Source: The Associated Press

U.S. federal bank regulators on Wednesday defended their actions leading up to the collapse of Lehman Brothers and the purchase of Wachovia at the height of the financial crisis before members of an inquiry panel who criticized government oversight of the banks.

The regulators told the Financial Crisis Inquiry Commission at a hearing that government officials’ decisions in the fall of 2008 not to rescue Lehman and to encourage Wells Fargo & Co.’s takeover of Wachovia made sense under the circumstances.

Former Lehman Chairman and CEO Richard Fuld Jr. said in prepared testimony that Lehman did everything it could to limit its risks and save itself.

“Lehman’s demise was caused by uncontrollable market forces, and the incorrect perception and accompanying rumours that Lehman did not have sufficient capital to support its investments,” Fuld said in his testimony. He said Lehman proposed to federal regulators measures that could have buttressed the firm but “each of those requests was denied.”

Unfairly, Fuld said, other financial firms later received the government assistance that Lehman was denied. Lehman was “mandated” by regulators to file for bankruptcy on Sept. 15, 2008 — the only firm ordered to do so, he said.

Thomas Baxter, general counsel of the New York Federal Reserve, said in his prepared testimony that the Fed and other agencies “tried hard to save” Lehman Brothers.

The congressionally appointed panel is examining potential systemwide risk from financial institutions and the banks that were deemed too big and too interconnected to fail. Under the landmark financial overhaul law enacted in July, regulators are empowered to shut down financial institutions whose collapse could threaten the system.

In the years before the crisis as banks grew aggressively and took on increasing risk, the regulators failed to look at their potential damage to the financial system until mid-2007, panel chairman Phil Angelides said. Then, after things unravelled, regulators declined to rescue Lehman but pumped billions of dollars into other teetering financial institutions like insurance conglomerate American International Group Inc., he said.

“One was in and one was out,” said Angelides

Scott Alvarez, general counsel of the Federal Reserve, and John Corston, an official of the Federal Deposit Insurance Corp., said their agencies lacked the legal authority to check on the banks for potential systemic risk and were limited to overseeing their individual financial soundness.

“We didn’t have the tools to do anything other than what we did,” Alvarez testified.

Robert Steel, the former Wachovia CEO, related how FDIC Chairman Sheila Bair directed Wachovia in late September 2008 to enter into talks with Citigroup Inc. as a potential buyer.

The FDIC had decided not to provide aid to Citigroup or Wells Fargo in acquiring Wachovia.

The negotiations with Citigroup “proved extremely complicated and difficult,” Steel said.

Panel members questioned the leeway the Internal Revenue Service granted in October 2008 to banks seeking to write off losses. It likely inspired the nearly $13 billion premium that Wells Fargo agreed to pay for Wachovia above Citigroup Inc.’s previous offer, they said. The IRS change boosted banks’ ability to offset the losses from loans and other bad debts held by other banks they acquire. Citigroup sued.

The changes reversed more than 20 years of tax law and was undeniably a form of government assistance to Wells Fargo and Wachovia, said panel member Bill Thomas, a former Republican House member from California who headed the Ways and Means Committee.

“They changed the law, but it was convenient, … it was a better deal,” Thomas said.

After the subprime mortgage bubble burst in 2007, complex investments called credit default swaps — which insured against default of securities tied to the mortgages — collapsed. That brought the downfall of Lehman Brothers, the biggest bankruptcy in U.S. history, and triggered a panic in financial markets.

Wachovia had a huge amount of business in adjustable-rate mortgages, enticing borrowers who later defaulted on their home loans. The $12.7 billion acquisition by Wells Fargo, announced in early October 2008, created an institution with operations in 39 states and the District of Columbia.