What Was Repo 105?
Repo 105 was once a type of loophole in accounting for repurchase (repo) transactions that the now-extinguished Lehman Brothers exploited in an attempt to cover true amounts of leverage throughout its cases of trouble throughout the 2007-2008 financial crisis. In this repurchase agreement, since up-to-the-minute to close the loophole, a company would possibly classify a short lived loan as a sale and because of this truth use the cash proceeds from the “sale” to scale back its liabilities.
Key Takeaways
- Repo 105 was once an accounting loophole that allowed companies to hide true amounts of leverage.
- Repo 105 was once a repurchase agreement that a company used to reach price range by way of transient loans which may well be backed by means of collateral.Â
- Underneath Repo 105, if a company had the ability to repurchase the valuables, it was once considered a financing transaction and if it did not, it is usually a sale.Â
- Lehman Brothers used the loophole to hide the fact that it was once extraordinarily leveraged throughout the financial crisis.Â
- Specifically, Lehman claimed it gave up environment friendly regulate because it won best possible $100 for every $105 in posted collateral (due to this fact the “105”).Â
Figuring out Repo 105
Throughout the repo market, an organization can achieve get right to use to further price range of various firms for short categories, typically in one day, in exchange for collateral. The corporate that borrows the price range promises to pay once more the transient loan with a small amount of passion; the collateral in most cases on no account changes arms. That’s what shall we in firms to file the incoming cash as a sale—the collateral is assumed to have been “introduced off” and acquired once more later.
Lehman Brothers and Repo 105
Repo 105 made headlines following the collapse of Lehman Brothers. It was once reported that Lehman grasped for this accounting maneuver to pay down $50 billion in liabilities to scale back leverage on their steadiness sheet.Â
Technically, in line with the repo rule as written then, and to the stretched imagination of CFO Erin Callan and her underlings, their Repo 105 transactions allowed the recognition of product sales instead of borrowings, saved the borrowings off the steadiness sheet and did not require disclosure of the debt obligations.Â
Actually, given the site at the time, they were not professional in observe. Underneath the rule that existed, a repo may also be reported as a sale or financing, depending on whether or not or no longer a company retained environment friendly regulate over the collateralized assets for the transient loan. If a company had the ability to repurchase the valuables, it is usually a financing transaction; if it did not, it is usually a sale.Â
Throughout the Repo 105 transactions, Lehman claimed it gave up environment friendly regulate because it won best possible $100 for every $105 in posted collateral (due to this fact the “105”). Thus, the investment monetary establishment stated, they’d been sale transactions that generated proceeds for leverage support.
Explicit Problems
Having learned a treasured lesson about how Wall Facet highway will be capable to abuse an accounting rule, the Financial Accounting Necessities Board (FASB) issued ASU No. 2011-03, “Transfers and Servicing (Matter 860): Reconsideration of Environment friendly Control for Repurchase Agreements.”Â
The rule of thumb has been stepped ahead upon, the FASB mentioned in a press release, “by means of eliminating consideration of the transferor’s talent to satisfy its contractual rights and obligations from the factors in understanding environment friendly regulate.”
