In a stunning expose, Anton Valukas, the court appointed investigator charged with probing the Lehman Brothers collapse, revealed that the investment bank had about $39 billion in encumbered cash.  This represented almost all of its $41 billion cash reserves.  The $39 billion was encumbered to a host of lenders that included Citigroup, JPMorgan Chase and Co and Bank of America Corp.

After the collapse of Bear Sterns Co, Lehman began to consider obligatory deposits and collaterals pledged to banks as cash, using these amounts in their talks with analysts and the authorities, many of whom were misled into believing Lehman was more liquid than it actually was.  One such party was Buckingham Research Group, who only 2 days before Lehman’s collapse on September 15, 2008 stated in their report that “Lehman remains well positioned in a ‘run on the bank scenario’” due to its perceived buffer of $42 billion to meet its demand for cash.  In reality only about $2 billion of this amount was readily available.

Valukas’ report states that there are possible grounds for taking Lehman officials to court for causing the company to file erroneous financial reports that clearly misrepresented the risks behind the company at that time.

Another area of misrepresentation was Lehman’s accounting methods that could have misled investors.  One example was the transactions that made $50 billion disappear from the books within half a year.  Another example was the company’s method of valuing real estate investments that avoided write-downs but instead focused on a project’s future prospects.

At the time of its bankruptcy filing, Lehman was the nation’s fourth-largest investment bank with estimated debts of $613 billion.  This included short term agreements to repurchase assets of $159 billion that made up almost 26% of total debts.

Lehman started their practice of using encumbered assets to inflate their cash in June 2008 when Citigroup required them to make a $2 billion deposit against trades that Citi was settling and clearing for Lehman.  About a week later, when JPMorgan requested $5 billion in the form of securities as part of revised margin requirements, Lehman did the same thing.  As time went on, Lehman continued to consider these amounts as liquid assets, knowing full well that the securities were pledged as collateral to JPMorgan and that a withdrawal of their deposit with Citigroup would jeopardize Citi’s willingness to settle and clear trades for them.

In August of 2008, the pattern continued when Lehman deposited $500 million as collaterl in the Bank of America to secure its daytime exposures on trades and again counted this as part of its cash pool “despite the fact that the collateral was subject to a security interest, was returnable to Lehman only on three days’ notice and was placed to ensure that Bank of America would continue its clearing operations,” according to the Valukas report.

Likewise, Lehman deposited more than $800 million with HSBC Holdings Plc and an undisclosed amount with JPMorgan in 2 accounts, again counting these amounts as readily available cash.

All these activities went unnoticed by the US Securities and Exchange Commission, the primary watchdog of the industry until the day before Lehman’s bankruptcy on September 15, 2008.  Lehman collapsed when its lenders pulled back making it the largest US bankruptcy ever.