Repo [Leh]men

March 13, 2010 7:00 AM

The September 2008 colapse of Lehman Bros. was the percipaticing event which channged a credit crunch to a panic. The examiner apointed by the bancrupcy court has produced a 2200 page report about what went wrong. The whole report is here. Summaries and links to analysis after the jump.

Explanation from NYT, FT, zero hedge. The most important thing that the examiner found is that at the end of each quarterly reporting period Lehman would pretend some assets were off its books - reducing leverage or the ratio of assets to capital - with a "Repo 105" transaction. Leverage is used by investors and counterparties as a measurement of risk and deliberately misrepresenting it is extremely serious. The Repo 105 transactions were a misrepresentation because the assets (mainly illiquid securities) were treated as if they were sold but were actually sold but only on the condition that Lehman would repurchase the assets in a few days. That is, the assets would be right back on Lehman's books immediately after the reporting period.

Here are some key quotes from the report ("colorable claim" means roughly that the examiner is making a claim he believes a court could support based on the facts he has uncovered)

A few quotes from the report, these are from the executive summary in section one

The Examiner concludes that there is sufficient evidence to support a colorable claim that: (1) certain of Lehman’s officers breached their fiduciary duties by exposing Lehman to potential liability for filing materially misleading periodic reports and (2) Ernst & Young, the firm’s outside auditor, was professionally negligent in allowing those reports to go unchallenged. The Examiner concludes that colorable claims of breach of fiduciary duty exist against [former CEO/CFOs] Richard Fuld, Chris O’Meara, Erin Callan, and Ian Lowitt, and that a colorable claim of professional malpractice exists against Ernst & Young...

Lehman’s own accounting personnel described Repo  105  transactions as an  “accounting gimmick” and a “lazy  way  of  managing  the  balance  sheet  as  opposed to legitimately meeting  balance  sheet  targets  at  quarter  end.” 

There was a whistleblower too, as described on page 21. "In May 2008, a Lehman Senior Vice President, Matthew Lee, wrote a letter to management alleging accounting improprieties in the course of investigating the allegations, Ernst & Young was advised by Lee on June 12, 2008 that Lehman used $50 billion of Repo 105 transactions to temporarily move assets off balance sheet at quarter end." Its seems as if Ernst & Young did not report these aligations to the audit committee.

posted by shothotbot (31 comments total)

This is my surprised face. No, really.
posted by Slothrup at 7:06 AM on March 13, 2010

Jeebus - what a mess. Really.

The worst part of this is its astonishing complexity - and I believe it is going to become even more complex as finance bloggers start pushing open all the doors. Unfortunately however, very few folks are going to be able to follow the discussion and it will all disappear from wide public scrutiny. Unchanged.

What would CNN rather broadcast - this, or the balloon boy?
posted by Aetius Romulous at 7:08 AM on March 13, 2010 [1 favorite]

Lehman Bros is a corpse, so this is merely an autopsy (Though nailing E&Y on this would be useful). I'd like to see this sort of scrutiny performed on all the government-saved big boys like Goldman Sachs, B of A, etc. Could be a nice way to grab back some of that bonus money flying around.

The financial geniuses who created this mess should be digging ditches in Alabama, not reaping bonuses.
posted by Artful Codger at 7:13 AM on March 13, 2010 [1 favorite]

According to one pundit on NPR last night, the 105 Repos were technically not illegal. What got Lehman in trouble was not disclosing the transactions.
posted by ZenMasterThis at 7:18 AM on March 13, 2010

I struggled to understand what exactly happened until I saw Dylan Ratigan describe it in a way a six-year old could understand (scroll to the bottom of the post for the video). I often find Ratigan is a bit much, but this was helpful.
posted by Hypnotic Chick at 7:22 AM on March 13, 2010 [1 favorite]

What got Lehman in trouble was not disclosing the transactions.

What got Lehman in trouble was not having the same friends as AIG and Goldman Sachs.
posted by three blind mice at 7:23 AM on March 13, 2010 [10 favorites]

Lehman’s officers breached their fiduciary duties by exposing Lehman to potential liability for filing materially misleading periodic reports

If this is right, they were incredibly stupid (1) to begin with and (2) not to disclose. Goodbye, Business Judgment Rule! Hello, lawsuits!

What got Lehman in trouble was not having the same friends as AIG and Goldman Sachs.

No, their boneheaded behavior is what got them in trouble. Not having the same friends is what left them there.
posted by sallybrown at 7:30 AM on March 13, 2010 [2 favorites]

The narrative portions of the report are quite readable and you should take a look at the executive summary if you are curious.

