The non blues

What goes well with grey jeans?

The Lehman Report

Beancounters in a bind

Mar 18th 2010 | NEW YORK
From The Economist print edition

Banks’ professional advisers come under scrutiny

IF SUNSHINE really is the best disinfectant, the 2,200-page report into Lehman Brothers’ downfall by its court-appointed bankruptcy examiner may do more to clean up finance than any number of new regulations. It paints a remarkably detailed, and damning, picture of Dick Fuld, Lehman’s ex-boss, and the executives around him. Their spectacularly ill-advised strategy was to take on oodles more risk in property just as everyone else was running the other way. Risk management was risible, with risk limits raised whenever they were breached and dodgy investments excluded from stress tests.

Lehman’s former leaders are not the only ones squirming in the glare. Some of its counterparty banks get a slap on the wrist for changing the terms of their collateral demands, for instance. But the strongest criticism of those who interacted with the flailing firm is reserved for Lehman’s auditor, Ernst & Young (E&Y), for failing to “question and challenge improper or inadequate disclosures”. The main “accounting gimmick” hidden from investors, but apparently known to the auditor, was called Repo 105. This technique helped the firm flatter its numbers by temporarily moving assets off its balance-sheet at the end of each quarter. Lawyers are also in the spotlight: unable to find an American law firm to approve the transaction as a “true sale” of assets, Lehman got the nod from Linklaters in London. Both E&Y and Linklaters deny any wrongdoing.

Although Repo 105 appears to have been in line with American accounting standards, its effect was to deceive. The technique allowed Lehman to reduce its reported leverage substantially and thus avoid ruinous ratings downgrades as it fought for survival. Investors would like to think that auditors consider not just the letter of the rules but their spirit, too. The examiner concluded that there was enough evidence to support a case for malpractice against E&Y.

The report identifies two other aspects to E&Y’s involvement. Lehman used subjective, inconsistent methods to value its illiquid assets. The examiner raises numerous questions about the auditor’s scrutiny of those “marks”, though he finds no evidence of deliberate misvaluation. Secondly, he accuses E&Y of failing properly to investigate claims about Repo 105 by a whistleblower, or to report these to the company’s audit committee (a claim which E&Y disputes).

All of which threatens to dent E&Y’s credibility and, perhaps, lighten its pockets. Class-action suits may follow. Lehman’s trustee could sue to recover losses suffered by creditors, who are seeking more than $800 billion in (at the last count) 64,000 separate claims. Nobody expects E&Y to suffer the same fate as Andersen, whose work for Enron led to its break-up in 2002, reducing the Big Five global accounting firms to four. But the industry, which had to swallow a raft of reforms, including Sarbanes-Oxley, after that scandal, could face calls for further tightening if similar tactics are exposed elsewhere.

Lehman is unlikely to be an isolated case, argues Prem Sikka, an accounting professor at the University of Essex, because “the guards are in bed with the prisoners.” Like rating agencies, auditors suffer from a potential conflict of interest because they are paid by those they judge (and can still tout for other work from them, despite post-Enron restrictions). E&Y’s annual bill for Lehman was $31m. With such big fees on the line, there may be a temptation to wave through practices that meet the rules but present a misleading picture of a client’s financial health.

Economist link

Municipalities and derivatives

Cities in the casino

Mar 18th 2010 | BERLIN
From The Economist print edition

A derivatives farce makes its way to court in Milan. Others are sure to follow

ONE of the great advantages of financial innovation, it was often said, was that risk would end up going to those best qualified to hold it. In fact, much of it seems to have ended up in the hands of those least able to understand it. How some of it got there may soon be revealed in an Italian court. On March 17th four big banks, 11 bankers and two former city officials were charged with fraud in connection with the sale of interest-rate derivatives to the city of Milan. The trial is due to start in May.

