I have a trip coming up at the end of this week, and in the meantime I have two articles to write, and a section of a legal thingy, and I’m sick, and my daughter’s sick, so I won’t be able to do justice to the Lehman report issued by the bankruptcy examiner on Thursday. So here are just some moderately quick thoughts.
- The report is great reading (I’ve read some sections of it). You can get the whole thing here, in nine separate PDF files. If you want to get an overview of the report, Volume I has a comprehensive table of contents. Note that the TOC is thirty-eight pages long. Like many legal documents, some of the section heads are written as sentences, so you can sort of “read” the TOC. In particular, you can see from the TOC which parties might be the subject of legal causes of action. (Note that the “Volume” numbers have nothing to do with the logical organization of the report; they only reflect how it was chopped into nine PDFs.)
- The topic that has gotten the most press attention (here’s the main Times story, for example) is “Repo 105,” which takes up all 300+ pages of Volume III. A repo agreement is a short-term sale of securities (collateral) with a promise to buy it back later at a slightly higher price — in other words, a collateralized loan. With Repo 105, it seems that Lehman would sell the securities before the end of a quarter and promise to buy them back early the next quarter, and book the transaction as a sale, not a loan. The effect was to reduce the apparent amount of Lehman’s leverage at the end of the quarter — which is when the published balance sheet snapshot is taken. Here’s the Alphaville summary if you want more. In other words, Lehman was cooking the books.
- If this sounds like Nigerian barges (Enron) to you, you’re not the only one. The examiner’s report itself (section III.A.4(j)(4)(b)) finds that Dick Fuld and his CFOs Chris O’Meara and Erin Callan were “grossly negligent” and that claims for breach of fiduciary duty could be made against all of them. Peter Henning talks about the potential for criminal charges.
- One theme that has been sounded is that Lehman was an outlier (a “bad apple,” a recent president might have said), and there is an internal email in which a Lehman exec says that the other banks were not engaging in Repo 105-type transactions. Should we believe this? naked capitalism has a tip from a reader saying that other banks (or at least one other bank) were using total return swaps to dress up their balance sheets. I find it plausible that some banks were not cooking the books because, like Goldman, they had shorted the real estate market enough to protect themselves. But Lehman was not the only bank that was in deep trouble in 2007-2008.
- Frank Partnoy says that alongside the fraud of Volume III, the incompetence of Volume II is perhaps even more troubling. His post has some good examples. Here’s Partnoy’s conclusion: “The Repo 105 section of the Lehman report shows that Lehman’s balance sheet was fiction. That was bad. The Valuation section shows that Lehman’s approach to valuing assets and liabilities was seriously flawed. That is worse. For a levered trading firm, to not understand your economic position is to sign your own death warrant.”
- Volume IV (Section III.A.5, “Secured Lenders”) discusses actions by Lehman’s counterparties and whether they are guilty of murdering Lehman. For the most part, the report says that the various banks involved did nothing wrong, or at least nothing wrong that rises to the level of legal action. There is one exception, though. In section III.A.5(f), pages 1220-24, the examiner finds that JPMorgan Chase may have violated an implied covenant of good faith and fair dealing by demanding too much collateral from Lehman shortly before its collapse. There is some evidence (p. 1216) that JPMorgan was overcollateralized and knew it was overcollateralized. (“All we need to talk this morning about the calls Leh has been making about having us return a portion of our excess collateral to their holding co. We have taken the position that their is no excess but they have not yet accepted that. We should make sure our statements are consistent since I am sure you will soon get called as well.”) But there is also evidence (p. 1217) that JPMorgan was behaving reasonably enough.
- But Yves Smith discusses the most interesting question, which only gets sixty pages in Volume IV (Section III.A.6, “Government”): what was the government doing? The examiner uncovers more evidence that the SEC was not up to the task of monitoring Lehman (similar to the earlier report by the SEC’s own inspector general, finding that the SEC did not effectively oversee Bear Stearns). Here’s a juicy paragraph that various people have seized on (pp. 1488-89): “After March 2008 when the SEC and FRBNY began on‐site daily monitoring of Lehman, the SEC deferred to the FRBNY to devise more rigorous stress-testing scenarios to test Lehman’s ability to withstand a run or potential run on the bank. The FRBNY developed two new stress scenarios: ‘Bear Stearns’ and ‘Bear Stearns Light.’ Lehman failed both tests. The FRBNY then developed a new set of assumptions for an additional round of stress tests, which Lehman also failed. However, Lehman ran stress tests of its own, modeled on similar assumptions, and passed. It does not appear that any agency required any action of Lehman in response to the results of the stress testing.” The general message is that the SEC did not take any real action to address the problems at Lehman; the Fed and the New York Fed must have been aware of them, but acted primarily as a lender, not as a regulator, deferring to the SEC.
- There is also a discussion on pages 1500-01 of a plan to create a Maiden Lane-type entity to hold $60 billion of toxic Lehman assets, financed by $5 billion from Lehman and a $55 billion non-recourse loan from the Fed. This seems to contradict the line often stated by Bernanke, Geithner, and Paulson that the Fed could not have rescued Lehman in a manner similar to Bear (backstopping enough of the toxic assets to make Lehman a palatable acquisition for someone else). It is possible, however, that the Fed decided that Lehman’s assets were too toxic for such a maneuver; the report doesn’t say why the Fed decided not to go ahead with the plan.
Overall, I’m surprised by how little interest the report has gotten in the media, given its depth and the surprising nature of some of its findings. Of the blogs I read, naked capitalism is giving it the most coverage and discussion.
Update: Andrew Ross Sorkin, the prince of the mainstream media when it comes to Wall Street, is getting on the case. In Dealbook, he points out that regulators saw everything that was going on at Lehman during the crucial months:
“There’s a lot riding on the government’s oversight of these accounting shenanigans. If Lehman Brothers executives are sued civilly or prosecuted criminally, they may actually have a powerful defense: a raft of government officials from the S.E.C. and Fed vetted virtually everything they did. . . .
“The problems at Lehman raise even larger questions about the vigilance of the S.E.C. and Fed in overseeing the other Wall Street banks as well.”
To Sorkin’s credit, he also cites Yves Smith for asking the question before he did.