Fannie Fight About to Get Nastier

But according to Dow Jones Newswires, the SEC later issued a statement that said: "Chairman Donaldson's comments were intended to reflect the complexity of this matter. In no way did he intend to indicate a disagreement with Mr. Falcon's position."

The feeling in some quarters has been that Fannie and OFHEO just have differing views of two accounting rules that could, in the final analysis, be seen to be valid in both cases. The thinking has been that the SEC will not push for a restatement of past results and is happy that Fannie has agreed with OFHEO to start applying both rules in a way OFHEO approves of.

But here's why the issue won't pan out this way: According to a person familiar with the SEC probe, Fannie gave a presentation to the SEC Friday that was designed to advance its side of the story. But according to this person, OFHEO also got to attend the meeting, and that would have allowed it to contest Fannie's defense. Another source says Fannie requested the meeting because it didn't feel the SEC probe was going Fannie's way.

Moreover, it is almost impossible to believe that the SEC agrees with Fannie's implementation of accounting rule FAS 133. The alleged misapplication of this rule appears to be responsible for leaving billions of dollars of derivatives losses out of earnings and capital.

The SEC is extremely clear about how this rule needs to be applied, going by a speech given just under a year ago by an official from the SEC's Office of the Chief Accountant. Indeed, this speech cautions companies against misapplying the rule in the way that Fannie is alleged to have done.

Moreover, it's hard to see KPMG aligning itself with Fannie against the SEC and OFHEO. Detox has obtained portions of the accounting firm's handbook for dealing with derivatives accounting. Any company that stuck by the guidelines of this handbook would have a very hard time doing its FAS 133 derivatives accounting in the way that Fannie did. It appears, then, that KPMG allowed Fannie to go against its own guidelines.

Indeed, there are strong clues that suggest that to be the case. Earlier this year, KPMG worked with mortgage company Impac Mortgage (IMH) to correct its FAS 133 accounting, and that led to Impac recently restating its SEC filings. KPMG and Impac found that the company was misapplying FAS 133 in very much the same way that OFHEO alleges Fannie misapplied FAS 133. The Impac matter went up the head office of KPMG in the U.S., according to a person familiar with the situation. In other words, either KPMG got its Impac position wrong -- or its Fannie opinion. Both cannot be right. KPMG almost certainly checked and double-checked its FAS 133 thinking with Impac, which means it's much more likely to be correct.

Clearly, Raines has nowhere to turn. This is Frank's Fallujah.

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