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Background

The Enron bankruptcy in 2001 was enabled through the use of fraudulent accounting featuring the use of off
balance sheet entities. Enron engaged in transactions with related entities that had no economic substance but
were designed to create book profits.

The banks followed up in the following years by parking subprime mortgages in off balance sheet entities called
Special Purpose Vehicles (SPVs). When the value of these mortgages was found to be impaired, the fiction of
the SPVs as independent entities collapsed, and the securities landed back on the balance sheets of the banks.
One of the primary purposes behind the use of SPVs was to disguise the level of leverage of the banks.

When Lehman failed in 2008, it was found that excessive leverage was disguised through the abusive use of
repurchase agreements, also called “Window Dressing” transactions. They are designed to make a transaction
appear as a sale of an asset when the substance of the transaction is a loan with the security pledged as
collateral. The seller in actuality retains the risks and rewards of ownership of the asset. Window dressing has
been found to peak at companies at the time financial results are reported publicly.