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The Continuing Mystery of the Lehman Black Hole

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We’ve taken the liberty of designating the biggest money pits of the financial crisis as “black holes.” And one the characteristics of black holes is that anything that crosses the so-called “Schwarzschild radius” does not escape. That means that it is impossible to obtain any information from inside the Schwarzschild radius.

That feature seems particularly relevant as far as AIG and Lehman are concerned. With AIG, there has been no interest in ascertaining why a bailout that was supposed to total $85 billion, max, was retraded four times, with the amount going to AIG rising each time. By contrast, as we have pointed out repeatedly, UBS was made by the powers that be in Switzerland to explain in detail why it needed a rescue.

For Lehman, despite the voluminous so-called Valukas report, prepared by the bankruptcy examiner, the biggest question remains unanswered. How could an investment bank that sported a positive net worth suddenly show such massive losses? Even Lehman skeptics were stunned at the magnitude of the losses.

As we noted before, Repo 105 and the hasty bankruptcy are not sufficient explanations:

But the numbers do not add up. The bankruptcy administrator has put the losses at $130 billion (although that number is still in play) and was (remarkably) denying that Lehman had a solvency problem at the time of its collapse, when the tenor of the Government section suggests the reverse. In addition, Lehman’s net worth as of May 31, 2008 was reported at $26 billion. So if we accept the $130 billion estimate, the swing from reported net worth to losses realized was over $150 billion. We still have no satisfactory explanation of how that took place. The bankruptcy administrator, Alvarez & Marsal, blamed some of the losses on the “disorderly collapse”, but assigned “only” a maximum of $75 billion. We do not know the composition of the value shortfalls that led Lehman to play Repo 105 games, which presumably totaled $50 billion (some sus items have been singled out, but that falls short of an explanation). So not only do we lack a decent explanation of that $50 billion, even if we accept the high end of the Alvarez & Marsal estimate, we have an additional $25 billion missing in action.

Reader Hubert, in comments yesterday, voiced continued frustration with the lack of an explanation for the magnitude of Lehman losses and thought the Naked Capitalism community might come up with answers:

Maybe we can do some open source algebra to bring some light into the biggest financial crime ever:

A+B+C = D

A) Equity Lehman 20 bn
B) Loss to subordinated debt 150 bn
C) Money stolen from London prime brokerage counterparties: 15 bn
D) damage in total: 185 bn
(all my estimates, from the hip) [Yves comment: A was $24 billion, latest loss estimates I've seen from official sources is $130 billion. So I'd put D at $170 billion]

Now in accounting identities, we will have to find responsible business lines where the losses might have occured. Unfortuanately tho other side is more convoluted:

D= E + F + G + H + I + J + K + L + M + N + ………..

E) Losses on Residential Mortgage Bonds/CDOs 20 bn ?
F) Losses on Leftovers from Pipelines of their mortgage origination subs x?
G) Deficiency in Assets presumably sold but whoops, maybe not: REPO 105 – max 58 bn
H) Commercial Real Estate in various forms (Archstone ….): 20 bn
I) Money stolen by Barclays – 5-10 bn
J) MOney stolen by JP MOrgan 3-8 bn
K) Money stolen by various other Derivative counterparties ????
L) Bankruptcy court and lawyers, 1 bn counting – let´s say 2 bn
M) Hot Air In LEH Derivative Book ?????
N) Neuberger Berman – 2,6 on book – appraised for 8 bn, sold for 1 bn – loss 1,6 bn.

E – F – G might be very well interconnected
G depends on quality of “REPO” assets. My guess: 20 bn – might or might not be included in E and/ or F.
All has to add up to 185 bn and I have trouble reaching 100 bn.

The solution of this riddle might bring quite some jailtime for Dick Fuld – that should be enough motivation to bring it along.

Yves – for the sake of earthly justice – would you motivate your readers to join in this endeavour ?

Yves again. I’m pinging some readers and fellow bloggers who might take up this challenge. Anyone who has insight (as to any adjustments might be needed to come up with a better estimate of the size of the hole and what its constituent elements might be) PLEASE comment!

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51 comments

  1. Doc Holiday

    Ok ok , stop right there: “Schwarzschild radius.”

