Fallout from Fannie, Freddie

More than three years after Freddie Mac first acknowledged that it may have made accounting errors in what some people think was an effort to "smooth out" earnings, both Freddie and secondary market rival Fannie Mae remain mired in efforts to revamp their accounting infrastructure and regain the confidence of regulators and investors.

The plight of the two secondary market giants, which have spent hundreds of millions of dollars trying to fix their problems, is a cautionary lesson for companies trying to account for complicated mortgage assets in their financial statements. You've heard the saying that an ounce of prevention is worth a pound of cure. The cost of re-mediating accounting problems at the two giant secondary market corporations illustrates that principle well.

Both Fannie Mae and Freddie Mac announced news lately that highlights just what they've been through, and just how far they will have to go before their problems are put behind them.

Fannie Mae went first, announcing in late May that it had agreed to pay a $400 million fine amid charges that the company manipulated earnings to meet executive bonus targets. The company still faces shareholder litigation that could put the eventual cost much higher and is nowhere near the point where it can report regular quarterly financial results.

Freddie Mac, which was first to get dragged into the accounting mess and is further along in its restatement, announced its 2005 financial results a week later, but the market focused in on the fact that Freddie Mac's earnings fell considerably from one year earlier - in no small part because of costs associating with the accounting fix - and on the fact that Freddie Mac won't be reporting timely financial results until at least early in 2007. The company's stock price fell in the aftermath of its earnings news.

Both companies also face possible limits on their highly profitable investment portfolios. (Fannie has already agreed to hold its mortgage portfolio at year-end 2005 levels.)

So far, the accounting issue hasn't hit servicers directly. But a look at some of the largest mortgage lenders in Puerto Rico shows that managing mortgage assets can be tricky terrain for lenders as well as for the secondary market agencies. (c) 2006 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com