This Wall Street Journal ($) editorial examines the recent report issued by the Office of Federal Housing Enterprise Oversight (Ofheo) in regard to Fannie Mae‘s accounting machinations and what it found is troubling, to say the least.
By improperly delaying the recognition of income, Fannie Mae created a cookie jar of reserves and by improperly classifying certain derivatives, it was able to spread out losses over many years rather than recognizing them immediately. Accordingly, Fannie Mae’s managers in any quarter could reach into the cookie jar of reserves to compensate for poor results or add to it to lessen good ones. As the WSJ notes, this arrangement gave Fannie Mae “inordinate flexibility” in reporting the amount of income or expenses over reporting periods, which allowed it to manipulate earnings in order to hit target numbers for executive bonuses for Fannie Mae executives:

Ofheo details an example from 1998, the year the Russian financial crisis sent interest rates tumbling. Lower rates caused a lot of mortgage holders to prepay their existing home mortgages. And Fannie was suddenly facing an estimated expense of $400 million.
Well, in its wisdom, Fannie decided to recognize only $200 million, deferring the other half. That allowed Fannie’s executives — whose bonus plan is linked to earnings-per-share — to meet the target for maximum bonus payouts. The target EPS for maximum payout was $3.23 and Fannie reported exactly . . . $3.2309. This bull’s-eye was worth $1.932 million to then-CEO James Johnson, $1.19 million to then-CEO-designate Franklin Raines, and $779,625 to then-Vice Chairman Jamie Gorelick.

The WSJ concludes:

Fannie Mae isn’t an ordinary company and this isn’t a run-of-the-mill accounting scandal. The U.S. government had no financial stake in the failure of Enron or WorldCom. But because of Fannie’s implicit subsidy from the federal government, taxpayers are on the hook if its capital cushion is insufficient to absorb big losses. Private profit, public risk. That’s quite a confidence game — and it’s time to call it.