Lehman Brothers

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Repo 105 and accounting rules

The limit of which repo can be accounted as sales is within 98-102%. Other than it, it should be accounted as loan. But Repo 105/108 which means the collateral’s value is 105% and 108%, so it should be accounted as loan.

Lehman Brothers wanted to make the loan look like it wasn’t borrowing so much money, so they did repo deals where they took less cash than the asset was value. For example, they owned a bond valued $105 in market, but they will sell it $100 and record it as sales. They used the money to pay its debts so after they had issued their quarterly report, they will borrow more money to repurchase the bond.

Loan vs. Sales in accounting

Lehman Brothers supposed to treat the repo as loan instead of sales. It created illusion as they had less liability which can affect the liquidity ratio that makes their report look healthier. Let’s start with an example.

A company borrows $10 for pay off current debt. Currently they have:

Assets = $100 Liabilities = $70 Equity = $30

This loan can takes place with or without collateral, but there will no entry for the collateral since the company still own and possesses the asset.

[pic 2]

As you can see after they pay the $10 loan, the asset, liabilities and equity remain the same.

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But what Lehman Brothers did was using sales to change some assets to cash to pay liabilities, which supposed to be a loan since they will repurchase it after few days. So the problem here is that when the liabilities decrease but the equity still remains the same. The ratio goes from 70/30=2.33 to 60/30=2 and that make it appear more liquid than it should be.

During the financial crisis period in 2007 and 2008, they increased the use of repo by 2 or 3 times right before the end of an accounting period and accounted it as sales.

Here is Lehman Brothers balance sheet comparison in 30 Nov 2007

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In the 2nd quarter of 2008, Lehman Brothers use this technique to move $50 billion liabilities off of its balance sheet, created impression they had $50 billion more cash.

There are 2 reasons why they did it. First, is to keep the stock prices from dropping by creating report with illusion that they are not relying on debts. And second, is to prevent regulators from stepping in and forcing bankruptcy.

The Impact and consequences of the collapsion

The collapse of Lehman Brothers has bring a huge impact to the domestic economy of the United States, as well as on other economies in the world.

The impact of the fall of Lehman Brothers on the economy of the United States is having the loss of investor confidence in the America economy that result in the withdrawal of their funds from the capital market.

Subprime Mortgage crisis that resulted in the collapse of Lehman Brothers had decrease the availability of liquidity in the capital markets and the impact on the difficulty of finding sources of funding for companies that want to expand or develop.

Not only that, the company has assets of bonds and other securities that would decrease the value of assets due to falling stock prices and bond, they also cannot do development, the company also suffered losses that impact on operational savings; including a reduction in the number of workers, and thus the performance of the real sector is also distracted.

The fall of Lehman Brothers that accelerate and worsen the crisis in the United States also spread to other countries where it can be seen by the decrease of index stocks that has joined with several stock exchanges.

Other effect also include the increase in unemployment in some countries due to the closure of the company.Approximately 25,000 employees of Lehman Brothers in various countries do not have a job.

The fall of the confidence of investors on the performance of the US stock market has become an indicator for the performance of the international stock exchanges, it strengthen the action of the withdrawal of capital from the stock exchange in many countries.

On 17 September 2008, Lehman Brothers was abolished in the list of trading on the New York Stock Exchange.

The consequences after the bankruptcy of Lehman brothers were very extreme for the world economy and worldwide financial crisis that the political outcry and public has led to some changes. Large bonus is paid in shares so that it can allow awards to be taken back if business turns bad. Structure of regulation is also changed in the Bank of England so that they are able to take responsibility for banking supervision.

The biggest change is where risk management is taken more seriously compared to the past. There is also a new international agreement made which is called the Basel III arrangements which mean that banks must hold larger amount of capital so that they can absorb potential losses.

Conclusion

Lehman brothers are using tricky actions where they use unethical financial and accounting tricks so that investors wouldn’t know about their leverage, and soon subprime mortgage crisis happened that led to the bankruptcy and closing down of Lehman Brothers, and because of that, financial crisis starts to affect thorough out the world.

From this case study, we are able to learn that Bubbles happen quite often,price of houses are able to go down in anytime and the problem for the investors was that they need to take several years to predict when the bubble can happen.

But people sometimes guess wrongly and the fall in the price of houses can bring danger to the entire economy. Also, don’t overdo investments and stocks because it is far too risky as it is impossible to forecast.

REFERENCES

5 Lessons from the Collapse of Lehman Brothers-Kiplinger. (n.d.). Retrieved from http://www.kiplinger.com/article/investing/T038-C007-S003-5-lessons-from-the-lehman-brothers-collapse.html

KASUS ETIKA PROFESI DALAM LEHMAN BROTHERS HOLDINGS INC. | Layar Asdos. (n.d.). Retrieved from http://layarasdos.blogspot.co.id/2014/05/kasus-etika-profesi-dalam-lehman.html

Kasus