Securitization accounting is “gimmickry”

The Accounting Onion would like Financial Accounting Standards Board Statement 140 to be wiped off the face of the earth. He calls it, “that bric-a-brac of off-balance sheet accounting gimmickry.”

Statement 140 is the ruling in 2000 that established how companies can securitize loans. It laid the groundwork for the robust and highly profitable securitization industry that is now crashing down around us. In securitization, banks pool consumer and business loans, including home loans, and sell asset-backed securities backed by the loans.

Statement 140 lets financial institutions move loans off their books into trusts that then pool the loans and sell securities backed by them. Moving loans into trusts moved them into the world of shadow banking, which is less known and less regulated than conventional banking. It was shadow banking that blew up in 2007 and 2008.

Selected bits from accountant Tom Selling’s Accounting Onion blog of August 11:

Given the checkered history of financial instrument accounting, it is somewhat ironic that the core provision of FAS 140 is deceptively straightforward and even sensible: a transferor may only derecognize a financial asset, or a component of a financial asset, if it has surrendered ‘control’ over it. …
As simple as that sounds, implementation has been complicated for two related reasons. First, a loss-of-control derecognition threshold still allows an entity to have all kinds of continuing interests in a financial asset subsequent to being “transferred.” Second, allowing derecognition, while at the same time allowing the transferor to have certain forms of a continuing interest in transferred financial assets, opens a Pandora’s box of detailed additional criteria for a broad range of specially-defined off-balance sheet financing gimmicks. Naming them is a bit like reciting the FBI’s ten most-wanted list: securitizations (via SPEs and QSPEs), variable interest entities, repurchase agreements, securities lending, transfers of receivables with retained interests, etc. Investors have grown to despise each one of these, as the accounting too often obfuscates important risks that have come back to bite far too many. …

The FASB’s decades-long, quixotic quest to find just the right definition of ‘control’ that will make everybody happy is never going to end well, and it is clearly time to look for a workable solution somewhere else. …

Both the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) concluded back in 2006, before this latest current financial crisis, that FAS 140 was “irretrievably broken.” Now, far too late (as usual), FAS 140 will be modified to eliminate Qualified Special Purpose Entities, and FASB Interpretation Number 46(R) will also be modified to reign in some of the severest known abuses of securitization accounting. But as I hope I have demonstrated in this post, much more can, and should, be done. Otherwise, it’s just a matter of time before some enterprising Ira Fastow-type financial executive or banker will serve us up yet another latest and greatest off-balance sheet vehicle that blows up in our faces.


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