GIPS 2010 And Operational Definitions

Stan Liebowitz’ informative study, “New Evidence on the Foreclosure Crisis”, in Friday’s Wall Street Journal brought to mind one of the 2010 Global Investment Performance Standards (GIPS®) changes. The change is the requirement of firms claiming GIPS compliance to revalue its portfolios at every large cash flow.

Mr. Liebowtiz’ operational definition of sub-prime mortgage provides the basis of his study. He uses the technical one used by mortgage and lending professionals to show it isn’t sub-prime borrowers (FICO scores less than 620) that are the root of the foreclosure crisis, but those borrowers who have negative equity in their home.

He contrasts that with the operational definition politicians and ordinary people may be using for “sub-prime mortgage” – a loan to a person who cannot afford it. Whether this is an actual sub-prime loan or prime one or a liar loan or a 103% loan, these are mortgages taken out by borrowers, and granted by lenders, who would not have been expected to get one even 15 years ago.

Here is where the 2010 GIPS requirement to value portfolios at “large cash flows” runs into the issue of operational definitions. The CFA Institute is not providing a definition of what a “large cash flow” is. As a result, expect wide latitude in operational definitions of “large cash flow” amongst firms claiming GIPS compliance.