The Securities and Exchange Commission is examining whether any of the 19 largest U.S. banks are using an accounting trick that a bankruptcy examiner has said led to the collapse of Lehman Brothers, SEC Chairman Mary Schapiro said Tuesday.
Schapiro testified at a congressional hearing that the SEC is scrutinizing Lehman's use of the accounting move, known as Repo 105, that allowed it to mask its weakness before it failed.
She said the agency has sent letters to the 19 banks, seeking information about any such transactions.
The hearing is looking into what led to Lehman's meltdown in September 2008. But it also drew lawmakers into a partisan squabble over the Obama administration's push for financial regulatory reform.
Lehman's collapse was the biggest corporate bankruptcy in U.S. history and threw global financial markets into crisis. The hearing probed the bankruptcy examiner's report that said the firm masked $50 billion in debt.
Schapiro said the SEC is examining "the truthfulness of the disclosure" in Lehman's financial filings.
"It's not clear any action by the SEC could have saved Lehman Brothers, but we are determined to use the lessons of that experience to be more effective," Schapiro said. "More vigorous oversight and a new approach are essential."
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. After reviewing the transactions, he said the firm complied with accounting standards.
Fuld expressed regret about the company's collapse.
"One day we had a firm," he said. "The next day we did not. A lot of people got hurt by that, and I have to live with that."
The bankruptcy examiner, Anton Valukas, criticized the company and the SEC.
"Although the public had a right to expect that firms like Lehman were being regulated in a meaningful way, in reality, they were not," Valukas told lawmakers. Regulators, he said, missed opportunities to alter Lehman's conduct "before its situation had reached the point of no return."
In his report last month, Valukas disclosed that Lehman put together complex transactions that allowed the firm to sell 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."
Valukas' report reached no conclusion on whether executives violated securities laws. But it did suggest there may be enough evidence to support civil damages in a trial.
Cities lost $1.7 billion
Two lawmakers testified at the hearing that Lehman's meltdown cost school districts, local governments and hospitals millions, forcing them to make cutbacks.
Rep. Anna Eshoo, D-Calif., 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. Eshoo said San Mateo County, which is in her district, lost $155 million.
Another lawmaker said numerous governments and hospitals in his state suffered huge losses.
"These were school districts and local governments that made investments that they believed were conservative," said Rep. Ed Perlmutter, D-Colo. "They trusted that federal regulators were keeping a watchful eye on companies like Lehman Brothers."
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.
Lawmakers used the hearing to spar over the Obama administration's push for financial regulatory reform.
Republicans asserted that regulators' failure to prevent Lehman's collapse is proof that the proposed financial reforms won't work either.
"Given their track record, giving these regulators more power will provide the markets with a false sense of security, while hampering the free market," said Rep. Scott Garrett, R.-N.J.
‘A more effective regulator’
Republicans accused Democrats of trying to continue federal bailouts by injecting more money into Wall Street companies.
But the committee's chairman, Rep. Barney Frank, D-Mass., called that a "blatant mischaracterization," arguing that "no money can be spent in these cases until the institution is out of business."
Schapiro, who was not at the SEC in the fall of 2008, said the agency didn't do enough to oversee the five largest investment banks, even though it had authority over them since 2004. That oversight program, she said, did not have enough resources.
Going forward, "the SEC is determined to become a more effective regulator," she told lawmakers. "We are determined to use the lessons of that experience to be more effective."
Her comments come days after the SEC filed civil fraud charges against Goldman Sachs, alleging it withheld information in a complex transaction involving risky mortgage securities.
Federal Reserve Chairman Ben Bernanke testified at the hearing that 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, he said.
Although the SEC was Lehman's chief regulator, the Fed began to monitor the firm after trouble surfaced in the financial industry.