July 28 (Bloomberg) -- Forget everything you've read about how woefully undercapitalized Fannie Mae and Freddie Mac are. The situation is much worse. Unlike other companies, the two government-chartered mortgage financiers publish quarterly fair-value balance sheets showing what the real-world values of their assets and liabilities supposedly are. By this measure, both companies' net- asset values are much lower than what the government lets them show as capital, or what the accounting rules let them report as shareholder equity. The companies' critics for years have pointed to the gaps between these figures as proof that the government's capital requirements are a joke. What I hadn't realized, until an astute reader tipped me off, is that the fair-value balance sheets overstate the companies' asset values, too. The issue centers on the way Fannie and Freddie calculate their fair values for deferred-tax assets, which is really just a fancy term for deferred losses. If you believe the companies' numbers, the more money they lose, the more their deferred taxes are worth. Deferred-tax assets consist of tax-deductible losses and expenses carried forward from prior periods, which companies can use to offset future tax bills. Under generally accepted accounting principles, they are valuable only to companies that are profitable and paying income taxes. To the extent a company doesn't expect to have enough profits to use them, it's supposed to record a valuation allowance on its GAAP balance sheet. So Profitable Fannie and Freddie so far have recorded no such allowances. The two companies, of course, are so profitable right now that they're on the verge of a government bailout. By the government's main capital measure, Fannie had ``core capital'' of $42.7 billion on March 31, or $5.1 billion more than required, while Freddie had $38.3 billion, or a $6 billion surplus. Meanwhile, on a fair-value basis, Fannie said its net assets were worth $12.2 billion, while Freddie showed negative $5.2 billion. One reason the core-capital figures are so much higher is that the government lets Fannie and Freddie exclude tens of billions of dollars of pent-up losses on mortgage-related securities they're holding for sale, solely because the companies have deemed the losses ``temporary.'' Another reason is that core capital includes deferred-tax assets. Commercial banks, by comparison, normally don't get to count these in their capital, because they can't be sold by themselves and, thus, can't be used as a cushion against losses. Looking Ugly Here's where it gets tricky: On their fair-value balance sheets, Fannie and Freddie included adjustments to their deferred taxes that added billions of dollars to their asset values. Without the boosts, the companies' fair-value tallies would have looked even uglier. Start with Fannie. As of March 31, it showed $17.8 billion of net deferred-tax assets on its GAAP balance sheet. Fannie's fair-value balance sheet doesn't show a separate line for deferred taxes. Instead, Fannie included them in an item called ``other assets,'' to which it assigned a GAAP carrying value of $45.5 billion and a fair value of $60.7 billion. Using the methodology described in Fannie's footnotes, I was able to estimate that about $14.3 billion of that $15.2 billion differential came from adjustments to the company's deferred-tax assets. The way this works is the company calculates the tax effects on the difference between its shareholder equity at fair value and under GAAP; it then includes these in other assets. Going Negative Without that $14.3 billion of tax adjustments, the fair value of Fannie's net assets would have been negative $2.1 billion, by my math. Exclude deferred-tax assets entirely, and it would have been negative $19.9 billion as of March 31. (Fannie raised $7.4 billion of additional capital in May.) As for Freddie, it showed $16.6 billion of net deferred-tax assets under GAAP as of March 31. Like Fannie, it put deferred taxes in ``other assets'' on its fair-value balance sheet. Freddie said its other assets had a GAAP carrying value of $31.6 billion and a $42.5 billion fair value. By my calculations, using the methodology in Freddie's footnotes, it looks like Freddie wrote up the deferred-tax assets on its fair-value balance sheet by about $10.1 billion. So, take out the tax write-up, and Freddie's net assets had a fair value of negative $15.3 billion. Exclude deferred-tax assets entirely, and that falls to negative $31.9 billion. Asked for comment, Fannie spokesman Terence O'Hara and Freddie spokesman Michael Cosgrove each referred me to their companies' respective disclosures. Dream On In its latest quarterly report, Fannie said ``we anticipate that it is more likely than not that our results of future operations will generate sufficient taxable income to allow us to realize our deferred tax assets.'' Hence, no valuation allowance. Freddie gave a similar explanation in its July 18 registration statement with the Securities and Exchange Commission. The company also cautioned that ``if future events differ from current forecasts, a valuation allowance may need to be established which could have a material adverse effect on our results of operations and capital position.'' It's fishy enough to say no valuation allowances were needed under GAAP. Yet it seems beyond the pale to claim that, on a fair-value basis, their tax assets actually were worth more than what their regular balance sheets said. My guess is they're worthless now. Brace yourselves, taxpayers. Uncle Sam soon may have to write a very large check. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aryKxwWwjIDQ