REPO 105

I will make a brief tangent from my discussion of CDO's to comment on Anton Vukas's report on Lehman Brothers and the use of "Repo 105".

Repo or Repurchase Agreements are a means of financing positions for the owners of securities and is a way of lending on a collateralized basis for the lenders. The key is ownership of the securities during the transaction. The owners maintain ownership during the transaction-unless they are unable to repay the lender's financing in which case the securities become the possession of the lender. This is similar to a mortgage-the bank providing the financing can only have access to the house if the mortgagee doesn't make their payments. As long as the mortgagee is current the ownership of the house stays with them.

It is important to understand that this is collateralized lending- not a transfer of ownership. In fact, although the name Repo has survived, the original name reflects the fact that it consisted of selling a security and then repurchasing it on an agreed date for an agreed price. This was soon recognised as being an actual transfer of ownership (and hence risk), and was not the intent. For this reason the market evolved into the collateralized lending market as it is today. One of main drivers of the change was precisely to stop organisations from entering into so-called "window dressing" transactions designed to give the appearance of liquidity, solid core-ratios or whatever to external viewers.

Lehman Brothers was fully aware of the prohibitions to window-dressing, but rather than expose their (untenable) financial state they scoured the market for a solution to their problem. Their "salvation" was to be a legal opinion from Linklaters which allowed Lehman Brothers to "sell" their securities and then buy them back on a prearranged date for a prearranged price. If it appears surprising that Lehman would do this it is even more surprising that Linklaters would write an opinion justifying it.

Window dressing is illegal in the UK as it is in most developed markets. The purpose of balance sheets and income statements is to provide accuracy and transparency which allows third parties to evaluate a company's financial position.

I have already written earlier on my distaste for the accounting profession which created the framework for off-balance sheet accounting as if hiding contingent liabilities made them any less contingent! But for a major legal firm to write an opinion supporting balance sheet manipulation reeks of either the utmost stupidity-or the utmost arrogance-not to mention greed.

What is equally ridiculous is the attempt by Richard Fuld's lawyer Patricia Hynes to claim that "Mr Fuld did not know what those transactions were--he didn't structure or negotiate them, nor was he aware of their accounting treatment". Well Mr. Fuld, in his own words, was the one "who ultimately signs off" and that he was "comfortable with our valuations" and that "we have always had a rigorous internal process". Maybe Ms Hynes is referring to a different Mr. Fuld?

Just think. If a firm like Lehman Brothers was willing to engage in such actions to deliberately deceive it's shareholders and regulators as to it's financial health, what would they be willing to do to unsuspecting investors when structuring and marketing structured products....