By Gillian Tett of the Financial Times

Anton Valukas’s 2,200 page report on the demise of Lehman Brothers has provoked outrage among many investors and politicians.

Among some senior American and European bankers, however, the main reaction has been a wince – or a groan.
For while the revelations about Lehman’s use of accounting and regulatory tricks might startle many non-bankers, one dark secret that looms over the industry is the type of cross-border games at Lehman were nothing but an (extreme version of what has occurred at many other corporations.

And the darker secret still – one that should cause some politicians to hang their heads – is these games are unlikely to disappear.

For the conditions which gave rise to the type of cross-border arbitrage that Lehman exploited – namely a fragmented global regulatory and accounting regime – do not seem to be on their way out. On the contrary, on current trends this fragmentation may soon increase. And that not only defies common sense, but flies in the face of one of the most basic lessons of the Lehman report.

One of the juiciest details in the report by Mr. Valukas, the court-appointed examiner, is the description of how Lehman used a device dubbed “Repo 105”, a type of repurchasing transaction which allowed the bank to reduce leverage on the public balance sheet.

This was apparently deemed legal by the UK offices of Linklaters, and was thus widely used by Lehman, even though some lawyers question its validity under US law.

What drove Repo 105, in other words, was a type of “forum shopping”. And on the face of it, this situation suggests that there is now an urgent need for global financial leaders to close this type of loophole, by introducing more harmony between accounting rules and banking laws in Europe and the US (or, at the very least, between London and New York).

One year ago, most financial bureaucrats appeared determined to do just that. Most notably, during early 2009 a plethora of committees linked to the Basel group – the global body that unites supervisors and central bankers – were working hard to produce unified banking reforms supposed to prevent the use of tricks such as Repo 105.

Back then, efforts were also underway in the accounting industry to introduce more transatlantic harmony, between the US system (which revolves around generally accepted accounting principles) and that used in Europe (centred on International Financial Reporting Standards).

But in recent months, this drive by western bureaucrats to introduce more global harmony in the financial system has been repeatedly undercut by national politics – with the result that fragmentation, not harmonisation, is becoming the new order of the day.

In the US, for example, the chief accounting body has unilaterally changed the way that American banks account for toxic assets – setting those banks at odds with Europe, yet again. Meanwhile, in the banking world, national politicians have unveiled unilateral measures which have also undermined the Basel initiatives. Just look, for example, at the proposals by Paul Volcker, an adviser to the Obama administration, on proprietary trading, which – yet again – also seem likely to put the US on a different track to Europe.

Now, it is possible that this unilateralism will turn out to be short-lived, and that common sense will eventually triumph; it is also likely that, in the short term, many bankers will be circumspect about exploiting all the existing cross-border loopholes (or those which may soon be created as a result of this unilateralism).

But don’t bet on that restraint lasting for ever; once the current hullabaloo dies down, it is a fair bet that profit-hungry or desperate financiers will start sniffing around again for new areas of regulatory arbitrage.

So, if politicians want to fix the fundamental problems revealed by the Lehman report, it will not be enough to bash the bankers, brainwash them or lock them up; nor will it be enough to simply give the regulators sharper teeth. What is really needed, above all else, is a new drive for harmonisation. Whether that happens, however, is still anyone’s guess.

gillian.tett@ft.com