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<div style="font-size:12pt"><p>1. Summary of Significant Accounting Policies<br /><br />Organization<br /><br />We are a stockholder-owned corporation organized and existing under the Federal National Mortgage Association Charter Act (“The Charter Act” or our “charter”). We are a government-sponsored enterprise (“GSE”), and we are subject to government oversight and regulation. Our regulators include the Federal Housing Finance Agency (“FHFA”), the U.S. Department of Housing and Urban Development (“HUD”), the U.S. Securities and Exchange Commission (“SEC”), and the U.S. Department of the Treasury (“Treasury”). Through July 29, 2008, we were regulated by the Office of Federal Housing Enterprise Oversight (“OFHEO”), which was replaced on July 30, 2008 with FHFA upon the enactment of the Federal Housing Finance Regulatory Reform Act of 2008 (“Regulatory Reform Act”). The U.S. government does not guarantee, directly or indirectly, our securities or other obligations.<br /><br />We operate in the secondary mortgage market by purchasing mortgage loans and mortgage-related securities, including mortgage-related securities guaranteed by us, from primary mortgage market institutions, such as commercial banks, savings and loan associations, mortgage banking companies, securities dealers and other investors. We do not lend money directly to consumers in the primary mortgage market. We provide additional liquidity in the secondary mortgage market by issuing guaranteed mortgage-related securities.<br /><br />We operate under three business segments: Single-Family Credit Guaranty (“Single-Family”), Housing and Community Development (“HCD”) and Capital Markets. Our Single-Family segment generates revenue primarily from the guaranty fees on the mortgage loans underlying guaranteed single-family Fannie Mae mortgage-backed securities (“Fannie Mae MBS”). Our HCD segment generates revenue from a variety of sources, including guaranty fees on the mortgage loans underlying multifamily Fannie Mae MBS and on the multifamily mortgage loans held in our portfolio, transaction fees associated with the multifamily business and bond credit enhancement fees. Our Capital Markets segment invests in mortgage loans, mortgage-related securities and other investments, and generates income primarily from the difference, or spread, between the yield on the mortgage assets we own and the interest we pay on the debt we issue in the global capital markets to fund the purchases of these mortgage assets. <br /><br />On September 7, 2008, the Secretary of the Treasury and the Director of FHFA announced several actions taken by Treasury and FHFA regarding Fannie Mae, which included: (1) placing us in conservatorship; (2) the execution of a senior preferred stock purchase agreement by our conservator, on our behalf, and Treasury, pursuant to which we issued to Treasury both senior preferred stock and a warrant to purchase common stock; and (3) Treasury’s agreement to establish a temporary secured lending credit facility that was available to us and the other GSEs regulated by FHFA under identical terms until December 31, 2009. We entered into a lending agreement with Treasury pursuant to which Treasury established this secured lending credit facility on September 19, 2008. The secured lending facility terminated on December 31, 2009 in accordance with its terms. <br /><br />Conservatorship<br /><br />On September 6, 2008, at the request of the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve and the Director of FHFA, our Board of Directors adopted a resolution consenting to the company’s placement into conservatorship. After obtaining this consent, the Director of FHFA appointed FHFA as our conservator in accordance with the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, as amended by the 2008 Reform Act, (together, the “GSE Act”). Under the GSE Act, the conservator immediately succeeded to all rights, titles, powers and privileges of Fannie Mae, and of any stockholder, officer or director of Fannie Mae with respect to Fannie Mae and its assets, and succeeded to the title to the books, records and assets of any other legal custodian of Fannie Mae. <br /><br />FHFA, in its role as conservator, has overall management authority over our business. The conservator has since delegated specified authorities to our Board of Directors and has delegated to management the authority to conduct our day-to-day operations. The conservator retains the authority to withdraw its delegations at any time.<br /><br />As of February 26, 2010, the conservator has advised us that it has not disaffirmed or repudiated any contracts we entered into prior to its appointment as conservator. The GSE Act requires FHFA to exercise its right to disaffirm or repudiate most contracts within a reasonable period of time after its appointment as conservator. <br /><br />The conservator has the power to transfer or sell any asset or liability of Fannie Mae (subject to limitations and post-transfer notice provisions for transfers of qualified financial contracts) without any approval, assignment of rights or consent of any party. The GSE Act, however, provides that mortgage loans and mortgage-related assets that have been transferred to a Fannie Mae MBS trust must be held by the conservator for the beneficial owners of the Fannie Mae MBS and cannot be used to satisfy the general creditors of the company. As of February 26, 2010, FHFA has not exercised this power.<br /><br />Neither the conservatorship nor the terms of our agreements with Treasury changes our obligation to make required payments on our debt securities or perform under our mortgage guaranty obligations.<br /><br />The conservatorship has no specified termination date and the future structure of our business following termination of the conservatorship is uncertain. We do not know when or how the conservatorship will be terminated or what changes to our business structure will be made during or following the termination of the conservatorship. We do not know whether we will exist in the same or a similar form or continue to conduct our business as we did before the conservatorship, or whether the conservatorship will end in receivership. Under the GSE Act, FHFA must place us into receivership if the Director of FHFA makes a written determination that our assets are less than our obligations (i.e., we have a net worth deficit) or if we have not been paying our debts, in either case, for a period of 60 days. In addition, the Director of FHFA may place us in receivership at his discretion at any time for other reasons, including conditions that FHFA has already asserted existed at the time the Director of FHFA placed us into conservatorship. Placement into receivership would have a material adverse effect on holders of our common stock, preferred stock, debt securities and Fannie Mae MBS. Should we be placed into receivership, different assumptions would be required to determine the carrying value of our assets, which could lead to substantially different financial results.<br /><br />Senior Preferred Stock and Warrant Issued to Treasury<br /><br />On September 7, 2008, we, through FHFA in its capacity as conservator, entered into a senior preferred stock purchase agreement with Treasury. The agreement was amended on September 26, 2008, May 6, 2009 and December 24, 2009. Pursuant to the amended senior preferred stock purchase agreement, Treasury has committed to provide us with funding as needed to help us maintain a positive net worth thereby avoiding the mandatory receivership trigger described above. Treasury’s maximum funding commitment to us under the agreement is the greater of (a) $200 billion or (b) $200 billion plus the cumulative amount of our net worth deficit (the amount by which our total liabilities exceed our total assets) as of the end of any and each calendar quarter in 2010, 2011 and 2012, less any positive net worth as of December 31, 2012. As consideration for Treasury’s funding commitment, we issued one million shares of senior preferred stock and a warrant to purchase shares of our common stock to Treasury. We also have agreed to pay Treasury a quarterly commitment fee beginning on March 31, 2011. Treasury, as holder of the senior preferred stock, is entitled to receive, when, as and if declared by our Board of Directors, out of legally available funds, cumulative quarterly cash dividends at the annual rate of 10% per year on the then-current liquidation preference of the senior preferred stock, which was initially $1.0 billion but is subject to adjustment for amounts Treasury pays to us pursuant to its funding commitment, as well as any dividends that are not paid in cash for any dividend period and any commitment fees that are not paid in cash to Treasury or waived by Treasury. If at any time we fail to pay cash dividends in a timely manner, then immediately following such failure and for all dividend periods thereafter until the dividend period following the date on which we have paid in cash full cumulative dividends, the dividend rate will be 12% per year. We have received a total of $59.9 billion to date under Treasury’s funding commitment and the Acting Director of FHFA has submitted a request for an additional $15.3 billion from Treasury to eliminate our net worth deficit as of December 31, 2009. The aggregate liquidation preference of the senior preferred stock was $60.9 billion as of December 31, 2009 and will increase to $76.2 billion as a result of FHFA’s request on our behalf for funds to eliminate our net worth deficit as of December 31, 2009.<br /><br />On September 7, 2008, we issued a warrant to Treasury giving it the right to purchase, at a nominal price, shares of our common stock equal to 79.9% of the total common stock outstanding on a fully diluted basis on the date Treasury exercises the warrant. Treasury has the right to exercise the warrant, in whole or in part, at any time on or before September 7, 2028. We recorded the warrant at fair value in our stockholders’ equity as a component of additional paid-in-capital. The fair value of the warrant was calculated using the Black-Scholes Option Pricing Model. Since the warrant has an exercise price of $0.00001 per share, the model is insensitive to the risk-free rate and volatility assumptions used in the calculation and the share value of the warrant is equal to the price of the underlying common stock. We estimated that the fair value of the warrant at issuance was $3.5 billion based on the price of our common stock on September 8, 2008, which was after the dilutive effect of the warrant had been reflected in the market price. Subsequent changes in the fair value of the warrant are not recognized in the financial statements. If the warrant is exercised, the stated value of the common stock issued will be reclassified as “Common stock” in our consolidated balance sheets. Because the warrant’s exercise price per share is considered non-substantive (compared to the market price of our common stock), the warrant was determined to have characteristics of non-voting common stock, and thus is included in the computation of basic and diluted loss per share. The weighted-average shares of common stock outstanding for the year ended December 31, 2009 included shares of common stock that would be issuable upon full exercise of the warrant issued to Treasury for the year ended December 31, 2009.<br />Impact of U.S. Government Support<br /><br />We receive, directly and indirectly, substantial support from various agencies of the United States Government, including the Federal Reserve, Treasury, and FHFA, as our conservator and regulator. We are dependent upon the continued support of the U.S. Government, FHFA and Treasury to eliminate our net worth deficit, which avoids our being placed into receivership. Based on consideration of all the relevant conditions and events affecting our operations, including our dependence on the U.S. Government, we continue to operate as a going concern and in accordance with our delegation of authority from FHFA.<br /><br />We fund our business primarily through the issuance of short-term and long-term debt securities in the domestic and international capital markets. Because debt issuance is our primary funding source, we are subject to “roll-over,” or refinancing, risk on our outstanding debt. Our roll-over risk increases when our outstanding short-term debt increases as a percentage of our total outstanding debt.