Fannie's Hedging Deals Look Thorny

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Fannie Mae (FNM Quote), fending off serious accounting allegations by its regulator, said Tuesday that it is now the subject of a Justice Department investigation.

The question everyone's going to be asking is this: What might end up in any criminal complaint against Fannie, the nation's largest mortgage buyer?

In fact, thanks to some serious digging by Fannie's regulator, the Office of Federal Housing Enterprise Oversight, there now appears to be enough material in the public domain to assemble a strong hypothetical case against Fannie, whose management team is led by CEO Franklin Raines and finance chief Tim Howard.

Raines and Howard, as well as some Fannie supporters, have made broad-brush criticisms of the findings contained in OFHEO's Sept. 22 report on Fannie's accounting. But no one in the Fannie camp has so far made a convincing effort to defend the company against the particular allegations of the OFHEO report. At congressional hearings last week on OFHEO's report, Howard had to answer detailed accounting questions, but often tied himself in self-contradictory knots.

Using what is known so far, a prosecutor could make a simple and serious case against Fannie. There's much in the OFHEO report to suggest that Fannie misapplied accounting rules to make both its earnings and regulatory capital look a lot stronger than they actually were. According to some estimates, Fannie may have excluded as much as $12 billion of losses from its income statement.

Fannie's defenders have every interest in making the issues seem as complex as possible. First, so that people get lost in the details and switch off. And second, to make it look like the accounting rules are so open to interpretation that there is no one right approach and that Fannie and OFHEO merely had a difference of opinion.

But a prosecutor would have no problems drawing out simple and clear-cut abuses. As with nearly all accounting scandals, Fannie's alleged abuses aimed to do one thing: Make the books look better than they really were. Enron's ruses were sometimes complex, but after a long gestation period, the Justice Department hasn't had any real trouble putting together a convincing case against ex-Enron employees. Don't expect it to be any different when it comes to Fannie.