Making Wall Street Pay

The heads of the big Wall Street firms go to Congress this week to testify about what they knew (or didn’t) about the causes behind the financial crisis. Charlie Gasparino asks: Will we finally learn the truth about why Lehman Brothers failed?

On Wednesday, the heads of the remaining big financial firms are scheduled to be in Washington for a hearing before Barney Frank's committee on financial services. Representative Frank is billing the testimony as a matter of accountability. His committee has direct oversight of the firms, and each of them has accepted government bailout money amid reports that Wall Street is funneling the money for fancy bathrooms, offices, and big bonus checks. Staffers tell me the committee wants to make sure taxpayer funds are being used for essential purposes, namely to repair the banks’ battered balance sheets so they can begin lending money once again to individuals and small businesses. And those questions will be put directly to the men who run those banks as Treasury Secretary Tim Geithner gets ready to announce a new plan to fix the system these guys broke.

"This is a lynching," said a publicist for one of the big Wall Street firms, who’s dreading this appearance.

That's the story from Washington. Back in New York—where Citigroup CEO Vikram Pandit, Morgan Stanley CEO John Mack, Lloyd Blankfein of Goldman Sachs, and JP Morgan's Jamie Dimon all work—the hearings have been described much differently. "This is a lynching," said a publicist for one of the big Wall Street firms, who’s dreading this appearance. Another flack called the hearing "theater of the absurd." A third called it "an inquisition." And still another called it a "public anal exam."

Pandit was apparently so uneasy about his possible appearance that at first he told committee staffers he had a conflict: A long-planned trip to China. The committee, which has subpoena power, told Pandit's people that it would probably be a smart move if he reconsidered his travel plans. "We said 'Look, this would appear a little odd if all your peers are all going to be here and you're not," said Steven Adamske, a spokesman for the committee. "We said 'It's a good idea for you to be here, too.'"

Shortly thereafter, Pandit cancelled his trip and he's now scheduled to testify. A Citigroup spokesman said: "When the committee inquired about Vikram's availability for a possible hearing on February 11, we indicated he had a trip scheduled that week. The committee subsequently notified us that the hearing would be held that day and Vikram cancelled his trip in order to participate."

Probably the only Wall Street executive who may be breathing a sigh of relief is former Merrill CEO John Thain. That's because he was recently fired by Bank of America CEO Ken Lewis, after the big Charlotte, North Carolina-based bank purchased Merrill amid reports of huge losses, and big bonuses being handed to top executives, not to mention Thain's own lavish spending on his office, as first reported by The Daily Beast. As a result, the rug-loving Thain won’t be called out on the carpet on Wednesday, but Lewis will be, and he's sure to receive tough questions about Thain’s office—including the $35,000 commode, $1,400 wastebasket and the bonus payments paid to Merrill executives after Bank of America received two rounds of government assistance.

There is, however, another big story unfolding about Wall Street accountability that is happening behind the scenes as the US Attorney's office for the Southern District of NY—the most powerful white-collar prosecutor in the country—investigates the implosion of investment bank Lehman Brothers. Lehman's fall from Wall Street darling with a stock price that was the envy of the financial business to liquidation last September is a story of epic proportions in a year filled with epic stories.

The firm's demise sent global markets into chaos—lending that was already restricted began to dry up. Investors began to pull credit lines from other banks, fearing that Lehman's problems were endemic to the financial industry. Maybe most alarming, Lehman's fall was preceded by the company's reckless fight for survival—in the weeks and months before the firm crashed, its top executives, including CEO Richard Fuld and CFO Erin Callan, had promised investors that the firm was fit and would survive. Many analysts bought the story even as others began to question Lehman's books—namely its massive holdings of debt tied to real estate. Through the summer, as the bad news began to dribble out, Lehman went on the offensive, lashing out at critics as rumormongers, and continuing—almost up until the day the firm filed for bankruptcy-court protection—to assure the markets that things would be fine.

Well, they obviously weren't and unraveling this story will do more to restore accountability to Wall Street than any hearing ever will. Of course, Lehman wasn't alone in spinning positive as the market shuttered last year. Thain, when he was CEO of Merrill, promised that the firm was well-capitalized and had mostly repaired its balance sheet before it announced major capital raises and losses. Wall Street executives will tell you that making public statements about the financial condition of their firms is tricky business; it's often like trying to catch a falling knife. They'll tell you Dick Fuld and Erin Callan were being completely honest when they gave positive assessments before the bottom fell out of Lehman because they were merely relaying to investors what they knew at the time, before conditions changed.

That might be accurate, but it fails to address bigger issues: Why make the statements if the situation has a good chance of deteriorating? Doesn't it erode investor confidence in the entire financial system when CEOs and their underlings consistently make positive assessments that stand a good chance of being way off the mark? Better yet, why make these statements in the first place if you could be plain wrong? (Especially because making demonstrably false statements to investors, though difficult to prove, constitutes securities fraud.)

Those are the kinds of questions I hope investigators ask Callan, who should have had a good handle on just how good—or in this case, how bad—the firm's books were when she made her positive statements. Keep in mind, Callan left the firm this summer, months before its liquidation, but her departure was controversial. It came just before the firm announced massive losses and the need to raise capital, all while she was attacking a hedge-fund manager named David Einhorn, who began predicting the firm's downward spiral. After she left Lehman, Callan went to work at Credit Suisse to develop a business that, ironically, deals with hedge funds. Just last week, Credit Suisse announced that Callan was taking a leave of absence. The firm provided no reason other than citing "personal reasons."

People close to Callan assure me her leave has nothing to do with the federal probe, though they won't say exactly what prompted her departure. But according to people with knowledge of the federal investigation, Callan has received a subpoena from the US Attorney for Southern District for information about Lehman Brothers, and she is one of a number of top executives at Lehman, including Fuld, and his former No. 2, Joe Gregory—whom Callan reported to as CFO—who have received these demands for information. Callan, through her lawyer, had no comment.

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I've been told by people close to the Southern District's investigation, that it began shortly after the Lehman's bankruptcy filing last year but that it's currently bogged down in investigative bureaucracy. The US Attorney's office from the Eastern District of New York and New Jersey are also investigating the Lehman case and the various agencies haven't sorted out how they will proceed. That's too bad. For my money, finding out how Lehman blew up—and whether top officials violated the law when they promoted the company's prospects before its implosion—is a necessary step toward holding Wall Street accountable for what it says and what it does. In the meantime, we will just have to settle for the theater of the absurd in Washington on Wednesday. Can't wait.

Charles Gasparino appears as a daily member of CNBC's ensemble. He is also a columnist for Trader Monthly Magazine, and a freelance writer for the New York Post, Forbes and other publications.