Fannie Mae used improper accounting to steady its earnings from quarter to quarter, federal regulators have told the top mortgage finance company, setting the stage for the industry's second bookkeeping drama in less than 18 months.

The review by the Office of Federal Housing Enterprise Oversight found Fannie Mae used improper "cookie jar" accounting to mask swings in earnings, and it called into doubt past financial results, the company's board said in a statement on Wednesday.

The company's stock dropped 7 percent after the news. It was the biggest one-day percentage drop for Fannie Mae in more than a year.

Regulators also told the company the review of accounting practices raised questions about the adequacy of the company's regulatory capital, the quality of its management supervision, and its overall safety and soundness, Fannie Mae board member Ann Korologos said in a statement.

The review of Fannie Mae's accounting began after an accounting scandal at sibling mortgage finance enterprise Freddie Mac in 2003 that resulted in a $5 billion earnings restatement and a $125 million civil penalty for that company. Fannie Mae and Freddie Mac are among the largest financial institutions in the United States and own or have guaranteed close to half of the $7.8 trillion U.S. residential mortgage debt outstanding.

With Fannie Mae's accounting now also in question, Congress could revive stalled efforts to pass legislation overhauling regulatory oversight of the companies, although little time is left before the legislature adjourns.

Senate Banking Committee Chairman Richard Shelby called the revelations troubling.

"I continue to believe that OFHEO has inadequate authority to regulate institutions as large and financially complex as the housing GSEs (government-sponsored enterprises). This situation reaffirms my belief," the Alabama Republican said in a statement.

Fannie Mae's stock was down $5.30, or 7 percent, to $70.35 in late morning trading on New York Stock Exchange.

Traders appeared to be buying put options to sell Fannie Mae shares in the future to protect against further losses, said Paul Foster, options strategist at Mercury Trading and insideoptions.com.

Spreads between agency debt and Treasuries widened slightly as traders waited to hear more details about OFHEO's report. Neither the company nor the regulator would make the report public.
OFHEO issued biographies of leaders of members of the examination team but declined further comment.

U.S. Treasury Secretary John Snow said on Wednesday the review reinforces the need for a stronger watchdog for government-sponsored enterprises.

"These reports ... if they're credible, they underscore the importance of a strong safety and soundness regulator," Snow told reporters following a roundtable discussion with businessmen in Mechanicsburg, Pennsylvania.

Regulators told Fannie Mae that its derivatives accounting methods deviated from standard practice, that it had internal controls shortcomings and that it maintained a corporate culture that emphasized stable earnings at the expense of accurate financial disclosures, Korologos said on behalf of the company's board.

Fannie Mae's chief executive and chairman, Franklin Raines, expressed support for the non-management directors in a separate press release.

Regulators told the company that in at least one instance, deferred expenses apparently to achieve bonus compensation targets, Korologos said.

The Securities and Exchange Commission has launched an informal inquiry into the company's accounting, she said. The SEC declined to comment.

"OFHEO's report to the board states that 'the matters detailed in this report are serious and raise serious doubts concerning the validity of previously reported financial results,"' Korologos said in a statement.

Korologos said the board takes the report seriously and would work with the regulator to resolve the matter

Article © Anywhere Communications All Rights Reserved