Mortgage Giants Take Beating On Housing, Accounting Fears

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Shares of mortgage purchasers Fannie Mae and Freddie Mac tumbled Monday after a Federal Reserve official warned housing market problems would likely extend into next year and an analyst said accounting changes could leave the two woefully short of necessary capital reserves.

The government-sponsored enterprises are the nation's largest purchasers of mortgages. Their shares each hit fresh 52-week lows in Monday trading, and other financial stocks also lost ground.

In a speech in San Diego, San Francisco Federal Reserve President Janet Yellen said problems in the ailing housing market and banking system could get even worse before the economy recovers.

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"My expectation is that market functioning will improve markedly by 2009," Yellen said in a speech Monday. "But things could get worse before they get better," she warned.

Further declines in home prices could lead to larger losses for financial companies and hurt their ability to make new loans.

A continuation of the housing slump would hurt Fannie Mae and Freddie Mac's new business.

Freddie Mac shares plunged $2.59, or 17.9 percent, to $11.91 Monday after sinking to a 52-week low of $10.28 earlier in the session. Fannie Mae shares tumbled $3.04, or 16.2 percent, to $15.74 after hitting an annual low of $14.65.

Shares of many financial companies also fell. Lehman Brothers Holdings Inc. lost $2.01, or 8.8 percent, to $20.84; Morgan Stanley was down 84 cents, or 2.3 percent, to $35.07; and Merrill Lynch & Co. dropped 76 cents, or 2.4 percnt, to $30.36 and hit a 52-week low of $29.84, on worries that Wall Street hasn't seen the worst of the credit crisis.

Both Fannie Mae and Freddie Mac have been struggling since the middle of 2007 with rising defaults among mortgages and continued deterioration in the housing market as fewer homes are being sold and prices fall.

Freddie Mac lost $151 million during the first quarter, while Fannie Mae lost $2.2 billion.

Lehman Brothers analyst Bruce Harting said, in a note to clients, if a proposed change to accounting standards occurred, the companies could also be billions of dollars short of capital requirements.

The Financial Accounting Standards Board has proposed a change to accounting rules that would require financial services firms move off-balance sheet securitizations to their balance sheets.

Securitizations -- the sale of bonds backed by pools of loans -- are one of Fannie Mae and Freddie Mac's primary sources of generating new revenue.

If Fannie and Freddie were to have to add portions of their securitizations business back on to their balance sheets, Fannie Mae would need to raise $46 billion in cash to meet capital requirements, while Freddie Mac would need to raise $29 billion, Harting wrote.

Harting did note that Fannie Mae and Freddie Mac would likely be granted an exemption to the new accounting standard because they would be so undercapitalized under the new rule it would be nearly impossible for them to raise enough cash.

Friedman, Billings, Ramsey & Co. analyst Paul Miller said he strongly believes Fannie Mae and Freddie Mac would be excluded from the proposed change in the accounting rule.

Other capital raising efforts are affecting the stocks as well, Miller said.

In May, Freddie Mac said it would raise $5.5 billion in new capital to shore up its balance sheet, but has yet to complete that transaction. Half of the new capital would be raised through the sale of common stock, while the other half would come from the sale preferred stock.

Miller said minor accounting issues that need to be cleared up are hindering that deal from getting completed. In the interim, shares of Freddie Mac have continued to fall.

As the share prices fall, the capital raise becomes increasingly dilutive since it will require more shares to raise the $5.5 billion. That is creating a downward spiral that has investors unwilling to buy shares until the new stock is offered, Miller said.

AP Business Writer Jeannine Aversa in Washington contributed to this report.