What got Lehman in trouble was not disclosing the transactions.
I would say, what got Lehman in trouble was needing to not disclose transactions.

It seems like a pattern, they also excluded their riskest assets from stress tests (a risk control tool).
posted by shothotbot at 7:34 AM on March 13, 2010

I was all excited that I'd get to be the pedant, but I just can't do it.
posted by cmoj at 8:10 AM on March 13, 2010

No, their boneheaded behavior is what got them in trouble.

Yes, but AIG and Goldman were no less "boneheaded." It is still not clear to me why Lehman was allowed to fail and the others were bailed out.

Moreover, I don't really buy the "boneheaded" excuse. Seems to me these guys knew exactly what they were doing.... The "we didn't know those triple A bonds were junk" is something I'm just not buying.

Cynic that I am, I suspect the trick was to keep their shells moving (all the while stuffing their pockets with money) until they ran up their exposure to the point where they could hand the government a ransom note that they were certain would be paid.

For some reason Lehman was odd man out. This to me is the real unsolved mystery.
posted by three blind mice at 8:24 AM on March 13, 2010 [1 favorite]

three blind mice: "What got Lehman in trouble was not having the same friends as AIG and Goldman Sachs."

This.
posted by Joe Beese at 8:40 AM on March 13, 2010

Moreover, I don't really buy the "boneheaded" excuse. Seems to me these guys knew exactly what they were doing
AIG and Lehman definately misjudged their risks and were - to that extent - boneheaded. They may felt forced to do it to support their stock valuations or they may have misjudged Paulson's willingness to let them go under, but those two companies lost at the game they were playing.

For some reason Lehman was odd man out. This to me is the real unsolved mystery.
This is getting at a very interesting point: the repo 05 scam was to reduce their balance sheet, why did Lehman want to reduce thier balance sheet? Their counterparts demanded it. Why was it demanded? A loss of confidence in Lehman. So I think the real question is, why was there the loss of confidence in Lehman in particular? I don't know the answer.
posted by shothotbot at 8:40 AM on March 13, 2010

It is still not clear to me why Lehman was allowed to fail and the others were bailed out.

Really? The fact that the Treasury Secretary was the former CEO of Goldman Sachs and had a secret meeting with the board of Goldman in Moscow -- in the middle of the crisis -- doesn't give some clue as to why Goldman was bailed out?

It's pretty clear to me.
posted by ryoshu at 8:58 AM on March 13, 2010 [1 favorite]

I will take this opportunity to remind everyone of this reaction to the collapse.
posted by Saxon Kane at 9:33 AM on March 13, 2010 [1 favorite]

AIG and Lehman definately misjudged their risks and were - to that extent - boneheaded. They may felt forced to do it to support their stock valuations or they may have misjudged Paulson's willingness to let them go under, but those two companies lost at the game they were playing.

Bull. It was deliberate gaming, the risks (albeit big) were known and GS, AIG, etc haven't lost, they gambled and won big-time. Only Lehman stockholders lost out, the upper crust of Lehman's all had parachutes and have now, no doubt, landed softly on greener pastures.

(Taxpayers and small investors have also lost, but they don't count)
posted by Artful Codger at 9:38 AM on March 13, 2010 [1 favorite]

i thought it was common knowledge that some hedge funds were making a bit extra at the end of quarters by helping to dress up the balance sheets of some banks
posted by drscroogemcduck at 9:41 AM on March 13, 2010

According to one pundit on NPR last night, the 105 Repos were technically not illegal. What got Lehman in trouble was not disclosing the transactions.

Nothing Enron did was "Technically" illegal either. They filled out all the appropriate paperwork, and were audited. Their problem came from the fact that they were making public statements saying they were good to go, when the truth was buried in piles of documents.

For some reason Lehman was odd man out. This to me is the real unsolved mystery.

Well, they were the first to go. But yeah, I would bet that the fact that Paulson was the former CEO of Goldman Sachs and If AIG went down it could have destroyed GS, played a major role in saving AIG.
posted by delmoi at 9:43 AM on March 13, 2010

Lets say, for a moment, that Lehman was entirely and totally fraudulent (at least from a casual handling of their investors money point of view). So they fail. What bothers me isn't really that they were fraudulent, nor that they failed, it is that the whole economy has taken such a hit. That wasn't just Lehman, and that is the realy problem; there will always be shysters and crooks, but society (and economy) is supposed to be structured to limit their scope and influence; no one industry is supposed to run completely amok and crash the works. To me that is the bigger problem, not the problem of how individual companies failed.
posted by Bovine Love at 10:03 AM on March 13, 2010 [9 favorites]

... there will always be shysters and crooks, but society (and economy) is supposed to be structured to limit their scope and influence; no one industry is supposed to run completely amok and crash the works. To me that is the bigger problem, not the problem of how individual companies failed.

quoted for truth.

