Tuesday, March 30, 2010

The latest speculative disaster: Box Office Futures!

Amazingly, as if the current $1,500,000,000,000,000 global derivatives “market” is not adequately irresponsible, fanciful, and insulting in itself, we are actually standing on the cusp of removing yet more blocks from the bottom of this economic Jenga tower, thanks to an another brilliant idea by the ever-creative fiatists. This one is not a bundle of toxic subprime mortgage-pieces magically granted AAA status; not a handful of Greek paper; not a bucket of Duetsche Banks’ gold ETN’s. No, those are soooo 2007! Now way--get with the program, man, it’s time for the latest, greatest, sure-fire investment that’s gonna make us all of gazillion dollars: its time for Box office futures!

I kid you not. Very soon—soon as in weeks--the CFTC will likely grant a major investment bank the authority to host a futures exchange market for trading contracts based on domestic box office revenue. The firm is
Cantor Fitzgerald, an established Wall Street player in debt/equity brokerage, investment banking, securities dealings, and especially market data. You can bet they have a carbon trading arm: CantoCO2e. And now they want a Hollywood scheme.

The prototype for the deal has been around now for over decade, though it has been a roller coaster decade.
Max Keiser (yeah, that Max Keiser who you hear on Alex Jones and see in Fall of the Republic!) and some partners invented a virtual, web-based box office futures trading platform in the late 1990's with the goal of predicting box office performance. The timing on it was perfect, considering the .com bubble at the time, but it was only a virtual system--no real money, only "Hollywood dollars." They called it the Hollywood Stock Exchange (HSX). At its peak, Keiser was on television predicting movie performances, and producers were getting quite upset about these hot-shots telling them (and the audience) what a particular movie was going to gross before it was even released. But the platform proved an excellent predictor of revenue, perhaps due to its huge, enthusiatic base. At its peak in 1999, the HSX had investors and companies lining up with millions to get a piece of it, and an IPO was the goal. The .com crash quickly quelled that goal, and the company lost nearly all of its paper value. Enter Cantor Fitzgerald. In 2001, Cantor bought the company and has been operating it since.

Cantor's virtual
Hollywood Stock Exchange (HSX) has been up for almost a decade now. Since its inception, HSX has had millions of traders, and has just under 1 million today. That's a lot of experienced virtual traders who might be willing to start risking real money. As it stands now, the HSX is still a vitual money trading scheme where people can join up and get a free 2 million "Hollywood dollars" with which to trade. You can apparently win prizes, but again, no real money changes hands. Cantor holds patents on the exchange and exchange processes, which they probably acquired from Keiser’s company when they bought the exchange. Personally, I had never heard of this exchange, but I don't, exactly follow movies. I follow commodities. I know about the ICE Futures for Tropical Winds, but I wasn't watching the movie futures. So this is my crash course, because the virtual HSX is about to go real Cantor Exchange.

Cantor Fitzgerald is expecting the CFTC the okay their creation by April 20. It will be called the "Domestic Box Office Receipt Movie Futures" contract, or DBOR (DBOR--will this be pronounced as de-bore? As in, to make us not "bored" anymore? Is that a Fruedian slip or what?!). It will be traded on the Cantor Exchange (CX). Click here for the
contract rules book (pdf) that Cantor submitted to CFTC. Below are some choice parts:

"Chapter II-1-(a) Pursuant to each DBOR Contract entered into through the Exchange, the seller agrees to sell to the purchaser, and the purchaser agrees to purchase from the seller, a specified portion of an identified film title’s DBOR, as measured by the sum of the daily box office receipts in the U.S. and Canada, in accordance with these Rules, during the first four weeks after the film title’s initial release (such contract a “DBOR Contract”).

