Lehman & Repo 105 = Goldman & Greece: The Global Finance System Has Irreversibly Failed

15 March 2010.

Even for freaks like us, a nine-volume, 2200 page report – like the one analyzing the Black September 2008 collapse of Lehman Bros, compiled under the direction of court-appointed Bankruptcy Trustee Anton Valukas, former Federal prosecutor & chair of the Chicago corporate law firm Jenner & Block – is a bit much to swallow in one bite.

15 March 2010.

Even for freaks like us, a nine-volume, 2200 page report – like the one analyzing the Black September 2008 collapse of Lehman Bros, compiled under the direction of court-appointed Bankruptcy Trustee Anton Valukas, former Federal prosecutor & chair of the Chicago corporate law firm Jenner & Block – is a bit much to swallow in one bite.

Especially when media from all over the world – not just the US, but notably Britain, where, interestingly enough, several crucial “evaluative decisions” in the Lehman case were made – are frothing at the mouth attempting to make sense of it for their various, often niche, readers.

So though it’s going to take a bit until every juicy morsel can be fully digested, certain facets of the situation have already become painfully evident, while one aspect – so glaringly obvious to us we couldn’t believe it didn’t come up anywhere in a Google © search conducted around 2 am Monday morning Singapore time – seems to have escaped everyone’s attention.

Before we get to that, however, let’s quickly review the relatively un-controversial themes that have already emerged.

1)     Most of the senior leadership at Lehman – including former airline pilot and chair Dick Fuld [amusingly pronounced Fooled] are in for a lot of legal problems.

Whether these will be criminal or merely civil remains to be determined, but already both Wall Street lapdog Securites & Exchange Commission [SEC] and the Department of Justice “have indicated Valukas’ work is going to speed up completion of their own reports.”

2)   Lehman’s alleged watchdogs – notably Big Four accounting firm Ernst & Young [E&Y], but also every Federal body supposedly overseeing such matters, above all the SEC – consistently and over a long period of time failed miserably at “carrying out their appointed rounds.”

Indeed, several sources immediately started comparing E&Y’s failure to be of similar magnitude to that of the extinct-as-a-result Arthur Andersen’s mis-handling of the infamous Enron fraud – an event that, as others noted, was supposed to make sure little happenings like the Lehman collapse, and every other glorious nugget uncovered since Black September , were never going to happen again.

3)   In that context, it’s fascinating to see how many of the key “opinions” that allowed this charade to proceed – whose most inventive little trick we haven’t even arrived at yet – came NOT from the US, but – in a grim echo of Tony Blair’s lapdog role with Cheney/Bush on the Iraq disaster – from the UK.

In fact, the crucial legal opinion that allowed Lehman to keep on pulling “fast ones” at the end of every quarter came from the so-called “Magic Circle” City of London – UK equivalent to Wall Street – law firm Linklater’s, which gave the thumbs up to an accounting practice that NO American firm was willing to certify as legitimate.

Which gives us Americans at least SOMETHING to be proud of in the generally sordid mess we have made of the US and – because the world political economy is and will remain for the foreseeable future “American-centered” – global economies due to all our “inventive” chicaneries – although it does give a rather sinister spin to the alleged wonder of “globalization”.

4)   So what was this little “magic formula” the geniuses at Lehman came up with – with which E&Y eventually became “quite comfortable,” in the words of the report, and that was somehow missed by the “ever-vigilant” SEC under corporate promoters Dick Cheney and George W Bush ???

The now-in-famous Repo 105.

We’ve been having all the fun so far, so let’s let the ever-reliable – and very right-wing – Telegraph of London, appropriately enough, give an overview of how this little maneuver worked:

[quote]

Repo 105 was the name used at Lehman for what its own staff called an “accounting gimmick”.

The bank had used the trick since 2001, but what started as “a lazy way of managing the balance sheet” became crucial as the bank tried to survive the credit crisis.

At the end of each quarter, Lehman sold some of its loans and investments temporarily to other financial institutions for cash using short-term repurchase (or “repo”) agreements and then bought them back a few days later.

Ordinarily the assets would still be included on the bank’s balance sheet, but because they were valued at 105pc or more of the cash received, the transactions counted as a “sale” under accounting rules and Lehman was able to report a less risky balance sheet.

The bank stuck roughly to a limit of $25bn of Repo 105 until early 2007 but increased its use so that in the first and second quarters of 2008 Lehman was hiding $50bn of assets from investors, the government, rating agencies and regulators.

For the second quarter, Lehman reported a net leverage ratio of 12.1 when the true figure was 13.9 – and a difference of 0.1 was regarded as material [which means a gap of 1.8 was near-astronomical.]

In Mr Valukas’s words, Lehman was “trumpeting” its reduced leverage as it reported a massive $2.8bn second-quarter loss without revealing that it had bought the assets back once its books were signed off.

