by Eric Englund & Karen De Coster
shortcomings of Fannie Mae have been overlooked on the basis
that Fannie plays a critical role in driving the housing
sector, and thus the American economy. As Fannie goes, so
goes the nation.
Fannie means housing, and accordingly, Fannie is the conduit
that takes one from "inequitable ownership" to the American
Dream. In a nation
where equality is everything, and where advantage need not
be earned, but only redistributed, how can anything be more
Fannie Mae (FNMA or Federal National Mortgage Association),
a government-sponsored enterprise (GSE), finances
one of every five home loans
in the United States. In
1938 this GSE was founded by the federal government with a
mission to increase home ownership across the United States.
It is subject to congressional oversight via the Office of
Federal Housing Enterprise Oversight (OFHEO). Fannie Mae stock
(FNM) is actively traded on the New York Stock Exchange and
is part of the Standard & Poor's 500 Composite Stock Price
Fannie Mae may be one of the most ill-fated welfare creations,
ever, on the part of the United States government. In the
beginning, Fannie Mae's impact was negligible, however, from
the outset there were plans to swell Fannie's waistline by
expanding her purchasing authority. At about the time the
American soldiers were coming home from WWII, Fannie was enabled
to purchase loans guaranteed by the Veterans Administration,
in addition to the Federal Housing Administration-insured
mortgages it was already purchasing. This creation and expansion
of a secondary market for mortgages was a vital boost to the
supply of lendable money in the United States.
The notion of a "right" to home ownership by means of government
subsidies is so firmly entrenched in the American mindset
that Fannie could only grow and grow she did. In 1968,
as a part of Lyndon Johnson's societal engineering agenda,
Fannie was converted into a private
corporation and the ability to guarantee government-issued
mortgages was switched from Fannie to the federal government's
newest creation, Ginnie Mae (Government National Mortgage
Association). This meant that Fannie would begin to operate
with private capital on a self-sustaining basis. Fannie was
growing up, and she was going on to bigger and better things.
In 1970, Richard Nixon authorized Fannie Mae to purchase
conventional mortgages, launching a national secondary market
for home mortgages. As Fannie's foray into the conventional
mortgage market began to surge upward, in the 1980s it began
to purchase second mortgages and adjustable-rate mortgages,
and it also commenced its mortgage-backed securities scheme.
Fannie Mae advertises
itself as "a shareholder-owned company with a public purpose."
True to its words, in January of 2000 Fannie introduced its
"Mortgage Consumer Bill of Rights" program. This rundown of
entitlements promised the consumer the "right" to access credit
and the "right" to qualify for the lowest-cost mortgage possible.
No de facto private corporation can or will guarantee any
consumers' rights whatsoever that is, unless it has
the authority of government behind it to bolster its business
model and guarantee its guarantees.
Between Fannie Mae and its "little brother" Freddie Mac (another
GSE), you have the largest source of cash for home buying
in the United States they accounted for almost 50%
of all mortgage bonds sold through April of 2007, according
to Insider Mortgage Finance. Since the beginning
of 2006, over fifty mortgage companies have discontinued operations,
claimed bankruptcy, or are seeking a buyer. Yet Fannie Mae
continues to flourish. Since the end of March 2007, Fannie
Mae's stock price has increased by almost 20% whereas the
S&P 500 Index has risen only 8.1%.
Remember that corporations are generally chartered by
states, and Fannie Mae was a New Deal innovation
created by and for the federal government. The sole purpose
of this federally chartered, quasi-private entity was to directly
intervene in the housing market while avoiding a more conspicuous
regulatory apparatus governed by rules, thus allowing the
government to advance and steer the government's progressive
entitlement programs while in a semi-mute mode. Meanwhile,
Fannie has expanded into mortgage insurance, sub-prime mortgages,
and non-mortgage investments, exposing taxpayers to a massive
risk of default or bankruptcy.
Fannie is a very willing lender with the power of prominence
behind it. Its GSE status allows it to get away with not maintaining
the necessary underlying capital and enables Fannie to borrow
on more favorable terms than its state-chartered competitors.
In addition, Fannie Mae is exempt from paying state or local
income taxes and from filing with the Securities & Exchange
In February 2004, the Chairman of the Federal Reserve, Alan
before the Senate Committee on Banking, Housing, and Urban
Because Fannie and Freddie can borrow at a subsidized rate,
they have been able to pay higher prices to originators
for their mortgages than can potential competitors and to
gradually but inexorably take over the market for conforming
mortgages. This process has provided Fannie and Freddie
with a powerful vehicle and incentive for achieving extremely
rapid growth of their balance sheets. The resultant scale
gives Fannie and Freddie additional advantages that potential
private-sector competitors cannot overcome. Importantly,
the scale itself has reinforced investors' perceptions that,
in the event of a crisis involving Fannie and Freddie, policymakers
would have little alternative than to have the taxpayers
explicitly stand behind the GSE debt. This view is widespread
in the marketplace despite the privatization of Fannie and
Freddie and their control by private shareholders, because
these institutions continue to have government missions,
a line of credit with the Treasury, and other government
benefits, which confer upon them a special status in the
eyes of many investors.
