Bad pun.
Suddenly there’s a lot of fuss about VIEs – variable interest entities. A lot of which, it seems, stems from the lede in this Bloomberg article:
The new source of potential losses: so-called variable interest entities that allow financial firms to keep assets such as subprime-mortgage securities off their balance sheets. VIEs may contribute to another $88 billion in losses for banks roiled by the collapse of the housing market, according to bond research firm CreditSights Inc. Goldman, which hasn’t had any of the industry’s $163 billion in writedowns, said last month it may incur as much as $11.1 billion of losses from the instruments.
VIEs, however, aren’t anything new. VIE is just a catch-all accounting term for SIVs, ABCP conduits, CDOs, CLOs, and a host of other structured investment vehicles.
The VIE came into being in the wake of the Enron crisis. Tighter accounting rules under Financial Accounting Standards Board Interpretation 46 required firms to be more open – or at least aware – about their relationship with off balance sheet special purpose vehicles. From the FASB:
In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate or other property.
The worry being that unregulated, SPVs could be used as accounting dodges to shift funds around the place and skew a parent company’s numbers.
The phrase “variable interest” then, denotes an unconsolidated SPV, run, for example, by a bank which is not necessarily the “primary beneficiary” of the structure. Comparatively, an organisation must consolidate a VIE onto its books if it is determined to have more than a “variable interest” – if it has a primary interest in the vehicle.
Under the current FASB interpretation of rule 46, a company must consolidate if:
- It owns a majority of the controlling equity in the VIE. Or;
- It is entitled to receive a majority of the VIEs residual returns. Or;
- It is subject to a majority of the risk loss from the VIE’s activities
Which is why with SIVs, for example, banks are – or were – being forced to consolidate them onto their balance sheets as liquidity backstops came into play.In a similar fashion Citi also consolidated a whole raft of CDOs onto its balance sheet over the autumn thanks to liquidity puts it had in place on the super-senior facilities of those CDOs.