[/quote]

The interesting and legally-oriented JD Supra clearly explains at a more specific level how the Repo 105 maneuver was so useful for Lehman:

[quote]

By recharacterizing the Repo 105 as a “sale,” Lehman removed the item from its balance sheet, thereby reducing their publicly reported net leverage. Its periodic report did not disclose the cash borrowing from the Repo 105 transaction – i.e., although Lehman had in fact borrowed tens of billions of dollars in these transactions, they did not disclose the known obligation to pay the debt. Lehman used the cash from the Repo 105 transactions to pay down other liabilities, thereby reducing both the liabilities and the total assets reported on its balance sheet, and lowering its leverage ratios. Lehman never publicly disclosed its use of Repo 105 transactions, nor its accounting treatment of these transactions.

[/quote]

This was particularly useful as the financial crisis that had started to take shape with the Bear Stearns collapse in early 2008 began to become more concrete.

[quote]

Leverage had become a focus of the ratings agencies, and was widely thought to be an indicator of bank risk, which meant Lehman would have been hell-bent on reducing its leverage – at least publicly. [As other “assets” began to fail,] Lehman couldn’t reduce its leverage by selling things off, since that would force them to record large losses. Hence, not just the repo – which could seemingly reduce leverage – but [as the Telegraph summary notes] the increasing limits of Repo 105 transactions starting in late 2007 and into 2008.

[/quote]

5)    Now here’s where it starts to get really interesting, and the economedia © “double game” we’ve talked about previously begins to come into play.

Immediately after the Valukas report was released, all the other investment banks put out statements denying they had ever used the same maneuvers Lehman had.

Most amusing, as always, was Goldman Sachs, as reported in Portfolio.com’s Daily Brief by Steve Rosenbush. Referring to the Jonestown “massacre,” where everyone voluntarily “drank the Kool Aid” they knew would lead to their own deaths, his post was wittily headlined: “Goldman Says It Did Not Imbibe”:

[quote]

Well, that didn’t take long.

One day after Lehman bankruptcy examiner Anton Valukas issued a damning report that outlines how Lehman Brothers made billions of dollars of debt briefly disappear for the benefit of its quarterly reports, banks are starting to assert that they never used such techniques. …

“Goldman Sachs has never used this transaction,” the bank told MarketWatch.

[/quote]

6)   And yet … and yet … and yet … AND YET, as the Financial Times points out in a quote that somehow seemed to have eluded many other sources, a key conclusion of the Report was:

[quote]

“There are many reasons Lehman failed, and the responsibility is shared,” Mr Valukas wrote in his report, [but in terms of the large-scale picture] “Lehman was more the consequence than the cause of a deteriorating economic climate.”

[/quote]

So Lehman alone was doing this, Goldman and the others would have us believe.

But no one with a brain can give such a deadpan denial even the slightest bit of credibility – especially since GS above all considers itself the shrewdest trader on the Street.

And such a statement has to be particularly amusing for, and certainly NOT credible to, readers of this site, especially if they, correctly, feel the dynamic described as Repo 105 in the Lehman case sounds so familiar –

because it’s the exact same trick Goldman Sachs used several years before to help Greece do EXACTLY what Lehman did:

hide the true picture of its leverage situation by arranging shady deals that were recorded as sales, but were in fact arrangements in which long- or short-term debts were simultaneously mounting, but hidden from the relevant authorities:

in the case of Lehman, from ITS own investors / counter-parties / and the US government, even though the latter was hardly very assiduous in its efforts to check what was going on;

in the case of Greece, these arrangements were being hidden from ITS own lenders / counter-parties / and the European Union authorities, most notably from the European Central Bank !!!

7)    So what’s the difference between what Lehman did under the rubric of Repo 105, in which it got short-term cash that it a) could record as a sale, but b) later had to pay back, and has now been definitively exposed and universally condemned as a fraudulent maneuver –

and what Goldman did, when IT gave Greece short-term funds that IT could show the ECB as “sales”,

while the “underlying asset” from which the future income would be “derived” – hence “derivative” – like its air- and sea-port fees – would end up in the pockets of the Boys from 85 Broad Street in Manhattan???

In fact, there IS no difference between Lehman’s Repo 105, and the sort of Credit / Currency Derivative Swaps that Goldman had been so jauntily employing since at least 2001.

8)   And that’s why the dire warnings of so many financial sector voices have even more resonance than they did before:

Under the heading, Outrage Over Valukas Report Should Shake Wall Street to the Core, one writer argues:

[quote]

Bankruptcy examiner Anton Valukas’s 2,200 page report detailing how and why Lehman Brothers collapsed is so damning that it should be a turning point in financial history.

Whether it amounts to more than a footnote will be up to the lawmakers who have managed to delay reform of the financial markets.

If this report isn’t enough to compel them to take action, nothing will.

[/quote]

Or as the New York Times puts it,

[quote] [W]e were all blindsided. And we could be blindsided again. Congress is not even close to passing meaningful regulatory reform. The surviving banks have only gotten bigger and more politically powerful.

If the Valukas report is not a wake-up call, what would be?

[/quote]

Well, dudes, we’re going to find out, aren’t we ???

Our feeling is that, in fact, this WON’T change anything, and the global crisis – which would be ridiculous if it weren’t so vitally important for the whole world – is simply going to enter yet another bizarre stage where everyone involved appears, and is, more venal than was previously imagined.

Welcome to the Lost Decades.

David Caploe PhD

Chief Political Economist

Economy Watch.com

President / ACALAHA