Financial Sector: More Damage to Come

by: Barry Ritholtz

Someone needs to inform the SEC that their job is to protect shareholders -- not wayward corporate management.

For an SEC commission staff to even hint that it's okay to move sub-prime junk off balance sheets is not only wrong -- it's outside of their jurisdiction. That's FASB's purview, not the SEC. The goal should be accurate, transparent accounting -- not sleight of hand and misdirection.

Allowing this kind of misleading reportage is simply unacceptable gimmickry from the regulatory body that is SUPPOSED TO STOP this sort of crap:

"Just when it seemed as if the mortgage mess had hit a new low, now comes this: The Securities and Exchange Commission's staff has granted the subprime-lending industry a huge exemption from the normal rules for off-balance-sheet accounting.

In effect, the move will let home lenders keep their balance sheets looking much smaller and less leveraged, even while the off-the-books loans they made get a makeover.

For months, banking regulators and politicians have been pressing lenders to freeze the interest rates on many adjustable-rate subprime mortgages that are scheduled to reset soon at higher interest rates. The idea is to minimize defaults and foreclosures.

While that's a noble objective, all good deeds must be accounted for, and that's been a sticking point for many banks. Through September, just 3.5 percent of subprime mortgages that reset in the first eight months of 2007 had been modified, according to Moody's Investors Service. Even lenders inclined to help don't want to hurt their financial results. And now they might not have to, thanks to a Jan. 8 letter from the SEC's chief accountant, Conrad Hewitt. . . .

The SEC and the FASB at least should acknowledge this subterfuge for what it is."

Strong words -- but it raises the question: Why is the SEC allowing investors to be misled? Aren't they merely delaying the eventual truth coming out? Why get in the way of that process?

Thursday's Heard on the Street column notes that some of the bigger banks have been dribbling out the write downs -- and there is very likely more to come:

"After racking up more than $100 billion in mortgage-related losses in recent months, banks and their investors had hoped they were out of the woods. They aren't.

UBS AG's warning yesterday that its 2007 write-downs would be $4 billion higher than it predicted last month signaled that further pain may lie ahead for Wall Street banks still vulnerable to the U.S. housing sector's strife."

And that's before we get to the issue of Counter Party Risk, and the losses that will result if Ambac (ABK) and MBIA (NYSE:MBI) don't make good on their derivative trades. Those losses potentially range from $50 billion to $150 billion.

Me? I prefer to rip the band aid off all at once. I find Death by 1000 cuts totally unappealing...

Subprime Lenders Get Big Accounting Break at SEC
Jonathan Weil
Bloomberg, Jan. 30 2008

More Subprime Pain in Store
UBS Write-Downs, Insurer Downgrades Point to More Unraveling
January 31, 2008; Page C2

Banks May Write Down $70 Billion, Oppenheimer Says Adam Haigh and Eric MartinBloomberg, Jan. 30 2008

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