The ongoing discussion on securitization usually focuses on the role of financial institutions, who actually buy receivables, securitize them, and sell. Banks' demand for assets to securitize have been blamed for irresponsible lending by mortgage originators. While that is probably accurate, the role of financial reporting in the securitization boom is often overlooked.
In finance, when asked what the most important financial statement is, the answer must be the cash flow statement. Companies can manipulate their balance sheets and income statements using valuation accounts, off-balance sheet accounting, and other gimmicks--think of how Enron, BFA, HealthSouth, and others misled investors. In many cases of accounting fraud, the statement of cash flows was the best early indicator of trouble. But the increased importance of the statement of cash flows to Wall Street has been a curious boon to securitization.
Wall Street values companies with stronger Operating Cash Flows higher than others. A company with higher Operating Cash Flows is seen as healthier than a company with high Investing or Financing Cash Flows, for obvious reasons. Investors want a firm's cash to come from operations and not selling assets and raising capital. WorldCom took advantage of this by capitalizing operating expenses, meaning the cash outflows were classified as Investing Cash Flows rather than Operating Cash Flows. It wasn't until they had done this for $3.8bn that people noticed.
This incentive to increase OCF actually promotes securitization. By selling receivables to banks, companies can increase their operating cash flows. Since uncollected receivables are subtracted from income out of the cash flow statement, selling receivables will record these sales as cash income. I have no numbers as to how much this affected securitization, but considering the ubiquity of this practice, I would expect the effect to be high.
An interesting example in regards to this topic is how US automakers considered leasing deals and car financing arrangements as Investing Cash Flows, thus keeping Operating Cash Flows misleadingly high. The SEC finally fought back in 2005 and made automakers classify these financing deals as Operating Cash Flows. GM's OCF decreased from $7.6bn to $3bn. If GM sold these receivables rather than holding them, it could increase its OCF back to $7bn.
It's an interesting progression. Companies learned in the 90's they could record income from dubious sales to related entities. After investors shifted their attention to cash flows, management found a way to manipulate these as well. It supports my view that most financial innovation is designed primarily to bypass regulation.
(With regards to cash flows, another innovation directed towards arbitraging accounting regulation was the development of auction-rate securities, which are ultra-safe asset-backed securities whose rates reset by auction every couple weeks, allowing issuing entities to borrow long at short rates. Investment banks guaranteed liquidity in these securities (until February 2008) so companies could consider auction-rate securities cash equivalents, thus boosting their statement of cash flows.)
