Disgraced Bank Execs Sail Off Into the Sunset

There's a good chance, it seems, that no Lehman Brothers executive will be charged with civil or criminal wrongdoing. This after Lehman's bankruptcy examiner found numerous instances of Lehman executives jumping through hoops to mislead shareholders about the true state of the company's balance sheet.

At the center of the mess is an accounting maneuver called Repo 105. It goes like this: Banks often use transactions called repurchase agreements (repos) to fund their balance sheets. In a repo transaction, a bank lends assets to an outside investor in exchange for cash, and promises to repurchase those assets at a set date and slightly higher price. These transactions are typically booked as loans, which is important because they show up as a liability and increases the bank's leverage ratios.

But there's a loophole. These transactions only have to be booked as loans if the assets are worth less than 102% of the loan's value. If the assets are worth more -- say 105% -- it counts as an asset sale, even though the bank is obligated to repurchase the assets at a later date. Bottom line: Lehman was able to make its leverage look far lower than it really was.

Yet as The Wall Street Journal now reports:

SEC officials have grown more worried 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 actually explains something many wonder about the financial crisis: Why haven't any major financial executives been sent to jail? The answer all too often is that what blew the system apart was immoral, unethical, incalculably risky, and intentionally misleading, but, alas, legal.

It's also a reason I've vowed to avoid the common stocks of big financial institutions. Even post financial crisis, there are examples of ridiculous accounting shenanigans at Goldman Sachs (NYSE: GS  ) , Wells Fargo (NYSE: WFC  ) , Citigroup (NYSE: C  ) and Bank of America (NYSE: BAC  ) . All of these examples have a common thread: They blatantly mislead shareholders, but in a perfectly legal way.

To a certain extent, accounting gimmicks are rife among public companies, regardless of industry. Banks, however, consistently take it to a different level.

Got a different take? Share it in the comments section below.

Fool contributor Morgan Housel owns Bank of America preferred stock. The Fool owns shares of Bank of America and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On March 14, 2011, at 4:45 PM, tonyg963 wrote:

    Legal but misleading accounting encourages potential shareholders to purchase stock at a discount?, then articles are published either wholy or partially explaining the accounting behind the numbers. I'm a bit of a skeptic, which makes me wonder what the rest of the story is behind the accounting practices that are described in the article. Why are banks allowed to do it if it is mis-leading and in a company as large as those mentioned in the article, how much does this really affect the overall value of the company's stock price? I doubt it's as significant as the author wants you to believe. There are some pretty savvy investors that are buying truckloads of some of these stocks. Do your homework and be comfortable with your stock pick and never invest more in a company during a time of volatility that you're not prepared to lose.

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