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Fannie Correction: 'What If?'

By David S. Hilzenrath
Washington Post Staff Writer
Thursday, December 14, 2006

Three years ago, Fannie Mae assured lawmakers that it had the required capital to cope with a broad variety of business setbacks.

Since 1992, "Fannie Mae has met or exceeded our capital requirements in every year," Franklin D. Raines, then its chief executive, testified in September 2003. "Indeed, we are one of the best-capitalized financial institutions in the world, when compared to the risk of our business."

As it turns out, the assurance was false.

Last week, when the giant mortgage funding company corrected years of flawed financial reports, the new numbers showed that it fell short of a key capital requirement by billions of dollars in 2002 and 2003.

Had it been apparent at the time, the $7.3 billion shortfall at the end of 2002 could have put Fannie Mae on a different trajectory. Regulators might have intervened -- as they did later, when accounting problems came to light. Wall Street might have reevaluated Fannie Mae's vaunted management, not to mention the value of its stock. And Fannie Mae might have been forced to raise additional capital or liquidate investments, sacrificing profits.

Instead, based on Fannie Mae's financial reports, the Office of Federal Housing Enterprise Oversight, which monitors Fannie Mae's financial safety and soundness, gave the company a passing grade.

"Fannie Mae's core capital of $28.079 billion exceeded the minimum capital requirement by $877 million," the agency said in early 2003.

The accounting correction Fannie Mae filed with the Securities and Exchange Commission last week offers an alternative version of history, inviting investors to roll back the tape and play it forward again without the illusions. Like all adventures in time travel, it's a matter of conjecture. The very act of traveling back in time equipped with better information might have altered the reality.

Ed Groshans, a stock analyst at Fox-Pitt, Kelton, speculated that Fannie Mae would not have allowed itself to be declared undercapitalized. If Fannie Mae executives had been forced to keep their books properly, they would have taken steps to avert a shortfall, Groshans said.

One option would have been to reduce Fannie Mae's investment portfolio, a major source of profit. In that case, investors could have seen Fannie Mae's earnings "come down fairly significantly," Groshans said. "People would have been a little bit concerned as to what was going on internally," he said.

A Fannie Mae spokesman declined to comment.

Chartered by the federal government, Fannie Mae plays a major role in the nation's housing finance system. It buys mortgages from lenders and helps lenders replenish their funds by packaging mortgages into securities for sale to investors.

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