Fannie Mae's Trust Fund Troubles
There's no disputing anymore that Fannie Mae (FNM) will have to recognize huge losses that were previously kept out of earnings and that its financial statements are a terrible mess.
But there are indications that the mortgage giant's bookkeeping was so badly done that it could end up having to bring huge amounts of assets onto its balance sheet as part of a cleanup of its financial statements.
And any large-scale transferal of assets onto its balance sheet would be a nightmare for Fannie, because it could be extremely expensive to carry out, take many months to execute and, in a worst-case scenario, leave the government-sponsored company severely undercapitalized.
Potential PitfallsEver since Fannie mentioned that OFHEO was looking at the off-balance-sheet assets, investors were forced to look for ways in which Fannie's accounting for the assets might be wrong. And there are a number of ways in which it might have been misapplied. Fannie buys billions of dollars of residential mortgages each year and then does one of two things with them. It keeps a large portion on its balance sheet and earns interest from them. The others it bundles up into bonds called mortgage-backed securities. Fannie guarantees the mortgages in these MBS deals and aims to make profits from the guarantee fees over time. To issue MBS, Fannie uses so-called qualified special-purpose entities, or QSPEs. But it appears that Fannie may have failed to take the necessary steps to gain QSPE status for its off-balance-sheet assets. If the entities don't qualify, Fannie would have to bring all the assets they contain onto its balance sheet. Last year, when discussing an amendment to FAS 140, the accounting rule that partly governs QSPEs, former Fannie accounting officer Jonathan Boyles said that consolidating off-balance-sheet entities "would substantially increase Fannie Mae's minimum capital requirements." In a previous column, Detox estimated that if a fourth of the $1.42 trillion of assets came on balance sheet, it would mean Fannie raising its minimum capital by a range of $7.3 billion to $9.9 billion.
Control FreaksThe first big problem is that Fannie appears to continue to have too much control over the loans in the QSPEs, which are supposed to be almost totally independent of Fannie. In the disclosures for its MBS entities, Fannie says that it has the "right and the option, without obligation and in its discretion, to withdraw" certain delinquent loans from the pools of MBSs. But FAS 140 says that a company that runs a QSPE can't have ad hoc discretion over what assets go in and out of the trust. Any additions or removals have to happen according to preset "automatic" guidelines.
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