naked capitalism

It would be nice if Fannie and Freddie would have the good taste to stay out of the spotlight, particularly since bad news is a sign of higher odds that Things Are Not Going Well, Especially for Bagholders Taxpayers.

However, it looks like we may not be so lucky. Bloomberg’s Jonathan Weil did some digging into the GSE’s reports, and they are even less pretty than we thought. Remember Poole’s remark that Freddie is “technically insolvent’? That view is based on a reading of the GSE’s “fair value” report (the comparable figure for Fannie as of March 31 is a not very encouraging $12.2 billion). The GSEs of course maintain that these reports are irrelevant and misleading, yet that methodology is more comparable to the published financials of banks and investment banks than the presentation more commonly used.

Weil tells us even those reports are overly rosy. From Bloomberg:

Forget everything you’ve read about how woefully undercapitalized Fannie Mae and Freddie Mac are. The situation is much worse….

Deferred-tax assets consist of tax-deductible losses and expenses carried forward from prior periods, which companies can use to offset future tax bills. Under generally accepted accounting principles, they are valuable only to companies that are profitable and paying income taxes. To the extent a company doesn’t expect to have enough profits to use them, it’s supposed to record a valuation allowance on its GAAP balance sheet.

Fannie and Freddie so far have recorded no such allowances

As noted above, Fannie’s fair value, which is tantamount to its mark-to-market net worth, is a mere $12.2 billion, and as former Fed president William Poole and others have discussed, Freddie’s is negative. Weil tells readers that the deferred taxes are one of the reasons the GSEs, which are not subject to SEC requirements, can report higher equity levels in their public financial statements:

….core capital includes deferred-tax assets. Commercial banks, by comparison, normally don’t get to count these in their capital, because they can’t be sold by themselves and, thus, can’t be used as a cushion against losses….

But even the fair value balance sheets contain this adjustment:

Without that $14.3 billion of tax adjustments, the fair value of Fannie’s net assets would have been negative $2.1 billion, by my math. Exclude deferred-tax assets entirely, and it would have been negative $19.9 billion as of March 31….take out the tax write-up, and Freddie’s net assets had a fair value of negative $15.3 billion. Exclude deferred-tax assets entirely, and that falls to negative $31.9 billion….

And removing these adjustments means both GSEs have negative net worth.