In 2004, the Office of Federal Housing Enterprise Oversight (OFHEO) found out that the firm Fannie Mae was violating the Generally Accepted Accounting Principles (GAAP). This practice, as per the government investigation took place from 1998-2004, while in the year 1998, the management over stated revenues and understated the expenses. In accordance with a report that has been recently presented by OFHEO, there was involvement of high level executives that led to the misinterpretation and violation of accounting standards, which was a massive scale 'organized-accounting-robbery' mounting the dollar amount to 11 billion. The director of OFHEO took an immediate note and directed correction, which was turned down by Fannie Mae making an excuse that it could have been an end-user issue as the company is not fully automated.
What truly went improper was the fact that loans and mortgage are fairly risky games and there are always chances of customers defaulting, alongside the interest rate risk makes the venture further riskier. For securing their investment and giving better return to stakeholders, Fannie Mae undertook risky ventures and investment for better returns and compensating the main stream line of business. When there were phenomenal profits, the shareholders and executives remain satisfied due to income (dividend yield and capital gains) and bonuses respectively.
Violation of GAAP
In the recently presented report by OFHEO, after three years of extensive investigations, there was a major accounting flaws in the accounting practices of Fannie Mae noticed and marked. The major ones are highlighted as the violation of the following GAAP standards:
1. SFAS-91: Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases
2. SFAS-133: Accounting for Derivative Instruments and Hedging Activities
As mentioned previously, that there was too much over-estimation of income and underestimated expenses that mainly contributed to increased bottom-line of the financial statements. The excess income was mainly recorded by means of non-refundable fees. Alongside, the future in-flows of cash were adjusted by using hedging and futures counters that introduced lesser risk with fluctuating interest rates, however, these also increased the risk by means of gambling over the same counters with excess money.
Official Involvement & Auditors
The major player/official involved in this scandal was the Chief Executive of Fannie Mae i.e. Franklin Raines. He always defended the company in good terms by making others responsible by tarnishing the repute of the company. The CFO (Chief Financial Officer) also defended the company in good terms by stating that the financial statements were as per the GAAP requirements. The audit of this firm was KPMG who backed out after sometime. The denial of having the firm involved in such a violation gave a view of KPMG being involved them in the issue but it could have been a case of negligence as well as the auditors drew their hands from this case soon. OFHEO