Attempting to Heal a Fractured Mortgage Market

By David S. Hilzenrath
Washington Post Staff Writer
Wednesday, April 16, 2008

A federal regulator said yesterday that it has "significant supervisory concerns" about the conditions of Fannie Mae and Freddie Mac, two government-sponsored housing finance companies that own or guarantee trillions of dollars of mortgages.

Both companies have suffered financially from the meltdown in the housing market and remain vulnerable to further declines, but Freddie Mac's problems run deeper, the regulator said.

Freddie Mac still has some ineffective internal controls, has invested in poorly underwritten loans and lacks "sufficient executive management depth," the Office of Federal Housing Enterprise Oversight said in an annual report to Congress.

The regulator also raised questions about accounting decisions Freddie Mac made last year, saying they need further review. Those issues include Freddie Mac's approach to calculating the amount of money it should hold in reserve and other accounting choices that enabled the company to report a one-time gain of about $1 billion.

Under an accounting rule, Freddie Mac was able to book income from changes in the value of securities it held and was able to choose which securities to use that way, presenting the opportunity to cherry-pick.

In an interview, OFHEO Director James B. Lockhart III said the agency was not challenging the accounting judgments Freddie Mac has already made but will be monitoring its approach going forward "to make sure there's a logical and ongoing methodology."

The Securities and Exchange Commission may look at the accounting issues as Freddie Mac seeks to register with the SEC this year, Lockhart said.

At the end of last year, Fannie Mae and Freddie Mac had $4.8 billion and $15 billion of paper losses, respectively, that they had not counted against earnings, OFHEO said. The deferred losses involve what the companies regard as temporary declines in the value of mortgage-related investments, but determining whether the losses are permanent and therefore must be counted against earnings is a judgment call, OFHEO said.

"This is raising a yellow flag," Lockhart said. "Obviously, if we had a major issue with any of these they would have made a change," he said.

The regulator's assessment came several years after twin accounting scandals prompted Fannie Mae and Freddie Mac to replace their top managers and begin overhauling the systems they use to track finances.

The government has been counting on Fannie Mae and Freddie Mac to help prop up the troubled mortgage market, and toward that end OFHEO last month agreed to let them operate with thinner financial cushions. In announcing the decision, OFHEO emphasized the progress both companies had made in recovering from the accounting scandals.

In the report released yesterday, OFHEO gave Fannie Mae more credit than Freddie Mac. Fannie Mae's internal controls range "from satisfactory to adequate," the regulator said.

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