"Chapter II-2-The unit size of each DBOR Contract will be the aggregate DBOR during the Final Settlement Period for the relevant underlying film title, divided by the contract divisor of 1,000,000. Therefore, each DBOR Contract will represent 1/1,000,000th of the aggregate DBOR during the Final Settlement Period; a $1,000,000 change in revenues will cause a $1.00 change in the value of a Contract. The method of determining the Final Settlement Price is further described in Rule IV-9(a)."

"Chapter II-6-(c) Entities that are engaged in hedging activities through the use of short positions in DBOR Contracts, and Market Makers, may be granted hedge exemptions that exceed the short side speculative position limits by application to the Exchange; provided, however, that no short side hedge exemptions will be granted that would permit sale of more than 30% of the underlying position on which such hedge exemption is based and provided further that under no circumstances shall any hedge exemption be granted that would permit a Participant to hold a position exceeding 300,000 DBOR Contracts. Commercial entities eligible for short side hedge exemptions include (but are not necessarily limited to) film studios, film funds or other investors in films. Participants that are engaged in hedging activities through the use of long positions in DBOR Contracts, and Market Makers, may be granted hedge exemptions that exceed the long side speculative position limits by application to the Exchange. Any application for hedge exemptions made under this Rule shall include by any information or supporting material prescribed or reasonably requested by the Exchange, and shall include such facts as may be necessary to demonstrate the applicant's need to use DBOR Contracts for hedging purposes."

"Chapter IV-2-(a) The Exchange’s DBOR Contract market (excluding the Pre-Opening Auction) is a continuous (seven days a week, 24 hours each day), first-in first-out, two-way, limit order book, as described in Rule IV-3 below. Orders will be accepted in price/time priority effective 9:30 A.M. on the First Trading Day. Continuous trading of a DBOR Contract in this manner commences immediately following the close of its Pre-Opening Auction at 9:30 A.M. on the First Trading Day and terminates at the End of Trading on the Last Trading Day.

"Chapter IV-6- (b) On each Trading Day, the amount by which the price of a DBOR Contract may increase or decrease is limited to an amount equal to 10% of its prior day’s Settlement Price rounded to the next highest 0.5, which in no event will be less than 2.5, provided that the Exchange shall have the authority, under extraordinary market circumstances, to set daily price limits at different levels if, in the reasonable judgment of the Exchange, such action is warranted for the protection of the market and Participants."

"Chapter IV-12-(a) Subsequent to the commencement of the Pre-Opening Auction with respect to any DBOR Contract, any person in possession of Material Non-Public Information regarding the relevant film title will be prohibited from trading in DBOR Contracts with respect to such title.
(b) Notwithstanding anything to the contrary in these DBOR Contract Rules, the prohibitions on trading described in Rule IV-12(a) will not supersede any applicable prohibitions on fraud and manipulation, whether such prohibitions are prescribed by law, regulation or the Rules of the Exchange or the Rules of the Clearinghouse. The Exchange and the Clearinghouse each retain the right to take any appropriate disciplinary actions against Participants as permitted by the Rules of the Exchange or the Rules of the Clearinghouse, as applicable."

It reads like a regular future contract rule book--except for the fact that it is talking about movie revenues! Yes, I'm sure there will be no such need for "appropriate disciplinary actions against Participants" references in IV-12-(b), because I can't possibly see anybody finding a way to add fraud to this! Oh man, I can't even believe I'm writing about a futures contract on Hollywood box office reciepts--excuse me, I mean DBOR’s--but I am.

As you can see from the contract, much of it is very similar to another other futures contracts. The biggest difference is that you're betting on "movie commodities" that will disappear from trading after a certain period of time. It is very much like the sports betting: the game will be over soon, in other words. The contracts are limited by time. This is a huge difference from something like copper, where trading is building on previous years of data and looking out years to the future.

