Revenge of the Nerds: QSPEs an Endangered Species
It turns out that perhaps the single most powerful arbiter of industry reform isn't on Capitol Hill or in the halls of state legislature, doesn't sit on the Fed's board of governors, doesn't work for the Treasury, and isn't with the Securities and Exchange Commission. It's none other than -- drum roll, please -- the Financial Accounting Standards Board. Yes, really. Those often-quiet CPAs and accountants responsible for setting the arcane and mostly boring standards that govern financial reporting have been busy making their will known in the past few weeks. Early returns suggest that FASB's actions will do more to shape the future of the secondary mortgage market (and, by extension, the primary market) than any other single entity out there. Don't believe me? Imagine a secondary mortgage market without off-balance sheet securitization trusts, and then read on. FASB tips its hand Earlier in January, the Mortgage Bankers Association had asked FASB if the industry could employ an older accounting rule known as FAS 5 in calculating loan impairments, rather than the current standard known as FAS 114. In short, assessing impairments under FAS 5 is relatively easier and only requires an evaluation of whether or not principal is likely to be paid back; FAS 114 requires fair value assessment of a loan, and calculation of both principal and interest cash flows. FAS 5 can lead to substantially lower recorded impairment values, and helped fuel the S&L crisis of the late 1980s; FAS 114 was FASB's response. Forcing the issue here was a surge in loan modifications expected to swarm the industry as it looks to implement a voluntary subprime ARM rate freeze plan announced by President Bush in December. The MBA had argued that servicers could not capably take on FAS 114 assessments in light of the number of loans involved. By all media accounts, the FASB board didn't just turn down the request -- they pretty much shafted it, and got snarky in the process. From Financial Week:
FASB also said the staff is â€œconcerned that by permitting a statement 5 approach, no losses would be recognized.â€? ... FASB noted in its decision that FAS 114 has been around for 13 years. Indeed, the staff rather bluntly suggested that bankers should have been prepared for this: â€œThe staff believes that lenders should consider the costs to comply with Statement 114's requirements when continuing to offer teaser-rate loan programs.â€?The above lends credence to an account of the Board's meeting provided by Bloomberg's Jonathan Weil on Wednesday [pull edited for readability]:
"In some respects, this industry has already received some exemptions," FASB member Tom Linsmeier said. "I don't have any sympathy for another exemption in this circumstance." The FASB's chairman, Robert Herz, spoke immediately after Linsmeier. "I don't support the project either, for all the reasons stated," Herz said.FASB's mood probably should have served as a tip-off as to what was coming next. Say goodbye to 'the Q' FASB has said since roughly May of last year that it would consider, possibly, eliminating qualifying special purpose entities as set forth in another accounting standard, FAS 140. Such language, however, has hardly been a cause for industry concern: FASB had long sought to clarify the permissible activities of an off-balance sheet entity within the boundaries of FAS 140, but had never issued guidance on the matter (which is what set me off on last week's diatribe against Bloomberg's Weil, for one thing). Meeting minutes from this past July, for example, show that the Board was still grappling with this very issue; the thinking at the time was clearly how to amend FAS 140 and clarify permissable QSPE activities. But that was then -- and this is now. In an accounting standards session at this past week's American Securitization Forum, FASB director Russell Golden told audience members that the standards board has since decided to eliminate QSPEs altogether; the focus now is now on how to best to handle the issues created by so doing. You could have heard a pin drop among audience members after Golden said FASB would "eliminate QSPEs." Attempting to fix one problem kept causing other problems to pop up, Golden said. He also hinted that the recent SEC letter by chief accountant Conrad Hewitt, which apparently gave the green light to fast-track loan mods, understated the real discussions that have been taking place in private between SEC and FASB officials. Bloomberg's Weil suggests that FASB officials have been irked at what they saw as the SEC undermining FASB due process -- a line of motiviation that I think misses the truth behind what's really been going on. It's probably fairer to say that FASB had been letting sleeping dogs lie in this area after shoring things up in the wake of the Enron scandal in 2001; and those dogs are no longer sleeping -- or lying down -- thanks to the ARM rate freeze plan. Forced to address the issue of loan servicing, FASB apparently decided it was easier to eliminate the concept of a QSPE altogether than to try to modify the rules under which it should be allowed to exist. It's unclear, exactly, how a 'Q-less' world ultimately would affect the secondary markets; many of the details have yet to be nailed down. One thing, however, would seem to be crystal clear: loans would, in all likelihood, no longer be able to be transferred off of a lender's balance sheet. Golden said that FASB is still working through details of a proposal in this area, however, and would want input from market participants. Golden also indicated that while SEC officials would like to see something implemented immediately, any move to eliminate QSPEs on FASB's part would likely take some time to materialize. Any implementation prior to the end of 2009 would probably be far-fetched, he said. All of which means we now know who's really wearing the pants in this relationship, don't we?