“We’ve Got to Find the Middle Ground”

In his new book, Too Big to Save?, Robert Pozen proposes fixes for the biggest financial crisis of our lifetimes.

How so?
The Financial Accounting Standards Board has thrown up its hands and said, effectively, that there isn’t anything that can be off balance sheet anymore. If a sponsor has modest indices of control and some of the benefits and risk, the sponsor is almost always going to be considered to have that off-balance-sheet entity on its balance sheet.

That has much larger repercussions. I don’t think it was aimed at corporates; it was aimed at the money center banks. But FASB doesn’t want anyone to do off-balance-sheet [accounting]. I think that’s a mistake. We’ve gone from one extreme, where some bank like Citigroup would have $40–$50 billion off balance sheet, to one where it is all on balance sheet. That’s quite a switch for that amount of money. The reality in most off-balance-sheet financing is that the sponsor lays off some, but not all, of the risk. These are never all-or-nothing situations.

We’ve got to find a middle ground, because loan securitizations are the key to loan volume. President Obama said last week he was very disappointed that banks weren’t lending anymore — as if banks were the key to lending. They aren’t. The key to lending is loan securitization. And if we force banks and corporates to put all the securitizations on their balance sheets and to treat them as if none of the risk has been laid off, well, I don’t think you’re going to have much in the way of securitization.

So your book proposes that off-balance-sheet accounting should remain.
You would have an off-balance-sheet entity. The sponsor, whether it be a corporate or a bank, would disclose its contingent obligations, [such as] credit supports. And in the case of the financial institutions, there would be some capital support for that based on actual allocations of risk.

You say that FASB has essentially given up on securitization accounting. But hasn’t FASB repeatedly tried to find a middle ground, only to find that the rules it devised were circumvented?
It’s a fair point that FASB, after Enron, tried to come up with [better] rules. But it has always had rules that are all-or-nothing tests. Either you’re off balance sheet or you’re not. The whole nature of those [type of] rules encourages gaming.

So your proposal says there should be a realistic allocation of risk and capital to each of the various stakeholders.
Yes. That’s not amenable to gaming. Maybe you could game it so you’ll only have 55% of the risk instead of 60%. But it’s not an all-or-nothing situation.

Your proposal actually sounds analogous to what FASB and international accounting standards-setters are considering for leasing, which is also off balance sheet.
Right. [Current] lease accounting has that same characteristic. [Editor's note: A lease can be held off balance sheet if the present value of the lease payments is less than 90% of the leased asset's fair value.] [As a result], people have 89.9% and they do these crazy things just to get under the rule. So of course it’s gamed. But, yes, if we had a leasing rule that recognized allocations and didn’t see this as all or nothing, then we wouldn’t have that sort of gaming. It’s an important lesson for FASB to learn.

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