These DBOR contracts will be announced 6 months in advance of the expected opening day of the film (aka First Trading Day) to start the price discovery process. If there are delays, I guess that's just going to happen. The DBOR futures contracts themselves are one-one-millionth of the buyer's predicted revenue for the film. This
article explains it nicely:

"This exchange will enable the trading of contracts based on a movie's first four weeks of domestic box office sales. Each contract will be priced at one-millionth of the ticket sales estimate. So a contract trades for $100 if it predicts a $100 million box office gross. A prediction of $150 million in ticket sales would trade for $150, etc. If the movie grosses more, the contract increases proportionally, if it comes in short of expectations, the contract drops in value. The speculation will begin six months before a movie opens and will continue through the first four weeks at the box office."

It is that last part that is just flashing "DANGER!!" to me (beside the fact that this is MOVIES!)--six months of "speculation"? That's a very unique thing--there's nothing else in the futures world that just comes into existence, is speculated on for six months, reaches an actual price, and then disappears in four weeks. The speculation part is danger...especially when you combine it with these quotes:

"Richard Jaycobs, president of the Cantor Exchange, says he expects most of the investors will be people already familiar with the vagaries of the film industry, including producers and distributors who want to hedge against their investment in a particular film. However, anyone may invest and he says the "public response to this product has been very positive."" (

“I’ve worked in the futures industry for a long time,” said Richard Jaycobs, the president of Cantor Exchange, who has worked with derivative markets and the cotton exchange. “And none of the products has the overall appeal that this does. This just has a tremendous potential audience.” (
different article)

The last thing we need the public getting into is nationwide, 24-hr movie "DBOR" gambling. And, as it is a futures contract, yes, margins are fine! In fact, if it is like any of the other futures contracts, margin trading will be the base, because the whole investor/speculator attraction of a futures contract is the leverage you can get on swings using margins. DBOR Margins must be secured through a clearinghouse, and cash, Treasuries, or "other non-cash assets that may be approved by the Clearninghouse from time to time" are eligible collateral for against the margin. That last "asset class" is interesting--we can only guess what will end up as "collateral" in these margin accounts if "non-cash assets that may be approved by the Clearinghouse from time to time" is the standard. But hey, anyone who plays this game gets exactly what they deserve!

You can check it all out here, at Cantor's flashy new "Cantor Exchange" (CX) DBOR site:
http://www.cantorexchange.com/. In fact, you can even start practice trading DBOR contracts right now! Yes, to introduce everyone to the joys of blowing your entire paycheck on a Box Office bet, the CX is currently running the "It Pays to Practice!" Promotion. Sign up free and get $10,000 fake dollars to start trading now! Whatever you're left with, Cantor will give you $10 real dollars for every $1000 fake ones you have left after March 31, and you'll be ready to go when the real market opens April 20, where you will promptly lose your rent, phone bill, and electricity bill money! Cantor says: "Now, with Cantor Exchange, you can do what you love to do - trade on box office revenues - for real money!" (Oh, yes, this is just so great...I can't see any problems with this at all...oh my gosh, we are so screwed!)

So come April 20, we will likely have Cantor's CX streaming us live, 24-hr DBOR contract prices. With a CFTC like the one we have, I'd be stunned if they didn't approve it. After all, it will boost our economy, right? Cantor will likely be the first--but they won't likely be the last. In Sept 2009, another company called
Media Derivatives, applied to the CFTC to launch a box office revenues trading platform of their own, called the MDEX. Why have one death-nail when you can have two?

By the way, Cantor was
fined half a million bucks in 1997 by the CFTC, and agreed to an entry that it "aided and abetted fraud and registration violations" in a case where "although Cantor became aware that VFS falsely represented the ownership of a securities trading account VFS had opened in its own name, Cantor allowed the account to be traded in VFS' name. The account was actually owned by a commodity pool, the order finds. The order also finds that Cantor failed to determine the ownership of the VFS account, and failed to obtain the trading authority needed to allow VFS to enter trades in this account. In addition, the order finds that Cantor assisted VFS in obtaining $950,000 to which VFS was not entitled by making wire transfer payments to First Republic Securities, a wholly owned subsidiary of VFS, out of customer funds held in the account at Cantor." That's from the CFTC report--but I'm sure they've spiffied-up their trading practices since then. They've been holding this potato for almost a decade now, and they are ready to go. They want this derivative machine a-movin.'

