If FAS 157 started it will FAS 140 will keep the party going?

March 27, 2009 11:14 AM

The Fed's Public Private Partnership Program, promises to clear down as much as $1T worth of "legacy assets" from banks balance sheets. Globally, equity markets responded positively. But what about assets held off balance sheet?

Off balance sheet vehicles originally were designed to mitigate risk, focusing investments into subsidiaries so credit ratings or leverage ratios of parent companies wouldn't be impacted. Many financial firms improperly used such vehicles to hide poorly performing assets, culminating in the well known collapse of Enron in 2002. Last July The Financial Accounting Standards group postponed FAS statement 140 - which would require firms to move assets on to their balance sheets - for one year, an impending deadline that concerns many analysts.

How much is held off balance sheet? As of Q1 2009 off balance sheet assets at the four largest US banks - Wells Fargo, JP Morgan, Citigroup and Bank of America - totaled roughly $5T, or a sum potentially dwarfing Geithner's trillion dollar plan.

Regulators are aware of the problem and already are planning to increase requirements for economic capital, but considering how reluctant the United States was to adopt Basel II [.pdf] , a real fix could take a while.

Note: FAS 157 - the accounting standard requiring that banks mark assets to market not to model - now suspected to have triggered the credit crunch, was previously discussed here.

posted by Mutant (27 comments total)

With the economy reaching this new milestone, we need to come up with a better way to denote 'trillion' than "1T." Because when I see that, I go "Whoa, a whole tablespoon??
posted by mudpuppie at 11:25 AM on March 27, 2009 [3 favorites]

If a company trades any stock publically, they should be obliged to be transparent. Period. Failure to do so should place all the board's and VP and ups PERSONAL wealth and liberty at stake.
Jail and pauperize these fraudulent fuckers who steal from everyone by slight of hand.

This limited liability (i.e. infinite ability to make $$$, but no actual liability when you're too big to fail) company and corprorate personhood bullshit is what's got us here. Lets get rid of it, or at least hew it to societys needs.
posted by lalochezia at 11:34 AM on March 27, 2009

A related askme thread.

Also, Krugman's blog had an interesting debate the other day between four economists regarding the prospects of Geithner's plan (see also this related NYT bloggingheads video debate: Are bankers necessary?)

Whether one agrees with Krugman and others that the Geithner plan potentially exacerbates the problem by ignoring the structural problems, or agrees with Roubini and others that the Geithner plan, while not perfect, needs to be given the benefit of the doubt, all can agree that we are now in uncharted waters: never in history has so much money been pumped into so many untested federal recovery plans. A lot is at stake, and the logistics alone are daunting.
posted by ornate insect at 11:39 AM on March 27, 2009

Stupid question I'm sure, but if they are off-balance sheet, how do we know how much is on them, or is still on them?

More to the point, $5 trillion??? Even if Geithner's plan were expanded to accommodate that amount is there enough private money (let alone private interest) to absorb that? The Fed purchase of treasuries earlier this week was offset by lower then usual purchase of them by ordinary purchasers, suggesting at least the possibility that foreign capital is less than enthusiastic about taking on more US risk. And on top of that, equity prices are once again in value-investor territory, which means equities are going to compete with these goofy derivatives for the same, largely foreign, dollars.

Perhaps this is what the bankers are discussing with the President as we speak.
posted by Pastabagel at 11:39 AM on March 27, 2009

I think I'm confused. Why would bringing $5T in assets onto their balance sheets be a problem? Or do these subsidiaries really have balance sheets with negative net assets? (Or would have if they assets were correctly valued?) Hasn't keeping these overvalued assets off-balance sheet at least prevented financial institutions from leveraging themselves even more against those assets? Or is that leveraging happening at the subsidiary level? Am I thinking about this completely wrong?