The prosecution relates to a huge bet on interest rates that the four banks—UBS, JPMorgan Chase, Deutsche Bank and Hypo Real Estate’s DEPFA unit—helped the city authorities to take in 2005. The banks helped arrange the sale of €1.7 billion ($2.3 billion) of bonds for the city and then also helped it swap the fixed interest rate it was paying on the bonds for a lower, floating rate. Part of the contract is thought to have involved a “collar”, a way of limiting the range of outcomes on a bet, which protected Milan from rising rates but which also meant it would have to pay out if they fell.

The city claims that it was originally promised interest savings of about €60m on the deal but has now made big losses because interest rates have fallen, triggering payments to the banks. Bankers with knowledge of the transaction claim that, in fact, the city has benefited from offsetting gains as the interest rate it pays on the underlying debt has fallen too. The prosecution also claims that the banks charged more than €100m in fees that were built into the price of the swaps and were not properly disclosed to city officials. The banks all deny any wrongdoing.

The outcome of the case will be closely watched elsewhere. In Italy alone, local municipalities had derivatives exposures with a face value of €25 billion last year, according to the Bank of Italy. Some academics reckon that losses on these may go as high as €8 billion. In many of these cases local authorities swapped fixed rates for floating ones, only for collars incorporated into the deals to leave them with losses as interest rates fell. In other cases, losses may only start to show when rates move the other way. Had their bets paid off, however, it seems unlikely that any cities would be crying foul.

Other egregious examples of financial incompetence can be found in nearby Germany, where scores of public authorities also signed contracts that they seem not to have understood. In Leipzig the courts have been asked to rule in a dispute between the city and UBS. That case relates to a complex sale-and-leaseback agreement that the city signed for its local waterworks. Part of the deal reportedly entailed the city agreeing to insure a portfolio of loans against default through a collateralised-debt obligation (CDO). Making good on those loans may bankrupt the city.

In all, about 100 German local authorities are thought to have entered into sale-and-leaseback agreements with American investors over the past decade in a bid to take advantage of loopholes in tax laws. In many of these deals local municipalities unwittingly agreed to take on credit risks for various counterparties, exposing them to demands for collateral as the ratings of institutions such as AIG, an American insurer, fell.

Municipalities in America are also grappling with derivative contracts they barely understand. The city of Los Angeles is pressing Bank of New York Mellon to soften the terms of an interest-rate swap on $443m of bonds that is costing the city money because rates fell. And Jefferson County in Alabama is teetering on the edge of bankruptcy after it entered into swaps that were worth more than $5.4 billion at their peak.

Sorting out this mass of claims and counterclaims will keep lawyers busy for decades. In the meantime, cities can expect to have less room for financial manoeuvre. On March 11th Italy’s Senate Finance Committee endorsed proposals that will restrict the use of derivatives by municipalities. It will, for instance, force them to get an opinion on a proposed deal from the Economy Ministry and require them to prove that a transaction would leave them better off than simply repaying their current debt. To keep dancing, high finance and low-level bureaucrats may need a chaperone.

Economist link

Favourite Chopin

Nocturnes op.9. Nº2
Nocturne in C sharp minor op.posth.
Nocturne in C Minor, Op. 48 No. 1

Impromptus. Nº4 (Fantaisie-Impromptu) in C sharp minor op.posth.66.
Nocturne in E minor op.posth.72 Nº1.

A postmortem on Lehman Brothers

A postmortem on Lehman Brothers
Oh, brother

Mar 12th 2010
From Economist.com

Shining a harsh light on Lehman’s bankruptcy

IT SOUNDS distinctly unpromising. A nine-volume, 2,200-page report by a court-appointed examiner into the causes of Lehman Brothers’ bankruptcy, published on Thursday March 11th, has a table of contents that lasts for 38 pages. Its most exciting finding relates to an off-balance-sheet accounting gimmick. But the work of Anton Valukas, the chairman of Jenner & Block, a law firm, is crisp, clear and explosive.

