Can Fannie’s appraisal/valuation policies be trusted?

Do Fannie Mae's recent accounting misadventures suggest its appraisal policies need to be examined more closely? One analyst in the New York Times thinks so.

A probe into the financial practices stretching back into the 1990s of Fannie Mae by its regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), found, as Gretchen Morgenson of the New York Times succinctly put it, "the truth about Fannie Mae: that it is just another scheming corporation run by me-first managers."

The revelations in the meaty report on results of OFHEO's investigation included that "Fannie Mae intentionally developed accounting policies and selected and applied accounting methods to inappropriately reduce earnings volatility and provide management with the flexibility to determine the amount of income and expense recognized in any accounting period."

Fannie's auditor, KPMG, aided the GSE's officers by identifying hundreds of millions in losses as an "audit difference," the report said. This, OFHEO charged, meant that Fannie's chief executives could still collect huge bonuses that would have been considerably smaller had the losses been recognized when they should have - for example, $1.9 million and $1.1 million bonuses received by then Chairman and CEO James Johnson in 1998 and by Franklin Raines, then the Chairman and CEO designate.

Four other Fannie executives - Lawrence Small, Jamie Gorelick (who went on to become one of the 10 members of the 9/11 Commission), Tim Howard and Robert Levin - shared another $3,270,384 in bonuses in 1998 alone, on top of their $2.1 million in salaries.

OFHEO investigators said they found a pattern of Fannie "not recogniz[ing] estimated income or expense up to certain thresholds" and would "defer the recognition of income or expense that exceeded recommended thresholds over a several year planning horizon" in order primarily to boost officer bonuses. OFHEO found that Fannie was mostly a straight shooter when it came to estimated income, but contorted and distorted estimated expenses.

In a damning statement, OFHEO's report said "The practice and the latitude within the policy that authorized it meant that [Fannie Mae] was no longer making adjustments to improve the accuracy of its reported financial results. Rather, the Enterprise was making preemptive adjustments for the sole purpose of managing prospective earnings."

OFHEO said it is "not aware of any basis in promulgated accounting standards that would support this accounting treatment."

Monday, OFHEO announced that Fannie Mae agreed to address improper accounting by, among other things, implementing accepted accounting standards, undertaking a "top-to-bottom review of staff structure, responsibilities, independence of functions, compensation and incentives," and appointing an independent chief risk officer and separate other key business functions.

All this academic, eco-speak, this-week's-accounting-scandal flavor of the Fannie Mae story was brought to appraisers' ground level in the Times article. Josh Rosner, a financial services analyst at Medley Global Advisors, a policy and regulatory research firm in New York, told the Times that "If allegations that they engineered systems for growth without regard to safety and soundness are correct, other systems, including underwriting, appraisal and loss mitigation systems should be called into question as well."

When it was suggested anonymously by AVM vendors and resellers that Fannie was accepting AVMs in lieu of appraisals - see our coverage here - we told you the story wasn't new, and besides, economic and mortgage industry realities would prevent AVMs from taking hold at Fannie. Americans are more encumbered by debt than ever, file bankruptcy more often, and are more delinquent on their mortgages, and yet fully half the people who would have been denied a mortgage just six years ago are approved today. What we didn't consider because we didn't know until this revelation about questionable accounting is that Fannie is in no position to risk certainty in the value of its collateral while under investigation by its regulator and the microscope of Wall Street.

All in all not the best time to plant a story about AVMs taking hold at Fannie.