 
    Mr. Donnelly. No, that is fine.
    Mr. Fuld. --matchbook was a series of short-term financings 
where we would sell securities to clients, buy them back and 
finance them. They were a series of 3-, 5-, and 7-day 
transactions with a limited tail and very little, if any, risk. 
So I looked at our balance sheet without--
    Mr. Donnelly. So you feel those 30:1, 40:1 references, 
those are not fair, in your mind?
    Mr. Fuld. Correct, sir.
    Mr. Donnelly. All right. Now, let me ask you this: Do you 
think that packaging no-doc loans, no-document loans, do you 
think those are solid products? Do you think it made sense to 
be involved in those?
    Mr. Fuld. I can only tell you that, at the time when we 
made those loans, or, actually more importantly, not so much we 
made the loans but we bought as a conduit, that our investors--
I will put it to you differently. We never created a package 
thinking that our investors were going to lose money. That is 
not what our firm was about.
    Mr. Donnelly. So let me ask you this. No-document loans, 
interest-only loans in some mezzanines that you look and you 
go, how could they ever repay, were you, was anybody in the 
firm aware of the fact that each step of this made it much more 
likely that these bonds or loans could never pay off?
    Mr. Fuld. When we operated our own origination platforms, 
we stepped in and we changed the management where we thought it 
was appropriate, we changed underwriting standards where we 
thought they were lax, we discontinued certain products where 
we thought there was vulnerability.
    I believe that we did take a very solid and prudent 
approach to--our goal was not to sell securities that were 
going to hurt clients or hurt those people who were taking 
mortgages. We didn't want to be in the repossession business. 
That was not our goal.
    Mr. Donnelly. Let me ask you one last question. And going 
back to your initial remarks about, there was not a capital 
hole--but Lehman still went away. Was it a loss of confidence? 
If the capital was there, the $26 billion was there, why did we 
wake up and see Lehman gone?
    Mr. Fuld. Why did we wake up--
    Mr. Donnelly. Yes. Why, if the $26 billion is there, you 
had your board of directors firing away, working hard, how did 
it go down finally? Was it a loss of confidence, everybody 
calling in on you at once?
    Mr. Fuld. I think it was a loss of confidence. I think 
people have heard me talk long enough about naked short 
sellers; I don't want to do it again.
    I think that we could not convince the world about the 
condition that we were in, that we had collateral, that we had 
capital, we had a solid plan. And we did, in fact, have a solid 
    We could not convince the world--S&P came out with a 
report, don't hold me to a date but a week or 10 days after, 
and said, why was Lehman single A? They talked about our strong 
franchise, they talked about our having raised capital, they 
talked about our ability to earn money, they talked about our 
liquidity, they talked about those things. We lost, I don't 
know, $25 billion of liquidity in 2 days.
    Mr. Donnelly. Thank you very much.
    Thank you, Mr. Chairman.
    Mr. Miller of North Carolina. The Chair recognizes Ms. 
Speier for 5 minutes.
    Ms. Speier. Thank you, Mr. Chairman.
    Mr. Fuld, tens of thousands of people in my district are 
out of work, and have lost the opportunity to build classrooms 
because they invested in investment-grade Lehman Brothers 
stocks and bonds. They have lost it all. Now, I have no 
consolation in the fact that you may have to live with that 
every day. That is not good enough.
    Why is it you sold your home in Florida to your wife for 
    Mr. Fuld. That was misrepresented. Long before Lehman had 
any problems--this is a little bit personal, but you have asked 
me the question, so I will--
    Ms. Speier. It is public information.
    Mr. Fuld. Kathy decided to sell some of her art. And so 
that we had equal assets--it was her art in her name--I put the 
house in her name to rebalance that. Very plain, very simple. 
That was decided long before Lehman went down--
    Ms. Speier. But it took place in October.
    Mr. Fuld. --blown way out of proportion.
    Ms. Speier. It took place in October after Lehman had 
    Mr. Fuld. I had made the decision back in May and June.