<br /><br />Our access to long-term debt funding through the unsecured debt markets improved significantly in 2009. We believe that this improvement was primarily due to actions taken by the federal government to support us and the financial markets, including: <br /><br /></p><ul><li>Treasury’s funding commitment to us under the senior preferred stock purchase agreement; <br /></li><li>Treasury’s credit facility that was available to us; <br /></li><li>Federal Reserve’s active program to purchase debt securities of Fannie Mae, the Federal Home Loan Mortgage Corporation (“Freddie Mac”), and the Federal Home Loan Banks, as well as up to $1.25 trillion in Fannie Mae, Freddie Mac and Ginnie Mae mortgage-backed securities;<br /></li><li>Treasury’s agency MBS purchase program; and<br /></li><li>Federal Reserve and Treasury’s programs to support the liquidity of the financial markets overall, including several asset purchase programs and several asset financing programs.<br /></li></ul><p><br />Accordingly, we believe that continued federal government support of our business and the financial markets, as well as our status as a GSE, are essential to maintaining our access to debt funding. Changes or perceived changes in the government’s support of us or the markets could lead to an increase in our debt roll-over risk in future periods and have a material adverse effect on our ability to fund our operations and continue as a going concern. <br /><br />In September of 2009, the Federal Reserve announced that it will gradually slow the pace of its purchase of debt securities and mortgage-backed securities under these programs, originally scheduled to expire on December 31, 2009, in order to promote a smooth transition into the markets, and anticipates that these purchases will be completed by the end of the first quarter of 2010. In November of 2009, the Federal Reserve announced that, under its agency debt purchase program, it would purchase approximately $175 billion in agency debt securities, somewhat less than the originally announced maximum of up to $200 billion. On February 10, 2010, the Obama Administration stated in its fiscal year 2011 budget proposal that it was continuing to monitor the situation of Fannie Mae, Freddie Mac and the Federal Home Loan Bank System and would continue to provide updates on considerations for longer term reform of Fannie Mae and Freddie Mac as appropriate. These considerations may have a material impact on our ability to issue debt or refinance existing debt as it becomes due and hinder our ability to continue as a going concern. <br /><br />The U.S. Government continues to provide active and ongoing support to Fannie Mae’s operations consistent with their objective of stabilizing the housing market and the economy. Under our senior preferred stock purchase agreement with Treasury, Treasury generally has committed to provide us, on a quarterly basis, amounts, if any, by which our total liabilities exceed our total assets, as reflected on our consolidated balance sheets, prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). To the extent of its unused portion, this funding commitment is available to us (as specified in the agreement) or, in the event of our default on payments with respect to our debt securities or guaranteed Fannie Mae MBS, to the holders of that debt and MBS. <br /><br />On December 24, 2009, Treasury announced an update on initiatives established under the Housing and Economic Recovery Act (“HERA”) of 2008, which supports housing market stabilization and provides relief to struggling homeowners. The Treasury announcement includes the following:<br /><br /></p><ul><li>Ending the Treasury purchase program of MBS guaranteed by the GSEs on December 31, 2009.<br /></li><li>Terminating the Treasury credit facility established for Fannie Mae, Freddie Mac and the Federal Home Loan Banks on December 31, 2009.<br /></li><li>Amending the senior preferred stock purchase agreement to allow the cap on Treasury's purchase commitment to increase as necessary to accommodate any cumulative reduction in our net worth in calendar years 2010, 2011 and 2012.<br /></li><li>Modifying the senior preferred stock purchase agreement to provide us with additional flexibility to meet the requirement to reduce our investment portfolio. The portfolio reduction requirement for 2010 and after will be applied to the maximum allowable size of the portfolios - or $900 billion - rather than the actual size of the portfolios at the end of 2009. We are also required to limit the amount of indebtedness that we can incur to 120% of the amount of mortgage assets we are allowed to own.<br /></li><li>Amending the senior preferred stock purchase agreement to delay the date on which we are required to begin paying the Periodic Commitment Fee by one year from March 31, 2010 to March 31, 2011 and make technical changes to the definitions of mortgage assets and indebtedness to make compliance with the covenants of the senior preferred stock purchase agreement less burdensome and more transparent in light of impending accounting changes.<br /></li></ul><p><br />Basis of Presentation <br /><br />The accompanying consolidated financial statements have been prepared in accordance with GAAP. The accompanying consolidated financial statements include our accounts as well as the accounts of other entities in which we have a controlling financial interest. All intercompany balances and transactions have been eliminated.<br /><br />Related Parties<br /><br />As a result of our issuance to Treasury of the warrant to purchase shares of Fannie Mae common stock equal to 79.9% of the total number of shares of Fannie Mae common stock, we and the Treasury are deemed related parties. During 2009, Treasury engaged us to serve as program administrator for the Home Affordable Modification Program (“HAMP”). In addition, Treasury held a $59.9 billion investment in our senior preferred stock as of December 31, 2009.<br /><br />In addition to the transactions described above, on October 19, 2009, we entered into a memorandum of understanding with Treasury, FHFA and Freddie Mac. The memorandum of understanding set forth the terms under which we, Freddie Mac and Treasury would provide assistance to state and local housing finance agencies (“HFAs”) so that the HFAs could continue to meet their mission of providing affordable financing for both single-family and multifamily housing. The memorandum of understanding contemplated providing assistance to the HFAs through three separate assistance programs: a temporary credit and liquidity facilities program, a new issue bond program and a multifamily credit enhancement program. <br /><br />In December 2009, under the temporary credit and liquidity facilities program, we provided $870 million of three-year standby credit and liquidity support for outstanding variable rate demand obligations issued by HFAs. Treasury has purchased participation interests in the temporary credit and liquidity facilities.<br /><br />In December 2009, under the new issue bond program, we issued to Treasury $3.5 billion of partially guaranteed pass-through securities backed by new single-family and certain new multifamily housing bonds issued by HFAs. <br /><br />We are not participating in the multifamily credit enhancement program.<br /><br />FHFA’s control of both us and Freddie Mac has caused us and Freddie Mac to be related parties. No transactions outside of normal business activities have occurred between us and Freddie Mac. As of December 31, 2009 and 2008, we held Freddie Mac mortgage-related securities with a fair value of $42.6 billion and $33.9 billion, respectively, and accrued interest receivable of $230 million and $198 million, respectively. We recognized interest income on Freddie Mac mortgage-related securities held by us of $2.0 billion and $1.6 billion for the years ended December 31, 2009 and 2008, respectively. In addition, Freddie Mac may be an investor in variable interest entities that we have consolidated, and we may be an investor in variable interest entities that Freddie Mac has consolidated. <br /><br />Use of Estimates<br /><br />Preparing consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect our reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities as of the date of our consolidated financial statements, as well as our reported amounts of revenues and expenses during the reporting period. Management has made significant estimates in a variety of areas, including but not limited to, valuation of certain financial instruments and other assets and liabilities, the allowance for loan losses and reserve for guaranty losses, and other-than-temporary impairment of investment securities and LIHTC partnerships. Actual results could be different from these estimates. In the fourth quarter of 2009 we updated our single-family loss allowance model which resulted in a change in estimate to decrease our loss reserve by approximately $800 million. <br /><br />Principles of Consolidation<br /><br />If we determine that we have a controlling financial interest in an entity, then we must consolidate the assets, liabilities and noncontrolling interests of the entity in our consolidated financial statements. A controlling financial interest typically arises as a result of ownership of a majority of the voting interests of an entity. We may also have a controlling financial interest in an entity through an arrangement that does not involve voting interests, such as a variable interest entity (“VIE”). We evaluate entities deemed to be VIEs using a risk and rewards model to determine whether we must consolidate them. A VIE is an entity (1) that has total equity at risk that is not sufficient to finance its activities without additional subordinated financial support from other entities, (2) where the group of equity holders does not have the power to direct the activities of the entity that most significantly impact the entity's economic performance, or the obligation to absorb the entity's expected losses or the right to receive the entity's expected residual returns, or both, or (3) where the voting rights of some investors are not proportional to their obligations to absorb the expected losses of the entity, their rights to receive the expected residual returns of the entity, or both, and substantially all of the entity's activities either involve or are conducted on behalf of an investor that has disproportionately few voting rights.<br /> <br />In order to determine if an entity should be considered a VIE, we first perform a qualitative analysis, which requires us to make subjective decisions to complete our assessments. Among other factors, we analyze the design of the entity, the variability that the entity was designed to create and pass along to its interest holders, the rights of the parties and the purpose of the arrangement. If we cannot conclude after a qualitative analysis whether an entity is a VIE, we perform a quantitative analysis. Quantifying the variability of a VIE’s assets is complex and subjective, requiring analysis of a significant number of possible future economic outcomes as well as the probability of each outcome occurring. <br /> <br />If an entity is a VIE, we determine whether our variable interest causes us to be considered the primary beneficiary of the entity’s expected losses or residual returns. We are the primary beneficiary and are required to consolidate the entity if we absorb the majority of expected losses or expected residual returns, or both. In determining whether we are the primary beneficiary, we evaluate the design of the entity, including the risks that cause variability, the purpose for which the entity was created, and the variability that the entity was designed to pass along to its interest holders. <br /> <br />If we cannot conclude after qualitative analysis whether we are the primary beneficiary, we perform a quantitative analysis, using internal cash flow models, which may include Monte Carlo simulations, to compute and allocate expected losses or residual returns to each variable interest holder. We base the allocation of expected cash flows upon the relative contractual rights and preferences of each interest holder in the VIE’s capital structure. The result of each possible outcome is allocated to the parties holding interests in the VIE and, based on the allocation, a calculation is performed to determine