Jonathan Weil was one of the first mainstream journalists to question Enron’s use of mark to market accounting in a September 20, 2000 Wall Street Journal article. The questions Wiel raised had Enron-friendly answers – at the time. In a Bloomberg opinion article Weil analyses the current Lehman problems by looking back at Enron, and this time he’s not quite so rosy about the company. In fact, he seems to have been acquired by short-sellers to shill against Lehman.
He has six lessons for companies:
Lesson No. 1: When a company attacks short-sellers, run.
You didn’t need to know much about Lehman’s financial statements to see it was in trouble. All you had to know was that the fourth-largest U.S. investment bank was jousting in the press with a fund manager named David Einhorn, who had bet against Lehman’s stock and told a bunch of other investors (and journalists) why.
Good management teams embrace criticisms, address them, and move on. Lehman attacked the messenger. “Mr. Einhorn cherry- picks certain specific items from our 10-Q and takes them out of context and distorts them to relay a false impression of the firm’s financial condition, which suits him because of his short position in our stock,” Lehman said last month.
The smart read on that line, it’s now obvious, was that there were cherries to be picked. And for a guy whose compensation last year was $34.4 million, you’d think Lehman’s chief executive officer, Richard Fuld, would have known better.
This is the same strategy once embraced by stock-market flameouts like Overstock.com Inc., MBIA Inc., Biovail Corp. and, yes, Enron Corp. Now you can add Lehman’s name to that list.
First of all, anyone with a grain of interest in the markets understands just how incestuous Wall Street really is, as evidenced here in this piece. I posted earlier this week about an email conversation between Bethany McLean and Patrick Byrne of Overstock.com. In the article I referenced, you see this convoluted relationship:
Bethany McLean wrote a book review of a book by David Einhorn. David Einhorn is a short seller, though he’s often called a “fund manager”. David Einhorn’s wife, Cheryl Strauss-Einhorn, is an editor at Barron’s. As a quoted article by Cheryl Strauss-Einhorn makes clear, Jim Chanosis a favorite source and an luminary in shorting-circles. Jim Chanos was the short seller who told Bethany McLean to look into Enron’s financials. Presently Chanos and McLean are working in tandem to destroy an Australian bank.
Wiel’s mention of Overstock.com seems a little snide in this context. By the way, Lehman is holding tough so the final chapter has yet to be written. But this article is certainly exerting pressure on the stock. The relationship between financial journalists and short sellers should be suspect.
But to address Weil’s premise directly: bollox. Of course a CEO is going to attack those who are attacking his stock. Lehman’s quote that “Mr. Einhorn cherry- picks certain specific items from our 10-Q and takes them out of context and distorts them to relay a false impression of the firm’s financial condition, which suits him because of his short position in our stock,” could pretty much be a defense template. Insert “Mr. Chanos” or “Mr. Grubman” for “Mr. Einhorn”, and you have a perfectly correct, legitimate defense of Enron.
Lesson No. 2: There’s no such thing as an economic hedge.
Linda Richman, the chronically “verklempt” host of Coffee Talk on “Saturday Night Live,” would have loved this one. “Economic hedges are neither economic nor hedges. Discuss,” she might say, if only Mike Myers hadn’t left the show.
Lots of banks have downplayed their writedowns by stressing net figures that include gains on so-called economic hedges, or as Lehman calls them, “economic risk mitigation strategies.” In fact, the only thing these terms tell you is that the company made some bets that don’t qualify as bona fide hedges under the accounting rules. The words mean nothing, because there is no uniform standard.
Witness Lehman’s second-quarter results. The company said its gross writedowns were $3.6 billion. Including hedges, its writedowns were $3.7 billion. In other words, some of the hedges, uh, misbehaved. How’s that for managing risk?
Bollox. I don’t know the details of Lehman’s financials but I do know that economic hedges are real things. Denying this fundamental truth, this basic observation, seems less an attack on Lehman (or Enron) and more an gaping hole in Weil’s financial education.
Lesson No. 3: Don’t eat the Level 3 mystery meat.
As I noted in an April 23 column, Lehman would have shown a loss for the quarter ended Feb. 29, were it not for $695 million of non-cash gains on $9.4 billion of corporate equities that it classified as Level 3 assets.
The designation, which I like to call mark-to-make-believe, means the values included estimates that couldn’t be observed in the marketplace. Lehman didn’t disclose the names of the company or companies where these gains appeared. Meanwhile, the Standard & Poor’s 500 Index fell 10 percent during the same period.
If you had concluded this was a tip-off that Lehman’s earnings power was declining, you were correct.
I’ll hold off on commenting until the next “lesson”.
Lesson No. 4: Gains on declining debt values mean something.
The Financial Accounting Standards Board has taken a lot of flack over new rules that let companies book earnings based on declines in their own creditworthiness. And there’s much to be criticized, namely the wide latitude the rulemakers gave companies to pick and choose which balance-sheet items they want to measure at fair value, and which ones they don’t.
That said, from the start of fiscal 2007 through Feb. 29 of this year, Lehman posted $1.9 billion in gains from writing down the value of its own debt. It reported $3.3 billion in net asset writedowns during the same period.
Now look at Citigroup Inc. Since Jan. 1, 2007, it has booked $1.7 billion in gains on its own debt. Yet its asset writedowns were $37.3 billion.
While there’s no way for outsiders to know what the right proportion at a given company should be, there’s a message in those gains: When the fair value of a company’s debt slips, the market is telling you the company’s assets must be deteriorating, too. And if you had guessed from the ratio at Lehman that its asset values had further to fall, you wound up with the right answer.
WTF? Seriously: WTF? This article is full of allegations about a company – and by Weil’s own admission he can’t know what was really going on. Again, I do not have an opinion on Lehman, but I feel protective of any company being attacked like this by some journalist with an axe to grind.
Lesson No. 5: Beware CEOs saying “the worst is behind us.”
Fuld uttered those words at Lehman’s annual shareholder meeting in April. (What was he thinking?!?)
It wasn’t then. And he doesn’t know any better than you do now. Some folks just have to learn things the hard way.
As of this moment, Lehman is still alive. It’s hurting, but it’s alive. And Weil is writing about the company as if its ending is already a forgone conclusion. As if it’s impossible that “the worst” really could be behind a company. Remember Bear Stearns? It had a “worst” moment and recovered, albeit with the help of the federal government.
Weil’s commentary is nothing as much as a hit piece on an already floundering company. It’s a shame – he showed a lot of promise back in the day.
