Fannie business: dodgy, accounting at Fannie Mae

Reason, Jan, 2005 by Julian Sanchez

FANNIE MAE, the government-chartered corporation charged with providing liquidity in secondary mortgage markets, exists in the twilight realm between private and public. A report from the agency charged with overseeing the company suggests that its accounting records had a certain hallucinatory quality as well.

An investigation by the Office of Federal Housing Enterprise Oversight found that Fannie Mae systematically misapplied generally accepted accounting practices and manipulated earnings reports to maintain an aura of stability. Executive bonuses were tied to meeting earnings targets, providing a powerful incentive to "adjust" the books. In one year examined by the office, Fannie Mae met the target" right down to the penny," guaranteeing a maximum bonus. In October, responding to the report, the Securities and Exchange Commission launched a formal probe of the company.

The report finds that Fannie Mae's dodgy practices began about six years ago. So why has it taken so long for them to be noticed? One contributing factor: Official policy notwithstanding, there was a widespread perception by investors that the company was "too big to fail" and would be bailed out by taxpayers if it ran into trouble. As Federal Reserve Chairman Alan Greenspan put it in congressional testimony in early 2004, "The problem that exists is because they have a subsidy, granted not by the Congress but by the expectation that government will bail them out in the event of a crisis."

This assumption gave markets a false sense of security, even as Fannie Mae expanded its portfolio to take on more risk. As a spate of recent corporate scandals shows, you don't need strong ties to government to do fraudulent accounting but apparently it helps.