Friday, April 9, 2010

Lehman not the only firm using the repo markets to obscure risk levels

According to the WSJ, the Federal Reserve Bank of New York has released data showing that several major banks masked their risk levels over the past five quarters.  How did they do it?  Perhaps unsurprisingly, the banks were using repo transactions.
A group of 18 banks—which includes Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc.—understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods, the data show. The banks, which publicly release debt data each quarter, then boosted the debt levels in the middle of successive quarters.

The data highlight the banks' levels of short-term financing in the repurchase, or "repo," market. Financial firms use cash from the loans to buy securities, then use the purchased securities as collateral for other loans, and buy more securities. The loans boost the firms' trading power, or "leverage," allowing them to make big trades without putting up big money. This amplifies gains—and losses, which were disastrous in 2008.
I am interested in seeing how disclosure of the repo transactions varied across these firms.  Assuming some firms were forthright in the effect that the repo transactions were having on their financial statements, did investors punish firms for being honest?  I wonder if industry analysts were aware of the practice, and if so, did they expect most/all firms in the industry to engage in such transactions, regardless of whether or not the transactions were disclosed?

1 comment:

  1. Wouldn't it be nice to see some justice sought? Instead I think that time will show DC the FED and likely many of the states have been complicit in this. I have a feeling we are no where out of the evil woods yet.