FANNIE’S FINANCES

Americans have become used to reading about corporate accounting scandals. But, when the company involved operates under a government charter that gives it special benefits, the question of how these types of schemes continue takes on added importance. The answer isn’t more regulations but tougher enforcement of those already on the books.

Federal regulators have just issued a lengthy report about the Federal National Mortgage Association, known as Fannie Mae, alleging that the company’s executives manipulated earnings so they could earn bonuses. The report, by the Office of Federal Housing Enterprise Oversight (OFHEO), was the result of a three-year investigation. It was much harsher than a report by Fannie Mae’s own board that was released in February.

The company was fined $400 million, told to limit its growth and reform its corporate culture and accounting practices. The majority of the penalty – $350 million – was assessed by the Securities and Exchange Commission and will be used to compensate investors damaged by the alleged violations.

According to the acting director of OFHEO, James Lockhart, Fannie Mae’s executives managed the company’s earnings to the one-hundredth of a penny to maximize their bonuses. The company’s former CEO, Franklin Raines, earned more than $90 million in total compensation between 1998 and 2003, of which more than $52 million was tied directly to achieving earnings targets, according to the report.

The manipulation was hidden from internal auditors, although company accountants had raised concerns about Fannie Mae’s accounting practices. The company also “stonewalled” the oversight office, Mr. Lockhart said.

Although Fannie Mae is a private company, owned by shareholders, it operates under the Federal National Mortgage Association Charter Act, which confers certain rights and responsibilities on the company. These include exemption from state and local income taxes and the ability of the Treasury Department to purchase up to $2.25 billion of the company’s debt.

The latter implies a government guarantee of its loans which in turn causes banks and markets to look favorably on its loans because there is a low default risk.

In exchange, the company is charged with making homeownership more affordable for low- and moderate-income borrowers. Fannie Mae, and another federally chartered mortgage company, Freddie Mac, owns or guarantees nearly 40 percent of the $8.5 trillion U.S. residential mortgage market.

Its finances, therefore, are important to more than just the company’s shareholders. That’s why the government needs to take a stronger role in regulating Fannie Mae and Freddie Mac. A bill passed by the Senate banking committee would help by establishing an independent regulator within the Department of Treasury to oversee the companies. They are now regulated by the Department of Housing and Urban Development while other banks are overseen by the treasury department.

The bill is stalled in the Senate. The OFHEO report should prompt lawmakers to pass it.