Repo 105 at Lehman Brothers - Term Paper Example

Repo 105: Lehman Brothers Repo 105: Lehman Brothers Repo 105 is an accounting phenomenon that ifies a short-term repurchasing agreement as a sale. The cash received from this transaction is used as a revolving fund, where it is used to pay debts with a mission of reducing the company’s burden through a temporary payment of liabilities. The purpose of short-term repurchasing agreement is to change the aspect of balance sheet in order to attract the investors or other sources of financial support. This happens during the time of publishing the company’s balance sheet in its financial report. After the report is published, the company then borrows cash to repurchase its original assets that were sold to clear debts. The Repo 105 has been a practice being conducted by several companies in the current world of business in order to gain financial support or other favors from the stakeholders. However, this research paper aims to explore the usage of Repo 105 by Lehman Brothers that steered to its bankruptcy. In particular, the paper makes a focus on the perceived fraud in Lehman Brothers, the response from the corporation and the government, the core issue behind the fraud, and the suggested steps that could have prevented such a misconduct to occur. The purpose of the paper is to establish the financial viability of the accounting responsibilities of the organizations and the impacts associated with poor accounting and financial concepts and decisions. This exhibits the importance of morality and transparency of the overall business and corporate world. Lehman Brothers Holding Inc. was among the largest firm globally offering financial services. In fact, it was the fourth largest investment bank the United States before the declaration of its bankruptcy. It offered services such as sale of equity and fixed incomes, trading, investment banking, private banking and equity, investment management, and financial research. Lehman Brothers filed for bankruptcy on September 15, 2008, thereby breaking the world records for being the largest with $619 billion in debts and $639 billions for their assets. Their asset surpassed the previous corporate giants such as Enron and WorldCom that had followed the similar trend of bankruptcy. Lehman Brothers was the largest victim of the induced 2008’s financial crisis of the US that affects the global financial markets. Its collapse contributed to more injuries in the 2008 financial crisis, as it steered the erosion of more money from global equity markets, which caused the decrease of the market capitalization efforts. For example, the October 2008 was recorded as the biggest decline of equity markets at the time. The faults of the Lehman Brothers started during the credit crisis that erupted in August 2007. This is after the failure of hedge funds from the two Bear Stearns, steering the fall of the Lehman Brothers’ stock. This caused the company to eliminate about 2500 jobs related to mortgage services where they even its BNC sections (Shirkhedkar, 2007). The Alt-A offices were also closed in the three states but continued to be the major market player of the housing market in the US. It underwrote extra mortgage-backed securities in 2007 than any other company in the market, even accumulating huge portfolio of even four times the shareholder’s equity. In the last quarter of 2007, Lehman Brothers rebound its stock for staging its fixed income assets for a temporary rebound. Unfortunately, the company did not get a chance to reduce its massive mortgage portfolio. However, the huge portfolio of the mortgage securities continued to become vulnerable to the failing market conditions. In March 2008, Lehman shares fell in the stock market after various concerns were raised on the status of the company, especially due the indications given by the nearly collapsing Bear Steams. At this date, Lehman Brothers’ fell by 48 percent with the perceptions of becoming the next firm in the Wall Street to fail. Luckily, the stakeholders gained confidence with the company in April after a preferred stock was identified that raised $4 billion. The identified stock was converted into Lehman shares of 32 percent, which was premium to its price at that time. Unfortunately, the company continued to decline, causing the managers to start evaluating the valuation for mortgage portfolio of Lehman. On June 2008, Lehman Brothers announced a report providing several updates on its market conditions. It reported a loss of $2.8 billion, an investment of $6 billion from investors, and boosted its liquidity pool. Its gross assets and exposure to commercial and residential mortgages decreased, thereby cutting down the leverage. The measures were perceived to be ineffective and inefficient since they were running of time and the third