Yes, you read the title correctly. And it’s quite an accusation to make, right? Did you ever think you would one day read such a headline? I can tell you that it makes me absolutely ill to have to share this story. But at the end of the day, there is no other conclusion I believe one can draw. See what you think …
I first became aware of this story on March 16th, in an article by Andrew Sorkin of The New York Times. The travesty his article highlighted flowed from a report issued by a bank examiner named Anton Valukas. Mr. Valukas was the bank examiner hired by the court to investigate the bankruptcy filing of Lehman Brothers, and his report has stirred nothing but controversy since its release on March 11th. A wonderfully annotated version of volume 3 of that report, titled “Repo 105,” is likewise available at The New York Times Web site.
So what is “Repo 105” and why is it so egregious, you ask? Well it turns out, “Repo 105” was an internal catch phrase used at Lehman to describe a particular type of accounting fraud. The way it worked was pretty straight forward. Just before Lehman had to report quarterly results in 2007 and 2008, executives at Lehman would move as much as $50 billion of toxic assets off of their balance sheet. They achieved this by using a standard “repurchase and resale” transaction. Under this type of agreement, a company can obtain short-term financing by providing financial securities as collateral for a loan. In a typical re-purchase agreement, the borrower “sells” assets (collateral) to the lender, but with a pre-arranged agreement to buy those assets back (repay the loan) at a slightly higher price a few days later. The inflated price is paid to cover the interest charged on the loan. But under standard accounting practices, this kind of transaction is always rightfully characterized as a loan or liability, because of this mandatory “buy back” of the assets in question. However in Lehman’s case, they committed fraud with the clear intent to deceive investors. Instead, Lehman recorded these transactions as regular sales, but purposefully failed to report the offsetting and associated liability to re-purchase those toxic assets.
And how do you know this method violates all legally recognized accounting practices? According to Mr. Valukas’ report, Lehman had engaged in this kind of behavior as far back as 2001. But like any sleazy, lying, investment bank would, it had shopped around for a supporting legal opinion. It was revealed in the records examined by Mr. Valukas that Lehman could find no law firm in the entire country to sign off on this practice. (Meaning everyone knew it was illegal here in the U.S.) The only law firm Lehman could find to help launder its books was U.K. global legal giant Linklaters LLP. Linklaters’ only demand—besides huge sums of cash—was that all Repo 105 transactions run through their London channels.
And it doesn’t stop there. Lehman took it a further step. The money they borrowed was used to pay down other debts, thereby further distorting their balance sheet so as to appear solvent. According to Mr. Valukas’ report, “Lehman used the cash from the Repo 105 transaction to pay down other liabilities, thereby reducing both the total 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, its accounting treatment for these transactions, the considerable escalation of its total Repo 105 usage in late 2007 and into 2008, or the material impact these transactions had on the firm’s publicly reported net leverage ratio. According to former (Lehman) Financial Controller Martin Kelly, a careful review of Lehman’s Forms 10-K and 10-Q would not reveal Lehman’s use of Repo 105 transactions.”
Are you with me so far? So, Lehman issues its quarterly report to the general public and the investor community, based upon this slight of hand. Then they literally re-borrow the debt they had just paid off, re-purchased the toxic assets, and put them back on their balance sheets … all done mere days after the quarterly report was released. And they repeated this practice each quarter.
Oh my God, right? I know you’re shocked to learn that one or all of these “too big to fail” banks were involved in “materially misrepresenting” their financial position to the general public. However, I saved the biggest one-two punch for last. And you’re just going to love this …
In March 2008, and before Lehman filed the largest bankruptcy in U.S. history that September, the SEC and the Federal Reserve Bank of New York (FRBNY) began onsite daily monitoring of Lehman. And the answer to your next question is: “Yes!” That’s the same FRBNY run at the time by Timothy Geithner (our current Treasury Secretary), and the same Sheila Bair-run SEC. So it turns out Timmy and Sheila actually had offices set up inside Lehman’s headquarters, in a supposed effort to prevent another collapse, and in obvious response to the near collapse of Bear Sterns just the week before. In fact, the SEC and the NY Fed sent similar SWAT teams into the home offices of Goldman Sachs, Merrill Lynch, Morgan Stanley, and several others. So what did the Feds do when they learned about these “material misrepresentations” being conducted openly in Lehman’s books? Well, they “blessed” those misrepresentations, of course! In fact, the FRBNY actually provided some of these very Repo 105-type loans to Lehman. Valukas’ report actually reveals that Lehman packaged all its toxic assets into a single “investment” (pool of bad loans) called “Freedom CLO.” Then in a series of transactions with Timmy’s NY Fed, it shifted Freedom CLO back and forth off its balance sheet in exchange for cash. What, you didn’t expect Timmy to provide such a valuable service for free, did you?
But it gets even better. Ready? There was even a Bernie Madoff-esque whistleblower! Mr. Valukas’ report also reveals that a lower-level Lehman executive named Matthew Lee sent a letter to management in June of 2008. Mr. Lee had suddenly sprouted a conscience after being told of his imminent layoff. Nonetheless, he sent a letter specifically raising a whole host of questions about this fraudulent practice, a full three months before the collapse … all while the NY Fed and the SEC oversaw and/or participated in every Repo 105 transaction.
And now maybe you can finally understand why the Federal Reserve wants nothing to do with any audit of its books—and why it’s absolutely imperative we demand nothing less.
So what’s my advice? Well, I think you can see the financial turmoil that may come with Mr. Geithner’s now imminent (?) departure. On the other hand, you can imagine the turmoil not removing him will likewise cause, as these kinds of similar stories continue to break. Lord knows Lehman wasn’t even the Fed’s favorite lap poodle. They were, after all, allowed to “fail.” Imagine what Bernanke, Geithner, and the Fed did for its “to big to fail friends!” In the end, if you need a loan of any kind, for any reason, I urge you to take action now rather than later. Waiting will only cost you more in the future.
