Editorial: "ACCOUNTING AND ECONOMICS: WILL THE TWAIN MEET FOR MORTGAGE ORIGINATORS?"

Abstract

The challenge for accounting standard setters is to develop accounting procedures that enable financial analysts to understand and assess the economic health and prospects of reporting institutions. In the U.S. the Financial Accounting Standards Board (FASB) bears this responsibility; and as a rule, accounting principles and practices that the FASB has put forth have received high marks for approaching this ideal. In the case of the mortgage industry, however, the current guidance may be falling short of the mark. The genesis of this criticism is Financial Accounting Standard No. 133 (FAS 133), “Accounting for Derivative Instruments and Hedging Activities,” which was released in June 1998. One source of controversy surrounding this standard had to do with the fact that, with the advent of FAS 133, financial reporters had to decide if contractual arrangements that had never previously been considered to be derivatives satisfied the FASB’s new definition. Loan commitments fell into this category. Were they derivatives, or not? In March of 2002, the FASB resolved this question for one class of commitments by explicitly dictating that commitments relating to loans intended for resale were, in fact, derivatives. In making this determination, FASB left a host of related, unanswered questions. This paper endeavors to air these issues and highlight how or why inconsistent accounting treatments may have resulted. Identifying such inconsistencies should be of interest to standard-setters, accounting professionals, and analysts seeking to understand and evaluate the performance of mortgage issuing firms. The paper is organized as follows: First, we describe the economics of the mortgage banking activity giving rise to the accounting issues examined in the paper. Second, we detail the steps in the standard-setting process that resulted in the current guidance. And finally, in the third section we lay out the possible resolutions that might reasonably come to be adopted and discuss the respective ramifications.