Mr Valukas and his team took more than a year to research their report. They collected more than 5m documents and reviewed an estimated 34m pages of information. Looking at Lehman’s IT systems was a particular challenge. The firm had a rat’s nest of more than 2,600 systems and applications at the time it went bust; Mr Valukas boiled that down to the 96 most relevant ones, some of which are now operated by Barclays (the buyer of Lehman’s American arm after the holding company failed). He also conducted more than 250 informal interviews, many of them with Lehman’s directors and most senior executives.

The report’s juiciest finding relates to Lehman’s use of an accounting device called Repo 105, which allowed the bank to bring down its quarter-end leverage temporarily. Repurchase (“repo”) agreements, whereby borrowers swap collateral for cash and agree to buy the collateral back later at a small premium, are a very common form of short-term financing. They normally have no effect on a firm’s overall leverage: the borrowed cash and the obligation to repurchase the collateral balance each other out.

But Repo 105 took advantage of an accounting rule called SFAS 140, which enabled Lehman to reclassify such borrowing as a sale. Lehman would give collateral to its counterparty and receive cash in return. Because the deal was being recorded as a sale, the collateral disappeared from Lehman’s balance-sheet and the bank used the cash it generated to pay down debt. To outsiders, it looked as though Lehman had reduced its leverage. In fact, the obligation to buy back the collateral remained. Once the quarter-end had come and gone, Lehman borrowed money to repay the cash and buy back the collateral, and its leverage spiked back up again.

Mr Valukas marshals plenty of evidence to back up his claim that “Lehman painted a misleading picture of its financial condition”. The effect of Repo 105 was material: the firm temporarily removed around $50 billion-worth of assets at the end of the first and second quarters of 2008, a time when market jitters about its leverage were pervasive (see table below). Mr Valukas can see no legitimate business reason to undertake the transaction, which was more expensive than a normal repo financing and had to be done through its London-based arm because Lehman was unable to get an American lawyer to agree that Repo 105 involved a true sale of assets.

He also uncovers all sorts of unguarded e-mail traffic about the practice, which employees variously described as “window-dressing” and an “accounting gimmick”. Bart McDade, who became president of Lehman in June 2008 and tried to stop the bank from being so aggressive in its use of Repo 105, described it in April of that year as “another drug we r [sic] on”. Mr Valukas believes that “colourable claims”—meaning a plausible legal claim for damages—could be brought against Dick Fuld, the firm’s boss, and three of Lehman’s chief financial officers for filing “materially misleading” quarterly reports. He also thinks that Ernst & Young, Lehman’s auditor, has a case to answer for allowing these reports to go unchallenged.

Whether the report will actually lead to lawsuits remains to be seen. Mr Fuld says he did not know about the Repo 105 transactions; Ernst & Young says that Lehman’s reporting was in line with accounting principles. But even if executives were not breaching their fiduciary duties, the examiner’s report gives Lehman’s creditors and shareholders an awful lot of other reasons to feel aggrieved.

 
Lehman's liquidity pool was not that liquid, after all 
As well as his findings on Repo 105, Mr Valukas describes how Lehman’s liquidity pool, which was designed to allow the bank to survive in stressed financial conditions for 12 months, contained cash and securities that had been assigned as collateral to its clearing banks, which grew increasingly nervous about doing business with Lehman. On September 10th 2008, just five days before it filed for bankruptcy, Ian Lowitt, the bank’s chief financial officer at the time, told investors that its liquidity pool remained strong at $42 billion. Yet an internal document from September 9th showed that it had a “low ability to monetise” almost 40% of the assets involved. The liquidity pool was not that liquid, after all.

Mr Valukas also draws back the curtain on the decisions that led Lehman into trouble in the first place. Lehman’s chiefs signally failed to see the potential contagion from the subprime implosion. In its pursuit of growth, the firm’s overall risk appetite was repeatedly increased and limits on the size of single leveraged-loan transactions were routinely ignored. Incredibly, stress tests failed to include many of Lehman’s most illiquid assets. Even when executives began to understand the scale of the risks they were taking, they kept taking on business rather than walk away from deals. Board directors were unaware for several months in 2007 that Lehman had breached its risk-appetite limit. They also did not know that executives had used a new methodology, based on aggressive revenue projections, to increase that risk-appetite threshold again in January 2008. And so on, for page after damning page.