which, if any, is the primary beneficiary. <br /> <br />Specifically, quantitative or qualitative analyses were performed on certain mortgage and asset-backed investment trusts. These analyses considered whether the nature of our variable interests exposed us to credit or prepayment risk, the two primary drivers of expected losses for these VIEs. For those mortgage-backed investment trusts that we evaluated using quantitative analyses, we used internal models to generate Monte Carlo simulations of cash flows associated with the different credit, interest rate and housing price environments. Material assumptions included our projections of interest rate and housing prices, as well as our expectations of prepayment, default and severity rates. The projection of future cash flows is a subjective process involving significant management judgment. This is primarily due to the inherent uncertainties related to the interest rate and housing price environment, as well as the actual credit performance of the mortgage loans and securities that were held by each investment trust. If we determined an investment trust to be a VIE, we consolidated the investment trust when the modeling resulted in our absorption of more than 50% of the variability in the expected losses or expected residual returns. <br /> <br />We also quantitatively and qualitatively examined our LIHTC partnerships and other limited partnerships that were considered VIEs. Qualitative analyses considered the extent to which the nature of our variable interest exposed us to losses. For quantitative analyses, we also used internal cash flow models to determine if these partnerships were VIEs and, if so, whether we were the primary beneficiary. LIHTC partnerships are created by third parties to finance construction of property, giving rise to tax credits for these partnerships. Material assumptions include the degree of development cost overruns related to the construction of the building, the probability of the lender foreclosing on the building, as well as an investor’s ability to use the tax credits to offset taxable income. The projection of these cash flows and probabilities thereof requires significant management judgment because of the inherent limitations that relate to the use of historical data for the projection of future events. Additionally, we reviewed similar assumptions and applied cash flow models to determine both VIE status and primary beneficiary status for our other limited partnership investments. <br /> <br />We are exempt from evaluating certain securitization trusts for consolidation if the trusts meet the criteria of a qualified special purpose entity (“QSPE”), and if we do not have the unilateral ability to cause the trust to liquidate or change the trust’s QSPE status. The QSPE requirements significantly limit the activities in which a QSPE may engage and the types of assets and liabilities it may hold. Management judgment is required to determine whether a trust’s activities meet the QSPE requirements. To the extent any trust fails to meet these criteria, we would be required to consolidate its assets and liabilities if we determine that we are the primary beneficiary of the entity. <br /><br />We are required to evaluate whether to consolidate a VIE when we first become involved and upon subsequent reconsideration events (e.g., a purchase of additional beneficial interests). Generally, if we are the primary beneficiary of a VIE, then we initially record the assets and liabilities of the VIE in our consolidated financial statements at fair value.<br /><br />With our adoption of the most recent accounting standard on business combinations effective January 1, 2009, we began recording any difference between the fair value and the previous carrying amount of our interests in a VIE that holds only financial assets as “Investment gains (losses), net” in our consolidated statements of operations. Prior to 2009, we classified such differences as “Extraordinary losses, net of tax effect” in our consolidated statements of operations.<br /><br />If a consolidated VIE subsequently should not be consolidated because we cease to be deemed the primary beneficiary or we qualify for a scope exception (for example, the entity is a QSPE that we no longer have the unilateral ability to liquidate), we deconsolidate the VIE.<br /><br />Effective January 1, 2009 with our adoption of the accounting standard on the treatment of noncontrolling interests in consolidated financial statements, we began recording any retained interests in a deconsolidated entity at its respective fair values. Any difference between the fair values and the previous carrying amounts of our investment in the entity is recorded as “Investment gains (losses), net” in our consolidated statements of operations. Prior to 2009, we deconsolidated the entity by carrying over our net basis in the consolidated assets and liabilities to our investment in the entity.<br /><br />Portfolio Securitizations <br /><br /> <br />Portfolio securitizations involve the transfer of mortgage loans or mortgage-related securities from our consolidated balance sheets to a trust to create Fannie Mae MBS, real estate mortgage investment conduits (“REMICs”) or other types of beneficial interests. We evaluate a transfer of financial assets via portfolio securitizations to determine whether the transfer qualifies as a sale. Transfers of financial assets for which we surrender control and receive compensation other than beneficial interests in the transferred assets are recorded as sales. <br /> <br />When a transfer that qualifies as a sale is completed, we derecognize all transferred assets. We allocate the previous carrying amount of the transferred assets between the assets sold and the retained interests, if any, in proportion to their relative fair values at the date of transfer. We record a gain or loss as a component of “Investment gains (losses), net” in our consolidated statements of operations, which represents the difference between the allocated carrying amount of the assets sold and the proceeds from the sale, net of any transaction costs and liabilities incurred, which may include a recourse obligation for our financial guaranty. Retained interests are primarily in the form of Fannie Mae MBS, REMIC certificates, guaranty assets and master servicing assets (“MSAs”). We separately describe the subsequent accounting, as well as how we determine fair value, for our retained interests in the “Investments in Securities,” “Guaranty Accounting,” and “Master Servicing” sections of this note. If a portfolio securitization does not meet the criteria for sale treatment, the transferred assets remain on our consolidated balance sheets and we record a liability to the extent of any proceeds we received in connection with such transfer. <br /> <br />We also enter into repurchase agreements, including dollar roll repurchase agreements, which we account for as secured borrowings. Refer to the “Securities Purchased under Agreements to Resell and Securities Sold under Agreements to Repurchase” section of this note for discussion of our accounting policies related to these transfers.<br /> <br />Cash and Cash Equivalents and Statements of Cash Flows <br /> <br />Short-term investments that have a maturity at the date of acquisition of three months or less and are readily convertible to known amounts of cash are generally considered cash equivalents. We may pledge as collateral certain short-term investments classified as cash equivalents. <br /> <br />We classify cash flows from trading securities based on their nature and purpose. Prior to 2008, we classified cash flows of all trading securities as operating activities. Following the adoption of the updated accounting standard on the fair value option for financial assets and financial liabilities in 2008, we began to classify cash flows from trading securities that we intend to hold for investment (the majority of our mortgage-related trading securities) as investing activities and cash flows from trading securities that we do not intend to hold for investment (primarily our non-mortgage related securities) as operating activities. We reflect the creation of Fannie Mae MBS through either securitization of loans held for sale or advances to lenders as a non-cash activity in our consolidated statements of cash flows in the line items “Securitization-related transfers from mortgage loans held for sale to investments in securities” or “Transfers from advances to lenders to investments in securities,” respectively. Cash inflows from the sale of a Fannie Mae MBS created through the securitization of loans held for sale are reflected in the statement of cash flows based on the balance sheet classification of the associated Fannie Mae MBS as either “Net decrease in trading securities, excluding non-cash transfers,” or “Proceeds from sales of available-for-sale securities.” <br /> <br />In the presentation of our consolidated statements of cash flows, we present cash flows from derivatives that do not contain financing elements, mortgage loans held for sale, and guaranty fees, including buy-up and buy-down payments, as operating activities. We present cash flows from federal funds sold and securities purchased under agreements to resell as investing activities and cash flows from federal funds purchased and securities sold under agreements to repurchase as financing activities. We classify cash flows related to dollar roll transactions that do not meet the requirements to be accounted for as secured borrowings as purchases and sales of securities in investing activities. <br /><br />Restricted Cash <br /><br />When we collect and hold cash that is due to certain Fannie Mae MBS trusts in advance of our requirement to remit these amounts to the trust, we record the collected cash amount as “Restricted cash” in our consolidated balance sheets. Additionally, we record “Restricted cash” as a result of partnership restrictions related to certain consolidated partnership funds. We also have restricted cash related to certain collateral arrangements. <br /> <br />Securities Purchased under Agreements to Resell and Securities Sold under Agreements to Repurchase <br /><br />When securities purchased under agreements to resell or securities sold under agreements to repurchase resulting from dollar roll transactions do not meet all of the conditions of a secured financing, we account for the transactions as purchases or sales, respectively. We treat securities purchased under agreements to resell and securities sold under agreements to repurchase as secured financing transactions when all of the conditions have been met. We record these transactions at the amounts at which the securities will be subsequently reacquired or resold, including accrued interest. <br /><br />Investments in Securities <br /> <br />Securities Classified as Available-for-Sale or Trading <br /> <br />We classify and account for our securities as either available-for-sale (“AFS”) or trading. We measure AFS securities at fair value in our consolidated balance sheets, with unrealized gains and losses included in “Accumulated other comprehensive loss” (“AOCI”), net of applicable income taxes. We recognize realized gains and losses on AFS securities when securities are sold. We calculate the gains and losses using the specific identification method and record them in “Investment gains (losses), net” in our consolidated statements of operations. We measure trading securities at fair value in our consolidated balance sheets with unrealized and realized gains and losses included as a component of “Fair value losses, net” in our consolidated statements of operations. We include interest and dividends on securities, including amortization of the premium and discount at acquisition, in our consolidated statements of operations. We describe our amortization policy in the “Amortization of Cost Basis and Guaranty Price Adjustments” section of this note. When we receive multiple deliveries of securities on the same day that are backed by the same pools of loans, we calculate the specific cost of each security as the average price of the trades that delivered those securities. Currently, we do not have any securities classified as held-to-maturity, although we may elect to do so in the future.