(Breath.) OK, my other question: what is the actual legal relationship between the financial firms and these off-balance sheet subsidiaries? And what are the subsidiaries set up to do? Ie, can they cut loose the subsidiaries and let them go bankrupt and, if they do, what impact does that have on other entities in the economy?
posted by yarrow at 11:43 AM on March 27, 2009

never in history has so much money been pumped into so many untested federal recovery plans. A lot is at stake, and the logistics alone are daunting.
posted by ornate insect at 2:39 PM on March

I know that the money being pumped in is to offest money that vanished, i.e. to offset or at least mitigate both stunning deflation, a climbing savings rate, and lower economic activity, the latter two of which are publicly reported numbers and which require a larger money supply to maintain the same level of economic activity.

What is difficult for me is determining the extent of the deflation. Are any numbers related to this being reported? Where? And what is our confidence in those numbers?

Also, I can't help but think the last two weeks were short-cover/short profit-taking, and a head fake. Someone around here keeps posting a chart (which I can never seem to find again) where the current market graph is superimposed over the 1929-1934 crash, and the 2000's dot-com bust. Judging from that graph, and history, it would seem to suggest we are in for a bit more pain that we've felt so far, but what do I know.
posted by Pastabagel at 11:47 AM on March 27, 2009

Why would bringing $5T in assets onto their balance sheets be a problem?

Bringing those assets into the light of day will make evident (well, not automatically, but potentially) their real value. In theory they shouldn't be entirely toxic, but even if we are generous and assume their current value is 75% of what it was before... well, that means $1.25 trillion disappears into thin air. Which is kind of peanuts compared to what the stock market has already been through, I guess...
posted by mek at 11:49 AM on March 27, 2009

Yeah, I'm confused as well. If an asset is already off the balance sheet, then how can adding it to a banks balance sheet cause problems unless the assets have negative value? In that case, they would be debts, right?
posted by delmoi at 11:50 AM on March 27, 2009

Or do they put the 'value' of their subsidiary on their balance sheet? And if that's the case, why don't the subsidiaries have to use the same accounting standards as their parents? or not?
posted by delmoi at 11:52 AM on March 27, 2009

The title of this post, and your opinion that FAS 157 started the crisis, is not sustained by the reality of the situation.

When you have an accounting rule that says that you can take a piece of paper, (CDO, CLO, CDS, MBS, ABS, Synthetic CDOs, CDO squared or what have you), make up a value for it using some mathematical model, and then claim on your books that the value you come up with is really what the piece of paper is worth, then your accounting rule has no basis in reality.

This is a fine example of the kind of thing that you can only get away with if you are the one who writes the rules. If I tried to tell the IRS that I shouldn't have to pay taxes because all the money that I made was spent creating a piece of paper that I say is worth exactly what I made last year, they would laugh at me.

The values were fraudulent. Blaming the rule that happened to point out that they were fraudulent is besides the point.
posted by jefeweiss at 11:58 AM on March 27, 2009 [1 favorite]

jefeweiss--get ready to be told you don't know what you're talking about. It's the default mode of criticism directed at anyone who questions the mystique of complex financial management.
posted by ornate insect at 12:02 PM on March 27, 2009

Uhm was Basel II a big part of how we got in here? The whole abuse of risk weighted assets thing?

When people say an asset is held off balance sheet usually they mean there is another pile of assets and liabilities laying around out there that is in some way recourse to the parent company either explicitly or more often implicitly that the parent has used some perversion of the GAAP accounting rules to prevent consolidating in the holding companies financial statements.

The way the "value" of the subsidiary usually appears on a B/S is the equity invested in the vehicle is an investment and the income comes in the form of dividends or equity income.

To look at that nominal number as meaning anything is a bit fearmongery as you have no idea what the two sides of the B/S look like.

To answer Delmoi's question, GAAP appliles to the subsidiary of course, but the banks are not required to disclose the financials to anyone since technically they don't control it.
posted by JPD at 12:05 PM on March 27, 2009

Mutant do you have a link to what the off balance sheet assets are?

