The main issue of this working paper is whether the accounting treatment of the Repurchase agreement 105 contributed to the collapse of Lehman Brothers. It was questioned how the Repos were used and the following effects over Lehman’s financial stability.
While seeking for an appropriate solution of the main issue, the paper goes through the historical fluctuations of the financial system, from the 1950s till 2006 (two years before the Lehman’s bankruptcy). Further, the paper reviews some causes that may have led to the collapse of the investment bank. Finally, the global impact of the collapse has been summarized and possible preventions from future crisis have been proposed by the author.
Table of Contents
1. Introduction
2. Company background
3. The case of one of the world’s leading investment banks – Lehman Brothers Holding Inc.
3.1. Before the beginning
3.2. The boom and the bust
3.3. Reasons for the financial bankruptcy and moral hazard
3.4. The accounting treatment of the Repurchase agreement Repo 105
3.5. The impact of Lehman Brothers’ collapse at the global level
4. Could Lehman’s failure have been avoided?
4.1. The role of the corporate governance and the audit practices
4.2. Analyzing the case of Lehman by using CAMELS ratios
5. Conclusion
Objectives and Topics
This bachelor thesis investigates whether the specific accounting treatment of the financial instrument known as "Repo 105" contributed to the collapse of the investment bank Lehman Brothers. By analyzing the firm's historical background, the underlying causes of the 2008 financial crisis, and the internal governance failures at Lehman, the paper aims to determine if the collapse was an unavoidable systemic event or a consequence of misleading financial reporting practices.
- Historical evolution of Lehman Brothers and its expansion into aggressive investment strategies.
- The mechanics of the subprime mortgage crisis and the rise of the "shadow banking" sector.
- In-depth examination of the Repo 105 transaction structure and its utilization for balance sheet manipulation.
- Evaluation of corporate governance, audit practices, and the effectiveness of the CAMELS rating system in detecting financial instability.
Excerpt from the Book
3.4. The accounting treatment of the Repurchase agreement Repo 105
Sale and repurchase agreements are usually used by financial institutions to finance their operations. Repo agreements are widely used, the overall size of the repo market is large, estimated at close to $12 trillion.
Repurchase agreement is an agreement, at which one company transfers assets to another company in exchange for short-term cash. At a specific date, usually a week or ten days, the transferee returns the securities to the borrower, who repays the loan with interest in cash. As part of the deal one counterparty receives securities as collateral for the cash loaned, while the other one receives cash collateral for the securities loaned.
In the middle of the 2007, Lehman Brothers faced the subprime mortgage crisis, at this time market participants began to more carefully examine the leverage of the investment banks and therefore the banks were persuaded to decrease their leverage ratios. In order to avoid ratings downgrade Lehman Brothers had an incentive to reduce its balance sheet and lower its net leverage computed as the division of the net assets by the shareholder’s equity. Because the inability to reduce leverage could lead to ratings downgrade and therefore the trust of the lenders, investors and the market could be lost.
Summary of Chapters
1. Introduction: This chapter introduces the collapse of Lehman Brothers and identifies the core research question regarding the role of Repo 105 transactions in the bank's bankruptcy.
2. Company background: This section provides a historical overview of Lehman Brothers, tracing its origins from a cotton commodity trader to one of the largest investment banks on Wall Street.
3. The case of one of the world’s leading investment banks – Lehman Brothers Holding Inc.: This chapter details the build-up to the 2008 crisis, including the US housing bubble, the failure of corporate oversight, and the technical implementation of Repo 105 to manipulate financial statements.
4. Could Lehman’s failure have been avoided?: This chapter analyzes governance failures within Lehman, the role of auditors, and utilizes CAMELS ratios to evaluate the bank's precarious financial health prior to collapse.
5. Conclusion: This chapter summarizes findings, asserting that while Repo 105 provided temporary relief, it could not prevent the inevitable bankruptcy, and highlights necessary regulatory lessons for future stability.
Keywords
Lehman Brothers, Repo 105, Financial Crisis, Investment Banking, Accounting Standards, SFAS 140, Subprime Mortgages, Corporate Governance, Leverage, Bankruptcy, CAMELS Ratios, Shadow Banking, Financial Regulation, Asset Securitization, Moral Hazard
Frequently Asked Questions
What is the core subject of this thesis?
The thesis examines the collapse of Lehman Brothers in 2008, specifically focusing on whether the accounting treatment of Repo 105 transactions contributed significantly to the firm's failure.
What are the central themes discussed in this work?
The work covers the evolution of Lehman Brothers, the mechanics of Repo 105, corporate governance failures, auditing practices, and the broader global impact of the investment bank's collapse.
What is the primary research question?
The primary research question is whether the usage of the Repo 105 accounting trick by Lehman Brothers was a decisive factor in their financial collapse and whether it was used to mislead stakeholders.
Which scientific methodology is applied here?
The author employs a case study methodology, utilizing historical financial data, institutional reporting, and the CAMELS rating system to evaluate the bank's financial stability and risk management.
What is covered in the main body of the paper?
The main body covers the economic environment leading to the crisis, the specific Repo 105 operational structure, an audit of Lehman’s governance, and a quantitative analysis of its financial ratios.
Which keywords best characterize this work?
Key terms include Lehman Brothers, Repo 105, financial crisis, accounting standards (SFAS 140), corporate governance, and CAMELS ratios.
How did Repo 105 technically function at Lehman Brothers?
Repo 105 allowed Lehman to reclassify short-term secured borrowings as "sales," enabling the temporary removal of assets from the balance sheet to lower reported net leverage ratios before quarter-end reporting.
What role did external auditors play in this situation?
While Ernst & Young was aware of the Repo 105 transactions, they issued clean audit reports as the practice technically conformed to existing GAAP standards (SFAS 140) at the time, despite the misleading nature of the transactions.
What conclusion does the author reach regarding the collapse?
The author concludes that while Repo 105 provided temporary window dressing, it was not the sole cause of the collapse; Lehman was already fundamentally insolvent due to its aggressive pursuit of risky assets.
- Citation du texte
- Viktoriya Sheyretova (Auteur), 2015, Did the accounting treatment of financial instruments contribute to the collapse of Lehman Brothers?, Munich, GRIN Verlag, https://www.grin.com/document/426871
