Post-Enron, Structured Finance Addiction Hasn't Ebbed

Fastow's deals were good in a pinch, helping Enron book paper earnings as quarterly deadlines neared. So should investors be worried when S&P observes, as it did Tuesday, that "structured finance repeated its usual quarterly pattern with a surge of activity in the final month of the quarter?"

Stephen Ryan, a professor at New York University's Stern School of Business, says it wouldn't surprise him if some element of earnings management were driving the end-of-the-quarter rush.

"The biggest piece of structured finance is residential mortgages, and I don't doubt that banks may choose to securitize them with a number of motives in mind, such as risk management, regulatory management and earnings management," says Ryan, a derivatives specialist.

But others say there's too fine a line between legitimate monetization and earnings management to draw any definitive conclusions.

It's perfectly reasonable for companies to assess the state of their balance sheets when they begin preparing their earnings reports, this camp says. The last month is a natural time for a credit card lender or manufacturer to package together loans or accounts receivable into a bond that can be sold to investors and recorded as a gain on the company's income statement.

"Managing your balance sheet at quarter-end seems reasonable," says Janet Tavakoli, a structured finance consultant. A company has "accumulated assets and wants to take a gain and get them off balance sheet. It makes sense to do it later in the quarter, because that's when you've accumulated the most assets."

Whether or not the volume of these deals and their timing indicate anything nefarious, Enron's legacy might be about to catch up with the structured finance market.

Wall Street bankers are up in arms about a set of proposed federal rules that are aimed at putting the kibosh on structured financings that serve no other purpose than to manipulate profit. The new rules proposed by the Securities and Exchange Commission and bank regulators would require financial institutions to vouch for the accuracy of company's accounting, disclosure and tax treatment for a structured finance deal.

Already, banking groups are weighing in with their objections to the new rules, contending that they will increase the cost of structured finance deals and cause companies to shy away from legitimate risk-shifting transactions.

In a July 19 letter to the regulatory agencies considering the proposal, The Bond Market Association, the Securities Industry Association and the International Swaps and Derivatives Association said the new rules would "result in significant burdens for participants in these markets." The industry groups contend that the proposal would lead to "new and unwarranted legal exposures for financial institutions."

Many on Wall Street also made the same dire predictions when regulators were considering Fin 46, a year-old accounting rule that forces companies to consolidate on their balance sheets any special-purpose entities that don't have enough outside investors in them.

Wall Street bankers complained long and loud about Fin 46, the first post-Enron accounting reform to impact the structured finance market. They whined that Fin 46 would have a devastating impact on the asset-backed commercial paper market, which relies heavily on SPEs to arrange short-term financing for companies. A year-old J.P. Morgan Chase research report suggested that Fin 46 might cause the asset-backed commercial paper market, which averages around $723 billion, to decline by as much as 10% in value.