    Ms. Speier. All right. Let's move on then.
    Mr. Fuld. No, I am sorry. In all fairness, these things 
don't get done overnight.
    Ms. Speier. I understand. You have answered the question. 
Let me move on to another question.
    You have said in your testimony that you feel vindicated by 
the results in Mr. Valukas's report. And yet Mr. Valukas 
clearly states over and over again in his report that there are 
colorable claims that can be made against Lehman for 
misrepresenting the 10K and the SK document. In fact, he says, 
``Billions of Lehman's shares traded on misinformation.''
    So there is nothing in this report that vindicates you. 
There is plenty of information in this report that suggests 
that the SEC did not do its job, that the Fed may not have done 
its job, but that you, in fact, misrepresented Lehman's status.
    Now, you had said that you did not know anything about Repo 
105, and yet, according to Mr. Valukas, having looked at 25 
million e-mails, he says that there is every reason to know 
that you did.
    But, having said that, you have to be concerned as the CEO 
of the company with the rating agency's rating of Lehman, 
    Mr. Fuld. Yes.
    Ms. Speier. That has to be number one on your priority 
list, to make sure they continue to rate your company and your 
products as investment-grade, correct?
    Mr. Fuld. On my list, but clearly not number one. But on my 
list, yes.
    Ms. Speier. Was it number 10?
    Mr. Fuld. I can't quantify. My number one concern was 
protection of our capital and shareholder equity.
    Ms. Speier. And shareholder equity has everything to do 
with whether or not the rating agencies are grading your 
products as investment-grade.
    Mr. Fuld. That is actually a very interesting question. The 
rating agencies reacted more to our stock price than they did 
to our timeliness. The rating agency focus on debt is the 
timely ability to pay back debt. They reacted more to our stock 
price where they heard the rumors about the hole in the balance 
sheet and thought that we couldn't raise equity.
    One of the real shortfalls was our ability--when I said we 
couldn't convince the world, there were so many rumors about 
Lehman's condition that people thought that, given that hole, 
we wouldn't be able to raise equity, when, in fact, we had the 
    Ms. Speier. Okay. Mr. Fuld, excuse me, but my time is about 
to run out. Let me ask you one last question. Have you ever 
shorted securities that you were selling to the public?
    Mr. Fuld. I, myself?
    Ms. Speier. Pardon me?
    Mr. Fuld. I, myself?
    Ms. Speier. Your company.
    Mr. Fuld. Not that I am aware of.
    Ms. Speier. Thank you.
    Mr. Miller of North Carolina. Thank you.
    Ms. Kilroy is recognized for 5 minutes.
    Ms. Kilroy. Thank you, Mr. Chairman.
    Mr. Fuld, there have been several things that you have 
answered today or answered to the bankruptcy examiner ``not 
that you are aware of'' or ``not that you recall.'' Did you 
review any documents in preparation for today's hearing?
    Mr. Fuld. Yes, ma'am, I did.
    Ms. Kilroy. And what were those?
    Mr. Fuld. I don't even know how to begin to answer that.
    Ms. Kilroy. Did you practice your answers for today's 
hearing with any kind of a murder board?
    Mr. Fuld. I am sorry, with a who?
    Ms. Kilroy. Did you rehearse? Did you go over some practice 
    Mr. Fuld. I wrote questions for myself. I thought about 
    Ms. Kilroy. Did you engage in a murder board preparation, 
where other people asked you questions?
    Mr. Fuld. A murder board?
    Ms. Kilroy. You have not heard that term before? All right, 
move on.
    Mr. Frank. Will the gentlewoman yield? Let me ask unanimous 
consent for 15 seconds. I don't want to leave that hanging for 
people who don't know.
    A murder board is what they call it in an Administration 
when they prepare a nominee who is facing confirmation to 
appear before a Senate committee and be attacked.
    Mr. Fuld. A separate group? No. I actually wrote out a 
number of questions, myself.
