Fannie Mae's Trust Fund Troubles

Second, it appears that Fannie may not have made its off-balance-sheet entities sufficiently remote. FAS 140 suggests strict guidelines for this. Companies transferring assets to the QSPEs are supposed to execute a legally clear-cut sale of the assets, but since Fannie doesn't typically book gains on the assets it transfers, the legal requirements many not have been fulfilled.

In addition to possible accounting problems, Fannie may also have failed to properly document the assets held in off-balance-sheet trusts. That could mean that the yield on Fannie's MBS may not exactly match the underlying loans that are supposed to be in the MBS, since Fannie may have failed to classify which loans go with which securities.

Of course, if Fannie's QSPE accounting isn't correct, it could in theory transfer the assets back on balance sheet and immediately reissue them with the correct accounting. But it wouldn't be as easy as that. Investors would probably demand some fee for participation in an exchange offer. Moreover, it might be extremely difficult to do because the documentation may be too slipshod to do an organized reissue.

In that case, OFHEO would be best advised to demand the assets come on balance sheet until an orderly solution is found. It would have to demand sharply higher capital during that period. And since Fannie is already undercapitalized, a demand for more capital could result in Fannie being classified as severely undercapitalized and put it on an extremely shaky footing.

While this may seem outlandish, it's hard to think of any alternatives.

In theory, OFHEO could just order the assets on balance sheet but demand only a small capital hike. But that would be extremely risky, as it's not clear how long the assets may have to stay on balance sheet. For example, if the value of the once-off-balance-sheet assets slid in an economic downturn and Fannie was holding less capital than it should against them, the company would be horribly exposed.

Clearly, the Fannie mess is nowhere close to being cleared up.

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