Fannie and Freddie and Shady Accounting

It appears that both firms grossly overstated their capital using accounting tricks, and the Morgan Stanley auditors hired caught the problems:

Indeed, one person briefed on the company’s finances said Freddie Mac had made accounting decisions that pushed losses into the future and postponed a capital shortfall until the fourth quarter of this year, which would not need to be disclosed until early 2009. Fannie Mae has used similar methods, but to a lesser degree, according to other people who have been briefed.

Some techniques used:

• Not writing down their subprime and alt-A loans to market prices.
• Counting deferred tax credits, which are worthless until a company generates a profit, as capital. (Only Fannie and Freddie have the right to do this)
• Extending the default period on a loan before declaring a loss from 90 days to two years.

This is all stuff that only Fannie and Freddie could do. No other US bank is allowed to.

This is why the elimination of political and lobbying activities is important. The mess uncovered will become even bigger as normal accounting is applies.