Lehman's Accounting Trick Repo 105

Just to start: "repo" is short for a "repurchasing" agreement in banking.

By the time Lehman Brothers imploded, $25bn in capital was supporting $700bn of assets and liabilities, a leverage ratio that was regarded as extremely high. FT

I've been curious about Repo 105 (and it's Euro counterpart Repo 108) for a while, so I thought I'd post something. Repo 105 was created in 2001. This aggressive tactic was created after a new accounting standard had come into affect - FAS 140 and banking heads were ready to use it to their advantage.

None of Lehman's American accounting firms would sign off on the aggressive tactic so Lehman took to London and used the "magic circle" law firm Linklaters, who signed off on Repo 105.

Here's how the Lehman's system worked:

Linklaters wrote the whole thing in English Law, where they could book the transaction as a sale verses a loan, like most repurchases. In fact, these expensive loans were already valued at 105% of their value, so Lehman was paying an expensive premium with interest for the gimmick. The firm explicitly said: “This opinion is limited to English law as applied by the English courts and is given on the basis that it will be governed by and construed in accordance with English law.” These transactions had to go through Lehman's euro arm: Lehman Brothers International (Europe) (LBIE). That didn't seem to matter at all when it came to moving almost 50bil off Lehman's balance sheet with this accounting slight of hand.

Aside from the statement above "the law firm decreed in its briefs, at least as outlined in the 2006 iteration obtained by Mr. Valukas, that intent matters. If two parties intend to exchange assets for cash, and then later the party receiving the assets decides to hand back “equivalent assets (such as securities of the same series and nominal value) rather than the very assets that were originally delivered,” that amounts to a sale." (Link)

From the examiners statement: “Repo 105 and Repo 108 contracts typically are executed by Lehman Brothers International (Europe) (‘LBIE’) because true sale opinions can be obtained under English law. We generally cannot obtain a true sale opinion under U.S. law. (Link)

So, to rehash, Repo 105 was a gimmick created in response to FAS 140 and then moved to international law to avoid US accounting regulation, but still used to balance US books...

In fact, it was a shell game. To call it a gimmick evokes innocence and childish behavior.  This was public deception & plain old fraud. Read the snippet between Steve Kroft & Anton Valukas, the court appointed bankruptcy examiner.

"Anton Valukas: It certainly, in our opinion, was against civil law if you will. There were colorable claims that this was a fraud, yes…

Anton Valukas: They’d fudged the numbers. They would move what turned out to be approximately $50 billion of assets from the United States to the United Kingdom just before they printed their financial statements. And a week or so after the financial statements had been distributed to the public, the $50 billion would reappear here in the United States, back on the books in the United States.

Steve Kroft: And then the next financial statement, they would move it overseas again, and file the report, and then move it back?

Anton Valukas: Right.

Steve Kroft: It sounds like a shell game.

Anton Valukas: It was a shell game. It was a gimmick."

Thank you Dealbook, FTAlphaville & Columbia Journalism Review