Lehman: where were the watchdogs? Where are they now?

Another potentially explosive aspect of the 2,200-page Lehman report (as well as the likely wave of lawsuits against those named as having “colorable causes of action” against them) is the claim that the regulators knew about the problem, but failed to act. Consider the action of the Federal Reserve Bank of New York after Bear Stearns collapsed in 2008: (report page 1488)

The FRBNY [New York Fed] developed two new stress scenarios: “Bear Stearns” and “Bear Stearns Light.” Lehman failed both tests. The FRBNY then developed a new set of assumptions for an additional round of stress tests, which Lehman also failed. However, Lehman ran stress tests of its own, modeled on similar assumptions, and passed. It does not appear that any agency required any action of Lehman in response to the results of the stress testing.

Smart move, guys. Here’s some more from the report:

Although various Government agencies had information that raised serious
questions about Lehman’s reported liquidity and about the sufficiency of its capital and
liquidity to withstand stress scenarios, the agencies generally limited their activities to
collecting data and monitoring.

But they’ve learnt their lesson, right? Karl Denninger worries that they have not. He points out the 2009 stress tests which convinced the markets that the (remaining) banks were now financially sound were also carried out by the banks. Can we believe them? If so, why?

As an aside, at the time when the New York Fed was ignoring Lehman’s failed stress tests, Tim Geithner was its head. He is now Treasury secretary, and subject of a deep-dive profile in this month’s Atlantic.

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Christopher Cook is an FT editorial writer. Before joining the FT in 2008 as a Peter Martin Fellow, he worked for three years for the Conservative party.

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