House Legislation Requires FASB to Study Securitization Standards

The House has passed legislation requiring the Federal Reserve Board, in consultation with the SEC, to conduct a study and report to Congress on the impact on individual classes of asset-backed securities of FASB’s new securitization accounting standards, FAS 166 and 167, and the Act’s new credit risk retention requirements.

The Wall Street Reform and Consumer Protection Act, HR 4173, says that the report must 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.
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.

The legislation also authorizes the new systemic regulator, the Financial Services Oversight Council, to review and make recommendations to the SEC and FASB on any adjustments to accounting standards impacting financial institutions when the Council determines that these accounting standards pose a significant risk to financial stability. For example, this provision allows the Council to make recommendations when there is no functional market for derivatives and other financial instruments.

The provision also directs the Council to monitor international accounting developments and identify any developments that may conflict with the policies of the US or place US financial services firms or US financial markets at a competitive disadvantage. The Council must also advise Congress on financial domestic and international regulatory developments, including accounting developments.

The legislation in this area 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. These provisions do 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. Presumably, only if an accounting standard poses systemic risks would the Council make recommendations, and those recommendations would be with the SEC. But Congress 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, these provisions are not about mark to market. Rather, they are 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.

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