    Ms. Kilroy. So did you consider that we might ask about the 
warnings Mr. Paulson gave to Lehman about the state of Lehman's 
balance sheet? Did you review that?
    Mr. Fuld. No, I didn't.
    Ms. Kilroy. And you don't--do you recall Mr. Paulson's 
    Mr. Fuld. I have read his book, I am embarrassed to say, 
but I read his book.
    Ms. Kilroy. Do you recall Mr. Geithner's concerns and 
urging that Lehman move to a more conservative place with its 
balance sheet?
    Mr. Fuld. Secretary Geithner and I had a number of 
conversations regarding liquidity, potential capital raise. I 
do not recall a warning from him.
    Ms. Kilroy. Okay. Do you recall a warning from the Office 
of Thrift Supervision that you were materially overexposed?
    Mr. Fuld. I do not.
    Ms. Kilroy. Do you recall the concerns of Michael Gelband 
or Matthew Lee with respect to the risk management of the risk 
levels of Lehman or off-balance-sheet accounting?
    Mr. Fuld. I will start backwards.
    I saw Matthew Lee today. He reminded me that he and I had 
met at a social event. So I was not familiar with him.
    Michael Gelband was a long-time member of the firm. I will 
only tell you that the day after Mr. Gelband left the firm, the 
senior officer who took his place came to see me, told me that 
we were overexposed in leveraged loans. I said, how bad is it? 
He took me through it. I said, what is your recommendation? He 
said, let me bring it to the executive committee, but I would 
like to bring it down. I said, bring it to executive committee; 
start to bring it down today. And, from that point, we took it 
down something like from $45 billion to $7 billion.
    Ms. Kilroy. And did any of these discussions of lowering 
your exposure or lowering your leverage include lowering 
leverage specifically for a quarterly report to investors filed 
with the SEC, with specific targets of lowering your leverage 
for the quarterly reports for the investors?
    Mr. Fuld. I am sorry, are you asking me, did I ever set a 
specific target? No.
    Ms. Kilroy. And you continue to say that you do not recall 
engaging in any decision-making or even hearing about the use 
of Repo 105s with respect to that quarterly report and moving 
them on or off balance sheet to improve how that balance sheet 
looked for those investments?
    Mr. Fuld. I recall no conversation, and I recall seeing no 
    Ms. Kilroy. Do you recall an individual by the name of, I 
believe, David Einhorn?
    Mr. Fuld. I know his name.
    Ms. Kilroy. Were you concerned with what short sellers were 
saying about your company?
    Mr. Fuld. Yes, I was.
    Ms. Kilroy. And was he one of those short sellers?
    Mr. Fuld. I believe he was.
    Ms. Kilroy. And were you aware of a speech that he gave to 
a high-level group of investors in which he criticized your 
first-quarter report and questioned the numbers in your first-
quarter report versus your 10-Q filing?
    Mr. Fuld. I don't have all the pieces of that, but I was 
very much aware that he was claiming that we misrepresented 
items in our, I forget, CDOs and CLOs, claiming that they were 
all mortgages. They, in fact, were not. They were corporate 
loans. We tried to tell him that. He ignored that. He continued 
to talk about Lehman--I will be kind and just say, in an 
unflattering way.
    Ms. Kilroy. In any of that discussion, in taking a look at 
what the reasons were for maybe some of these discrepancies, 
did the use of Repo 105s come up at all?
    Mr. Fuld. Not at all.
    Ms. Kilroy. Am I over time?
    Mr. Miller of North Carolina. Not as gloriously as some 
other members, but yes, somewhat.
    The Chair does thank all the witnesses for their testimony 
    The Chair notes that some members may have additional 
questions for this panel, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 30 days for members to submit written questions to these 
witnesses and to place their responses in the record.
    This hearing is adjourned.
    [Whereupon, at 5:10 p.m., the hearing was adjourned.]

                            A P P E N D I X

                             April 20, 2010