Repo 105

Great video that explains how Lehman deceived the investment public through an accounting technique referred to as "Repo 105." For example, if Lehman owned a bond that was worth $105, it would sell it on the repo market for $100. (Technically, the seller of the repo agrees to purchase it back, say within day to a week.) The "105" in Repo refers to the fact the bond is worth at least 105% of what the seller (Lehman) was receiving for them. Since Lehman was only receiving $100 for $105 worth of collateral, Lehman could record it as a sell of securities and not a loan. However, for all practically purposes, it was a loan.

Why did Lehman institute Repo 105? By instituting Repo 105, it made its financial position look a whole lot better than what it really was. Let's assume that Lehman had assets of $105 and liabilities $100 and equity of $5. Therefore, Assets = Liabilities + Equity. Given these financial numbers, Lehman's "Equity Multiplier (Assets/Equity)" is 21x, which would indicate that Lehman is highly leveraged. Not good! Enter Repo 105. Lehman sells $50 worth of securities through the use of Repo 105. (Keep-in-mind that it does not have to record this financial transaction as a loan because of the Repo 105 rule.) It immediately takes the $50 and pays off $50 of its debt, which is reduced to $50. Now, the equity multiplier is only 5.5x, which is a drastic improvement from 21x. The equity multiplier of 5.5 is what gets reported to investors and everyone else. Once the reporting dates pass, Lehman has to reverse everything and the equity multiplier is back to 21x.

Lehman did not disclose its use of Repo 105 to the rating agencies, SEC, investors, or to its own Board of Directors. Doesn't anyone remember Enron, especially its auditors during this time?

Repo 105 from Marketplace on Vimeo.

I thought these types of accounting gimmicks ended with Enron. Where are the auditors? I know, everything was done within the standard framework of guidance promulgated by the GAAP. But, something is terribly wrong with such standard guidance.