By the time the government moved in, Freddie had accumulated $34.3 billion of paper losses on mortgage-related securities that it excluded from its calculations of regulatory capital. All Freddie had to do was say the losses were ``temporary,'' and they could be kept out of the company's capital figure. It didn't seem to matter how ridiculous the claim was.
Fannie played the same game. As of June 30, it had $11.2 billion of supposedly temporary losses on mortgage-related securities, which it excluded from its calculations of core capital, as the government calls it. (A better name would be ``kore kapital,'' like the imitation krab sticks on a sushi bar menu.)
The so-called temporary losses had the warped effect of inflating a line item on both companies' balance sheets called deferred-tax assets. The bigger the companies' losses got, the more these tax assets grew, based on the premise that someday the companies would be able to use the losses to offset future income-tax bills.
The catch is that if a company doesn't expect to have enough profits to use these assets, it's supposed to record a valuation allowance on its balance sheet to reduce their size. Freddie and Fannie didn't let this requirement get in the way. They never set up any allowances.
This is from Bloomberg, Sept. 9, by Jonathan Weil. I don't get why the auditors didn't challenge this for 2007 statements and refuse to give the GSEs an unqualified opinion?