Here are some exerpts from this thread. It was derivatives/hedging related stuff. Actually probably not too far off what's going on today if only for the reason they were improperly valuing stuff on their books, much like CDOs are completely and utterly improperly valued on everyone's books today and will significantly need to be marked down. I expect quite a few more hedge funds to bite the dust before it's all over.
quote: | From the WSJ on 9/24/2004:
quote:
According to OFHEO, FNM's accounting for its hedging activities and derivative transactions is not in accord with GAAP.
OFHEO found that FNM used "an imporper cookie jar" reserve for its portfolio of MBS, the likely source of most of the "smoothing" of EPS.
Both findings contradict FNM's assurances that it can deliver non-volatile earnings, year after year, b/c its business isn't risky.
OFHEO found that FNM "tolerated" lax internal controls, deferred expenses to achieve bonus compensation targets, and "maintained a corporate culture that emphasized stable earnings at the expense of accurate financial disclosures."
Comments from Lynn Turner on 10/14/2004:
quote:
FNM's study of its practices & policies for OFHEO will take at least as long as FRE, possibly up to a year or two.
SEC informal inquest will likely become a formal investigation in due time.
There's a possibility that FNM will be reporting unaudited earnings going forward, but unalbe to give an audited account in the 10Q filings as KPMG has recently refused to certify financial statements when there is an investigation ongoing.
That KPMG put $200M in unrecognized errors from 1997 on the scoresheet will go towards showing materiality under SAB 99 that mgmt left it out there to affect bonus payouts.
Being an SEC registrant exposes the CEO and CFO if internal controls are no good and the SEC would likely push to remove them if it believes they made false certifications. Facts so far indicate that there are serious internal control issues. It will be difficult for the CFO to survive, especially since he's on the board.
Restatements that could total in excess of $5B will dramatically reduce the company’s book value, its regulatory capital levels, and its ability to grow. The process will take time...
And the kicker/summary/ramifications from my source...
quote:
12/16/2004 Fannie faced with a potential $9B earnings restatement following SEC investigation for improper hedging and improper accounting. Ramifications of the SEC decision include:
· Likely departure of Franklin Raines and Tim Howard, leaving FNM temporarily without leadership.
· Restatement of 4 years of earnings, leaving the company vulnerable to investor lawsuits, like that filed by the Ohio AG.
· A filing of potential criminal charges by the DOJ.
· Need to raise capital, which could come from preferred stock, balance sheet shrinkage, or asset mix changes(i.e. securitizations require lower capital requirements).
·An impetus for Congress to push through GSE oversight legislation tha t will result in a stricter and more powerful regulator. Rep. Richard Baker(R-LA) has already called for further investigative hearings to take place in early ’05.
·Incentives for OFHEO to push harder with their investigative probing into the management practices, accounting policies and auditor independence. The SEC’s decision may actually provide Congress with the impetus to provide greater funding to OFHEO to pursue this role.
·Potential for the rating agencies to review their debt ratings of the GSEs, with the prospect that a downgrade in the future could have negative ramifications in the banking industry for holders of agency debt of GSE guaranteed MBS.
· A move by accountants, particularly Deloitte & Touche(which aided in the forensic accounting review of FNM’s accounting practices) to review the accounting policies and procedures for derivative structures at firms like IFIN or COF.
·This action could further spur the PCAOB to take further steps toward insuring auditor independence.
· Now that the losses in the “pay fixed/receive floating” rate swaps will be recognized, there could be an unwinding of the hedge of the hedge(i.e. selling the “receive fixed/pay floating” rate swaps), which could put pressure on the bond markets thereby creating a whipsaw to higher rates and a widening of swap spreads.
· A widening of swap spreads and higher nominal rates would send a chill through the “games playing” occurring right now in the sub-prime market.
·A significant delay before any SEC certified financial statements are made available again, which technically should bring into question NYSE listing requirements.
Not to mention the imminemt slowdown in the housing boom/rising rate environment/move to ARMs from FRMs, which Fannie can't deal in. And now that juicy little 3% dividend might be in jeopardy? Where do I sign up?!
But on second thought, you're right. This sounds like the ideal place to stash my hard earned duckets. These guys are the poster child of proper management and accounting. All of the negative issues are clearly behind them now and the skies are clear going forward. I know this is true because the stock price has gone up. Nevermind what could possibly happen if the government didn't give them "implicit backing". But I digress...this is for another discussion on another day. |
quote: | Mortgaging the Future
Fannie Mae's troubles are far from over
THE BIG HEADS FINALLY ROLLED at Fannie Mae last week, but the soap opera starring the company's crummy accounting is far from over.