Mr Valukas’s conclusion is that Lehman’s aggressive growth strategy and its approach to risk reflected “serious but non-culpable errors of business judgment” rather than any breach of fiduciary duties. But the stain on the reputation of the bank’s executives and directors has grown even larger.

Economist link

Repo 105

Posted by Tracy Alloway on Mar 12 08:05.

Think window-dressing on a massive, and possibly misleading, scale.

Much of the 2,200-page Examiner’s report into the Lehman Brothers bankruptcy centres around an “accounting gimmick” used by the bank, and signed off by auditors Ernst & Young, to reduce leverage.

That would be Repo 105 and Repo 108 — or Repo 105 for short.

And it/they worked like this, according to Volume III of the report:

Lehman employed off‐balance sheet devices, known within Lehman as “Repo 105” and “Repo 108” transactions, to temporarily remove securities inventory from its balance sheet, usually for a period of seven to ten days, and to create a materially misleading picture of the firm’s financial condition in late 2007 and 2008.

Repo 105 transactions were nearly identical to standard repurchase and resale (“repo”) transactions that Lehman (and other investment banks) used to secure short‐term financing, with a critical difference: Lehman accounted for Repo 105 transactions as “sales” as opposed to financing transactions based upon the overcollateralization or higher than normal haircut in a Repo 105 transaction. By recharacterizing the Repo 105 transaction as a “sale,” Lehman removed the inventory from its balance sheet.

Lehman regularly increased its use of Repo 105 transactions in the days prior to reporting periods to reduce its publicly reported net leverage and balance sheet. Lehman’s periodic reports did not disclose the cash borrowing from the Repo 105 transaction – i.e., although Lehman had in effect borrowed tens of billions of dollars in these transactions, Lehman did not disclose the known obligation to repay the debt.2851 Lehman used the cash from the Repo 105 transaction to pay down other liabilities, thereby reducing both the total liabilities and the total assets reported on its balance sheet and lowering its leverage ratios. Thus, Lehman’s Repo 105 practice consisted of a two‐step process: (1) undertaking Repo 105 transactions followed by (2) the use of Repo 105 cash borrowings to pay down liabilities, thereby reducing leverage. A few days after the new quarter began, Lehman would borrow the necessary funds to repay the cash borrowing plus interest, repurchase the securities, and restore the assets to its balance sheet.

Lehman never publicly disclosed its use of Repo 105 transactions, its accounting treatment for these transactions . . .

You can see why Repo 105 would be a tempting thing in the midst of a brewing financial crisis.

Leverage had become a focus of the ratings agencies and was widely thought to be an indicator of bank risk, which meant Lehman would have been hell-bent on reducing its leverage — at least publicly.

At the same time prices for things like CMBS and subprime loans were falling and/or illiquid — Lehman could not have reduced its balance sheet simply by selling things off without incurring large losses.

Hence the Repo, which the bank increasingly used between 2007 and 2008 — even breaching its own internal cap on the Repo’s use (about $22bn as of summer 2006).

And the effect is pretty clear. From the report:

Hence the Examiner’s conclusion:

The Examiner concludes that there is sufficient evidence to support a colorable claim that: (1) certain of Lehman’s officers breached their fiduciary duties by exposing Lehman to potential liability for filing materially misleading periodic reports and (2) Ernst & Young, the firm’s outside auditor, was professionally negligent in allowing those reports to go unchallenged. The Examiner concludes that colorable claims of breach of fiduciary duty exist against [former CEO/CFOs] Richard Fuld, Chris O’Meara, Erin Callan, and Ian Lowitt, and that a colorable claim of professional malpractice exists against Ernst & Young.

And the response, as reported by the FT:

In a statement, Mr Fuld’s lawyer wrote: “Mr Fuld did not know what those transactions were – he didn’t structure or negotiate them, nor was he aware of their accounting treatment,” his attorney wrote in a statement.

