In the years leading up to its collapse, Lehman Brothers nearly doubled its risk and took a scattershot approach to valuing its assets, according to an oversight report released Thursday. The investment bank didn't break the law by doing any of this.
And there's no reason to think it couldn't happen again somewhere else.
The report, issued by the Center for Policy and Research at Seton Hall University Law School, is at once an indictment of Lehman Brothers' business practices in the period immediately preceding the financial crisis and an examination of a system that could find no legal reason to charge Lehman with misconduct, despite the bank's key role in precipitating a global economic meltdown.
Lehman Brothers, at the time the country's fourth-largest investment bank, collapsed in September 2008 with $613 billion in debt. It was the biggest bankruptcy filing in history and one of the most dramatic moments in a crowded month that saw the sale, seizure or federal takeover of some of America's largest financial institutions.
The Seton Hall report appears just as the dust from Lehman's bankruptcy case is finally beginning to settle. This week, some three years after the initial filing, Lehman received court approval for the final stage of its bankruptcy plan. It will begin paying out $65 billion to creditors in early 2012, and the sale of its assets will likely continue for years after that.
However, the Seton Hall report suggests that none of this is really over.
In addition to spotlighting many questionable choices made by Lehman higher-ups in the past half decade, the Seton Hall report warns that "the legal system that allowed Lehman's failure will permit similar failures in the future because, for the most part, Lehman's actions did not violate the law."
The report combs through a nine-volume account published last year by Anton Valukas, an examiner appointed by the U.S. Bankruptcy Court to probe the collapse of Lehman Brothers.
Valukas' report, which he delivered in March 2010, made headlines at the time for its exploration of Lehman's "Repo 105" rule -- an accounting technique that allowed the bank to move billions of dollars off its balance sheets so that the company would appear to be in better financial condition than it actually was.
There were other tidbits buried in Valukas' 2,200-page report, but not everyone had the time to go digging for them. Now, the Seton Hall document -- compiled after a "careful review" of Valukas' report -- brings to the fore other Valukas findings that have more or less gone unnoticed, according to the Seton Hall researchers.
"What we have here is a story that's important because no one of the examples leaps out as a great dramatic headline," Mark Denbeaux, a law professor at Seton Hall and the lead author of the report, told The Huffington Post. "The significance is only in the accumulation."
Denbeaux and his co-authors identify two major patterns in Lehman's business conduct -- a steady ratcheting up of risk and a consistent misvaluing of assets on the balance sheet -- that the report says worked together to undermine the security of the bank.
For example, Lehman Brothers nearly doubled its degree of risk between December 2006 and January 2008, from $2.3 billion to $4 billion over a series of incremental increases. The Seton Hall report notes that Lehman took on this additional risk -- a 74 percent rise in the space of 13 months -- even while the market was declining and in violation of its own self-imposed risk limits.
The report also finds that Lehman had no consistent method for determining the value of its assets, which ended up increasing the precariousness of the company's position.
Some real estate investments, according to a Lehman vice president quoted in Valukas' report, were valued based on a combination of financial projections and "gut feeling."
Another set of assets, known as collateralized debt obligations -- which played a major role in the acceleration of the financial meltdown -- had their values checked by Lehman's Product Control Group, an internal committee that, according to Valukas, lacked the resources to properly perform its job. One out of every five of the collateralized debt obligations never got price-checked at all.
Some assets were left out of routine stress-test calculations, a decision that the Seton Hall report implies had the effect of increasing Lehman's vulnerability -- because without running these scenarios, the company couldn't know how much money it was actually in a position to lose.
Of these excluded assets, some were stress-tested after they were already on the books and were found to represent as much as $10.9 billion in potential losses -- findings that "were never shared with Lehman's senior management," according to Valukas' report.
For all these irregularities, the Seton Hall report places the most emphasis on the fact that none of Lehman's practices were found illegal in Valukas' assessment, which Denbeaux said sets a disquieting precedent.
"There's no reason to believe he's wrong on the facts," Denbeaux told HuffPost, referring to Valukas. "We don't dispute his factual conclusions."
The concern, Denbeaux added, is that, however ill-advised Lehman's habits of pushing up its risk limits and carelessly valuing its assets, Valukas' report found them to be acceptable from a legal standpoint, meaning they have been effectively legitimized.
"My assumption is that anyone looking at this ... should say something has to be done and the law has to be changed, or we have to be prepared to accept this happening over and over and over again," Denbeaux said.
"Either it's allowed to happen and will continue to happen as lawful conduct," he added, "or we're going to have to change something."
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