Fannie Mae Conservatorship: A Forensic Look At The Bailout

Fannie Mae Conservatorship: A Forensic Look At The Bailout

Special Report For Adam Spittler And Mike Ciklin: Fannie Mae Conservatorship by Dr. D. Larry Crumbley, CPA


I was asked to independently analyze the math, including certain assumptions surrounding the numbers included in the following reports (reports):

  1. A Forensic Look at the Fannie Mae Bailout: Scrubbing the Tricky Accounting of Conservatorship by Adam Spittler and Mike Ciklin
  2. A Follow up To: A Forensic Look at the Fannie Mae Bailout: Scrubbing the Tricky Accounting of Conservatorship by Adam Spittler and Mike Ciklin
  3. Deloitte! Restate Thou Must!! (Or a Follow Up to the Follow Up to: A Forensic Look at the Fannie Mae Bailout: Scrubbing the Tricky Accounting of Conservatorship by Adam Spittler and Mike Ciklin


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A list of resources utilized for my analysis is located in Appendix E. All resources are either available publicly or though academic journals listed. Information about myself is in Appendix F. In the preparation for this report, I consulted with Dr. Christine Cheng, Assistant Professor at Louisiana State University, who is Associate Editor of my Journal of Forensic & Investigative Accounting and on the editorial advisory board of my Oil, Gas & Energy Quarterly.


To facilitate the discussion of the Adam Spittler and Mike Ciklin’s reports, I identify three main parties to a typical principal-agent problem:1 (1) the majority shareholders following the conservatorship (The U.S. Government), (2) the minority shareholders following the conservatorship (shareholders other than the U.S. Government), and (3) the management team implemented following the conservatorship. Spittler and Ciklin assert there was (is) an alignment between the majority shareholders and the management team following the conservatorship. In my opinion the Spittler and Ciklin’s assertion is correct; there appears to be an alignment between the majority shareholder and the management team following the conservatorship. I detail my justification for my opinion below.


The Federal Housing Finance Agency (FHFA) was established when Congress passed the Housing and Economic Recovery Act of 2008 (HERA) (Pub. L. 110-289 122 Stat 2654) on July 30, 2008.2 The following information is taken from the FHFA Office of Inspector General (OIG) Evaluation Report (EVL-2012-006) titled FHFA’s Certifications for the Preferred Stock Purchase Agreements dated August 23, 2012 (See Appendix A) unless otherwise noted.

  • Fannie Mae was placed into conservatorship on September 6, 2008.
  • The conservatorship was overseen by FHFA .
  • On September 7, 2008, Treasury exercised its authority under HERA to provide support to the Enterprises through equity investments in Fannie Mae and Freddie Mac.
  • In return for Treasury’s commitment to provide the necessary draws, the Enterprises must fulfill a number of obligations.
    • First, each Enterprise issued to Treasury senior preferred stock in the amount of $1 billion, with a liquidation preference of that amount plus the amount of all draws contributed to that Enterprise from the inception of the PSPAs.
    • Second, each Enterprise must pay Treasury quarterly dividends on the outstanding draw balance in the amount of 10% per annum until December 31, 2012. After that, the dividend would be based on how much positive net worth the Enterprises attain, rather than a percentage of the outstanding draw balance.
    • Third, Treasury holds common stock warrants, which it may exercise for a nominal price at any time, allowing it to purchase up to 79.9% of each Enterprise’s common stock.
    • Fourth, each Enterprise owes Treasury a commitment fee on a quarterly basis (although this fee has been consistently waived by Treasury), and will be permanently suspended so long as the current dividend formulation remains in place.

Summarizing the information above, when FHFA placed Fannie Mae into conservatorship on September 6, 2008, FHFA assumed the authority of the management and the boards.6 Herbert M. Allison, Jr. was appointed as the Chief Executive Officer on September 7, 2008, and Philip A. Laskawy as the nonexecutive chairman of the Board on September 16, 2008.7 Allison received a salary of $900,000 (plus bonus), but he resigned September, 2010. While testifying before Congress, Allison said he was “working to determine the value of the assets on their balance sheets, so [he] can get a better idea of whether [he] needs to access a Treasury Department lending program to prop them up.” At the same time David M. Moffett was appointed CEO of Freddie Mac, and he announced his resignation by March 13, 2009. [An important red flag of earnings management is the sudden resignation of a CEO.]

The remainder of the Board of Fannie Mae was announced on December 25, 2008.8 These changes to the management team and board were made either directly by the FHFA (Allison) or with FHFA’s input (Laskawy and the remainder of the board). The Treasury Department infused $1 billion into Fannie Mae in Exchange for the Senior Preferred Stock. The placement of Fannie Mae into conservatorship and the infusion of the $1 billion in exchange for Senior Preferred Stock at least, effectively, if not actually, made the U.S. Government the controlling shareholder of Fannie Mae by the end of September 2008. FHFA’s appointment of the Chief Executive Officer, and the subsequent influence on the remainder of the board in all appearances ensured alignment of interests between the management and the majority shareholders (the U.S. Government).

While alignment between management and the majority shareholders may seem enough to ensure responsible and prudent decision making for most firms, a concern can, should, and has been raised by Spittler and Ciklin regarding the protection of the interests of minority shareholders following the conservatorship. The U.S. Securities Exchange Commission (SEC) has a long history of concern regarding the protection of the minority shareholder interest. As a testament to this, Reese, Jr., and Weisbach (2002) research is consistent with the notion that non-U.S. firms are motivated to cross-list on the NYSE as a signal of their intent to protect minority shareholder interests. Spittler and Ciklin contend that the minority shareholders of Fannie Mae were not protected. Specifically, Spittler and Ciklin contented that the alignment between the management and the government (principal-agency conflict), motivated these managers to engage in balance sheet management, which benefitted the majority shareholder (U.S. Government) at the expense of the minority shareholders. My opinion is that Spittler and Ciklin’s assertion is correct; the evidence is consistent with an alignment between the majority shareholder and management motivating managers to engage in balance sheet management. This balance sheet management benefitted the majority shareholder at the detriment of the minority shareholders. I detail my justification for my opinion below.

Balance Sheet Management

In discussing balance sheet management, I begin with the more familiar concept of earnings management, since the balance sheet and reported earnings are related. Dechow, Ge, and Schrand (2010) discuss why an accounting measurement system does not perfectly measure earnings performance. Dechow, Ge, and Schrand (2010) introduce the roles estimates, judgment, and earnings management have in distorting accounting measurement from performance: “Implementation: An accounting system that measures an unobservable construct (X) inherently involves estimations and judgment, and thus has the potential for unintentional errors and intentional bias (i.e., earnings management).”

The authors of these reports attempt to disentangle estimations and judgments from intentional bias (i.e., earnings management or balance sheet management). While most cases of earnings management involve upward earnings management, nothing in Dechow, Ge, and Schrand’s (2010) description or the earnings management literature, in general, requires the intentional bias to result in upward earnings management (e.g., wrong-way earning management is possible).

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