Fannie Books Said to Show More Problems

Investigators combing through Fannie Mae’s finances have found new and pervasive accounting violations on top of what has already been disclosed, people close to the probe said.

The investigation showed that executives embellished the company’s earnings over the years by overvaluing its assets, underreporting credit losses and misusing tax credits, the sources said.

Several of these people examining Fannie’s books also said evidence indicated that the company purchased so-called finite insurance policies to hide losses.

Securities regulators, including New York State Atty. Gen. Eliot Spitzer, are cracking down on corporations they say have bolstered earnings by using abusive financial reinsurance policies that are more akin to loans with which little or no risk is transferred to the insurer.

The news sent Fannie Mae stock down $4.99, or 11%, to $41.71, its lowest closing level in eight years.

The sources said Fannie’s accounting problems stood in stark contrast to those found at fellow government-sponsored enterprise Freddie Mac, whose earnings restatement in 2003 showed that the company deferred about $5.3 billion in excess, after-tax profit to future quarters.

The government enterprises -- which buy mortgages, guarantee their payment and bundle them as securities that are sold or held in portfolio -- own or guarantee nearly half of the $8-trillion residential mortgage market. Their accounting scandals have left the companies vulnerable to increasing criticism in Washington, where lawmakers are considering legislation to rein in the giants.

At Fannie, much of the accounting violations have helped it conceal losses over the years, rather than delay gains, according to the sources. In addition, they said Fannie’s restatement would probably show that its total cumulative losses would be higher and would include more “realized” losses, as opposed to paper losses, than the company has previously disclosed and many investors anticipate.

That’s attributed, at least in part, to new evidence that Fannie has artificially pumped up the underlying value of its $768-billion mortgage portfolio and other investments, compounding the size of the errors to be corrected. Unlike Freddie, the real economic losses at Fannie aren’t going to show up in future quarters because the underlying value of their assets was inflated, these people said.

Fannie Mae executives declined to comment.

The company’s board initiated its own review of Fannie’s finances last year after the Office of Federal Housing Enterprise Oversight accused executives of manipulating accounting rules in a scathing report delivered to the board 12 months ago.

Fannie vehemently defended its accounting until the Securities and Exchange Commission sided with the oversight office and directed the company to correct errors. Fannie began its multiyear earnings restatement and ousted former Chief Executive Franklin Raines and Chief Financial Officer Timothy Howard shortly thereafter.

Besides the board’s internal review, which is targeted for completion before year-end, the oversight office, the SEC, the Justice Department, the Internal Revenue Service and the Labor Department are conducting separate probes. Oversight office spokeswoman Stefanie Mullin declined to comment on its inquiry.

Company executives have said they expect to revise previous estimates as new issues are identified and resolved.