- The Washington Times - Wednesday, September 22, 2004

ASSOCIATED PRESS

Regulators have discovered serious accounting problems at mortgage giant Fannie Mae, prompting an inquiry by the Securities and Exchange Commission and calling into question its financial soundness, the company disclosed yesterday. Its shares fell nearly 7 percent.

The board of the government-sponsored company has named a special committee of outside directors to respond to the crisis at the second-largest U.S. financial institution behind Citigroup.

In at least one instance, the regulators found, it appeared that Fannie Mae’s accounting for expenses was put off to a future reporting period in order to meet earnings targets that brought bonuses for executives.

The developments come a little more than a year after Freddie Mac, Fannie Mae’s competitor in the multitrillion-dollar home mortgage market, disclosed that it had understated profits by some $4.5 billion for 2000 to 2002 in an effort to smooth earnings and maintain its image as a steady performer.

Sen. Richard Shelby, Alabama Republican, chairman of the Senate Banking Committee, called the revelations concerning Fannie Mae “seriously troubling.”

On Monday, federal regulators who have been investigating Fannie Mae’s accounting for eight months submitted a report to its board that found earnings manipulation, lax internal controls and a corporate culture “that emphasized stable earnings at the expense of accurate financial disclosures,” according to a letter to the directors.

The letter from the Office of Federal Housing Enterprise Oversight was disclosed in a public statement yesterday by Ann McLaughlin Korologos, the presiding director of the Fannie Mae board.

The regulators found that Fannie Mae violated generally accepted accounting principles in its reckoning for transactions involving derivatives, financial instruments it uses to hedge against interest-rate and other risk.

They also found that the company used an improper “cookie jar” reserve in accounting for some items. The SEC maintains that the practice — setting aside artificially large cash reserves to reduce revenues, with the idea of reversing that procedure to bolster revenues in less profitable times — gives investors an inaccurate picture of a company’s financial performance.

The regulators’ report said their findings “are serious and raise doubts concerning the validity of previously reported financial results, the adequacy of regulatory capital, the quality of management supervision, and the overall safety and soundness” of Fannie Mae, according to Miss Korologos’ statement.

Miss Korologos also disclosed the preliminary inquiry by the SEC, which she said includes issues raised in the regulators’ report.

SEC spokesman John Nester declined to comment. OFHEO spokeswoman Corinne Russell also declined to comment, except to note that the agency has not made the report public. It couldn’t be determined when, or whether, it planned to do so.

In addition, Miss Korologos said, the Fannie Mae board has named a committee of independent directors to deal with the accounting matters.

That means a crucial function effectively has been removed from Fannie Mae’s chairman and chief executive, Franklin Raines, and other top managers.

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