Fannie Accused of Disregarding Rules on Derivatives.

To smooth earnings, Fannie Mae managers intentionally disregarded accounting rules so that changes in the value of its derivatives used to hedge its giant mortgage portfolio would not impact earnings, according to a report by federal regulators.

The report by the Office of Federal Housing Enterprise Oversight says Fannie's misapplication of derivative accounting rules "appears to be pervasive and reinforced by management whose objective is to reduce earnings volatility."

The regulator also raises "serious doubts" about the validity of the mortgage company's financial statements for 2001, 2002 and 2003.

But so far, OFHEO officials have not called for a restatement of earnings because they don't know the magnitude of the quarterly losses or gains that Fannie Mae obscured by its accounting practices.

"That is something that will be determined in the future," an OFHEO official told reporters last week.

OFHEO is still conducting a special examination of Fannie's accounting policies and practices. But it issued an interim report to alert Fannie's board of directors and the Securities and Exchange Commission about serious accounting problems at the government-sponsored enterprise.

The report shows that Fannie classified 99% of its $1.04 trillion derivative portfolio as "perfectly effective" hedges so that that losses or gains on the derivative transactions would not show up in quarterly earnings.