Tuesday, September 16, 2008

Lehman analyst bet the farm and lost

Bruce Harting, managing director and senior stock analyst who specializes in finance companies, savings and loans, and GSEs (government sponsored enterprise, Fannie Mae and Freddie Mac) joined Lehman Brothers in 1996, is/was part of the Institutional Investor magazine’s All-American Research Team, gets 26,800 Google hits (search: Bruce Harting Lehman), and wrote a report that eventually brought down Lehman Brothers.

On July 7, 2008, Mr. Harting released a report to shareholders stating that a new accounting rule could cost Fannie Mae and Freddie Mac $75 billion. The report was based on revisions to the FAS 140 public accounting standard over off-balance sheet accounting. The Financial Accounting Standards Board (FASB) proposed that assets normally considered off balance sheet would be added to bank balance sheets. Fannie Mae’s and Freddie Mac’s loan guarantees ($5.3 trillion), which are currently booked off of their balance sheets, would be counted as liabilities on their balance sheets. Fannie and Freddie would need to raise enough capital to offset the liability of $5.3 trillion in mortgage guarantees. The balance sheets of Fannie Mae and Freddie Mac were already under close scrutiny, and a $75 billion bill would certainly cause the firms to be insolvent.

And so Fannie and Freddie tumbled, but
Lehman tumbled, too
I just don’t understand Bruce Harting’s nor his superiors’ thinking. If your firm is neck-deep in Mortgage Backed Securities (MBS), why would you speculate over the health of the two mortgage giants that underscore the value of the MBS assets themselves? Bruce gets 26,800 Google hits, he has reported extensively on Bloomberg and various finance programs, so he (and his superiors) had to have known that this report would be published immediately.

To be fair, it was Lehman’s extensive holdings of Mortgage Backed Securities that eventually brought it down. However, Mr. Harting certainly contributed. Perhaps he wanted to make a name for himself, perhaps he was watching out for the best interest of the shareholders (unlikely, given that two months later the firm went bankrupt), or perhaps he was just particularly interested in accounting standards that day, but he did contribute to the eventual demise of Lehman Brothers. In the wake of his report, shares of Lehman Brothers tumbled 40% in one week.

Now that Fannie Mae and Freddie Mac have been nationalized and Lehman Brothers is filing for bankruptcy, the FDIC will surely push for more regulation. Yesterday, it released a statement regarding the same FAS 140 accounting standards that were the subject of Bruce Harting’s report:

“The FASB’s proposed amendments would remove the concept of a qualifying special purpose entity (QSPE) from FAS 140. This would require that variable interest entities previously accounted for as QSPEs under FAS 140 be analyzed to determine whether they must be consolidated in accordance with FIN 46(R). The amendment also would revise the criteria for reporting a sale versus a financing.”

The FDIC’s statement is full of accounting jargon that I simply don’t understand, but I do see the term FAS 140 several times. Get ready: The government regulation steam engine is moving.

Please leave comments. Best, Rebecca Wilder


  1. Lehman isn't the only firm using that off balance sheet accounting tactic. There are a bunch of the large firms doing it and it is considered lying out here in the west. I pity their shareholders. I wish reports would center on "greed" as the real reason for this general mess. So many people were/are doing the wrong thing.

  2. This has beena topic of discussion out here at least since June - bad accounting practices and how the companies involved are hiding all this debt.

  3. Rebecca,

    Nice post, however, I am not sure what is the moral of the story. Should analysts cover up for bloated financial institutions?



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