The report, released Thursday, was prepared by bankruptcy examiner attorney Anton Valukas, a former U.S. attorney. Valukas found that because Lehman's assets were predominantly long-term while its liabilities were largely short-term, the firm had to tweak its books to buy time.
"Lehman funded itself through the short-term repo markets and had to borrow tens or hundreds of billions of dollars in those markets each day from counterparties to be able to open for business," he wrote. If the counterparties, typically other huge banks, lost confidence -- which they ultimately did -- then Lehman would lose access to the daily funding required to operate its business.
"So at the end of the second quarter of 2008, as Lehman was forced to announce a quarterly loss of $2.8 billion -- resulting from a combination of write-downs on assets, sales of assets at losses, decreasing revenues and losses on hedges -- it sought to cushion the bad news by trumpeting that it had significantly reduced its net leverage ratio," Valukas found. But what the firm did not disclose, he continued, is that it used the Repo 105 to remove $50 billion from its balance sheet.
Repos, which stands for repurchase agreements, are an ordinary part of high finance. In a regular repo, a firm sells assets with the obligation to buy them back in a few days. That frees up cash, but the assets remain on the firm's balance sheets. In "a Repo 105 transaction, Lehman did exactly the same thing, but because the assets were 105 percent or more of the cash received, accounting rules permitted the transactions to be treated as sales rather than financings, so that the assets could be removed from the balance sheet," the report explains.
Lehman didn't disclose the trick to the government, ratings agencies or its own board; nor was it questioned by the firm's auditors, Ernst & Young, according to Valukas. (In the wake of the report's revelations, some are now calling on the government to press Lehman's Repo 105 counterparties -- banks such as Mizuho, Barclays and UBS -- to disclose whether any other financial institutions are using similar "off-balance sheet gimmicks.")
The Repo 105 transactions served no substantive purpose, only to obfuscate the true state of Lehman's finances, Valukas said. The firm's own accountants agree, describing them as a "lazy way of managing the balance sheet as opposed to legitimately meeting balance sheet targets at quarter end."
The transactions may have been technically legal. And in themselves they were not responsible for bringing down Lehman. But such obfuscation typically goes hand-in-hand with criminality and financial collapse. Remember Enron?