Scandal stocks
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NEW YORK (MONEY Magazine) -
Fannie Mae is reeling. In December, CEO Franklin Raines was forced out largely because of charges that Fannie had manipulated its earnings.
The SEC said Fannie's improper accounting, which involved complex questions about investments in derivative securities, overstated earnings by as much as $9 billion.
But there are more fundamental problems. The corporation, which was created by Congress, was designed to keep the U.S. mortgage market functioning smoothly and to encourage home ownership by middle-class and working-class people.
It buys home loans from banks and either sells them in the form of mortgage-backed securities or adds the loans to its own mortgage portfolio. Fannie can borrow cheaply to finance its enormous mortgage business, despite having relatively little capital, because creditors assume that the government stands behind the company.
But Republican-controlled Washington is looking less favorably on all such government-sponsored programs. As banks merge and get larger, they also complain more vocally about the special treatment Fannie Mae enjoys. The accounting scandal just bolsters the critics' case.
Fannie has been allowing the size of its mortgage portfolio to grow rapidly -- nearly 17 percent a year -- because that contributes more to profits than repackaging mortgages does.
But directly owning more loans also increases risk. The company will probably have to rein in its portfolio growth -- either to manage down risk or because the government tells it to.
To conserve cash and meet new capital requirements imposed by regulators, Fannie had to cut its dividend in January and will probably remain on a tight budget.
And while the stock's P/E of less than 10 looks cheap, there are lots of big lenders with below-average P/Es that don't have Fannie's problems.
Next: Merck and Pfizer
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