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A bad accounting rule.

I think Curt Verschoor's January article ("Does the Fraud Triangle Apply to the Credit Crisis?") misses a key cause. Citi used FAS 140 to move $1.2 trillion in CDOs backed by mortgage securities off their balance sheet. Ironically, the FAS 140 rule was the product of a new standard-setting process under SOX.

As the saying goes, everything changes and everything stays the same. An earlier version of this standard had a 3% rule that was exploited to create Enron's Special Purpose Entities. The current FAS 140 has the Section 9(c) loophole, or 10% rule, that was aggressively exploited by Citi and other key players in the subprime crisis to move mortgage-backed securities off balance sheets after selling just 10% to outsiders. Citi did this right under the nose of their regulator, the Federal Reserve, and thereby avoided banking reserve requirements on this debt.

I suggest this is not ethics, but bad accounting policy. FYI, this lousy policy was the result of heavy lobbying by the financial industry, which said that a higher (say 51% is common sense) rule would inhibit capital formation. Guess we know the truth now. This was not bad ethics but a bad accounting standard.

--Gordie Brenne, CMA
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Author:Brenne, Gordie
Publication:Strategic Finance
Article Type:Letter to the editor
Date:Apr 1, 2009
Words:203
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