Fannie Mae 2009 Annual Report Download - page 65

We make significant use of business and financial models to measure and monitor our risk exposures and to
manage our business. For example, we use models to measure and monitor our exposures to interest rate,
credit and market risks, and to forecast credit losses. The information provided by these models is used in
making business decisions relating to strategies, initiatives, transactions, pricing and products.
Models are inherently imperfect predictors of actual results because they are based on historical data available
to us and our assumptions about factors such as future loan demand, prepayment speeds, default rates, severity
rates, home price trends and other factors that may overstate or understate future experience. Our models
could produce unreliable results for a number of reasons, including limitations on historical data to predict
results due to unprecedented events or circumstances, invalid or incorrect assumptions underlying the models,
the need for manual adjustments in response to rapid changes in economic conditions, incorrect coding of the
models, incorrect data being used by the models or inappropriate application of a model to products or events
outside of the model’s intended use. In particular, models are less dependable when the economic environment
is outside of historical experience, as has been the case recently.
In addition, we continually receive new economic and mortgage market data, such as housing starts and sales
and home price changes. Our critical accounting estimates, such as our loss reserves and other-than-temporary
impairment, are subject to change, often significantly, due to the nature and magnitude of changes in market
conditions. However, there is generally a lag between the availability of this market information and the
preparation of our financial statements. When market conditions change quickly and in unforeseen ways, there
is an increased risk that the assumptions and inputs reflected in our models are not representative of current
market conditions.
The dramatic changes in the housing, credit and capital markets have required frequent adjustments to our
models and the application of greater management judgment in the interpretation and adjustment of the results
produced by our models.
Actions we may take to assist the mortgage market may also require adjustments to our models and the
application of greater management judgment. This application of greater management judgment reflects the
need to take into account updated information while continuing to maintain controlled processes for model
updates, including model development, testing, independent validation and implementation. As a result of the
time and resources, including technical and staffing resources, that are required to perform these processes
effectively, it may not be possible to replace existing models quickly enough to ensure that they will always
properly account for the impacts of recent information and actions. The application of management judgment
to interpret or adjust modeled results, particularly in the current environment in which many events are
unprecedented and therefore there is no relevant historical data, also may produce unreliable information.
If our models fail to produce reliable results on an ongoing basis, we may not make appropriate risk
management decisions, including decisions affecting loan purchases, management of credit losses and risk,
guaranty fee pricing, asset and liability management and the management of our net worth, and any of those
decisions could adversely affect our business, results of operations, liquidity, net worth and financial condition.
Furthermore, any strategies we employ to attempt to manage the risks associated with our use of models may
not be effective.
Changes in option-adjusted spreads or interest rates, or our inability to manage interest rate risk
successfully, could adversely affect our net interest income and increase interest rate risk.
We fund our operations primarily through the issuance of debt and invest our funds primarily in mortgage-
related assets that permit the mortgage borrowers to prepay the mortgages at any time. These business
activities expose us to market risk, which is the risk of adverse changes in the fair value of financial
instruments resulting from changes in market conditions. Our most significant market risks are interest rate
risk and option-adjusted spread risk. We describe these risks in more detail in “MD&A—Risk Management—
Market Risk Management, Including Interest Rate Risk Management.” Changes in interest rates affect both the
value of our mortgage assets and prepayment rates on our mortgage loans.
Changes in interest rates could have a material adverse effect on our business, results of operations, financial
condition, liquidity and net worth. Our ability to manage interest rate risk depends on our ability to issue debt
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