At its most basic level, Anton R. Valukas’ report on the Lehman failure is the story of our Wall Street worship culture encapsulated in one firm.
Corporate hubris: check
Accounting chicanery: check
Questionable asset valuations: check
Shareholder appeasement: check
Corporate executive denial of knowledge and/or accountability: check
Billions of dollars of other people’s money lost: check
Failure of regulatory oversight: check
Failure of the media to fulfill its skeptical watchdog role: check
I could go on, but what’s the point?
I mean, are these revelations really so shocking? Look at where most of the attention is focused: the so-called Repo 105 transactions. ZeroHedge takes on Repo 105, quoting extensively from the examiner’s report with appropriate indignation. There’s plenty more here at FT Alphaville and here on DealBook.
I see it boiling down this way: Lehman took bad assets and moved them off its balance sheet so as to appear as though it was reducing its leverage. The idea was to make everyone think the bank was healthier than it actually was, to hang on and hopefully ride out the storm. And it worked, at least for a while. Check out the headlines in mid-March:
Get the picture? Better-than-expected Lehman results = a boost to the firm’s stock price and calming of fears on the Street. See, it’s all OK now. Hardly anybody really cared to ask how Lehman managed to report good news when everyone was expecting bad news. And even if they had, it’s not likely Lehman would have said anything about Repo 105.
From pages 734 and 735 of the examiner’s report (or pages 17 and 18 of the 336-page section on Repo 105): “Lehman never publicly disclosed its use of Repo 105 transactions, its accounting treatment for these transactions, the considerable escalation of its total Repo 105 usage in late 2007 and into 2008, or the material impact these transactions had on the firm’s publicly reported net leverage ratio. According to former Global Financial Controller Martin Kelly, a careful review of Lehman’s Forms 10-K and 10-Q would not reveal Lehman’s use of Repo 105 transactions.”
Valukas wrote in his report that Kelly expressed his concerns about Lehman’s Repo 105 transactions to CFO Erin Callan and her successor, Ian Lowitt, telling them that “Repo 105 transactions meant ‘reputational risk’ to Lehman if the firm’s use of the transactions became known to the public. In addition to its material omissions, Lehman affirmatively misrepresented in its financial statements that the firm treated all repo transactions as financing transactionsâ€”i.e., not salesâ€”for financial reporting purposes.”
According to Reuters and other news sources, Erin Callan’s lawyer declined to comment. Shocking. Attorneys for the others were’t available. Equally shocking.
Once Callan’s attorney gets his or her arms around the report, though, I’d be willing to bet the defense will be along the lines of: Repo 105 had been used for nearly a decade; it wasn’t illegal; there were no intentionally material misrepresentations; there was no accounting fraud; we complied with GAAP; etc. Which may be all true.
Former Lehman CEO Richard Fuld’s attorney is saying his client didn’t know what the Repo 105 transactions were. “‘He didn’t structure them or negotiate them, nor was he aware of their accounting treatment,’ attorney Patricia Hynes said, noting that the firm’s outside auditor and legal counsel had not raised any concerns about the transactions with [Mr. Fuld].”
Willful ignorance? It’s certainly not an original defense. But “unoriginal” is probably the nicest thing Dick Fuld will be called today.
The longer I live, the more convinced I am that many of the people popularly regarded as “smart” or “responsible” are in fact a bunch of ignorant dumbasses who’ve Forrest Gump-ed their way to positions of respect and power. I’m pretty sure I could have run Lehman Brothers as well as Dick Fuld did, although I’d like to think that if I saw something like “Repo 105″ in a memo or email I’d be curious enough to ask what it was. Or maybe just curious enough to ask, “Everyone thought our results were going to suck. How come they suck less than everyone thought?”
It’s entirely possible Callan and others in positions of responsibility at Lehman saw nothing wrong with buying a little time in the markets, and saw Repo 105 as an acceptable way to do that.
Which is, in fact, the problem.
When a company takes bad stuff from its books over here and moves it over there without telling anyone, thus distorting the true financial picture of the firm, it should be wrong. It’s not always, but it should be. Repo 105 would probably find some staunch defenders among the anti-fair value/anti-mark-to-market crowdâ€”the same folks responsible for pressuring FASB to water down its accounting rules. Their point is well-taken: They shouldn’t be penalized for holding assets that are at the time illiquid and hard-to-value. Like mortgage-backed assets back in 2009 when the markets were frozen.
You know what? Tough. Write it down, take the pain and then when the markets un-freeze reflect the new asset values on your balance sheet. More volatility? Yup. Might the hit to the stock price ding some execs’ compensation? Quite possibly. But if you can’t take the short-term pain, don’t buy those securities. And if you say “hundreds of thousands wouldn’t have been able to buy homes (or do whatever) if we hadn’t bought those securities,” that may be true. I think history will show some people shouldn’t have been able to buy housesâ€”or 42-inch LCD TVs, or Hummers.
Look, the world is volatile. Artificial smoothing leads to artificial confidence, in individual firms and in the markets as a whole. And I think we’ve seen where that leads.
Not everyone bought the bullshit Lehman was shoveling. The first thing I thought when I read about this report yesterday was that David Einhorn was right. Short sellers take their share of grief, some of it deserved, Einhorn is right about something else, too, something more important than just Lehman: As Emma Trincal noted in her story, Einhorn thinks “Wall Street is more eager to accuse short sellers of conspiring against corporations than it is to scrutinize companies’ financial statements.”
That’s nothing new. And if you sit back and reflect on it, neither are the revelations of Lehman’s behavior contained in the examiner’s report currently getting so much attention.
By focusing on Lehman, we may miss the broader picture, which in my opinion is that this kind of behavior is rampant, it’s widely-accepted and it’s under-reported. We will be traveling down this road again soon. The question is which company will be the subject of an examiner’s report next?