The perversion here is that the rating agencies, and the
financial markets overall, have interpreted the GSE status
to mean that there is an implied government backing, and thus
their securities have been priced accordingly.
Cooking the Books for
Fun Special Favors and
In 2004, Fannie was caught cooking the books.
The Office of Federal Housing
Enterprise Oversight (OFHEO) alleged widespread accounting
errors at Fannie Mae. James Lockhart, Director of the OFHEO,
commented that "The image of Fannie Mae as one of the lowest-risk
and 'best in class' institutions was a façade. Our examination
found an environment where the ends justified the means. Senior
management manipulated accounting, reaped maximum, undeserved
bonuses, and prevented the rest of the world from knowing."
The latest tally will have Fannie Mae restating its earnings
to the tune of $11 billion. Flagrant accounting errors go
back to at least the 1990s, when the company was improperly
deferring expenses in order to boost reported net income as
it paid out huge bonuses to top executives. 
Upon being hit by the scandal in 2004, Fannie Mae stopped
filing its financial statements with the SEC. It is interesting
to note that past and present Board members of Fannie Mae
some of whom are appointed by the president
have been highly representative of the Beltway elite: a former
Reagan chief of staff, lobbyists, a former aide to Nixon,
a Reagan Secretary of Labor, a US trade representative, and
a top economic advisor to President Bush. 
The company plans to hold its shareholder meeting in December
of this year, for the first time in three years.
Maintaining the Momentum
So here we have a company surrounded with much misconception
in the financial markets and accused of deceit by its own
government overseers. It has chunked away nearly 40% of its
profits via restatements of its fraudulent financial statements
for recent years. Certainly, then, we can predict the collapse
of this mortgage giant due to (1) a lack of audited financials
and thus no conveyance of reliable information to the public,
(2) an accounting scandal that produced achievements which
OFHEO described as "illusions deliberately and systematically
created by the Enterprise's senior management with the aid
of inappropriate accounting and improper earnings management,"
(3) and a collapsing business model in light of a bursting
housing bubble, along with an imploding sub-prime mortgage
Wait. Not so fast.
Instead we witness a publicly traded company with four high-profile
- Fannie Mae's financial condition serves as a proxy for
- Fannie Mae's "health" serves as a proxy for the health
of the housing market;
- Fannie Mae's stock price has an influence on one of the
world's most closely watched stock market indexes;
- Leading up to the 2004 Presidential election, President
Bush had an aggressive housing agenda to "…dismantle
the barriers to homeownership…" with Fannie Mae
playing a significant
role in "financing" this agenda and perhaps garnering
more than a few votes for Bush and those congressmen who
hung on to the coattails of this agenda.
With mortgage defaults on the rise, a financial meltdown
at Fannie Mae would certainly demonstrate that foreign policy
wasn't President Bush's only major weakness, and it could
prove embarrassing for members of Congress aspiring to move
into the White House.
Considering the four aforementioned attributes, and the fact
that this GSE is deeply mired in scandal,
Fannie Mae is no doubt being closely monitored by the Working
Group on Financial Markets (a.k.a. the Plunge
Protection Team which reports directly to the President
of the United States).
Accordingly, we would take great pleasure in seeing Ben Bernanke,
a member of the working group, asked the following questions
including the supporting commentary the next
time he appears in front of the House
Committee on Financial Services.
- After the collapse of the NASDAQ bubble in 2000, and after
the shock of 9/11, the Federal Reserve came to believe that
the United States was heading into a deep recession. As
is typical of any central bank, the prescription to reinvigorate
the economy entailed creating more money and granting more
credit. By June of 2003, the Fed funds rate had been reduced
to 1%. To be sure, this set America's housing market ablaze.
And this is exactly what the Federal Reserve desired because
it views housing as "…a
key channel of monetary policy transmission."
A strategic cog in the monetary transmission mechanism is
Fannie Mae. In the four-year period from 2000 to 2003, Fannie
Mae's outstanding Mortgage-Backed Securities grew from $706.7
billion to an astounding $1.3 trillion. Moreover, its mortgage
portfolio ballooned from $607.7 billion to $901.8 billion.
With Fannie Mae financing one in every five home loans in
the United States, didn't it ever occur to the Federal Reserve
that it should look into this financial institution's accounting,
management control, and credit quality systems? If this massive
transmitter of money Fannie Mae was not up to
the task of responsibly lending such vast quantities of money
into existence, did it not occur to the Federal Reserve that
it may have to clean up the mess it had a hand in making?
Does the Federal Reserve have a plan to bail out the second
largest financial institution in the United States?
Since the Federal Reserve is so focused on consumer confidence
and expectations, wouldn't the share price of Fannie Mae's
common stock be of keen interest to the Federal Reserve
and the Working Group on Financial Markets? After all,
the Federal Reserve engineered
the housing bubble, and the health of Fannie Mae may be
viewed as a proxy for the health of America's housing
market. Interestingly enough, America's housing market
is experiencing a significant decline while Fannie Mae's
stock price has appreciated by about 50% from its 52-week
low, and it recently hit its 52-week high. There seems
to be a disconnect here, especially when factoring in
rising interest rates and the meltdown in subprime mortgages.
