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Collapse of Lehman Bros. Examined

WASHINGTON (CN) - Federal regulators could have "softened" the disastrous economic impact of Lehman Brothers' collapse in fall 2008 if they had acted sooner, bankruptcy examiner Anton Valukas told a Congressional committee Tuesday.

Federal regulators knew in June 2008 that Lehman Brothers was boosting its liquidity pool by counting risky securities as assets and using an accounting strategy known as the Repo 105 transaction, but "acquiesced" as Lehman continued to pile on risk until it filed for bankruptcy on Sept. 15, 2008, Valukas said.

Testifying before the House Financial Services Committee, Valukas said the regulators missed crucial opportunities to alter Lehman's behavior because they "failed to ask the right questions" which, Valukas added, "in this post-Enron era is hard to understand."

If regulators had compelled the banking giant to cut back on risks, they "might have prevented the precipitous fall of the cliff," Valukas said.

Valukas, an attorney charged with sorting through 25 million documents for the report, cited "lack of cooperation" between government agencies, saying better communication between the Securities and Exchange Commission and the Federal Reserve "would have triggered concerns earlier rather than trying to cram it in on a weekend in September," Valukas said.

"The Fed did not have the authority, and the agency that had the authority, the [Securities and Exchange Commission], did not have the skill set," Valukas said. "If they had combined skill sets they would have solved some of these problems," Valukas said.

The weekend before the Lehman collapse, which marked the largest bankruptcy in U.S. history, the firm reported $41 billion in liquidity but failed to disclose that more than $15 billion of those reported assets were encumbered, Valukas said.

"The Federal Reserve was not Lehman's supervisor," Federal Reserve Chair Ben Bernanke said. "We only had the nuclear option of essentially letting it fail."

The SEC, Lehman's primary regulator, could have used its Consolidated Supervised Entity program to compel the firm to act, Valukas said.

SEC Chairman Mary Schapiro said the CSE was "undermanaged," "never adequately staffed," and "flawed in its design."

"We could have pushed the limits of our authority of this program more than we did," Schapiro said.

Lehman Brothers failed three stress tests assessed jointly by the SEC and the Fed leading up to the collapse, but by the time the regulators called 20 Wall Street executives together in September 2008, "no means of preventing Lehman's failure existed," Bernanke said.

Lehman had internal risk assessments, but as they continually exceeded their own risk limits, the response was to raise those limits, Valukas said.

Lehman Brothers showed their risk matrix to the SEC as proof that it was maintaining adequate risk assessments, but in fall 2008, the assets became "an anchor around them" that caused the firm to sink, Valukas said.

When several former Lehman Brothers executives were called to testify, they said regulators did their part, but expressed the wish that the U.S. government had kept them afloat like they did other firms such as Morgan Stanley and Goldman Sachs.

"I do not understand why the government did not help finance the firm," former board member and audit committee Chairman Thomas Cruikshank said.

Cruikshank said if the firm had been unwound and sold, the financial crisis "might not have been nearly as severe and widespread."

Committee members suggested that maybe it was because Lehman Brothers was a firm charged only with making a profit, not meeting federal requirements for increasing homeownership, such as Morgan Stanley.

Former Lehman Brothers senior Vice President Matthew Lee testified that he hand-delivered letters to Lehman executives asking why issues involving risky investments were not being resolved, but was ignored. Lee, who teared up during his testimony while he recounted being pulled out of his office and fired without notice, said "I was so mad that nothing was being done about my letter." When asked what response he received, he said "annoyance."

Former Chairman and CEO of Lehman Brothers Richard Fuld said the company had been "unfairly vilified" and that the Fed and SEC had been monitoring its day-to-day activities up until its collapse.

"Not once did I hear any feedback that led me to believe we were deficient," Fuld said. "If the Fed had something to say they would have said it to me," he said.

When asked what went wrong at Lehman brothers, Fuld started out on a history of the firm and was cut off by committee member Paul Kanjorksi, D-Pa. "Don't give me an advertisement. What caused the demise of Lehman Brothers?"

Fuld pursed lips his lips and paused, again carefully outlining the firm's evolution, finally nailing the fault to "a number of initiatives that we undertook as we grew."

"What are they?" Kanjorski demanded.

"We did not understand the contagion of a security -- one asset class to the next. 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," Fuld said.

"On any given day, Lehman moved more than a trillion dollars through its system," Fuld said. "There is no reason that I would have known about these Repo 105 transactions because there is inherently nothing wrong with them," Fuld said.

When asked how he did not notice that the firm was unloading $50 billion in assets at the end of a quarter, Fuld said, "That was not my focus."

"In view of what's happened," Kanjorski said, "should it have been your focus?"

"I focused on what do I really need to know -- what could impact our capital," Fuld said.

"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, and I have to live with that," he said.

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