Accounting Troubles at Lehman Brothers (#101)
/In this podcast episode, we cover the underlying accounting issues that contributed to the collapse of Lehman Brothers. Key points made are:
Lehman improperly accounted for repurchase agreements, recording sales of the securities held as collateral, without any offsetting repurchase liability. Normally, these agreements are legitimately used as window dressing at month-end to make the balance sheet look better, but are not recorded as sales.
This approach gave users of Lehman’s financials the false impression of having higher-quality assets than was really the case, by making the firm look less leveraged. At the time, they had a 17:1 debt to equity ratio, and proper treatment of these transactions would have increased the ratio even more.
They pushed the envelope by stretching the accounting rules, which would not have been possible under principles-based accounting, such as IFRS.
They essentially made up their own accounting rules, and the auditors (Ernst & Young) went along with it, based on a legal opinion from a British law firm. EY also knew of the practice for a number of years prior to the financial crisis.