<br /><br />We determine fair value using quoted market prices in active markets for identical assets when available. If quoted market prices in active markets for identical assets are not available, we use quoted market prices for similar securities that we adjust for observable or corroborated (i.e., information purchased from third-party service providers) market information. In the absence of observable or corroborated market data, we use internally developed estimates, incorporating market-based assumptions when such information is available. <br /> <br />Other-Than-Temporary Impairment of Debt Securities<br /><br />Prior to April 1, 2009, we considered a debt security to be other-than-temporarily impaired if its estimated fair value was less than its amortized cost basis and we determined that it was probable that we would be unable to collect all of the contractual principal and interest payments or we did not intend to hold the security until it recovered to its previous carrying amount. In making an other-than-temporary impairment assessment, we considered many factors, including the severity and duration of the impairment, recent events specific to the issuer and/or the industry to which the issuer belongs, external credit ratings and recent downgrades, as well as our ability and intent to hold such securities until recovery. <br /><br />We considered guarantees, insurance contracts or other credit enhancements (such as collateral) in determining whether it was probable that we would be unable to collect all amounts due according to the contractual terms of a debt security only if (1) such guarantees, insurance contracts or other credit enhancements provided for payments to be made solely to reimburse us for failure of the issuer to satisfy its required payment obligations, (2) such guarantees, insurance contracts or other credit enhancements were contractually attached to that security and (3) collection of the amounts receivable under these agreements was deemed probable. Guarantees, insurance contracts or other credit enhancements are considered contractually attached if they are part of and trade with the security upon transfer of the security to a third party. <br /><br />When we determined that it was probable that we would not collect all of the contractual principal and interest amounts due or we determined that we did not have the ability or intent to hold the security until recovery of an unrealized loss, we identified the security as other-than-temporarily impaired. For all other securities in an unrealized loss position, we had the positive intent and ability to hold such securities until the earlier of full recovery or maturity. <br /> <br />When we determined an investment was other-than-temporarily impaired, we wrote down the cost basis of the investment to its fair value and included the loss in “Other-than-temporary-impairments” in our consolidated statements of operations. The fair value of the investment then became its new cost basis. We did not increase the investment’s cost basis for subsequent recoveries in fair value, which were recorded in AOCI. <br /><br />In periods after we recognized an other-than-temporary impairment of debt securities, we used the prospective interest method to recognize interest income. Under the prospective interest method, we used the new cost basis and the expected cash flows from the security to calculate the effective yield. <br /><br />On April 1, 2009, we adopted the FASB modified standard on the model for assessing other-than-temporary impairments, applicable to existing and new debt securities held by us as of April 1, 2009. Under this new standard, an other-than-temporary impairment is considered to have occurred when the fair value of a debt security is below its amortized cost basis and we intend to sell or it is more likely than not that we will be required to sell the security before recovery. In this case, we recognize in the consolidated statements of operations the entire difference between the amortized cost basis of the security and its fair value. An other-than-temporary impairment is also considered to have occurred if we do not expect to recover the entire amortized cost basis of a debt security even if we do not intend or it is not more likely than not we will be required to sell the security before recovery. In this case, we separate the difference between the amortized cost basis of the security and its fair value into the amount representing the credit loss, which we recognize in our consolidated statements of operations, and the amount related to all other factors, which we recognize in “Other comprehensive loss,” net of applicable taxes. In determining whether a credit loss exists, we use the best estimate of cash flows expected to be collected from the debt security. <br /><br />We consider guarantees, insurance contracts or other credit enhancements (such as collateral) in determining our best estimate of cash flows expected to be collected only if (1) such guarantees, insurance contracts or other credit enhancements provide for payments to be made solely to reimburse us for failure of the issuer to satisfy its required payment obligations, (2) such guarantees, insurance contracts or other credit enhancements are contractually attached to the security and (3) collection of the amounts receivable under these agreements is deemed probable. Guarantees, insurance contracts or other credit enhancements are considered contractually attached if they are part of and trade with the security upon transfer of the security to a third party. <br /><br />In periods after we recognize an other-than-temporary impairment of debt securities, we use the prospective interest method to recognize interest income. Under the prospective interest method, we use the new cost basis and the cash flows expected to be collected from the security to calculate the effective yield. <br /><br />As a result of adopting the FASB modified standard on the model for assessing other-than-temporary impairments, we recorded a cumulative-effect adjustment at April 1, 2009 of $8.5 billion on a pre-tax basis ($5.6 billion after tax) to reclassify the noncredit portion of previously recognized other-than-temporary impairments from “Accumulated deficit” to AOCI. We also reduced the “Accumulated deficit” and valuation allowance by $3.0 billion for the deferred tax asset related to the amounts previously recognized as other-than-temporary impairments in our consolidated statements of operations based upon the assertion of our intent and ability to hold certain of these securities until recovery. Refer to “Note 5, Investments in Securities” for disclosures related to our investments in securities and other-than-temporary impairments and “Note 11, Income Taxes” for disclosures related to our deferred tax assets and related valuation allowance.<br /><br />Mortgage Loans <br /> <br />When we acquire mortgage loans that we intend to sell or securitize, we classify the loans as held for sale (“HFS”). When we acquire mortgage loans that we have the ability and the intent to hold for the foreseeable future or until maturity, we classify the loans as held for investment (“HFI”). We initially classify loans as HFS if they are product types that we actively securitize from our portfolio, such as 30-year fixed rate mortgages, because we have the intent, at acquisition, to securitize the loans (either during the month in which the acquisition occurs or during the following month) and sell all or a portion of the resulting securities. At month-end, we reclassify loans acquired during the calendar month, from HFS to HFI, if we have not securitized or are not in the process of securitizing them because we have the intent to hold those loans for the foreseeable future or until maturity. <br /> <br />We initially classify loans as HFI if they are product types that we do not currently securitize from our portfolio, such as reverse mortgages. We reclassify loans from HFI to HFS if our investment intent changes. Reclassification of loans from HFI to HFS is infrequent. <br />If the underlying assets of a consolidated VIE are mortgage loans and we were initially the transferor of such loans, we classify the consolidated loans consistent with our intent and ability to hold the securities of the consolidated entity; otherwise, mortgage loans in consolidated VIEs are classified as HFI. <br /><br />Loans Held for Sale <br /> <br />We report HFS loans at the lower of cost or fair value (“LOCOM”). Loans held for sale are typically single-family loans, because we generally do not sell or securitize multifamily loans from our portfolio. Any excess of an HFS loan’s cost over its fair value is recognized as a valuation allowance, with changes in the valuation allowance recognized as “Investment gains (losses), net” in our consolidated statements of operations. We recognize interest income on HFS loans on an accrual basis, unless we determine the ultimate collection of principal or interest payments is not reasonably assured. When the collection of principal or interest payments is not reasonably assured, we discontinue the accrual of interest income. Purchase premiums, discounts and other cost basis adjustments on HFS loans are deferred upon loan acquisition, included in the cost basis of the loan, and not amortized. We determine any LOCOM adjustment on HFS loans on a pool basis by aggregating those loans based on similar risks and characteristics, such as product types and interest rates. <br /> <br />In the event that we reclassify HFS loans to HFI, we record the loans at LOCOM on the date of reclassification. We recognize any LOCOM adjustment recognized upon reclassification as a basis adjustment to the HFI loan. <br /> <br />Loans Held for Investment <br /><br />We report HFI loans at their outstanding unpaid principal balance adjusted for any deferred and unamortized cost basis adjustments, including purchase premiums, discounts and/or other cost basis adjustments. We recognize interest income on HFI loans on an accrual basis using the interest method, unless we determine the ultimate collection of contractual principal or interest payments in full is not reasonably assured. When the collection of principal or interest payments in full is not reasonably assured, the loan is placed on nonaccrual status. <br /> <br />Nonaccrual Loans <br /> <br />We discontinue accruing interest on single-family and multifamily loans when we believe collectability of principal or interest is not reasonably assured, unless the loan is well secured and in the process of collection based upon an individual loan assessment. When a loan is placed on nonaccrual status interest previously accrued but not collected becomes part of our recorded investment in the loan and is collectively reviewed for impairment. If cash is received while a loan is on nonaccrual status, it is applied first towards the recovery of accrued interest and related scheduled principal repayments. Once these amounts are recovered, we recognize interest income on a cash basis. If we have doubt regarding the ultimate collectability of the remaining recorded investment in a nonaccrual loan, we apply any payment received to reduce principal to the extent necessary to eliminate such doubt. We return a loan to accrual status when we determine that the collectability of principal and interest is reasonably assured. <br /> <br />Restructured Loans <br /> <br />A modification to the contractual terms of a loan that results in granting a concession to a borrower experiencing financial difficulties is considered a troubled debt restructuring (“TDR”). A concession has been granted to a borrower when we determine that the effective yield based on the restructured loan term is less than the effective yield prior to the modification. We measure impairment of a loan restructured in a TDR individually based on the excess of the recorded investment in the loan over the present value of the expected future cash inflows discounted at the loan’s original effective interest rate. Cost incurred that affect a TDR are expensed as incurred. <br /> <br />A loan modification for reasons other than a borrower experiencing financial difficulties or that results in terms at least as favorable to us as the terms for comparable loans to other customers with similar credit risks who are not refinancing or restructuring a loan is not considered a TDR. We further evaluate such a loan modification to determine whether the modification is considered “more than minor.” If the modification is considered more than minor and the modified loan is not