What a real representative would do regarding real reform

In a March 15 statement aimed at President Obama, Senator Ted Kaufman of Delaware voiced his support for what Eliot Spitzer and Bill Black wrote recently on these pages: the SEC and Justice Department must launch a thorough investigation of Lehman Brothers’ accounting misrepresentations. And he emphasizes, as Spitzer and Josh Rosner have done here, that Lehman is just the tip of the iceberg. Looking at the Wall Street culture of fraud and irresponsibility so painfully highlighted by Lehman’s conduct, Kaufman calls for “financial regulatory reform that is tough, far-reaching, and untainted by discredited claims about the efficacy of self-regulation.” There’s plenty of blame to go around, Kaufman assures us, from members of Congress and regulators who drank the Kool-Aid about self-interest being the best regulation, to accountants and lawyers who helped their clients skirt the law. Kaufman concludes, as have experts like Robert Johnson, Simon Johnson, and Frank Partnoy in the Roosevelt Institute’s Make Markets Be Markets report and conference, that the “folly of radical deregulation has given us financial institutions that are too big to fail, too big to manage, and too big to regulate.”

The Rule of Law and Wall Street

“Mr. President, last Thursday, the bankruptcy examiner for Lehman Brothers Holdings Inc. released a 2,200 page report about the demise of the firm which included riveting detail on the firm’s accounting practices. That report has put in sharp relief what many of us have expected all along: that fraud and potential criminal conduct were at the heart of the financial crisis. Now that we’re beginning to learn many of the facts, at least with respect to the activities at Lehman Brothers, the country has every right to be outraged. Lehman was cooking its books, hiding $50 billion in toxic assets by temporarily shifting them off its balance sheet in time to produce rosier quarter-end reports. According to the bankruptcy examiner’s report, Lehman Brothers’ financial statements were “materially misleading” and its executives had engaged in “actionable balance sheet manipulation.” Only further investigation will determine whether the individuals involved can be indicted and convicted of criminal wrongdoing.

According to the examiner’s report, Lehman used accounting tricks to hide billions in debt from its investors and the public. Starting in 2001, that firm began abusing financial transactions called repurchase agreements, or “repos.” Repos are basically short-term loans that exchange collateral for cash in trades that may be unwound as soon as the next day. While investment banks have come to over-rely upon repos to finance their operations, they are neither illegal nor questionable; assuming, of course, they are clearly accounted for.

Lehman structured its repo agreements so that the collateral was worth 105 percent of the cash it received - hence, the name ‘Repo 105.’ As explained by the New York Times’ DealBook, ‘That meant that for a few days - and by the fourth quarter of 2007 that meant end-of-quarter - Lehman could shuffle off tens of billions of dollars in assets to appear more financially healthy than it really was.’”

Click here to read full text of Kaufman’s speech.