In light of this, does the working group exercise any
influence on the price of Fannie Mae's stock?
On May 2, 2007, Fannie Mae filed its latest form 10-K
with the SEC. One would assume that this 10-K contained
Fannie Mae's 12/31/06 audited financial statement. With
Fannie Mae's internal accounting nightmare, it turns out
that this 10-K contains audited financial information
as of 12/31/05. Management hopes to have the 12/31/06
audited financial statement available by next
quarter. Since you have a PhD in economics, you must
be cognizant of the fact that security analysis begins
with examining a publicly held company's fiscal year-end
audited financial statement. Does it not strike you as
odd that of the 16
Wall Street brokerage houses tracking this security,
9 had "buy" recommendations, 5 were "neutral" and 2 had
"sell" recommendations? Considering that the investment
community has waited a couple of years to receive any
kind of credible financial information, and that the 2006
audited financial statement is still not available, doesn't
it seem a bit unethical for any brokerage house (including
Bank of America and Morgan Stanley) to recommend buying
the stock of a company for which only stale audited financial
data exists? Therefore, it begs the question as to what
influence the Working Group on Financial Markets is exercising
over the powerful Wall Street brokerage houses? Quite
candidly, this smacks of a cozy relationship between certain
powerful brokerage firms and the working group.
The Chairman of the Securities and Exchange Commission
also serves on the Working Group. Have you ever asked
him why he hasn't recommended that Fannie Mae's stock
be delisted from the New York Stock Exchange? After all,
if any other publicly held company hadn't provided an
audited financial statement for fiscal-years 2004 and
2005 until December 6, 2006 and May 2, 2007 respectively
wouldn't such a company have been delisted long
Is the Working Group pressuring Standard & Poor's
to keep Fannie Mae in its prestigious S&P 500 Index?
How else could Fannie's presence in the S&P 500 Index
Fannie Mae is not a free-market entity, nor is it a private
body that must compete on the same playing field as its competitors.
Fannie Mae is representative of all that's wrong with central
planning institutions: it is a government-created conduit
for carefully crafted financial and market socialism that
the bureaucrats uphold for the purpose of propping up their
fantasies for pandemic social engineering.
There's nothing "American" about this dream. In the eyes
of the Republic's visionaries, this particular dream has turned
into a nightmare.
 Back in the "good
old days" when GM had mega-market share and was the nation's
corporate powerhouse, the saying was "As GM goes, so goes
the nation." With home ownership being the pinnacle of equality
nowadays and thus the focus of government's interventionist
policies perhaps Fannie should be given that honorable
 In 2001, Fannie
Mae introduced its American
Dream Commitment (ADC) a promise to increase home
ownership rates through minority ownership initiatives; keep
families from losing their homes; and support housing for
the chronically homeless.
 The FNMA was partitioned
into two separate entities: the GNMA remained a wholly owned
corporation of the Department of Housing and Urban Development
and Fannie Mae became a "private" corporation by virtue of
the government "retiring" its stock in FNMA. The fact that
Fannie became shareholder-owned and is therefore "private"
is a hoodwink.
 Freddie Mac had
its own book-cooking going on. This company misstated earnings
by $5 billion and is still trying to figure out how to fix
what it did. In spite of that, on the week of June 18, 2007,
one brokerage house upgraded Freddie Mac's stock.
 Fannie had to conclude
in a management assessment required by the Sarbanes-Oxley
law that internal controls over financial reporting
for both 2004 and 2005 were ineffective. That's putting it
 The May 2006 report
from the Office of Federal Housing Enterprise Oversight (OFHEO)
is truly an eye opener. Yes, it is a government oversight
organization, and that's why the report's frankness and vitriol
is a refreshing surprise. (The report is available here
names: Kenneth M. Duberstein, a lobbyist and former chief
of staff to President Ronald Reagan; Frederick Malek, an investor
and former aide to President Richard Nixon; Ann McLaughlin
Korologos, a former secretary of labor under Reagan; Stephen
Friedman, formerly President George W. Bush's top economic
adviser and former co-chairman of Goldman Sachs with Robert
Rubin; Robert Zoellick, US trade representative.
 The Working Group
on Financial Markets is not a figment of any one person's
imagination, nor is it a twisted conspiracy theory created
by "whacko" conspiracy theorists. The mainstream press has,
for a long time, been calling this issue to the carpet, with
nary a response from its members. See Karen
and Eric's July 2006 article on the working group and
their suspicion regarding GM stock prices. Note that Ron
Paul used this article as the basis for questioning Ben Bernanke
about the inner workings of the group during a House Financial
Committee hearing. Also see
the Washington Post on plunge protection.
De Coster, CPA, is a Certified Public Accountant and has an
MA in Economics. She works in the securities industry. See
her website and blog at www.karendecoster.com.
Send her mail.