subject to the accounting requirements for acquired credit-impaired loans, we treat the modification as an extinguishment of the previously recorded loan and recognition of a new loan. We recognize any unamortized basis adjustments on the previously recorded loan immediately in “Interest income” in our consolidated statements of operations. We account for minor modifications and modifications to acquired credit-impaired loans as a continuation of the previously recorded loan unless the modification is considered a TDR. <br /> <br />Loans Purchased or Eligible to be Purchased from Trusts <br /> <br />For MBS trusts that include a Fannie Mae guaranty, we have the option to purchase loans from the trust after four or more consecutive monthly payments due under the loan are delinquent in whole, or in part. With respect to single-family mortgage loans in MBS trusts with issue dates on or after January 1, 2009, we also have the option to purchase the loan from the trust after the loan has been delinquent for at least one monthly payment, if the delinquency has not been fully cured on or before the next payment date (i.e., 30 days delinquent) and it is determined that it is appropriate to execute a loss mitigation activity that is not permissible while the loan is held in an MBS trust. Fannie Mae, as guarantor or as issuer, may also purchase mortgage loans when other pre-defined contingencies have been met, such as when there is a material breach of a representation and warranty. Under long-term standby commitments, we purchase loans from lenders when the loans subject to these commitments meet certain delinquency criteria. Our acquisition cost for these loans is the unpaid principal balance of the loans plus accrued interest. <br /> <br />For a loan that will be classified as HFI, when there is evidence of credit deterioration subsequent to the loan’s origination and it is probable, at acquisition, that we will be unable to collect all contractually required payments receivable (ignoring insignificant delays in contractual payments), we account for the loan as an acquired credit-impaired loan. We record such loans at the lower of the acquisition cost or fair value. We record each acquired loan that does not meet these criteria at its acquisition cost. <br /><br />For MBS trusts where we are considered the transferor, we recognize the loan on our consolidated balance sheets at fair value and record a corresponding liability to the MBS trust when the contingency on our options to purchase loans from the trust has been met and we regain effective control over the transferred loan. <br /><br />We base our estimate of the fair value of delinquent loans purchased from MBS trusts upon an assessment of what a market participant would pay for the loan at the date of acquisition. Prior to July 2007, we estimated the initial fair value of these loans using internal prepayment, interest rate and credit risk models that incorporated management’s best estimate of certain key assumptions, such as default rates, loss severity and prepayment speeds. Beginning in July 2007, the mortgage markets experienced a number of significant events, including a dramatic widening of credit spreads for mortgage securities backed by higher risk loans, a large number of credit downgrades of higher risk mortgage-related securities, and a severe reduction in market liquidity for certain mortgage-related transactions. As a result of this extreme disruption in the mortgage markets, we concluded that our model-based estimates of fair value for delinquent loans were no longer aligned with the indicative market prices for these loans. Therefore, we began utilizing indicative market prices from large, experienced dealers and used an average of these market prices to estimate the initial fair value of delinquent loans purchased from MBS trusts. We consider acquired credit-impaired loans to be individually impaired at acquisition. However, no valuation allowance is established or carried over at acquisition. We record the excess of the loan’s acquisition cost over its fair value as a charge-off against our “Reserve for guaranty losses” at acquisition. We recognize any subsequent decreases in estimated future cash flows to be collected subsequent to acquisition as impairment losses through the allowance for loan losses. <br /><br />We place credit-impaired loans that we acquire from MBS trusts on nonaccrual status at acquisition in accordance with our nonaccrual policy. If we subsequently determine that the collectability of principal and interest is reasonably assured we return the loan to accrual status. We determine the initial accrual status of acquired loans that are not credit-impaired in accordance with our nonaccrual policy. Accordingly, we place loans purchased from trusts under other contingent call options on accrual status at acquisition if they are current or if there has been only an insignificant delay in payment and there are no other facts and circumstances that would lead us to conclude that the collection of principal and interest is not reasonably assured. <br /><br />When the acquired loan is returned to accrual status, the portion of the expected cash flows, excluding prepayment estimates, that exceeds the recorded investment in the loan is accreted into interest income over the contractual life of the loan. We prospectively recognize increases in future cash flows expected to be collected as interest income over the remaining contractual life of the loan through a yield adjustment. <br /><br />Allowance for Loan Losses and Reserve for Guaranty Losses<br /><br />The allowance for loan losses is a valuation allowance that reflects an estimate of incurred credit losses related to our recorded investment in HFI loans. The reserve for guaranty losses is a liability account in our consolidated balance sheets that reflects an estimate of incurred credit losses related to our guaranty to each Fannie Mae MBS trust that we will supplement amounts received by the Fannie Mae MBS trust as required to permit timely payment of principal and interest on the related Fannie Mae MBS. As a result, the guaranty reserve considers not only the principal and interest due on the loan at the current balance sheet date, but also any additional interest payments due to the trust from the current balance sheet date up until the point of loan acquisition or foreclosure. We recognize incurred losses by recording a charge to the “Provision for credit losses” in our consolidated statements of operations. <br /><br />Credit losses related to groups of similar single-family and multifamily HFI loans that are not individually impaired, or those that are collateral for Fannie Mae MBS, are recognized when (1) available information as of each balance sheet date indicates that it is probable a loss has occurred and (2) the amount of the loss can be reasonably estimated in accordance with the FASB standard on accounting for contingencies. Single-family and multifamily loans that we evaluate for individual impairment are measured in accordance with the FASB standard on measuring individual impairment of a loan. When making an assessment as to whether a loan is individually impaired, we also consider whether a delay in payment is insignificant. Determination of whether a delay in payment or shortfall of amount is insignificant requires management’s judgment as to the facts and circumstances surrounding the loan. We record charge-offs as a reduction to the allowance for loan losses or reserve for guaranty losses when losses are confirmed through the receipt of assets, such as cash in a preforeclosure sale or the underlying collateral in full satisfaction of the mortgage loan upon foreclosure.<br /><br />Single-family Loans <br /> <br />We aggregate single-family loans (except for those that are deemed to be individually impaired), based on similar risk characteristics for purposes of estimating incurred credit losses and establish a collective single-family loss reserve using an econometric model that derives an overall loss reserve estimate given multiple factors which include but are not limited to: origination year; loan product type; mark-to-market loan-to-value (“LTV”) ratio, and delinquency status. Once loans are aggregated, there typically is not a single, distinct event that would result in an individual loan or pool of loans being impaired. Accordingly, to determine an estimate of incurred credit losses, we base our allowance and reserve methodology on historical events and trends, such as loss severity, default rates, and recoveries from mortgage insurance contracts that are contractually attached to a loan or other credit enhancements that were entered into contemporaneous with and in contemplation of a guaranty or loan purchase transaction. Our allowance calculation also incorporates a loss confirmation period (the anticipated time lag between a credit loss event and the confirmation of the credit loss resulting from that event) to ensure our allowance estimate captures credit losses that have been incurred as of the balance sheet date but have not been confirmed. In addition, management performs a review of the observable data used in its estimate to ensure it is representative of prevailing economic conditions and other events existing as of the balance sheet date. We implemented the econometric model in the fourth quarter of 2009. The previous model, used during 2007, 2008 and the first nine months of 2009, was a loss curve-based model that was driven primarily by original LTV ratio, loan product type, the age of the mortgage loan and the performance to date of the vintage to which the loan belonged. Our previous model required that we consider certain factors when determining whether adjustments to the observable data used in our allowance methodology are necessary, such as levels of and trends in delinquencies; levels of and trends in charge-offs and recoveries; and terms of loans. Our new model directly incorporates delinquency status and vintage effects in the estimation, and thus certain of these adjustments are no longer required. <br /><br />The excess of our recorded investment in a loan, including recorded accrued interest, over the fair value of the assets received in full satisfaction of the loan is treated as a charge-off loss that is deducted from the allowance for loan losses or reserve for guaranty losses. Any excess of the fair value of the assets received in full satisfaction over our recorded investment in a loan at charge-off is applied first to recover any forgone, yet contractually past due interest, and then to “Foreclosed property expense” in our consolidated statements of operations. We also apply estimated proceeds from primary mortgage insurance that is contractually attached to a loan and other credit enhancements entered into contemporaneous with and in contemplation of a guaranty or loan purchase transaction as a recovery of our recorded investment in a charged-off loan, up to the amount of loss recognized as a charge-off. We record proceeds from credit enhancements in excess of our recorded investment in charged-off loans in “Foreclosed property expense” in our consolidated statements of operations when received. <br /> <br />Individually Impaired Loans <br /> <br />We consider a loan to be impaired when, based on current information, it is probable that we will not receive all amounts due, including interest, in accordance with the contractual terms of the loan agreement. When making our assessment as to whether a loan is impaired, we also take into account more than insignificant delays in payment. Determination of whether a delay in payment or shortfall of amount is insignificant requires management’s judgment as to the facts and circumstances surrounding the loan.