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PUBLIC POLICY ISSUES RAISED 

BY THE REPORT OF THE LEHMAN 

BANKRUPTCY EXAMINER 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED ELEVENTH CONGRESS 

SECOND SESSION 

APRIL 20, 2010 

Printed for the use of the Committee on Financial Services 

Serial No. 111–124 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

CHARLES A. WILSON, Ohio 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

WALT MINNICK, Idaho 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

STEVE DRIEHAUS, Ohio 

SUZANNE KOSMAS, Florida 

ALAN GRAYSON, Florida 

JIM HIMES, Connecticut 

GARY PETERS, Michigan 

DAN MAFFEI, New York 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

LEONARD LANCE, New Jersey 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

April 20, 2010 ................................................................................................... 1 

Appendix: 

April 20, 2010 ................................................................................................... 101 

WITNESSES 

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 

APPENDIX 

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 

Page

IV 

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 

(1) 

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. 

STATEMENT OF THE HONORABLE ANNA ESHOO, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF CALIFORNIA 

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 NaVerDate Nov 24 2008 16:08 Sep 22, 2010 Jkt 057742 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 K:\DOCS\57742.TXT TERRIE
2 

tion 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 ratios.’’ 

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 

3 

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 supplement. 

Ms. ESHOO. I thank you again. 

The CHAIRMAN. Mr. Perlmutter? 

4 

STATEMENT OF THE HONORABLE ED PERLMUTTER, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF COLORADO 

Mr. PERLMUTTER. Thank you, Mr. Chairman, Mr. Bachus, fellow 

members. 

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 difficulties. 

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 repeated. 

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 

5 

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 time. 

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 

6 

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 they— 

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. 

7 

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 capitalism. 

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 ask. 

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 enactVerDate Nov 24 2008 16:08 Sep 22, 2010 Jkt 057742 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 K:\DOCS\57742.TXT TERRIE
8 

ment 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 reVerDate Nov 24 2008 16:08 Sep 22, 2010 Jkt 057742 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 K:\DOCS\57742.TXT TERRIE
9 

sult, 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 prof- ited 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 responsible. 

10 

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 liability. 

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 governmentprovided 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 

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11 

tions 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 gentleman. 

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 12⁄3 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 seconds. 

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 happen. 

Thank you, Mr. Chairman, for your consideration and your 

strong leadership. I yield back. 

12 

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 crisis. 

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 

13 

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 testimony. 

STATEMENT OF THE HONORABLE TIMOTHY F. GEITHNER, 

SECRETARY, U.S. DEPARTMENT OF THE TREASURY 

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 weren’t. 

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 

14 

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 system. 

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 bankVerDate Nov 24 2008 16:08 Sep 22, 2010 Jkt 057742 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\57742.TXT TERRIE
15 

ruptcy 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 mess. 

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 disaster. 

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? 

STATEMENT OF THE HONORABLE BEN. S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE 

SYSTEM 

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 supervision. 

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. 

16 

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 activities. 

During this period, Federal Reserve employees were in regular 

contact with their counterparts at the SEC; and in July 2008, thenChairman 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 board. 

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 Department. 

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 inadequate. 

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 acquiVerDate Nov 24 2008 16:08 Sep 22, 2010 Jkt 057742 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 K:\DOCS\57742.TXT TERRIE
17 

sition 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 questions. 

[The prepared statement of Chairman Bernanke can be found on 

page 118 of the appendix.] 

Mr. KANJORSKI. [presiding] Chairman Schapiro? 

STATEMENT OF THE HONORABLE MARY L. SCHAPIRO, 

CHAIRMAN, U.S. SECURITIES AND EXCHANGE COMMISSION 

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 

18 

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 leverage. 

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. 

19 

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 history. 

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 

20 

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-tofail’’ 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 

21 

the Senate. I know Secretary Geithner has now called that it be 

removed, and I think that is an important step. 

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 examiner: 

‘‘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 that. 

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. 

22 

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 statement? 

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. 

23 

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 

24 

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. 

25 

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 that. 

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. 

26 

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 year. 

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 

27 

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 

Brothers? 

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 system. 

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 

28 

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 agencies. 

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 

29 

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. 

30 

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 quarter. 

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. 

31 

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 like. 

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 information. 

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 firms. 

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 regulator. 

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 

32 

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 information? 

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 needed. 

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 information. 

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 discipline? 

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 

33 

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 distinction. 

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 

34 

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 them. 

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— 

35 

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 before. 

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 that. 

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 exVerDate Nov 24 2008 16:08 Sep 22, 2010 Jkt 057742 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 K:\DOCS\57742.TXT TERRIE
36 

ception 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 assetbacked 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? 

37 

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 disclosure. 

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/jsp/ 

FASB/Page/PreCodSectionPage&cid=1218220137031] 

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? 

38 

So with that said, I would like to start with Mr. Geithner. This 

plan that has been proposed to allow these institutions to fail, ‘‘toobig-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 challenge. 

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 economy. 

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 

39 

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 contexts. 

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 agencies?’’ 

40 

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 documents. 

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 future. 

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 

41 

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 justified? 

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 full. 

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. 

42 

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 reforms. 

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 innovation. 

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, 

43 

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 first. 

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 crisis. 

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 shaky. 

44 

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 distress. 

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. 

