The "qualified special-purpose entities" (QSPE) — those not unlike Enron-style SPVs in which many leveraged financial institutions have been placing transactions that may turn into giant losses — may no longer be allowed to be used for that purpose.
At least, that is the concern if a new FASB rule (FAS 140) gets passed.
U.S. Banker, comes this discussion:
"Losses tied to banks’ off-balance-sheet subprime-mortgage investments have reached into the hundreds of billions of dollars and caused some real soul searching among the nation’s top accounting group, The Financial Accounting Standards Board, which has moved quickly to radically alter the rules for how banks must account for so-called qualified special-purpose entities, or QSPEs…
The IMF, The Bank of England, the Securities and Exchange Commission, the President’s Working Group and other groups have jumped on the reform bandwagon. And since March, FASB staffers have been gathering data and assessing whether risk was masked under current accounting rules used by banks for securitized investment vehicles, collateralized debt obligations and other toxic instruments currently languishing in an illiquid market.
Now comes a rather under-the-radar bombshell. FASB has decided to “eliminate the concept of the QSPE” in the revised financial-accounting standard, FAS 140, and also will “remove the related scope exemption from FIN 46R,” says FASB director of technical activities Russ Goldin. FASB is sill studying actual implementation and disclosure issues, but it seems pretty clear those unpriceable, lamentable assets are headed for the balance sheets.
This is hyper-technical accounting stuff, but it has enormous potential impact on markets. There may be trillions of dollars worth of derivatives buried on banks’ QSPEs.
To grossly oversimplify, Banks have been using QSPEs to effectively boost their leverage and hence, their return on capital. Without the balance sheet constraints of the old days, banks were encouraged to create assets — by making lots of loans they shouldn’t have — that could, in theory, be sold off later. It hasn’t quite worked out that way.
QSPEs can have legitimate purposes — but they also can obfuscate the true financial condition of a bank or broker. The purpose is not to simply hide losses off balance sheet, but to get those assets off balance sheet so leverage/Tier 1 capital ratios look better. Essentially you can be much more leveraged than you appear, so that ratios like ROA and ROE look stronger than they would if they weren’t employed.
The author of this above article wonders if "The migration of exotics to the balance sheet may be inevitable." If he’s correct, it bodes poorly a quick recovery for the financials. They have years worth of leveraged derivatives on their books, and writing them down won’t be quick or painless.
9th inning? Hardly.
UPDATE June 5, 2008 10:05 am
A hedge fund manager friend suggest this research piece:
The FASB Wades Into The Securitization Swamp
The Accounting Observer, Volume 17, No. 6: May 22, 2008
Its free with a trial subscription.
FASB 157 — Delayed, or Not? (November 2007) http://bigpicture.typepad.com/comments/2007/11/fasb-buncha-bit.html
FASB Lobs a Balance-Sheet Bombshell
U.S. Banker | June 2008
FASB Seeks to Improve Accounting for Qualified Special Purpose Entities
Business Wire, June 10, 2003
BENDING THE RULES
CFO, March 2008
What’s Right and What’s Wrong With (SPEs), SPVs, and VIEs http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm