One Spark that Could Set Wall Street Ablaze: FAS 167

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Here’s a new abbreviation to add to our crisis vernacular: FAS 167

That’s short for Federal Accounting Standards revision 167, effective Jan. 1, 2010. In essence, it’s a new accounting rule that will force financials to bring bad, off-balance sheet assets onto their books… thus a potential trigger for more Wall Street carnage.

“FAS 167 will be a larger and larger issue for the financial markets in the coming months,” explains Dan Amoss, our resident CFA, “and an emerging story in the financial media. “In short, the banks with large off-balance sheet variable interest rate entity (VIE) exposures will have to hold more capital against these exposures. So they're actively going to shrink the potential size of these VIEs, which are used to house things like credit card receivables.

“This coming consolidation of VIEs is likely one reason that banks have been hoarding cash and jacking rates on business credit cards -- for creditworthy customers -- up to 30% with no advance warning. “This ultimately means slower formation of new credit, and in many cases -- i.e., Citigroup -- the outright shrinking of its balance sheet to a degree that starves a credit-addicted U.S. economy.”

And lest you think we’re making too big a fuss over FAS 167, check out these sound bites. The first is from Freddie Mac’s Q3 earnings report, the second from a Wells Fargo Q3 conference call.

“Under these accounting standards [SFAS 166 & 167], the company will record the underlying mortgage loans in these single-family PC trusts and some of its Structured Transactions on its balance sheet. These mortgage loans have an outstanding unpaid principal balance of approximately $1.8 trillion as of Sept. 30, 2009… While Freddie Mac continues to evaluate the impacts of adoption, the company expects that the adoption could have a significant negative impact on its net worth.”

“I want to update you on our most recent analysis of the impact of the application of FAS 166 and 167, which is expected to result in the consolidation of certain off-balance sheet assets currently not included in our financial statements. We provided a preliminary analysis in our second-quarter 10-Q. Based on our continued refinement of this analysis, we now expect approximately $55 billion in incremental GAAP assets to be brought on balance sheet, representing approximately $28 billion in incremental risk-weighted assets… we continue to explore the sale of certain interests we hold in securitized residential mortgage loans, which would further reduce the amount of incremental GAAP assets and incremental risk-weighted assets.”