by Damozel | To reduce the chances of Freddie or Fannie becoming "so weak that they are unable to meet their obligations without a bailout, they [have been] required to operate with at least a certain amount of capital." (WaPo)
Alas. Though The New York Times suggests that it didn't actually violate any rules by doing so, Freddie seems to have pumped a certain amount of air into its core capital, causing it to seem bigger and more reassuringly cushiony than it actually was. I guess that's one way to make sure you get a satisfying PPPPPPBBBLLLT! if it's ever needed as an actual cushion.
Last week, advisers from Morgan Stanley hired by the Treasury Department to scrutinize the companies came to a troubling conclusion: Freddie Mac’s capital position was worse than initially imagined, according to people briefed on those findings. The company had made decisions that, while not necessarily in violation of accounting rules, had the effect of overstating the companies’ capital resources and financial stability. (NYT)
Specifically, the company's accounting methods seem to have inflated the apparent amount of its capital base---the assets it's required to keep on hand as a cushion to cover their losses. (NYT) According to the article:
Freddie Mac "made accounting decisions that pushed losses into the future and postponed a capital shortfall until the fourth quarter of this year" (so it wouldn't have to be disclosed till early 2009) (NYT)
Apparently Fannie Mae has used some of the same methods, just not as aggressively.
Here are some of the allegations or imputations concerning Freddie's (and to some extent, Fannie's) calculation of their respective "capital bases" that are set out in The New York Times:
- Though Freddie Mac's portfolio contains many securities backed by subprime loans and alt-A loans, the company has not written their value down to market value. (While other companies have written down such loans, Freddie's guys said since they plan to hold the loans to maturity and therefore didn't need to do that.)
- .Both Freddie and Fannie have counted deferred-tax assets in determining their financial worth---i.e., they added in tax credits that could be used to offset future profits. Most companies aren't allowed to do this. And in Freddie and Fannie's case, there is a catch. To use the credits, they'd need to make a profit. That hasn't happened for the lost four quarters and isn't very likely now.
- Both companies may have managed earnings by deferring loan loss reserves. (Naked Capitalism)
- The companies may have relaxed their accounting policies on losses. From 90 days, they've gone to waiting till payments have been past due for 2 years to recognize losses. The result, if so? "[T]ens of thousands of loans have not been marked down in value."(NYT; MORE)
Economics blog Calculated Risk expresses doubt that Freddie Mac violated any accounting rules. Naked Capitalism isn't so sure.
Naked Capitalism points to this April 22, 2008 article in The Washington Post: an interesting look backward, given current developments. At that time, the Office of Federal Housing Enterprise Oversight was having "issues" with Freddie Mac's accounting practices and its application of a new accounting rule. (WaPo)
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