Professor Elam

Sunday March 14, 2010

Friday we linked to reports by the bankruptcy examiner on the Lehman Brothers Fraud. Those transactions are the subject of longer reports in Section 2 of the WSJ Weekend Edition out now. But the most clear explanation we have seen is from Dylan Ratigan.  The video clip runs ten minutes but is a must see for accounting students and anyone else interested in the ongoing financial crisis. 

Ratigan makes it clear that Lehman, using backs as pawn shops, swapped assets for cash which would later be repaid. These are known as repo transactions which stands for reverse purchase. The borrower pawns an asset for cash, the cash will later be repaid along with an interest charge. However, Lehman represented these repos as sales, not as a temporary loan. And CEO Fuld and his three CFOs during the period, note the turnover, knew of the fraud. And Ernst and Young, outside auditors, also knew what was going  on but rendered a clean opinion.  Students will recall that SARBOX requires CEO and CFO sign off on the accuracy of the statements. So, they lied instead to perpetuate the fraud. Oh, and Fuld paid himself a total of $500 M over the years he did this. And, Jeff Skilling of Enron is in jail while Fuld is not. Gee life is not fair.

Observations

As Ratigan says, Wall Street uses complex instruments to perpetuate fraud, recall that Carlo Ponzi used Postal Reply Coupons in the 1920s for the basis of his scheme. We study derivatives in Intermed II, this is, ahem, not a proper use of derivatives.

Now, as humorists Dave Barry and Jeff Foxworthy say, you just can't make this stuff up. In the first appearance I have seen since his resignation as Governor about a year ago, Ratigan has Eliot Spitzer aboard to describe, with suitable outrage, a transaction whose only purpose was to mislead the public. This is surely the height of irony given the subterfuge Spitzer used to cover up his relations with a young lady who was not his wife. 

I will grant that Spitzer is an expert on the Justice Dept having worked there and come under criticism for over zealous prosecution to advance his own agenda. And I suppose it is rather like having Barry Minkow describe a fraud, but then Minkow has recanted and admitted his misdeeds. 

Okay, now what?  Will the Justice Dept pursue Fuld and his auditors, Ernst and Young,  oh by the way, where was the SEC while all this was going on, out to lunch as usual. 

From a socionomic standpoint,  the science of social prediction,  again this is unfolding like the Watergate scandal. The mood has improved reflected in the stock market advance. But let the markets fall again and the public and politicians who are just as complicit will look for a scapegoat. Then I would expect this investigation to really gather steam. 

This is a good example of why I author this blog, there is not time to cover all this in class and well, Foxworthy is right, I can't make this stuff up!