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Fannie Mae Accounting Scandal

Fannie Mae Accounting ScandalThe United States Federal Government created the Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, in 1938 to establish a secondary market for mortgages insured by the Federal Housing Administration (FHA).

Fannie Mae buys mortgages on the secondary market, pools them and sells them as mortgage-backed securities to investors on the open market.

 

This secondary mortgage market helps to replenish the supply of lendable money for mortgages and ensures that money continues to be available for new home purchases.

In 1968, the Federal National Mortgage Association was partitioned into two separate entities-one wholly owned by the government and known as the Government National Mortgage Association (Ginnie Mae), and the other to retain the name Federal National Mortgage Association (Fannie Mae).

Fannie Mae is a consistently profitable American corporation. While it receives no direct government funding or backing it has certain looser restrictions placed on its activities than normal financial institutions. For example, it is allowed to sell mortgage backed securities with half the capital backing them up than is required by other financial institutions.

In 2004, Fannie Mae came under fire for its accounting practices, prompting an investigation into the Fannie Mae Accounting Scandal. The Office of Federal Housing Enterprise Oversight released a report on September 17 alleging widespread accounting errors, including shifting of losses so senior executives could earn bonuses from making earnings targets.

The difficulty centered on how to account for various interest rate hedges Fannie Mae buys as part of its risk management strategy. When Fannie Mae did not release its third quarter results for 2004, doubts increased.

Supporters of the company, including senior management, said the problem was merely a disagreement over FASB accounting standards, but in December, the Securities and Exchange Commission ruled that Fannie Mae would have to restate the past 3 1/2 years of earnings, potentially losing $9 billion of earnings over that timeframe, and possibly necessitating increased capitalization.

 

This has not yet impacted the stock price for Fannie Mae, but Moody's and Standard and Poor's have downgraded some of Fannie Mae's subordinate debt. Given the large percentage of the American economy that is tied up in housing values, a major scandal involving Fannie Mae could be highly damaging to investor confidence.

However, Freddie Mac was able to overcome its summer 2003 scandal without serious damage.

In December 2004, CEO Franklin Raines and CFO Timothy Howard were forced to resign. The company also dismissed its auditor, KPMG.

In testimony given to the U.S. Senate Banking Committee in April 2005, it became clear that Congress, with support from all the parties, was planning to strengthen oversight of all the GSEs.

A contentious issue in the second quarter of 2005 was whether the retained portfolios of Fannie and Freddie should be reduced.

This issue became prominent after an April AEI symposium, and continued to gain ground leading up to Alan Greenspan's major May 19, 2005 speech recommending strict portfolio limits.

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