WSJ Story Shows Repo 105 Was Just the Beginning

An excellent investigation uncovers Wall Street hiding its true debt levels

This is what you call a great piece of enterprise reporting.

The Wall Street Journal this morning has a major story that shows Wall Street banks have been hiding their true debt levels from investors—and everybody else. This raises serious questions about how many banks are using tactics like Lehman Brothers’ Repo 105, the cheat it used to take up to $50 billion off its balance sheet at the end of each quarter so it wouldn’t have to report it to investors.

That’s surely what set the Journal’s Kate Kelly, Tom McGinty, and Dan Fitzpatrick looking through regulatory data to compile this analysis:

A group of 18 banks—which includes Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc.—understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods, the data show. The banks, which publicly release debt data each quarter, then boosted the debt levels in the middle of successive quarters.

It seems like the WSJ leaps to a conclusion here that dilutes its scoop:

That practice, while legal, can give investors a skewed impression of the level of risk that financial firms are taking the vast majority of the time.

And this:

The repo market played a role in recent accusations leveled by an examiner in Lehman’s bankruptcy case. But rather than reducing quarter-end debt, Lehman took steps to hide it.

But we don’t know how—at least from what I can tell from the story—these eighteen banks masked their leverage. Maybe they used legal means and maybe they used arguably fraudulent means like Repo 105. We don’t even have data on the percentage amounts debt declines for specific banks among the eighteen. If it’s an average 42 percent, it’s likely that some banks were higher and some were lower.

The Journal reports that Goldman Sachs (an Audit funder), for instance, said in its annual report that “although its balance sheet can ‘fluctuate,’ asset levels at the ends of quarters are ‘typically not materially different’ from their levels in the midst of the quarter.”

If true, that means somebody else among the other seventeen banks had higher than 42 percent. If untrue, Goldman could be in some big trouble.

John Hempton has already analyzed Bank of America’s balance sheet’s and deduced that it was using something similar to Repo 105.

Appallingly, the Journal’s resident Wall Street bank lackey/columnist Evan Newmark came on its News Hub video program to excuse this stuff, arguing that everybody does it. Really. That’s his defense. I don’t know what value ex-Goldman employee Newmark brings other than to show just how cynical and clueless the Street and its alumni are.

It’s been going on for centuries… Let’s be honest: Who are you trying to protect? Are you trying to protect the sophisticated institutional investors who know exactly what’s going on, who have discussions with the CFOs of the banks throughout the quarter… Are you talking about mom and pop hoping to get their dividend on their shares of Bank of America?

And let’s unpack why this story is so good. First, it shows the journalists’ priorities are in the right place: Pulling thread on the Repo 105 story. I criticized the press for de-emphasizing the story too quickly, so let me praise the Journal here for pushing it to new territory. Second, this story wasn’t just sitting there. It had to be gotten, and that took creativity and resourcefulness. Even Zero Hedge has high praise:

The WSJ has compiled some data that gives us hope about the future of the MSM journalistic model (and makes us blush for not having thought of it first).

The Journal goofs by dropping this story on C1 instead of the front page. I imagine it will have a big impact nevertheless. It’s great work.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.