The Valukas Report on Lehman: My Questions


The Valukas Report on Lehman: My Questions

Posted by Karl Denninger

Giving that House Financial Services is having a hearing today on the Valukas report on the Lehman collapse, I thought I’d put forward the questions I would ask if I was a member of the committee.

In no particular order:

  • From Mr. Valukas written testimony:
    (But) we found that Lehman was significantly and persistently in excess of its own risk limits. Lehman management decided to disregard the guidance provided by Lehman’s risk management systems. Rather than adjust business decisions to adapt to risk limit excesses, management decided to adjust the risk limits to adapt to business goals.

    We found that the SEC was aware of these excesses and simply acquiesced.

    In 2004, prior to becoming Treasury Secretary, Henry Paulson, then the head of Goldman Sachs, came to The SEC and asked for the leverage limits that formerly constrained investment banks – including Lehman – to be dropped.  SEC rules formerly limited leverage to 14:1.  It is important to note that this was Mr. Paulson’s second request – the first, made in 2000, was turned down.  This second request was granted.

    In point of fact, all of the firms that failed – AIG, Lehman, Bear, Fannie and Freddie – had leverage at the point of failure dramatically higher than the former limit.  At 14:1, Lehman would not have failed at all (neither would have Bear Stearns.)

    To Mary Shapiro, Ben Bernanke, and Tim Geithner:  How can we sit here today, more than three years into this crisis and coming up on two years since Lehman failed, and not have rescinded the leverage limit change that was asked for by Henry Paulson – and without which the failures would not have taken place?

  • Again, from Mr. Valukas:
    The SEC

    knew that Lehman was reporting sums in its reported liquidity pool that the SEC did not believe were in fact liquid; the SEC knew that Lehman was exceeding its risk control limits; and the SEC should have known that Lehman was manipulating its balance sheet to make its leverage appear better than it was. Yet even in the face of actual knowledge of critical shortcomings, and after Bear Stearns’ near collapse in March 2008 following a liquidity crisis, the SEC did not take decisive action.

    This is not a unique failure.  The OTS has been fingered by its own Inspector General for having an employee who was an OTS inspector during the S&L crisis and during that crisis allowed an S&L to fraudulently backdate deposits perform the exact same outrageous action with IndyMac bank.  The bank subsequently failed and a significant part of the FDIC loss was taken as a consequence of its delayed action.

    OTS was also fingered in the WaMu collapse for treating the bank as not a regulated entity but rather as a constituent, a term actually used by the OTS in hearings last week.

    The SEC clearly has historically taken the same sort of approach to so-called “regulation” leading up to this crisis with Lehman Brothers.   Indeed, we know from the report that:

    But months earlier, it
    learned critical information that put it on notice that Lehman’s liquidity was not as was portrayed to the investing public.  But the SEC did not act on its knowledge, it simply acquiesced.

    This is, for all intents and purposes, the same misrepresentation made by IndyMac bank and was both countenanced and intentionally ignored by The SEC.
    Both The Federal Reserve Board and FRBNY in addition have effectively ducked their responsibility as the primary safety and soundness regulator of the banking system as a whole.

    To Tim Geithner, Ben Bernanke and Mary Shapiro: As of the present day we have financial institutions throughout the land that we know for a fact are holding “assets” at dramatically above fair market value.  We know this through the weekly FDIC bank seizures where the discrepancy is, every week, outlined.  How can your agencies defend your actions both leading to Lehman’s bankruptcy and in the nearly two years hence when these practices are continuing even today and, since OTS is in fact  under Treasury, why are the person(s) responsible for the aforementioned egregious and documented conduct still employed?  Further, when are you going to force firms to actually account for their assets at market value instead of intentionally-inflated numbers that make financial institutions appear dramatically healthier than they really are?

I would additionally ask all present:

  • Why has nobody bothered to finger the seminal change that led to the inflation of the terminal phase of the bubble and it’s collapse: the removal of former hard-cap leverage limits that was requested by Henry Paulson of Goldman Sachs in 2004, and why should we not legislatively re-impose this hard cap immediately – on all financial institutions?

  • Why, after the collapse of Enron and MCI, two firms that used off-balance sheet structures to hide risk and distort their financial health, were such structures not entirely banned (as was often-claimed would be the case in the wake of both firms’ failure), and why to this day are these structures still outstanding in the aggregate of trillions of dollars among US Financial firms?  How do you and your agencies justify computing Tier Capital ratios without including these so-called “off balance sheet” exposures?
  • Why, after the S&L Crisis and now IndyMac, as well as Lehman, have not each and every one of the alleged “regulators” that willfully looked the other way or even worse, were knowingly involved in manipulation of balance sheets and valuations, been at minimum been removed form their posts?  It is clear from the record that multiple Federal Agencies have in fact been willfully blind to either dramatic increases in risk among institutions or, in some cases, been willfully complicit in acts that give rise to a colorable claim of corruption.  Yet in exactly none of these cases has enforcement action been taken within the regulatory agencies.  Why not?