Industry | 2010.03.25
Lehman Brothers: accounting to us all | David Davis
Lehman\'s case shows how auditors accepted banks\' machinations, instead of acting for the public good
Last month, two weeks before he died, Sir Brian Pitman, a chief executive and then chairman of Lloyds for 18 years and one of the wisest commentators on today\'s banking crisis, appeared before the Future of Banking Commission . He said "One of the great differences between banking, financial services generally, and other activities, is that you can increase the profits of the outfit simply by changing the risk profile … And [you] will wind up short term with very big profits, and if you gear up the remuneration system appropriately, become rich quite quickly."
What he described was exactly what Lehman Brothers was up to in 2008 , before its collapse. Not only did Lehman gear up its leverage with just $25bn of capital to support $700bn of assets and liabilities, but it also failed to disclose $50bn of off-balance sheet assets by using an accounting gimmick internally nicknamed Repo 105 .
According to last week\'s US bankruptcy proceedings report, "Lehman\'s auditors, Ernst & Young, were aware of but did not question Lehman\'s use and nondisclosure of the Repo 105 accounting transactions". This despite a whistleblower bringing it to their attention. They claim they did nothing wrong.
The accountants were correct, in a narrowly defined sense. The Repo 105 scam and its near relative, Repo 108, were technically legal but certainly morally repugnant. Bank balance sheets are supposed to inform, not deceive, and accountants are supposed to ensure that they do so accurately and precisely.
Lehman\'s bankruptcy was, of course, the trigger for the global financial collapse – but more important, the practice of deliberate deceit and opacity exemplified by it was one of the systemic causes of the crunch. At the end of the boom, some parts of the financial services industry looked like the insatiable in pursuit of the incomprehensible.
The Lehman accounting gimmick is of course just an extreme version of a whole suite of techniques designed to maximise leverage without degrading the credit rating of the bank or company using it. Too often, however, a method supposedly designed to reduce risk merely concealed risk, and very often the effect was to increase system risks to phenomenal levels.
It was in large part the willingness of the accountancy profession to accept the opacity of banks\' accounts, and the instruments they invested in, that blinded the regulators to the risks, and that deceived the investors into believing that high returns could be had.
There is nothing new in the idea that markets suffer from herd instincts, and that the sum of individual benefit can lead to collective harm. That is why we have rule systems and laws. The real keepers of these rule systems are the central banks, the competition authorities, the regulators, the credit rating agencies, and the accountants. If one part of this system fails, it all fails.
That\'s why the accounting problem with banks is fundamental. When accountants signed off a set of accounts, they used to attest that it represented a "true and fair view" of the company\'s activities. Today the accounting firms avoid such useful assessments. Instead, they simply state that it meets one of the two international accounting standards. That is not good enough. When they sift through the records of a bank, they are acting as the agents of the wider public. It is time they recognised this.
It may be that we need to impose a direct responsibility to the regulator on the auditors. Maybe we need to ensure that bank audit committees are entirely independent of the bank\'s executives. Whatever, there is no doubt that we need this profession to shine far more light on the darker recesses of the financial services industry if we are not to face a repeat of our problems.
For more information, please visit
http://www.guardian.co.uk/commentisfree/[...]mans-bank-repo-105-accountants
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