Footnote on the Valukas Report

Just one for the accountants and others interested out there who have visited me this week on Repo 105, the slight-of-hand in the Lehman scandal.

Here is what I have as the journal entries

Illustration 1:
No change

Illustration 2:
DR Cash (A) 50,000
CR Collateralized Financings (L) 50,000
(recording a repo in the normal course)

Illustration 3:
DR Collateralized Financings (A) 50,000
CR Cash (A) 50,000
(Valukas simply applies the cash back to other collateralized financings, but I think he means that the cash is available against any liability that is due in the near term–including employee payments like salary and bonus)

Illustration 4:
DR Cash (A) 50,000
CR Financial Instruments (A) 50,000
(This shows as a sale. The financial instrument is presumably the bond that is being Repo 105’d. The cash is the same cash coming from the bank.)

Illustration 5:
DR Collateralized Financings (L) 50,000
CR Cash (A) 50,000
(Valukas says that the cash obtained can, like above example 3, be applied against any short term liability.)

Athough this is being described as “shrinking the asset side of the balance sheet”, what in fact has happened is that the loan from the bank has not been recorded. The real purpose of the transaction is to grab some cash where you don’t have to show that you have a liability back to the lender.

Maybe it is presented this way because presumably, if Lehman let the repo fail, the counterparty keeps the collateral and Lehman books a loss on the “five” part of “105” But at the moment of close, that didn’t happen, if ever.

It’s semantics to say they were really shrinking the asset side. Of course, in order to shrink the liabilities, you have to shrink the asset side, because it’s a balance sheet. The assets equal the liabilities plus firm equity.

So the critical piece of this is where is liability back to the counterparty bank?

[P.S., then, obviously, somewhere in the dark recesses of Lehman Brothers Europe or “Libby”, were entries, at least kept on paper, like this:

DR Cash (A) 50,000
CR Due to Lehman Affiliate (L) 50,000
(The Lehman Affiliate would have been a subsidiary like Lehman Brothers Japan, which actually did the transaction)

and

DR Due to Lehman Affiliate (L ) 50,000
CR Financial Instruments (A) 50,000
(to show the, ehem, “sale”, but which on the affiliates books would have appeared as a normal repo)

then lastly a mental note by the Repo 105 conspirators:

DR Financial Instruments (A) 50,000
CR He he! Money we really owe (L) 50,000
(To show the bond is really a repo, not a sale.)