House Legislation Would Require FASB to Study Securitization Standards and Orders New Regulator to Be Involved When Standards Affect Systemic Risk

Two amendments added during mark-up to the Financial Stability Improvement Act (HR 3996) could impact FASB standard-setting. The Garrett Amendment would require FASB to conduct a study of its new securitization accounting standards, while the Perlmutter-Lucas Amendment would require the new systemic risk regulator to make recommendations to the SEC on FASB standards affecting market-wide financial stability. The legislation is expected to pass the House Financial Services Committee in early December.

The amendment introduced by Rep. Scott Garrett would require FASB to conduct a study of the combined impact by each individual asset-backed security of the new credit risk retention requirements contained in the Act and also of FASB’s new securitization accounting standards, FAS 166 and 167. After the study, FASB would make statutory and regulatory recommendations for eliminating any negative impacts on the continued viability of the asset-backed securitization markets and on the availability of credit for new lending. The study would be required to be completed in 90 days and must the Board must coordinate and consult with the SEC, OCC and FDIC.

Taking effect at the end of 2009, FAS 166 and 167 will eliminate qualified special purpose entities, which are the primary securitization accounting vehicle for asset-backed securities. They will also change the criteria for the sales treatment and consolidation of financial assets and apply all of these changes retroactively.

The new securitization requirements in the legislation and the changes by FASB to the securitization accounting rules will impact both the U.S. financial sector and securitization. Federal Reserve Board Member Elizabeth Duke has noted that, if the risk retention requirements in the legislation, combined with accounting standards governing the treatment of off-balance-sheet entities, make it impossible for firms to reduce the balance sheet through securitization and if, at the same time, leverage ratios limit balance sheet growth, there could be substantially less credit available.

Thus, as policymakers and others work to create a new framework for securitization, cautioned Gov. Duke, they must avoid falling into the trap of letting either the accounting or regulatory capital drive the US to the wrong model.

Another amendment introduced by Reps. Ed Perlmutter and Frank Lucas authorizes the new systemic regulator created by HR 3996, the Financial Services Oversight Council, to make recommendations to the SEC on any adjustments to accounting standards impacting financial institutions when the Council determines that these accounting standards pose a significant risk to financial stability. This bi-partisan amendment allows regulators to make recommendations when there is no functional market for derivatives and other financial instruments.

According to Rep. Perlmutter, the amendment is intended to provide the accountability and transparency necessary for investors to assess their investments in financial institutions, while at the same time providing regulators with the flexibility they need to work with financial institutions to keep credit flowing. The amendment does not place accounting rulemaking with the Financial Services Oversight Council. The setting of accounting standards remains with FASB, subject to SEC oversight. The Council will have no authority to oversee the FASB since the legislation only allows the Council to become involved on accounting issues with systemic risks.

Only if an accounting standard poses systemic risks would the Council make recommendations, and those recommendations would be with the SEC. But the Committee strongly believes that the Council must be permitted to address systemic risks, one of which includes accounting standards.

While mark to market accounting and loan loss accounting rules did exacerbate the financial crisis, explained Rep. Perlmutter, the amendment is not about mark to market. It is about ensuring that policymakers and regulators have a way to examine systemic risks going forward, while working together to ensure that financial statements remain fairly presented for investors and other users of financial statements.

.