I would have thought this was obvious, myself ... except it's 18 months after economic ground zero, and NOTHING meaningful has been done to either discover and punish the errors and wrongdoing, or to ensure it can't happen in the future.

No corporation should be too big to fail, yet those monstrosities still exist intact, munching contentedly on taxpayer money, earning profits on it and paying bonuses.
posted by Artful Codger at 10:28 AM on March 13, 2010 [1 favorite]

Sorry to derail but there were six typos in this post, five of which were in the first two sentences. I was thinking about not posting this since the content is good, but the better the post content the more readers and links it will get. So you've got to try your best to represent MeFi in an eloquent way!
posted by PostOfficeBuddy at 10:42 AM on March 13, 2010 [2 favorites]

2200 pages to say "They're greedy."?
posted by yoga at 10:51 AM on March 13, 2010

I agree with PostOfficeBuddy: this is an important, substantial post, and really good stuff, but the failures of proofreading and the poorly constructed sentences obscure rather than clarify.

For example, in the first paragraph, the sentence

The most important thing that the examiner found is that at the end of each quarterly reporting period Lehman would pretend some assets were off its books - reducing leverage or the ratio of assets to capital - with a "Repo 105" transaction.

would be much clearer as, "At the end of each quarter, Lehman would use a 'Repo 105 transaction' to reduce its leverage (the ratio of assets to capital) by pretending some assets were off its books." The pretending is what's important, not the name Lehman used for the transaction.

</writingteacher>
posted by vitia at 11:11 AM on March 13, 2010 [2 favorites]

Sam Buell, a former Enron prosecutor turned US law professor, says there are "uncanny" parallels in colourful internal emails about accounting tricks, signed off by a major auditing firm, used to bolster balance sheets at the end of a quarter
posted by adamvasco at 11:35 AM on March 13, 2010

Looks a lot like Enron to me. This was the most interesting take I read this morning.
posted by bukvich at 12:07 PM on March 13, 2010

So, how long will their jail terms be?
posted by DreamerFi at 12:35 PM on March 13, 2010

So, how long will their jail terms be?
I wish. I think the interesting question is: will anything happen to Ernst & Young? I am very surprised they went along with this in the post-Arthur Anderson world. the blog I linked to says all the big investment banks are doing this. A week ago I would have said their auditors would never let them do it.
posted by shothotbot at 1:41 PM on March 13, 2010

I just did a google search of the word 'percipaticing' because I didn't know what it meant. The only instances of it occur in direct quotes of shothotbot's post. Then I realized the word's supposed to be precipitating. Dur.
posted by boghead at 2:51 PM on March 13, 2010 [1 favorite]

Looks a lot like Enron to me.

Yes, yes it does. The Enron Era never ended: the buck just got passed.

will anything happen to Ernst & Young? I am very surprised they went along with this in the post-Arthur Anderson world.

I'm not. They no doubt were paid millions by Lehman to give their stamp of approval (to counting loans as "sales.") From the NYT article:

The accounting tactic, first used by Lehman in 2001, had one catch, according to Mr. Valukas: no American law firm would sign off on its use.

Enter Linklaters, a highly respected British law firm that gave Lehman the answer it wanted. So long as the repos were conducted in London through the bank’s European arm, and so long as the company took other cosmetic steps to make these transactions appear to be sales instead of financings, Linklaters determined that they would pass regulatory muster.

[...]

Lehman also had the backing of Ernst & Young, which certified the bank’s financial statements despite receiving warnings from a whistle-blower who said there were accounting improprieties. An Ernst & Young spokesman said on Thursday that the firm stood by its work for 2007, the last year it conducted an audit of Lehman’s financial results.
posted by HP LaserJet P10006 at 6:54 PM on March 13, 2010

[comment removed - I'm sorry the typos bother you but please leave it alone now, thank you.]
posted by jessamyn at 9:14 AM on March 14, 2010

I just did a google search of the word 'percipaticing' because I didn't know what it meant. The only instances of it occur in direct quotes of shothotbot's post. Then I realized the word's supposed to be precipitating. Dur.

You're losing your perspicacity.
posted by neuron at 1:32 PM on March 14, 2010

What did Geithner and Bernanke know, and when did they know it?
posted by adamvasco at 9:12 AM on March 15, 2010