Fannie Mae Scandal Term Paper

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Fannie Mae Scandal

Fannie Mae is the second largest government sponsored U.S. financial institution engaged in mortgage finance after Citigroup Inc. An investigation lasting for eight long months by the Office of Federal Housing Enterprise Oversight or OFHEO revealed massive manipulation of earnings that have been engineered to fulfill Wall Street expectations and smooth volatility in earnings from one quarter to next quarter. The revelations deserve quick corrective action announced by the Director of the Agency in a letter to the Board members of Fannie Mae. The Securities and Exchange Commission is also inspecting the books of accounts of Fannie Mae. However, a statement issued by Fannie Mae states that the company has modified its employment contracts with the three top ranking executives i.e. The Chairman and Chief Executive, Franklin Raines, Chief Operating Officer Daniel Mudd and Chief Financial Officer, Timothy Howard to make sure that in the event their services are terminated, they will lose massive severance packages. (Fannie Mae management may be ousted)

The OFHEO report stated that the management at Fannie Mae intentionally developed and were practicing wrong accounting policies, favored large scale infringement of Generally Accepted Accounting Principles or GAAP, ignored slipshod internal checks and measures and was unsuccessful in correctly examining an employee's concerns regarding accounting. The report that was given to the Press further showed an incidence happening in 1998, wherein accounting for $200 million in expenditures was postponed to a future reporting period to ensure that Executives could get full bonuses. The reasons for the scandal which the OFHEO officials stated that they had revealed that the problems which they had found lay in a major area of accounting at Fannie Mae was extremely severe, increasingly more complicated.

The area entails accounting for expenditures over a time span connected to the home mortgages that Fanne Mae purchases from the Banks and other lender of funds. The company is the second biggest seller of securities after the U.S. Treasury. It utilizes the monies from the proceeds of these sales to purchase trillions of dollars in home mortgages from Banks and other lender that according to the company gives increased liquidity and lower mortgage rates to home buyers. It could be financially prudent that Fannie Mae could be instructed to lower its financial leverage through raising fresh capital or purchasing fewer amounts of mortgages possibly rendering it difficult in case of home buyers to get financing. (Fannie Mae management may be ousted)

Reasons for the scam:

The primary reason for the financial scam was the pre-intended desire to have earnings conform to some pre-existing plans that became the root cause for problems at the large corporation. In one of the most pejorative sections of the OFHEO report analyses the manner in which it is to be considered as low risk, Fannie Mae lit up an idea that it has to show earnings growth on a regular basis. The fulfilling of earnings objectives was so important that the bonuses to be paid to top-level executives were linked with them. During the year 1998, bonuses were based on achieving targets which was $3.13 Earnings per Share or EPS for the minimum bonus, $3.18 bonus for meeting target, and $3.23 or more than that for achieving maximum bonus. In a candid remark, OFHEO stated that in 1998 the EPS was $3.2309 and it was felt that in order to arrive at the target, the company might have deferred around $200 million in expenses. The broader suspension of skepticism is provided by the people who purchase, own, and trade the $1.37 trillion in securities issued by Fannie Mae. During every probable turn of events, government and the executives at Fannie Mae take all the trouble to observe that the government does not in any manner, shape, or structure, provide the debt that the company issues to the public. (The Truth about Fanie: The Real Scandal at Fannie Mae)

It is being held by investors that Fannie Mae enjoys some implicit government guarantee which might not be a total guarantee, but a considerably sizeable one. Besides, substantial proof exists that Fannie Mae enjoys immunity from the government like the most-favored company status. The President appoints five among the eighteen directors. Another advantage which the company enjoys is the fact that it does not have to register its mortgage-backed securities with the Securities and Exchange Commission whereas it has its own regulator in the form of OFHEO. The company enjoys complete waiver of state and local taxes and is subject to lower capital requirement compared to banks.

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It is widely understood that a company of Fannie Mae status will never fail, and the government and Congress have a huge stake in the success of Fannie Mae. (The Truth about Fanie: The Real Scandal at Fannie Mae)

Greed and Abuse of Power:

In a stark abuse of power, all internal accounting norms were flouted to meet earnings target and in this manner they paid hefty bonuses amounting to a whopping $249 million for top executives for the last 6 years which were all based on dubious earnings statements. According to OFHEO officials, when correct accounting procedures wouldn't give satisfying financial statements, the managers at Fannie breached the rules and made new ones in its place. In a blatant act of favoritism, a lot of Congress members were more inclined in representing the executives of Fannie Mae rather than the citizens, who subsidize the company and possibly arrange for a bail-out in the event of its failure. The recent committee hearing concentrated on dubious accounting practices at Fannie Mae which are nearly similar to that of Enron. Nevertheless, not like Enron, a financial downfall at Fannie Mae would have severe consequences for the broader economy. (Congress Ignores Fannie Mae Scandal)

The company handles in excess of $1 trillion in debt and its mortgage portfolio raced ahead by $573 million previous year which is an increase of 55% compared to the previous year. However, many of the lawmakers who pointed their fingers at the Enron debacle surprisingly went to greater extent to take lightly the accusations against Fannie Mae, warning against to jump to conclusion and charging the authorities at OFHEO for braving to act as the regulating body. The denial of the lawmakers to deal with the corporate misdemeanor at such an important financial institution appears perplexing, till one considers that Congress has a major hand in the imbroglio by overlooking the whole issue while the Government Sponsored Enterprises or GSEs used billions of tax paid dollars to fill their pockets and bankroll huge congressional lobbying operations which surpasses all other corporation in the U.S. (Congress Ignores Fannie Mae Scandal)

Till Fannie Mae was able to undeniably, assert that it was aiding besieged families fulfill the American dream, Congress had the political veneer it required to do nothing. However, the executives at Fannie Mae have really been leveraging the prized deal which the Congress gave them to have the maximum profits, helping themselves with massive bonuses, and defending their valued congressional charter at all costs. Congress has turned a blind eye towards the misgivings of Fannie Mae. Professionals have cautioned against the uncontrolled growth of GSE and its lack of transparency. Alan Greenspan, Chairman Federal Reserve has warned that the potential of GSEs to borrow at subsidized rates in the absence of genuine limits permits the company to make profits from the investments, while transferring all the risks into the shoulders of the taxpayers.

Nevertheless, the Senate recently scurried a Bill which would have made an independent GSE regulator and imposed stringent accountability norms. Congress failed to be on vigil, thus allowing GSE executives in their slipshod accounting practices and their relentless thirst for massive profits at the expense of homebuyers and taxpayers. It is the onerous duty of the Congress to substantiate the reasons for its apathy on the whole issue which led to the likes of Fannie Mae to have unregulated control on one of the most crucial segments of our economy without seemingly any checks and balances. This shows that the likes of Fannie Mae have abused their charters endangered the financial security of the taxpayers. (Congress Ignores Fannie Mae Scandal)

Impact on Stakeholders:

The impact of the Fannie Mae on the stakeholders has been the unparalleled fall in the interest rates, which although has been a gain for the homeowners, however has disturbed the equilibrium between the firm's $747 billion portfolio of mortgages and its debt liabilities of $789 billion as on June 30, 2002. The principal job of Fannie Mae is buying mortgages from banks and other mortgage brokers. Through provision of cash to the primary lenders, Fannie Mae aids homeless people to own homes. However, in the opinion of the critics, the company was taking undue risks to fulfill the ambitious target of doubling the EPS in the five years which ended in 2003. They observed that Fannie Mae's portfolio has grown at a far more aggressive rate. On the other hand others complain that.....

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