U.S. Federal Reserve Chairman Ben Bernanke said on Thursday he could not have legally saved Lehman Brothers from bankruptcy and the firm's catastrophic failure in 2008 was a source of sadness.

Bernanke, testifying before a congressional commission examining the causes of the worst financial crisis in 80 years, said a freshly minted financial reform law would help reduce the risk of future problems, provided regulators follow through on its implementation.

It was with great reluctance and sadness I conceded that there was no other option to save Lehman, Bernanke said.

There was never any discussion that says 'here's how we can save Lehman, should we do it or not?'. The discussion was 'there is no way' and that was my belief and that's how I proceeded, because, as I said, if I could have done anything to save it, I would have saved it.

The crisis commission wraps up a two-day session on Thursday focussing on too big to fail firms whose disorderly collapse could destabilize the global economy.

The 10-member, congressionally-appointed commission is due to issue its report on the financial crisis by December 15.

On Wednesday, commission Chairman Phil Angelides questioned whether politics had played a role in the September 2008 decision not to bail out Lehman Brothers. Its bankruptcy triggered widespread panic, hastening the worst global recession since World War Two.

The Fed has insisted it had no authority to rescue Lehman because the firm lacked sufficient capital to borrow enough to stave off collapse.

Any attempt to lend to Lehman within the law would be futile and would only result in loss of cash, Bernanke said.

The financial crisis, which began with failing U.S. home mortgages, led to the bankruptcy, bailout or government-brokered buyout of large financial firms including Bear Stearns, Lehman Brothers, Wachovia and Washington Mutual.

The costly bailouts have been hugely unpopular with voters, and many politicians are still paying the price with angry voters as November congressional elections near.

BREAKING UP HARD TO DO

Bernanke said stricter capital and liquidity rules, a regime to wind down a failing firm in an orderly fashion, and requirements that most derivatives are to be settled in clearinghouses, will strengthen the financial system and help address the too-big-to-fail problem.

Regulatory reforms enacted to prevent a repeat of the crisis included a rule requiring large financial companies to produce living will plans for how they could be safely dismantled if necessary. Federal Deposit Insurance Corp Chairman Sheila Bair said if those plans are not deemed credible, regulators can break them up.

The government would be authorized to break up the institution so that it no longer creates undue risk to the financial system, she wrote in her testimony. She is scheduled to testify after Bernanke.

Bair, who heads the agency which protects depositors in failed banks, said regulators play a vital role in ensuring the newly enacted regulatory reforms are successful.

If implementation is not properly carried out, the reforms could be ineffective in preventing future crises or containing financial market disruptions should they occur, she said.

Breaking up banks that fail to produce credible resolution plans was a last resort that would only be taken if, over two years, firms ignore other entreaties to produce a credible plan. Before breaking up a firm, Bair said regulators could impose stricter requirements for capital, liquidity and leverage.

She also took aim at critics who say the struggling economy is reason to postpone new capital requirements, including those now being worked out as part of the international Basel III negotiations.

While acknowledging that the economic recovery has been slow, and stricter requirements will not be easy for banks to implement, she said this was no excuse for repeating the mistakes of the past when it comes to responsible capital requirements.

(Reporting by Mark Felsenthal and Dave Clarke; Writing by Emily Kaiser; Editing by Tim Dobbyn)

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