I don't know what, but Cantor is definitely up to something. Maybe they are tired of masquerading trading as an "investment practice" and they are just outright advertizing it as gambling (which, of course, it is). Earlier this year, Cantor acquired the sports betting parts of three Las Vegas casinos-- Palazzo, the Venetian, and the new M Resort. That's right--sports betting. It is detailed in this
Wall Street Journal article, from which is a quote by a Cantor executive in charge of the operation. He said: "We wanted to turn gamblers into traders." Indeed. They call it Cantor Gaming.

Cantor Gaming has transformed the floors of these betting rooms into models of Wall Street trading floors. They opened bets on everything from win, to spread, to whether or not the quarterback would complete the next pass, or if the field-goal would be good or not. And no, I’m not exaggerating: Cantor allows mid-game bets and even bets on particular plays. The
article mentions the exposure that Cantor Gaming is accepting, which is certainly something worth noting!

"In the back room, Cantor employees plugged in data so a computer could spit out a new set of odds for the next play.
Cantor makes money by charging a small commission on bets. It tries not to take on any risk itself. That means that a bet that Miami is about to score has to be matched with the opposite wager. But frequently, there isn't the same amount of money on the other side of the bet, leaving Cantor exposed.

"Employees scan a risk-management chart—imported from trading platforms—which shows bets that Cantor still hasn't been able to match. When the charts show too much imbalance, Cantor gaming operator Andrew Patterson adjusts the odds to try to persuade gamblers to bet for the other team. "I manage risk," Mr. Patterson said. "If the pricing gets heavy on one side, I can adjust."

"While most Las Vegas sports books discourage professional betters because they expose the house to more risk, Cantor is trying to increase its gambling business to the point where it can use its software to create an efficient market. To do that, it must convince more casinos to sign up with Cantor's service."

Yeah, that's just great. I'm sure you've got it totally under control. Your sports and your movies. And, and in case your wondering, Cantor Fitzgerald itself is NOT publicly traded. It’s a private partnership. And one last thing about Cantor Fitzgerald, their Cantor Exchange, and the Domestic Box Office Revenues future contract: Cantor Fitzgerald, the mastermind behind this all, has been a primary dealer in the Federal Reserve System since
2006. (What do you mean you're not surprised?!)

So, now we just have to sit back and watch the CFTC okay this, and here we go. Witness a bubble, right before our eyes! There has been a lot of media attention about this over the last week that I detected during my searches. I found articles in the WSJ, NYT, CBC, CNBC, Reuters, Vanity Fair, LA Times, Business Wire, and many more. People are going to be hearing about this soon. Those million traders on the HSX surely already know about it. We'll see how much this magic trick drains from the American economy in the name of "financial innovation."

Isn’t this getting old?

Friday, March 12, 2010

Repo 101 on Repo-105's

The recent examiner's report on the Lehman Brothers' bankruptcy has introduced the world to Repo-105's. If you're just a little confused about repos, nevermind repo-105's, here's a fictitious example that might be helpful.

We will use gold because its easy to imagine, and we will use the Bank of Keri (me) and the Banc You (you)! For the record, repo's use securities, not commodities because commodities are too volatile, but I'm just using gold so we can visualize it better (and no, I don't have a Bank and I don't have 10,000 oz of gold!)

The Bank of Keri will be originating the transaction, so it will be a repo from Bank of Keri's perspective. Banc You will be the counterparty, so it will be a reverse-repo from Banc You's perspective.

1.) Bank of Keri has 10,000 oz of gold, and gold is at $1,000/oz. Therefore, Bank of Keri has $10 million "in" gold--but wants cash, for whatever reason. Bank of Keri doesn't want to sell the gold outright, for whatever reason--plus, Bank of Keri needs cash now.

