Essay About Risk Assessment And Lehman Brothers Case

Lehman Brothers Case
My risk assessment would consist of two parts: an evaluation of Lehman’s risk profile (including the degree of leverage) and an analysis of its risk classification. First, Lehman’s risk profile should be assessed. It is made up of specific aspects of its activities and its strategy, which in the end determine the leverage ratio (total assets/shareholders’ equity) – how much liabilities it uses to finance its assets. Secondly, several risk metrics inherent to different activities should be evaluated: Credit risk (risk of non-payment or default by customer), market risk (exposure to market developments or price fluctuations of certain assets), liquidity risk (refinancing risk; imbalance of maturities of longer-term investments and shorter-term financing), reputational risk (loss of confidence in Lehman), and legal risk. Also, investment decisions taken for long-term investments (what kind of investments) and the classification of assets (level 1 – 3 assets) would be areas to have a close look at. Lehman Brothers regularly used an accounting technique called Repo 105 to classify a short-term repurchase agreement as a sale. In a repurchase agreement, one party transfers cash in exchange for a collateral (often a financial assets) of equal value plus an extra amount (interest). When the repurchase takes place, the borrower pays the lender the originally borrowed amount plus the interest and takes repossession of the collateralized asset. In Lehman’s case, a Repo 105 transaction was used to temporarily remove securities from its books. It was recorded as a sale although Lehman was obliged to repurchase the securities after some days (this fact was not mentioned in the financial statements). Lehman then used the cash proceeds to pay down its liabilities (lower liabilities by unchanged shareholders’ equity), thus improving its leverage ratio and presenting itself to be less risk-laden than it actually was. The volume of Repo 105 transactions was significantly increased (up to $50bn) days before quarterly reports were due, in order to signal investors of Lehman’s a “healthy” financial state. At the point of turmoil in the markets and widespread loss of confidence, appearing to be healthy (decreasing leverage ratio) was deemed vital for the continuation of operations by Lehman executives. However, non-disclosure of actual Repo 105 accounting, including Lehman’s obligation to repurchase assets worth billions of dollars, constituted a deception since the financial statements were not presented in a “full, fair, accurate and timely manner” (Lehman’s Code of Ethics). The transactions’ only purpose was to manipulate the balance sheet over a short time period, so that the quarterly reports would look improved. Regulatory bodies such as the SEC or the Federal Reserve allegedly were unaware of Lehman’s extensive use of Repo 105 transaction aimed at decreasing leverage ratios and boosting investors’ confidence. I believe that they were at fault to the extent that they did not impose stricter accounting control mechanisms after major accounting frauds like at Enron. One possible measure could be to make auditors (in Lehman’s case Ernst & Young) partially responsible for wrongfully signing off on dubious client accounts. The task of independent auditors is to provide an impartial assessment of the lawful and compliant reporting of client. Colluding with a client to assist in manipulation the books should clearly be punished severely.