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Derivatives losses fuel doubts over Fannie Mae

By Stephen Schurr in New York
Financial Times
Tuesday, March 9, 2004

a href=http://news.ft.com/servlet/ContentServer?http://news.ft.com/servlet/Cont...
pagename=FT.com/StoryFT/FullStoryamp;c=StoryFTamp;cid=1078381640902amp;p=101257
1727088

Fannie Mae paid a net $25.1 billion on derivatives transactions
in under four years -- nearly all of which may represent losses
that cannot be recouped, in turn depressing future earnings.

The potential scale of the liabilities, which have yet to be
recognised in the company's earnings or in the minimum
capital adequacy required by its regulator, raise fresh doubts
about the financial health of the mortgage finance giant.

Regulation of Fannie Mae and its sibling Freddie Mac is
rapidly moving up the agenda in Washington, amid concerns
that the two goverment-sponsored entities have grown so big
that they pose a systemic risk to the U.S. financial system.
The two entities own or guarantee mortgages totalling $4,000
billion.

How the $24 billion losses estimate is reached

On Tuesday John Snow, U.S. treasury secretary, renewed the
criticism, saying: quot;We don't believe in a too-big-to-fail doctrine,
but the reality is that the market treats the paper as if the
government is backing it.quot;

His comments follow similar warnings from Alan Greenspan,
chairman of the Federal Reserve, and Gregory Mankiw,
chairman of George W. Bush's council of economic advisers.

Fannie Mae acknowledges it has taken losses in its derivatives
trading that have not yet been recognised it its earnings, but
declines to disclose the amount. The reason, said Jonathan
Boyles, vice-president of financial standards and taxes at
Fannie Mae, is that quot;we don't believe it's all that meaningful.quot;

A Fannie Mae spokeswoman added that the company typically held
its positions to maturity and as such it did not see the losses
as material.

Next Monday Fannie Mae is due to release its annual quot;fair
value disclosurequot; -- a statement of the current market value of
its derivatives positions. Observers will be watching to see if
the gap between the company's regulatory capital and fair value
has widened further than the $6 billion shortfall of a year ago.

A Financial Times analysis of Fannie's accounts suggests it
may have incurred losses on its derivatives trading of $24
billion between 2000 and third-quarter 2003. That figure
represents nearly all of the $25.1bn used to purchase or settle
transactions in that period. Any net losses will eventually
have to be recognised on Fannie Mae's balance sheet, depressing
future profits.

Fannie Mae maintained that the losses from cashflow hedging
will have no bearing on the capital adequacy required by its
regulator.

However, critics increasingly question whether Fannie Mae's
financial disclosure offers a complete picture of its fiscal
health.

quot;They have used the derivative accounting rules for cash-flow
hedges to defer some losses that they have taken,quot; said John
Barnett, senior analyst at the Center for Financial Research amp;
Analysis, an independent research firm. quot;They may not be as
well-capitalised as they appear to be for regulatory purposes.quot;

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