In Depth Analysis: CalculatedRisk Newsletter on Real Estate (Ad Free) Read it here.

Thursday, February 07, 2008

The End of Off-Balance Sheet Securitization?

by Tanta on 2/07/2008 10:02:00 AM

P.J. at Housing Wire reports that FASB (the Financial Accounting Standards Board) is threatening to end the arguments over "the Q election" by simply eliminating QSPEs entirely:

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.
At this point, I take this to mean that mortgage loan (and other asset-backed) securitizations would have to be treated as financings, rather than sales, of the underlying assets. Therefore both the assets and the corresponding liabilities would be reflected on the issuer's balance sheet, with the (presumed) effect of increasing the issuer's capital requirements as well as the cost of financing (investors would have to be compensated for the loss of the "bankruptcy remote" vehicle structure). I think we can pretty much guess what the "input from market participants" is going to be.

In case you missed this in yesterday's New York Times:
Until the banks rebuild their capital, they will not have the wherewithal to lend money and support economic growth. If banks of all sizes could regain their capital immediately and easily, it would be a tremendous benefit to the American economy.

The federal government could make this happen by entering into an arrangement with American banks that hold subprime mortgages, in which homeowners typically pay a low interest rate for two or three years then face much higher payments. Here’s how it would work: The government would guarantee the principal of the mortgages for 15 years. And in exchange the banks would agree to leave their “teaser” interest rates on those loans in effect for the entire 15 years.

This would instantly give the lending banks new capital. As these mortgages would be guaranteed by the Treasury, they would suddenly be assessed, on bank balance sheets, at their original value — and a significant amount of the banks’ lost capital would be restored. Plus, the banks would receive, from most of the homeowners with subprime mortgages, up to 15 years of teaser-rate payments.
Certainly a government guarantee of principal--with no guarantee fees, insurance premiums, or interest income to the guarantor, like those mean GSE and FHA alternatives require--would take care of the capital problem.