U.S. Federal Reserve Chairman Ben Bernanke said he was partly to blame for leaving the wrong impression that the central bank could have saved Lehman Brothers from failure in 2008.
Bernanke, testifying on Thursday before a congressional commission examining the causes of the worst financial crisis in 80 years, said he thought it very likely the investment bank was insolvent and lacked sufficient collateral to borrow enough from the central bank to avert collapse.
But he said he kept that view to himself in congressional testimony given just days after Lehman's September 2008 bankruptcy because he was worried that such comments might have spooked already panicky financial markets.
I regret not being more straightforward there because clearly it has supported the mistaken impression that in fact we could have done something we could not have done, he said.
The Financial Crisis Inquiry Commission wraps up a two-day session on Thursday focussing on too big to fail firms whose disorderly collapse could destabilize the global economy.
On Wednesday, commission Chairman Phil Angelides questioned whether politics had played a role in the decision not to bail out Lehman Brothers. Its bankruptcy triggered widespread panic, hastening the worst global recession since World War Two.
It was with great reluctance and sadness I conceded that there was no other option but to let Lehman fail, Bernanke said. The only way we could have saved Lehman would have been by breaking the law and I'm not sure I'm willing to accept those consequences for the Federal Reserve and for our system of laws.
The central bank serves as the lender of last resort for banks in financial difficulty, but it is required to lend against good collateral. Bernanke said it was the unanimous opinion of New York Fed lawyers and leadership that Lehman did not meet that requirement.
The financial crisis, which began with failing U.S. home mortgages, led to the bankruptcy, bailout or government-brokered buyout of large financial firms including Bear Stearns, Lehman Brothers, Wachovia and Washington Mutual.
The costly bailouts have been hugely unpopular with voters, and many politicians are still paying the price with angry voters as November congressional elections near.
The 10-member, congressionally-appointed commission is due to issue its report on the causes of financial crisis by December 15.
BREAKING UP HARD TO DO
Bernanke said a freshly minted financial reform law would help reduce the risk of future problems, provided regulators follow through on its implementation.
He listed stricter capital and liquidity rules, a regime to wind down a failing firm in an orderly fashion, and requirements that most derivatives are to be settled in clearinghouses, as among the measures that will strengthen the financial system and help address the too-big-to-fail problem.
Federal Deposit Insurance Corp Chairman Sheila Bair, who heads the agency which protects depositors in failed banks, said regulators play a vital role in ensuring the newly enacted reforms are successful.
If implementation is not properly carried out, the reforms could be ineffective in preventing future crises or containing financial market disruptions should they occur, she said.
One of the new rules requires large financial companies to produce living will plans for how they could be safely dismantled if necessary. Bair said if those plans are not deemed credible, regulators can break them up.
The government would be authorized to break up the institution so that it no longer creates undue risk to the financial system, she said in written testimony.
Breaking up banks that fail to produce credible resolution plans was a last resort that would only be taken if, over two years, firms ignore other entreaties to produce a credible plan. Before breaking up a firm, Bair said regulators could impose stricter requirements for capital, liquidity and leverage.
She also took aim at critics who say the struggling economy is reason to postpone new capital requirements, including those now being worked out as part of the international Basel III negotiations.
While acknowledging that the economic recovery has been slow, and stricter requirements will not be easy for banks to implement, she said this was no excuse for repeating the mistakes of the past when it comes to responsible capital requirements.
(Reporting by Mark Felsenthal and Dave Clarke; Writing by Emily Kaiser; Editing by Tim Dobbyn)