A quick video primer on Repo 105

Here is a good video from Marketplace Senior Editor Paddy Hirsch explaining the mechanics of the now infamous Lehman Brothers 105 transactions.

One or two tidbits, first. Even though Hirsch mentions Lehman undertook these transactions to pretty itself up during the credit crisis, evidence shows they had been doing these sale Repo agreements since 2001.  Obviously, the purpose of the transactions was to disguise the leverage Lehman was employing by substituting securities for cash on its balance sheet as reported at the end of each financial quarter.

To my eyes, this is what is known as “parking” whereby a securities firm makes a sale of securities to a counterparty with the explicit intent to buy back those same securities at a future date. Parking is illegal, and has been for a long time.

During the early 1990s, I worked in a corporate law firm on a number of SEC complaints of this type. In the largest case, in the mid-to-late 1980s during the junk bond S&L heyday, the securities firm in question bought hundreds of millions of junk bonds right before calendar yea-end (Dec 29-31, depending on the year). The next January, it re-sold those exact same securities back to its insurance company counterparty.

In the late 1990s, well after I had moved on, the SEC dropped the charges.

Although the law judge found that [the individual securities professional] violated the law, she dismissed this matter because she concluded that the only remedy available to the Commission, a cease-and desist order, could not be imposed because the Division had not shown that [the individual securities professional] was reasonably likely to violate the securities laws in the future.

Needless to say, when I learned this, I was left feeling that regulators didn’t take securities law seriously.

The insurance company in question was clearly looking to increase returns through leverage, just as Lehman was. This firm had been acquired in a leveraged buyout in the mid 1980s and was desperate to meet its debt obligations by increasing short-term gains by acquiring more customers through an under-pricing of insurance contracts and then reaching for yield in the junk bond market to make up for the expected premium loss with junk bond returns. It wanted to park these high yield securities in order to disguise this strategy. Having escaped the particular episode, by 2001, the insurance company had filed for bankruptcy and been taken over by the state insurance regulator.

Also see Financial Accounting and Decency from Uwe Reinhardt at the New York Times’ blog Economix which gives more color on the fiduciary responsibilities behind accounting.

Enjoy the clip.


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