Fannie Mae to Boost Capital to Correct Accounting Problems

Under pressure from federal regulators, Fannie Mae's (FNM) board has agreed to sweeping action to correct what were cited as serious accounting problems.

Fannie Mae (search) agreed to boost the mortgage giant's capital, recalculate key transactions back to 2001 and tighten internal controls.

Experts said Monday that the agreement could crimp profits, slow growth or force the sale of assets at the nation's largest financer of home mortgages.

The government-chartered mortgage financer and its regulator said Monday they had reached an agreement late Sunday after negotiations last week and over the weekend.

A week ago, the Office of Federal Housing Enterprise Oversight (search) told Fannie Mae that its eight-month-old investigation had found pervasive earnings manipulation to meet Wall Street expectations as well as serious accounting misdeeds. It ordered "immediate remedial action."

"This agreement is an important step toward resolving these concerns and helping to assure safe and sound operations," OFHEO Director Armando Falcon said in a statement Monday.

A Treasury official, meanwhile, renewed the Bush administration's call for tighter government reins over Fannie Mae and Freddie Mac (search), the other huge government-sponsored mortgage company, which faced an accounting crisis 15 months ago.

"We think the legislation needs to be re-enacted, and the sooner the better," Wayne Abernathy, the assistant Treasury secretary for financial institutions, told reporters. He said action by lawmakers might even be possible in the few remaining weeks before Congress adjourns. Key Republican senators and House members also have urged such a measure, which the two politically influential companies have lobbied against for years.

The housing oversight regulators last week raised the possibility of removing top management of Washington-based Fannie Mae, the second-largest U.S. financial institution after Citigroup Inc. (C) That's still possible.

The revelations pushed down Fannie Mae's stock more than 13 percent, to a 52-week low, in a three-day slide last week. The shares stabilized Monday, rising 99 cents to close at $66.50 on the New York Stock Exchange.

Neither the regulators nor the company said whether the massive recalculations ordered for Fannie Mae would force it to restate earnings. It is the Securities and Exchange Commission, which also is investigating Fannie Mae's accounting, that will determine whether a restatement is called for, oversight office spokeswoman Corinne Russell said.

Freddie Mac wound up having to restate $4.5 billion in earnings for 2000-2002, which mostly had been understated.

Under the agreement, Fannie Mae will increase, within the next nine months, its cushion of reserve capital, needed in case future problems arise, by about $5 billion.

To raise that money, Fannie Mae has several options. It could issue new stock, a move that could further weaken its share price; sell assets from its portfolio of investments, which includes billions in mortgages plus items such as aircraft leases; or even scale back its purchase of home mortgages, which could reduce the supply of home loans for prospective buyers.

Fannie Mae is unlikely to pass the costs onto home buyers, meaning the requirements could cut into the company's profits, Keith Gumbinger, a vice president at HSH Associates, a publisher of mortgage information based in Pompton Plains, N.J.

"Those funds to build reserves have to come from some place, most likely profits on products they sell," he said.

Still, analysts at credit-rating agency Standard & Poor's -- which last week said it was considering downgrading some of Fannie Mae's debt -- said Monday they were "encouraged" by the speed with which the company and the federal agency had reached an accord.

The company also agreed to recalculate all its transactions for derivatives, financial instruments it uses to hedge against interest-rate and other risk, for all quarters going back to 2001.

Fannie Mae and Freddie Mac pump money into the home mortgage market by buying billions of dollars of home loans each year from banks and other lenders, then bundling them into securities that are resold to investors. Their stock and debt -- Fannie Mae's is at nearly $1 trillion -- are widely held by investors in the United States and around the globe.