Case Study: Lehman Brothers

832 Words 4 Pages
One major issue to do with the banking system and deregulation of the financial regulators was Lehman Brothers’ misrepresentation of financial statements caused by the freedom in shadow banking system. The examiners of the Lehman Brother’s bankruptcy stated that the company had been engaged in “accounting gimmicks” at the end of the years, decorating financial statements to make it seem healthy and strong when in fact the company’s financial situation was unstable (Valukas, 2010). In 2007 when the property market started to collapse with the skyrocketing number of defaults, Lehman began to suffer huge losses and billions of dollars of bad debts were forced to be written down in the books, which led to a downfall of its financial position. At …show more content…
It was described as a “lazy way of managing the balance sheet” (Mensah, n.d.). A repo agreement involves temporary transfers of securities with an exchange in cash, which would be settled when the borrower repays the money with an agreed interest rate and repossesses the securities. In the legal perspective, the legal title of the securities shifts from Lehman Brothers to its buyer until the occurrence of repurchase. According to the repurchase agreement, it is accepted as a secured loan liability on the balance sheet when the seller received cash by selling its securities. Then, the liability would be disappeared on the balance sheet after the repayment of this loan (Akbarli, 2012). On the other hand, haircut is the amount that by which the security amount surpassed the borrowed amount, which is usually 2%. If the investment bank does not follow the terms of the haircut transaction, the lender keeps and sells the securities. In the case of Lehman Brothers, it established new types of transactions namely repo 105 and repo 108 by setting higher haircut rates of 5% and 8% respectively. Under this financial action, the transactions were recorded as sales but not loans, and omitted securities and liabilities from its balance sheet (Jeffers, 2011). This allowed the decrease in leverage ratios and this could paint a healthy-looking financial …show more content…
As in 2007, Lehman faced a crisis and investment banks were forced to reduce their leverage since the inability to lower leverage ratio could lead to a downgrade on ratings (Williams, 2010). Lehman’s CEO Fuld ordered a firm-wide deleveraging strategy in 2008, aiming to reduce the company’s positions in commercial and residential housing and leveraged loans by half. Fuld suggested that Lehman had to improve its net leverage ratio by selling its inventory as “there was a perception issue” with raising equity (Mensah, n.d.). Yet at that time it is hard to sell inventory without significant losses as the property prices declined. What is more, selling sticky inventory at lowered prices caused a loss of market confidence in Lehman’s inventory valuations because emergency sales would reveal the valuation errors (Division of Corporate Finance, 2010). With the above practice and without financial regulations, as the Repo 105 is a legal practice, Lehman relied at the accelerating pace of it. The examinations on Lehman’s bankruptcy identified blames against culprits such as Lehman’s external auditor, Ernst & Young for their negligence to question and challenge the inappropriate disclosures in Lehman’s books (Valukas, 2010). If the regulations and monitoring

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