Fannie Findings Put Raines on Defensive

The long era of corruption and recklessness could soon be drawing to a close at mortgage giant Fannie Mae (FNM - commentary - Cramer's Take), thanks to the pluckiness of its thinly staffed regulator.

After conducting an accounting probe, Fannie's regulator now has serious doubts about "the validity of previously reported financial results," according to a press release from Fannie's board Wednesday. The regulator, the Office of Federal Housing Enterprise Oversight, or OFHEO, also questions the adequacy of regulatory capital, the quality of management supervision and the overall safety and soundness of the enterprise, the board's release said. OFHEO's findings should be detailed in a report from the regulator that could be released soon.

The board also said that the Securities and Exchange Commission is conducting an informal inquiry at Fannie into some of the same accounting areas that OFHEO has looked at.

Fannie Mae's senior management, led by CEO Franklin Raines, a well-connected Washington insider, has so far managed to fight back accounting criticisms and calls for tighter regulation of the company. Earlier this year, the company thwarted attempts in Congress to put Fannie under a tougher regulatory regime. And Fannie's stock has not suffered from accounting-related allegations, many of which were made first by this column.

However, that looks set to change Wednesday. News of OFHEO's doubts and the SEC probe sent Fannie stock down nearly 7% in morning trading. And if OFHEO's report backs up assertions made in the board's press release, Fannie will find few defenders in Congress, making it much easier for a bill to pass that toughens up regulation of government-sponsored enterprises like Fannie.

Falcon Crest

Fannie is a public company but operates under congressionally granted advantages. As the nation's largest mortgage buyer, with over $1 trillion of assets, it is the backbone of the U.S. housing market. OFHEO is headed by director Armando Falcon, who decided to launch the Fannie probe after accounting missteps were revealed at rival Freddie Mac (FRE - commentary - Cramer's Take) in 2003. From what is known, Freddie's accounting chicanery looks less serious than Fannie's.

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In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send any to [e-mail].