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Lawmakers assail regulators over failure to catch accounting maneuver at Lehman

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By Neil Irwin and Zachary A. Goldfarb
Washington Post Staff Writer
Thursday, March 18, 2010

A week after the disclosure that Lehman Brothers used an unconventional accounting technique to make its balance sheet look stronger than it was in the months before its collapse, lawmakers Wednesday attacked the federal regulators who failed to detect and halt the practice.

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The head of the Securities and Exchange Commission accepted primary responsibility on behalf of her agency for shortcomings in its oversight of Lehman at a congressional hearing. And at a separate hearing, Federal Reserve Chairman Ben S. Bernanke faced tough questions on why Fed examiners monitoring Lehman in spring 2008 failed to catch the accounting tactics, which helped the bank hide $50 billion in liabilities from its quarterly reports.

The scrutiny from lawmakers comes as both agencies try to fend off attacks in the debate over how to remake the nation's system of financial regulation and shows how the Fed's extraordinary efforts to shore up the economy have exposed it to wider criticism of its performance.

The SEC oversaw Lehman Brothers and other investment banks under a voluntary regulatory program that the agency's chairman, Mary Schapiro, said was "terribly flawed in design and execution." Testifying before the House Appropriations Committee, she blamed the agency's failure on "our enforcement and disclosure mentality," which focused more on whether a firm was adhering to securities law than whether it was financially sound. She said the agency lacked the staff and skills to do the job.

The investment bank oversight program has since been eliminated, and the officials who ran the program have left the agency. But Schapiro said that to the best of her knowledge, none of the officials involved had been fired.

Schapiro said SEC staff members were not aware of the bank's use of the controversial accounting treatment, which came to light in a report last week from the court-appointed examiner in Lehman's bankruptcy case. But it wasn't clear whether the SEC overlooked the practice as it examined Lehman's books or whether Lehman concealed it from the agency.

According to the examiner's report, Lehman engaged in transactions at the end of each quarter that temporarily moved $50 billion in risky assets off its balance sheet, with an agreement to repurchase them later. The maneuvers made the firm appear stronger financially in its quarterly reports than it was.

Although the SEC had primary responsibility for regulating Lehman, the Fed had also had examiners working inside the firm since the March 2008 decision to bail out Bear Stearns. Those officials also failed to raise red flags about Lehman's accounting.

Bernanke said that the Fed had only two staff members on-site at Lehman during that period and that they were focused mainly on ensuring that the Fed would be repaid for emergency loans made to Lehman under a program started after the Bear Stearns bailout.

"We had only a couple of people in the company whose primary objective was to make sure we got paid back the money we were lending to Lehman," Bernanke said. "We were not the supervisor. And in any case, we would not have the authority to address accounting and disclosure issues in that context."

He contrasted the situation with Lehman to the current oversight of Goldman Sachs, where the Fed is the primary supervisor. (Goldman converted from an investment bank to a bank-holding company in fall 2008, putting it under the Fed's oversight.) The central bank has about a dozen regulators working at Goldman and another dozen monitoring the firm from the Fed's offices.

The failure to detect questionable accounting comes as Bernanke and the Fed seek to defend their role overseeing banks more broadly against efforts on Capitol Hill to limit that authority.

"As many as a dozen government officials were provided desks, phones, computers -- and access to all of Lehman's books and records," said Rep. Spencer Bachus (R-Ala.), the ranking Republican on the House Financial Services Committee. "Despite this intensive on-site presence, the New York Fed and the SEC stood idly by while the bank engaged in the balance sheet manipulations. . . . This raises serious questions regarding the capability of the Fed to conduct bank supervision."

The episode shows some hazards of the Fed's expansive moves to support the financial system. Before the Bear Stearns bailout, the Fed would have had no role overseeing investment banks, but that action left it open to criticism for mistakes in that industry. Similarly, the Fed has been criticized for actions by the insurance company American International Group -- which it had nothing to do with before it bailed that firm out in September 2008.

Bernanke's main message at the hearing was that the Fed should remain the major regulator of banks large and small. Legislation introduced this week by Sen. Christopher J. Dodd (D-Conn.) would strip the Fed of oversight of most banks, leaving it with only the largest ones. The comments were the first by a Fed official since Dodd proposed his bill Monday.

"We are quite concerned by proposals to make the Fed a regulator only of the biggest banks," Bernanke said. "It makes us essentially the 'too-big-to-fail' regulator."


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