Cleanup Is No Easy Task

Wall Street Journal (05/27/08) P. C12; Reilly, David; Eavis, Peter
A compromise on housing legislation between Congress and the Bush administration means the government-sponsored enterprises (GSEs) could soon have a new regulator that observers believe will focus on reducing their risks to the financial system. However, observers point out that the complexity of Fannie Mae and Freddie Mac's balance sheets could pose a challenge for the new watchdog. They note that the GSEs are allowed to put deferred tax assets on their balance sheets; these assets are called "mirage capital" because they would not help them raise cash if necessary, and they also are not required to write down a portion of these assets if it appears they will not be used during their approximate 20-year life span. Additionally, Fannie Mae and Freddie Mac can include unrealized losses on their balance sheets; and while these are expected to be temporary, experts point out that the GSEs have reported unrealized losses on debt securities that are more than a year old--suggesting that they are more than temporary. Finally, observers note that Fannie Mae and Freddie Mac's loan-loss reserves are much less than the 20 percent to 40 percent of loan value that lenders are encouraged to reserve when a standard mortgage becomes delinquent.