Accounting Observer > Public Blog - Epilogue: Frank's 140 Request

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Epilogue: Frank's 140 Request

Location: Blogs AAO Weblog (Public)
Posted by: Jack Ciesielski	7/27/2007 4:04 AM
About a month ago, House Financial Services Committee Chairman Barney Frank sent a letter to SEC Chairman Christopher Cox asking for clarification on whether renegotiation of subprime loan terms (before default) would spoil a "sale treatment" on a securitization. The concern is that perhaps lenders have been a bit starchy about helping out borrowers who have turned out to be subprime repayers. The lenders may have been afraid of having too much involvement, beyond the typical servicing of loans, with a supposedly "autopilot" securitization trust - and perhaps having to undo the sale of the loans. That would put assets and obligations back on their balance sheet. On Tuesday, the SEC responded to Representative Frank: no problem. Based on the SEC's request, the FASB held an educational forum on June 22 with about 30 participants. As a result of the forum, the SEC concluded: "There was general agreement among participants at the FASB educational forum that, subject to certain constraints, the ability to restructure mortgages when default is reasonably foreseeable is an activity that is not inconsistent with the notion of continued off-balance sheet accounting treatment...[W]orking out a loan where default is reasonably foreseeable is similar to the discretion required when a loan becomes delinquent or default has occurred. When a loan is delinquent or when default has occurred, FAS 140 implementation guidance provides that a servicer may have discretion in restructuring or working out a loan, subject to certain limitations, without calling into question off-balance sheet treatment for the loan. Currently, the Commission's staff does not believe that additional interpretive guidance is necessary in order to clarify the application of FAS 140 to the contemplated types of securitized mortgage loan work-out activities..." So far, everyone gets what they wanted. Barney Frank gets the exemption he sought. Borrowers might get more slack from lenders who won't be afraid of jeopardizing their sale accounting treatment. The SEC doesn't have to issue any more prescriptive interpretation than this, and the FASB doesn't add anything to its agenda. In deferring to clients on securitization conflicts, auditors can point to Conrad Hewitt's memo as a guideline for not pushing for re-recognition of assets and obligations. Hey - is this principles-based accounting great or what? Are investors worse off because of this decision? Maybe. If you take the strict view that these things never should be accounted for as sales, you'll be unhappy any time sales treatments are preserved. But there is also justification for the view that servicers of the securitizations can have some latitude in working out these arrangements - the question is how much of that latitude gets back into really managing the assets once again, and that's something of a facts-and-circumstances kind of judgment to make. Where the damage might really be done to investors: if there are no consistent consequences for accounting with mediocre accountability (contorting the idea of "ongoing activity" to fit into a pattern that won't ruin sale treatment), then there's no incentive for issuers to stop making loans to poor credits that they package into securities, fob off on someone else, and not have to re-recognize when the underlying loans meet the wall. Weak accounting reinforces weak lending behavior. Renegotiating the already-bad loans out there might just be like the little Dutch boy plugging the leaky dike with his finger. It's not likely that it will end the subprime problems. So why keep up the facade in the accounting?

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