2.) Bank of Keri calls Banc You and says, "Hey there, Banc You, if you want to give me $9,900,000 for this here gold, I will sell it to you, it will become yours, but I'll also agree to buy it all back from you next Tuesday for $10,000,000 cash. Whattaya say?"

3.) Banc You thinks about it, considers the gold "collateral" and the market price and whatnot, and thinks about whether or not Banc You is going to need that $9.9 million between now and Tuesday, and finally decides, "Yeah, that's an easy $10,000, I'll do it."

4.) We agree--Banc You gives Bank of Keri the cash, and Bank of Keri sells Banc You the gold. Bank of Keri signs a contract that I'll buy the gold back--no matter what--next Tuesday for $10 million. Now, Bank of Keri has the cash and Banc You has the gold.

5.) Banc You can go sell that gold, if you want to, because its yours--you bought it. Maybe all your Banc You's people say that gold is surely going to go down between now and Tuesday, so you plan to get the most cash for it right now, and when its lower on Tuesday morning, you'll buy it back for cheaper, and increase your profits off the deal even before I, over at Bank of Keri, have to buy it back from you. Or, maybe your Banc You's people all think that gold is going to go up, and you plan to use it for your own repo deal on Tuesday morning when gold is worth $1,100/oz, and you'll use the same amount of gold as collateral for a $11,000,000 repo as I over at Bank of Keri did for $9.9 million.

6.) Whatever Banc You does, you just need to have it back Tuesday so Bank of Keri can buy it back from you and close the deal. It works nicely for both of us: you at Banc You get $10,000 just for playing, plus whatever plan you have, and I at Bank of Keri get cheaper financing than I would have otherwise been able to get, faster than I would have otherwise been able to get, and don't have to sell my gold.

So now let's flesh this out: why would these banks do this?

Scenario 1: Banc You is happy with the $10,000 off the repo. Banc You takes the gold and puts it in a footlocker. Tuesday comes by, and Bank of Keri comes over and buys it back for $10 million. Banc You makes $10,000, Bank of Keri gets the cheap cash financing. Everyone's happy.

Scenario 2: Banc You wants to make a little more money off this deal. Banc You's people all think gold is going down, so Banc You sells the gold the moment it gets it from Bank of Keri. The gold goes for $1,000--the high for the day--and Banc You pockets $10 million. Gold prices start to slide, and by Tuesday morning, spot is $950. Banc You needs the 10,000 oz to sell to Bank of Keri at noon. You buy it off the market for $9.5 million. You have the gold ready for Bank of Keri to buy back for $10 million--and you have a nice $500,000 profit.

Scenario 3: Just as above, but Banc You's people are wrong. You sell the gold at $1,000 today, and tomorrow you are looking at $1010. By Tuesday, gold is at $1,025. Banc You should not have sold that gold--you have to eat the loss, and buy it back to meet your side of the repo so Bank of Keri can buy it back.

Scenario Lehman Brothers: Bank of Keri (read: Lehman Brothers) did the repo because Bank of Keri knew gold (read: toxic RMBS) was going decline, but it needed to show the $10,000,000 (read: $50 Billion!) as a positive part of its balance sheet Monday morning or else it would be downgraded. Bank of Keri (Lehman) sold the gold (toxic securities)--temporarily--to avoid the mark down. When Bank of Keri buys the gold back from Banc You on Tuesday, it will decrease capital on the balance sheet, but that's okay, because the end-of-the-quarter number-crunching will be over, and Bank of Keri (Lehman) will have another month to figure it out, when it will very likely just repeat the same scheme! Moody's slaps Bank of Keri with a shiny AAA rating, and shareholders know nothing! (Insert Dick Fuld's evil laughter here.)

