How much is perception worth?
How much is a company’s good name worth? For Fannie Mae, we may be about to find out. As the largest Government Sponsored Enterprise, Fannie Mae has an enormous presence in US mortgage markets: Last week, the SEC issued a statement chiding Fannie Mae for significant accounting failures:
Our review indicates that during the period under our review, from 2001 to mid-2004, Fannie Mae’s accounting practices did not comply in material respects with the accounting requirements in Statement Nos. 91 and 133. Regarding Statement No. 91, during the period under the SEC staff’s review, Fannie Mae failed to record timely adjustments to the recorded amount of its loans based on changes in the estimated speed with which those loans would be prepaid.
The SEC concluded the changes were material enough that:
Fannie Mae should:
- Restate its financial statements filed with the Commission to eliminate the use of hedge accounting.
- Evaluate the accounting under Statement No. 91 and restate its financial statements filed with the Commission if the amounts required for correction are material.
- Re-evaluate the information prepared under generally accepted accounting principles (GAAP) and non-GAAP information that Fannie Mae previously provided to investors, particularly in view of the decision that hedge accounting is not appropriate.
For a mortgage giant (by one measure, the US’s fourth largest company) with a portfolio measured in the trillions – that’s millions of millions! – to restate the value of its assets is no mere peccadillo, but a blow to the foundations of its financial integrity – and therefore to the viability of its business model. The stakes are even higher because the GSEs enjoy a halo effect from their Federal charter. As a Los Angeles Times editorial succinctly puts it:
The reason Fannie and Freddie enjoy lower borrowing costs, after all, is the widespread belief among investors that Uncle Sam won’t let either institution fail. If that were to happen, taxpayers, not company shareholders, would be on the hook for a costly savings-and-loan-style bailout.
Should Chairman and CEO Frank Raines resign? Some say Yes :
So many questions had been raised about these issues over the past two years that there are really only two possibilities: Raines either knew that Fannie’s accounting was questionable, which I doubt, or he should have known, in which case he failed in his duty of care. In either case, with $9 billion in reported profit in jeopardy, he is now duty-bound to resign and take Chief Financial Officer Timothy Howard with him.
And some say No :
Accounting rules are complex and the regulators who enforce them are fallible. Pressures and incentives can shape the judgments of regulatory employees just as they shape the judgments of executives. The agency investigating Fannie, OFHEO, is still scarred from the whipping it received for missing the Freddie Mac debacle, and Congress is perpetually threatening to move its regulatory responsibility elsewhere. Does this explain OFHEO’s harshness? Who knows. But there is no better way to address a reputation for weakness and ineptitude than to start throwing charges around. Practically no company is safe from a determined, powerful government opponent. OFHEO has concluded that Fannie manipulated earnings. Well, every company manipulates earnings (the polite word is “manages”) – the only question is to what degree.
Yet even Fannie Mae’s friends are finding things to criticize :
Fannie doesn’t help matters by paying its executives fat bonuses and hiding behind the universal appeal of its mission, declaring itself “in the American Dream business,” and bludgeoning critics as “anti-housing.”
Indeed, back in October, at a House hearing, Raines himself more or less said as much :
“I’ve always tried my best to ensure that our company does the right thing in the right way,” Raines told lawmakers. “If, however, after a thorough review of all the facts, it is determined that our company made significant mistakes, our board and our shareholders will hold me accountable. And I’ll hold myself accountable.”
Ultimately, there’s one way to test whether a brand has been impacted: what happens to its stock price .
Though we don’t know what is being said behind closed doors, we can watch the stock market price. If it holds, Raines and company may weather the storm, for Washington is a town with Attention Deficit Disorder. Or they may try throwing a few executives overboard in hopes that will calm the troubled waters. But if the stock price moves south, expect departures from Fannie Mae’s executive suite.
