Banking & Capital Markets

Giving Structure to Structured Finance

Some observers have voiced dismay that the Fed and other banking regulators seem unconcerned about the interests of investors.
Ronald FinkJuly 19, 2004

In May, the Federal Reserve Board announced new guidelines designed to rein in banks’ sales of complex securitizations known as structured finance. Such deals were at the heart of the fraud that ultimately destroyed Enron and were arranged by several banks, including Citigroup and J.P. Morgan Chase & Co. at the behest of Enron’s former CFO, Andrew Fastow. While Fastow has since been sentenced to 10 years in prison for his role in the case, Citigroup and JPMorgan Chase settled their federal complaints by agreeing to less-than-hefty fines.

The new guidelines, however, fall well short of prohibiting the kinds of deals that did in Enron. Instead, they amount to a list of steps banks should take to identify which transactions are likely to subject them to legal or reputational risk, which of course bank examiners themselves have some control over.

Curiously, along with the guidelines, the Fed released a letter from the Securities and Exchange Commission describing what activities amount to aiding and abetting securities fraud. The Fed originally distributed the letter — at the SEC’s request — to financial institutions last December. Yet when CFO requested a copy of the letter as part of its preparation for a feature article on the Fed, an SEC spokesman said that public disclosure of such correspondence would be highly unusual.

(That article — “Playing Favorites,” in the April issue — questioned whether the Fed was sufficiently concerned about the role that Citigroup and JPMorgan Chase played in Enron’s failure.)

Observers have subsequently voiced dismay that the Fed and other banking regulators seem unconcerned about the interests of investors. In a letter to CFO, former SEC chief accountant Lynn Turner, now an accounting professor at Colorado State University, cited a meeting with the heads of the agencies, during which the chairman of one dissuaded him from proceeding with a proposal to require banks to more clearly disclose their loan losses to investors. And former SEC chairman Richard Breeden told CFO the same thing had happened earlier, when he had sought better disclosure of the value of banks’ securities.

Perhaps the Fed’s disclosure of the SEC letter to the banks means that bank regulators are taking such criticism to heart. Still, the Fed won’t prove it is serious about this issue until the SEC initiates a case against a U.S. bank based on evidence turned over by bank examiners.

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