Now, how many times do you think Banc You is going to have to be approached by Bank of Keri (Lehman) to buy this same gold every month before Banc You figures out what Bank of Keri is up to? And what do you think Banc You is going to do once it figures out what Bank of Keri is up to, hum? Banc You is going to up the ante from repo, to the now famous "repo-105."

Repo-105 is when Banc You (Barclays) says to Bank of Keri (Lehman), "Okay, Bank of Keri, you want to do this again? We'll, we've made some good money off you in the past doing this, but we just realized what this is all about, you see. So, indeed, we can do it again, your deal still sounds good...well, almost. Because actually, what you're going to do for us now is give us not $10 million in gold, but $10,500,000 in gold (100% collateral plus 5%), and we'll give you the same $9,900,000. And come next Tuesday, Bank of Keri, you're gonna buy it back for $10,500,000--come hell or high water. Got it?"

Now Bank of Keri (Lehman) is fronting 105%: it's tying up $10.5 million in gold for $9.9 million in cash, while Banc You is getting 5% overcollateralization on Bank of Keri's promise to buy it back. As you can see, this is a sign something is really bad. Banc You is demanding overcollateralization because:

1.) You know what Bank of Keri is up to, and they know they have a blackmail card, and
2.) You are really, actually taking a risk because Bank of Keri is really, actually in distress.

Under normal circumstances, if Bank of Keri was giving Banc You more collateral, Banc You would at least reduce by rate, as their risk goes down. But not with this, and not with Lehman Brothers. If Bank of Keri was really in straits, and Banc You could see this through analysis of the un-window-dressed balance sheet (as you knew was Bank of Keri was up to), then it also might be a good strategy to consider shorting Bank of Keri at some point. Did Barclay's do this is Lehman? I don't know. But they certainly knew about the repo-105's because they were half the contract.

So that's the short story on repo-105.

Examiner finds Lehman Brothers' dirty little secret: Repo-105

An bombshell report on the Lehman Brothers fiasco released this week demonstrates the level of financial shenanigans--and perhaps fraudulent misrepresentations--taking place behind the doors of 745 Seventh Ave. The report is a court document, prepared by the court-appointed Lehman Brothers bankruptcy examiner, Anton Valukas, as the bankruptcy resolution still winds its way through New York Supreme Court today, some 18-months after bankers were last seen leaving the Lehman headquarters with boxes the day the firm went belly-up on September 15, 2008. Most of those Lehman employees clearing their offices had no clue that the firm was up to--and neither did shareholders until this week's report.

While the examiner does not have any prosecutorial authority, the report is apparently a blueprint for creditors still trying to get their pieces back, and an expose on what the executives at Lehman were up to--including signing off on materially misleading statements, which, the last time I checked, was in violation of Sarbanes-Oaxley. Here's an article from Bloomberg, which is worth reading in full:
Fuld "Negligent" as Lehman Hid Levage, Report Says. If you'd like to read the examiner's entire 2,200 page report for yourself, you can do so here.

Central in the report is the discovery that Lehman Brothers was surreptitiously using a special type of repurchase agreement (repo) known as a "repo 105." Regular repo's are very commonly used by banks, and serve the purpose of allowing a bank to access cash as a low rate in return of exchanging collateral that it cannot sell or does not want to sell, usually yield-bearing collateral.

A crude repo example between two persons could be explained if I need $50,000 liquid cash, but didn't have the liquid cash. Let's say I have, however, $50,000 in a CD that is bearing 5% (back when CD's used to do that). I can't access the $50,000 because I don't want to incur the penalty, and the cheapest rate I can get for short loan is 6%. I devise a repo plan and approach you: I offer you the CD as collateral for an advance of $50,000, agree to let you collect the interest it bears while you own it for a month (about $208), and agree to repurchase the CD from you in one month for $50,010. This means that you'll make $218 virtually risk-free, because you have the CD as collateral if for some reason I don't buy it back. I, on the other hand, am actually saving $32 over what it would have otherwise cost me to borrow $50,000 at 6% for 30-days. That's the basic form of a repo, but for Lehman Brothers, we're not talking $50,000--we're talking $50 Billion. In such huge numbers, a hundredth of a percentage point (aka a "basis point") is a huge difference in financing cost.