    The thing I still can’t wrap my head around is that the radius of a black hole has an internal and external radius, as in inside or outside, and this will cause variation with calculating where you are in relation to an external source looking in — or an internal place, where your sitting inside like your in a movie theater waiting for the show to start. There was a point I was going to make … but never mind, no wait, the black hole, that was it ..

    Re: “That means that it is impossible to obtain any information from inside the Schwarzschild radius.”

    > How do we know there is information inside the black hole?

      1. attempter

        I thought the so-called laws break down at the singularity.

        It’s funny the way everyone refers to these “laws” of the universe as if they were real laws rather than mere descriptive metaphors which function more or less well as a practical matter.

        “Laws of physics” as a workable if somewhat pretentious metaphor, good.

        Reifying them and thinking our monkey brains are actually explaining reality rather than just describing it(that we actually have true knowledge rather than just workable heuristics), silly.

          1. Moopheus

            There’s some other kind of money? Money is an artificial construct–it doesn’t occur in nature. It’s a creation of human culture. Therefore all money is “fictional.”

          2. aet

            Fictionality inversely proportional ti the square of the gravity which it exerts on those around it.

        1. Andrew Foland

          There is, in general, no singularity at the Schwarzchild radius. Nor is there expected to be any breakdown in our understanding in what happens at the SR. The singularity is, if you will, a point at the “center” of the BH. Between the SR and the singularity our understanding is on pretty solid ground.

          1. attempter

            I know that, but the point I was referring to is the proposition that we could know what’s happening inside the event horizon, when of course we can’t. So who knows if the information “leaks” through the singularity (i.e., if the universe doesn’t “conform to our laws”) or not.

            I was goofing on, not Foppe’s comment in particular but the hubris of epistomology in general (and the way it thinks terminology captures reality) and especially its more absurd technocratic aspects.

            Like for example in “economics”.

          2. Doc Holiday

            I think the point your all missing is that the point, i.e, the singularity is fluid and dynamic, and elastic like the brains that are at BP.

        2. Bates

          ‘I thought the so-called laws break down at the singularity.’

          If, like me, one does not believe that black holes forever take in matter, growing ever larger, but instead grow for a time then explode in a spectacular manner, then the problem of gamma ray bursters, the infinite size of the universe, and the swiss cheese nature of the distribution of matter (galaxies, etc) is solved.

          I believe that black holes take in matter until a critical mass is attained, based more on what matter is taken in… not simply the total of all matter taken in. Then, when a critical mass is reached black holes explode and are labeled by man to be a gamma ray bursters…if the explosions are large enough.

          If the above is true then our universe is infinite (some gamma ray bursters originate far beyond 14 billion light years distance) and at the same time the only perpetual motion machine ever devised, since it is a given that the matter entering the black hole is transformed into different elements under the enormous gravity within the black hole.

          Of course, this does not square with what conventional science offers us.

          If conventional science admitted that the universe is infinite then somewhere we would have a sister planet with all attendent follies…Since those living on our sister planet would be like us, human nature included, their experiences would be similar or identical to ours…Pity them.

          When thinking of the enormity and complexity of the universe…who really cares if a few stupid sociopathic derivitives salesmen stole some pieces of colored paper with numbers printed on them from Lehman Bros? On the other hand gold is one of the items created within the black hole and is dispersed in small quantities throughout the universe by nature at work. Man has yet to discover how to create gold… the best man can do is dig up a little of what was created in the black hole and deposited on earth by the occasional enormous black hole explosion, and use it as a store of value based on it’s rarity.

          Besides, thinking about the universe and it’s wonders is a far more pleasant way to spend one’s time than thinking of the folly of Keynesian Theory on steroids.

          1. aet

            Black holes stretch things until they break.
            Perhaps this “black hole” metaphor, too, has been over-extended.

  2. Hubert

    1) Hudson Castle might be a candidate for point (O). Other form of assets not really sold. The loans/ other schemes to Hudson might have been a total write off. There was a good NYT story about it in March.

    In general, the LEH black hole, without ever being mentionned, is the central theme (“elephant in the black hole?”) in the policy of “no more Lehmans”. It implies that there might be not only some other weak banks but some other Black Holes out there – and nobody wants to find out ……

    1. pros

      Bingo!

