“By Dawn Kopecki Of DOW JONES NEWSWIRES

WASHINGTON -(Dow Jones)- Investigators combing through Fannie Mae’s (FNM) finances have found new and pervasive accounting violations showing executives embellished the company’s earnings over the years by overvaluing its assets, underreporting credit losses and misusing tax credits - on top of what’s already been disclosed, according to people close to, or who have been involved in, the inquiries.

Several of these people examining Fannie’s books also said evidence indicates the company purchased so-called finite insurance policies to hide earnings losses after they were incurred.

Securities regulators, including New York State Attorney General Eliot Spitzer, are cracking down on corporations they say bolstered earnings by using abusive financial reinsurance policies that are more akin to loans where little or no risk is transferred to the insurer.

These people said Fannie’s accounting problems uncovered thus far stand in stark contrast to those found at fellow government-sponsored enterprise Freddie Mac (FRE), whose earnings restatement in 2003 showed the company deferred roughly $5.3 billion in excess, after-tax profits to future quarters. The GSEs - which buy mortgages, guarantee their payment and bundle them as securities that are sold off or held in portfolio - own or guarantee nearly half of the $8 trillion residential mortgage market. Their accounting scandals, however, have left the companies vulnerable to increasing criticism in Washington where lawmakers are considering legislation to rein in the home financing giants.

At Fannie, much of the company’s accounting violations have helped them to conceal losses over the years - rather than delay gains, according to these people. In addition, they said Fannie’s restatement is likely to show that its total cumulative losses will be higher and will include more “realized” losses, as opposed to paper losses, than the company has previously disclosed and many investors anticipate.

That’s attributed, at least in part, to new evidence that Fannie has artificially pumped up the underlying value of its $768 billion mortgage portfolio and other investments, compounding the size of the errors that need to be corrected. Unlike Freddie, the real economic losses at Fannie simply aren’t going to show up in future quarters period since the underlying value of their assets was inflated, these people said.

Fannie Mae officials declined to comment on specific accounting issues raised in this story.”

It seems that Mr. Potato Head (Franklin Raines)’s profits are, at the very least, substantially overstated. Quite apart from the reputation impact, this means that FNM’s dividend is likely to disappear permanently and, in fact, FNM may need a bailout.

Mortgage companies’ profits have been based primarily on the “carry trade”, that is, profiting from the spread between mortgage rates and short-term borrowing rates. Since the Fed has raised short rates to the point where this spread is now slim to non-existent, it is very difficult for these companies to make any money. An example would be Annaly Mortgage (NLY), generally believed to be the best-managed such outfit. This is a major risk to FNM’s “earnings”.

In addition, of course to the extent that long-term rates rise (if they do) then the value of the portfolio declines. FNM attempts to hedge these effects using derivatives, but it appears that they are not very expert at doing so. One would therefore conclude that FNM is at substantial risk from interest rate fluctuations.

Last but not least, FNM is an owner or guarantor for probably half of the outstanding mortgage debt. Current hurricane damage will prove a big hit for FNM, but more importantly any economic downturn causing a significant level of mortgage defaults will negatively impact FNM’s bottom line.

IMO, this news makes it quite likely that FNM will need a government bailout in due course which will honor its debt but leave the common stockholders with nothing except some pretty paper.

“Stan Sexton, a broker in La Mesa..said there are more than 300 homes on the market now in La Mesa and the College Area, a high number that he attributes to people wanting to take their equity to the bank. ‘Prices have leveled out,’ he said. ‘Everyone’s trying to cash out now, but it’s too late. Now they’ve got hundreds of properties to compete with. A lot of agents like myself have more activity than accomplishment. Negotiating is taking longer, you don’t have people lining up making multiple offers, and you have a lot more buyers coming in with lowball offers.’”

San Diego Union-Tribune

“The American Bankers Association reported Wednesday that the seasonally adjusted percentage of credit card accounts 30 or more days past due rose in the April-to-June quarter to 4.81 percent. That followed a delinquency rate of 4.76 percent in the first quarter and was the highest since the association began collecting this information in 1973.”

AP

“Investing some of China’s massive foreign reserves into U.S. Treasurys is ‘not worthwhile,’ a senior party official said Thursday.”

“‘I think it’s better that China should invest its huge forex reserves in overseas energy resources stocks as reserves,’ said Zheng Xinli, deputy minister of China’s Central Policy Research Office.”

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