<br /> <br />Individually impaired loans currently include those restructured in a TDR, acquired credit-impaired loans and certain multifamily loans. Our measurement of impairment on an individually impaired loan follows the method that is most consistent with our expectations of recovery of our recorded investment in the loan. When a loan has been restructured, we measure impairment using a cash flow analysis discounted at the loan’s original effective interest rate, as our expectation is that the loan will continue to perform under the restructured terms. If we determine that the only source to recover our recorded investment in an individually impaired loan is through probable foreclosure of the underlying collateral, we measure impairment based on the fair value of the collateral, reduced by estimated disposal cost on a discounted basis and adjusted for estimated proceeds from mortgage, flood, or hazard insurance or similar sources. Impairment recognized on individually impaired loans is part of our allowance for loan losses. <br /><br />We use internal models to project cash flows used to assess impairment of individually impaired loans, including acquired credit-impaired loans. We generally update the market and loan characteristic inputs we use in these models monthly, using month-end data. Market inputs include information such as interest rates, volatility and spreads, while loan characteristic inputs include information such as mark-to-market loan-to-value ratios and delinquency status. The loan characteristic inputs are key factors that affect the predicted rate of default for loans evaluated for impairment through our internal cash flow models. We evaluate the reasonableness of our models by comparing the results with actual performance and our assessment of current market conditions. In addition, we review our models at least annually for reasonableness and predictive ability in accordance with our corporate model review policy. Accordingly, we believe the projected cash flows generated by our models that we use to assess impairment appropriately reflect the expected future performance of the loans. <br /><br />Multifamily Loans <br /><br />We identify multifamily loans for evaluation for impairment through a credit risk classification process and individually assign them a risk rating. Based on this evaluation, we determine whether or not a loan is individually impaired. If we deem a multifamily loan to be individually impaired, we measure impairment on that loan based on the fair value of the underlying collateral less estimated costs to sell the property on a discounted basis, as we consider such loans to be collateral-dependent. If we determine that an individual loan that was specifically evaluated for impairment is not individually impaired, we include the loan as part of a pool of loans with similar characteristics that are evaluated collectively for incurred losses. <br /> <br />We stratify multifamily loans into different risk rating categories based on the credit risk inherent in each individual loan. We categorize credit risk based on relevant observable data about a borrower’s ability to pay, including reviews of current borrower financial information, operating statements on the underlying collateral, historical payment experience, collateral values when appropriate, and other related credit documentation. Multifamily loans that are categorized into pools based on their relative credit risk ratings are assigned certain default and severity factors representative of the credit risk inherent in each risk category. We apply these factors against our recorded investment in the loans, including recorded accrued interest associated with such loans, to determine an appropriate allowance. As part of our allowance process for multifamily loans, we also consider other factors based on observable data such as historical charge-off experience, loan size and trends in delinquency. In addition, we consider any loss sharing arrangements with our lenders. <br /> <br />Advances to Lenders <br /><br />Advances to lenders represent payments of cash in exchange for the receipt of mortgage loans from lenders in a transfer that is accounted for as a secured lending arrangement. These transfers primarily occur when we provide early funding to lenders for loans that they will subsequently either sell to us or securitize into a Fannie Mae MBS that they will deliver to us. We individually negotiate early lender funding advances with our lender customers. Early lender funding advances have terms up to 60 days and earn a short-term market rate of interest. In other cases, the transfers are of loans that the lender has the unilateral ability to repurchase from us. <br /> <br />We report cash outflows from advances to lenders as an investing activity in our consolidated statements of cash flows. Settlements of the advances to lenders, other than through lender repurchases of loans, are not collected in cash, but rather in the receipt of either loans or Fannie Mae MBS. Accordingly, this activity is reflected as a non-cash transfer in our consolidated statements of cash flows. Currently, we include advances settled through receipt of securities in the line item of our consolidated statements of cash flows entitled “Transfers from advances to lenders to investments in securities.” Advances settled through receipt of loans are not material, and therefore are not separately disclosed in our consolidated statements of cash flows. <br /> <br />Acquired Property, Net <br /> <br />“Acquired property, net” includes foreclosed property received in full satisfaction of a loan. We recognize foreclosed property upon the earlier of the loan foreclosure event or when we take physical possession of the property (i.e., through a deed-in-lieu of foreclosure transaction). We initially measure foreclosed property at its fair value less its estimated costs to sell. We treat any excess of our recorded investment in the loan over the fair value less estimated costs to sell the property as a charge-off to the “Allowance for loan losses.” Any excess of the fair value less estimated costs to sell the property over our recorded investment in the loan is recognized first to recover any forgone, contractually due interest, then to “Foreclosed property expense” in our consolidated statements of operations. <br /> <br />We report foreclosed properties that we intend to sell, are actively marketing and that are available for immediate sale in their current condition such that the sale is reasonably expected to take place within one year as held for sale. We report these properties at the lower of their carrying amount or fair value less estimated selling costs, on a discounted basis if the sale is expected to occur beyond one year from the date of foreclosure. We do not depreciate these properties. <br /><br />We determine the fair value of our foreclosed properties using third party appraisals, when available. When third party appraisals are not available, we estimate fair value based on factors such as prices for similar properties in similar geographical areas and/or assessment through observation of such properties. We recognize a loss for any subsequent write-down of the property to its fair value less its estimated costs to sell through a valuation allowance with an offsetting charge to “Foreclosed property expense” in our consolidated statements of operations. We recognize a recovery for any subsequent increase in fair value less estimated costs to sell up to the cumulative loss previously recognized through the valuation allowance. We recognize gains or losses on sales of foreclosed property through “Foreclosed property expense” in our consolidated statements of operations. <br /><br />Properties that we do not intend to sell or that are not ready for immediate sale in their current condition are classified separately as held for use, are depreciated and are impaired when circumstances indicate that the carrying amount of the property is no longer recoverable. Properties classified as held for use are recorded in “Other assets” in our consolidated balance sheets.<br /><br />Guaranty Accounting <br /> <br />Our primary guaranty transactions result from mortgage loan securitizations in which we issue Fannie Mae MBS. The majority of our Fannie Mae MBS issuances fall within two broad categories: (1) lender swap transactions, where a lender delivers mortgage loans to us to deposit into a trust in exchange for our guaranteed Fannie Mae MBS backed by those mortgage loans and (2) portfolio securitizations, where we securitize loans that were previously included in our consolidated balance sheets, and create guaranteed Fannie Mae MBS backed by those loans. As guarantor, we guarantee to each MBS trust that we will supplement amounts received by the MBS trust as required to permit timely payments of principal and interest on the related Fannie Mae MBS. This obligation represents an obligation to stand ready to perform over the term of the guaranty. Therefore, our guaranty exposes us to credit losses on the loans underlying Fannie Mae MBS. <br /><br />As guarantor of our Fannie Mae MBS issuances, we recognize at inception a non-contingent liability for the fair value of our obligation to stand ready to perform over the term of the guaranty as a component of “Guaranty obligations” in our consolidated balance sheets. Prior to 2008, we measured the fair value of the guaranty obligations that we recorded when we issued Fannie Mae MBS based on management’s estimate of the amount that we would be required to pay a third party of similar credit standing to assume our obligation. We based this amount on market information obtained from spot transaction prices, when available. In the absence of spot transaction prices, which was the case for the substantial majority of our guarantees, we used internal models to estimate the fair value of our guaranty obligations. We reviewed the reasonableness of the results of our models by comparing those results with available market information. Key inputs and assumptions used in our models included the amount of compensation required to cover estimated default costs, including estimated unrecoverable principal and interest that we expected to incur over the life of the underlying mortgage loans backing our Fannie Mae MBS, estimated foreclosure-related costs, estimated administrative and other costs related to our guaranty, and an estimated market risk premium, or profit, that a market participant of similar credit standing would require to assume the obligation. If our modeled estimate of the fair value of the guaranty obligation was more or less than the fair value of the total compensation received, we recognized a loss or recorded deferred profit, respectively, at inception of the guaranty contract. <br /> <br />Beginning in 2008, as part of the implementation of revised fair value measurement standard, we changed our approach to measuring the fair value of our guaranty obligation to use the transaction price, as a practical expedient, to measure the fair value of a guaranty obligation upon initial recognition. Specifically, we adopted a measurement approach based upon an estimate of the compensation that we would require to issue the same guaranty in a standalone arm’s-length transaction with an unrelated party. When we initially recognize a guaranty issued in a lender swap transaction, we measure the fair value of the guaranty obligation based on the fair value of the total compensation we receive, which primarily consists of the guaranty fee, credit enhancements, buy-downs, risk-based price adjustments and our right to receive interest income during the float period in excess of the amount required to compensate us for master servicing. Because the fair value of those guaranty obligations equals the fair value of the total compensation we receive, we do not recognize losses or record deferred profit in our consolidated financial statements at inception of those guaranty contracts. <br /> <br />In 2008, we also changed the way we measure the fair value of our existing guaranty obligations subsequent to inception to be consistent with our new approach for measuring guaranty obligations at initial recognition. The fair value of all guaranty obligations measured subsequent to their initial recognition is our estimate of a hypothetical transaction price we would receive if we were to issue our guaranty to an unrelated party in a standalone arm’s-length transaction at the measurement date. To measure this fair value, we continue to use our models and inputs that were used prior to our adoption of the revised fair value measurement standards and, in 2008, calibrated those models to our current market pricing. Beginning in the first quarter of 2009, we concluded that the credit characteristics of the pools of loans upon which we were issuing new guarantees increasingly did not reflect the credit characteristics of our existing guaranteed pools; thus, current market prices for our new guarantees were not a relevant input to our estimate of the hypothetical transaction price for our existing guaranty obligations. Therefore, our estimate of the fair value of our existing guaranty obligations is based solely upon our model results, without further adjustment.