March 11, 2002
From the desk of Mindles H. Dreck:Credit Where Credit is Due
An excellent and thoroughly-researched article by Diana Henriques appeared in Saturday's times. Since I regularly pop veins in my forehead over the Times, I thought I would mention it. This is detailed, informative business journalism, and it deserves recognition in a world of tainted Jack Welch interviews.
Do try to get past the "Three Little Piggies" lede and read the article. It makes some excellent points about how Enron abused structured finance techniques that have been a tremendous boon to financing of legitimate businesses. If we eliminate or over-regulate structured finance we are in danger of throwing the baby out with the bath water:
Home mortgages, car loans, credit card debt, student loans, equipment leases — all these assets, and more exotic ones like future receipts from British pubs and the box-office take for Steven Spielberg's future movies, have been remodeled into asset-backed securities. Those securities can now be found generating handsome returns for pension funds, mutual funds, banks, brokerage houses, insurance carriers, hedge funds and even some individual investors. A result, bond market experts say, has been the expansion of credit to consumers, greater liquidity and flexibility for lenders and the modulation of risk for corporations.There's just one problem: The same financial tools used to create asset- backed securities were also used to construct the elaborately camouflaged and booby-trapped partnerships that have been blamed for Enron's collapse.
[...] in fact, many of Enron's off- balance-sheet partnerships, on paper, are simply wildly complicated permutations of the basic structures involved in the creation of asset- backed securities: special-purpose entities, credit enhancements and contractual arrangements — including interest-rate swaps and other derivatives — that move assets, and the risks and rewards of owning them, from one entity to another.
Consequently, whatever courts, regulators, lawmakers, accountants and investors decide about the permissible uses of special-purpose entities could have far-reaching and unintended consequences for Wall Street's highly profitable structured- finance business. And that, in turn, will affect the companies that rely on structured finance to solve legitimate credit and cash-flow problems.
The solution, as I've suggested before, is disclosure, and plenty of it:
Companies that want to use complicated structured-financing techniques should be prepared to explain them completely, he (Professor Gilson) said. And in plain English, please — if only to demonstrate that the board of directors and chief executive understand the deals themselves. (Don't even try to persuade anyone that a structured-finance deal involving a closely related party — the company's chief financial officer, for example — is a good idea, he added.)Posted by Mindles H. Dreck at March 11, 2002 10:27 PM | Technorati inbound links