Fannie Mae update

Daniel Gross explains the risks of Fannie Mae:

Fannie Mae has convinced itself that massive exposure to interest-rate volatility can be a low-risk business. It has propounded the notion that a giant financial company, through efficient hedging, can produce earnings that are as smooth and predictable as those reported by General Electric in Jack Welch’s heyday. The people who owned Fannie’s stock–worth $74 billion just two weeks ago–explicitly bought into this belief.

The desire to have earnings conform to some pre-existing plan is a recipe for trouble at a large corporation. One of the most damning segments of the OFHEO report (see Pages 7-12) discusses how, in order to be perceived as low risk, Fannie felt it had to present regular earnings growth. The meeting of earnings goals was so crucial that bonuses for top executives were pegged to them. In 1998, bonuses were based on hitting targets: earnings of $3.13 a share for the minimum bonus, $3.18 for the target bonus, and $3.23 or above for the maximum bonus. “Remarkably the 1998 EPS number turned out to be $3.2309,” OFHEO deadpans. In order to meet the target, OFHEO suggests, Fannie Mae may have improperly deferred some $200 million in expenses.

When it comes to risk, as with everything else, there is no free lunch (with apologies to Kenneth Arrow). Read the whole thing. And here is my previous post on Fannie Mae.


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