Bad Accounting 101: Fannie Mae

Topics: Fannie Mae, Subprime mortgage crisis, Mortgage Pages: 13 (4569 words) Published: April 13, 2014
Bad Accounting 101: Fannie Mae
Background on Fannie Mae
Fannie Mae is the common name of the Federal National Mortgage Association, also abbreviated as FNMA. It is one of two of America’s largest mortgage companies, along with Freddie Mac (Federal Home Loan Mortgage Corporation – FHLMC).1 Fannie Mae guarantees and purchases loans from mortgage lenders to help ensure families can buy new homes or refinance.2 Fannie Mae was founded in 1938 as part of Franklin Delano Roosevelt’s New Deal during the Great Depression. As borrowers began to default on mortgages during the country’s major downturn the government, led by Franklin D. Roosevelt and Congress, created Fannie Mae in order to buy the mortgages from lenders so as to free up the bank’s capital. Fannie Mae grew quickly over the years as it paved the way for banks to be able to offer loans to otherwise non-creditworthy borrowers. Then in 1968, as the government’s budget was pressed by the Vietnam War, President Lyndon Johnson removed Fannie’s debt portfolio from the government balance sheet and the government-sponsored enterprise was converted into a publicly traded company. Freddie Mac was then created primarily to compete with Fannie Mae so as to prevent a Monopoly.1

Cash used by Fannie to buy mortgages is raised from various sources including pension funds, mutual funds, and foreign governments. There is a common belief that Fannie and Freddie loans carry a guarantee that the government will not let either of these fail. Therefore, the two public companies dominate the mortgage market.1 Bad Accounting 101: Fannie Mae

In the early 2000’s, Fannie Mae used financial loopholes to adjust its books.5 It managed to keep derivative financial holdings off its income statements. As mortgage rates dropped during this time and prepayments on mortgages increased, this caused a decrease in the expected gains of Fannie Mae. In 2002, for example, Fannie recorded earnings of $6.4 billion, yet managed to keep $8.9 billion in cash-flow hedging losses off its books. To “hide” this loss, Fannie transferred negative numbers from its income statement to its balance sheet under Accumulated Other Comprehensive Income.5 Critics claim that Fannie Mae was able to get away with this because it is considered a government-sponsored enterprise and therefore can exclude its Accumulated Other Comprehensive Income from its calculation of capital.5 It had not yet been determined that Fannie Mae was practicing any illegal acts.

However, in 2004, Fannie and Freddie’s regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), revealed that Fannie did not follow generally accepted accounting principles on recorded obligations for manufactured homes and aircraft leases. Fannie was then required to write-off millions in subsequent quarters to account for the losses.5 Eventually, in December 2004, Fannie Mae was ordered by the SEC to restate its earnings back to 2001. In total, this restatement was then estimated at an $11 billion correction.6 Then in 2006, Fannie Mae was finally fined $400 million in civil penalty (the largest at the time) due to its “bad accounting” which spanned from 1998-2004. The investigation was again conducted by Fannie’s regulator, the Office of Federal Housing Enterprise Oversight,6 with the assistance of Deloitte & Touche.7 Senior executives at Fannie Mae were caught manipulating the accounting methods in order to collect millions of dollars in bonuses. Specifically, in 1998, Fannie Mae’s accounting records were manipulated to put off $200 million in expenses to future periods, allowing executives to collect $27 million in bonuses.6 As was confirmed in 2004, this was mainly related to Fannie Mae managing to keep derivative holdings off its income statement, and instead defer these derivative losses to its balance sheet as Accumulated Other Comprehensive Income.7 A violation of Statement of Accounting Standards No. 133 – Accounting for Derivative Instruments and...

Bibliography: 1. Pickert, Kate. (2008). A Brief History of Fannie Mae and Freddie Mac. Time Magazine – Business and Money.
2. Fannie Mae
3. Fannie Mae. (2013). Investor Relations.
4. Securities and Exchange Commission. (2013). Fannie Mae 10-K.
5. Crum, Rex. (2004). Fannie Mae Faces More Income Issues. Wall Street Journal.
6. NBC News. (2006). Report: Fannie Mae manipulated accounting.
7. McClean, Bethany
8. New York Times. (2008). Scandal to Cost Ex-Fannie Mae Officers Millions.
10. Gross, Daniel. (2004). The Truth About Fannie Mae. Slate.
11. Public Law. (2008). Housing and Economic Recovery Act of 2008.
12. Olick, Diana. (2013). Fannie, Freddie making billions – Why Shut Them Down?. CNBC.
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