The days of bailouts of large financial institutions are officially over, Federal Reserve Board Chairman Ben Bernanke said Thursday.
Testifying at a hearing before the Financial Crisis Inquiry Commission, the central banker said the regulatory reform law effectively ties the Fed's hands, preventing it from saving any single institution.
"Changes in the bill have eliminated the ability of the Fed to lend to an individual institution," Bernanke said. "Barring some midnight session of Congress that rewrites the law, I don't think it would be feasible for us to bail out firms the way we did during the crisis."
During much of the hearing, Bernanke was asked to explain the Fed's bailout of American International Group and why it did not act in a similar fashion to save Lehman Brothers.
But commissioners also questioned Bernanke on whether the Dodd-Frank law would work as intended, preventing future government assistance to save financial institutions.
"What would be different now?" asked Douglas Holtz-Eakin, a member of the panel and former economic adviser to Sen. John McCain's presidential campaign. "How would it play out for Bear [Stearns], Lehman, AIG, if those authorities were in place?"
Bernanke said all three would have been seized by the government and dismantled.
"In all three cases, they would have been appropriate candidates for use of the resolution authority," he said. "I don't know what the alternative would have been unless we could have stopped the [liquidity] runs with cheery words. But I don't know how to do that."
Under the law, which was enacted July 21, the Fed's emergency 13-3 lending powers were significantly curtailed. The central bank can no longer lend to a single institution, as it did with AIG, but must restrict assistance to broad programs available to the industry.
But the law also gave regulators new powers to detect problems earlier and seize and unwind systemically important firms. Bernanke said such power would be critical going forward.
Asked whether large firms should be broken up, Bernanke reiterated that size itself was not the problem, but whether a firm had the ability to properly manage the institution.
"It's our responsibility to make sure their management is effective," he said. "If we are persuaded that they cannot manage the risks of the organization because it is too complex, we have the ability to change their structure."
He said regulators would take action in such a scenario.
"Where there is a failure of risk management or business management because of business complexity, it's very important regulators work to address the problem, and I assure you that we will," he said.
During the hearing, the central bank chief rejected claims that the Fed allowed Lehman to fail, saying he sought out every option to prevent its collapse.
"I believed deeply that if Lehman was allowed to fail or did fail that the consequences for the U.S. financial system and the U.S. economy would be catastrophic," Bernanke said. "And I never at any time wavered in my view that we should do absolutely everything possible to prevent the failure of Lehman."
Ultimately, Bernanke said that the Fed could not lend to Lehman because it did not think it would be paid back.
"Lehman did not have enough collateral to allow the Fed to lend it enough to meet" a run on the bank's liquidity, Bernanke said. "If we lent the money to Lehman, all that would happen would be is that the run would succeed… the firm would fail and not only would we be unsuccessful, but we would have saddled the taxpayer with tens of billions of dollars of loses."