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Fannie Mae Agrees to Accounting Changes

By David S. Hilzenrath and Ben White
Washington Post Staff Writers
Tuesday, September 28, 2004; Page E01

Fannie Mae, the giant mortgage finance company, yesterday agreed to stop using accounting methods that its regulator criticized last week and to raise billions of dollars of additional capital as a cushion against potential losses.

The agreement with the Office of Federal Housing Enterprise Oversight also calls for Fannie Mae to begin addressing management problems, including reviewing the role of its chief financial officer, J. Timothy Howard. His multiple responsibilities put him in a position to set financial targets and influence the way the company met them, regulators said in a report last week.

Fannie Mae chief executive Franklin D. Raines appeared before the Senate Banking Committee in February. (Dennis Cook -- AP)

_____FANNIE MAE_____
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Yesterday's agreement said Fannie would appoint an independent chief risk officer, a post now held by Howard, and assure the independence of the internal auditor, whose performance is now reviewed by Howard.

Fannie, based in the District, neither admitted nor denied wrongdoing in the agreement, which was negotiated by and will be monitored by independent board members. OFHEO's report accused the company of manipulating accounting to achieve desired financial results, tolerating weak financial controls, ignoring a whistle-blower and permitting a culture that made the problems possible.

The agreement left the fate of company management, headed by chairman and chief executive Franklin D. Raines, under review. In a letter to Fannie Mae directors last week, OFHEO Director Armando Falcon Jr. said that he doubted management's ability to bring about the "broad cultural and operational changes" needed at the company and that he was "prepared to act if the Board does not."

The company and its smaller, McLean-based rival, Freddie Mac, play a major role in the mortgage business, borrowing money from investors to buy mortgages from lenders such as banks and savings and loans. The companies, chartered by the government to assure ready availability of funds for home buyers, also package mortgages as securities for sale to investors.

Under yesterday's agreement, Fannie Mae agreed to change the way it deals with two accounting issues. Fannie will change the way it accounts for derivatives, complex financial instruments used to hedge against shifts in interest rates. The company also agreed to discontinue what regulators described as a financial cookie jar that the company kept on hand to dip into as needed and smooth over fluctuations in results.

While committing to correct its accounting methods in future financial reports, the company also agreed to calculate the impact such changes would have on previously issued financial statements. Corinne Russell, an OFHEO spokeswoman, said the Securities and Exchange Commission will decide whether past financial statements must be corrected.

The agreement "doesn't mean that the company is at all out of the woods," said Charles M. Elson, who heads a corporate governance program at the University of Delaware. "This is just really the beginning of a long inquiry into what happened," Elson said.

The company faces an ongoing review by OFHEO into additional accounting issues, a probe by the SEC, an Oct. 6 congressional hearing, and an investigation by a committee of outside board members who hired former senator Warren B. Rudman. Rudman helped lead the Senate's investigation of the Iran-contra affair in the 1980s and has since conducted a number of corporate investigations.

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