- The Washington Times - Monday, September 27, 2004

ASSOCIATED PRESS

Mortgage giant Fannie Mae, under pressure from federal regulators, has agreed to boost its reserve cushion against risk by several billion dollars.

Fannie Mae also consented to other sweeping actions to correct what were cited as serious accounting problems, including recalculating key transactions back to 2001 and tightening internal controls.

The government-chartered mortgage financer and its regulator said yesterday they had reached an agreement after negotiations last week and over the weekend.

On Sept. 20, the Office of Federal Housing Enterprise Oversight (OFHEO) told the Fannie Mae board that its eight-month-old investigation had found pervasive earnings manipulation to meet Wall Street expectations and serious accounting misdeeds, and it ordered “immediate remedial action.”

“This agreement is an important step toward resolving these concerns and helping to assure safe and sound operations” at Fannie Mae, OFHEO Director Armando Falcon said yesterday.

A Treasury official, meanwhile, renewed the Bush administration’s call for tighter government reins over Fannie Mae and Freddie Mac, the other huge government-sponsored mortgage company, which faced an accounting crisis 15 months ago.

“We think the legislation needs to be re-enacted, and the sooner the better,” Wayne Abernathy, the assistant Treasury secretary for financial institutions, told reporters, saying action by lawmakers might even be possible in the few remaining weeks before Congress adjourns. Key Republican senators and House members have urged such a measure.

OFHEO’s investigation continues, and Mr. Falcon said the issues being scrutinized include the accountability of Fannie Mae’s management. The Securities and Exchange Commission also is investigating the company’s accounting. The housing oversight regulators last week raised the possibility of removing top management of Fannie Mae, the biggest financer of home mortgages in the country and the second-largest U.S. financial institution after Citigroup Inc.

The revelations pushed down Fannie Mae’s stock more than 13 percent, to a 52-week low, in a three-day slide last week. The shares rose 53 cents to $66.04 yesterday in trading on the New York Stock Exchange.

Neither the regulators nor the company said whether Fannie Mae would have to restate its earnings, as happened last year at Freddie Mac.

Under the agreement with OFHEO, Fannie Mae will increase, within the next 270 days, its cushion of reserve capital against risk to 30 percent above its core capital of some $30 billion. The reserve level currently is at 18 percent above that core level, according to the company. The company also will recalculate all its transactions for derivatives, financial instruments it uses to hedge against interest rate and other risk, for all quarters going back to 2001.

To raise the approximately $5 billion needed to fill that gap, Fannie Mae could issue new stock, a move that could further weaken its share price; sell assets from its portfolio of investments, which in addition to billions in mortgages includes such items as aircraft leases; or even scale back its purchases of home mortgages from lenders for resale as bonds on Wall Street, which could reduce the supply of home loans for prospective buyers.

By contrast, Freddie Mac, which in January entered into a similar agreement with the regulators for a 30 percent reserve, did not have to raise the money because it had a surplus from having understated some $4.5 billion in earnings for 2000-2002.

Morgan Stanley and Prudential Equity Group swiftly downgraded their rating of Fannie Mae stock yesterday. “We believe that the requirement to carry extra capital could slow [Fannie Mae’s] growth over the near-to-intermediate term,” Prudential analyst Bradley Ball said in a research note.

In addition, Mr. Ball wrote, the requirement for the company to recalculate its accounting for derivatives and spreading out the cost of expenses over time “will at a minimum create uncertainty and confusion surrounding [Fannie Mae’s] past and prospective future results.”

Fannie Mae and Freddie Mac pump money into the home mortgage market by buying billions of dollars of home loans each year from banks and other lenders, then bundling them into securities that are resold to investors. Their stock and debt — Fannie Mae’s is nearly $1 trillion — are widely held by investors in the United States and around the globe.

An accounting crisis that erupted 15 months ago at Freddie Mac, with the restatement of earnings, the ouster of top executives and investigations by the SEC and the Justice Department, prompted OFHEO to examine Fannie Mae’s accounting.

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