Fannie Mae, the second largest financial institution in the country and the backbone, along with its sister corporation Freddie Mac, of the nation's mortgage industry, learned that it would indeed have to restate its earnings statements because of accounting irregularities.

Fannie's problems first surfaced in September when it was accused by the Securities and Exchange Commission (SEC) of attempting to smooth its earnings over time, possibly to trigger bonuses for top executives. Since that time both the SEC and the Justice Department have announced investigations of the corporation, the Attorney General of Ohio has brought suit, and top executives have undertaken a major PR initiative to repair the corporation's credibility.


Throughout this, Fannie had hoped that its denial of wrongdoing and cooperation with the SEC would allow it to escape an earnings restatement.

But, SEC Chief Accounting Donald Nicolaisen on Wednesday advised, but did not order, Fannie to revise financial statements filed with the SEC to eliminate the use of 'hedge' accounting.

Since the problem was first publicized in September, analysts have widely speculated that such a restatement could wipe at least $9 billion off of Fannie's books over the years in question, from 2001 to mid 2004.

It is also widely speculated that top Fannie executives, particularly CEO Franklin Raines and CFO J. Timothy Howard cannot survive this latest news from the SEC. Both had testified before Congress in October, calling the accounting rules extremely complex and subject to interpretation. Raines, in particular, has repeatedly stated the he would take full responsibility if his corporation's accounting practices were deemed inappropriate.

A much bigger ramification of the SEC announcement may be increased government regulation of both Fannie Mae and Freddie Mac. While both are publicly traded corporations, they enjoy special privileges under U.S. law and Republicans have long wanted to shorten the leash that accompanies these perks. Yesterday Senate Banking Committee Chairman Richard Shelby, House Financial Services Committee Chairman Michael Oxley and Richard Baker, a member of that same committee all weighed in on the need for increased oversight and/or reform.

The Office of Federal Housing Enterprise Oversight (OFHEO) which currently oversees Freddie and Fannie announced that they are working with Fannie to address the impact of the SEC's decision.

Fannie Mae's NYSE traded stock took a huge hit on Thursday, dropping at the open to $68.00, down $2.69 from the close on Wednesday. By mid-day Friday the stock had recovered to $69.41.