Lehman Brothers Repo 105
Paolo A Rojas
Introduction and Background
On September 15, 2008, Lehman Brothers filed for bankruptcy. With $639 billion in assets and $619 billion in debt, Lehman Brothers bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees worldwide. Lehman had been unhealthy for a while and covered it up by secretly shuffling bad debt around to make its books look more attractive to investors, regulators and credit rating agencies. In a practice known within Lehman as Repo 105, bad assets were loaned to other firms at the end of the quarter in exchange for short-term financing. The temporary absence of the bad debt gave the illusion of a much healthier balance sheet. But Lehman would quickly reclaim the assets, usually within days. According to the New York Times, repos, short for repurchase agreements, are standard practice on Wall Street, but Lehman was very aggressive in engineering such deals. The report indicates that Lehman hid $39 billion at the end of the fourth quarter of 2007, $49 billion in the first quarter of 2008 and $50 billion in the second quarter of that year. The way that Lehman brothers Lehman Brothers entered into repurchase agreements with banks in the Cayman Islands. Under the deal, Lehman would "sell" toxic assets to the other bank, with the understanding that they would buy them back in a short time. The trick made Lehman Brothers look much more profitable on paper, at least. These guys were desperate to fool investors and credit rating agencies. They had screwed up on a truly colossal scale, and lined their pockets all the while. When the truth got out, executives knew their careers and reputations would be at stake. But by engaging in this kind of book-cooking to cover it up, they could end up behind bars. Many other banks have used similar repo agreements before. But the difference is that they would mark them on their books as loans, because that's what they are. Lehman Brothers marked them as sales. That might not sound like a huge deal, but the effect was that Lehman Brothers had $50 billion or more in cash on its books, and $50 billion less in toxic mortgage assets. Discussion of Ethical Issues
The first ethical issue is that of CEO Richard Fuld not wanting to admit that the company was not as well as off, as they appeared. It appeared that Fuld did not want to show that the way that he was running the company was wrong, or that any of the trade decisions that he made were also wrong. When the housing marketing began wavering in 2007, Fuld was fixed in a highly aggressive and leveraged business model, very similar to many other Wall Street players at the time. Unlike the competitors, a few of whom had the foresight to identify the pending collapse and evaluate possible consequences of mortgage defaults, Fuld did not rethink his strategy. Instead he preceded into mortgage-backed security investments, continuously increasing Lehman Brothers’ asset portfolio to one of unreasonably high risk given market conditions. Fuld had an opportunity in 2007 to voice concerns about his bank’s short-term financial health and its heavy involvement in risky loans, and he wasted it in favor of communicating to investors and Wall Street that no foreseeable concerns existed. He would have been truthful if more competitive solutions, along with the benefit of time , would have been available, likely helping prevent or minimize the financial outflow that loomed on the horizon. There would have been some negatives to admitting that the company was not doing as well as thought, but as the CEO Fuld should have taken those responsibilities. Some of the immediate effects of admitting a shaky outlook would have been, large capital investors would have been appreciative of the transparency and...
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