As if Enron’s effects on the accounting industry weren’t enough, Financial Week reported on September 18 that Fannie Mae and Freddie Mac inflated their core capital with the use of deferred tax credits.
The article states: “When companies have losses, they are allowed to recognize tax-deferred credits in the year of the loss, even though the reduction in taxes they produce will only be realized in future years in which they have taxable income, and thus a liability they can use the credit to reduce. Fannie Mae and Freddie Mac used that method to almost double the amounts they claimed as capital reserves.”
Financial Account Statement 109 provides the methods for computing deferred tax assets and requires that firms consider whether it is more likely than not that the deferred tax asset will be not be realized. Freddie and Fannie haven’t shown a profit in several years and little prospect of futrue profit against which to use these deferred tax assets.
Quoting Robert Willins, a tax and accounting consultant, the article continues: “They’re not writing down the tax assets at all,” said Mr. Willens, even though “it’s almost impossible to avoid a write-down when you have a history of cumulative losses. Nevertheless, these guys have been able to avoid it with the concurrence of their auditors.”
Fannie and Freddie counted these “assets” toward their regulatory capital and were able disguise their lack of liquidity.
And so it goes.