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$11 billion hole in Fannie Mae’s accounting

Kai Ryssdal and Amy Scott Dec 6, 2006

KAI RYSSDAL: Here’s how you know the hole in Fannie Mae’s accounting is one for the record books. Just cleaning up the aftermath cost more than a billion dollars. A small army of accountants and consultants took two years to wrap things up. And as of this afternoon, they’re finished.

Fannie Mae’s earnings restatement was filed today after the markets closed. It’s the first official look at the company’s books anybody’s had in about two years. Marketplace’s Amy Scott is in New York following the story for us.

Hey, Amy.

AMY SCOTT: Hello, Kai.

RYSSDAL: Remind us, would you, why Fannie Mae needed to restate to begin with?

SCOTT: The Securities and Exchange Commission basically ordered Fannie Mae to restate its earnings going back to 2001. That was after it came out that executives had been manipulating earnings to meet bonus targets. You may recall the CEO, Franklin Raines, was ousted, and Chief Financial Officer Timothy Howard. The company had to pay a $400 million fine and, as you said, it took years to go back over the books. And, apparently, there were so many of those outside consultants and accountants, they had to take over the company cafeteria.

RYSSDAL: Alright, so what do the numbers actually look like?

SCOTT: Well, the headline is that Fannie Mae overstated its earnings between 2001 and 2004 by $6.3 billion, mostly due to errors in the way it accounted for derivatives. That’s actually more than $4 billion less than the company had predicted. So, it’s good news from a business standpoint. It’s also a big step politically. You know, Congress has been hammering out new regulations for Fannie Mae and Freddie Mac, which are both government-sponsored entities. Freddie Mac is also recovering from an accounting scandal of its own.

I talked to Jaret Seiberg, who’s a policy analyst with the Stanford Group. He says the restatement sends a message to politicians that the company is finally getting its house in order:

JARET SEIBERG: This is an important step forward for Fannie Mae in overcoming its scandal. But it’s only one step. They still need to get current with their regular financial reporting, and they need to implement the many changes to their internal controls that their regulator is insisting upon. And that process could take another two years.

SCOTT: Now, Fannie Mae’s got something else going for it. With the change in leadership on The Hill, any bill Congress passes is likely to be less harsh than it might have been under Republican control.

RYSSDAL: You know, Amy, I mentioned up at the top that Fannie Mae backs about one in every five mortgages in this country — 20 percent or so. How does the housing downturn play into its business prospects now?

SCOTT: Well, with mortgage delinquencies on the rise, Fannie Mae is exposed to more risk. Actually, its stock has held up pretty well. It’s up about 25 percent since its low in July. And analysts say that’s partly because Fannie Mae, as well as Freddie Mac, tend to finance what are known as “good loans”— those with a high repayment rate. It’s really the subprime lenders that are vulnerable to this downturn. And again, politically, the market softening helps Fannie Mae. It shows how important the company is to the economy. And analysts say, you know, you don’t want to tinker too much with that in an uncertain market.

RYSSDAL: Alright, Marketplace’s Amy Scott in New York. Thanks, Amy.

SCOTT: Thanks, Kai.

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