Tanta over at Calculated Risk has an interesting take on a New York Times article that attempted to proffer a take on gain-on-sale accounting techniques and how corporate misdeeds inflated earnings and led to the downfall of both Enron and also drove the downfall of a recent spate of subprime lenders, including New Century. Tanta’s take can be summed up thusly:
Someone is so desperate to tie gain on sale to inflated earnings that she is wandering way far off the reservation when it comes to repurchase warranties.
You’d have to read the full post, but suffice to say that very few people understand the process of how loans are sold or securitized, and when they get it wrong, they make all sorts of incorrect conclusions — like tying problems at Enron to problems in the current subprime mortgage industry. The problem at New Century wasn’t in accounting problems tied to some obtuse explanation of how a company recognizes income in the form of gain-on-sale — New Century’s problems sat squarely in the fact it didn’t have adequate liquidity reserved to cover EPDs and other repurchase requests forced onto it by Wall Street. We (and by we, I mean those of us in the industry as well as the business public) should be discussing whether the above was due to corporate largesse or an act of God that the company’s Board couldn’t have seen coming — or more likely, if it was just poor planning in an effort to keep paper profits high. Preventing this sort of thing from ever happening again requires first focusing of the real problem at hand, rather than creating convenient phantoms that make for a good press story.