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Editor’s Note: This is one of the better explanations for just how we got into the mess we’re currently in that we’ve come across. It illustrates the consequences of pervasive lack of regulation in the financial services industry. FDL Contributor Bill Black scorched everyone with his testimony on the failure of Lehman Brothers when he testified before the House Financial Services Committee today. His prepared remarks can be found here (PDF). CHAIRMAN KANJORSKI: And now we’ll hear from Mr. William K. Black, Associate Professor of Economics and Law, the University of Missouri, Kansas City School of Law. Mr. Black. BILL BLACK: Members of the Committee, thank you. You asked earlier for a stern regulator, you have one now in front of you. And we need to be blunt. You haven’t heard much bluntness in hours of testimony. We stopped a nonprime crisis before it became a crisis in 1991 by supervisory actions. We did it so effectively that people forgot that it even existed, even though it caused several hundred million dollars of losses — but none to the taxpayer. We did it by preemptive litigation, and by supervision. We broke a raging epidemic of accounting control fraud without new legislation in the period of 1984 through 1986. Legislation would’ve been helpful, we sought legislation, but we didn’t get it. And we were able to stop that because we didn’t simply consider business as usual. Lehman’s failure is a story in large part of fraud. And it is fraud that begins at the absolute latest in 2001, and that is with their subprime and liars’ loan operations. Lehman was the leading purveyor of liars’ loans in the world. For most of this decade, studies of liars’ loans show incidence of fraud of 90%. Lehmans sold this to the world, with reps and warranties that there were no such frauds. If you want to know why we have a global crisis, in large part it is before you. But it hasn’t been discussed today, amazingly. Financial institution leaders are not engaged in risk when they engage in liars’ loans — liars’ loans will cause a failure. They lose money. The only way to make money is to deceive others by selling bad paper, and that will eventually lead to liability and failure as well. When people cheat you cannot as a regulator continue business as usual. They go into a different category and you must act completely differently as a regulator. What we’ve gotten instead are sad excuses. The SEC: we’re told they’re only 24 people in their comprehensive program. Who decided how many people there would be in their comprehensive program? Who decided the staffing? The SEC did. To say that we only had 24 people is not to create an excuse — it’s to give an admission of criminal negligence. Except it’s not criminal, because you’re a federal employee. In the context of the FDIC, Secretary Geithner testified today that this pushed the financial system to the brink of collapse But Chariman Bernanke testified we sent two people to be on site at Lehman. We sent fifty credit people to the largest savings and loan in America. It had 30 billion in assets. We had a whole lot less staff than the Fed does. We forced out the CEO. We replaced the CEO.

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