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In 2010, Richard Fuld, the former CEO of Lehman Brothers, told a congressional committee that he had "absolutely no recollection whatsoever of hearing anything" about Repo 105 at the time of the transactions. Lehman's demise, he claimed, was caused by "uncontrollable market forces" and the U.S. government's unwillingness to rescue the firm. Of course, Henry Paulson, the U.S. Treasury Secretary in 2008, had tried in vain to get Fuld to accept a buyer offering a reasonable price; Fuld had been holding out for more in spite of the financial condition of Lehman. It is stunning that a man who had been allowed to reach such a pristine and lofty office in the business world would not even permit himself to acknowledge any contributory role in the downfall of the organization he had run. Such an attitude alone seems worthy of a prison sentence (and the return of his salary and bonuses); how he and his "team" had manipulated the books to make the bank look wealthier than it was would seem to make such a sentence inevitable.

However, as of March 15, 2011, no high-profile executives involved in the finacial crisis of 2008 had been successfully prosecuted. In Feburary of the same year, for example, a federal criminal investigation of former Countrywide Financial Corp. Chief Executive Angelo Mozilo had been, according to The New York Times, "closed without charges." Regarding "the battered real-estate portfolio and an accounting move known as Repo 105," the paper reported that SEC officials were growing more worried in the early months of 2011 that "they could lose a court battle if they bring civil charges that allege Lehman investors were duped by company executives. The key stumbling block: The accounting move, while controversial, isn't necessarily illegal." This is an extremely important point, for it means that FASB, the non-profit quasi-regulatory body that promulgates generally accepted accounting principles (GAAP) in the United States, is too permissive--too accommodating of how executives of publicly-held corporations want to value assets and liabilities.

Punctum saliens, the means by which accounting standards are determined is too susceptible to influence from CPA firms and their clients, the public corporations being audited.  The structural conflict of interest existing between the "independent" auditors and their clients is magnified to the extent that either of the two parties have inordinate influence on FASB.  Even if a government agency such as the SEC were to set the regulations, there would still be the risk that the accounting firms and/or public corporations could gain leverage over the regulators, in what is called regulatory capture. The root problem behind both allowing the conflict of interest and being too accommodating in terms of GAAP is that Americans, and thus the values in American culture, are too conducive to business--meaning not sufficiently realistic concerning the possibility of greed and any resulting harm. An examination of why the Lehman executives could manipulate their books unfairly and yet legally points to this proclivity manifested through a too-flawed and friendly accounting regulatory system.

The New York Times reports that in March of the same year in which Richard Fuld testified before Congress to disavow any responsibility in the failure of the bank he had run, "the Repo 105 transactions were condemned by court-appointed examiner Anton R. Valukas, who said in a report that they enabled Lehman to 'paint a misleading picture of its financial condition.' . . . In the transactions, Lehman swapped fixed-income assets for cash shortly before the securities firm reported quarterly results, promising to buy back the securities later. The cash was used to pay down the company's debts. Emails sent by executives at the company referred to Repo 105 as a 'drug' and 'basically window dressing.'" Valukas concluded there were "colorable," or credible, legal claims against Ernst & Young, Fuld and former Lehman finance chiefs Ian Lowitt, Erin Callan and Christopher O'Meara. Indeed, when he was the Attorney General of New York, Andrew Cuomo criticized the Repo 105 transactions as a "house-of-cards business model, designed to hide billions in liabilities in the years before Lehman collapsed."  The implication is that Fuld and his subordinate managers had committed fraud.

Even so, Ernst & Young "had concluded that the accounting in the Repo 105 transactions was acceptable."  In a statement, Ernst & Young "said," we stand "behind our work on the Lehman audit and our opinion that Lehman's financial statements were fairly stated in accordance with the U.S. accounting standards that existed at the time." (italics added) Fairness, in other words, depends solely on whether the books of a company are in line with the accounting standards, rather than on whether the values recorded on the books reflect the values of the underlying assets and liabilities. In terms of the repos at Lehman, The New York Times reports that SEC officials generally concluded that "the transactions were consistent with accounting standards." Successfully prosecuting former Lehman execcutives for making misleading statements about the bank's financial condition is an uphill battle, according to the paper, because the executives relied on legal and accounting opinions. Furthermore, in his report, Valukas wrote that he didn't find "sufficient evidence to support a colorable claim for breach of fiduciary duty in connection with any of Lehman's valuations." Also, SEC officials were not "convinced that Lehman shareholders suffered material harm, since executives were trading one type of highly liquid asset for another." However, the apparently lower debt levels might have influenced existing and potential investors in their decision-making regarding their level of exposure from investing in Lehman. In other words, their risk was being deliberately understated by Lehman's management. Even if particular investors were not actually harmed, showing an apparent lower risk than would be the case without the repos (and cost valuations on the real estate investments) was not in the investors' interest. Moreover, it just isn't fair, even if it is legal because it is allowed by GAAP. The problem, in other words, extends from Fuld and his sycophants at Lehman to the FASB.

