Fannie Mae and Freddie Mac, which have reported record profits after a taxpayer bailout, are ignoring billions of dollars in potential losses on delinquent loans as they take three years to adopt a new accounting system, a government auditor said in a letter made public today.
The accounting change could have a material impact on the companies' finances and should be implemented immediately, according to the Aug. 5 letter to Federal Housing Finance Agency Acting Director Edward J. DeMarco from Steve Linick, the regulator's inspector general.
"Three years appears to be an inordinately long period to fully implement" the change, Linick wrote in the letter posted on his office's website today.
The FHFA, which oversees Fannie Mae and Freddie Mac, in April 2012 ordered the companies to start writing off all loans delinquent for at least 180 days, a standard practice for regulated financial institutions. The companies previously hadn't charged off all loans in that category. FHFA later gave the companies until January of 2015 to comply.
The longer timeline is necessary to accommodate "considerable changes to systems and operations that could take time to complete in a safe, sound and well-controlled manner," FHFA Deputy Director Jon Greenlee said in an Aug. 9 letter responding to Linick.
Because they're not charging off some loans delinquent longer than 180 days, Fannie Mae and Freddie Mac aren't setting aside reserves against those losses, Linick said.
The companies have mentioned the coming accounting change in public disclosures filed with the Securities and Exchange Commission. They have not disclosed the potential extent of the losses.
In a May 2 meeting, Greenlee told the Office of the Inspector General that fully implementing the change "could potentially require them to charge of billions of additional dollars related to loans classified as 'loss,'" Linick wrote in the letter.
Both companies, which were seized by regulators in 2008 as they neared insolvency, have been posting record profits in recent quarters as the housing market rebounded. They purchase mortgages from lenders and package them into securities on which they guarantee principal and interest payments.
Fannie Mae officials said they were "currently assessing the impact of implementing these accounting changes on our future financial results," in the annual report for 2012 that the company filed with the SEC.
Both companies have reported in recent quarters that some of the increase in earnings is due to reductions in their reserves set aside to cover losses as the credit quality of the loans they back has improved.
Fannie Mae and Freddie Mac will be required to start providing quarterly estimates of the financial impact of the accounting change to FHFA and the Office of the Inspector General, Greenlee said. The agency also expects the companies to start reporting those estimates in their public financial statements, he said.
The two government-sponsored enterprises have received $187.5 billion in taxpayer aid since 2008. They've sent Treasury dividends totaling $132 billion, including $76 billion this year alone. Those payments count as a return on the government's investment, not as a repayment of the aid.
President Barack Obama has called for the two companies to be wound down and replaced by a government reinsurer that would cover mortgage losses in catastrophic circumstances. Private capital would take the initial losses.
Congress is also working on legislation that would liquidate them. In the Senate, Tennessee Republican Bob Corker and Virginia Democrat Mark Warner introduced a bill that would require private capital to take at least 10 percent of the first losses on mortgage securities. The government would step in with more aid during a financial catastrophe.
Republicans in the House of Representatives led by Jeb Hensarling of Texas are working on a bill that would eliminate Fannie Mae and Freddie Mac and limit government involvement in housing finance to the mortgage insurance provided by the Federal Housing Administration.