Tuesday, March 23, 2010

Hughes on Lehman

Banks use repurchase agreements, known as repos, all the time for short-term financing. One borrows cash and gives the other securities, such as government bonds, as collateral. Both agree to unwind the arrangement on a set date. The deals, which usually run only for days or weeks, are accounted for as financings, and remain on the books with banks recording an asset – the cash – and a matching liability in the promise to buy back the collateral.

Lehman’s 105 was different – instead of handing over securities equivalent to the cash it received, the bank gave more than was necessary. The point was to exploit a loophole allowing such over-collateralised deals to be accounted for as true sales. Lehman then reported its obligation to repurchase the securities at a fraction of the full cost, and used the cash it had received to pay off its liabilities, thereby “shrinking” its balance sheet.

Use of Repo 105 spiked sharply at the end of each accounting quarter – more so in 2008 as pressure grew on Lehman to reduce its leverage – and fell just as dramatically soon after the new accounting period began, as deals were unwound.

Copyright The Financial Times Limited 2010. You may share using our article tools.

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