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Freddie Mac justifies hiding $Billions on off balance sheet losses because "30 years from now" the hedges will be profitable?

 
triple wtf???!!!
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12/05/2007 12:19 PM
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Freddie Mac justifies hiding $Billions on off balance sheet losses because "30 years from now" the hedges will be profitable?
[link to www.bloomberg.com]
Anonymous Coward (OP)
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12/05/2007 12:21 PM
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Re: Freddie Mac justifies hiding $Billions on off balance sheet losses because "30 years from now" the hedges will be profitable?
Freddie Mac's Accounting Evokes Shades of Enron: Jonathan Weil

By Jonathan Weil

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Dec. 5 (Bloomberg) -- You have to wonder if a company is playing games when its earnings hinge on predictions no mere mortal is capable of making. That's one of Enron Corp.'s great lessons. And it's one that Freddie Mac investors might heed now.

Before it collapsed in 2001, Enron recorded large profits by estimating the values of its future cash flows from energy contracts that extended 20 years or longer. It then booked those amounts as current earnings. Even if Enron's executives had been acting in good faith, which they weren't, the forecasts they made weren't humanly possible.

Freddie's results depend on similar predictions, with a twist. The Mclean, Virginia-based company is using far-out forecasts of future cash flows to avoid recognizing large losses in its net income and capital. To believe Freddie's financial statements, you must believe the government-sponsored mortgage financier can make prognostications about its cash flows and debt issuances as long as 26 years from now.

``It's preposterous to think anyone can predict cash flows out that far,'' says Edward Ketz, an accounting professor at Pennsylvania State University. ``When you start thinking 26 years out, it becomes doubtful that the cash flows would occur as predicted.''

Here's how the accounting works. Freddie's Sept. 30 balance sheet shows $4.3 billion of pent-up losses on derivatives called cash-flow hedges. Companies use these side bets to guard against interest-rate fluctuations on, for example, variable-rate debt.

Changes in the hedges' values don't hit net income immediately. Instead, they go into a line in shareholder equity called accumulated other comprehensive income, or AOCI. From there, they are released gradually into net income as payments come due.

Doesn't Count

These losses also don't count in the primary gauge the government uses to measure Freddie's capital, the financial cushion that helps any company absorb losses. Had Freddie counted them in net income, it would have fallen $3.7 billion short of its minimum capital requirement at the end of the third quarter.

Freddie says it has closed out almost all its cash-flow hedge positions, meaning the losses are now fixed. It says about 70 percent of its AOCI will be released into earnings over the next five years. The rest will take longer.

So what's getting hedged? Many of the hedged items don't exist yet. That's because they are ``forecasted transactions,'' primarily future issues of debt. The company says it has hedged the cash-flow risks on such deals as far out as 2033.

Under the accounting rules for derivatives, a future deal must be ``probable'' to qualify as a hedged transaction. So must the deal's terms, such as size and timing. This is where the forecasts get tricky.

Think Back

Consider how hard it would have been for a company in 1981 to envision and hedge its cash-flow risks on a debt sale it thought back then that it would make in 2007.

``Who could have predicted the Internet being where it is today?'' Ketz says. ``Who could predict that China would be the economic power that it is? Even in the U.S., the decline of, say, General Motors -- I don't think anyone would have predicted that in 1981. These are structural changes that affect the society and economy, and they can affect the cash flows that occur.''

Predictions even a few years out are tough. Will the next president be a Democrat friendly to Freddie and Fannie Mae, or a Republican who's not? How much more will home prices fall in the next year? Where will interest rates be? And wouldn't these developments affect Freddie's business and plans?

Consider the History

A Freddie spokeswoman, Sharon McHale, says the company knows its forecasted transactions are probable because it ``has a history of issuing significant amounts of debt instruments, well in excess of amounts hedged.'' The mortgages and mortgage securities it purchases stretch over 15 to 30 years, she notes, while the longest maturity for Freddie's debt is 10 years. Therefore, ``we know there is a need for debt issuances in the future to fund existing and future mortgage securities that have not fully prepaid prior to their stated maturity.''

Still, knowing the need will exist isn't the same as knowing what the terms and risks will be.

Judging by Freddie's $34.6 billion of so-called core capital at Sept. 30, which was about $600 million above the government-set minimum, Freddie already was adequately capitalized. And by keeping its $4.3 billion of losses in the AOCI holding tank, Freddie is signaling that a like amount of benefits will materialize in years to come.

Nonetheless, after posting a $2 billion net loss for the third quarter, Freddie last week had to raise $6 billion through a preferred-stock offering and cut its dividend by half to shore up its dwindling capital. That undercuts the notion that its cash-flow hedges are working properly. If they were, then Freddie should be getting around $4.3 billion of gains over the next 26 years. So there would be no need for a capital infusion.

Yet there was such a need. And until just recently, Freddie didn't see it coming. The lesson for investors: Freddie's crystal ball is no better than yours.

(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)
pissedoff
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12/05/2007 02:10 PM
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Re: Freddie Mac justifies hiding $Billions on off balance sheet losses because "30 years from now" the hedges will be profitable?
Welcome to zany world of government financing! The way our 'leaders' cook the books makes Enron look like childs play. The last time the FED was audited was in 1993 and many serious problems were uncovered. Was anything done? Has an audit occured since then? HELL NO!!!!! Just like Clinton's 'surpluses'which were simply accounting entries the government could not tell the truth if their lives depended on it because they have sold out lock stock and barrel in order to save their collective asses at the cost of the citizens. Why do you think the Bushs have bought tens of thousands of acres in a country with no US extradition treaty?
Anonymous Coward
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12/05/2007 02:15 PM
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Re: Freddie Mac justifies hiding $Billions on off balance sheet losses because "30 years from now" the hedges will be profitable?
WELL AT LEAST WE KNOW WE CAN DEPEND ON THEM TO TELL US THE TRUTH ABOUT SEPTEMBER 11TH, THAT'S ONE THING YOU CAN TAKE TO THE BANK. NO WAY WOULD THEY EVER TELL US A LIE ABOUT THAT ONE, NO SIREE.





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