Fannie Mae's Accounting Fraud

Recently, the US economy has seen many companies go under because of "cooking their books" by hiding liabilities. This is a clear view that accounting fraud has been done. Fannie Mae is one of the largest financial institutions in the United States and the OFHEO has found Fannie Mae's earnings misleading. The company did not hide its liability, instead they hide their earnings. Is this still accounting fraud by making the company look worse off financially? I believe that not disclosing all information is a criminal act and should be accounted for. The reason for this fraud is to keep earnings constant and not have large fluctuation. They wanted to be able to help themselves in times of need when they aren't make the large income. This has an effect on the small and large investor because there are still scandals going on even after Sarbanes-Oxley Act of 2002. The investor may not invest because they don't know if they can trust the financials of a company.


John West said...

Both Fannie Mae and Freddie Mac are supposedly upstanding firm's. I simply believe that all it takes for a scandal to break, is for one executive/officer to place his or her influence on others within the organization in order to alter viable financial records and in-turn create an edge in their firm. It all goes back to ethics, but can we teach individuals to care about the man or woman who may be buying their companies stock?

Dr. Tufte said...

This goes back to the principal agent problem that we discussed in Chapter 1, and in a lecture on a few other days.

Fannie Mae and other "companies" created by the government have the same principal agent problem that other companies do: how to keep managements interests aligned with those of shareholders.

Unfortunately, it is probably worse in the case of these companies because there is moral hazard involved. A moral hazard is a situation where an immoral or unethical act may be in your own (perhaps selfish) best interest. It doesn't necessarily mean that you take the opportunity, just that everyone is tempted, and some of them succumb. The moral hazard here is that many people in the public believe that these corporations that were created by the government will be backed up by the government if they fail in some way. This encourages their managers to act in ways that a publically traded corporation normally wouldn't.

Juicy gossip: two of the people at the top of Fannie Mae who are in trouble were big players in the Clinton administration.