Fannie Mae's chief executive and chairman was on Capitol Hill yesterday to defend the company's accounting practices before members of Congress.
Franklin D. Raines responded to allegations about Fannie Mae's implementation of two accounting standards raised in a damning report issued last month by its regulator, the Office of Federal Housing Enterprise Oversight.
The report alleges that, in 1998, the company willfully violated generally accepted accounting principles in order to maximize executive bonuses. "This is a serious allegation, and we strongly disagree with it," Raines said in prepared testimony before a House Subcommittee.
The OFHEO report also alleges that Fannie Mae misapplied GAAP with respect to two accounting standards: FAS 91, which requires that the premiums or discounts on the purchase of mortgage-backed securities be amortized over the expected average life of the security, and FAS 133, the standard for derivative and hedge accounting.
"We believe we applied those standards in accordance with GAAP, and our independent auditor, KPMG, reviewed our application of those standards and concurred," Raines said. Raines added that the issue of whether the company's implementation of FAS 91 and FAS 133 was consistent with GAAP "remains with the Securities and Exchange Commission."
He also noted that Fannie Mae hasn't withdrawn its financial statements and its auditor, KPMG, hasn't withdrawn its opinion that those financial statements were prepared consistently with GAAP in all material respects.
"Our accounting staff has repeatedly determined that our policies and practices with regard to FAS 91 and 133 are reasonable and in accord with GAAP, and KPMG has issued unqualified opinions on our financial statements. That remains their position today," said Raines. "Our purpose in describing our approach to these standards is not to argue that we are right and OFHEO is wrong. What we want to demonstrate is that we intended to do the right thing and we took care to do the right thing."
He added, "When I certify our financial statements, I certify that these documents 'fairly present in all material respects the financial condition, results of operations and cash flows' of the company. That is a very serious statement, and I take it very seriously. We engage in a rigorous due diligence process before I ever put a pen to paper and make that certification."
Days after the release of the highly critical report, Fannie Mae entered into an agreement with OFHEO in which it agreed to several measures, including changes to its accounting. Fannie Mae agreed to discontinue the use of a range in implementing FAS 91 beginning in the fourth quarter of 2004. With respect to FAS 133, Fannie Mae will shift in the first quarter to the "long haul" approach where applicable.
Fannie Mae also agreed to build up to a 30 percent capital surplus over the next nine months, to appoint an independent chief risk officer, and to hire an independent counsel and an independent accounting consultant to review and report on its accounting policies and practices.
"Some people have mistakenly concluded that the company's agreement with OFHEO constituted an admission by the company to the findings and conclusions of the report. Let me clarify that is not the case," Raines said. "The agreement itself states that the company was not admitting or denying any wrongdoing as a result of signing the agreement."
The board's independent review committee has hired the law firm of Paul, Weiss, Rifkind, Wharton & Garrison to conduct an independent investigation of the allegations in the special examination report.
