Fannie Mae Update: Years to Recovery

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Fannie Mae announced earlier this month in its second quarter filing with the Securities and Exchange Commission (SEC) that it was on schedule to file restated results for the years 2001 through 2004 by the end of this year, but it acknowledged that two more accounting errors have been discovered, one of which will lead to an unspecified gain on a previously estimated $2.4 billion loss on mortgage commitments.

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The impact of the accounting scandal on the company is likely to be felt for years, however, according to James Lockhart, the new director of the Office of Federal Housing Enterprise Oversight (OFHEO). In testimony before Congress in June, Lockhart said, according to the New York Times, “These companies [Fannie Mae and Freddie Mac] were so poorly run that it's going to take many years to fix.” In addition to implementing new financial systems and a new executive culture, Fannie Mae will have to contend with high management turnover, a possible new regulatory environment and limits on its operations.

The company said that it “doesn't expect to find any other mistakes that would alter its planned restatement." “We believe that, with the filing of this report, we have identified all errors requiring restatement.”

The error relating to mortgage commitments occurred because the company had mislabeled an unspecified amount of long-term loan-purchase agreements which will have to be reclassified as derivative investments, says. The company's loss on derivatives of $8.4 million remains unchanged.

The second error was a failure to account for “master servicing agreements” and is not expected to have a significant impact on results.

Lockhart has been active in pushing for legislative reform of the congressionally chartered but publicly traded mortgage companies, and wants to replace OFHEO with a stronger regulator. “If someone was running an agency and was not concerned about the long-term future of the agency, I'd be very worried,” he told Reuters in an interview. Lockhart said OFHEO has been hamstrung by a lack of funds and unclear regulatory powers.

Fannie Mae continues to be troubled by a very high level of management turnover. Of the 55 top executive positions, 44 have new occupants, either outside hires or a few insiders who have switched jobs, Brian Faith, a spokesman for the company told the Washington Post.

Three senior executives at Fannie Mae departed in June and July of this year, bringing the total who have left the company to 15, the Post reports. The recent departures were the chief information officer, Julie St. John, Deputy general counsel, Renie R. Grohl, and Barry Zigas, senior vice president for corporate and regulatory housing goals.

The company's management may also be affected by ongoing investigations of at least 29 present or former executives for possible participation in the accounting manipulation

CEO Mudd, who joined Fannie Mae in 2000 as vice chairman and chief operating officer, was cleared by a committee of the board of directors that reviewed management personnel involvement in the accounting manipulation. But he is among the present and former executives who may be forced to return bonus payments based on faulty accounting under an agreement reached with OFHEO and the SEC in May, the Wall Street Journal says.

Fannie's board concluded that while Mudd wasn't involved in the scheme that boosted bonus payments, he missed an opportunity to dig more deeply into accounting questions that arose in 2003, the Journal reports.

Fannie Mae was forced to accept a cap on its mortgage portfolio at December 31, 2005, levels as part of its agreement with OFHEO and the SEC. At the time, the giant mortgage company objected to limits on its future growth. Freddie Mac has voluntarily agreed to limit the growth of its mortgage holdings to 2 percent a year, at OFHEO's request.

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