Central banks use repo's, commercial banks use repo's, investment banks use repo's-- everybody's using repo's. Repo's have become ever more common and integral in the system, especially since the boom in securitization and other "asset-backed" paper, because this collateral, particularly during the RMBS boom, was both something that banks wanted to hold on to (they didn't want to sell it for cash because the value was increasing), and because the paper behind the collateral was also higher yield-bearing securities. Now, let's compare the basic repo, which is therefore a financing device, to what the examiner discovered in Lehman's hamper--the repo-105.

To put it bluntly, Lehman's repo-105 is a specialized device with a specifically different purpose from the regular repo which, at least in Lehman's case, is used primarily for deceiving regulators, investors, and shareholders by allowing for a $50 Billion quarterly window-dressing charade. The regulators were "lazy" because if the examiner could figure this out, they could have too; additionally, please note that missing from this list is "auditors," because the auditors were actually informed of this action by a whistle-blower,
Matthew Lee, but they didn't want to hear it. Neither did Fuld and the other executives, as they fired Lee for questioning the practice.

You see, like a regular repo, a repo-105 has the repo-seller (Lehman) selling securities to a counterparty (repo-buyer) with the promise from Lehman to buy the same securities back at a set price and set date in the future. The "105" part, however, is the red light: "105" is referring to the fact that the counterparty (repo-buyer) demands not just 100% collateral (or "matching collateral") in return for agreeing to the deal and delivering the cash for the securities upfront, but the counterparty is actually demanding more collateral--ie, 105%--upfront before advancing the cash. Considering our above example of you and me as parties to the CD repo, this might smell a little fishy to you: if you would have demanded 105% collateral, I would have been better off getting the loan from the bank at 6%, right?

Right--so, if Lehman's repo-105 smells fishy to you, it should.

As you can probably see from the example, the only reason a bank would want to engage in a repo-105 is because:
A.) it had few other choices for getting cash, ie, other financing was too expensive; or
B.) it was trying to hide something.

The examiner's report reveals that both were true for Lehman:

1.) Banks were not willing to advance Lehman cash for the collateral it was offering because the collateral--largely backed by RMBS--was losing value by the minute. A 100% collateral match simply wasn't enough, as the counterparty was not only taking risk extending cash to Lehman, but was giving up an instrument--cash--that was actually bearing more yield than the collateral Lehman offered (which were disintegrating RMBS).

2.) Lehman was desperate to make the deals at whatever cost because they were not accounting for them as financing on the balance sheet, but as sales of toxic debt! The examiner's report reveals that the firm was financing up to $50 Billion of toxic debt in a single repo-105, while simultaneously shifting the bad debt "off" the balance sheet by listing it as a sale at quarter end--when it was actually financing that the bank had to cover days later. Lehman was using the repo-105's to hide its turn state of insolvency. If that also smells fishy, you're right again!

So, Lehman managed to "shift" billions off its balance sheet through the use of repo-105 accounting magic by simply writing the repo financing as an asset sale. If you did this--say, wrote off your monthly mortgage payment as a "sale" of the same amount to your checking account--well, then you'd be a multi-billion dollar investment bank, too! Of course, I don't suggest you try it, seeing as it is nonsensical and illegal, but if you'd like more details as to how Lehman did it, read Repo 101 on Repo-105's.

