Subprime accounting stretched from day one: Herz

By Emily Chasan

WASHINGTON (Reuters) - Banks bent and stretched accounting rules from "day one" to keep risky securitized assets, such as those linked to subprime mortgages, off their books, the top U.S. accounting rule maker said on Thursday.

Robert Herz, chairman of the U.S. Financial Accounting Standards Board, said the current accounting rules governing treatment of securitized assets on banks' books are "a fantasy" and need to be redone.

"It didn't work, it was stretched, and not complied with," Herz said at the Reuters Regulation summit in Washington, referring to FAS 140, the rule that decides whether a bank can treat assets held in various securities as sales or secured financing.

"The original rules made sense, it's just the market practice didn't comply with that," Herz added.

Under the current accounting rules, complex legal structures and accounting methods were used to allow mortgage-backed securities and other asset-backed structures to be named "qualifying special purpose entities" or QSPEs.

The QSPEs were thought to be sufficiently out of control of the banks that they did not have to be booked on their balance sheets. But Herz said that principle was not strictly followed.

"Things were written into the agreements and in some cases the auditors didn't see them and even the companies didn't see that they violated these rules," Herz said.

"It's a fantasy given today's structures," Herz said. "It was constructed to be a narrow, very passive, almost brain-dead vehicle."

The FASB, which sets U.S. accounting rules, plans to rewrite FAS 140, eliminating the special treatment for QSPEs. Herz said on Thursday he expects to release a proposal on that in the middle of the year.

Herz compared the revision to other FASB projects where companies did not want to expense stock options, or preferred not to account for pension obligations as liabilities on their balance sheets.

"People like... to do business off balance sheet, and we like transparent accounting and those things tend to clash," Herz said.

(For summit blog: summitnotebook.reuters.com/)

(Reporting by Emily Chasan; Editing by Tim Dobbyn)