Back in early summer, a friend of mine who works used to work at Lehman as an analyst told me about this New York Magazine article on David Einhorn. She said all her coworkers anticipated its publication. I wonder what they think of David Einhorn now. Einhorn began shorting Lehman’s stock last May when he uncovered discrepancies between what finances Lehman reported to the government and what Lehman discussed about those filings during a conference call announcing them. When Lehman’s CFO refused to clarify the discrepancies in a phone call, Eihorn decided to use the Ira W. Sohn Investment Research Conference as a platform to publicly announce his strategy to short Lehman. According to NYMag:
His firm had a short position on Lehman Brothers, [Einhorn] maintained, not only because Lehman had fudged its numbers but because its recklessness had put the financial system as we know it at grave risk. He ended with a call to federal regulators to “guide Lehman toward a recapitalization and recognition of its losses—hopefully before federal taxpayer assistance is required.”
We can now rest assured federal regulators didn’t heed his advice. Anyway the article continues:
Lehman was taking advantage of a new accounting mechanism that allowed it to book revenue based on the declining value of its own debts. In other words, because of the increasingly risky state of Lehman, loans that other firms had made to Lehman had dropped in value, and under the new accounting, Lehman could count this as a gain.
Lehman is not the only firm that employs this trick, but in Einhorn’s view, it was the least transparent about it. “Morgan Stanley announced their quarter and they did the same thing, although they were incredibly explicit about it. ‘We’re fair-valuing our liabilities, it creates a gain for us, here’s the amount of our gain.’ Lehman wouldn’t even tell you the amount of the gain. This is crazy accounting. I don’t know why they put it in. It means that the day before you go bankrupt is the most profitable day in the history of your company because you’ll say all the debt was worthless. You get to call it revenue. And literally they pay bonuses off this, which drives me nuts.” Einhorn almost sounded like he might be getting mad. But he kept his tone at the level of intense bemusement.
The final list of the origins and causes of this current economic downturn are beyond my ken. But it strikes me as worth noting that it is among the most regulated aspects of the industry that we have seen the most carnage, whereas the relatively unregulated hedge-funds remain quiet, patiently awaiting the outcome atop Mount Olympus in Greenwich, CT. I would go even further. Much has been said recently about the injustice of increasingly exponential returns to highly skilled labor. Many have lamented the salaries of hedge-fund managers. But one thing this current crisis has shown is how, among hedge-funds, the best managers are worth every dollar. Just ask David Einhorn’s clients.