Rep 105 sounds like a schlock movie not fraudulent accounting trick used by Lehman Brothers before bankruptcy. Now Bank of America is implicated

John Hempton, a noted commentator on financial affairs, has pointed out that Bank of America may have been up to the same trick. As per usual, he forgives the fraud artists in the end.

Repo 105’s antecedents Ken Lewis

I agree with Felix Salmon that the former Lehman staffers who defend Repo 105 are psychopaths – certifiably insane.  They state (as if this justifies it) that …

The only people who would worry about using an old trick to reduce leverage from 13.9 to 12.1, are “yappers who don’t know anything.”

For those that don’t know Repo 105 was a sale and repurchase agreement by which Lehman parked about 50 billion in assets (presumably assets they did not want to discuss) overnight via a repo transaction so they would not appear on the balance sheet.

By now anyone who does not realize that sort of accounting legerdemain is unacceptable is (a) entirely out of touch with reality and (b) self aggrandizing on a magnificent scale.  Both are signs of mental illness.

But unfortunately the Lehman executives do have one point.  Repo 105 type balance sheet faking was “an old trick” and well known to anyone who cared to read balance sheets (very) carefully.*

Let me take you back to 2006 and Bank of America.  Pages 94 and 95 of the 2006 Annual Report show (amongst other things) the average total assets by quarter from the fourth quarter of 2005 to the fourth quarter of 2006 inclusive.  Here are the numbers:

Now lets extend this table by including period end assets.  You can find the data here (see page 4 for both fourth quarters and third quarter, and page 4 here for the first and second quarters).

You will notice that the end period assets were always lower than the average assets.  Moreover it was not obvious unless you really looked because the quarterly earnings releases did not include average assets (but you could work it out because they stated return on average assets).

It was not just 2006 either – this had been happening for a while.  Bank of America was parking its assets off balance sheet at the end of every quarter for some time and had been obscuring the fact.

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Counterparties

If Bank of America wanted to shove the assets off balance sheet someone (credit worthy) needed to be found to house the assets overnight.  There are not that many parties credit worthy for $50 billion or more of overnight repos.

Well – being an obsessive reader of bank accounts I found the counterparty.  It was MUFJ.  If you wish to you can show – the same way that MUFJ had end period assets higher than average assets and that the differences and timing roughly match.  Someone had to assist BofA in its financial legerdemain and we know the counterparty.

Once – through an interpreter – I asked senior MUFJ executives about this.  Any nuance in the answer was lost in translation.

So back to Repo 105

Repo 105 is fraud.  Its a lie to investors and rating and regulatory agencies.  It was also fraud when BofA did it.  But both Lehman and Ken Lewis compartmentalized it as OK.  And it was not the fraud that undid them – it was the overweening arrogance that thought this was alright.  The same overweening arrogance that made Ken Lewis think it was alright to pay a big premium to close for Merrill Lynch (and later force mass dilution of BofA common shareholders).

But the chief executive (or other executive) who thought this was alright was probably certifiable.  Just as certifiable as the Lehman execs who Felix rightly chastises.

Do we want to prosecute?

There is a big debate in the blogosphere as to whether anything in the Valukas Report rises to the level of prosecution.

I suspect in a vacuum it does.  But this was a collective insanity every bit as mad as the poisoning craze written about Charles Mackay.  Mass insanity does lower moral culpability and it takes an extraordinary person to stand up to it.

Besides – if we are going to slap Erin Callan’s wrists in handcuffs then we are going to have to do the same to Ken Lewis and probably have to extradite the top-end of the Japanese establishment who were the counterparties.

I do not want to go there – and I do not think it would be constructive.

After ProPublica published, they got this from Bank of America on 2/23

Tuesday afternoon, Bank of America’s media rep Scott Silvestri responded to my inquiries with this statement:

“Efforts to manage the size of our balance sheet are routine and appropriate, and we believe our actions are consistent with all applicable accounting and legal requirements.”

My only thought is that this is very similar to what Lehman’s auditors, Ernst & Young, said in response to criticism about their review of Lehman’s accounting, right after Repo 105 hit the news earlier this month. Here’s what the auditor’s spokesman, Charles Perkins, said at the time:

“Our opinion indicated that Lehman’s financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles, and we remain of that view.”