When I first heard the news last week that the Lehman Brothers bankruptcy examiner had submitted his report and that it concluded that Lehman cooked its books big time to hide its problems, I thought of Casablanca.
In the Oscar-winning film, corrupt local official Captain Renault (played with suave cool by Claude Rains), pressured by the Nazis, closes Rick’s Café. Rick (the immortal Humphrey Bogart) asks him why the café is being closed. Renault’s answer: “I’m shocked, shocked to find that gambling is going on in here!” A half-second later, one of Rick’s croupiers brings the captain his gambling winning for the evening.
I’m not accusing the bankruptcy examiner of such cynicism. On the contrary, it sounds like his 2,200-page report will be the nails in the coffin. But the folks at Lehman Brothers sound as if they were auditioning for the role of the cynical Renault. A story in The New York Times, “Report Details How Lehman Hid Its Woes” by Michael J. de la Merced and Andrew Ross Sorkin contains this little nugget:
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In a series of e-mail messages cited by the examiner, one Lehman executive writes of Repo 105: “It’s basically window-dressing.” Another responds: “I see … so it’s legally do-able but doesn’t look good when we actually do it? Does the rest of the street do it? Also is that why we have so much BS [balance sheet] to Rates Europe?” The first executive replies: “Yes, No and yes. :)”
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Yes, it’s legally do-able but doesn’t look good. No, the rest of the Street does not do it. Yes, that’s why the balance sheets look good.
What’s worse than all of the above, is that this sort of thing was going on at Lehman, according to the examiner, since 2001. That means Lehman Brothers continued at this even after Enron imploded (in part for similar accounting chicanery), after Arthur Anderson collapsed (for okaying Enron’s cooked books), and after the passage of Sarbanes-Oxley in 2002.
And there are some people out there in Corporate America who continue to utter the tired old bromide: “We don’t need more regulations; we need to enforce the ones we have.”
I’m not suggesting that repos (repurchase agreements), the specific instrument that Lehman abused by prohibited. Repos serve to create liquidity, and that’s a very good thing. But it should be illegal to treat them as Lehman did in its accounting and make it look as if the company is less leveraged than it actually is. Lehman was so adept at this, the company actually “reduced” the leverage on its books by $50 billion. Yes, that was Billion.
When you hide that much leverage, you artificially plump the pillows for your shareholders and potential shareholders. You make your company appear to be worth more than it is. After all, the balance sheets look good, right?
This is fraud — representing a falsehood as truth and then benefiting by the falsehood.
And no matter how much enforcement is brought to bear on the folks at Lehman Brothers — after-the-fact enforcement — it’s highly unlikely all the shareholders who lost so much money can be made whole.
That’s why enforcing the rules we have isn’t enough.
We need something that forces a more accurate accounting of repos. While we’re at it, let’s get something to stop naked short selling. And maybe get an uptick rule that actually accomplishes something, instead of the ridiculous little nothing of a reg that the SEC just passed.
It’s astonishing that the market crashed in October 2008, and nothing substantial has been done to change the way the market works — or in this case, doesn’t work.
The following is uttered in complete sincerity: I’m shocked, shocked to find that nothing is going on in here!