It used to be that Fannie Mae and Freddie Mac, the two giants of the mortgage industry, were as reliable as sunrise but now both have failed the most basic test of any business, the ability to get their books right.

Freddie Mac has admitted that it did not report a total of $4.4 billion in profits in 2000, 2001 and 2002 as well as $600 million in prior years -- that's a total of $5 billion. In addition, Freddie Mac also failed to mention that, whoops, it lost $111 million in the first quarter of 2001 rather than the $719 million profit it originally announced -- a difference of $820 million.

Now comes Fannie Mae with an accounting problem objectively worse than Freddie Mac's for two reasons: First, a bigger number is involved. Second, the number is a loss, not a profit.

The Securities and Exchange Commission says Fannie Mae needs to re-do its numbers to account for unreported losses between 2001 and mid-2004.

How much is involved? According to a statement released by Fannie Mae in November that would be $9 billion.

In plain language, what's happened here is that losses which the SEC says companies should report each quarter were not disclosed when Fannie Mae's financial results were announced.

Investing has always been defined by the effort to maximize profits and avoid losses. It would seem that such results cannot be guaranteed, but a number of years ago very bright people with lots of advanced degrees set out to prove that assured results or at least less marketplace risk are possible.

The alleged trick is to hedge investments so that any loss is off-set by profits, to buy and sell at the same time. In the world of big-time finance this is done with the use of "derivatives," financial instruments with values based on such things as the movement of commodity prices and foreign currencies.

The idea is not so much to make a profit as to preserve the value of your holdings. If the current price of hot dogs in your inventory is $8 apiece you might sell hot dog futures short so that if the price falls to $6 you profit from the futures even though the value of your inventory has declined.

In theory, though, you can sometimes work this system so that even though the futures contracts are bought to only offset inventory risk it's actually possible to profit from such arrangements. Of course, if you can make the system work to make a profit it follows that the system can work to produce a loss -- and that brings us to Fannie Mae.

Big financial entities such as Fannie Mae want derivatives to protect the value of their holdings in the face of changing interest rates. There are standard rules to report such investments, including what's known as "FAB 133" -- more than 200 pages of exciting accounting tips and guidelines.

The SEC says that under FAB 133 Fannie Mae should have shown the value of its derivatives portfolio for each quarterly accounting period. Had it done so, some $9 billion in losses would have been disclosed.

Fannie Mae will now have to re-state past accounting reports and set aside additional dollars to increase its capital base.

Is there a bottom line to all of this? Sure.

First, there's no such thing as investment without risk. You have a better chance of breeding unicorns.

Second, had the derivative losses been shown would Fannie Mae managers have been entitled to any or all of the reported $245 million in bonuses they received in the past five years?

Third, would not $245 million have been better spent furthering Fannie Mae's core mission and holding down mortgage costs for borrowers?

Fourth, one way for Fannie Mae to raise additional capital would be to sell off part of its loan portfolio -- in effect, to downsize. Downsize enough and Freddie Mac could wind up as the bigger entity.

Both Fannie Mae and Freddie Mac are GSEs -- government sponsored enterprises. They each enjoy special tax breaks and other advantages which allow them to borrow money at lower costs than private-sector competitors.

In addition to the usual reasons why Fannie Mae and Freddie Mac should be privatized -- unfair competitive advantages, profits for private shareholders but risks for Uncle Sam -- we now have the issue of woeful management.

As government-related entities, Fannie Mae and Freddie Mac shares have historically been outside the jurisdiction of the SEC. In March 2003 Fannie Mae elected to "voluntarily" register its stock with the SEC, as did Freddie Mac.

This is nonsense. General Motors, Microsoft, IBM, Time Warner and other major corporations do not have the option of volunteering to accept SEC oversight. They do not get to avoid a host of taxes and fees merely because they are large.

What's important here is that we need a functioning and efficient secondary market to assure that mortgages are available nationwide at the lowest possible cost. Accounting disputes and unreported financial results suggest risk, increased risk makes investors nervous, and nervous investors want higher interest rates.

Plainly there would be a lot less risk in the mortgage marketplace if Fannie Mae and Freddie Mac were private companies subject to the same rules and costs as every competitor. After all, while Fannie Mae and Freddie Mac may be too big to fail, they're small enough to privatize, regulate and tax.

For more articles by Peter G. Miller, please press here.