quarter report had to be prepared. Therefore, the Lehman Brothers’ management teams did their best to save the company but were unsuccessful in every deal they were making with their partners. in the early September 2008, the company’s stock plunged 77 percent, creating a great impact to the global equity markets. This created many concerns to the stakeholders including the investors who question the CEO to exercise the independency of the firm by selling some of its assets to stabilize the conditions of the company in the market. According to Greg (2008), there were hopes that Korea Development Bank would buy a stake of Lehman Brothers, although the talks could not continue after the Korean Bank declined the proposal on September 9. This because a death blow for the company where clients began to pullout and the short term lenders cutting their credit lines, thereby leaving the firm with an option to announce their bankruptcy. In their accounting metrics, the Lehman Brothers used different tricks of dammed lies and the balance sheets to rip from investors and gain more clients (Trumbull, 2010). The company used to sell Eurobonds, Treasury bonds, mortgage packages, and the Canadian government instruments on a temporary basis at every quarter of reporting the financial status. The deals that amounted to $50 billion made Lehman Brothers to publish a cleaner and healthy financial report than previous reports. The exposure of Lehman Brothers’ unique trick provided a clue of the mysterious failure of other companies such as Bear Steams, Northern Rock, and Washington Mutual, among others, which provided impressive and healthy debt ratios that lead them to financial collapse (Veljko et al., 2009). The Lehman Brothers’ management needs to take full responsibility for the fraud to the company, its shareholders, investors, clients, and other stakeholders by publishing a precise balance sheet in order to entice them. The adoption of accounting laws aimed to protect the investors, shareholders, and other financial stakeholders including clients from being provided with wrong information by the beneficial government, companies, and individuals. The accounting regulations aimed to guide, prevent, or protect the financial transactions, thereby eliminating frauds in the accounting departments. Repo 105 provided the Lehman Brothers to secure borrowings but defining it as sales, where they moved off the ‘sold’ assets from the balance sheets. This was to reduce the reported market leverage. After the investors became more focused on the investment bank leverage in the Lehman Brothers, the company continued to practice the use of Repo 105 concepts in order to conceal the true position of their financial health. At the end, Lehman Brothers had a deficit of about $50 billion that were hidden in the Repo 105 deals, thereby reducing the overall net leverage reports in financial reports. The cash received from Repo 105 transactions were used to pay the pay down the liabilities and the reported assets on the balance sheet. This lowers the leverage since its reduces the liabilities and assets reflected in the balance sheet. In order to achieve the fraudulent activities, Lehman Brothers started by characterizing Repo 105 as the sales instead of financing transactions. However, both corporation and the government responded where the Examiner was given the task to investigate the matter and give the report to the public. The report technically claimed that there was no usage of Repo 105, where it explains that Repo 105 provides an identical procedure that costs 5 percent. This means that an asset valuing 105 could produce only 100 in cash. The report made the Securities and Exchange Commission (SEC) to send interesting letters to large companies and insurance firms requesting their usage of repurchase agreements in order to determine whether they used the same tricks. On the other hand, the auditors responded by claiming that all the transactions made by Lehman Brothers were accounted according to the General Accepted Accounting Principles but not the Repo 105 concepts (Tibman, 2009). This was an effort to defend the colleagues from the collapsed Lehman Brothers. The government, through the Attorney General also delivered the government position by filing a suit against the Lehman Brothers’ auditors, Ernst & Young (Rappaport et al., 2010). The government alleges that the accounting firm assisted Lehman Brothers to a massive and dangerous accounting fraud that could affect the business community at large. This is because the firm had been approving the accounting treatments since 2001 to 2008, when the Lehman Brothers had been paying them. Other senior authoritative agencies also responded to this Lehman Brothers’ bankruptcy by converging the meeting to discuss the way forward on the issue. They met to review