The Mortgage Twins’ Demise: Looking Beyond Financial Reporting Fraud at Fannie and Freddie


Fannie Mae (Federal National Mortgage Association, or FNMA) and Freddie Mac (Federal Home Loan Mortgage Corporation, or FHLMC), the formerly government-sponsored, now government-owned, entities that were created to provide liquidity to the mortgage markets and to support social goals relative to housing availability and affordability, have not presented sympathetic images in recent years.

After literally decades of warnings (particularly from the Wall Street Journal’s editorial pages) regarding the huge risks that FNMA’s and FHLMC’s implicit government guarantees had created for taxpayers, the bursting of the housing bubble caused these enterprises to become official wards of the Federal government, in which status they have already cost taxpayers some $153 billion, with more losses anticipated to come.

Albeit with the benefit of hindsight, it seems crystal clear to many that FNMA’s and FHLMC’s portfolios of loans, mortgage derivatives, and guarantees were riskier than had generally been perceived – and that these entities’ financial statements had not appropriately disclosed these risks to shareholders and others. Indeed, the SEC has recently sent so-called "Wells notices" to former executives, alerting them to the fact that they might be targeted in civil actions, and rumor has it that even FNMA and FHMLC themselves (i.e., the companies, not just the former executives) might be named in forthcoming complaints.

But is it really so obvious that financial reporting by these behemoth organizations had been flawed, perhaps even fraudulently so? A revisiting of the financial statements filed by FNMA and FHLMC suggests that this may not necessarily have been the case.

A first, but fairly detailed, review of the FNMA’s 2007 financial statements does not reveal any failure to report the mandated information, and cautionary language is found in abundance, including about the yet-unknown outcomes of ratings reviews. While some technical reporting deficiencies may be found to have existed, it appears to this writer that the fault for FNMA’s and FHLMC’s respective collapses – and many contributing causes could be readily recited – does not prominently include financial reporting fraud.

Substandard financial reporting certainly exists, and failed audits are legion, but not every failure can be attributed to fraudulent financial statements and/or auditor negligence. When politically imposed-upon private (at least, nominally so) enterprises are forced to implement government-mandated social or economic policies, accuracy in financial reporting sometimes suffers the consequences. Financial reporting aberrations, even if they are found to exist, may thus be more a symptom than a cause. It may be that the FNMA and FHLMC collapses will ultimately be found to have exemplified this phenomenon. Read the full story for more details.

ABOUT THE AUTHOR: Forensic accountant Barry Jay Epstein, Ph.D., CPA, CFF, is a partner at Russell Novak & Company LLP ( in Chicago. He is the author of The Handbook of Accounting and Auditing, published by RIA, the tax and accounting business of Thomson Reuters. Dr. Epstein served as the lead author of 26 annual editions of Wiley GAAP (1985 through 2010) and 14 annual editions of Wiley IFRS (1997 through 2010), all published by John Wiley & Sons. He is also a consulting expert on GAAP, auditing standards, and financial reporting matters. He can be reached at or 312-464-3520.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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