Lawmakers: Lehman Brothers costs schools, governments millions

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Published: April 20,2010

Tags: financial crisis, recession

WASHINGTON — Two lawmakers say Lehman Brothers’ historic collapse cost school districts and local governments in the U.S. millions, forcing many to make major cutbacks.

Rep. Anna Eshoo, a California Democrat, said 40 municipalities nationwide lost around $1.7 billion after the firm went under. She is introducing legislation that would require the federal government to compensate those governments.

At a hearing Tuesday probing what led to Lehman’s collapse, Eshoo said San Mateo County, which is in her district, lost $155 million.

Lehman’s meltdown in September 2008 was the biggest corporate bankruptcy in U.S. history. It threw global financial markets into crisis.

Another lawmaker said numerous governments suffered huge losses.

“These were school districts and local governments that made investments that they believed were conservative,” said Rep. Ed Perlmutter, a Colorado Democrat. “They trusted that federal regulators were keeping a watchful eye on companies like Lehman Brothers.”

The former chief executive for Lehman is scheduled to testify at the hearing, which will probe a bankruptcy examiner’s report that the firm masked $50 billion in debt.

The examiner, Anton Valukas, however, criticized the company and the Securities and Exchange Commission. Lehman, he said, “was significantly and persistently in excess of its own risk limits,” he said in prepared remarks. The SEC, meanwhile, “was aware of these excesses and simply acquiesced.”

In his report last month, Valukas disclosed that Lehman put together complex transactions that allowed the firm to sell “toxic” securities — mainly those made up of mortgages — at the end of a quarter. That wiped them off its balance sheet, avoiding the scrutiny of regulators and shareholders. Then the bank quickly repurchased them — hence the term “repo.”

Richard Fuld, Lehman’s former CEO, said he has “absolutely no recollection whatsoever” of any documents related to the so-called Repo 105 accounting maneuver, according to prepared testimony.

Treasury Secretary Timothy Geithner said at the hearing that Lehman’s collapse highlights why the Obama administration’s proposal to reform the financial system is needed. That legislation includes a mechanism to allow the government to safely wind down ailing financial companies whose collapse could take down the entire financial system and the broader economy.

“Lehman’s disorderly bankruptcy was profoundly disruptive,” Geithner said, according to prepared remarks. “It magnified the dimensions of the financial crisis, requiring a greater commitment of government resources than might otherwise have been required. Without better tools to wind down firms in an orderly manner, we are left with no good options.”

Geithner’s predecessor, Henry Paulson, is not appearing at Tuesday’s hearing. In written remarks, he supported several pieces of the Obama administration’s proposed financial reforms, without mentioning the bill itself.

“The government must have the authority to wind-down, and eventually liquidate, nonbank financial institutions in a manner that prevents harm to the system as a whole,” Paulson wrote. “We sorely felt the need for this authority at the time of Lehman’s failure, and, had we had it, I think the situation would have ended quite differently.”

The chairman of the SEC, Mary Schapiro, also is scheduled to testify. She will say that after Lehman’s rival Bear Stearns nearly collapsed two years ago in a government-managed sale, the SEC had little ability to prevent Lehman from going under.

She did, however, concede that the SEC “did not do enough” to oversee the five largest investment banks, even though it had authority over them since 2004. That oversight program, she said, was “insufficiently resourced, staffed, and managed from its inception.”

Lawmakers are also likely to question Schapiro about the SEC’s case against Goldman Sachs. The agency filed civil charges Friday against the venerable Wall Street firm, claiming the bank misled investors about mortgage-linked securities.

Federal Reserve Chairman Ben Bernanke, also scheduled to testify, said the central bank wasn’t aware that Lehman used the accounting move. And even if the Fed did know, it wouldn’t have changed the Fed’s view that the company was in bad financial shape, according to Bernanke’s prepared remarks.

Although the SEC was Lehman’s chief regulator, the Fed began to monitor the firm after trouble surfaced in the financial industry.

Two Fed employees were placed at Lehman to keep tabs of the company’s cash position and its general financial condition, Bernanke explained. Beyond information gathering, the employees had no authority to regulate Lehman’s disclosures, capital standards, risk-management practices or other business activity, Bernanke pointed out.

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