First Freddie Mac, Now Fannie Mae in the Hot Seat?

Just two weeks after a shake up at Freddie Mac led to the ouster of three executives in the nation’s No. 2 mortgage company, the No. 1 company, Fannie Mae, now finds itself under the microscope.

The New York Times is reporting that industry insiders are asking about profits reported by Fannie Mae. They claim that Fannie Mae’s letter-of-the-law reporting may have shielded substantial losses last year, a statement Fannie Mae hotly contests. ("Fannie Mae's Accounting Finds Critics of Its Own," June 23, 2003, New York Times.)

Fannie Mae is a government-sponsored company that owns or backs a quarter of all U.S. mortgages. Last year, the company reported a $6.4 billion profit, marking the seventh straight year that the company has shown a 10 percent growth rate.

The point of contention arises when Fannie Mae’s fair-value balance sheet is compared against its income statement. The former shows a more accurate picture of all assets and liabilities and that is where a large loss is shown, especially when considering the fall in interest rates last year. Technically, Fannie Mae is allowed to keep these losses off its profit report, but the concern is how that will affect later earnings.

"On an economic basis, they made no money last year," Lawrence Kam, president of Sonic Capital, a Boston hedge fund that has sold Fannie Mae stock short, betting that its price will decline, told the New York Times. "That's the simplest way to put it."

Fannie Mae does not agree with Sonic’s assessment, but acknowledged that the falling interest rates hurt the company’s bottom line last year.

"Our core business earnings provide a better measure of our financial results and better reflect our risk-management strategies," a spokesman for Fannie Mae, Chuck Greener, told The Times. Industry watchers say that the company miscalculated how fast the interest rate would fall and the rate at which homeowners would refinance.

Earlier this month, Freddie Mac, replaced its top three executives in the wake of an accounting investigation. The company’s president was accused of not fully cooperating with auditors reviewing the company’s 2000-2002 financial statements.

In spite of attempts to control damage, the mortgage giant now faces even greater scrutiny. Results of an informal probe of the company, begun by the Securities and Exchange Committee (SEC) in January, 2003, has prompted a formal investigation. Additionally, the U.S. Attorney's office in Virginia's eastern district has opened a criminal investigation, which will likely focus on Freddie Mac's recently ousted executives and its accounting practices.

Word of the Freddie Mac shakeup sent shock waves through Wall Street as new questions arose about the company’s handling of its $1.29 trillion worth of home loans.

The stock market fell sharply on the news and the yield of Treasury bonds hit a near 45-year low as investors dumped mortgage-backed securities. Stocks of Freddie Mac and Fannie Mae fell dramatically. Other mortgage lenders and recently hot housing stocks also fell and the dollar was weakened.

Investors spoke of fears that Freddie Mac's problems could hurt the housing market, which has been one of few areas of strength in a troubled economy since the stock market bubble burst in 2000.

"This is bad," said Paul Miller, an analyst at Friedman, Billings, Ramsey, on word of the Freddie Mac shake-up. "We've always felt that there was more here than met the eye, and it turns out that's exactly what it is."


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