      This Lehman unwinding was one of the things that
      scared the hell out of the Fed and resulted in their asset-inflating program.
      think Citibank, e.g.

  3. Siggy

    Forget about the arithmetic and algebra. The balance sheet in its entirety was a fiction.

    Consider Repo105. It was reported as a pure sale and the buy back liability was omitted. That’s an accounting control fraud.

    Call in that fellow with the beard from Missouri to lead the prosecution Fuld etal. FASB should be brought to the bar as well as the accounting firm who passed on the applied accounting methods.

    1. Hubert

      No, basic algebra is very important here.
      Basic accounting identies garantie that the money was
      1) either gone before already (in which case LEH had transgressed from reckless to deeply criminal)
      2) was stolen by different parties in the few days around bankruptcy until the court started counting what was left. Ones loss is another ones gain in this case. Which means LEH going bankrupt was VERY profitable to some parties.
      Now we certainly look at a combination of 1) and 2).
      And this makes the BLACK HOLE Metaphor very apt. We do not know either what happens in physics there. Difference: we could find out about LEH; only those with the means to it do only want to bury the whole thing. 50- 100 bn $ probably looted in delicate legal maneuvering. To understand the future of this racket we should at least all try to understand its recent past.
      Though the truth might not set us free here; in Dick Fulds case quite the opposite.

      1. Siggy

        Hubert,

        Suppose I buy a big bag. I pay $100 million for the bag. I credit cash $100 million and I debit big bag, as a long term asset, $100 million. The big problem is that the big that I bought is empty. Sadly, all the other fools have left the market for big empty bags.

        Now I have a choice, I can carry my big empty bag at $100 Million; or some lesser number, say $50 million and when I do that I will reduce my equity account by $50 million. When I reduce my equity account by $50 million comes now Moody’s and S&P and Fitch who say my credit rating must go down two steps. That rating adjustment puts me in the category of being a questionable credit. Comes now all the people from whom I borrowed money saying please repay. I can’t. What should I do?

        The choices are: Cheat by saying that my big empty bag is worth something; or go to the bankruptcy court.

        It seems that Lehman said that its big empty bag was worth something when it wasn’t. It may have been that some of the paper that was offerred up as security to a repurchase agreement wasn’t worth anything.

        Call it what you will, a black hole, a death star, whatever. Consider it to be analogous to any natural phenomenom and it remains the same, an accounting missrepresentation if not a fraud.

        Looking for the money that might be subject to recapture? Well, the money left the moment Lehman bought all that stuff that it was carrying as assets and in that it is improbable that the basis for recapture was present.

        There is no mystery here other than the degree of fiction attributable to Lehman’s accounting practices. Mr. Valukas lays it out. His report is a road map for both civil and criminal suits.

        To equate Lehman to a black hole is to fail to apprehend the reality of what 35 to 1 leverage means.

        1. Hubert

          Siggy,

          all you describe is point 1) accounting fraud or latidute to the extent of 150 bn. But that is not the whole story.
          “Alvarez & Marsal, blamed some of the losses on the “disorderly collapse”, but assigned “only” a maximum of $75 billion.” I think they (A&M) are crooks but still there might be some truth to this. Who made this 75 billion or whatever? Were LEH derivatives mismarked before or were they liquidated at fire-sale prices. And more importantly: What would that imply to happen if they pull another financial institution into bankruptcy orbit? Is that a license to steal from debtholders? What about the Bankruptcy Reform Act of 2005 – what role did it play in this scharade ?
          These and some more questions are in there Siggy, and we do not know the answers …..

          1. Tar, etc.

            I agree, Hubert. There is a white elephant in the black hole. The money went somewhere.

  4. Blurtman

    Anyone going to jail? Anyone going to jail? Anyone going to jail?

    Is Eric Holder a part-time contractor?

    Recall that over this last Christmas, a street vendor in NYC who was attempting to scam $10 out of passers-by was pursued by law enforcement and shot dead. He was armed, and police appeared to have acted appropriately.

