What Is Fannie Mae's Accounting Fraud

Fannie Mae’s Fraud

1. Fannie Mae was established in 1938 as a federal charter under President Franklin Roosevelt as a secondary market to expand the flow of mortgage money under any economic condition because millions of Americans could not become homeowners before Fannie Mae. In 1968 Fannie Mae was rechartered by congress as a shareholder owned company, funded solely with private capital raised from investors. The charter is directed to increase the availability and affordability for homeownership for low, moderate, and middle-income families. Fannie Mae purchases home mortgages from banks, guaranteeing them, and then resells them to investors, which helps the banks to eliminate the credit and interest rate risk. (Fannie Mae Case) Fannie
Fannie Mae did not follow all of the GAAP compliances, which led them to their accounting fraud. The government agency that regulates Fannie Mae’s operation and accounting is the Office of Federal Housing Enterprise Oversight (OFHEO). One of the issues is derivative losses, which both OFHEO and Deloitte believed should have been recorded on the income statement instead of the balance sheet. The OFHEO also stated that Fannie Mae recognized $200 million in expenses when they should have recognized $400 million. Overall Fannie Mae misstated the financials by $10.6 billion from 1998 through 2004. There were four main accounting manipulations used in the Fannie Mae fraud. The first was improper accounting for loan fees, premiums, and discounts, which requires companies to recognize loan fees, premiums, and discounts as an adjustment over the life of the applicable loans, to create a constant effective yield, stated under the SFAS No. 91. The SFAS No. 91 also requires that any changes to the amortization of the fees, premiums, and discounts should be recognized as a gain or loss in the income statement, which Fannie Mae referred to as the “catch-up adjustment.” Fannie Mae had $439 million catch-up adjustments, but they only reported a $240 million catch-up adjustment in the income statement, which was directed by management. This manipulation affected Fannie’s financials by understating their expenses and overstating income by a pretax amount of $199 million. The second manipulation was improper hedge accounting. “Fannie Mae used derivative instruments to hedge against the effect of fluctuations in interest rates on its debt cost.”(Fannie Mae Case) SFAS No. 133 requires the value of derivatives to change with the market values. SFAS No. 133 also requires companies to measure and record the ineffectiveness of hedging a debt with derivative in the income statement, this method is also known as the long-haul method. If a company qualifies then they do not have to use