ben s bernanke : lessons from the failure of lehman brothers testimony by mr ben s bernanke, chairman of the board of governors of the federal reserve system, before the committee on financial services, us house of representatives, washington dc, 20 april 2010. * * * 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 subsidiaries of lehman were securities broker - dealers under the supervisory jurisdiction of the securities and exchange commission ( sec ), which also supervised the lehman parent company under the sec ’ s consolidated supervised entity ( cse ) program. importantly, the cse program was voluntary, established by the sec in agreement with the supervised firms, without the benefits of statutory authorization. although the federal reserve had no supervisory responsibilities or authorities with respect to lehman, it began monitoring the financial condition of lehman and the other primary dealers during the period of financial stress that led to the sale of bear stearns to jpmorgan chase. 1 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, then - chairman cox and i negotiated an agreement that formalized procedures for information - sharing between our two 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,

: abundant global liquidity searching for returns in the wrong places, feeding unsustainable asset booms and growing economic imbalances. against this is the risk of a slower, more fragile recovery. it will be some years before we can judge how appropriate this normalisation has been. the difficulty of our job will also depend on the wider domestic policy context. in particular, achieving both low inflation and balanced growth is considerably easier in an environment of fiscal discipline, and where the tax system is neutral with respect to households ’ and firms ’ investment decisions. in this respect, a failure to gradually remove the recent fiscal stimulus would put added pressure on monetary policy over the coming period. we are also hopeful that the recently released report of the tax working group will lead to a more efficient and even - handed tax system. tax policy is complex and needs to meet multiple objectives. our concerns are to minimise tax - fuelled property investment and consumption that might detract from more balanced savings and growth. another important part of the domestic policy context is our financial policy framework. a lot of work is being done in this space internationally. central banks, financial regulatory bodies, the basel committee on banking supervision and the financial stability board are working out ways to strengthen and improve the prudential supervision of financial institutions. this includes raising the quantity and quality of minimum capital buffers held by banks, and improving the resilience of banks to liquidity shocks. it includes measures to make banks easier to restructure and unwind should they become insolvent. financial regulators are also working on designing a “ macro - prudential ” architecture for bank regulation. this essentially means taking into account the impact of individual banks on the riskiness of the financial system as a whole. for example, a large systemically important bank needs larger capital buffers than a smaller player. similarly, larger buffers may need to be built up in boom times, when banks are more vulnerable to a systemic downturn. in new zealand, the financial system is a lot simpler than in other parts of the oecd, and has not seen the same types of excesses. nevertheless we have taken steps to make our banks more resilient to financial system shocks. in implementing the basel ii capital framework, we have ensured that banks ’ assessment of risk is based on a “ through - thecycle ” approach rather than just on the period of recent growth. we have also put in place a new prudential liquidity