Risk & Compliance

Fannie and Freddie Warned to Play “Fair”

Regulator overseeing the government-chartered mortgage firms says accounting issue requires them to be consistent on using fair value.
Stephen TaubApril 23, 2008

The regulator that oversees Fannie Mae and Freddie Mac warned the government-chartered buyers of mortgages to be judicious in using fair-value accounting rules, according to the Washington Business Journal.

The publication said that the issue focuses on Accounting Standard No. 159, Fair Value Option for Financial Assets and Financial Liabilities, permitting a company to change its accounting of an asset from “book value” to “fair market value.” In certain situations, however, a firm could wind up reporting gains when the value of a security declines, the publication explained.

“It is important that Fannie Mae and Freddie Mac apply fair value in a sound and consistent manner,” said James B. Lockhart, director of the Office of Federal Housing Enterprise Oversight (OFHEO), according to the Business Journal. “Although Fannie Mae and Freddie Mac are using fair value for only a portion of their assets and liabilities, the use of fair value should help dampen fluctuations in earnings caused by their large derivative portfolios.”

According to the publication, OFHEO provided the two entities with guidance outlining standards for OFHEO examiners to apply when overseeing and evaluating the use of the fair-value option.

OFHEO reportedly warned that it may request supplemental information to help it assess how the two government-sponsored entities use fair-value accounting principles and their impact, according to the report. OFHEO also warned Fannie and Freddie that it may prevent the practice in situations, “where risk management or controls are deficient,” or, “when it raises other safety and soundness issues, even if the option is being applied in a way that technically complies with the accounting standard.”

Fair-value accounting has become a controversial issue and a lightning rod for executives and regulators.

We previously reported that trade groups representing the international banking community have criticized current accounting standards requiring fair-value measurement of financial instruments. They are “a step in the wrong direction,” is the way the president and CEO of the American Bankers Association, Edward Yingling, put it in a recent statement.

The ABA and its international counterpart, the International Banking Federation, contend that full fair-value measurement, as proposed by U.S. and international accounting standard-setters, is appropriate for financial instruments that are held for trading purposes. However, for assets and liabilities that are not geared to short-term trading, or are held to maturity — such as loans, deposits, and receivables — fair-value measurement leads to income statement volatility, measured by both understatements and overstatements, according to the groups.

The bankers are complaining about the Financial Accounting Standards Board’s and the International Accounting Standards Board’s recent “Invitation to Comment” discussion paper, which calls for fair value for financial instruments, and rules such as the FAS 159, and the IASB’s IAS 39 Financial Instruments: Recognition and Measurement, as well as FAS 157 Fair Value Measurement.

Meanwhile, some members of the Public Company Accounting Oversight Board’s Standing Advisory Group recently echoed the recent concerns expressed by PCAOB Chairman Mark Olson month that auditors lack enough technical know-how to properly deal with complex estimates for those assets and liabilities that are thinly traded or not traded at all.

While auditors have been dealing with fair-value assumptions for some time, their exposure hasn’t been as widespread as the extent that FASB is increasingly allowing. FAS 159, for instance, applies to measurements for stocks, bonds, loans, warranty obligations, and interest-rate hedges.