The wrench in the works with my thesis is the fact that there are indeed different ways in which an asset or liability can be valued fairly. There are different viable assumptions, for example, regarding whether an asset should be valued at cost or market. Each assumption has a downside. Showing a real estate investment at cost, for instance, has the downside that the market-value of the asset, if significantly lower, is not shown. That is, the transactions-value of the asset at the time is ignored. Even if the firm intends to hold the asset, the lower market value would determine what the firm could do with that asset in covering for any needed debt payments. On the other hand, if market values fluctuate substantially, changes in an asset's value may not make much difference to the underlying value of the asset, and thus to the firm, especially if the firm intends to hold the asset long term.  To the extent that speculators can artificially push up or short an asset's market price, the latter does not reflect the underlying, or fundamental, value of the asset or even the real supply and demand (e.g., oil price hikes in the wake of the Libyan disruptions in 2011). Unfortunately, the companies being regulated and the accounting firms they hire can use such authentic debates to open GAAP up wider than a sloppy whore so they can have their way with her in order to look better than they are. That such selfishness, deceitfulness and greed can be accommodated by GAAP, and thus the FASB, and ultimately the American electorates, is the real problem, and unfortunately there is not an easy solution because the basic problem lies in values and assumptions held by a population.

As useful as flexibility is in accommodating different assumptions and plans regarding assets and liabilities, the refusal of FASB to fortify its sanctioned accounting methods with conditions so investors are not misled--a refusal that I contend is from inordinate influence from the regulated and their public accountants--means that managers running publicly-held companies like Lehman Brothers are enabled to do practically-speaking whatever they want to show the public (and the owners) only the asset values and debt levels that they want. Allowing only cost to value real estate, for instance, could be conditioned not on whether the firm intends to hold the asset (a subjective matter that a manager could manipulate and even falsify), but rather on the extent of difference in percentage terms between the market value and cost. An accounting breed of relativism unchecked allows for and enables greed. Lest we want to succumb to such decadence, fairly stated ought not be tied to conforms to GAAP if the latter is too tolerant. The regulated will always prefer relativism in regulation.  Even if GAAP is tightened, fairly stated ought not to be determined solely in terms of those standards. Additionally, CPA firms ought to be on the look out for fraud or misleading practices even if they are allowed by the FASB's standards.  The latter are means rather than ends in themselves. According to Kant, beings of a rational nature must be treated as ends in themselves (as well as means). GAAP are not rational beings.

Beyond changes in GAAP and what CPA firms are charged to look at, the friendliness of the FASB to the business world, or at the very least the extent of the organization's accommodation, should convince the American people and government officials that more government regulatory involvement is warranted. While some government regulators could come from industry to contribute their technical knowledge, they should be checked by superiors who have a healthy skepticism of business and a salient regard, or value, for the public interest. Ultimately, it is up to the American people, operating through our elected officials and the related governmental agencies, to stand up to the temptation to have regulation esssentially by the regulatees. However, this requires esteeming values that are sufficiently realistic concerning the role that greed and selfishness can play in those of us who run the world of business. Power as well as money can be intoxicating, especially in high doses. Lest the value of economic liberty blind us to this subterranean all-too-human propensity, we as a society could pay more attention to the societal blind spot of structural or institutional conflicts of interest implicit in the very design of some of our most important regulatory systems.
Source: http://online.wsj.com/article/SB10001424052748703597804576194871565429108.html

Click to add a Comment or Question (or View Posted Comments) on business ethics at Lehman Brothers.


On greed, see related essay, "Godliness and Greed": http://thewordenreport.blogspot.com/2011/02/godliness-greed-how-effective-is.html

On Lehman's corporate governance, see: http://thewordenreport.blogspot.com/2011/02/godliness-greed-how-effective-is.html

Talking with a senior citizen about the 2010 midterm election, I was intrigued by her agreement with me; my views are perhaps too unusual for widespread agreement.  We were both just shaking our heads on how the local republican US House candidate won at 63 or 65% even though so many people disapprove of Congress.  I looked at the NYT map of the US House districts and realized that many incumbents won in spite of the fact that only something like 12% of Americans approve of the job Congress has been doing. Strangely, many more Americans are voting for their incumbents.  odd. Perhaps the voters are simply creatures of habit. The senior citizen and I were shaking our heads not only because of this discordance, but also because local unemployment is so high and yet the anti-government (anti-unemployment-compensation) party candidate won the US House seat so handily.  Moreover, we were amazed that people have apparently ignored the need for more or better regulation—a need evinced by the financial crisis of 2008 and the BP explosion of 2010.

