Wall Street ‘Abuzz’ Over Lehman Autopsy Report


A massive 2,200-page report detailing what brought about the collapse of Lehman Brothers in September 2008 was released late Thursday, concluding that “accounting gimmicks” and “balance sheet manipulation” by some executives helped turn the 158-year-old financial firm into the biggest bankruptcy in American history.

A court-appointed examiner, Anton Valukas, chairman of Chicago-based law firm Jenner & Block LLP and a former senior federal prosecutor, and his team spent the past year interviewing witnesses and poring over millions of documents to prepare their findings.

We spoke to Justin Baer, Wall Street correspondent for the Financial Times, about the report’s scathing conclusions and how they change the storyline of Lehman’s collapse.

In a nutshell, what did the Lehman examiner conclude?

JUSTIN BAER: Ultimately he found that a number of individuals were responsible for the demise of the firm. They had knowingly engaged in accounting tricks that made their financial position appear better than it was or they were negligent in maintaining the firm’s balance sheet.

Can you explain what the examiner means by “accounting gimmicks” and “balance sheet manipulation” that he cited in the report?

JUSTIN BAER: Wall Street is really abuzz over the use of these repo 105 trades [that the examiner cited]. These date back to about 2001, but Lehman had really picked up [their use] by 2007 and 2008. Repo trades are short for sales and repurchase agreements. Generally they are widely used; they are a vital source of financing for investment banks and have been for years. In a repo trade, a firm transfers assets as collateral to a counterparty in exchange for cash to fund their business. Within that agreement, they agree to buy back assets the next day, perhaps with interest. It’s a basic funding mechanism and essentially all securities firms use them.

What Lehman did differently is they were booking these repo trades as sales. When they did that, given the accounting rules in place, they were able to wipe the liability off their balance sheet. Why that is important is, as we headed in 2007, they wanted to make it appear they were under less duress, that they had lower leverage levels than they actually did. Had they reported their actual leverage, they could have lost their credit rating.

Their use of repo 105 trades really picked up into 2007 and early 2008 as Bear Stearns failed and their access to other liquidity dried up. They had a lot of assets they couldn’t sell without taking a big loss, so use of these repo trades let them look like they were in better shape than they were. The [trades] would occur in the last few days of the quarter, so they booked them as sales as the quarter ended, and their results looked better when they reported to shareholders and credit rating firms. Then they completed the trade a few days later, but in a new quarter, and the assets came back on [their books].

Why is it called repo 105?

JUSTIN BAER: You are paying what’s called “a haircut” to park that collateral. You pay 105 percent or more of the value of the asset. You are paying more because you are asking a counterparty to hold onto it for a longer period time. Typically, [a repo] is one day. By asking them to hold on to it for a week or longer, you have to pay for that benefit.

How does this change the storyline of Lehman’s collapse?

JUSTIN BAER: I think that the description in the report of the 105 trades has caught Wall Street by surprise. There were deep suspicions that Lehman was being aggressive in the valuing of their assets and that was why they lost the confidence of counterparties. But to disclose this stuff is brand new.

Once you strip away the intricacies of the contracts and whether it was illegal or not or whether they had the approval of their auditors – it was pretty clear the intent was to make their balance sheet and financial health look better than it was.

There are a slew of investigations into what the reason was and who is at fault for the collapse. This report gives those agencies or potential plaintiffs’ attorneys a ton of material they can use. [The examiner] interviewed hundreds of people, looked through millions of documents, and picked through individual transactions. This is work the SEC and Justice Department won’t have to do themselves.

Are there potential consequences for former executives?

JUSTIN BAER: Yes, it certainly would build a case against individuals. [It has implications] on behalf the Lehman estate and how to recover claims on behalf of people. Clearly this is one of the main conclusions: that people were negligent in their duties in running this firm and did not disclose things they should have. This was not clear to the general public before the report.

It’s unclear whether [the repo 105 trades are illegal.] The whole process began with an accounting change that came down in 2000 that made it OK to book repo trades as sales. In Lehman’s case, as they sought to find out what was OK to do, they couldn’t find a U.S. law firm to sign off on the trades. So, they went to a firm in London to get their legal blessing. To the examiner, it seems they knew it may not be ok for the legal community.

Is there concern other firms are doing this – manipulating their balance sheets in order to appear healthier than they truly are?

JUSTIN BAER: Times have changed – the heavy use of the repo market was something born out of standalone investment banks. There are clearly fewer of those around. As we called around to other banks, they said they weren’t participating and other regulators are calling around to make sure no one is doing the same thing. People the examiner interviewed, including those [who used to work] at Lehman — in speaking with them, they believed they were the only firm [using repo 105 trades].

But it certainly raises questions about who is doing it now. There are doubts, given the events of the last few years, that [anyone] would do that. But there are questions about who did it perhaps earlier this decade. Lehman believed it was the only one – but it’s an open question how widespread it was.