Securitization Accounting as a Microsocial Contract—The Mechanism and the Ethical Challenges

• In Event: Public Interest 1

Abstract

This article addresses the ethical challenges embedded in financial assets securitizations and the accounting mechanism that enhances such ethical challenges. Two sources of ethical challenges are identified in financial assets securitizations: 1) the securitization transactions themselves; and 2) the securitizing-entities’ accounting for the transactions. Securitization transactions, with the separation of loan originatorship and loan ownership, shift financial institutions’ lending practices to more volume-driven; securitization accounting, by incorporating estimated future benefits in current period accounting earnings, introduces unverifiable discretion into the accounting numbers.

Empirical evidences indicate that: 1) financial institutions frequently engaged in financial assets securitizations have lower quality of loan receivables; and 2) servicing assets are aggressively valued upon the securitization transactions, resulting in uncertain intangible assets carried on the accounting books. While securitization accounting is a mircosocial contract reached by the banking industry, financial statement users should be aware that this unique accounting challenges the accounting hypernorm of conservatism and fluctuation in asset values are expected under the current securitization accounting standards.

Author

• Kang Cheng, Morgan State University