Two weeks ago, the Securities and Exchange Commission stunned Fannie Mae and its many camp followers in Wall Street's analytic community and on Capitol Hill by corroborating serious accounting violations at the government-sponsored mortgage giant that will entail the reversal of about $9 billion in profits reported by Fannie over the past three and a half years. Then, on Tuesday, Fannie directors forced the departure of chief executive Franklin Raines and chief financial officer Tim Howard, and dismissed Fannie's outside accounting firm KPMG.
Raines, a former high-ranking official in the Clinton Administration, was a big-time power broker in Washington D.C., with the ability to reward politicians with large campaign donations and funding for pet housing initiatives in home districts. Fannie played the lobbying game with unmatched vigor and aplomb. Adding to Raines's cachet was the fact that he was one of the first African-Americans to head a Fortune 500 company.
Barron's readers were amply prepared for the latest developments. In a cover story earlier this year ("Swept Away," May 17) we warned that the quasi-public housing giant used unorthodox accounting to pump up its earnings and capital position and, at the same time, justify huge pay packages for Raines and other senior managers. We even detailed where the accounting games were being played: The company classified more than $13 billion of losing derivative positions as "cash-flow" hedges.
This treatment allowed Fannie to spread the losses over many years rather than expensing them immediately. These losses were incurred as a result of Fannie's inept hedging and ill-timed bet that mortgage rates would remain steady or rise.
[photo]
Fannie's Franklin Raines: out of a job
Three months ago, Fannie's regulator, the Office of Federal Housing Enterprise (Ofheo), released a stinging 200-page report that delineated serious violations of accounting rules. It charged Fannie with abuse of, among other things, expense recognition and its use of derivative accounting. Raines and other Fannie officials stoutly defended the outfit's accounting procedures in subsequent congressional hearings, stating that it would abide by any decision on accounting questions by the SEC, which in the meantime had launched its own investigation. Thus, Fannie rolled the dice and lost big-time when the SEC, in effect, ruled in favor of Ofheo.
Yet Fannie's chorus of cheerleaders on Wall Street remains mostly in denial. Last week, Robert Napoli of PiperJaffray held to his view that the Fannie contretemps is largely a mere "accounting issue" and kept his 12-month target price for Fannie's stock at 95. The shares currently trade around 72.
Jonathan Gray of Sanford Bernstein, a longtime holder of Fannie in his personal account, saw fit to drop his price target to 84 from 86, following the departures of Raines and Howard. Yet he has long depicted Ofheo's investigation of Fannie as a witch hunt by an overzealous regulatory agency.
We would observe the following, however. Since it will take Fannie months, if not years, to restate nearly four years of results, the company will be unable to file current earnings reports with the SEC for many, many quarters to come. Thus, earnings projections are an exercise in the theater of the absurd.
And more bad news seems likely to emerge as Ofheo continues to probe other accounting areas at Fannie. Likewise, Wall Street seems to be ignoring an ongoing Justice Department probe of possible criminal-accounting fraud at Fannie. Before it's all over, Fannie may well enjoy the dubious distinction of perpetrating the largest accounting fraud in U.S. corporate history, topping the $11 billion mark set by WorldCom that sent the telecom concern careening into bankruptcy in 2002.
[chart]
After expensing its derivative losses, Fannie will be some $3 billion below its Ofheo-mandated minimum-capital requirement, with regulatory capital of around $30 billion. At least that's the capital deficiency as of the end of the third quarter. If nothing materially changes, that capital deficiency would balloon to over $12 billion by June 30, 2005, when Fannie must meet an Ofheo-mandated capital surcharge of 30%.
At a minimum, Fannie likely will have to suspend its dividend, which would save it about $2 billion a year. The company likely will marshal more capital by shrinking its billion-dollar investment portfolio through run-off and cutbacks on new purchases of mortgages and mortgage-backed securities.
Some analysts hope Fannie can realize gains in its investment portfolio. (Gray claims that as of the end of last year there were $14 billion of such after-tax gains, based on Fannie's "fair value", marked-to-market balance sheet.) However, most of these gains can't be harvested because they sit in Fannie's hold-to-maturity portfolio. Besides, at this point, who can believe the values Fannie assigned to either its assets or liabilities as of that date? And rising rates won't help much in paring the losses in its derivative portfolio, since the bulk of those losses already have been locked in or offset by swap positions that would lose value in a rising rate environment.
