Saturday, September 6, 2008

Shady Accounting Pressed the Treasury to Take Action

I am going to roll this stuff out to you this weekend as I find it. This is unbelievable. It looks like both GSE's were using borderline fraudulent accounting to hide losses. Geez...Where are the cops?

This story has just begun to be unfold folks. This is from the New York Times. Is this Enron part 2? You decide. Here is the link:

"The government’s planned takeover of Fannie Mae and Freddie Mac, expected to be announced as early as this weekend, came together hurriedly after advisers poring over the companies’ books for the Treasury Department concluded that Freddie’s accounting methods had overstated its capital cushion, according to regulatory officials briefed on the matter.

The proposal to place both mortgage giants, which own or back $5.3 trillion in mortgages, into a government-run conservatorship also grew out of deep concern among foreign investors that the companies’ debt might not be repaid. Falling home prices, which are expected to lead to more defaults among the mortgages held or guaranteed by Fannie and Freddie, contributed to the urgency, regulators said.

The accounting issues that brought so much urgency to the bailout appear to center on Freddie Mac’s capital cushion, the assets that regulators require them to keep on hand to cover losses.
The methods used to bolster that cushion have caused serious concerns among the companies’ regulator, outside auditors and some investors. For example, while Freddie Mac’s portfolio contains many securities backed by subprime loans, made to the riskiest borrowers, and alt-A loans, one step up on the risk ladder, the company has not written down the value of many of those loans to reflect current market prices.

Executives have said that they intend to hold the loans to maturity, meaning they will be worth more, and they need not write down their value. But other financial institutions have written down similar securities, to comply with “mark-to-market” accounting rules. Freddie Mac holds roughly twice as many of those securities as Fannie Mae.

Freddie Mac and Fannie Mae have also inflated their financial positions by relying on deferred-tax assets — credits accumulated over the years that can be used to offset future profits. Fannie maintains that its worth is increased by $36 billion through such credits, and Freddie argues that it has a $28 billion benefit.

But such credits have no value unless the companies generate profits. They have failed to do so over the last four quarters and seem increasingly unlikely to the next year. Moreover, even when the companies had soaring profits, such credits often could not be used. That is because the companies were already able to offset taxes with other credits for affordable housing.
Most financial institutions are not allowed to count such credits as assets. The credits cannot be sold and would disappear in a receivership. Removing those credits from assets would probably push both companies’ capital below the regulatory requirements.

Regulators are also said to be scrutinizing whether the companies were trying to manage their earnings by waiting to add to their reserves. Both companies have gradually increased their reserves for loan losses — Fannie’s reserves today stand at $8.9 billion, and Freddie’s at $5.8 billion.

Other companies, like private mortgage insurers, have been quicker to identify large losses and have set aside much greater amounts. Fannie and Freddie have dribbled out bad news with each quarterly announcement, suggesting they may be trying to manage this process.

Finally, regulators are concerned that the companies may have mischaracterized their financial health by relaxing their accounting policies on losses, according to people familiar with the review. For years, both companies have effectively recognized losses whenever payments on a loan are 90 days past due. But, in recent months, the companies said they would wait until payments were two years late. As a result, tens of thousands of loans have not been marked down in value.

The companies have injected their own capital into pools of securities containing these loans, arguing that their new policies are helping more borrowers.
Under conservative accounting methods, changing these policies would not have any impact on the companies’ books. However, people briefed on the accounting inquiry said that Freddie Mac may have delayed losses with the change.

“We have just had to nationalize the two largest financial institutions in the world because of policy makers’ inaction,” said Josh Rosner, an analyst at Graham Fisher, an independent research firm in New York, and a longtime critic of the government-sponsored enterprises. “Since 2003, when these companies’ accounting came under question, policy makers have done nothing. Even though they had every reason to know that the housing market’s problems would not be contained to subprime and would bring down the houses of Fannie and Freddie.”

7 comments:

Jeff said...

I am changing my mind on where the markets go on Monday. After this tape bomb, I think we are headed south.

The details of the ponzi scheme are going to be revealed. It looks like these two companies were nothing but trillion dollar levered hedge funds.

This could create massive fear in the markets on Monday. I still need to know more but this is staggering news.

This is unbelievable. I am speechless. Smoke and mirrors everyone. The jig is about up. We could still bounce as J6P buys on bailout news, but its not going to have legs.

It looks like I will be up late tomorrow night watching this story develop.

Jeff said...

How in the hell was this allowed to happen? Where was the SEC? Where were the auditors?

Where were the cops?

All I can say is WOW. I am very afraid as to how this story ends.

Jeff said...

Update!

looks like the command AND THE PREFERRED may go to zero.

That will destroy many regional banks. The language is getting increasingly nasty. This looks to be no full bailout. Many are exposed here.

WOW. What a crazy weekend.

Oh boy

Its looking increasingly bad for equities on Monday.

here it is:

"Sept. 6 (Bloomberg) -- Treasury Secretary Henry Paulson will use his authority to rescue Fannie Mae and Freddie Mac, likely placing the beleaguered mortgage-finance companies under government control as early as this weekend.

The Treasury plans to put Fannie and Freddie into a so- called conservatorship and pump capital into the companies, House Financial Services Committee Chairman Barney Frank said in an interview after being briefed by Paulson. The government would make periodic injections of funds by buying convertible preferred shares or warrants in the companies as needed, avoiding large up- front taxpayer costs, according to a person briefed on the plan.

``This is no bailout, particularly for the shareholders,'' Frank said. The federal government ``will be senior to all shareholders, preferred and common.''

Holders of the companies' corporate debt and preferred shares are ``very unlikely to come out of this at all happy,'' and the chief executive officers will be forced out, Frank said. Paulson met with Fannie Mae CEO Daniel Mudd and Freddie Mac CEO Richard Syron yesterday to tell them of the decision to put the companies into conservatorship, and remove the executives from their jobs, according to two people briefed on the discussions"

http://bloomberg.com/apps/news?pid=20601087&sid=aA419ISkTYD4&refer=home

Minton Mckarkquey said...

Reading much enthusiasm and trepidation - but at least the game is up and we can start working our way out of this mess.

Fannie/Freddie both down 20% in after markets - suggests 50-60% collapse on Monday depending on Fed's announcement tomorrow. Urgh.

Jeff said...

Minton

I agree. Let the fireworks begin.

Its going to be very interesting as to how this all plays out next week and in coming months.

I can't wait to see what the Treasury comes up with.

Imagine the pressure that they feel right now. This decision will be written about in history books.

Lets hope they get it right. We cannot afford a mistake here where hyperinflation becomes a concern.

They must make Wall St. take losses here. A bailout with no pain solves nothing and will lead to further problems down the road.

Lets see what happens tomorrow!

Anonymous said...

Wish I had some(any) artistic talent. Just thought of the best cartoon for this. Little league baseball player standing in the outfield his shirt says 'Taxpayers.' He is holding his glove up yelling, 'I got it!' as at 2 story tall, extremely sharp butcher knife labeled 'Fannie Mae, Freddie Mac' falls toward him.

Jeff said...

LOl anon

The Taxpayer just got screwed today

Working on a post right now. This intervention is not friendly to Wall St.