Lehman failed for a variety of reasons and the responsibility for the failure is shared by
management, Lehman's high-risk investment bank business model and the failure of government
oversight. However, all of these problems were compounded by the actions of the executives.
Some were simple errors in business judgement, but others were deliberate balance sheet
Lehman's business model rewarded excessive risk-taking and high-leverage. Near the end
Lehman had $700 billion in assets but only $25 billion (about 3.5%) in equity. Furthermore, most
of the assets were long-lived or matured in over a year but liabilities were due in less than a year.
Lehman had to borrow and repay billions of dollars through the "repo" market every day in order
to remain in business. This was considered normal for investment banks, but if counterparties
lost confidence in Lehman's ability to repay, this market would close to the bank and the
business would fail.
Lehman's management did not foresee the depths of the sub-prime residential mortgage crisis,
nor its broad-reaching effects on other markets. Instead they elected to "double-down" their bets,
expecting to make high profits when the market "came back".
Bear Stearns' March 2008 failure revealed the flaws of both the at-that-time-typical investment
bank model as well as the deepening sub-prime crisis. Counterparty confidence in Lehman
began to decline and the executives felt they needed to manipulate their financial statements in
order to halt further erosion. Lehman focused on the leverage ratio (debt-to-equity) and liquidity
as metrics most watched by counterparties and credit rating agencies.
In the second quarter of 2008 Lehman tried to cushion reported losses by claiming improved
leverage and liquidity. What Lehman failed to report was that they had used an accounting trick
(known within Lehman as "Repo 105") to manage their balance sheet. Normal repo transactions
consisted of selling assets with the obligation of repurchase within a few days. Considered a
financing event, these "sold" items stayed on the bank's balance sheet. Repo 105 made use of
an accounting rule where, if the assets sold were valued at more than 105% of cash received,
the transaction could be called a true sale and the assets removed from Lehman's books. $50
billion of assets were removed from the balance sheet in this way, improving their leverage ratio
from 13.9 to 12.1 at the time.
Multiple sources from the time note there was no substance to transaction except to remove
unwanted assets, a significant violation of generally accepted accounting principles in the United

September 12. were aware of Repo 105 and the non-disclosure of its scope. significant portions of the reported amounts were in fact encumbered or otherwise unavailable for use. Lehman's auditors. Repo 105 was not inherently improper. 2 days after reporting $41 billion in liquidity. concealment endorsed by Chief Financial Officer Erin Callan. Repo 105 solely existed to manipulate financial information. Ernst & Young. throughout 2008 Lehman made false claims of having billions of dollars in available cash to repay counterparties when in reality. Instead its demise was the cumulative effect of a number of missteps perpetrated by several individuals and parties. These offenses can be categorized into three acts: Lies told by Chief Executive Officer Richard Fuld. In a written letter in June 2008. Summarized Conclusions While the business decisions that brought about the crisis were largely within the realm of acceptable business judgement. Auditors "Ernst & Young" failed to investigate the allegations and likely failed to meet professional standards So what went wrong? The collapse of Lehman Brothers was not the result of a single lapse in ethical judgment committed by one misguided employee. In the opinion of the Examiner. especially after it successfully withstood so many historical trials. the actions to manipulate financial statements do give rise to "colorable claims". especially against the Richard S. Regarding liquidity. 2008. It would have been nearly impossible for an isolated incident to bring the Wall Street giant to its knees. and negligence on behalf of Ernst & Young. Fuld (CEO) and Erin Callan (CFOs) but also against the auditors. Three Wrongs . Lehman filed for bankruptcy on September 15.States. true available funds totaled only $2 billion. but its use here violated accounting principles that require all legitimate transactions to have a business purpose. Lehman Senior VP Matthew Lee advised the auditors and Audit Committee that he thought Repo 105 was being used improperly. "colorable" is generally meant to mean that sufficient evidence exists to support legal action and possible recovery of losses. The auditors failed to advise the Audit Committee about issues raised by this whistle-blower despite specific requests by the Committee.

As a firm of certified public accountants expected to honor and uphold an industry-wide code of ethics. not unlike many other Wall Street players at the time. Unlike the competitors. Finally. But past scandals involving questionable accounting observances. 3. When the housing marketing began faltering in 2007. This blatant misrepresentation of financial health. and failure to act successfully discredited Ernst & Young on the basis of ethical and industry standards. The real tragedy lies in the lack of ethical behavior of its executives and professional advisors. Ernst & Young may be accused of being responsible for gross negligence and lack of corporate responsibility. What can be improved. A global financial crisis such as that of 2008 may not be prevented from happening again. More than just a paycheck was at risk.1. Instead he proceeded into mortgagebacked security investments. perpetrated through the employment of Repo 105. 2. was Callan’s approval of siphoning assets away from Lehman Brothers accounts and into Hudson Castle. was an attempt to grossly manipulate the bank’s many stakeholders and also clearly indicative of a much bigger problem. the only third party privy to the happenings at Lehman Brothers. They made conscious decisions to deceive and manipulate. a few of whom had the foresight to identify the pending collapse and evaluate possible consequences of mortgage defaults. continuously increasing Lehman Brothers’ asset portfolio to one of unreasonably high risk given market conditions. the phantom subsidiary created for the benefit of its parent company’s balance sheet. Right action up front may sting initially. such as Enron. is how corporations behave. failed to reveal the extensive steps taken by executive leadership to conceal financial problems. Fuld was entrenched in a highly aggressive and leveraged business model. The story of Lehman Brothers’ demise is unfortunate. Wall Street should take note of the case of Lehman Brothers to ensure history does not find a way to repeat itself . Why would such a highly respected organization risk its own reputation and turn a blind eye on behavior that is clearly unethical? Obviously Lehman Brothers was a sizeable (and presumably lucrative) client of the firm. Fuld did not rethink his strategy. transparency and accountability are paramount. have demonstrated firsthand that inaction is as equally reprehensible as direct involvement in the scheme itself. Even more telling is the fact that this technique was used in two consecutive quarters. gross unethical business practices rarely endure in the long term. Ernst & Young. but as history has repeatedly shown. The second ethical lapse. and the consequences proved too dire to preserve the historic investment bank’s existence. which was perhaps the most premeditated and fundamentally wrong. The perennial lesson of the Lehman Brothers case is that no matter how dire the circumstances may appear. in large measure through ethics education. and not just because its collapse meant the end of a Wall Street institution.