Fannie over the years has used its huge permitted capital leverage to gun its growth and earnings. But leverage can hurt when operations are shrunk. To come up with $10 billion in new capital if all else fails, Fannie would have to dump over $300 million of its trillion-dollar investment portfolio. That, of course, would decimate earnings. Sadly, Fannie promises to be a falling-rock zone for stock investors for the foreseeable future.
-- Jonathan R. Laing
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More than you wanted to read, right? I know.
As to why FNM and FRE may still have more risk on their balance sheets than they want you to know about...posted by Occ when he started working at Freddie--it would sound like FNM and FRE probably bought up a lot of subprime/"high yield" mortgages since they generally buy the smaller mortgages, which invariably are probably more weighted towards the lower end of the credit spectrum. Fannie and Freddie are public companies and are just as guilty of chasing profits and yields as anybody else, so who's to say they weren't seduced by higher-yielding, lower quality loans?
quote: | [b]originally posted by Occrider
So here goes ... I just started a new job working for Freddie Mac (which is one of the reasons why I never post during work hours anymore). To fill you in on what Freddie Mac and Fannie Mae (our primary competitor) do, we essentially were created by the federal government during the great depression in order to make affordable housing possible. It works like this: houses cost upwards of $300,000 to purchase. Banks loan money out to people so they can buy houses. Banks don't have enough money to loan out enough money to everybody in the community to buy houses. What would happen is that banks would be ultra elitist with who they lend money to (ensuring 0% deliquincies) and interest rates would be through the roof because risk would be high for that particular bank because it's a shitload of money to lend. Therefore Freddie Mac and Fannie Mae purchase mortages from banks, package them together into a security, and sell it to wallstreet and investors with gauruntees in case of deliquincy. The banks therefore have plenty of capital to lend out to homeowners.
Sounds peachy right? Well, Fannie and Freddie actually don't make the most of our money doing this. We make the most of our money by buying securities ourselves, hedging them, and retaining a portfolio much like most of the other investment banks do. In doing so, we have much more profits to issue to homeowners applying for mortages. This is ultimately a good thing, however, the problem is, is that we focus on making money as opposed to truly helping homeowners. Now then, Bush hates Fannie and Freddie. Treasury Secretary Snow hates Fannie and Freddie. They don't like governments in private markets, and they recognize us for what we are ... government sponsored private enterprises that are motivated towards profit rather than helping homeowners. As a result, Fannie and Freddie have been making enormous sacrifices to help homeowners at the expense of profit ... a good thing to a certain degree.
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In retrospect, I was almost prophetic...
quote: | originally posted by Shakka
Second, I think the GSE's have gotten themselves into trouble due to their wreckless hedging tactics. Not that they're doing what anyone who wants to make money wouldn't do, but as GSE's with a specific role/obligation to help create affordable housing, they have taken on substantially more risk and have become increasingly more aggressive than they should due to that lovely "implied backing" from the gov't. They have become increasingly focused on the hedging side and have been playing some accounting shinanigans according to a lot of smart money--particularly with how they are able to defer unrealized losses in the "other income" portion of the balance sheet.
Bush is pro-reform here, and I'd bet it's in part because he understands business and would like to get a better regulator involved to prevent a potential meltdown as interest rates climb their way higher again. While some people think he's just throwing water on the fire and trying to slow down an economic boom, those with a longer view would prefer a new/more effective regulator even though doing so might cause some short-term pain. OFHEO is clearly not doing enough to mitigate the potential risks that could come from the massive hedging and risk that FNM and FRE have taken on.
Since you work there, I suppose self-preservation is a huge driver of personal choice! I think there needs to be better regulation, not to mention better disclosure on the derivative side of their books. Whether the OFHEO steps up or a new regulator gets involved, something is going to have to happen one way or another, though so much politicking and beaurocratic debate might make change a difficult thing to accomplish. |
Hell, I was talking about a possible subprime meltdown 3 years ago!
quote: | Originally posted by Shakka on 7/14/2004
Provided there's no sub-prime meltdowns! I don't know about Freddie, but Fannie got bit in the ass recently due to their exposure to manufactured housing. For the sake of the economy I hope nothing happens to them! |
Last edited by Shakka on Aug-05-2007 at 13:54
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