Dollars & Sense: Lehman: The Art of the 'Sale'

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Sunday, March 14, 2010



Lehman: The Art of the 'Sale'
by Dollars and Sense


Friday saw the release of a mammoth official report on the demise of the late, lamented Lehman Brothers. Written by Anton Valukas, a court-appointed Chicago securities lawyer, the over 2,000 page report, which was based on a staggering 350 billion pages of documentation , claims that practices designed by the megabank whose travails nearly took down the global financial system in September, 2008, "ranged from serious but non-culpable errors of business judgment to actionable balance sheet manipulation." Specifically, the report documents the use of a maneuver known as "repo 105" to disguise the fact that Lehman was supporting its own balance sheet, recently loaded up with subprime mortgages that were rapidly falling in value, with, well, almost nothing.

The way this deception worked involved a part of the finance industry that has become increasingly important over the years, but remains opaque to most people. The "repo," or "repurchase" market involves the transfer of bank assets, like bonds, to other financial firms, like broker-dealers, for extremely short periods of time (often just a few days), in return for cash. The securities, then, function as a sort of collateral. The banks, after the short period of time has elapsed, are required to take the collateral back, and pay a usually nominal amount by way of interest. In this way, the banks get ready cash, and the firms that take the securities are free to use the securities for potentially profitable short sales or to just to collect the interest.

In this case, however, Lehman tried to disguise what looked like repo transactions--to the tune of up to $50 billion a quarter--as a sale of securities. Funny kind of sale: they were "selling" something they were obligated to take back within days. And they were paying far above the rate of interest customary in such transactions. For "repo 105", for instance, Lehman was paying 5%; on "repo 108", 8%.

And why would Lehman do this? Well, repos remain on the bank's balance sheet. Lehman, as mentioned before, had, in the months running up to the crisis, piled into subprime loans. So this massive expansion of assets on the balance sheet was supposed to be offset by a similar build-up of equity, or of funds which might cover potential losses on the assets. Knowing that raising so much equity was impossible, Lehman asserted that the repo transactions were in fact sales, which, of course, constituted a permanent transfer of assets, and, therefore did not require booking on the balance sheet. But Lehman was not only taking these assets back in a few days, it was paying exorbitant amounts of money to offload the assets right at the time when they were supposed to be booked for quarterly results. It was as if a drug dealer sublet an apartment in which s/he had stowed away a a boatload far below the market rate, right when the landlord was supposed to come calling. Of course, this leads to the questions as to why so many of Lehman's counterparties were willing to go along with such unusual offers. .........(more)

The complete piece is at: http://www.dollarsandsense.org/blog/2010/03/lehman-art-of-sale.html