By James Tyson
September 29, 2005
SourceSept. 29 (Bloomberg) -- Fannie Mae investigators may need until January to complete a report on as much as $10.8 billion in bookkeeping errors at the government-chartered mortgage finance company, said Warren Rudman, who's heading the probe.
``We are looking at all the accounting issues we have looked at all along, and at this point, we don't have any conclusions,'' Rudman, a former U.S. Senator, said yesterday in an interview in Washington. ``We are still hoping to wrap up the investigation by the end of December, and if we don't make it we'll do it in January.''
Shares of Fannie Mae yesterday tumbled the most since the stock market crash of 1987 after Dow Jones reported ``new and pervasive accounting violations'' were uncovered by investigators, citing people ``close to, or who have been involved'' in the probe that it didn't identify. The stock fell 11 percent to $41.71, the lowest since July 1997, and wiped out about $4.82 billion in market value. Rudman declined to comment on the report.
Fannie Mae shares are down 41 percent this year as investors wait for the company to restate earnings going back to 2001. The accounting mistakes cost Chief Executive Franklin Raines and Chief Financial Officer Timothy Howard their jobs and prompted calls for stronger federal regulation.
The restatement may take until the second half of next year, Daniel Mudd, who was named chief executive in June, told the company's investors last month. Mudd, 47, joined Washington-based Fannie Mae in 2000 as vice chairman and chief operating officer.
``There are too many issues for us to be adding'' to our holdings, said Igor Krutov, a New York-based analyst at Vontobel USA Inc. The firm bought Fannie Mae shares since reporting to the U.S. Securities and Exchange Commission that it held 656,113 as of June 30, Krutov said.
Fannie Statement
Fannie Mae in an e-mailed statement yesterday said it provided its most recent update on the accounting review and the ``estimated impact of the most significant items'' in a SEC filing last month. The company also said it will provide more information ``as issues are identified and resolved.'' Last month's filing didn't mention the issues raised by Dow Jones.
The company's regulator, the Office of Federal Housing Enterprise Oversight, said yesterday it expects the company will be able to meet a month-end deadline to have a 30 percent capital surplus ``based on current assessments of accounting deficiencies and estimates of other potential impacts to capital.''
``Our target is to have our examination report complete in the first quarter of 2006, said Corinne Russell, an Ofheo spokeswoman in Washington, declining to comment further because the company is still under investigation.
Housing Ties
Fannie Mae was created by the government in 1938 to provide financing for home mortgages. The company and the smaller Freddie Mac, which is also working its way through accounting errors, own or guarantee almost half the $7.6 trillion mortgage market. They are the biggest borrowers in the U.S. behind the government.
The companies profit from the difference between their cost to borrow in the bond market and returns on mortgages held in their portfolios. They also earn money by charging lenders a fee for guaranteeing bonds backed by mortgage payments.
Fannie Mae's directors in September 2004 hired Rudman, 75, a New Hampshire Republican, to lead a probe after Ofheo determined Fannie Mae used improper ``cookie jar'' reserves and broke accounting rules when using financial contracts to protect its then $905 billion of mortgages and mortgage securities from swings in interest rates.
Three months later the SEC agreed with the regulator that Fannie Mae made errors, and called for a restatement.
``During the course of our investigation, there have been other accounting issues that we have come across and we are looking at them as well,'' Rudman said in an interview earlier this month, reiterating a comment from May that he uncovered problems not identified by the regulator.
Rudman yesterday said his investigators don't ``have any conclusions on these points.''
Finite Insurance
Fannie Mae on Aug. 9 said it was evaluating whether it will need to reclassify some of its investments into a so-called trading account, which would require it to record the gains and losses of those holdings through earnings instead of in shareholders' equity.
Fannie Mae may have bought so-called finite insurance policies to hide earnings losses after they were incurred, Dow Jones said. Executives at the company also embellished earnings by overvaluing assets, underreporting credit losses and misusing tax credits, according to Dow Jones.
Finite risk policies play on the boundary between financing and insurance and may be abused to smooth earnings. State and federal regulators are investigating instances when buyers, both other insurers and corporate policyholders, disguised what were essentially low-cost loans as insurance to get favorable accounting treatment.
Berkshire Hathaway Inc., the insurance and investment company controlled by billionaire Warren Buffett, said on Aug. 8 that investigators were examining its accounting on the policies.
`Serious Charges'
``There's a lot of serious charges without a lot of fact,'' said David Dreman, chairman and chief investment officer of Dreman Value Management in Jersey City, New Jersey. ``The fact may be there. But we haven't seen it.''
Dreman said he isn't prepared to sell Fannie Mae shares, which represent about 3 percent of the $13 billion he manages. His company was Fannie Mae's 25th-largest shareholder at the end of June, according to SEC filings.
To contact the reporter on this story:
James Tyson in Washington at
jtyson@bloomberg.net.