For those visiting me following the commentary.
1) The Financial Times’ Henny Sender says that Merrill Lynch was smelling the smell coming out of Lehman’s books and public statements. Because Merrill was in the same line of business as Lehman, people inside Merrill knew a thing or two about how to read Lehman’s balance sheet.
Merrill’s interpretation of the cash, the “liquidity” that Lehman seemed to have so much of, was that Lehman must have been including things that weren’t really “liquid”. Anything like cash, the “marketable securities” and other things that could be sold easily, yes, they counted. But Merrill assumed that Lehman was also including capital that was either not liquid, or that was part of “regulatory capital”. Regulatory capital are the amounts the government insists are not available in running the business, the minimum net capital.
If you were in the business as Merrill was, and you didn’t know about the Repo 105s, just the balance sheet geometry, this is a very likely conclusion. And it’s right, in a sense. Lehman was including regulatory capital in its liquidity, because it was engaging in a fraud to build up its regulatory capital!
It would have had to use the liquidity that it was showing “the Street”—the other big businesses of Wall Street that lent to Lehman—to cover its duties to the general public. If I have a small business and my lender requires me to keep $10,000 of my own money handy at all times, and I go find another bank to lend me $30,000 and keep it off my balance sheet, my balance sheet would look pretty good, too.
2) The New York Times’ Op-Ed contributor William D. Cohan puts out an excellent annotation of some key points in the Valukas Report. It is in a neat interactive where you click on page listed on the right, and it takes you to the actual Valukas Report page with Cohan’s annotation below.
Like my own small analysis of what Lehman Japan’s Enrico Corsalini or Erik Addington would have known or not known seeing the Repo 105s here in Tokyo – (*), Cohan shows all the points of the Report that suggest Dick Fuld, Erin Callan, Chris O’Meara, Herb McDade and the whole rest of that gang had to be fully aware of what they were doing.
As people study this business fraud (misstating net capital) and accounting scandal (materially misstated financial reports) further, I suspect that more will come out about what Cohan terms the “enabling accountants”, Ernst & Young.
(*) – Footnote: For example, read this annotation from Cohan.