Lehman Brothers Ran "Scams Like Enron," Led Wall Street in Liar Loans Say University Professor and Former Litigator

Turning for a moment to economics...

 Lehman Brothers played “three card Monte” with its customers by selling them known “Liar Loans and ran scams similar to scams run by Enron.  Those are a few remarks made to the U.S. House Financial Services Committee in the testimony of University of Missouri Professor William M Black, former loan litigation director Federal Home Loan Bank Board.  He said that Lehman Brothers led Wall Street in the sale of  "Liar Loans” and said the conduct of government regulators was akin to  “criminal negligence" but being the government the regulators are exempt from prosecution.  

Black said the Federal Reserve sent only two people to examine Lehman’s books and they should have sent "300."  He noted he had sent 50 people to investigate a smaller $30 billion bank that was failing.  He said Lehman ran similar scams as the “scams run by Enron” and that regulators have paid only lip service to closing the “Enron Loophole," and such scams can still be run.  

The collapse of Lehman's has been described as a runaway train wreck that everybody saw coming and nobody bothered to get out of the way. 

As the following chart demonstrates, H.R. 4173, the Wall Street Reform and Consumer Protection Act, addresses some of the most egregious problems raised by the Lehman Brothers’ failure, which precipitated the costly taxpayer bailout put forward by President Bush in 2008. For a more complete analysis of how the Republican substitute makes taxpayer bailouts more likely, click here

Problem	H.R. 4173	Republican “Substitute”
No mechanism to wind down and break up large, interconnected institutions in an orderly fashion	Ends taxpayer bailouts Creates comprehensive orderly dissolution regime for large, interconnected firms; Protects taxpayers by requiring costs to be borne by industry, creditors and shareholders, and management Directs regulators to take steps to control risks and break up firms before they become too large, interconnected, concentrated, or risky	Relies on changes to the Bankruptcy Code, which could lead to systemic disruption and uncertainty within the markets
Minimal regulation of investment bank holding companies	Strong, consolidated supervision of interconnected firms, including investment bank holding companies	No provision
No mechanism to identify and address systemic risks (firm specific or activity specific)	Consolidated supervision of systemically important financial services holding companies; Creates Systemic Risk Council to monitor the financial system for potential risks; Facilitates communication among Council members to enhance overall knowledge of the markets; Requires analysis of both firms and activities for potential risk	A Markets Stability and Capital Adequacy Board gathers data and reports to Congress and functional regulators; No provision for consolidated supervisor
Risky, undetected off- balance sheet exposures	Requires the computation of capital requirements for large, interconnected firms to take into account the off-balance sheet activities of the company (Fed authority to exempt a company or certain of its transactions)	No provision
Insufficient regulation of OTC Derivatives	Registration of swap dealers and major swap participants; Required clearing and trading of certain swaps; Reporting of all swap transactions; Regulators must set capital and margin; requirements for swap dealers and major swap participants; Regulators may remove end user exemption if systemically risky counterparty exposure is created	No mandatory clearing or trading requirements; Focuses on reporting of swap data Does require regulators to set margin requirements
Excessive compensation rewarding risky behavior	Gives shareholders a “say on pay” – an annual, non-binding, advisory vote on pay practices including executive compensation and golden parachutes; Enables regulators to ban inappropriate or imprudently risky compensation practices; Requires financial firms with more than $1 billion in assets to disclose any compensation structures that include incentive-based elements.	Agrees with Democrats for a non-binding “say on pay,” but requires a vote only once every three years; No provisions to allow regulators to address risky, incentive-based compensation structures
Credit Rating Agencies’ methodologies failed to identify key risks	Greater transparency in methodologies and ratings in structured and non-structured products; Enhanced oversight by the SEC; Conflicts of interest and liability provisions	No provisions except name change of NRSRO
Gaps in SEC authority	Increase funding to meet need for enhanced SEC regulation and greater enforcement activities	No corresponding provision
Breakdowns in inter-agency communications	Specific authority to share reports and other information among relevant regulators; Backup authority if primary regulator fails to act; Systemic Risk Council has authority to recommend increased prudential standards and requirements to primary regulators	Requires functional regulator to share reports with the Market Stability and Capital Adequacy Board
Excessive leverage and insufficient capital	Requires the computation of capital requirements for financial holding companies that are subject to stricter standards to take into account all off-balance sheet activities of the company (Fed authority to exempt a company or certain of its transactions); 15 to 1 cap on leverage ratios for these companies	Include swaps exposure in establishing capital requirements for swap users
Excessive reliance on short-term debt	Fed may limit the short-term debt of financial holding companies that are subject to stricter standards to prevent these entities from exposure to runs on the bank	No provision

** prepared by the Democratic Staff of the House Financial Services Committee