“Furthermore, the evidence available to the examiner shows that the Repo 105 transactions were done in accordance with an internal accounting policy, supported the legal opinions and approved by Ernst & Young, Lehman’s independent outside auditor.”

E&Y said in a statement: “Our opinion indicated that Lehman’s financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles (GAAP), and we remain of that view.”

Mr Lowitt’s attorney said in a statement: “In the three months during which he held the job, Mr Lowitt worked diligently and faithfully to discharge all of his duties as Lehman’s CFO, Any suggestion that Mr Lowitt breached his fiduciary duties is baseless.”

Mr O’Meara could not be reached for comment. A lawyer representing Ms Callan declined comment . . .

via FT

First impressions of Jetbook Lite

Arrived today with my other books loot from Amazon.

The JBL is my first ebook reader, initial impressions are good.

- Roughly the size of a paper back, much thinner of course. Handy, the portruding battery compartment serving as a grip

- The text show well on the screen, easier to look at than text on a computer LCD screen. I prefer the LED screen to an e-ink display, the former doesn’t suffer from the blackout screen and refresh lag in between page scrolls. However the battery life is said to be much shorter, waiting to see how the eneloop lite batteries hold up.

- Controls feel simple and intuitive so far. The scroll bar is nicely placed on the left, allows one hand operation. I can grip the unit and

- The unit powers off automatically after a period of inactivity. The time is customizable, default being 5 mins. Just nice.  The unit resumes after 2-3 secs on the last viewed page of the novel after powerup, nice! This is the beauty of a dedicated ereader, i can treat it like a paperbook. Put it down when i am done reading and pick it up later to resume reading. No waiting for system startup and launching programs as i would be doing with a convergeance device such as netbooks or PCs.

- Supports multiple bookmarking for every novels. This would come handy for mystery novels especially. Adobe reader needs this feature badly.

- There is no backlight, which reduces eye fratigue when reading but is also may be a tad inconvenient on dark cast afternoon when i don’t to turn the lights on. I need to check out what clip on reading lights are there on the web stores.

- Unit comes with a selection of classics novels on the 100mb internal memory.

- First book - A Study in Scarlet :)

- No SD card bundled :(

- I bought it for 115usd at a Newegg special. This is a great price, but considering i need to pay borderlinx($10?), the eneloop lites($15), buy a pouch plus a SD card, the cost adds up.  Last i check, the Jetbook with build-in lithium-ion batteries and a pouch was selling $279.44 locally..hmm.  This is a close one. If i knew of this offer i could have bought it without waiting for shipment. It would probably has some form of local warranty too. Ah well. The ability to swap batteries will be handy on a trip, i already have cellphone and camera charging to deal with. I can share AA batteries between my iriver mp3 and the JBL too. Now thats a plus.

To do

- What size of SD card to buy?

- Where to get a nice pouch for the JBL?

- Check out reading lights

- No more excuses! This is why i bought this, time to catch up on my PDF documents reading list. Reading PDF on computers was a pain and most of the time i turned to surfing net anyway. Get off the pc and start reading!

Cab home from Changi

After midnight.

Meter = $14.40

Late night +50% = $7.20

Airport surcharge = $3.00

Total = $24.60

Symbols in batch files

'>' and '<' are special characters in command prompt. They means input and output redirect. So they can't be directly echoed in command prompt. You need to escape them with '^'. 

C:\>echo <
The syntax of the command is incorrect.

C:\>echo ^<
<

This is mentioned in http://www.microsoft.com/windowsxp/home/using/productdoc/en/default.asp?url=/windowsxp/home/using/productdoc/en/ntcmds_shelloverview.asp

The following characters are special and have to be escaped:
<, >, |, &, or ^,

via MSDN blog

Fighting sore throats and cough

• Tussil Five – good for suppressing cough. Tried and tested by me!
• Avoid all fruits except papaya which is good. Orange,apples and other fruits have citrus acid which aggravate the condition.
• One Eye Ah Peh Liang Teh sachets