- The Washington Times - Thursday, March 18, 2004

Media attention on the opacity of the accounting practices of mortgage giant Fannie Mae has delivered a surprising result. In a break with past accounting practices, Fannie agreed to divulge its realized losses on derivatives trades. In the absence of much-needed congressional action on oversight over Fannie Mae and America’s other large mortgage financing company, Freddie Mac, media scrutiny has delivered tangible results. While this is positive, it doesn’t replace the need for regulatory reform, especially since Fannie failed to address calls for more frequent public disclosures.

For the first time in its history, Fannie Mae specified in a filing to the Securities and Exchange Commission its realized losses on derivatives trades. These were almost $7 billion at the end of 2003, while its total losses on derivatives, including unrealized losses, were $12 billion. Fannie Mae’s derivatives holdings surged 59 percent to more than $1 trillion by the end of last year.

There is good reason for all the attention on Fannie and Freddie. Any faltering by the two companies could have enormous implications for the U.S. economy as a whole. Washington-based Fannie Mae has more than $900 billion of debt, making it the second-largest borrower in the country, after the federal government.

But some qualifications are in order. It’s not so much the size of the companies that’s a problem, but also the companies’ failure to properly hedge their exposure. Perhaps what best illustrates the faulty hedging is the fact that both Fannie and Freddie had speculated on interest rate movements, and each expected rates to go in opposite directions. Fannie expected rates to trend upward (and took a hit), while Freddie bet on a trend downward and became flush with so much cash it improperly tried to make its earnings appear more stable to disguise the extent of its speculating.

So it is not so much the companies’s much-discussed derivatives exposure that is worrisome, but rather their overall hedging strategy. And while Fannie’s recent improvement in derivatives disclosure is welcomed, the company failed to address the more critical concern with the frequency of its filings, which this page and some legislators have highlighted. Fannie only reveals the value of its derivatives portfolio once a year. It should do so quarterly, as Freddie Mac currently does.

Fannie has taken a constructive step in quieting media furor. But it must also recognize the importance of timely transparency for its own long-term financial health.

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