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Fannie Report Details a Calculated 'Catch-Up'

Fannie Mae's former finance chief J. Timothy Howard testifies on accounting irregularities at the mortgage giant during a House Financial Services Committee hearing in October 2004.
Fannie Mae's former finance chief J. Timothy Howard testifies on accounting irregularities at the mortgage giant during a House Financial Services Committee hearing in October 2004. (By Susan Biddle -- The Washington Post)
By David S. Hilzenrath
Washington Post Staff Writer
Tuesday, February 28, 2006

As a vacationing Franklin D. Raines was preparing to take the helm of Fannie Mae in the summer of 1998, one of the company's top executives spelled out some stark realities for him to contemplate while "lying on the beach, jogging, looking for your ball in the rough."

The company had finished crunching profit forecasts, and it appeared that earnings per share for 1998 would fall short of two important targets: the $3.21 that Wall Street was expecting and the $3.23 that would trigger maximum funding of management bonuses, Lawrence M. Small wrote.

What happened in the next few months made headlines last week when a 2,652-page investigative study of the company's accounting problems was released. But the episode also demonstrated some of the broader problems that allowed Fannie Mae's problems to fester, according to the document. Not only did Fannie managers break accounting rules to unlock bonus payments, the report concluded, but the effectiveness of key controls also broke down.

By early 1999, Fannie had delayed booking almost $200 million of expenses, counted two years of tax credits in a single year and, on the day it closed its books for 1998, pulled $3.9 million of "miscellaneous income" from what investigators suspect was a "bucket account." It was just enough to deliver the maximum payout of $27.1 million in management bonuses.

Fannie's outside auditor, KPMG LLP, flagged the almost $200 million of delayed expenses as an "audit difference" but certified the company's books nonetheless, the report said. KPMG spokesman George Ledwith declined to comment.

The investigation, performed by former senator Warren B. Rudman and other lawyers at the firm Paul, Weiss, Rifkind, Wharton & Garrison LLP, concluded that management's disclosures to the board about the 1998 accounting maneuvers were "incomplete and misleading."

The audit committee of Fannie's board was told in 2000 that KPMG had identified delayed expenses as an "audit difference," the report said. The report, commissioned by a special committee of Fannie's board, does not say how the directors reacted to that information.

Despite the challenges Fannie Mae faces, Small was optimistic.

"For 1998, I'm reasonably confident there's enough in the 'non-recurring earnings piggy-bank' to get us to $3.21," he wrote. "Since we have generally been successful at dealing with this sort of challenge, I'm confident we'll be able to do so once again," he added.

Looking ahead to 1999, there was talk that the company might "offload" expenses to "an unconsolidated subsidiary," Small wrote.

Small, now secretary of the Smithsonian Institution, did not return calls seeking comment.

Small told investigators that his mention of a "non-recurring earnings piggy bank" was an unfortunate choice of words and probably referred to the possibility of unexpected or one-time revenue sources, such as the gain on a sale of property, the report said.


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