<br /> <br />Other than the measurement of fair value of our guaranty obligations as described above, the accounting for our guarantees in our consolidated financial statements is unchanged. Accordingly, the guaranty obligation amounts recorded in our consolidated balance sheets attributable to guarantees issued prior to 2008 as well as those issued on or after 2008 are amortized in accordance with our established accounting policy. <br /> <br />Guaranties Issued in Connection with Lender Swap Transactions <br /> <br />The majority of our guaranty obligations arise from lender swap transactions. In a lender swap transaction, we receive a guaranty fee for our unconditional guaranty to the Fannie Mae MBS trust. We negotiate a contractual guaranty fee with the lender and collect the fee on a monthly basis based on the contractual rate multiplied by the unpaid principal balance of loans underlying a Fannie Mae MBS issuance. The guaranty fee we receive varies depending on factors such as the risk profile of the securitized loans and the level of credit risk we assume. In lieu of charging a higher guaranty fee for loans with greater credit risk, we may require that the lender pay an upfront fee to compensate us for assuming additional credit risk. We refer to this payment as a risk-based pricing adjustment. Risk-based pricing adjustments do not affect the pass-through coupon remitted to Fannie Mae MBS certificateholders. In addition, we may charge a lower guaranty fee if the lender assumes a portion of the credit risk through recourse or other risk-sharing arrangements. We refer to these arrangements as credit enhancements. We also adjust the monthly guaranty fee so that the pass-through coupon rates on Fannie Mae MBS are in more easily tradable increments of a whole or half percent by making an upfront payment to the lender (“buy-up”) or receiving an upfront payment from the lender (“buy-down”). <br /><br />At inception of a guaranty to an unconsolidated entity, we recognize on our consolidated balance sheets a non-contingent liability for the fair value of our obligation to stand ready to perform over the term of the guaranty in the event that specified triggering events or conditions occur as a component of “Guaranty obligations.” We also record a guaranty asset that represents the present value of cash flows expected to be received as compensation over the life of the guaranty. As described above, for lender swap transactions entered into from 2003 to 2007, if the fair value of the guaranty obligation was less than the present value of the consideration we expected to receive, including the fair value of the guaranty asset and any upfront assets exchanged, we deferred the excess as deferred profit, which was recorded as an additional component of “Guaranty obligations.” If the fair value of the guaranty obligation exceeded the compensation received, we recognized a loss in “Losses on certain guaranty contracts” in our consolidated statements of operations at inception of the guaranty fee contract. Beginning in 2008, we consider the fair value of the guaranty obligations to be equal to the fair value of the total compensation received for providing the guaranty. Therefore, we do not recognize losses or record deferred profit in our consolidated financial statements at inception of those guaranty contracts issued after 2007. <br /> <br />In addition, we recognize a liability for estimable and probable losses for the credit risk we assume on loans underlying Fannie Mae MBS based on management’s estimate of probable losses incurred on those loans as of each balance sheet date. We record this contingent liability in our consolidated balance sheets as “Reserve for guaranty losses.” <br /> <br />Subsequent to initial recognition, we account for the guaranty asset at amortized cost. As we collect monthly guaranty fees, we reduce guaranty assets to reflect cash payments received and recognize imputed interest income on guaranty assets as a component of “Guaranty fee income” under the prospective interest method. We reduce the corresponding guaranty obligation, including any deferred profit, in proportion to the reduction in guaranty assets and recognize this reduction in our consolidated statements of operations as an additional component of “Guaranty fee income.” We assess guaranty assets for other-than-temporary impairment based on changes in our estimate of the cash flows to be received. When we determine a guaranty asset is other-than-temporarily impaired, we write down the cost basis of the guaranty asset to its fair value and include the amount written-down in “Guaranty fee income” in our consolidated statements of operations. Any other-than-temporary impairment recorded on guaranty assets results in a proportionate reduction in the corresponding guaranty obligations, including any deferred profit recorded prior to 2008. <br /> <br />We record buy-ups in our consolidated balance sheets at fair value in “Other assets.” We account for buy-ups issued prior to 2007 in the same manner as AFS securities with changes in fair value recorded in AOCI, net of tax. We assess these buy-ups for other-than-temporary impairment. Buy-ups issued beginning in 2007 are accounted for in the same manner as trading securities, with unrealized gains and losses included in “Guaranty fee income” in our consolidated statements of operations. When we determine a buy-up is other-than-temporarily impaired, we write down the cost basis of the buy-up to its fair value and include the amount of the write-down in “Guaranty fee income” in our consolidated statements of operations. <br /><br />Upfront cash receipts for buy-downs and risk-based price adjustments on and after 2003 and prior to 2008 are a component of the compensation received for issuing the guaranty and are recorded upon issuing a guaranty as an additional component of “Guaranty obligations,” for contracts with deferred profit, or a reduction of the loss recorded as a component of “Losses on certain guaranty contracts,” for contracts where the compensation received is less than the guaranty obligation. Beginning in 2008, we consider the initial fair value of the guaranty obligation to be equal to the fair value of the total compensation received for providing the guaranty. Therefore, we do not recognize losses or record deferred profit at the inception of a lender swap transaction and account for all upfront cash receipts for buy-downs and risk-based price adjustments for as a component of “Guaranty obligations.” <br /><br />We base the fair value of the guaranty asset at inception on the present value of expected cash flows using management’s best estimates of certain key assumptions, which include prepayment speeds, forward yield curves and discount rates commensurate with the risks involved. We project these cash flows using proprietary prepayment, interest rate and credit risk models. Because guaranty assets are like an interest-only income stream, we discount the projected cash flows from our guaranty assets using interest spreads from a representative sample of interest-only trust securities. We adjust these discounted cash flows for the less liquid nature of the guaranty asset as compared to the interest-only trust securities. <br /> <br />These initial recognition and measurement provisions apply to our guaranties issued or modified beginning in 2003. For lender swap transactions entered into prior to 2003, we recognized guaranty fees in our consolidated statements of operations as “Guaranty fee income” on an accrual basis over the term of the unconsolidated Fannie Mae MBS. We recognized a contingent liability based on management’s estimate of probable losses incurred on those loans as of each balance sheet date, and we deferred upfront cash payments received in the form of risk-based pricing adjustments or buy-downs as a component of “Other liabilities” in our consolidated balance sheets and amortized them into “Guaranty fee income” in our consolidated statements of operations over the life of the guaranty using the interest method. <br /><br />Guaranties Issued in Connection with Portfolio Securitizations <br /> <br />In addition to retained interests in the form of Fannie Mae MBS, REMICs, and MSAs, we retain an interest in securitized loans in a portfolio securitization, which represents our right to future cash flows associated primarily with providing our guaranty. We record the retained guaranty interest in a portfolio securitization in our consolidated balance sheets as a component of “Guaranty assets.” For a portfolio securitization entered into prior to 2007, we account for the retained guaranty interests in the same manner as AFS securities. For a portfolio securitization entered into on or after January 1, 2007, we account for the retained guaranty interests in the same manner as trading securities. We determine the fair value of the guaranty asset in the same manner as we do in a lender swap transaction. We assume a recourse obligation in connection with our guaranty of the timely payment of principal and interest to the MBS trust that we measure and record in our consolidated balance sheets under “Guaranty obligations” based on the fair value of the recourse obligation at inception in a similar manner as our lender swap transactions. We recognize any difference between the guaranty asset and the guaranty obligation in a portfolio securitization as a component of the gain or loss on the sale of mortgage-related assets and record the difference as “Investment gains (losses), net” in our consolidated statements of operations. <br /> <br />We evaluate the component of the “Guaranty assets” that represents the retained interest in securitized loans for other-than-temporary impairment. We amortize and account for the guaranty obligations subsequent to the initial recognition in the same manner that we account for the guaranty obligations that arise under lender swap transactions and record a “Reserve for guaranty losses” for estimable and probable losses incurred on the underlying loans as of each balance sheet date. When we recognize a guaranty obligation and do not receive an associated guaranty fee, we amortize the guaranty obligation using a systematic and rational method, dependent on the risk profile of our guaranty. <br /> <br />Fannie Mae MBS included in “Investments in securities” <br /><br />When we own unconsolidated Fannie Mae MBS, we do not derecognize any components of the guaranty assets, guaranty obligations, reserve for guaranty losses, or any other outstanding recorded amounts associated with the guaranty transaction because our contractual obligation to the MBS trust remains in force until the trust is liquidated. We value Fannie Mae MBS based on their legal terms, which includes the Fannie Mae guaranty to the MBS trust, and continue to reflect the unamortized obligation to stand ready to perform over the term of our guaranty and any incurred credit losses in our “Guaranty obligations” and “Reserve for guaranty losses,” respectively. We disclose the aggregate amount of Fannie Mae MBS held as “Investments in securities” in our consolidated balance sheets as well as the amount of our “Reserve for guaranty losses” and “Guaranty obligations” that relates to Fannie Mae MBS held as “Investments in securities.” Upon subsequent sale of a Fannie Mae MBS, we continue to account for any outstanding recorded amounts associated with the guaranty transaction on the same basis of accounting as prior to the sale of Fannie Mae MBS, as no new assets were retained and no new liabilities have been assumed upon the subsequent sale. <br /><br />Credit Enhancements <br /> <br />Credit enhancements that we recognize separately as “Other assets” in our consolidated balance sheets are amortized in our consolidated statements of operations as “Other expenses.” We amortize these assets over the related contract terms at the greater of amounts calculated by amortizing recognized credit enhancements (1) commensurate with the observed decline in the unpaid principal balance of covered mortgage loans or (2) on a straight-line basis over a credit enhancement’s contract term. We record recurring insurance premiums at the amount paid and amortize them over their contractual life, and, if provided quarterly, the amortization period is three months. <br /> <br />Amortization of Cost Basis and Guaranty Price Adjustments <br /> <br />Cost Basis Adjustments <br /> <br />We amortize cost basis adjustments, including premiums and discounts on mortgage loans and securities, as a yield adjustment using the interest method over the contractual or estimated life of the loan or security. We amortize these cost basis adjustments into interest income for mortgage securities and loans we classify as HFI. We do not amortize cost basis adjustments for loans that we classify as HFS but include them in the calculation of the gain or loss on the sale of those loans. <br /> <br />The following table displays unamortized premiums, discounts, and other cost basis adjustments included in our consolidated balances sheets as of December 31, 2009 and 2008, that may result in interest income in our consolidated statements of operations in future periods.