Most of the stories you will read today about the 2,200-page document that lays out how Lehman Brothers used accounting gimmicks to conceal its true financial condition will understate just how important the lies told by its top executives were.
This is one of those few news stories where there is much more than meets eye. The headlines are understating the seriousness of the deception Lehman’s executives employed in an effort to fool investors and creditors about the health of their investment bank.
The health of Lehman’s balance sheet was such an important question in 2008 that the bank went out of its way to claim multiple times that it was reducing the size of its balance sheet. Let’s start with the earnings call in June 2008.
“Regarding our balance sheet, we reduced our gross assets by $147 billion over the quarter, which exceeded the targets that we set,” chief executive Dick Fuld said at the start of the June 16th conference call in 2008.
“Turning now to leverage, we reduced our gross assets by $147 billion — from $786 billion to $639 billion — in the second quarter and we reduced net assets by $70 billion — from $397 billion to $327 billion. As a result, we reduced our gross leverage from 31.7X times to 24.3X at May 31, and we reduced net leverage from 15.4X to 12X prior to the impact of last week’s capital raise,” chief financial officer Ian Lowitt said on the same call.
Thanks to the bankruptcy examiner’s report, we now know this was not true. Lehman’s deleveraging was largely an accounting fiction. 50 billion of it’s supposedly $70 billion reduction in assets was produced entirely through the Repo 105 transactions.
The importance of this deception cannot be overstated. Their should be no doubt in anyone’s mind that the amount of leverage and the size of the balance sheet was pretty much all that mattered at the time. The catch phrase at the time was “Earnings are the past. The balance sheet is the future.” The extra details the firm was offering on that June conference call were meant to reassure everyone about the health of the balance sheet.
On that same call, the third question came from Merrill’s Guy Moszkowski.
Guy Moszkowski, Merrill Lynch
Just a follow-up on the question about the asset sales and whether there were vintage concentrations or anything like that. How about with respect to timing? Were the sales pretty much ratably spread over the quarter, or were they more skewed toward either the earlier or the latter part of the quarter?
Ian T. Lowitt, Chief Financial Officer
They were spread over the whole quarter. I mean, it was a focus of the entire firm to de-lever through the course of the quarter. That was obviously a focus which shifted attention, to some extent, and I think that impacted the quarter in some ways. But it was even across the whole quarter so there was no concentration in terms of the timing. That was true across all of the elements, so that would be true within residential as within commercial.
This wasn’t true at all. In fact, according to the bankruptcy examiner’s report, $50 billion in alleged “sales” were actually repos timed to reduce the balance sheet for exactly the period necessary for earnings reporting.
This is only going to get worse for the former executives of Lehman.