Lehman Brothers And Repo 105: The Dirty Truth

A 2,200-page report by Anton R. Valukas, the bankruptcy examiner for Lehman Brothers Holdings, sheds disturbing light on how an obscure accounting maneuver called Repo 105 enabled Lehman to hide $50 billion of troubled, toxic assets from investors and regulators alike.

Valukas’ report reveals that Lehman Brothers had actually reached the insolvency stage some time before it was forced to file for bankruptcy in September 2008. Investors never saw it coming, however, because of alleged accounting trickery and Lehman’s prolific use of Repo 105. Essentially, Repo 105 temporarily keeps certain assets off of a bank’s balance sheets for a short period of time, thereby giving a healthier financial appearance to investors.

Repo 105 is a common fixture in the investment banking world. The deals themselves are very short term, and occur when an investment bank exchanges securities or bonds for cash for a short period of time. The bank then agrees to repo, or repurchase, the bonds, less a small amount that the company gets to keep as interest.

As reported March 13 by the Wall Street Journal, if deemed as sales, the deals would shrink Lehman’s balance sheet, helping satisfy investors’ qualms about Lehman’s use of borrowed money, or leverage.

One of the most shocking revelations in the examiner’s report is Lehman’s growing dependence on Repo 105s. In the fourth quarter of 2007, Lehman’s turned to Repo 105 transactions to reduce its leverage by $38.6 billion, by $49 billion in the first quarter of 2008 and an astounding $50.4 billion in the second quarter of 2008.

Besides offering a slew of evidence on the factors leading up to Lehman’s downfall, the report squashes, once and for all, claims by ex-Lehman chairman Richard Fuld that Lehman met its demise because of rumors and loss of confidence on the part of clients and trading partners.

Among the tidbits of information Valukas raises in his report:

• A Lehman accounting executive, Matthew Lee, raised the alarm bells about Lehman’s questionable accounting methods and took his concerns to auditor Ernst & Young. One month later he was ousted from his job.
• Lehman failed to value its inventory of financial products in a “fully realistic or reasonable” manner, thereby once again giving a misleading and false picture of its true financial condition to investors.
• Oversight systems were ineffective and there were “tens of billions of dollars” of possibly toxic liabilities.

The bankruptcy of Lehman Brothers in September 2008 is the biggest bankruptcy in U.S. history involving $613 billion in debts.

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