    But this is symbolic of the two-tiered justice system in the USA. While police were pursuing a $10 scammer, across town on Wall Street people are scamming billions out of marks, and there is no pursuit by law enforcement. Worse, when things take an unfavorable turn, the taxpayer marks are ordered to bail them out.

    There was a large disconnect between American society and the US government over the lies the government continually trotted out regarding the Vietnam War. Even traditional values Americans came to distrust the government.

    The Wall Street scandal and ineffective government response is Obama’s Vietnam. And he is looking more and more like Richard Nixon.

  5. Peripheral Visionary

    I think the starting point for the analysis should not be Lehman’s assets, but rather its liabilities. And I think it is on the liabilities side that revelations are likely to be made. Traditionally for a corporation, liabilities have been long-term debt (bonds), short-term debt (commercial paper), and unpaid bills (salaries, taxes, misc. accounts payable.)

    The problem here seems to be that, while all the focus has been on the quality (or lack thereof) of Lehman’s assets, it is quickly becoming clear that Lehman had far more liabilities than a traditional corporate balance sheet would reveal. Financial insitutions have become capable of accumulating liabilities that don’t look like liabilities.

    Repurchase agreements, including the infamous Repo 105, are a perfect example: technically, a repo is a liability, as it is money that will have to be repaid. But accounting rules allow for it to not be accounted for as such, because it has an offsetting “asset”, namely, the securities which are being used to collateralize the deal. If there are any losses on the “asset” side, however, the hidden liability of it suddenly comes to light, in a rude surprise to anyone who was looking only at the balance sheet. But it isn’t just repos; any number of derivatives have accounting treatments that allow for only a fraction of the liability to be accounted for, certainly including credit default swaps.

    Once the liability side is looked at in more detail, it will quickly become evident that Lehman dramatically understated the full extent of its liability, as did AIG, which got destroyed over CDS liability. That would indicate a pressing need to review accounting rules for liabilities on structured transactions. But beyond accounting treatment, any transaction with a risk of the liability expanding (CDS, option, future contract) should carry with it much higher capital requirements. That obviously won’t solve the problem of Lehman, but the real task at hand should be ensuring that there is not another Lehman.

    1. Cog

      Thank you for bringing this back on topic. Oh yeah, they tabled the Dorgan amendment that could have been the entree’ to increasing capital requirements on CDS. One more item checked off which ensures we get to do this all over again.

      1. aet

        So…the accounts are , as of now, incompletein some way?
        Some kind of “unrepresented liability” ate the equity?
        What was it?

        1. aet

          I thought accountants were conservative…why would the liability not be shown at its full possible amount?
          Why the discount on the sum shown in the visible books?

          1. Peripheral Visionary

            They have always been accounted for differently, which began with relatively conservative derivatives like interest rate swaps, and with futures contracts which have the same feature of an uncertain future liability. It doesn’t make sense to value structured transactions at absolute-worst-case-scenario levels, because in some cases the results are absurd; e.g., a short call option, where the potential liability is literally unlimited.

            So the accounting profession has had an ongoing debate over valuing items at market value vs model value, “fair value”, etc. The problem is that even market value, often considered to be one of the best methods when prices are available, can be horribly flawed. Looking back, it’s perfectly clear that the “market values” on many derivatives were, at the time, extraordinarily underpriced. A model would have revealed that, depending on the model–but market prices did not, one case where mark-to-model may have been preferable, again depending on the model.

            It’s just not easy to put a reliable price on some financial instruments. That’s why a better approach may be on the capital requirements side–saying, it doesn’t matter what the market prices say, you have to account for certain classes of instruments in certain ways when calculating capital requirements; e.g., 5% on repos regardless of (e.g., in addition to) overcollateralization, 5% on swaps, 10%+ on off-balance sheet investment vehicles, etc.

  6. Wyndtunnel

    And they said that any blackhole the Large Hadron Collider would create could be maintained. They fired up the LHC for the first time on September 10th… on the 19th it suffered a failure and had to be shut down… Creepy.

    And then they fired her up again on March 30th, 2010. In a progress newsletter published yesterday CERN announced that on April 19th, 2010 they achieved “a ten fold increase in luminosity – in other words, the machine started delivering ten times as many collisions to the experiments in a given period of time than had previously been possible.”

