521 Corporate Financial Management

Lehman Brothers and How The Use of Repo 105 Bankrupted the Wall Street Giant

The year was 2008 and the United States was entangled in the most significant financial crisis since the great depression. Lehman Brothers the countries fourth largest investment bank with revenues of $19.2 billion in 2007 and in excess of $600 billion in assets became the largest bankruptcy in history when they filed on September 15 2008. Aggressive investment strategies, misuse of accounting practices, as well as significant exposure to the subprime mortgage market attributed to the demise of a legend that at its peak employed 25,000. As the housing bubble grew, Lehman Brothers acquired several mortgage lenders. Of the acquired firms some made loans to home buyers without full documentation (Jeffers 2011). When these mortgages began to default, market conditions became unpredictable and the likes of Lehman and scores of other banks faced immense losses. The write down of the defaulted debt securities had colossal adverse effect on Lehman’s balance sheet. Credit rating agencies honed their focus mainly on the leverage ratios of the investment banks and Lehman’s leverage ratios were already extremely high. Any downgrade on Lehman’s credit rating would have sent Lehman’s share prices sharply lower and eliminate their chances to receive any sort of financing. In hope of preventing such an occurrence, Lehman would attempt sell some of its assets to raise capital. As the case with most of the investment banks, Lehman found itself unable to sell any of its assets or raise capital given that the street had no ability to value any of the complex mortgage securities. At that time, Lehman decided to use a very aggressive accounting maneuver known as Repo 105 to temporarily improve its financial condition prior to the release of their financial