Dead Men Walking

By DeusExMacintosh

A report into the collapse of Lehman Brothers criticises senior executives and auditor Ernst & Young for serious lapses that led to the firm’s collapse. The report says Lehman was insolvent for weeks before it went bankrupt, sparking a global financial meltdown.

It accuses management of “actionable balance sheet manipulation” and using accounting tricks to hide debts. Ernst & Young said that its last audit of Lehman was “fairly presented” according to accounting rules.

The collapse of the 158-year-old investment bank in September 2008 was the world’s largest bankruptcy. Wall Street, the City of London, and the US and UK governments tried to organise a rescue, fearing – rightly – that Lehman’s failure would set off a chain reaction around the globe…

Much of the report, which took evidence from all the major parties involved in Lehman’s collapse and attempts to rescue the firm, contains allegations about an accounting “gimmick” known as “Repo 105”. This is a legal accounting device that involves shifting around assets to reduce the size of a company’s balance sheet, and effectively give the appearance that debts have been cut…

London appears to have played a key role in approving Lehman’s use of Repo 105. The report says Lehman at first tried to find a US law firm that would approve its shifting around of assets.

Unable to get US clearance, Lehman turned to London law firm Linklaters, which advised that the practice was allowed under UK law. So, assets Lehman wanted to “hide” were transferred to the London operation, which would “conduct the [Repo] transaction on their behalf,” the report said.

BBC News

The BBC’s Business Editor, Robert Peston, explains Repo 105 in more detail here

3 Comments

  1. Posted March 14, 2010 at 11:28 am | Permalink

    Seems to me there is a great deal of sloppy thinking on financial regulation. First, cases of failure to enforce existing regulations are too often treated as arguments for more regulation. Second, the question is too often presented as one of more or less regulation when it should be presented as better or worse regulation (not the same thing).

    Basically, regulations which reduce transaction costs are usually a good idea, those that increase transaction costs a bad one. Discretionary regulation (particularly over market entry) are a bad idea, same rules for everyone are usually a good idea. (These two sets of criteria typically march together.)

    A lot of the problems seem to have been that people simply did not know what they were actually buying. A property right is only a property right of any value if it is clear what its content and boundaries are. (And those boundaries are enforceable: the ability to transfer the right also matters, of course.)

    Since people can invent new financial instruments and new financial institutions quicker than regulators can regulator for them, one is much better off with general rules about clarity, transparency and prudential backing than chasing specific instruments and specific institutional forms.

    A lot of the financial regulation in the US and UK seems to have failed to measure up to these, not really very complex, criteria.

    That is without considering the US policy of encouraging riskier mortgages to spread home ownership, which was a another level of madness, but one made worse by the failure of the basic regulatory structure.

  2. Posted March 14, 2010 at 5:36 pm | Permalink

    I think your point about ‘better’ rather than ‘more’ regulations is a very good one, Lorenzo. The Economist had been arguing for years that financial firms were over-leveraged to blazes, but that was precisely the aspect that was never regulated, meanwhile regulators were crawling all over their books looking for trivialities.

    And yes, I do hope that people on both sides of the ideological fence in the US have learnt that dodgy mortgages do not an ownership society create.

  3. Posted March 15, 2010 at 1:16 am | Permalink

    I’m not sure trading while insolvent could be described as a triviality.

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