Leave it to the largest bankruptcy in history to make a bankruptcy report riveting (or at least, readable). Anton R Valukas's filing to a New York court last week details the demise of Lehman Brothers after a year-long review of five million documents and 250 interviews with former Lehman bankers and regulators. The most alarming element of the report may not be what it says about Lehman, but what it reveals about the rottenness and risks that still endanger the financial services industry and the global economy.
A large portion of the report's 2,200 pages is devoted to "Repo 105", a practice that bankers at Lehman described in internal e-mails and during interviews as "a drug", "window dressing" and an "accounting gimmick". Using the "Repo", or repurchase market, Lehman manipulated balance sheets at the close of a quarter to quell investor concern about its debt levels. If Lehman owned an asset that was actually valued at $105, it would sell it for $100, agreeing to buy the asset back at a premium after it had released its financial statements. Doing so allowed Lehman to report a better ratio of cash to debt to its investors.
But Lehman couldn't have been the only one borrowing from Peter to show Paul that its debts were manageable. According to Gary Gorton, a professor at Yale School of Management, $12 trillion in loans was circulating in the repo market on any given day before the financial crisis. From 2001, no American accounting firm or legal practice would certify Lehman's quarterly reports so long as they relied so heavily on the repo market, but auditors in London welcomed their business. This unevenness in accounting standards still provides incentive for banks to seek the weakest regulatory link. There remains little oversight of repurchase markets, whether in the US, Europe or elsewhere. What's worse, the spirit of co-operation that emerged at the height of the financial crisis is unravelling. On developing uniform regulations for executive compensation, derivatives markets and hedge funds, the EU and the United States are farther apart than at any time since Lehman collapsed.
An even larger critique of the financial services industry is also levelled in the Lehman report. The resources, energy and intellectual capital invested in developing "financial innovation", from the creation of complicated debt "products" to cunning methods of hiding debt, has produced nothing of real value. As Mr Valukas writes about Lehman's use of Repo 105, "there was no substance to these transactions".