Fannie Mae, the giant mortgage finance company, has used improper accounting methods that raise serious questions about the quality of its management and the validity of its financial reports, government regulators reported yesterday.
Though it didn't quantify the effect of what it called pervasive misapplication of accounting rules on the company's books, the report by the Office of Federal Housing Enterprise Oversight cited one instance in 1998 where the company inappropriately deferred $200 million of estimated expenses, which enabled management to receive full annual bonuses. Had Fannie recorded the expenses in 1998, no bonus would have been paid, the report said.
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Freddie Mac and Fannie Mae: Understanding the complexities of the organizations that help fund the nation's housing market
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The report also detailed numerous transactions over several years where it said Fannie Mae management intentionally smoothed out gyrations in its earnings to show investors it was a low-risk company. Fannie "maintained a corporate culture that emphasized stable earnings at the expense of accurate financial disclosures," regulators said in a letter to the company.
Chief executive Franklin D. Raines and the board of directors were not singled out for blame, but the report criticized "a culture and environment that made these problems possible." It did name J. Timothy Howard, the company's vice chairman and chief financial officer, saying he "failed to provide adequate oversight" of key control and reporting functions and had jobs in which he both set earnings targets and then the accounting policies that could be used to meet them.
The report said company management didn't adequately investigate allegations of irregularities by a former employee, Roger Barnes, who couldn't be reached for comment last night. It said his concerns were "substantive" and his cooperation with regulators important to their examination.
The findings echo those made last year about Freddie Mac, the other large government-chartered mortgage finance company. Regulators, who launched their Fannie Mae inquiry after the Freddie Mac problems came to light, found that Fannie failed to follow the rules in accounting for complex financial instruments known as derivatives, which the company uses to hedge against movements in interest rates. Much of rival Freddie Mac's accounting problems involved accounting for derivatives.
That probe resulted in a $125 million fine and a management shake-up at Freddie Mac.
The two companies were chartered by the government to provide a steady flow of funds for home mortgages. To do that, they borrow money from investors and buy mortgages from banks and other lenders. They also package mortgages into securities for sale to investors. Together they help finance half the home mortgages in the country.
The report's findings that Fannie lacks sufficient internal controls and that its accounting policymaking is "dysfunctional" added to the regulators' concern about the company's safety and soundness.
Federal Reserve Chairman Alan Greenspan and Treasury Secretary John W. Snow have called for tougher oversight of Fannie and Freddie because they worry that, given the huge scale of their operations, serious financial troubles at the companies could put nation's financial system at risk. Though the government disavows any responsibility for the companies' debts, public and private analysts say the government could be called upon to bail them out in a crunch.
