Shut banks that pose risk: Bernanke

Marcy Gordon

U.S. Federal Reserve Board Chairman Ben Bernanke told a panel investigating the financial crisis that regulators must be ready to shutter the largest institutions if they threaten to bring down the financial system.

“If the crisis has a single lesson, it is that the too-big-to-fail problem must be solved,” Mr. Bernanke said Thursday while testifying before the Financial Crisis Inquiry Commission.

Mr. Bernanke also said it was impossible for the Fed to rescue Lehman Brothers from bankruptcy in 2008 because the Wall Street firm lacked sufficient collateral to secure a loan. Lehman's former chief executive officer told the panel a day earlier that the firm could have been saved, but regulators refused to provide help.

The Fed chief presented his analysis of the crisis and views on potential system-wide risks as the panel approaches the end of its year-long investigation into the Wall Street meltdown.

The financial overhaul law enacted this summer gives regulators the authority to shut down firms when their collapse poses a broader threat to the system. The process resembles the one used by the Federal Deposit Insurance Corp. to close failing banks.

FDIC Chairman Sheila Bair told the panel “the stakes are high” for regulators to effectively exercise their new powers.

If not, “we will have forfeited this historic chance to put our financial system on a sounder and safer path in the future,” Ms. Bair said. “The tools are there. The regulators have to use them,” she testified.

Panel chairman Phil Angelides said the new law will be an enormous test of will of the regulators.

Ms. Bair and Mr. Bernanke said tougher rules and market pressures will lead huge firms to voluntarily shrink themselves. Executives can no longer count on the government to bail them out if they veer toward failure, they said.

Mr. Bernanke said that bailing out these institutions is not a healthy solution and great improvement will come from the new law.

“Too-big-to-fail financial institutions were both a source ... of the crisis and among the primary impediments to policy makers' efforts to contain it,” Mr. Bernanke said.

“We should not imagine ... that it is possible to prevent all crises,” he said. “To achieve both sustained growth and stability, we need to provide a framework which promotes the appropriate mix of prudence, risk-taking and innovation in our financial system.”

Mr. Bernanke led the economy through the financial crisis and the worst recession since the 1930s. The Federal Reserve took extraordinary measures to inject hundreds of billions of dollars into the battered financial system.

Last week he said the central bank is prepared to make a major new investment in government debt or mortgage securities if the economy worsened significantly.

Members of the congressionally appointed panel have questioned the government's decision to let Lehman fall while injecting billions of dollars into other big financial institutions during the crisis.

Former Lehman CEO Richard Fuld Jr. testified Wednesday that the firm could have been rescued. But the regulators refused to help — even though they later bailed out other big banks.

Mr. Bernanke said that he was partly to blame for leaving the wrong impression that the central bank could have saved Lehman from failure.

He 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.

Mr. Angelides questioned whether politics had played a role in the decision not to bail out Lehman, citing e-mails showing U.S. officials fretting over how the media might portray a taxpayer-funded rescue of a Wall Street titan. Lehman’s bankruptcy triggered widespread panic, hastening the worst global recession since the Second World War.

“It was with great reluctance and sadness I conceded that there was no other option” but to let Lehman fail, Mr. 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. Mr. Bernanke said it was the “unanimous opinion” of New York Fed lawyers and leadership that Lehman did not meet that requirement.

Asked how the Lehman case differed from that of American International Group Inc., which received $182-billion (U.S.) in taxpayer aid, Mr. Bernanke said there was a fundamental difference.

AIG, as the biggest insurance company in the U.S., had valuable assets which could back up the Fed's emergency loan, he said.

“The Federal Reserve will absolutely be paid back by AIG,” Mr. Bernanke said.

With files from Reuters