Repo 105

Definition

Repo 105 refers to a specific accounting technique used by Lehman Brothers Investment Bank prior to its collapse. This maneuver involved classifying a short-term repurchase agreement (repo) as a sale, rather than a loan, thereby allowing the firm to temporarily remove liabilities from its balance sheet to present a more favorable financial position. The practice was revealed during the financial crisis and played a central role in the Lehman Brothers scandal.

Examples

Lehman Brothers: Just before quarterly results, Lehman Brothers would transfer securities to another entity using a repo transaction at 105% of the cash received (hence the name, “Repo 105”). They would then use the cash from this repo to pay down liabilities, reducing leveraged ratios and giving an impression of a stronger financial position.
Hypothetical Bank A: If Bank A had $10 billion in liabilities, before reporting, it could engage in a Repo 105 transaction, transferring $1 billion in securities for $950 million in cash, reducing reported liabilities by 10%, and thus giving the appearance of a healthier balance sheet.

Frequently Asked Questions

What was the impact of Repo 105 on Lehman Brothers’ financial statements?

The use of Repo 105 allowed Lehman Brothers to temporarily reduce its reported leverage and liabilities, misrepresenting the company’s real financial health to investors and regulators.

Is Repo 105 legal?

While the specific use and classification of Repo 105 were within the technical frameworks of accounting rules at the time, it is considered unethical due to its intent to mislead financial statement users. Stricter regulations and accounting standards have been instituted since the scandal.

How was Repo 105 uncovered?

Repo 105 activities came to light through the investigation following Lehman Brothers’ collapse, most notably documented in the court-appointed examiner Anton Valukas’ report.

Lehman Brothers Scandal: A major event during the financial crisis of 2008, where significant accounting and financial misrepresentations by Lehman Brothers led to its bankruptcy and contributed to the global financial meltdown.
Repurchase Agreement (Repo): A form of short-term borrowing for dealers in government securities. The dealer sells the government securities to investors and buys them back the following day.
Window Dressing: Financial actions taken just before reporting dates to improve the appearance of the financial statements.
Off-Balance Sheet Financing: Financial obligations not recorded on the balance sheet to keep leverage ratios lower and financial positions healthier.
Accounting Fraud: Intentional manipulation, deceit, or falsification of financial statements to present inaccurate financial health of a company.

Online References

Suggested Books for Further Studies

“The Great Deformation: The Corruption of Capitalism in America” by David A. Stockman - Provides insight into financial practices and malpractices that contributed to the 2008 financial crisis including discussions on Lehman Brothers.
“Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System–and Themselves” by Andrew Ross Sorkin - Offers an in-depth narrative of the crisis, including the collapse of Lehman Brothers.
“Accounting Ethics and the Near Collapse of Lehman Brothers” by Jacqui MacDonald - Focuses on the ethics and accounting practices leading to financial misrepresentation.

Accounting Basics: “Repo 105” Fundamentals Quiz

### What did Lehman Brothers attempt to achieve by using Repo 105? - [ ] Increase investment assets - [x] Reduce its reported leverage and liabilities - [ ] Tax evasion - [ ] Increase operational staff > **Explanation:** Lehman Brothers utilized Repo 105 transactions to temporarily reduce its reported liabilities and leverage, creating a more favorable financial position prior to reporting financial results. ### Were Repo 105 transactions classified as loans or sales by Lehman Brothers? - [ ] Loans - [x] Sales - [ ] Investments - [ ] Liabilities > **Explanation:** Lehman Brothers classified Repo 105 transactions as sales rather than loans, thereby removing the associated liabilities from their balance sheet. ### Which crisis highlighted the ethical issues associated with Repo 105? - [ ] The Dot-Com Bubble - [x] The 2008 Financial Crisis - [ ] The Eurozone Crisis - [ ] The COVID-19 Pandemic > **Explanation:** The ethical issues of Repo 105 were highlighted during the 2008 Financial Crisis, particularly through the investigation into Lehman Brothers' practices. ### What percentage of securities' value was used to structure Repo 105 transactions? - [ ] 90% - [x] 105% - [ ] 100% - [ ] 110% > **Explanation:** The term Repo 105 derives from the practice of using 105% of the securities' value for the repurchase agreement. ### What is the fundamental purpose of a typical repurchase agreement (repo)? - [x] Short-term borrowing - [ ] Long-term investment strategies - [ ] Dividends distribution - [ ] Tax reduction > **Explanation:** Repurchase agreements are used primarily for short-term borrowing, where securities are sold with an agreement to repurchase them later. ### How does "window dressing" relate to Repo 105? - [ ] It is a way to increase taxable income. - [ ] It enhances management incentives. - [x] It involves financial actions aimed at improving short-term financial statement appearance. - [ ] It diversifies investment portfolios. > **Explanation:** Window dressing involves making short-term financial maneuvers, like Repo 105, to improve the appearance of a company's financial statements. ### What was the outcome for Lehman Brothers following the use of Repo 105 transactions? - [ ] Significant profit increase - [ ] Acquisition by another bank - [x] Bankruptcy - [ ] Market expansion > **Explanation:** Lehman Brothers eventually declared bankruptcy, and their dishonest use of Repo 105 transactions played a role in their downfall. ### Which document notably revealed the practice of Repo 105 used by Lehman Brothers? - [ ] GAAP Guidelines - [ ] Sarbanes-Oxley Act - [ ] Basel III Summary - [x] Valukas Report > **Explanation:** The practice of Repo 105 used by Lehman Brothers was notably detailed in the Valukas Report, a court-appointed examiner's investigation. ### According to later regulations, can Repo 105 practices be legally conducted in the same way today? - [ ] Yes, unchanged practices are still allowed. - [x] No, regulations have tightened. - [ ] Partially, under certain circumstances only. - [ ] Only outside the United States. > **Explanation:** Since the Lehman Brothers scandal, financial regulations and accounting standards have tightened, making the exact practice of Repo 105 no longer permissible. ### What key term describes activities that are not included in a company's balance sheet? - [x] Off-Balance Sheet Financing - [ ] Onshore Transactions - [ ] Revenue Recognition - [ ] Amortization > **Explanation:** Off-Balance Sheet Financing refers to financial activities not recorded on the balance sheet, such as those involved in Repo 105 transactions.

Thank you for exploring the intricate details of Repo 105 and tackling our challenging quiz questions. Continue to fortify your financial acumen and ethical comprehension in the field of accounting!