Quote of the Day

Roger Ehrenberg, looks at a number of financial transactions, including the rather mundane one known as leasing nails what should be the core of any reform of the financial markets:

Both cash-market and derivative instruments should be put to the “business purpose” test. Accounting rule-makers, with support of the SEC, should move towards a “principles-based” system where common sense, and not black-and-white rules around which myriad loopholes can be found, should become the new paradigm. But let’s be clear. The issue isn’t derivatives; it’s all financial transactions whose objective is to deceive or to weaken financial transparency.

(emphasis mine)

He notes that a very old transaction, leasing, has been used for the same purpose for years:

Consider leasing, a transaction that has been popular for over 50 years. As the industry has evolved, transactions such as sale/leasebacks and “asset defeasance” have been used to synthetically borrow money without the obligation being reflected as debt on the balance sheet. The form of the transaction: a lease. The substance of the transaction: a borrowing. The multi-trillion dollar securitization industry has the same motivation: moving assets (and liabilities) off the balance sheet, while economic recourse still exists should asset values and/or debt ratings drop. This is what the market discovered when Citigroup’s multi-billion structured investment vehicles (SIVs) began to fail and the assets and liabilities came back onto its financial statements. What is the proper characterization of a contractually obligated stream of payments? Debt. How should a portfolio of assets and associated liabilities be treated if the risks and rewards of ownership haven’t been completely transferred? As never having left the balance sheet. Yet the accounting profession, with the SEC’s support, has enabled this charade to continue.

The idea of a business purpose rule is a very good one.