As the mortgage mess grows, we are learning more and more about just how sloppy things were in the mortgage-issuing business as loans were churned out, carved into securities and sold off.
Judges have blocked some foreclosures with rulings that purchasers of mortgages could not prove that they owned them. The buyers of the mortgages complain that it is unfair to ask them to have complied with detailed rules.
And now the banks are begging the accounting rule makers to allow them to ignore a rule that has been on the books for almost 15 years. They explain that they never had any idea that they would have to restructure a lot of home mortgages, and thus had no reason to develop systems to deal with the accounting for such restructurings.
“No one anticipated a day when potentially hundreds of thousands of residential mortgage loans would be modified,” said Alison Utermohlen, an official of the Mortgage Bankers Association who has led the effort to get the accounting rules relaxed.
She said many members of the association did not have computer systems adequate to comply with the rule, but she did not identify any specific banks.
Some may doubt that the issue really is a systems problem at the banks, given that the accounting the banks prefer would allow them to report smaller losses as they restructure loans — and thus make their financial statements look better. If the reverse were true, the effort being put into changing the rule might instead be directed at finding ways to comply with it.
But the plea that the banks never saw it coming does ring true. In this cycle, those who lent the money thought that they had no reason to concern themselves with whether it would be paid back.
Instead, they planned to sell the loans, usually to trusts that would then finance the loans by issuing securities. Such trusts have different accounting rules.
In any case, the banks seem to have shared the general belief that house prices would always go up, so anyone unable to meet mortgage payments could sell the house. If losses are never going to appear, why prepare to deal with them?
Now home prices are falling in many areas. The risks of owning mortgage securities began to become apparent last spring, and the securitization markets virtually shut down by summer. Banks now own loans they cannot sell. And many of those loans, made when lending standards were at historic lows, are likely to go bad and need to be restructured.
The accounting rule in question, Financial Accounting Standard 114, was adopted in 1993. Lynn E. Turner, a former chief accountant of the Securities and Exchange Commission, recalls that it was enacted because of abuses by financial institutions during the savings and loan debacle. Under the old rule, banks could avoid reporting losses so long as they expected to get the principal back eventually, even if the borrower did not have to pay interest on the restructured loan. The rule put an end to that.
Or at least it put an end to it for most types of loans. These banks live with F.A.S. 114 for their commercial mortgages and corporate loans, but according to Ms. Utermohlen, they don’t have systems in place to do the calculations for large numbers of restructured residential mortgage loans.
The calculations, it turns out, are not that complicated. You could do them with a decent financial calculator, or an Excel spreadsheet. But the banks argue that would take too much effort, given the volume of loans likely to be restructured. “This would be extremely time-consuming and would likely involve additional staff dedicated to this purpose,” Ms. Utermohlen said in a letter to the Financial Accounting Standards Board this week.
Will the banks win this argument? It appears to be one that they want to win without having to actually admit that any specific bank has a problem at all. I called five members of the Mortgage Bankers Association that are represented on the committee that Ms. Utermohlen said she worked with: Citigroup, JPMorgan Chase, Bank of America, Countrywide Financial and Washington Mutual. Countrywide said that its computer systems were adequate to comply with F.A.S. 114, but that it felt it would be “less burdensome from an operational standpoint” if the rule could be ignored. None of the other four told me whether their systems were adequate.
The decision by the accounting standards board could hinge on whether banking regulators push for such a change. It was banking regulators who originally asked for F.A.S. 114 to be adopted, but some now might prefer to minimize reported losses at a time when the banking system is under great pressure.
No one will admit that the goal is to fudge financial statements, of course. With investors already nervous, the excuse that complying with the rule would cost too much is preferable to an explanation that the reported losses would be too high.
What a choice for the banks to face: report big losses or claim that they are not sophisticated enough to comply with an accounting rule that has been on the books for more than a decade. It’s no wonder they would rather leave the argument to a trade association.
