Fannie... Freddie... and Accounting?

[UPDATE 7.14.08: Over the weekend, U.S. Treasury Secretary Henry M. Paulson announced a plan in which the Treasury would bolster funding of Fannie Mae and Freddie Mac, and the Federal Reserve issued this statement on Sunday. See also this July 13 statement by the White House Press Secretary that "President Bush directed Secretary Paulson to immediately work with Congress to act on" a plan to bring stability to the 2 GSEs, adding, "It is crucial that Congress quickly works to enact this legislation as a complete package along with the strong oversight reform legislation recently passed in the Senate." See also press release issued by the SEC on Sunday, "Securities Regulators to Examine Industry Controls Against Manipulation of Securities Prices Through Intentionally Spreading False Information."]

The New York Times is reporting today (July 11) “U.S. Weighs Takeover Plan for Two Mortgage Giants.” Citing “people briefed about the plan on Thursday,” authors Stephen Labaton and Steven R. Weisman say “Bush administration officials are considering a plan to have the government take over one or both” of the Government Sponsored Enterprises (GSEs) in the housing loan business, Fannie Mae and Freddie Mac. Further, they say, the government may “place them in a conservatorship if their problems persist.”

The possible role of accounting standards with respect to changes in the position of the GSEs has been covered in the press this past week; for example, the above-cited NYT article says:
“Despite repeated assurances from regulators about the financial soundness of the two institutions, financial markets have concluded that by some measures they are deeply troubled. Freddie, for instance, is technically insolvent under fair value accounting rules, in which the company puts a market value on assets as if it had to sell them now. “

Another accounting topic cited regarding Fannie and Freddie is off-balance-sheet accounting. Some press reports earlier this week noted rumors swirled following release of a report from Lehman Brothers noting among other things that Fannie and Freddie may be forced to raise significant amounts of capital as a result of impending tightening of criteria to receive off-balance sheet accounting for securitizations in upcoming proposals amending FAS 140 and FIN 46R. A summary of proposed changes to FAS 140 and FIN 46R can be found on pdf pages 49-54 of the June 24 handout for FASB’s advisory committee, FASAC.

For example, Charles Duhigg reported in “Mortgage Fears Cast Shadows at 2 Agencies,” in the NYT yesterday that: “It is unclear precisely why Fannie Mae and Freddie Mac suffered so greatly Monday. Early in the day, analysts at Lehman Brothers estimated that a proposed change in accounting rules would require the companies to raise about $75 billion in additional capital — an enormous sum for two companies that have already asked investors for $25 billion since December.” Duhigg continued, “But other analysts disputed Lehman’s conclusions, and even the Lehman report predicted the proposed rule changes would not be enacted, or that the two mortgage companies would be exempt.”

Indeed, James Lockhart, Director of the Office of Federal Housing Enterprise Oversight (OFHEO), stated earlier this week, "From our standpoint, an accounting change should not drive capital. It would be no difference in the risks of the two firms,” as reported by Damien Paletta in the WSJ July 9, “Ofheo Allays Worries Over Fannie, Freddie.” Lockhart issued a similar message to soothe the markets in a followup OFHEO statement yesterday.

David Reilly wrote in the Heard on the Street column in the Wall Street Journal on Wednesday, “Investors panicked earlier this week over the possibility that accounting-rule changes could force Fannie Mae and Freddie Mac to raise $75 billion in additional capital.” He added, “Even if the proposed changes make Fannie and Freddie take back onto their books trillions of dollars in securitized assets, it is up to regulators to decide how much capital needs to be set aside.” Reilly also noted, “Even if Fannie and Freddie dodge them, the new rules … which govern the treatment of off-balance-sheet vehicles could potentially force Citigroup Inc., Bank of America Corp. and J.P. Morgan Chase & Co. to take billions of dollars in assets onto their books.”

“Fears about the impact on Fannie and Freddie could lead banks to argue that the changes will make the mortgage mess even worse and tie up capital that banks could use to shore up the economy,” said Reilly. A frequent moderator on FASB webcasts, Reilly continued, “FASB needs to stand firm in the face of such arguments. Banks need to set aside capital for the risks they face. The board also needs to reject calls for exceptions for Fannie and Freddie. That would only open the door for banks to argue for special treatment.”

For another point of view, see "Selloff in Financial Stocks Lacks Sense," by James B. Stewart, also in Wednesday's WSJ.

Concern about the potential changes in the off-balance-sheet accounting rules and the timing thereof in potentially deepening the current market crisis led a group of associations representing financial institutions to meet with staff of the SEC, Treasury and Federal Reserve earlier this week, reported Denise Lugo in yesterday’s BNA Daily Report for Executives. In her article, “Financial Coalition Wants FASB to Delay Proposals on Off-Balance-Sheet Activities,” Lugo said the consortium included representatives of the Commercial Mortgage Securities Association, American Securitization Forum, Securities Industry and Financial Markets Association, National Association of Realtors, Real Estate Roundtable and the Mortgage Bankers Association. She notes Chip Rogers, President of the Real Estate Roundtable, “said that the consortium urged regulators that the effective date being proposed by the FASB for implementing the guidance be postponed for another year so that companies would have more time to develop appropriate systems that would not impair market liquidity.”

Questions on the role of accounting rules in potentially driving investors and others behavior, vs. the role of accounting as a neutral picture of economic reality, were among issues debated at SEC’s Roundtable on Fair Value Accounting on Wednesday. Concerns were expressed at that roundtable about difficulties in determining fair values in accordance with FAS 157 when markets became illiquid. As we reported earlier this week, in response to concerns voiced by roundtable panelists and others (including the Financial Stabililty Forum), SEC Chairman Christopher Cox stated that SEC, FASB and PCAOB staff will follow-up by considering further guidance on fair value. Separately, it will be interesting to see if the timetable proposed by FASB (in part at the request of the SEC and President’s Working Group) will be extended, or if any exceptions will be made for Fannie Mae and Freddie Mac, in FASB’s upcoming revisions to the off-balance sheet accounting rules.

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