Lehman was using the repo-105 as a financing tool, meaning that they were pledging certain securities on the balance sheet as collateral for a cash advance from a counterparty, with the agreement that Lehman would re-purchase those same securities at a later day for a higher price. The counterparty advanced the cash, and in return made a profit off the repurchase from Lehman at that later date. Again, the reason Lehman had to front more than 100% collateral--105% or more--is because the "collateral" was comprised of increasingly compromised securities that the counterparty recognized as risky. The collateral was also illiquid, as evidenced by the fact that Lehman couldn't outright sell the securities for cash, and so the counterparty then appropriately demanded a risk premium. The next question you might be thinking is, "Okay, so even if the investors and shareholders didn't know that Lehman was engaging in repo-105, surely the counterparties who were demanding that 105% collateral knew--who were these counterparties, and what did they do with that information?"

Good question. Here's your answer: just seven non-US banks: Barclays, Mizuho, UBS, Mitsubishi, Deutsche Bank, KBC and ABN Amro. Why only non-US banks? Simple: Lehman could not get a single American law firm to sign off on the repo-105 "technique" it was utilizing, as they all recognized it as in violation of American reporting rules. Hell bent on using it, Lehman found
London-based law firm Linklaters, who approved the deal according to British law. The first name on that list--UK-based Barclay's--is the very bank that made a killing buying up Lehman Brothers assets in "the deal of the century" after its bankruptcy. And now we learn of Barclay's role in the repo-105, which clearly indicates that the bank knew of Lehman's balance sheet gymnastics and pending insolvency. (But this is fodder for another post all together.)

Other US banks, including
JP Morgan and Citigroup were engaged in regular repo's (not "repo-105's), but they also started demanding more collateral, according to the report. The examiner concludes that these increased collateral demands "had direct impact on Lehman’s liquidity," and that "Lehman’s available liquidity is central to the question of why Lehman failed," which is to be expected for an irresponsible and over-extended firm. Most essential in the report in regards to the repo's is that Valukas reveals Lehman had been using repo-105's for the purpose of window-dressing its balance sheet, and "removing" $50 Billion or more from its liabilities, for at least two quarters before the September 2008 collapse.

Most of the repo-105 business was through Barclays, Mizuho and UBS. Check
this article out. Below is a quote from the examiner's report that is in the article (broken up for easier reading):

"In the 2007 to 2008 period, Lehman’s Repo 105 counterparties were primarily restricted to Mizuho, Barclays, UBS, Mitsubishi, and KBC, though some of these also tapered off their Repo 105 trading in 2008...

"..E-mail from Chaz Gothard, Lehman, to Mark Gavin, Lehman, et al. (Sept. 4, 2007) [LBEX-DOCID 4553246] (“KBC are no longer able to finance our 105 agency trades. . . . This effectively means we only have 3 counterparts with which to transact this business – Mizuho, Barclays & UBS. Whilst they have taken all the paper we’ve thrown at them to date this situation should not be relied upon.”);

"...e-mail from John Feraca, Lehman, to Ian T. Lowitt, Lehman, et al. (Feb. 28, 2008) [LBEX-DOCID 3207903] (reporting Repo 105 trades with “Barclays – $ 3 billion, UBS – $ 6 billion, Mizuho – $ 2 billion”);

"...e-mail from Mark Gavin, Lehman, to Daniel Malone, Lehman, et al. (May 20, 2008) [LBEX-DOCID 736184] (noting in e-mail with subject line “RE: Repo 105 CPS” that “Mizuho - $5bln,” “[n]o longer at the table: Barclays up to $15 bln,” “UBS up to $10 bln,” “Mitsubishi up to $1 bln,” and “KBC up to $2 bln”)..." "

There are many more examples of this kind of funny business in the examiner's 2,200 page report. The fact is, we only know about this surreptitious "financing" because Lehman went bankrupt. We will likely never know which other banks were up to the same deciet and perhaps fraud, because the Federal Reserve has opened up the flood-gates of liquidity and lent taxpayer money to save the skins of dozens of others banks which otherwise deserve to be, and should be, in Lehman's bankrupt place as well.

By the way, the Federal Reserve still refuses to release any information of how much was given to how many banks: we will only know when we get the bill.