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FRM Part II · FRM Exam Part II · The Failure Mechanics of Dealer Banks

In the Lehman Brothers failure, the firm used Repo 105 transactions. From a liquidity and balance sheet perspective, what was the main effect of these transactions?

Repo 105 let Lehman treat certain repos as sales, removing assets from the balance sheet around quarter-end and using the cash to reduce liabilities. Reported leverage looked lower, but the underlying risk and funding dependence were unchanged because the assets came back when the transactions unwound.

  1. AThey increased the firm's reported liquidity pool by adding unencumbered Treasury securities
  2. BThey temporarily moved assets off the reported balance sheet near quarter-end, lowering reported leverage without changing underlying riskCorrect
  3. CThey converted overnight repo funding into long-term term debt, extending the firm's liability maturity
  4. DThey transferred credit risk of illiquid real estate assets to central counterparties

Explanation

Repo 105 transactions were treated as sales rather than financings, so assets were removed from the balance sheet at quarter-end and the cash used to pay down liabilities, reducing reported net leverage. The economic exposure returned when the repo was unwound. They did not lengthen funding maturity or transfer credit risk.

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