How Temporary is 'Temporary'?

Freddie Mac, the government-chartered mortgage financier has had its accountants label approximately $32.4 billion worth of losses as temporary, allowing it to keep the associated losses off its income statement. With those losses representing as much as 20% declines in the face value of the mortgages, these losses would be the biggest ever experienced by the company. One has to ask, therefore, how long is temporary and when will these write downs come, if ever?

According to generally accepted accounting principles, Freddie can get away with this for as long as the rules are changed. What's really scary about this is the magnitude of the losses that are being hidden from investors relative to the company's assets. $32.4 billion is more than double its $16 billion in shareholders' equity and almost equally outweighing its market capitalization. Compared to its net assets of NEGATIVE $5.1 billion, the comparison is just laughable. If you were in this position, you would have gone bankrupt long-ago.

Fannie Mae, Freddie's big sister, is in a similar position, albeit to a lesser extent, with $9.3 billion in such losses. Of course, both these companies are betting on a market turnaround, which would see the underlying assets appreciate and eliminate the losses that they refuse to realize. That said, anyone who's owned a home knows that this appreciation can take many years and neither Freddie or Fannie have included anything in the notes to their financial statements indicating what their own expectations are for these reversals.

It's just a loop-hole and it will be closed sooner or later - forcing these firms to face the music. The reality, however, is that facing the music earlier in the process could have prevented much of what they're now trying to hide. Marking-to-market would have forced the firms to acknowledge the losses as soon as they started to appear and would have likewise forced them to make adjustments to their practices and strategies to compensate for those losses. The capital markets are a great motivator for management to do their jobs well; if they don't, they get fired by their boards who in-turn represent the shareholders.