If the alien should produce the fannie probe -- run like hell!
Posted on 09/07/2004 9:44:36 PM PDT by AdamSelene235
Did mortgage giant Fannie Mae (NYSE:FNM - News) cook its books in order to exclude large derivatives losses from its income statement?
Finding an answer to that question is one of the main aims of a probe being conducted by Fannie's regulator, the Office of Federal Housing Enterprise Oversight, or OFHEO. And according to a person familiar with the investigation, one of the reasons that OFHEO has sent subpoenas to Fannie is to obtain information that would help it decide whether the company misapplied generally accepted accounting rules to keep losses on derivatives out of earnings.
As this column has often reported, Fannie has suffered gargantuan losses on derivatives under CEO Franklin Raines. The losses, which ballooned to nearly $17 billion in 2003, appeared to be the result of a risky interest rate hedging strategy that backfired badly. The derivatives losses in question are amortized into earnings over time. The OFHEO investigation aims to determine whether Fannie was amortizing too few losses into its income statement and thus artificially boosting earnings, according to the person familiar with the probe, which began in February and is expected to end by the end of this month.
Fannie has strived hard to give Wall Street earnings that grow at a strong and steady rate. If it was able to do that only because it was abusing its accounts to keep derivatives losses out of earnings, Fannie's reputation would be hurt badly and CEO Raines would come under fire.
Fannie didn't comment. Its stock dropped 60 cents to $73.85 Wednesday.
OFHEO declined to comment on any aspect of its investigation, which the regulator launched soon after its probe of accounting missteps at Freddie Mac (NYSE:FRE - News), Fannie's rival mortgage buyer. Having seen some of the tricks Freddie played, OFHEO said right from the start that its probe of Fannie would look at how earnings were calculated. Back in December, OFHEO said that one of the things it would do in its Fannie probe was to "focus on transactions that significantly accelerate or defer the pattern of income recognition."
With that being one of its main aims, it made perfect sense for OFHEO to look at how Fannie's billions of dollars of derivatives losses were treated. In theory, the accounting rule that covers derivatives -- known as FAS 133 -- could be abused to keep a portion of derivatives losses out of earnings. In a November 2003 letter from OFHEO director Armando Falcon to Raines obtained by TheStreet.com, OFHEO asked for documents pertaining to a range of subjects, but specifically requested documents "related to FAS 133."
Preparations for FAS 133 were started under former Fannie chief James Johnson, now a private equity investor and adviser to John Kerry. Johnson didn't return a call seeking comment.
However, Fannie may be doing all it can to avoid scrutiny of its derivatives accounting. At a congressional hearing in July, OFHEO director Armando Falcon has said that Fannie's cooperation with the probe has been "spotty." According to an AP report, he also said, "We've had some instances where deadlines have been missed without explanation, submissions in response to requests for information that weren't complete -- even though there were assertions that they were complete."
The lack of cooperation may have been the reason for the issuance of subpoenas, a development reported by The Wall Street Journal on Aug. 20. According to the person familiar with the investigation, the subpoenas are aimed at getting documents that would show whether certain accounting treatments were implemented as part of willful attempts to artificially smooth earnings.
Of course, while the derivatives losses don't all go into earnings when they occur, they have all been reflected in the balance sheet -- in the equity number. However, to the bemusement of many investors, Fannie has asked market participants to look at equity numbers that leave out the FAS 133-related derivatives losses when assessing the strength of the company's capital.
At the end of June, there were $8.5 billion of unrecoverable derivatives losses in Fannie's equity that had yet to be amortized into earnings. If, as makes sense, that sum were subtracted from the capital numbers Fannie asks investors to concentrate on, the company would look weakly capitalized. Since Fannie was betting on a drop in bond prices at the end of the second quarter, the recent rally in bonds may have created more derivatives losses, and the company's true capital base may be even weaker than it was at the end of the second quarter.
OFHEO's ongoing probe has scored a couple of successes. It led to Fannie changing its accounting for some impaired bonds, an issue this column was first to flag. Fannie ended up having to book heavier losses on the bonds.
