FASB Redux

The Financial Accounting Standards Board or FASB made the banking industry very happy (Check Is In the Mail) when it relaxed the mark to market accounting rule a few months ago, which basically ignited this huge banking sector rally, but that goodwill looks to be used up.

The FASB this past Monday announced that they will soon crackdown on SPV (Special Purpose Vehicles) and OBS (Off-Balance Sheet Transactions). SPV/OBS's are used by financial institutions and banks to place riskier assets in quasi/pseudo independent spin offs to keep them off corporate balance sheets.

The ruling has 2 basic parts:

1- It requires firms to bring most OBS and activities back onto their balance sheets.
2-Greater disclosure of remaining OBS issues.

OBS/SPV were great devices that became popular with financial institutions over the last decade. In theory, they work great because they offer a low risk way to launch a suite of financial products outside of their normal core business without forcing investors to take losses on them. These are partially funded by outside investors, and are not governed or dependent on the parent company. Like I said...In theory they work great.

In reality, it was totally different, especially in the financial industry. Last year's swift fall and hard landing of the major players made the FASB suspect that OBS's were being used more for their loopholes than to expand the scope of the business. When regulators and auditors started looking at how so many supposedly robust banks could lose so much money so fast, they realized that these theoretically independent OBS entities were really joined at the hip to their parent banks, and their fall had dragged down the larger enterprises. Banks liked OBS vehicles because they could package their own loans into securities and then sell them to the OBS entity, unloading the risk from the corporate bottom line and making a profit at the same time. These OBS entities were often little more than places for banks to park their own loans, holding bundles of mortgages or other consumer debt.

Funny thing is that OBS activities while they're not on the balance sheet, are generally tucked into the footnotes of financial filings, so they dont get sued.....So only the most sophisticated investors and or analysts know about them. It's still a harder task, though and puts the onus on ratings agencies (Frauds) and auditors (Jokes) to figure out whether the firm has adequately transferred its exposure to avoid getting burned, or if the OBS vehicle will eventually blow up.

The FASB ruling could lead to another capital deficit for the big banks, which could spark a scramble for more money to shore up their reserve bases when the FASB ruling kicks in at the start of next year.

Financial Institutions like State Street and Citigroup had to bring back SPV/OBS back onto their consolidated balance sheets, their stocks got hammered on the days they announced that. Currently Wells Fargo has the largest OBS exposure at a mind numbing $1 Trillion!

The main question to ask bank executives is:

What is the plan to repatriate SPV/OBS transactions by Year end 2009? In the case of Wells Fargo, this would mean increasing the assets on the balance sheet by 80%.

Answer: We have no plan.

The main question to ask the FDIC/TREASURY/GOV is:

Did the government Stress Tests for the banks take into account this SPV/OBV potential fiasco?

Answer: NOPE

The main question to ask investors is:

Were you told about potential FASB crackdown on SPV/OBS before you invested in the secondary offerings from WFC and BAC?

Answer: Probably not, did you read the prospectus?

I am constantly amazed how normally smart educated people on Wall Street continue to follow the herd to slaughter. They truly have learned nothing from falling off the cliff.

How can we believe in rational markets when so many investors are sticking their heads in the sand? Anybody who buys a bank stock based on "value" falls into this category.