July 16 (Bloomberg) -- In his zeal to crack down on false market rumors, here are a couple of places for Securities and Exchange Commission Chairman Christopher Cox to start looking: the U.S. Treasury Department and the Office of Federal Housing Enterprise Oversight.

At least Cox didn't know what he was talking about back in March when he publicly vouched for the strength of Bear Stearns Cos.' capital, just days before the investment bank collapsed. Treasury Secretary Henry Paulson and Ofheo's director, James Lockhart, have no such excuse for the way they pumped Fannie Mae and Freddie Mac last week.

In a statement on July 10, with shares of Fannie and Freddie in a freefall, Lockhart -- their chief regulator -- said they ``are adequately capitalized, holding capital well in excess of the Ofheo-directed requirement, which exceeds the statutory minimums.''

Paulson, testifying that day in Congress, backed Lockhart's assurances on Fannie and Freddie. ``Their regulator has made clear that they are adequately capitalized,'' he said. Federal Reserve Chairman Ben Bernanke also weighed in, saying, ``they are well capitalized in a regulatory sense.''

What these men should have known -- must have known -- is that the government's capital requirements for Fannie and Freddie are a joke.

Blown Credibility

The two government-chartered mortgage financiers were so well capitalized that Paulson had to announce a government rescue plan for them three days later on July 13, a Sunday. That was the same day the SEC issued its warning against ``manipulation of securities prices through intentionally spreading false information.'' Whatever credibility Paulson, Lockhart and Bernanke had in the marketplace before last week, they just blew a big wad of it.

The most amazing aspect of the government's capital requirements is that they let Fannie and Freddie count tens of billions of dollars of losses as capital, even though they don't qualify as equity. While it may be technically accurate to say that Fannie and Freddie are adequately capitalized by the government's measure, any assertion that they are adequately capitalized in real life just isn't true.

Let's start with Freddie. As of March 31, by the government's measure, it had $38.3 billion of core capital, $6 billion more than the minimum required. Under generally accepted accounting principles, though, the company had shareholder equity, or assets minus liabilities, of just $16 billion.

Overstate Reality

Both figures overstate economic reality. According to Freddie itself, the fair value of the company's net assets was negative $5.2 billion, while the fair value of the portion attributable to common stockholders was negative $16.9 billion.

The core-capital figure excluded $32.4 billion of unrealized losses on securities Freddie classified as available for sale. The sole reason these losses weren't counted is that Freddie said they were all ``temporary,'' even though $13.2 billion of them were on securities that had been valued below Freddie's cost for a year or longer. Some of the losses dated back more than two years.

That's not the kind of capital that would help Freddie absorb losses today. Rather, those are the kinds of losses that necessitate more capital.

Also excluded from the government's calculation was $3.9 billion of losses on derivatives that Freddie labeled as cash- flow hedges. The debt issuances being hedged haven't happened yet. Freddie calls them forecasted transactions, some of which stretch 26 years into the future. Freddie says it's ``probable'' they all will occur as projected. It's hard to imagine how ordinary human beings could be so prescient.

Deferred Losses

It gets sillier. As of March 31, Freddie showed $19 billion of gross deferred-tax assets, which is another fancy term for deferred losses. Companies can use such assets to offset future tax bills. However, they are valuable only to profitable companies that will pay income taxes in the future.

This seems a lot to expect of a company like Freddie, the very solvency of which is now in question. In fact, if Freddie were a regular bank, it wouldn't be allowed to count the vast majority of these assets as part of its regulatory capital.

The fuzzy math doesn't stop there. Those deferred-tax assets also lifted the asset values on Freddie's fair-value balance sheet. Without them, the fair value of Freddie's net assets would have looked much worse than negative $5.2 billion.

As for Fannie, it showed $42.7 billion of core capital as of March 31, $5.1 billion more than required. GAAP shareholder equity was $38.8 billion. On a fair-value basis, however, Fannie's net assets were worth just $12.2 billion. Of that, the portion attributable to common stockholders had a fair value of negative $2.1 billion. (Fannie raised $7.4 billion in additional capital in May.)

Fannie's Deferrals

Fannie's core capital excluded $9.3 billion of supposedly temporary losses on available-for-sale securities. It included $17.8 billion of deferred-tax assets, the kind that bank regulators normally wouldn't count. Like Freddie, Fannie hadn't recorded any valuation allowance against these assets as of March 31, meaning it had taken the position that it will be able to use every dollar of them.

In a July 11 statement, Fannie spokesman Chuck Greenersaid the company has ``more core capital, and a higher surplus over our regulatory requirement, than at any time in this company's history.'' The same day, Freddie said it's ``adequately capitalized, highly liquid and an essential part of the nation's housing system.''

If you didn't know the math yourself, you might be inclined to accept at face value the government's assurances that Fannie and Freddie are adequately capitalized.

That would make you a sucker.

No wonder our financial system is in such a perilous crisis of confidence.

(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Jonathan Weil in Boulder, Colorado, at jweil6@bloomberg.net

Last Updated: July 16, 2008 00:04 EDT