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Fannie Mae to boost reserve

Under pressure from federal regulators, mortgage giant Fannie Mae has agreed to boost its reserve cushion against risk by several billion dollars and take other sweeping actions to correct what were cited as serious accounting problems, including recalculating key transactions and tightening internal controls.

Some experts said Monday that the mandate to increase its reserve capital by mid 2005 means the biggest financer of home mortgages in the country might have to slow its growth or shrink in size.

The government-chartered mortgage financer and its regulator said Monday they had reached an agreement after negotiations that stretched over the weekend. Last Monday, the Office of Federal Housing Enterprise Oversight told the Fannie Mae board that its 8-month-old investigation had found pervasive earnings manipulation to meet Wall Street expectations _ and in one case to meet target levels for the award of executive bonuses _ and other serious accounting misdeeds, and it ordered "immediate remedial action."

OFHEO director Armando Falcon called the agreement reached late Sunday with the board "an important step toward resolving these concerns and helping to assure safe and sound operations" at Fannie Mae.

The new capital requirement "theoretically could make mortgages more expensive," said Keith Gumbinger, a vice president at HSH Associates, a publisher of mortgage information based in Pompton Plains, N.J.

"Those funds to build reserves have to come from some place, most likely profits on products they sell," he said. "So rather than seeing passthrough increases (in interest rates) to the consumer, it's likely their profitability will be trimmed over the next period."

Still, analysts at credit-rating agency Standard & Poor's _ which last week said it was considering downgrading some of Fannie Mae's debt _ said Monday they were "encouraged" by the speed with which the company and the federal agency had reached accord.

A Treasury official, meanwhile, renewed the Bush administration's call for tighter government reins over Fannie Mae and Freddie Mac, the other huge government-sponsored mortgage company, which faced an accounting crisis 15 months ago.

"We think the legislation needs to be re-enacted, and the sooner the better," said Wayne Abernathy, the assistant Treasury secretary for financial institutions, adding that action by lawmakers might even be possible in the few remaining weeks before Congress adjourns. Key Republican senators and House members have urged such a measure, which the two politically influential companies have lobbied against for years.

OFHEO's investigation continues, and Falcon said the issues being looked at include the accountability of Fannie Mae's management. The Securities and Exchange Commission also is investigating the company's accounting. The housing oversight regulators last week raised the possibility of removing top management of Fannie Mae, the second-largest U.S. financial institution after Citigroup Inc.

The revelations pushed down Fannie Mae's stock more than 13 percent, to a 52-week low, in a three-day slide last week. The shares rose 99 cents to close at $66.50 Monday on the New York Stock Exchange.

Last week, the Washington company announced it had named a special committee of outside directors to negotiate with OFHEO and deal with the SEC's inquiry. Fannie Mae said it had revised its employment contracts with the three top executives, including chairman and chief executive Franklin Raines, to ensure that if they were fired, they wouldn't get huge severance payouts.

Neither the regulators nor the company said Monday whether Fannie Mae would have to restate its earnings, as happened last year at Freddie Mac.

Under the agreement with OFHEO, Fannie Mae will increase, within the next 270 days, its cushion of reserve capital against risk to 30 percent above its core capital of some $30-billion. The reserve level is at 18 percent above that core level, according to the company. The company also will recalculate its transactions for derivatives, financial instruments it uses to hedge against interest-rate and other risk, for all quarters going back to 2001.

To raise the about $5-billion needed to fill the gap in reserves, Fannie Mae could issue new stock, a move that could further weaken its share price; sell assets from its portfolio of investments, which in addition to billions in mortgages includes such items as aircraft leases; or even scale back its purchases of home mortgages from lenders for resale as bonds on Wall Street, which could reduce the supply of home loans for prospective buyers.

By contrast Freddie Mac, which in January entered into a similar agreement with the regulators for a 30 percent reserve, did not have to raise the money because it had a surplus from its having understated some $4.5-billion in earnings for 2000-2002 in order to smooth future earnings.