Also, it would appear that OFHEO is leaning on Fannie to make some changes in its corporate structure to improve risk management. Last week, Fannie said it was going to "move transactional risk management responsibilities to its business units while strengthening the integration of its financial risk assessment capabilities at the corporate level." Why the changes? Well, in the press release containing the news on the organization change, Fannie CFO Timothy Howard implied the impetus for changes in risk management were coming from OFHEO.
Howard said that "because OFHEO's proposed corporate governance rule addresses issues related to the organization of risk management activities, the company anticipates making further changes to its risk-management structure once the final rule is in place."
Falcon's term at OFHEO is due to come to an end at the beginning of October, but an OFHEO spokeswoman said Falcon wants to ensure a smooth changeover and, if necessary, he would stay through the transition to the new director.
A Bush victory in November would be a disaster for Fannie, which has resisted reforms proposed by the White House to tighten regulation of Fannie and Freddie. The two companies have been told by the White House that a second Bush administration's stance would be tougher, according to a person familiar with relations between the administration and the government-sponsored entities, or GSEs.
However, Fannie management could find it hard to resist reform calls even under a possible Kerry presidency if OFHEO finds it did keep derivatives losses out of earnings.
One of the big corporate tricks of the '90s was to find ways to manipulate accounting to defer or bury losses. There would be few supporters left in Congress if Fannie were discovered to have had engaged in Enronesque practices and ethics.
Who cares what the article is about - just look at that headline!
If the alien should produce the fannie probe -- run like hell!
Fanny means something else (hehe) in Ireland. *LOL*
Dammit People, you have no idea what we are going to find when we probe this Fannie.
They've been probing Fanny for years and still dont understand it.
o/~ "I love to singa...about the moon and the June and the Spring-a...I love to sing-a..." o/~
Nonetheless, Fannie and Freddie's exposure to derivative risk makes LTCM (went bust in 1998, btw) look almost like a bank CD by comparison.
I really think -- speaking as a trader -- that it's absolutely wonderful that these two organisations have levered themselves not only UP to the guts, but 300% or so PAST that. It's even more heartwarming to know that, when their little pyramid game finally topples (and it will, within a decade at best and likely sooner), you and I and everyone here will each get to eat a tasty little chunk of their arrongance.
This bunch are nothing more, these days, than dice players on a hot streak -- what will occur when they crap out...which they inevitably will, is completely undefined at law.
Which fact, of course, means that the courts will make it up as they go along, and you and I will get to pay for the folly.
Apols for the typo.
Incidentally, it's not even the worst I've ever seen - that would be:
After Fatal Beating, Suspect Commits Suicide
Being an Olde Pharte, one of my favourites along these lines was a headline during the 1934 World Series contested by the Cardinals and the Tigers.
Dizzy and Paul Dean were the pitching stars for the Cardinals, and Dizzy, particularly, was a rather reckless baserunner (at such times as he reached base, of course). In game 4 of the series, after being inserted as a pinch-runner at first base, Dean was absolutely brained by a ball thrown by Tiger shortshop Billy Rogell, in the process of trying to make a double-play...Dean was coldcocked, went out like a light.
Naturally, he was taken off the field and to hospital, and duly treated. Fortunately, there was apparently nothing other than a severe bruise. However -- and anyone who says this is an urban myth, or something similar, is an outright liar -- the next day's headline, on the front page, not the sports page, read:
X-RAYS OF DEAN'S HEAD SHOW NOTHING
I've seen that day's edition with my own eyes in the archives of the old St. Louis Globe-Democrat. The Globe-Democrat's sports editor for 40+ years, Bob Burnes, commented on many occasions about both that headline and the lessons that (sports)writers should derive from it.
It is long past time for Fannie and Freddie and Sallie to be privatized completely instead of being "quasi-governmental" corporations. The tacit financial support of the U.S. Government (read you and me) is just a license for abuse of the system.
The derivatives issue is, if true a vio;ation of Sarbanes-Oxley and somebody is going to take a ride up the river.
Regards,
Hahah, thanks CJM, that's a winner.
Does this have anything to do with Hillry's "Hoover" economy rant to her pals in CT? Would it be in her interest to pull the plug sooner rather than later?
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