    And on the 20th of April…the BP oil disaster.. another black hole that is out of control.

    They’re firing her up again today… cue the Jaws theme.

  7. Mark

    Allow me to put on my country lawyer hat … It seems to me that understanding the math might require that we look not only at the contractural claims made on money, and who ran off with it, but at who had a vested interest in Lehman (or it’s assets/financial instruments) tanking.

    Put another way, this may not be a Black Hole problem. It may be a smoke & mirrors problem.

    We want to keep in mind that there were alot of people involved in getting the “net capital rules” (NCR) changed by the SEC so that market players could go out and borrow, and then recklessly gamble on financial instruments of dubious market utility. Getting the SEC to raise the NCR ratio from 12:1 to 35:1 was a really stupid thing to do, and eventually would have made alot of people look foolish. Unless, of course, you were trying to bury your industry’s (or your company’s) failures for a few years.

    Think about it. Who profits, both financially and professionally (if not politically), from pushing the NCR back to 35:1 and then watching Lehman and, later, AIG become scapegoats?

    Again, this might not be a Black Hole problem as much as it’s a smoke & mirrors issue.

    - Mark

      1. aet

        Aaah…they lowered the capital requirements.
        But they called it a “raise”, in some “ratio”….

        1. Mark

          Yeah, the financial industry needed to “raise” the NCR ratio in 2004 because they knew that they couldn’t keep the derivative game going without putting more Ponzi/leveraged money in. This financial hirewire act had been going on for some time. In fact, the FDIC warned the banks about accepting snazzy financial instruments as collateral as far back as 1998 because CDOs were already popping up on their radar screen as troubled assets (anyone who’s seen the Brooksley Born piece by Frontline knows the warnings go back further). Still, the derivatives market took off anyways after Bush’s election because the industry knew no one was going to mind the store. As should be expected, the claims on money and wealth jumped as well, as the growing gap between M-1 and M-3 after 2001 show. The Bush administration saw this, which might explain why they stopped keeping track of M-3 in 2006.

  8. Mathew Binkley

    Having studied black holes for a couple years in grad school, I believe there is actually a deep mathematical similarity between black holes and depressions, if only I was smart enough to figure out what it was.

    1. Black holes have an event horizon. Depressions have the zero bound.

    2. Assuming you’re only observing your trajectory through space, it’s impossible to determine whether you are about to hit a black hole or a “classical” object like a star. Similarly, it’s very difficult to tell in advance if you’re heading towards a recession or a depression.

    3. Our definitions of space (r) and time (t) break down at the event horizon. Inside, we have to construct new variables R=f(r,t) and T=g(r,t). Space becomes timelike and time becomes spacelike. Similarly, inside the zero bound behaviors which are normally considered good become bad (paradox of thrift, fallacy of composition).

    4. Inside the event horizon, you would have to move faster than light to escape, which is impossible. Inside the zero bound, you have to lower nominal interest below zero, which is impossible. So the 0% rate seems analogous to the speed of light.

    5. Fiscal stimulus seems to be the equivalent of warp drive. There’s an upper limit on how long you can use it before you run out of fuel, but if you don’t use it long enough, you fall back into the black hole.

    6. A black hole isn’t completely black. It will eventually evaporate due to Hawking radiation. Similarly, a depression isn’t permanent, but will end when people are forced to start replacing worn-out items.

    So am I completely crazy here? Or is it a case of “if you have a hammer every problem looks like a nail?” Any literature on this? The idea has been eating at me for a while.

    1. aet

      Like a black hole with matter, you have stretched the metaphor to the breaking point.

  9. Stelios Theoharidis

    In addition to some jail time for Fuld et al, Ernst and Young should hopefully burn a bit over this, possibly go the same direction as Arthur Anderson.

    I am unsure whether they want to take the big 4 down to big 3. It seems like a prospect that the government will be unlikely to pursue and potentially detrimental to the industry as a whole.

    Not like the new FASB rules haven’t created a farce of the whole practice.

