Bernanke explains why Fed couldn't save Lehman

WASHINGTON — Federal Reserve Chairman Ben Bernanke on Thursday strongly rejected as "myth" suggestions that he could have saved investment bank Lehman Brothers and prevented the near-collapse of the global financial system.

Former Lehman CEO Richard Fuld suggested Wednesday that the Fed could have given him a lifeline in September 2008 and spared the world the subsequent chaos. That view is wrong, Bernanke, a former Princeton economist, told the Financial Crisis Inquiry Commission.

"Before I came to the Fed chairmanship, I was an academic, and I studied for many years the Great Depression, financial crises, and this is my bread and butter. And I believed deeply that if Lehman was allowed to fail or did fail that the consequences for the U.S. financial system and the U.S. economy would be catastrophic," Bernanke said. "And I never at any time wavered in my view that we should do absolutely everything possible to prevent the failure of Lehman."

The problem, he said, was that Lehman lacked the sufficient collateral to provide to the Fed for any loans it would have received. Lehman was under the modern equivalent of a bank run, where investment firms on the other end of deals with it simply refused to lend it any more money, pulled out of existing deals and demanded immediate repayment from it.

Bernanke's testimony provided the most detailed public accounting yet of how the Fed reached the decisions it made in a pivotal point in American financial history. Almost two years later, another Great Depression has been averted, but the damage to the structure of the nation's financial sector led to a deep and seemingly intractable downturn.

On the fateful weekend of Sept. 13-14, 2008, regulators concluded that Lehman was dead. It would either be purchased at the last minute by the British bank Barclays or shuttered. Any government rescue effort amounted to a "Hail Mary" pass.

"The view was that failure was essentially certain in either case," the Fed chief testified.

Nearly two years after Lehman's bankruptcy on Sept. 15, 2008 — the largest in U.S. history — there are some who question why the Fed and other regulators rescued insurance giant American International Group days later, and then helped broker the sales of retail bank Wachovia to Wells Fargo, investment bank Merrill Lynch to Bank of America, and thrift Washington Mutual to JPMorgan Chase.

Bernanke apologized Thursday for not stating more clearly in congressional testimony days after Lehman's collapse that it was a dead man walking.

"This is my own fault, in a sense," Bernanke said.

Emphasizing Lehman's weakness so soon after the bank's failure "might have even reduced confidence further and led to a further pressure" in a stressed financial system, he said.

He added, "I regret not being more straightforward there, because clearly that ... has supported the mistaken impression that, in fact, we could have done something. We could not have done anything."

This week's two-day commission hearing focused on the concept of "too big to fail," where banks were rescued because their size made failure a threat to the global economy. Commissioner Byron Georgiou noted repeatedly that the efforts to save "too big to fail" banks through mergers and rescue made the remaining institutions bigger, and a more serious threat if they fail.

The size of what are now the nation's six largest banking firms was equivalent to about 58 percent of the nation's gross domestic product in 2007, he said, but by last year the firms were equal to 63 percent of the economy.

"I think it's happened because of the 'too big to fail' backstop," said Federal Deposit Insurance Corp. Chairman Sheila Bair, who testified after Bernanke.

Recently passed legislation, she said, should reduce the impression by investors that large institutions will get a government bailout if they need one. The legislation gives regulators the power to break apart institutions considered large enough to pose a risk to the financial system, she said.

Neither she nor Bernanke, however, gave any indication of which, if any, of today's large banks meet that category.

Once Lehman Brothers failed, shock waves ripped through global finance in ways not seen in 75 years. Banks stopped lending to each other or consumers. Corporations that rely on issuance of short-term bonds to fund their day-to-day operations couldn't attract buyers. Even the money-market funds that investors thought were equal to cash proved unsafe. Lending simply froze.

Although the cost of borrowing has come down in the past two years, banks remain reluctant to lend or invest, preferring to sit on cash or earn minuscule returns rather than take risks.

The commission, created by Congress, must prepare an exhaustive report on the causes of the financial crisis by Dec. 15.

Academic research is now beginning to show how the near-meltdown of global finance in the summer and fall of 2008 had many of the hallmarks of old-fashioned bank runs, Bernanke told the commission.

The sale of Charlotte, N.C.-based Wachovia to San Francisco-based Wells Fargo on Sept. 29, 2008, was an example. Bernanke clarified Thursday that it was Wachovia and not regulators who sought its quick sale.

"It was their judgment that they wouldn't be able to open up in a day or two," Bernanke said, pushing back on the notion that regulators were picking and choosing who to sell and who to save.

A deposit-taking institution with huge investment in mortgage bonds that were losing value, Wachovia concluded investors and depositors were heading for the exits.

The FDIC's Bair said the same was true for Seattle-based thrift Washington Mutual. At the time, the two were the largest federally insured lenders to fail.

"As the two companies' financial condition weakened, unsecured borrowing lines were cut, secured borrowing lines were restricted, and deposits were withdrawn at an accelerating pace," Bair said, describing a modern bank run. "Market pressure and deposit outflows increased rapidly in the week of the Lehman bankruptcy and the AIG collapse."