Voting for the de-regulation party (presumably because of the “out of control spending”…even as Bush spent $1 tillion of borrowed money on his wars and $800 billion on the bank bailout).  Obama’s only real spending was $800 billion on economic stimulus (which admittedly should have been for a CCC jobs program rather than paid to infrastructure contractor companies). I contend that Obama should have cut checks to the unemployed and to home-owners under water and in foreclosure (preventing foreclosures would have been good not only for the banks’ toxic balance sheets, but also for the supply/demand of the housing market!), rather than to infrastructure contracting companies and banks. Even so, Obama’s weakness does not justify voting for the de-regulation party. Voters should have been primarily oriented to the big picture … the failure of extant government regulation … and thus the need to strengthen regulation rather than to get rid of regulation … as evinced by the financial crisis and the BP explosion. The complicity of private enterprise in these two catastrophies was utterly lost on the voters who supported the Republican surge in 2010.  They may well have had other reasons, including how Obama spent the bailout/stimulus money. However, I contend that those voters missed the big picture: the big banks and big oil companies (as well as the health insurance companies) need to be regulated more, not less.

The fact that we almost lost our financial system and the Gulf of Mexico makes “But I’ve always voted Republican” not good enough.  Not good enough at all.  I suppose it is the politics/election/voting as usual that stands out for me as particularly odious this time around. I am appealing not for the Democratic Party (as its leaders have sold out to the banks, oil companies, and defense contractors), but, rather, to the public good.  To be sure, $13 trillion in US Government debt is itself a systemic risk evincing a severe imbalance in the American system of governance. However, voting to cut spending (after $1.3 trillion has already been spent on the wars—focusing on the unemployed) while urging tax cuts for the rich demonstrates a partial (or inconsistent) approach to taking the deficit seriously.  Given the size of the deficit in 2010, both spending cuts (including the military!) and tax increases are necessary.  The competing desire not to depress the economy mitigates both spending cuts and tax increases.  Even given the need to juggle these competing objectives (i.e., reducing the deficit and not putting a drag on the economy), I contend that the primary concern ought have been what lessons we could and should have drawn from the financial crisis of 2008 and the BP explosion in 2010—in other words, that business is more “the problem” than is government. I submit that the primary lesson should have been that we ought not to rely so much on private companies and the market mechanism—that government regulation is both currently flawed and necessary.  A de-regulation party is not interested in strengthening regulation or its enforcement because business wants less regulation.

In the wake of the financial crisis of 2008 and the near loss of the Gulf of Mexico in 2010, electoral politics as usual look banal in this context; even the perennial “tax and spend” debate looked small in 2010 relative to the near misses we had experienced in the previous two years.  Obama’s agenda was a mere speck in comparison to the near catastrophies we had witnessed.  The primary lesson I draw from the midterm elections of 2010 is that too many voters were still “voting as usual,” like cows chewing the cud.  The senior citizen with whom I spoke said, “Well, the fact that people have always voted a certain way … well, that’s just not good enough now.” I replied, “I completely agree.”

The Founding Fathers who fashioned the US Constitution believed that a virtuous and educated electorate is vital for a republic to be sustained.  This requirement is perhaps nowhere more salient than in how the voters react to systemic risk occasioned by near-catastrophies. Put another way, had it not been for government, the near-catastrophies would most likely have become full-fledged catastrophies (especially in the case of the financial system in September, 2008).  After that crisis, Alan Greenspan admitted in Congressional testimony that he had realized that his laissez-faire market philosophy contained a fatal flaw (involving volitility).  It is sad indeed that the de-regulation, big-business party surged less than two years after Greenspan’s comment.  Given the crisis of September, 2008, and the ensuring recession, the 2010 midterm elections should have been like the 1932 election rather than the 1994 election. That it was not indicates to me that lessons were not learned.  Sadly, at least in the American context, averting catastrophe is not sufficient for lessons to be learned.  Perhaps it is only human nature to act on minor issues and overlook the big picture; electoral campaigns are certainly oriented this way. Even so, voting for a de-regulation and big-business party simply does not make sense just months after BP and Halliburton cut corners to save time and money at the expense of safety (discounting the destruction of the Gulf) and just over a year after big banks created fraudulent mortgages with hidden ARM rate increases and went on to sell securities and allowing some of them to be rated AAA. I do not believe that memories can be even so short. Perhaps big business has manipulated the American campaigns without us realizing it. If so, we are complicit nonetheless for not recognizing it and just saying no.