Alert April 27, 2010

FRB Chairman Bernanke Testifies Before House Committee on Lessons from Failure of Lehman

Chairman Ben S. Bernanke of the FRB presented testimony before the U.S. House of Representatives Committee on Financial Services concerning the “Lessons Learned from the Failure of Lehman.”  In his testimony, Chairman Bernanke noted that Lehman Brothers (“Lehman”) was exempt from FRB supervision because it did not own a commercial bank, but rather owned a federally insured savings association.  Chairman Bernanke noted that Lehman’s core subsidiaries were broker-dealers subject to SEC supervision and that Lehman’s parent company was subject only to the SEC’s Consolidated Supervised Entity program, a voluntary program “without the benefits of statutory authorization.”

Chairman Bernanke stated that in March 2008, responding to increasing pressures on primary dealers such as Lehman, the FRB used its statutory emergency powers to establish the Primary Dealer Credit Facility and the Term Securities Lending Facility (the “Facilities”) to provide backup liquidity to primary dealers.  The FRB required all participants in Facilities, including Lehman, to provide the FRB with current financial information, but the FRB had no legal authority “to regulate Lehman’s disclosures, capital, risk management, or other business activities.”  Subsequently, the FRB and SEC shared financial information concerning Lehman and jointly conducted stress tests of Lehman’s liquidity.  The results of the stress tests showed that Lehman’s liquidity and capital were significantly deficient. 

Lehman was unable to raise a sufficient amount of capital to address its needs, market conditions deteriorated further and, in mid-September 2008, the FRB and other regulators tried unsuccessfully to arrange an acquisition of Lehman by another company or to find another means of saving Lehman.  Accordingly, Lehman’s only available option was to declare bankruptcy.  Chairman Bernanke pointed out that at the time of Lehman’s bankruptcy neither the FRB nor any other regulatory agency “had the authority to provide capital or an unsecured guarantee, and thus no means of preventing Lehman’s failure existed.”

Chairman Bernanke concluded that Lehman’s failure provides at least two important lessons:  (1) We must eliminate gaps in the U.S. financial regulatory framework “that allow large, complex interconnected firms like Lehman to operate without robust consolidated supervision;” and (2) “to avoid having to choose in the future between bailing out a failing, systematically critical firm or allowing its disorderly bankruptcy, we need a new resolution regime, analogous to that already established for failing banks.”