45 

So would you just admit, it was not under your watch, but just 

admit that the SEC failed to do its job in regulating Lehman? 

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 job. 

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 sales. 

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 

46 

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 investments. 

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 again. 

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-dealers. 

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. 

47 

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 management. 

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. 

48 

STATEMENT OF ANTON R. VALUKAS, PARTNER, JENNER & 

BLOCK LLP, COURT APPOINTED EXAMINER, LEHMAN 

BROTHERS BANKRUPTCY 

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 bankruptcy. 

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 action. 

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 offbalance 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 LehVerDate Nov 24 2008 16:08 Sep 22, 2010 Jkt 057742 PO 00000 Frm 00052 Fmt 6633 Sfmt 6633 K:\DOCS\57742.TXT TERRIE
49 

man’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 regulators. 

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 

50 

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 stern. 

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. 

51 

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 problems? 

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 numbers. 

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 September. 

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 

52 

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 successful. 

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. 

53 

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 attention. 

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 

54 

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. 

Royce. 

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 

55 

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. 

56 

Mr. KANJORSKI. The gentleman from North Carolina, Mr. Miller. 

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 alternatives. 

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 point. 

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 

57 

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 timeline. 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 

58 

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 correct? 

Mr. VALUKAS. That is correct. 

59 

Mr. GREEN. Is it also true that there was a company that received these off-balance sheets books? Is that a way to put it? 

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 knowledge? 

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 investigation. 

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. 

60 

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 testimony? 

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? 

61 

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 Lehman? 

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. 

62 

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 these. 

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 failure. 

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 time. 

Mr. KANJORSKI. Thank you, Mr. Wilson. 

And we will now hear from the gentleman from Texas, Mr. Hensarling. 

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.’’ 

63 

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 statement— 

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 me. 

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 

64 

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 public. 

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 disclosure. 

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. Chairman. 

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. 

65 

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 situation? 

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 

66 

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 time. 

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 arrangements. 

Mr. VALUKAS. Yes. 

Ms. SPEIER. So Lehman did not in its actual notification to investors talk about the off-balance sheet financing arrangements. 

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 

67 

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 correct? 

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 highrisk 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 process. 

The business judgment rule pretty much says that if you have 

this process in place and you are acting—you are making rational 

68 

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. 

69 

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 

back. 

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 response. 

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 sufficient. 

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? 

STATEMENT OF RICHARD S. FULD, JR., FORMER CHAIRMAN 

AND CHIEF EXECUTIVE OFFICER, LEHMAN BROTHERS 

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 examiner. 

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 

70 

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. 

71 

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, inperson, 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? 

STATEMENT OF THOMAS H. CRUIKSHANK, FORMER MEMBER 

OF THE BOARD OF DIRECTORS AND CHAIR OF LEHMAN 

BROTHERS’ AUDIT COMMITTEE 

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. 

72 

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 right. 

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. 

73 

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 shortterm 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? 

STATEMENT OF WILLIAM K. BLACK, ASSOCIATE PROFESSOR 

OF ECONOMICS AND LAW, UNIVERSITY OF MISSOURI-KANSAS CITY SCHOOL OF LAW 

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 

74 

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 

75 

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? 

STATEMENT OF MATTHEW LEE, FORMER SENIOR VICE 

PRESIDENT, LEHMAN BROTHERS 

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. 

76 

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 entities. 

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 earlier. 

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 email—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. 

77 

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, 

78 

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 deficient. 

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 us. 

79 

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 that— 

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 convincing? 

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 

80 

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 hypothetical. 

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 right. 

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 

81 

change something you were doing for safety and soundness reasons? 

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 

82 

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 Senate. 

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 quarter. 

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. 

83 

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. Royce. 

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 cushion. 

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. 

84 

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. 

85 

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 

you? 

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 them. 

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 

86 

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 structuring. 

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 Brothers? 

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 

87 

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 companies. 

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 

88 

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 AltA, 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 competitor. 

89 

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 night. 

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, specifically. 

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 landVerDate Nov 24 2008 16:08 Sep 22, 2010 Jkt 057742 PO 00000 Frm 00093 Fmt 6633 Sfmt 6633 K:\DOCS\57742.TXT TERRIE
90 

ing. 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. 

Lance. 

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 yes. 

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. 

91 

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 out? 

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 time. 

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? 

92 

Mr. LEE. That was underlying it, yes. 

Mr. GREEN. Did you ever have an opportunity to communicate 

this? 

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 well. 

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? 

93 

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 something. 

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. 

Cruikshank. 

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 diversification. 

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 something. 

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 

94 

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 focus. 

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 expired. 

Mr. Donnelly for 5 minutes. 

Mr. WILSON. Thank you, Mr. Chairman. 

Thank you, Mr. Fuld. 

95 

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 apologize. 

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. 

96 

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 technical— 

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 plan. 

97 

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 $100? 

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 fallen. 

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, correct? 

Mr. FULD. Yes. 

98 

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 equity. 

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 

questions? 

Mr. FULD. I wrote questions for myself. I thought about them. 

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. 

99 

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 warnings? 

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 document. 

Ms. KILROY. Do you recall an individual by the name of, I believe, David Einhorn? 

Mr. FULD. I know his name. 

100 

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 today. 

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.] 

(101) 

A P P E N D I X 

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