An analysis of Lehman Brothers bankruptcy and Repo 105 transactions

An analysis of Lehman Brothers bankruptcy and Repo 105 transactions

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An analysis of Lehman Brothers bankruptcy and Repo 105 transactions Charles Hines, Jerry Kreuze and Sheldon Langsam Department of Accountancy, Haworth College of Business, Western Michigan University, Kalamazoo, Michigan, USA Abstract Purpose – The purpose of this paper is to investigate the bankruptcy of Lehman Brothers, with particular focus on its use of Repo 105 transactions. Design/methodology/approach – The use of the Lehman’s bankruptcy report produced in part by Anton R. Valukas was used as a basis to explain how Lehman maintained acceptable leverage ratios through the use of Repo 105 transactions to paint a better picture of its financial position than actually existed. Findings – The study concludes that Lehman’s accounting method choice disguised its real problems, perhaps long enough for bankruptcy to become the only option. Practical implications – Lehman’s bankruptcy becomes part of a growing history of business failures where accounting principles have become the focus. The failure of Lehman reminds us that financial reporting must remain transparent, allowing users to make informed decisions with confidence. Originality/value – This bankruptcy provides a painful reminder that financial reporting must allow users to differentiate among investment alternatives, based on the relative, factual financial position of the investment. The credibility of our reporting model is at stake. Keywords Bankruptcy, Banks, Financial reporting, Repurchase agreements Paper type Case study Introduction The investment bank Lehman Brothers filed for bankruptcy in September 2008. Some of its business decisions leading to bankruptcy were in retrospect poor decisions, but not unusual given the investment climate. Many financial entities experienced financial trouble as the housing bubble burst and mortgage-backed securities lost significant value. Lehman’s path to bankruptcy nevertheless was paved with an increased appetite for risk in the pursuit of increased revenues. Lehman Brothers’ balance sheet grew rapidly beginning in 2006, and included many long-term investments financed through short-term borrowing (Examiner’s Report, 2010, Vol. 1, pp. 3-4). These assets included substantial amounts of residential and commercial mortgage-back securities, the same type of securities that precipitated the 2008 financial crisis, and resulted in the Federal Troubled Asset Relief Program. During 2007, the market for residential mortgage-backed securities began to show signs of trouble. Lehman however continued its aggressive growth expecting to benefit from the countercyclical crisis. During this time, Lehman executives took on more risk, ignoring its own risk models and excluding some assets from their risk analyses. These assets and other investments became increasingly difficult to sell without incurring significant losses (Examiner’s Report, 2010, Vol. 3, p. 763). Furthermore, a sale of some The current issue and full text archive of this journal is available at AJB 26,1 40
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  • Spring '12
  • warfield
  • Balance Sheet, Lehman Brothers, Lehman, Repurchase agreement, Lehman Brothers Holdings

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