Fun with Accounting

David S. White

Principal of the Law Firm of David S. White & Associates, West Los Angeles, specializing in litigation, arbitration and mediation of real-estate-related disputes and litigation since 1977; www.dswlawyers.com


Recent revelations concerning the
fall of Lehman Bros. and other financial shenanigans have revealed the fun side
of accounting – fun, that is, as long as you don’t get too hung up about
honesty and the ethics of ripping off other people’s money ("OPM").   The staggeringly huge Lehman
bankruptcy, the biggest in the history of American business failures, recently
produced a 2,200 page report and related documents released by Anton Valukas,
the court-appointed examiner charged by Bankruptcy Judge James M. Peck, to
figure out just what happened. 
Judge Peck said Valukas’ report read "like a best-seller."  Here’s the short version.

So let’s say you have decided to
take advantage of today’s historic lows in home loan rates and refinance your
home – before interest rates start going up, perhaps later in the year.  You owe a lot of money on your credit
cards (having not learned that paying for those lavish dinners and weekend
getaways with plastic and then paying the minimum on your monthly bill is just
a dumb trap).  You also have those
student loans to the tune of umpety-ump thousand dollars and a nagging
obligation to support wife #1, even though you are on to the greener pastures
of wife #2, who spends your money like it is water.  It is obvious that if you listed all these debts, nobody in
their right mind would re-fi your house. 
What to do? What to do?

Wait.  Why not simply form a holding company, say David S. White Global Industries, Ltd., and
make up two financial statements – on the first, for your new holding company,
you put all your debts; on your second, the spanking clean one for you to
present to your prospective lender, you list no debt at all, because all your
debt has been transferred to your new holding company.  Presto!  You are now a fine loan candidate and you get your new
loan.  All the debts are still
yours; you just made them look like they belonged to somebody else now.

Welcome to the wacky world of
corporate accounting!  It seems
that in 2007 and 2008, when their business was going to hell in the proverbial
handbasket, Lehman used a cutesy, financial-sounding name: "Repo 105 Transactions"
and did just that with their debt obligations, in order to make their company’s
finances sound all rosy and healthy. 
In Lehman’s business, their "net leverage numbers" were critical to
their credit rating, investors, trading partners and the rating agencies who would
rate the securities packages that they profitably marketed.  "Repo" is short for repurchase
agreements – simply,  Lehman
offered collateral for a loan to a trading partner, in exchange for Lehman’s
promise to buy that collateral back at a future date.

In the first two quarters of 2008,
Lehman held assets which were seriously de-valued; the beginning of the crash
which got so bad in the Fall of 2008 that it literally killed Lehman and caused
our US Congress to pony up nearly a Trillion Dollars in one fell swoop to
BailOut Wall Street.  Never mind
that nobody can tell you where that money went, Lehman needed to de-leverage
fast or face big financial trouble.  
Repo 105, enter stage left.

Lehman used Repo 105, a whole flock
of repurchase agreements, to temporarily remove (from its balance sheet) all
that nasty stuff that was pulling down its balance sheet for the first two
quarters of 2008 – suddenly, everything looked rosy again.  This, even though Lehman’s management
knew that Lehman’s leverage numbers would be compared to other investment banks
who were not using this accounting trick and Lehman knew further that it’s
newly lowered leverage numbers could now be touted, indeed, shouted from the
rooftops overlooking Wall Street, as wonderfully positive news for its
investors.  Truth, honesty and
ethics were forgotten by Lehman’s management in their efforts through this
creative accounting trick to mislead the market and its investors into
believing that Lehman was truly financially healthy and that all that bad news
the media was flogging about Lehman’s financial ship of state capsizing, well,
that was just media hype and pure nonsense.

Oh yes, I forgot to mention that
Lehman moved some $50 Billion worth of rotting financial garbage off of it’s
balance sheets by using Repo 105, according to the Bankruptcy Examiner Valukas’
report – now that’s some accounting trick

Despite a May 2008 letter from a
Lehman Senior Vice President, Matthew Lee, complaining to management about
certain "accounting improprieties," Lehman’s auditor, Ernst & Young,
breathing the rarified air of being among the four biggest auditing firms in
the world, did not figure out what was going on.  Not even after Lee wrote another letter, this time directly
to Ernst & Young, to inform them that Lehman used $50 billion of Repo 105
transactions to move nasty assets off their balance sheet and away from prying
eyes at quarter end, for just a little while.  The very next day, Ernst & Young representatives met
with the Lehman Audit Committee, who wanted to know all about what Lee was
complaining about, and still they did not disclose this sleazy accounting
artifice to defraud.

These guys needed to be driven over
by a truck to get the message.  The
truck hit them on September 15, 2008, after most of Lehman’s clients got out of
Dodge, Lehman stock truly crashed and burned in a little over a week, and the
credit rating agencies jumped ship and devalued Lehman’s assets to where they
should have been without the magic of corporate accounting, thus resulting in
the largest bankruptcy in U.S. history.  Lehman left a trail of $613
Billion in debt
, and the rest, as they say, is history.

We end this sordid tale by asking
if what happened at Lehman was unique. 
I seriously doubt it. 
Mountains of information are being sorted out and there will be more . .
.  enough to make you truly sick
(if this tale didn’t already do the job).

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