Also I meant "Wasn't Basel II a big part of how we got here"
posted by JPD at 12:10 PM on March 27, 2009

JPD - Here's an article from Bloomberg which touches on it. It's a pretty good summary of what's being discussed here.

"Even if only a portion of those assets return to the banks - - as much as $1 trillion is one dark possibility -- it would take up lending capacity the government is trying to free.

"The hidden assets that may return to banks consist of mortgages, credit-card debts and auto loans, among others. Over the years, banks bundled them together and sold them to investors as securities.

Whether these assets are “troubled” or “toxic,” their return to bank balance sheets could slow efforts to get credit flowing again. After all, banks shed the loans to make their balance sheets look smaller, allowing them to hold less capital to act as a buffer against losses."
posted by triggerfinger at 12:22 PM on March 27, 2009 [1 favorite]

So its previously sold securitizations? How does the economic risk in these assets end up getting put back to the banks then?

This is actually kind of an example of why off-balance sheet entities are allowed to exist.
posted by JPD at 12:31 PM on March 27, 2009

What is difficult for me is determining the extent of the deflation. Are any numbers related to this being reported? Where? And what is our confidence in those numbers?

Here are some numbers. Gives some idea of the relative size of government borrowing. Total US domestic nonfinancial sector debt growth as measured there in Q4 2008 was 6.3%. Excluding federal government debt, it would've been -0.2%. Stunning deflation! A few quarters like that and you'd be looking at nearly 1% less debt owed by all those households and businesses. Hard to imagine, I know.
posted by sfenders at 12:38 PM on March 27, 2009

Someone around here keeps posting a chart (which I can never seem to find again) where the current market graph is superimposed over the 1929-1934 crash, and the 2000's dot-com bust.

I'm not that someone, but I think you're referring to this. (Google for [four bad bears].) Looks like we're tracking 1929-32 more closely than 1973-4 or 2000-2, and yes, we're currently lined up with a head fake in early 1931.
posted by A dead Quaker at 1:22 PM on March 27, 2009

posted by A dead Quaker at 4:22 PM on March 27

Thank you, sir!
posted by Pastabagel at 2:26 PM on March 27, 2009

Economist James Galbraith on the Geithner plan.
posted by homunculus at 3:17 PM on March 27, 2009

A dead Quaker: how do they decide on the horizontal registration of that graph? Seems like you could make it track any of the previous markets just by deciding when "month 0" is.
posted by hattifattener at 7:20 PM on March 27, 2009

As I understand it, the off balance sheet assets are normally called SIVs (Special Investment Vehicles). They are typically Cayman Island or some other tax haven shelf companies. These companies enter into an agreement to buy debt from the bank involved, often buying the riskiest tranche of sliced up CDOs. The SIV at the same time applies for a loan with the bank to fund the purchase.
As the risky CDO isoff the balance sheet, the bank no longer has to mark the probably declining values to market. As long as the SIV continues to make its debt payments, the loan book numbers stack up too, although if the CDO payments stop, as looks pretty likely, the bank has a bad debt.
posted by bystander at 4:17 AM on March 28, 2009

hattifattener: Month 0 is the peak of the previous bull market (I think it's August 1929 and November 2007 respectively). I didn't mean to imply that we're tracking the 1929-32 bear market perfectly--looking at the charts, there are obvious differences. But there are two similarities, namely that we're currently down more than in any bear market since, and sickening drops in both October 1929 and October 2008.
posted by A dead Quaker at 5:37 AM on March 28, 2009

bystander - The SIV business doesn't exist anymore. And your description of it is wrong. An SIV was a fancy way of using a ton of short-term leverage to buy long-dated assets. A lot of those assets tended to be ABS, but they weren't created to obsfucate the risk levels on the B/S. They were created to hide the fact that the banks were engaging in very very low ROA businesses but using a ton of leverage to make the ROE look ok.

