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What Lehman Did

March 12, 2010

The long-awaited autopsy on Lehman Bros. is out. Big news: The bank hid liabilities off its balance sheet!

Everyone is shocked, shocked. The amazing thing is the mundanity of Lehman’s methods: Repos. This was inside-the-box thinking even 10 years ago, when the bank apparently started using them. As the New York Times explains:

Repos, short for repurchase agreements, are a standard practice on Wall Street, representing short-term loans that provide sometimes crucial financing. In them, firms essentially lend assets to other firms in exchange for money for short periods of time, sometimes overnight.

But Lehman used aggressive accounting in its Repo 105 transactions: It appears to have structured transactions such that they sold securities at the end of the quarter, but planned to buy them back again days later. These assets were mostly illiquid real estate holdings, meaning that they were hard to sell in normal transactions.

Well. Why would anyone bother with these kinds of transactions except at the end of the quarter?

The operative term here is “standard practice,” and it’s not just on Wall Street. Versions of this are also done by school systems and city and state governments: The quarterly (or annual fiscal year) cutoff date presents an opportunity to manipulate the figures to most flattering effect. As is often said, any financial statement is a snapshot; these accounting gimmicks simply crop the frame in in more or less creative ways.

It’s only deemed dishonest if disaster strikes—as with Lehman. Anyone who complains before disaster strikes is considered weird; if they persist, they become unemployed. If not unemployable.

By May and June of 2008, a Lehman senior vice president, Matthew Lee, wrote to senior management and the firm’s auditors at Ernst & Young flagging “accounting improprieties.” Neither Lehman executives nor Ernst & Young alerted the firm’s board about Mr. Lee’s allegations, according to the report.

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