Regulation and Supervision

Abstract

Why did Lehman Brothers have to go bankrupt? This question has often been asked since the bankruptcy of Lehman was recognized as having a hugely disruptive effect on the financial system and the economy around the world beyond expectations. For that question, a broad range of materials have provided various answers from each viewpoint. FCIC’s report indicates that risky trading activities, enormous leverage, reliance on short-term funding, problems in its corporate governance including risk management as well as inadequate regulatory oversight can be significant causes of Lehman’s collapse. However, why could such common weaknesses not be easily corrected or improved but be overlooked for a long time, and lead to such a huge calamity? A more in-depth investigation or a study from a different viewpoint may be required to grasp the essence of this problem and to find the right way and direction of regulatory reforms. In this essay, from the case studies of Bear Sterns, Lehman Brothers, and AIG, some of the essential weaknesses in their risk management and in the Federal Reserve’s supervision especially over their liquidity risk are pointed out. Then, by comparing with the framework and conduct of the BOJ’s monitoring of financial institutions’ liquidity, the reasons why the Federal Reserve could not sufficiently exert its regulatory and supervisory power over those financial institutions’ liquidity risk management will be examined. Finally, based on the analysis above, some assessment of Dodd-Frank regulatory reforms will be added.