These SPV that Mutants article addresses are just how you legally have to structure creating an Asset backed security. Any retained interest in the securitization is already on the companies balance sheet, and that is where the economic risk remains. Its these retained interests that make up a large portion of the assets Timmy G wants to buy. All putting these assets back on B/S will do is throw the capital ratios out of whack - but economically it doesn't mean anything.
posted by JPD at 8:55 AM on March 28, 2009

Guh! Getting back to this much later than I wanted to, lots came up just after I posted ...

Anyhow, I'll try to cover some of the loose ends as its seem most have been closed down already.

jefeweiss -- "When you have an accounting rule that says that you can take a piece of paper, (CDO, CLO, CDS, MBS, ABS, Synthetic CDOs, CDO squared or what have you), make up a value for it using some mathematical model, and then claim on your books that the value you come up with is really what the piece of paper is worth, then your accounting rule has no basis in reality."

Regardless of our positions on mark to market / model, I'm sure we'd all agree the transition was botched. They did a massive changeover, and nobody had the foresight to suggest a quantitative impact study, something that BIS required when deploying Basel II. We did five all together leading up to the adoption of Basel II.

That being said, I am aware of SEC study where they discount the impact of the switchover, but mitigate this conclusion by mentioning "Development of additional guidance and other tools for determining fair value when relevant market information is not available in illiquid or inactive markets, including consideration of the need for guidance to assist companies and auditors ..."

Paul Volcker's research team suggested that "...pure mark-to-market accounting model is generally preferred for trading activities and most elements of market risk." [.pdf] and went on to suggest that mark to model still be employed for some of a banks core activities.

So it's an interesting issue, but given the relativity fragility of the markets and economies, it seems like FAS 140 should be postponed again.

In any case, latest chatter I'm hearing from colleagues that are more directly involved is they suspect FAS will propose a "Level 4" classification be established, to hold Off Balance Sheet assets as they are migrated back to the parent company. Keep the stuff in a separate category and then migrate them back onto the parent companies balance sheet, in total as market dynamics and economic capital permit.


A dead Quaker yeh those charts are always very interesting to look at. I wonder how many folks actually try to trade these things, as there are lots of periods where you can overlay past market events. Although these do have a lot of impact.

Bear market rally? We'll know shortly. Most bear market rallies we've seen tend to last two to three months, with advances of roughly 20% or so before petering out. So while recent events are promising we're not out of the woods yet on this one, and Friday's retrenchment was indeed significant. Especially so when you think lots of institutional money is floating around, and we should be seeing the usual end of quarter window dressing exercise, where they buy the well performing shares and dump the dogs.

Another concern: the bond market has been screaming recession even as the equity markets surge ahead. We know each market looks at different factors for their trading signals, and the bond market has much, much less retail participation. Much less retail money looks to the bond market when the subject of investment comes up.

So this will be an interesting week.

JPD -- "All putting these assets back on B/S will do is throw the capital ratios out of whack - but economically it doesn't mean anything."

But the capital ratios are precisely the problem. If banks do end up needing additional capital where is it to come from? Most banks can't very readily revisit the equity or debt markets - little or no appetite from investors, especially so at this stage of the game, far too many investors have already been either diluted or wiped out totally.

So we're back to more government money. Yeh, FAS 140 could cause additional trouble if they deploy it as planned.
posted by Mutant at 10:39 AM on March 29, 2009

Patabagel: I get my charts on from CalculatedRisk.

The link has a chart comparing the current recession market values to others, as well as the great depression. It is periodically updated from these guys. But I'll echo others comments that the the stock market value is only one, often wrong, measure of market strengths.
posted by ilovemytoaster at 12:41 PM on April 6, 2009

Oops. ADQ beat me to it by 10 days. nevermind. grumble grumble.
posted by ilovemytoaster at 12:47 PM on April 6, 2009

Very informative post and very interesting comments. Having just completed its guidance on fair value in inactive markets (FSP 157-4, issued on April 9), FASB is ready to return to finalizing the amendments to FAS 140 and FIN 46R, as noted here.
posted by EdithO at 1:19 PM on April 11, 2009