the accounting treatments for such transactions that are claimed to be similar to Repo 10. The agencies including FASB and IASB and were responsible of setting various accounting standards. Such responses are not effective because the tactic used by Lehman Brothers could have been continuing even today if the company was stable. The identification of Repo 105 principles were established after thorough investigation on the cause of the Lehman Brothers’ failure (Hemerijck et al, 2009). This paper establishes that Lehman Brothers collapsed due to other financial factors such as poor management of finances, high economic pressures, lack of confidence from the clients and untrustworthy by the market stakeholders including investors and partners. The increased inability to secure and distribute prime mortgages in strategic growth master plan made the company to adopt various tactics to find ways of balancing the financial reposts. This is especially after there resulted world market experienced a global financial crisis, which Lehman Brothers failed to manage for sustainable operations in the market. Moreover, the countercyclical strategies used by the Lehman Brothers were associated with greater risks, used more capital from the invested funds and their liquidity were less, as compared to the Lehman Brothers’ business culture. The desperation of Lehman Brothers made them to adopt various strategies to raise instant cash in order to control their business ventures. This is because they could not be able to sell their assets at a much desirable price, forcing them to adopt the advanced accounting techniques of manipulating the figures of balance sheet (Williams, 2010). These manipulations are only for the purpose of making the precise financial reports to the public to maintain their perceptions in working together. Lehman Brothers became a victim of the policies they had adopted in agreeing to join a ten firms group that signed an agreement with the SEC, the Office of NY Attorney General, and other security regulators. They signed under the influence of their research analysts from investment banking sections. The companies were alleged to have improperly associating the compensations of analysts to the companies’ revenues, promising the market moving coverage, an exchange to the opportunities for underwriting. They also exerted financial penalties to the one breaking the agreements. This was a good start for Lehman Brothers that later ignored the set rules and could help them to avoid the miseries that steered to its collapse. In conclusion, the use of Repo 105 by the Lehman Brothers led to the fraud of $50 billion in order to reduce the overage net leverage in reporting their financial balance sheets. This accounting strategy was adopted to fool the investors and save the company by attracting the investors and financiers. This contributed to its collapse due to its poor performance in the market, even after conducting a series of Repo 105. This generated a heated debate of blame game in the company, especially when the court’s bankruptcy examiner released a report. The government blamed the company’s auditor while the auditors blamed poor market conditions, especially the financial crisis that affected the global market. Therefore, the use of Repo 105 strategy can help the companies to conduct undetected accounting frauds that destroy their progress, as evidenced in the paper. References Trumbull, M. (March 12, 2010). Lehman Bros. used accounting trick amid financial crisis and earlier. The Christian Science Monito. Retrieved March 1, 2014 from: http://www.csmonitor.com/USA/2010/0312/Lehman-Bros.-used-accounting-trick-amid- financial-crisis-and-earlier Greg, M. (September 4, 2008). Financials slip as Korea snags weigh on Lehman and Merrill. MarketWatch. Retrieved March 1, 2014 from: http://www.marketwatch.com/News/Story/Story.aspx?guid={9E9BDC4C-06D1-4EBD- 971B-FCD4A4249F24}&siteid=yhoof2 Veljko, F., Vikas R. and Pradeep K.Y. (May 22, 2009). Naked Short Selling: The Emperor`s New Clothes? University of Cologne: Centre for Financial Research. Retrieved March 1, 2014 from: http://www.cfr-cologne.de/download/workingpaper/cfr-09-09.pdf  Rappaport, L., and Rapoport M. (December 21, 2010). Ernst Accused of Lehman Whitewash. Wall Street Journal. Retrieved March 1, 2014 from: http://www.webcitation.org/query?url=http%3A%2F%2Fonline.wsj.com%2Farticle%2F SB10001424052748704259704576033540546160536.html%3Fmod%3DWSJEUROPE_ newsreel_business&date=2010-12-22 Tibman, J. (2009). The murder of Lehman Brothers: An insiders look at the global meltdown. New York: Brick Tower Press. Hemerijck, A., Knapen, B., Doorne, E. ., & Wetenschappelijke Raad voor het Regeringsbeleid (Netherlands). (2009). Aftershocks: Economic crisis and institutional choice. Amsterdam: Amsterdam University Press. Read More