Fannie Mae Execs Face the Music

All nonsense. Anyone who argues along these lines clearly hasn't read the report, or understood it. In the report, OFHEO has gone out of its way to show that when it comes to SFAS 133, this is not a mere disagreement between accountants. OFHEO also shows that the complexity argument is a canard when it comes to SFAS 133. To do that, it cites the 2003 remarks of a senior SEC accountant.

The rule does become burdensome to implement when companies try to use it to keep losses out of earnings. The reason SFAS 133 is burdensome in this respect is that it requires companies to clearly show why gains and losses on derivatives should be excluded from earnings. In that sense, it is a sound rule. Companies shouldn't be allowed to just keep losses and gains out of earnings at their own subjective discretion. That would be an accounting free-for-all.

And, critically, OFHEO's report indicates that Fannie failed in most cases to show why its derivatives losses should be kept out of earnings. The company appears to have used the provision in SFAS 133 that allows it to keep losses out of earnings, but for the most part it seems to have failed to fulfill the requirements for taking advantage of that aspect of SFAS 133.

But why? Another utterly silly theory going around is that OFHEO hasn't shown motive for the alleged abuse of SFAS 133. But the regulator has suggested motive in several parts of its report. OFHEO even quotes a senior Fannie accountant, Jonathan Boyles, saying what motivated Fannie when it was implementing SFAS 133, which companies had to abide by from 2001 on. In March 2003, Boyles wrote a memo describing what drove the implementation of SFAS 133. First on the list was that "earnings volatility was to be minimized."

Rickety Table

This is no surprise to Fannie watchers. Right from when the rule was first proposed, Fannie never hid its dislike for SFAS 133, chiefly because it would cause volatility in earnings. Despite intensive lobbying, Fannie failed to stop SFAS 133. What seems to have happened is that the company gave the appearance of properly applying the rule, but actually implemented it in such a way that volatility was excluded from earnings. That alleged approach became very useful when huge losses started to accumulate on derivatives from the end of 2001 on. The system that was possibly set up to avoid earnings volatility may suddenly have become very convenient for keeping the gargantuan derivatives losses out of earnings.