  10. Debra

    Reading the figures gave me the same kind of headache I get when looking at my tax return (not prepared by me…).
    Following the money is about on a parr with trying to follow a drop of oil in the Gulf of Mexico right now…

  11. yoganmahew

    To combine what Siggy and Peripheral Visionary are saying:

    Forget simple accountancy. There is nothing simple about the way assets and liabilities were valued on Lehman’s balance sheet (or continue to be valued on the balance sheets of other banks).

    Variations on the theme of risk-weighted assets and VaR will give most of the answers.

    On the assets size, the value of assets was overestimated to meet expectations (i.e. the figure was thought of first with the asset valued up to that). Methods included hold-to-maturity, revenue recognition (i.e. recognising a proportion of annual revenue as a loan was issued, even though it might take years to appear), and plain lies (this piece of Florida swampland is worth what we say it is).

    On the liabilities side, risks were underpriced. Even allowing for fat-tailed events, I’ll bet that much of the derivatives book was priced to model, with a shifting of assets between price to market and price to model depending on the most favourable place to put them (see assets above!).

    Fundamentally, accounting has let the rest of us down. It is striven for accuracy and forgotten fairness, as in fair value. In addition, the idea that the balance sheet of a bank should, well, balance is ridiculous. Shareholder equity should be cash (not a thin slice of each of the assets no matter how risky) and it should equate to a large chunk of the assets of the bank. Basle III belatedly recognises this (until it is watered down anyway).

    So, a pyramid scheme with magic formulas on both sides of the balance sheet squeezing a size 14 into a size 12 dress and wearing size 19 boots on size four feet… sounds more like a clown bank. Ah yes, the big red Fuld nose…

    1. aet

      I see…the accountants have not been real conservatives, regardless of whatever they may call their politics in public.

  12. Ex-Lehman

    Cannot even tell you how many swaps linked to CDOs that they did while I worked there that backstopped investor’s AAA and lower tranches…could be mind-boggling numbers. No one there was aggregating these numbers.

  13. Smells Like Chapter 11

    The solution of this riddle might bring quite some jailtime for Dick Fuld – that should be enough motivation to bring it along.

    That assumes that he knew what the numbers really were. He should of known but every account i have read indicates that he was completely clueless.

  14. i on the ball patriot

    Wrong title, that grossly deflects from the real problem. It should read …

    The Continuing Mystery of NO Justice Department Lehman Investigation

    Finding the real truth and the evidence in the sacrificial lamb of Lehman is like trying to find the real truth and the evidence of the assassination of MLK, RFK and JFK.

    Am I suggesting that there is some elite hanky panky going on here? You can bet your sweet ass there is!!!!!

    Rather than discussing deflective black holes we should be screaming for the Justice Department to get off of its crooked, sell out, scum bag ass and fulfill its mandate to the people.

    Siggy, PV and yoganmahew have the gist of it — scam rule of law no accountability!

    Election boycotts as a vote of No Confidence in this crooked government are long overdue.

    Deception is the strongest political force on the planet.

  15. ChrisPacific

    As entertaining as the black hole discussion has been, I don’t believe that the answers to the questions Yves has posed are to be found in theoretical physics.

  16. Gepay

    I am just a layman observer. Economics articles still have a tendency to put me to sleep in too short of time. The comments used to be a lot better.
    I still haven’t read a clear explanation of how the Lehman involved CDS turned out – how much net money was involved and how much net money was lost and who lost and who came out ok. It is clear that it was decided that AIG’s counterparties would not take a haircut but be bailed out by the the US taxpayer.
    As time goes by – ” the older I get, the more cynical I get, but I just can’t keep up.” Lilly Tomlin
    and I begin to wonder if anything can be done. Why bother when the SEC isn’t going to go after the big boys? Why bother when the FBI isn’t going to or doesn’t have the economic smarts to investigate? And even if they did, would the Justice department prosecute?
    It is obvious that it was decided that Lehman would be thrown under the bus. It is obvious that Paulson was one of the implementers. Bernanke A few others in the FED Geithner JP Morgan-Dimon Who else decides these things? Then some of the Lehman insiders plundered what they could. How did they know? There is so much money involved it would take (years?) a large corporate accounting firm to follow the money. Is that going to happen?
    It becomes clear that the system is going to have to totally fail for it to be fixed. Europe decided (or was it told by the Bilderbergers through Obama?) that it would have to throw a trillion or so at its banking-government bond problem. It is apparently taking the rich beyond greed types quite a while to figure out how to come out ok so the decision was made to ‘kick the can’ down the road rather than bite the bullet and clean up the mess that the global financial system is. In the meantime it is the middle class of Europe and the US who will make the sacrifices -pensions- health care – salary cuts- etc along with the poor and workers all over the world in order to keep some of the the big banks and bond investors as whole as possible.

