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Financial Times: School for scandal: “…as Royal Dutch/ Shell found with a difficult SEC rule on proved oil reserves, this does not mean a company can do its own thing” ( 22 Dec 04


Published: December 22 2004


Fannie Mae is turning into a case study for students of corporate scandal. More than three months ago its regulator, the Office of Federal Housing Enterprise Oversight, accused it of flouting accounting standards to manipulate earnings - to which bonuses were related. Last week the chief accountant at the Securities and Exchange Commission confirmed the breach, going back to 2001, and ordered a restatement of earnings that could uncover $9bn (£4.6bn) of losses on derivatives.


Fannie, a government-sponsored enterprise, has a business plan compromised by political motives and moral hazard. It seems to be on a mission to promote the "American Dream" by encouraging home ownership and is said to have "legendary clout" in Washington, yet it is privatised and owned by stockholders. It helped develop the secondary market in mortgages - a boon in terms of spreading mortgage credit risk. But it is a bad competitor because its borrowing costs are artificially low thanks to its GSE status, which is taken to imply a government guarantee.


As for corporate governance, in Franklin Raines, its politically well connected chairman and chief executive, you have the typical charismatic but over-mighty figure found at the heart of companies where things go wrong. And yet yesterday he was still there, in spite of the damning SEC conclusion and despite several hostages to fortune in his previous statements. These include that Fannie was "best of breed" for financial disclosure. The lack of an announcement after Sunday's board meeting is lamentable.


This is not to say that there are no mitigating factors in the Fannie case. One of the accounting standards that it failed to comply with, FAS 133, has its critics - as does its international cousin, IAS 39. But as Royal Dutch/ Shell found with a difficult SEC rule on proved oil reserves, this does not mean a company can do its own thing.


The SEC accountant says that Fannie "developed its own unique methodology to assess whether hedge accounting was appropriate". It was not. The SEC statement did not go into motives but the result of Fannie's hedge accounting exercise was to smooth earnings by neutralising the impact of marking derivatives to market.


When a company has a $1,000bn derivatives portfolio, the realisation that it is a volatile business - not the stable one of Mr Raines's American Dream - means that it must hold more reserves. That will sap growth.


In the new year, when the results of further investigations are known, policymakers will review the oversight of Fannie and Freddie Mac, another mortgage-market GSE that has suffered accounting irregularities. These institutions should be stripped of their special status and regulated in the same way as large banks, as Alan Greenspan, chairman of the Federal Reserve, has suggested. As he is concerned about potential systemic risk, there is a case for the Fed doing the job itself.

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