Richard Bove On Fannie Mae's Accounting Irregularities - Hedge Fund Alpha (formerly ValueWalk Premium)
Fannie Mae

Richard Bove On Fannie Mae's Accounting Irregularities

Richard X. Bove, Vice President Equity Research at Rafferty Capital Markets, highlights the forensic accounting analysis on Fannie Mae’s financial statements.

Fannie MaeFannie Mae Highlights

  • Adam Spittler CPA, MS, and Mike Ciklin JD, MBA, MRE have done some forensic accounting analysis on Fannie Mae’s financial statements. Spittler is a Senior Associate at KPMG and Ciklin is an investor in a number of start-up digitally based companies. The result of their work is a conspiracy theory concerning the government takeover of Fannie Mae in which the public has been lied to concerning Fannie Mae’s financial condition in 2008 and in subsequent years.
  • The arguments are presented in three monographs entitled A Forensic Look at the Fannie Mae Bailout: Scrubbing the Tricky Accounting of Conservatorship; A Follow Up To The Forensic Look … ; and Deloitte! Restate Thou Must!!
  • The basic argument is that in 2008 when the financial system was crumbling, the Treasury and the Federal Reserve made the decision to take over the two government sponsored agencies (GSEs). These companies were needed to pump money into the big banks in order to prevent them from failing. The GSEs pumped the money in by purchasing distressed mortgages at par.

Fannie Mae

  • They got the money to do this from the Treasury. This money, which was supposedly to be used to bailout the GSEs, was not needed for that purpose because the two GSEs were cash flow positive. However, to get the money into and out of the GSEs the Treasury had to prove that the GSEs were insolvent. This was accomplished by accounting manipulation.
  • The two authors use extensive quotes from the books written by Henry Paulson and Timothy Geithner as well as selected hearings to prove their point. Since I am not a conspiratalist thinker, I am unable to argue whether this theory is correct or not. I am not even willing to argue that if this was done the two officials who did it were acting against the public interest. They were doing what they thought was correct to solve a formidable problem – and they solved the problem.
  • I am willing to argue, however, that the forensic argument that was presented concerning the GSE balance sheet and income statements is correct since I have believed this all along. To me it has always been clear that accounting gimmickry was the basis of arguing that these two companies were insolvent. They were not and recent history proves this.


For years I have been writing that bank accounting does not reflect the true financial condition of banking companies. The reason is simple, bank accounting

  • Focuses primarily on asset values, and
  • It virtually ignores the cash flowing through the companies.

What this means is that subjective interpretation of asset values can often override cash flows when reporting banking net income.

  • Banks, for example, may be forced to estimate what future loan losses are and these estimates may be many times cash flows.
  • Fair value assumptions are based, in some cases (Level III assets), on interest rate predictions.
  • The recognition of deferred tax assets is based on an estimate of a company’s earnings many years into the future.

None of these numbers have anything to do with how many widgets a bank has sold, what the price of those widgets were, and what the expenses against these sales were. The accounting techniques in banking basically downplay this activity, or how banks make money.

The biggest problem with bank accounting is that given its fundamental structure it can be easily manipulated by managements, accountants, and the government if any of these entities so choose. What the work of Spittler and Ciklin shows is how this was done in the case of Fannie Mae.

Fannie Mae

Government Cooks the Books

It is not my intention to replicate the work of these accountants here. You can find their papers In HousingWire in an article entitled The three-card Monte accounting of Fannie Mae and Freddie Mac conservatorship at I thank Gary Hindes for bringing this work to my attention.

I do want to point out a few items in the third quarter of 2008, the period when the company was forced into conservatorship:

  • The company took a loan loss provision of $8.8 billion despite actual net loan losses of $291 million. The higher number was solely based on the government’s estimate of future losses in the loan portfolio.
    • In the third quarter of 2009, the company recorded a loan loss provision of $21.9 billion on an actual loss of $396 million.
    • Interestingly there has never been a quarter in which Fannie Mae actually lost $8.8 billion, let alone $21.9 billion. The biggest net loan loss the company ever took was $6.7 billion in the third quarter of 2010. These losses are believed to have been due to the fact that the firm was forced into buying distressed loans from the banks at par.
  • Also, in the third quarter of 2008, Fannie Mae recorded a $21.4 billion write-off of its deferred tax asset. This shows up on the income statement as a net number or the payment of $17.0 billion in taxes in the quarter despite a pretax loss of $11.9 billion. The theory here was the company would never earn enough money to validate the existence of this asset.
    • Yet less than five years later, Fannie Mae recovered 100% of its deferred tax asset and this allowed the company to book a tax refund of $50.6 billion despite a profit of $8.1 billion (that’s right it paid $17 billion on a loss and got a refund of $51 billion on a profit). Clearly the estimate made in 2008 was dramatically incorrect.
    • What is also fascinating here is that while the company booked a non-cash charge of $21.4 billion in the write-off of the deferred tax asset in 2008, it paid out $59.4 billion in cash to the Treasury. Again, that’s right, this supposedly insolvent company had $59.4 billion in cash, not accounting dollars, to give to the Treasury.
  • While the company took a number of other non-cash charges in the third quarter of 2008 causing it to be placed into conservatorship it is believed by the forensic accountants that it actually earned $1.1 billion in cash profits in that quarter and it had $36.3 billion in cash in the “bank.”.

Spittler and Chiklin point to a number of other irregularities in the company’s accounting and even go so far as to suggest that Deloitte should be sued for misstating the company’s financials. They argue that the accounting firm ignored basic accounting rules in making these subjective decisions concerning asset values (which history seems to prove is correct) and that Deloitte knowingly ignored certain receivables such as put backs when totaling up the company’s balance sheet.

Fannie Mae


It would appear that whatever the reason, the government did manipulate the books of this company to achieve its unstated goals. Fannie Mae was not insolvent in 2008. In fact, on a cash basis it would appear it was making money. One might argue, as I do, that the government is still actively manipulating the books of this company to drive Fannie Mae into true insolvency today. I just do not believe this is acceptable and that the business press has an obligation to reveal what Spittler and Chiklin have determined. But the press will not do it because it is too much a toady of the government. Let’s see what the courts do.


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