William Armstrong

The Murky World of Off-Balance-Sheet Items (Part 1)

Excellent article. I've been waiting for someone to focus on this issue.

The problem with the accounting rules is that they are focused on who has control of the off balance sheet entity rather than who runs the risk. The rules say, basically, that a bank has to put accounts onto its books if it has managerial control over the entity. This is easy to avoid by clubbing with other banks to create off balance sheet vehicles where no one bank has more than 50% of the shares or votes of the entity, thereby enabling each bank to claim they don't have control. Then they stuff the entity with commercial paper or auction rates securities or similar that are effectively guaranteed by the banks. The banks are running the full risk, since when the securities can't be rolled over in the market, the holders can (and do) call on the guaranty. All of this could be avoided by having booking rules that look to who has the risk rather than who has control.