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The Office of the Inspector General of the Federal Housing Finance Agency (OIGFHFA) recently released a statement accusing Fannie and Freddie of shielding billions of dollars in losses.
That should come as a shock to no one.
More disappointing, the statement and accompanying documents identify FHFA as complicit in this scheme to deceive Congress and taxpayers about the true health of the failed Enterprises.
This story begins in April 2012, when the Inspector General issued an advisory bulletin recommending changes to Fannie’s and Freddie’s accounting practices. In the most basic terms, the problem centers on how Fannie and Freddie treat single-family loans in their portfolio that are more than 180 days past due. The chances of these loans ever getting current again are extremely rare; therefore, they are generally categorized as losses. Accountants at Fannie and Freddie did not classify these loans as losses, and that raises questions about the true health of the housing giants.
Billions in Losses
The losses being concealed at Fannie and Freddie are estimated to be in the billions of dollars, but no one really has a firm grasp on how deep the losses may be.
From a policy perspective, this news is troubling on a number of levels. Fannie and Freddie have been reporting massive profits, and many have concluded those numbers are evidence of a housing recovery. It now appears that, at best, the quarterly results published by Fannie and Freddie are incomplete, and at worst, fraudulent. Furthermore, those figures are used to make broader policy decisions from Congress to the Federal Reserve. It seems many decisions based on the previously reported numbers will have to be reconsidered.
The Inspector General outlined its concerns about the accounting problems at Fannie and Freddie in great detail in a memorandum to acting director Edward DeMarco on August 5th. As far back as January 2012 the OIG identified a “significant risk management issue” in the treatment of single-family loans delinquent more than 180 days at Fannie and Freddie. The OIG stated that the failure to classify these loans as losses conflicted with conventional safety and soundness practices, was inconsistent with the system for loan classification followed by federal banking regulators, and violated generally accepted accounting principles (GAAP).
FHFA recognizes the issues raised by the OIG, but does not appear to be all that keen to be responsive or transparent. FHFA has proposed a deadline of January 2015 to implement the accounting recommendations made by the OIG – a full three years after OIG first spotted the irregularities. In response to OIG’s request to immediately begin reporting the losses, FHFA offered to report them through its “confidential supervisory process” starting in the third quarter of 2013. (No, I have no idea what that means, but it does not sound terribly transparent or compliant with the OIG’s request.)
What does this mean for us?
So, what does this all mean for investors and the housing market? We may not know until the numbers come out, but it is clear that the massive profits being reported by Fannie and Freddie were inflated due to an accounting gimmick. While there have clearly been signs of recovery in the housing market, those signs are accompanied by reports such as this which should give pause to anyone involved in the real estate market betting on a robust and speedy recovery.
Unfortunately, the accounting issues at Fannie and Freddie are completely consistent with their attitude toward distressed properties in general. Since the crash, Fannie and Freddie have made public statements and engaged in policies that tried to erase the reality of their situation. They tried to reject all notions of a discount for distressed properties by dismissing the discount as a “stigma” and implying that anyone who does not pay full retail value for their portfolio may be engaged in fraud. They are shielding a shadow inventory of at least 1.7 million properties. And now we learn they are cooking the books to inflate their profits.
For investors planning their short- and long-term business models, information is the key. Generally speaking, the press and Wall Street seem to be trying to sell everyone on the authenticity of the housing recovery. And their arguments have some merit. But there is no question, given facts uncovered by the OIG, our lobbying team, and other groups, that there will continue to be significant opportunities for distressed property buyers as the recovery lurches forward.
John Grant
is the president of the Distressed Property Coalition, a private advocacy effort formed by the top leaders in the residential real estate industry, and dedicated to private market solutions, smaller government, and protecting taxpayers. DPC exists because investors deserve an easier path to buy and sell houses. Investors deserve to shape policies that govern them, not to be subjected to them. Investors deserve better information on current laws and policies. Investors deserve a safe environment to learn more about the industry. DPC is dedicated to providing these services to the residential real estate community. Their content and track record of success in Washington are unprecedented for this industry.
To received Mr. Grant’s policy briefings and newsletter, please visit www.distressedpropertycoalition.com