Enron all over again

Post-Enron era was supposed to be different but just six years after the disaster it feels as though somebody hit rewind.

I read above lines searching for ''Fannie Mae'' this morning. Actually today morning, I was going through my website's tracker report and found that somebody from ''Fannie Mae'' was surfing my website doing an organic search using the keywords ''Risk Consulting Mumbai''.

Fannie Mae explained to its nervous investors about the change in the way it discloses its bad loans and whether the change is masking the mounting losses. However, the chief financial officer and other executives failed to answer some important questions about loan losses and left the investors in doubt about the Company's financial footing.

Fannie Mae changed the method for calculating its credit-loss ratio, an indicator of its bad loan losses as a percentage of its overall loans. Investors have been using the credit ratio to assess the credit quality of Fannie Mae's mortgages. Fannie Mae had announced recently an annualized credit-loss ratio of four basis points for the first nine months of the year that was well within the company forecast but If it had not changed the method, it would have had a credit loss ratio almost twice the four basis points, high enough to start making the investors nervous.

Essentially, the company was able to lower the ratio by excluding a certain type of loss known as SOP 03-3 loss.

Here is how SOP 03-3 losses work: Fannie Mae guarantees mortgages, which have been packaged and sold to investors as bonds. If a house-owner falls significantly behind on his payments, Fannie Mae has to buy back the loan from the bondholder. If the mortgage has an outstanding amount of, say, $100,000 and unpaid interest of $5,000, Fannie Mae would have to pay $105,000, its full value, to make the bondholders whole.

However, the $105,000 loan may actually be worth less on the market. It is Fannie Mae's job to estimate the market value, or fair market value, of the loan and to record that price on its books. So if the fair market value is $80,000, Fannie Mae takes a loss of $25,000 (the difference between $105,000 and $80,000). This loss is considered an SOP 03-3 loss.

Until recently, Fannie Mae included SOP 03-3 losses as part of its credit-loss ratio. But here's the trick: Fannie insists that, based on past trends, it can recover a large part of that $25,000 loss by, for example, helping the borrower renew payments. So it simply decided to stop including SOP 03-3 losses in calculating its credit-loss ratio.

Fannie Mae executives failed to provide numbers showing what proportion of SOP 03-3 losses are recovered, but promised to disclose them in the future. One possible reason why Fannie Mae doesn't want to provide information on recoveries is because it might be using assumptions that are too optimistic, potentially underestimating SOP 03-3 losses.

Now, question remains why somebody at Fannie Mae was looking for Risk Consulting in Mumbai at this time.