  17. Avg John

    I’m more comfortable with valuing items for yard sales than trading fancy multibillion dollar derivative contracts and such, but I do know that the accounting principles used in placing values on assets and liabilities on the books(or their disclosure in the notes instead of as line items), assumes the entity is a “going concern”. Maybe part of the black hole is related to liabilities that made their way to the financials that prior to collapse were given no recognition as either line items nor note disclosures.

    When a company goes into bankruptcy in the middle of a market in crisis, holding derivatives with underlying instrument credit rating changes and such, a collapse of demand for their product, and other extraordinary circumstances, many of the assumptions used to place value on assets and related liabilities and their recognition change dramatically(disorderly diposition referred to in article).

    The value of assets on the books will plunge wildly while the liabilities will tend to be fixed by contract, with some contingency liabilities finding their way to the financials as line items and the present value of the underlying assets plummeting.

    The balance sheets of prior periods no longer carry the same meaning (not that they represented reality in the first place) and trying to reconcile the value of assets and giving recognition to liabilities going into the crisis is the old apples and oranges exercise . In other words FASB accounting principles used for placing values on potential investments are a complete fraud and failure.

    Of course, Wall Street executive bonuses, as well as the power of leverage depend on treating valuations provided by these accounting frauds as some kind of representation of true value. When the global markets completely fall apart we will be asking the same question, “where did all of it go?” Truth is, it’s all illusionary wealth Wall Street generates with electronic debits and credits, and uses to trade and control the real wealth of the world’s economy.

  18. Anon

    2nd hand anecdote: a friend of a friend worked at a Lehman options desk. Every quarter-end (and especially at bonus time), they would gussy up their books to show higher “revenue”. How would they do this? By tweaking the inputs into the options pricing model (such as volatility), or even by simply fiddling with the options parameters themselves: changing strike prices, expiration dates, that sort of thing. Lehman’s risk controls simply did not pick up on this sort of thing. Some of these gains were given back at the start of the next quarter, but some were not. How did they keep hiding these piled-up fictional gains, quarter after quarter? By continually growing the books through ever-rising leverage. (Ponzi, anyone?).

    This is one small desk, far removed from the CDO and RE behemoths, trading relatively liquid and transparent instruments. Sum this up across dozens of desks in myriad markets over many years, and you start seeing where some of that $50-100B went: in the inflated revenues (and profits and compensation) over multiple years, backstopped by bogus assets on a fictionalized balance sheet.

    1. Tar, etc.

      You are making this sound like garden-variety fraud. The Bigs weren’t watching while the desks pumped assets to plump up their bonuses. The balance sheet was “fictionalized”. If these assets stayed within the company, then their collapse would have been no problem. But the fictionalized assets were sold, and therefore became a liability that tax payers had to cover to protect innocent buyers of the so-called toxic assets. If they were sold, someone was paid, and not just the traders’ bonuses. The money went somewhere.

  19. Jay

    Hi I work in the industry and I think it’s important to note that SEC Chief Accountant James Kroeker said 2 weeks ago that they hadn’t found evidence of balance sheet management being widespread (http://www.webcpa.com/debits_credits/Finance-Execs-Fret-over-Accounting-Standards-Overload-54317-1.html) and now less than a week later the Wall Street Journal (http://online.wsj.com/article/SB10001424052748704792104575264731572977378.html?mod=WSJ_Markets_LEFTTopNews) is reporting that Bank of America Corp. and Citigroup Inc. used balance sheet management, including the use of repo agreements. The SEC also asked 19 other firms to clarify its usage of balance sheet management practices. It is clear that the SEC is trying to marginalize a small number of firms in order to avoid criticism of failure to cover balance sheet management in the past.

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