Examiner: Repo 105 helped disguise Lehman's ailing health

MarketWatch ^ | March 12, 2010, 10:31 a.m. EST | Simon Kennedy, MarketWatch

[Ernest_at_the_Beach]

LONDON (MarketWatch) -- An accounting maneuver known as "Repo 105" was a "drug" that helped maintain a veneer of health on Lehman Brothers' crumbling balance sheet in the months running up to its bankruptcy, a report from a court-appointed examiner shows.

The firm began using the Repo 105 as far back as 2001, but its use picked up sharply toward the end of 2007, even in the face of concern from some staff, as banks worldwide came under more and more pressure to cut their leverage.

Responding to an April 2008 email asking if he was familiar with the transaction, Bart McDade, the firm's then-head of equities and subsequently chief operating officer, replied: "I am very aware... it is another drug we're on," according to the report by examiner Anton Valukas.

The report, which runs to 2,200 pages, said former top officers including ex-CEO Dick Fuld and Chief Financial Officers Chris O'Meara, Erin Callan and Ian Lowitt could face legal claims for negligence of breach of duty.

Auditor Ernst & Young could also potentially face a professional malpractice claim for not challenging Lehman's non-disclosure of the off-balance sheet transactions, the report said. See full story on the Lehman report.

At its peak in the second quarter of 2008, Lehman used Repo 105 to effectively move around $50 billion of assets off its balance sheet, according to the report.

An ordinary sales and repurchase agreement -- or repo -- involves the transfer of assets to another party in exchange for cash, while agreeing to repay the money and take back the assets at a later date.

It's essentially a type of secured loan and is booked that way in the accounts -- leading to an increase in both assets and liabilities.

[A_Former_Democrat]

Maybe Obama will nationalize Ernst & Young next

[Doogle]

...and the White Hut is crawlin with ex Lehman critters

[CharlesWayneCT]

The line about “increasing assets and liabilities” reminded me of the situation right before the Technology bubble burst.

IN that case, internet startups got in the habit of “cross-purchasing” services. This would drive up both the income and expenses of the companies. They could contract for any amount of money, and so long as the two companies bought and sold the same amount of services, it didn’t effect the balance sheet.

But what it did was drive up the “sales” number. See, the companies were all losing money. Losing 15 million on 15 million in income is REALLY BAD for a company, especially if it has been around a few years.

But losing 15 million on a BILLION in sales, especially when the sales have increased every year, looks REALLY good, because the assumption is that some day, they will stop growing, the “growth expenses” will go away, and they will make a big profit on all those sales.

But one day, someone figured out that this one company had no real sales at all, just these “tit-for-tat” sales. I can’t remember the name of that company, I just remember I was following it, and it’s stock dropped to worthlessness, and the Nasdaq followed.

It’s like we refuse to learn the lessons of the past.