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Fannie Mae’s Quiet $4 Billion Adjustment

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The debate over Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) usually starts with the idea that the two GSEs are now profitable and quickly moves on to whether or not re-privatizing them puts taxpayers at risk of another bailout. The debate over accounting (whether they are actually profitable or just cash flow positive) is usually skipped over, but now another problem is emerging with Fannie Mae and Freddie Mac’s accounting – it doesn’t seem that reliable.

Non-material errors add up to be material: McKenna

Last week, Dan Freed at The Street reported that Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) had disclosed $4 billion in accounting errors over a five quarter period, 4Q11 through 4Q12, but that most investors and analysts missed it because the changes were made as out-of-period adjustments instead of restatements. Fannie Mae argues that a restatement isn’t necessary because each of the adjustments is too small to be material concern to investors, but they add up pretty quickly. And the pattern of bad accounting slipping past auditors is reminiscent of much bigger scandals.

“How do you know?” asks Francine McKenna, about whether or not the misstatements might have been intentional manipulations. “That’s the WorldCom situation. Nobody adds it all up until someone says ‘Wait a minute. Over five years we’ve had so many billions of non-material errors it adds up to be material.’”

Fannie Mae had major accounting errors before the crisis as well

Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) had major accounting errors in 2005 and 2006, including a $400 million settlement with the Securities and Exchange Commission because it “engaged in a financial fraud involving multiple violations of Generally Accepted Accounting Principles (“GAAP”) in connection with the preparation of its annual and quarterly financial statements.”

KPMG was Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA)’s auditor until 2005, and Deloitte is the company’s auditor now, both Big 4 firms, so it’s not as if no one is looking at Fannie Mae’s books.

McKenna has been in support of shutting down Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) since at least 2010, and the string of accounting problems coupled with the perceived conflict of interest between serving shareholders while being the instrument of government housing policy is a big part of it. Even supporters of Fannie Mae and Freddie Mac have to admit that continued accounting errors makes the argument against reform more difficult.

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