Fannie Mae, Freddie Mac Warned on Accounting

By David S. Hilzenrath
Washington Post Staff Writer
Tuesday, April 22, 2008

Years after Fannie Mae and Freddie Mac were found to have misrepresented their earnings by billions of dollars, a federal regulator is warning them to follow both the spirit and the letter of a new accounting rule.

The Office of Federal Housing Enterprise Oversight said it would consider taking action against the government-sponsored mortgage funding companies if their handling of the new rule raises concerns, even if their conduct "technically complies with the accounting standard."

The OFHEO statement came less than a week after the regulatory agency said it found "certain issues" in Freddie Mac's implementation of accounting standards which "raise concerns" about the company's capital, the financial cushion it is required to maintain to protect against losses.

To reduce the risk of the companies becoming so weak that they are unable to meet their obligations without a bailout, the government requires them to operate with at least a certain amount of capital, determined by a federal formula.

The regulator noted last week that Freddie Mac's approach to implementing the new accounting rule generated a $1 billion gain as of Jan. 1, "providing an immediate boost to Freddie Mac's regulatory capital."

Freddie Mac briefly fell below its required capital level late last year. Maintaining sufficient capital can involve costly tradeoffs for the firms, such as issuing new stock, which can dilute the holdings of existing shareholders; scaling back their operations; or cutting the dividends they pay shareholders.

OFHEO's statement yesterday provided guidance to the companies and their examiners related to a rule called FAS 159, which allows companies to adjust their books each quarter to reflect changes in the value of certain assets and liabilities. The agency said the companies should document such decisions in detail when they are made -- preventing them from making retroactive changes.

"Further, if OFHEO detects patterns of use of the fair value option that impair transparency or distort earnings or capital, OFHEO will evaluate whether such application of the [rule] is unsafe and unsound," the regulator said.

The regulator seemed to be "sending kind of a shot across their bow," said Bert Ely, a financial services industry consultant and longtime critic of the two companies.

Asked whether the companies have done anything in the past that was inconsistent with the guidance that OFHEO issued yesterday, OFHEO spokeswoman Stefanie Mullin responded by e-mail that the agency is still evaluating their implementation of FAS 159. The companies have not yet reported results for the first quarter of 2008, she added.

"We believe that our implementation of this option meets the spirit of the OFHEO guidance," Freddie Mac spokeswoman Sharon McHale said.

As of Dec. 31, Freddie Mac's so-called core capital totaled $37.9 billion, which exceeded its federal requirement by $3.5 billion. The company's application of the new accounting rule boosted Freddie Mac's capital by $1 billion as of Jan. 1, making it that much easier for the company to meet its requirement for the first quarter of 2008.

Other accounting changes contributed $1.3 billion to Freddie Mac's capital as of Dec. 31, the company said in its 2007 annual report.

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