Fannie Mae derivatives accounting

I posted on this some time ago. Fannie Mae, the largest buyer of home mortgages, has been ordered to restate earnings over the last four years, which will force it to recognize a $9B loss by marking the value of its derivatives portfolio to market.

WSJ: Fannie and Freddie, whose shares are traded on the New York Stock Exchange, were chartered by Congress to pump money into the housing market. They both buy mortgages from banks and other lenders, holding some of those loans on their books and selling others in the form of securities to investors.

Both companies' rapid growth has been fueled by the investing public's longstanding belief that the federal government would bail out the two enterprises if they ever ran into solvency problems. Federal Reserve officials in recent years have tried to quash such notions, though with little success. And today, the companies continue to enjoy far lower costs of capital than other financial institutions and are held to much looser capital requirements than commercial banks or dealers in government bonds. They currently have combined debt outstanding of around $1.7 trillion, about a third of it owed to foreign central banks and other overseas investors.

...The findings concern accounting rules known as Financial Accounting Standards 133 and 91. FAS 133 sets requirements for booking gains and losses on derivative contracts, which Fannie uses heavily to hedge against swings in interest rates. In accounting for those derivative contracts, both the SEC and Ofheo found, Fannie incorrectly applied the rules in a way that allowed it to spread out losses over many years rather than booking them immediately. Fannie used its own methodology to determine that it qualified for so-called hedge accounting, which would have allowed it to spread out losses. But the SEC said Fannie didn't take the steps necessary to qualify for hedge accounting.

Fannie is increasingly holding a lot of mortgages in its portfolio (rather than just reselling them), exposing it to huge interest rate risks. I never felt confident they were hedging properly against these risks - hedge funds in this business blow up all the time. There are implications for the dollar as foreign central banks (particularly PBOC) have been buying a lot of agency debt (Fannie, Freddie). Franklin Raines is toast. Stay tuned for more...