FASB on Subprime: "We Warned You"

Tim Reason and Marie Leone, CFO.com
June 10, 2008 | COMMENTS

If only the financial world had paid more attention to FSP SOP 94-6-1, there might not have been a subprime mortgage crisis.

It is safe to say that many preparers of financial statements, not to mention the large majority of investors, pay little attention to the deliberations of the Financial Accounting Standards Board—at least, that is, until they result in rules that directly affect financial results.

Yet at a recent conference, FASB chairman Robert Herz reminded both investors and preparers that his staff issued an unusual six-page "reminder" back in December 2005 that warned that investments in subprime mortgages were risky.

"Terms of Loan Products That May Give Rise to a Concentration of Credit Risk," also known as FASB Staff Position SOP 94-6-1, warned investors and financial preparers alike that FASB's staff "is aware of loan products whose contractual features may increase the exposure of the originator, holder, investor, guarantor, or servicer to the risk of nonpayment or realization."

In that paper, FASB's staff warned specifically about types and features of subprime mortgages that have since become household phrases: negative amortization, option adjustable-rate mortgages, interest-only loans.

At the time it released its position paper, FASB's staff noted that it had done so to emphasize the need for financial statement preparers to consider whether they had disclosed enough information about the risks involved in such loans, and whether changes in market conditions required additional disclosure. The paper strongly suggested that additional disclosure was required — by a variety of accounting standards — for many of the subprime scenarios it described.

Under one of those rules, FAS 107, additional disclosures are required for significant concentrations of risk, although the staff added that "Judgment is required to determine whether loan products have terms that give rise to a concentration of credit risk."

This is a summary of the article entitled “FASB on Subprime: ‘We Warned You'” by Tim Reason and Marie Leone, published on www.CFO.com. Read the complete article online here. Reprinted with permission.