Editor's Note: Below is a piece from the BoomBust blog of Reggie Middleton. This guy knows how to dig, assimilate and present the facts.
What you don't know can collapse you! A primer on what lurks off the balance sheet...
Goldman Sachs is a very large, very diverse financial operation (although it appears that the vast majority of revenues and profits are emanating primarily from trading operations, hence it is essentially an overpriced public traded hedge fund). A very significant amount of Goldman's assets and operations are not privvy to the average investor or the capricious analysts. How significant an amount, you ask? How about to the tune of US$16 to US$58+ billion. I am getting ahead of myself though. In order to increase implied leverage and minimize collateral and reserve requirements, many entities carry much of their risk off of their balance sheet through vehicles called Variable Interest Entities (VIEs).
Why are they doing this? Well, because they can. How are they doing this? Well, let's reference my favorite (okay second favorite - BoomBustBlog carries a bias) open source info hub, Wikipedia: A Variable Interest Entity (VIE) is a term used by the United States Financial Accounting Standards Board in FIN 46 to refer to an entity (the investee) in which the investor holds a controlling interest which is not based on the majority of voting rights. It is closely related to the concept Special Purpose Entity. The importance of identifying a VIE is that companies need to consolidate such entities if it is the primary beneficiary of the VIE.
A VIE is an entity meeting one of the following three criteria as elaborated in paragraph 5 of FIN46:
The equity-at-risk is not sufficient to support the entity's activities (e.g.: the entity is thinly capitalized, the group of equity holders possess no substantive voting rights, etc.);
As a group, the equity-at-risk holders cannot control the entity; or
The economics do not coincide with the voting interests (commonly known as the "anti-abuse rule").
But "Wait", you may proclaim! "I never see these off balance sheet entities consolidated, measured, quantified, or even mentioned in my brokerage reports, SEC reports, or by may investment advisor or asset manager." Don't worry, don't fret, your brother from another mother has come to your rescue.
Read the full article - Click Here