Monday, March 15, 2010

Repo 105 - another Enron in the pipeline?

In the arcane terminology of the markets, a 'repo' is a transaction in which I sell you something today but guarantee to buy it back for a stated price at some stated time in future. ‘Repo’ is actually short for ‘repurchase’.

Dull, huh? Well, it may turn out to be a little more exciting than it seems. If you are near the end of the quarter and you’ve got a lot of liabilities and a lot of worthless assets and your accounts are going to look lousy, why not do a deal to repo the rubbish for billions, report these as sales (which they aren't) use the billions to pay off liabilities, and then once you have reported how healthy your books now are, borrow more money you can’t afford to buy back the rubbish you 'sold' a few days previously.

This is what Lehman's called a Repo 105. It makes your books look good, it fools the regulators and everyone is briefly happy, until the time comes when the size and riskiness of the deals is so huge no one will touch them and you fall with a resounding splash down the toilet.

This, it seems is exactly what Lehman’s did - round and round for years on end, until $700 billion of assets and liabilities was being held up by just $25 billion in capital - a ration of 28:1. Their boss, Richard Fuld, claims that he had no idea this was going on. So he is either lying or spectacularly incompetent, because a) this was the only thing keeping Lehman afloat, and b) the scale of the repos – $50 billion in the first and second quarters of 2008, for example – was so huge that even if it weren’t you’d need to be dead from the neck up not to have noticed them. And the banking regulators? This had been going on for years, and no one noticed or thought that it odd?

More importantly, there is now a growing suspicion that repos are a bit more pervasive than was previously realised – if Lehmann had been doing it for years and their accountants (Ernst & Youung) didn't care - they say they were 'comfortable with the policy for purposes of auditing financial statements' - it would make sense for any of the banks and the increasingly many other businesses and government institutions who rely on financial services to generate money have been doing the same. Coming to a bank near you soon? Already arrived but no one has told you? Never forget Enron and Arthur Andersen. As Tracy Alloway, the FT Alphaville blogger puts it, 'Think window-dressing on a massive, and possibly misleading, scale'.

The story is summarised here and its full grubbiess set out here. Well worth reading.

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