Fannie Mae 2008 Annual Report Download - page 146

Below we provide additional information that we believe may be useful in understanding our fair value
balance sheets, including: (1) an explanation of how fair value is defined and measured; (2) the primary
factors driving the decline in the fair value of net assets in 2008; and (3) the limitations of our non-GAAP fair
value balance sheet and related measures.
Fair Value Measurement
As discussed more fully in “Critical Accounting Policies and Estimates—Fair Value of Financial Instruments,”
we use various valuation techniques to estimate fair value, some of which incorporate internal assumptions
that are subjective and involve a high degree of management judgment. We describe the specific valuation
techniques used to determine the fair value of our financial instruments and disclose the carrying value and
fair value of our financial assets and liabilities in “Notes to Consolidated Financial Statements—Note 20, Fair
Value of Financial Instruments.”
Fair value as defined under SFAS 157 represents the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the measurement date (also referred
to as an exit price). Fair value is intended to convey the current value of an asset or liability as of the
measurement date, not the potential value of the asset or liability that may be realized from future cash flows
associated with the asset or liability. For example, the dramatic decline in the fair value of our mortgage
investments during 2008 was due in part to the significant widening of spreads during the year, which does
not affect the cash flows received over the life of the mortgage investments. Also, in general, fair value
incorporates the market’s current view of the future, which is reflected in the current price of the asset or
liability. However, future market conditions may be more severe than what the market has currently estimated
and priced into these fair value measures. Finally, the fair value balance sheet reflects only the value of the
assets and liabilities of the enterprise as of a point in time (the balance sheet date) and does not reflect the
value of new assets or liabilities the company may generate in the future. Because our intent generally has
been to hold our mortgage investments, the amounts we ultimately realize from the maturity, settlement or
disposition of these assets may vary significantly from the estimated fair values of these assets as of
December 31, 2008.
Our GAAP consolidated balance sheets include a combination of amortized historical cost, fair value and the
lower of cost or fair value as the basis for accounting and for reporting our assets and liabilities. The principal
items that we carry at fair value in our GAAP consolidated balance sheets include our trading and available-
for-sale securities and derivative instruments. The substantial majority of our mortgage loans and liabilities,
however, are carried at historical cost. Another significant difference between our GAAP consolidated balance
sheets and our non-GAAP fair value balance sheets is the manner in which credit losses are reflected. A
summary of the key measurement differences follows:
•Credit Losses under GAAP: In our GAAP financial statements, we are required to recognize only those
credit losses that we believe have been incurred as of the date of the financial statements. That is, GAAP
requires losses be recognized when the event that caused the loss has already happened, while losses that
may arise in future periods, such as may result from further declines in home prices, are only to be
recognized when the event triggering that loss has occurred. See “Critical Accounting Policies and
Estimates—Allowance for Loan Losses and Reserve for Guaranty Losses,” “Consolidated Results of
Operations—Credit-Related Expenses” and “Notes to Consolidated Financial Statements—Note 2,
Summary of Significant Accounting Policies” for additional information.
•Credit Losses in Fair Value Balance Sheet: The credit losses incorporated into the estimated fair values
in our fair value balance sheet reflect future expected credit losses plus a current market-based risk
premium, or profit amount.
These differences in measurement methods result in significant differences between our GAAP balance sheets
and our non-GAAP fair value balance sheets.
Primary Factors Driving Changes in Non-GAAP Fair Value of Net Assets
We expect periodic fluctuations in the fair value of our net assets due to our business activities, as well as
changes in market conditions, such as home prices, unemployment rates, interest rates, spreads, and implied
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