Senator Calls on Big Four to Fix Subprime Crisis

Sen. Charles Schumer sends a letter to the large accounting firms, asking them to educate lenders about the newly understood flexibility of FAS 140.
Sarah JohnsonAugust 27, 2007

One month after Securities and Exchange Commission chairman Christopher Cox made it more economically feasible for lenders to modify securitized loans when a default seems likely, Sen. Charles Schumer is encouraging the Big Four accounting firms to ensure their clients are aware of the option.

Schumer sent the largest firms a letter last week asking them to “assist this country’s mortgage crisis by ensuring that your clients are aware of the recent SEC and FASB guidance on FAS 140, and by otherwise encouraging them to modify subprime loans at risk of default.” Currently, according to Schumer, investors of securitized mortgages are still saying they are unable to refinance or modify loans because it would interfere with their off-balance sheet treatment of the loans. That has given mortgage borrowers on the brink of foreclosure little or no wiggle room to refinance their loans.

At issue is the Financial Accounting Standards Board’s rule for securitizations, in which loans are packaged together and sold, at varying risk levels, as bonds backed by future loan payments. When a securitized loan’s future proceeds are owned by a trust, the lenders — which continue to service the loans — are generally not able to modify them unless the loans are in default. If the lenders do make any modifications, they could be at risk of tampering with the “true sale” agreement they have with the trust and therefore would have to account for the loan as an asset on their balance sheet.

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However, prompted by queries from congressmen concerned about the burgeoning subprime mortgage meltdown earlier this year, Cox implied that the lenders could indeed make modifications without a change to their balance sheet — as long as the likelihood of default is “reasonably foreseeable.” Cox’s letter said that “modifications undertaken when loan default is reasonably foreseeable should be consistent with the nature of modification activities that would have been permitted if a default had occurred.”

Schumer considers this clarification from the SEC a “promising solution” to the repercussions he believes will arise when more subprime borrowers foreclose on their mortgages in the coming months. To stave off a further crisis in the mortgage industry, Schumer says, lenders could apply the new interpretation of FAS 140 and refinance the loans of subprime borrowers — those with a weak or nonexistent credit history.

But it may be up to the accounting firms to let, or remind, those lenders that they have this possibility. In his letter, Schumer urges the accounting firms to tell him what they are doing to make sure their clients know about the newly realized flexibility of FAS 140 and to “make it a priority” to do so.

For their part, the accounting firms aren’t yet saying if they will address Schumer’s letter.’s calls for comment were not immediately returned by spokespeople at Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers. The Center for Audit Quality, which represents the accounting firms and was copied on Schumer’s letter, referred to the firms’ press offices.

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