</p><table style="border-collapse: collapse; margin-top: 20px;"><tr><td height="16" width="9" align="left"> </td><td height="16" width="9" align="left"> </td><td height="16" width="480" align="center"> <sup></sup></td><td width="164" align="center" colspan="5" style="border-bottom: 1px solid #000000;" height="16"><b>As of December 31, </b></td></tr><tr><td height="16" width="9" align="left"> </td><td height="16" width="9" align="left"> </td><td height="16" width="480" align="center"> <sup></sup></td><td width="75" align="center" colspan="2" style="border-top: 1px solid #000000;border-bottom: 1px solid #000000;" height="16"><b>2009 </b></td><td height="16" style="border-top: 1px solid #000000;" align="left" width="13"><b> </b></td><td width="76" align="center" colspan="2" style="border-top: 1px solid #000000;border-bottom: 1px solid #000000;" height="16"><b>2008 </b></td></tr><tr><td height="16" width="9" align="left"> </td><td height="16" width="9" align="left"> </td><td height="16" width="480" align="center"> <sup></sup></td><td width="164" align="center" height="16" colspan="5"><b>(Dollars in millions)</b></td></tr><tr><td width="498" align="left" height="17" colspan="3">Investments in securities: <sup></sup></td><td height="17" width="11" align="left"> </td><td height="17" width="64" align="left"> </td><td height="17" width="13" align="left"> </td><td height="17" width="12" align="left"> </td><td height="17" width="64" align="left"> </td></tr><tr><td height="17" width="9" align="left"> </td><td height="17" width="9" align="left"> </td><td height="17" width="480" align="left">Unamortized premiums (discounts) and other cost basis adjustments, net<sup>(1)</sup></td><td height="17" width="11" align="left">$</td><td height="17" width="64" align="right"> 1,185 </td><td height="17" width="13" align="left"> </td><td height="17" width="12" align="left">$</td><td height="17" width="64" align="right">290 </td></tr><tr><td height="17" width="9" align="left"> </td><td height="17" width="9" align="left"> </td><td height="17" width="480" align="left">Other-than-temporary impairments<sup>(2)</sup></td><td height="17" width="11" align="left"> </td><td height="17" width="64" align="right"> (821)</td><td height="17" width="13" align="left"> </td><td height="17" width="12" align="left"> </td><td height="17" width="64" align="right">(6,457)</td></tr><tr><td width="498" align="left" height="17" colspan="3">Mortgage loans held-for-investment:<sup></sup></td><td height="17" width="11" align="left"> </td><td height="17" width="64" align="left"> </td><td height="17" width="13" align="left"> </td><td height="17" width="12" align="left"> </td><td height="17" width="64" align="left"> </td></tr><tr><td height="20" width="9" align="left"> </td><td width="489" align="left" height="20" colspan="2">Unamortized premiums (discounts) and other cost basis adjustments of loans in <sup></sup></td><td height="20" width="11" align="left"> </td><td height="20" width="64" align="left"> </td><td height="20" width="13" align="left"> </td><td height="20" width="12" align="left"> </td><td height="20" width="64" align="left"> </td></tr><tr><td height="17" width="9" align="left"> </td><td height="17" width="9" align="left"> </td><td height="17" width="480" align="left">portfolio, excluding acquired credit-impaired loans and hedged mortgage assets<sup>(3)</sup></td><td height="17" width="11" align="left"> </td><td height="17" width="64" align="right"> (10,332)</td><td height="17" width="13" align="left"> </td><td height="17" width="12" align="left"> </td><td height="17" width="64" align="right">(1,341)</td></tr><tr><td height="17" width="9" align="left"> </td><td width="489" align="left" height="17" colspan="2">Unamortized discount on acquired credit-impaired loans<sup>(4)</sup></td><td height="17" width="11" align="left"> </td><td height="17" width="64" align="right"> (11,467)</td><td height="17" width="13" align="left"> </td><td height="17" width="12" align="left"> </td><td height="17" width="64" align="right">(1,320)</td></tr><tr><td height="17" width="9" align="left"> </td><td width="489" align="left" height="17" colspan="2">Unamortized premium on hedged mortgage assets<sup> (5)</sup></td><td height="17" width="11" align="left"> </td><td height="17" width="64" align="right"> 806 </td><td height="17" width="13" align="left"> </td><td height="17" width="12" align="left"> </td><td height="17" width="64" align="right"> 921 </td></tr><tr><td width="498" align="left" height="17" colspan="3">Other assets<sup> (6)</sup></td><td height="17" width="11" align="left"> </td><td height="17" style="border-bottom: 1px solid #000000;" align="right" width="64"> (254)</td><td height="17" width="13" align="left"> </td><td height="17" width="12" align="left"> </td><td height="17" style="border-bottom: 1px solid #000000;" align="right" width="64"> (333)</td></tr><tr><td height="18" width="9" align="left"> </td><td width="489" align="left" height="18" colspan="2">Total<sup></sup></td><td height="18" width="11" align="left">$</td><td height="18" style="border-top: 1px solid #000000;border-bottom: 3px double #000000;" align="right" width="64"> (20,883)</td><td height="18" width="13" align="left"> </td><td height="18" width="12" align="left">$</td><td height="18" style="border-top: 1px solid #000000;border-bottom: 3px double #000000;" align="right" width="64">(8,240)</td></tr></table><table style="border-collapse: collapse; margin-top: 20px;"><tr><td width="705" align="left" height="15" colspan="3">__________</td></tr><tr><td height="14" width="26" align="left"> <sup> (1)</sup></td><td height="14" width="642" align="left">Includes the impact of other-than-temporary impairment of cost basis adjustments.</td></tr><tr><td height="6" width="26" align="left"> <sup></sup></td><td height="6" width="642" align="left"> </td></tr><tr><td height="14" width="26" align="left"> <sup> (2)</sup></td><td height="14" width="642" align="left">Accretable portion of impairments recorded as a result of previous other-than-temporary impairments. </td></tr><tr><td height="6" width="26" align="left"> <sup></sup></td><td height="6" width="642" align="left"> </td></tr><tr><td height="14" width="26" align="left"> <sup> (3)</sup></td><td width="642" align="left" height="28" rowspan="2">Includes the unamortized balance of the fair value discounts that were recorded upon acquisition of credit-impaired loans that have been subsequently modified as TDRs, which accretes into interest income for TDRs that are placed on accrual status. </td></tr><tr><td height="14" width="26" align="left"> <sup></sup></td></tr><tr><td height="6" width="26" align="left"> <sup></sup></td><td height="6" width="642" align="left"> </td></tr><tr><td height="14" width="26" align="left"> <sup> (4)</sup></td><td width="642" align="left" height="28" rowspan="2">Represents the unamortized balance of the fair value discounts that were recorded upon acquisition and consolidation that may accrete into interest income for acquired credit-impaired loans that are placed on accrual status. </td></tr><tr><td height="14" width="26" align="left"> <sup></sup></td></tr><tr><td height="6" width="26" align="left"> <sup></sup></td><td height="6" width="642" align="left"> </td></tr><tr><td height="14" width="26" align="left"> <sup> (5)</sup></td><td width="642" align="left" height="28" rowspan="2">Represents the net premium on mortgage assets designated for hedge accounting that are attributable to changes in interest rates and will be amortized through interest income over the life of the hedged assets.</td></tr><tr><td height="14" width="26" align="left"> <sup></sup></td></tr><tr><td height="6" width="26" align="left"> <sup></sup></td><td height="6" width="642" align="left"> </td></tr><tr><td height="14" width="26" align="left"> <sup> (6)</sup></td><td width="642" align="left" height="28" rowspan="2">Represents the fair value discount related to unsecured HomeSaver Advance loans that will accrete into interest income based on the contractual terms of the loans for loans on accrual status. </td></tr><tr><td height="14" width="26" align="left"> <sup></sup></td></tr><tr><td height="15" width="26" align="left"> <sup></sup></td><td height="15" width="642" align="left"> </td></tr></table><p>We hold a large number of similar mortgage loans and mortgage securities backed by a large number of similar mortgage loans for which prepayments are probable and we can reasonably estimate the timing of such prepayments. We use prepayment estimates in determining periodic amortization of cost basis adjustments on substantially all mortgage loans and mortgage securities in our portfolio under the interest method using a constant effective yield. We include this amortization in “Interest income.” For the purpose of amortizing cost basis adjustments, we aggregate similar mortgage loans with similar prepayment characteristics. We consider Fannie Mae MBS to be aggregations of similar loans for the purpose of estimating prepayments. We aggregate individual mortgage loans based upon coupon rate, product type and origination year for the purpose of estimating prepayments. For each reporting period, we recalculate the constant effective yield to reflect the actual payments and prepayments we have received to date and our new estimate of future prepayments. We then adjust our net investment in the mortgage loans and mortgage securities to the amount it would have been had we applied the recalculated constant effective yield since their acquisition, with a corresponding charge or credit to interest income. <br /><br />We use the contractual terms to determine amortization if prepayments are not probable, we cannot reasonably estimate prepayments, or we do not hold a sufficiently large number of similar loans or a sufficiently large number of similar loans do not underlie a security. For these loans, we cease amortization of cost basis adjustments during periods in which we are not recognizing interest income on the loan because the collection of the principal and interest payments is not reasonably assured (that is, when a loan is placed on nonaccrual status). <br /><br />Deferred Guaranty Price Adjustments <br /><br />We apply the interest method using a constant effective yield to amortize all risk-based price adjustments and buy-downs in connection with our Fannie Mae MBS issued prior to 2003. We calculate the constant effective yield for these deferred guaranty price adjustments based upon our estimate of the cash flows of the mortgage loans underlying the related Fannie Mae MBS, which includes an estimate of prepayments. For each reporting period, we recalculate the constant effective yield to reflect the actual payments and our new estimate of future prepayments. We adjust the carrying amount of deferred guaranty price adjustments to the amount it would have been had we applied the recalculated constant effective yield since their inception. <br /><br />For risk-based pricing adjustments and buy-downs that arose on Fannie Mae MBS issued beginning in 2003, we record the cash received and increase “Guaranty obligations” by a similar amount. We amortize these amounts as part of the “Guaranty obligations” in proportion to the reduction in the guaranty asset. <br /><br />Master Servicing <br /> <br />Upon a transfer of loans to us, either in connection with a portfolio purchase or a lender swap transaction, we enter into an agreement with the lender, or its designee, to have that entity continue to perform the day-to-day servicing of the mortgage loans. We refer to these activities as “primary servicing.” We assume an obligation to perform certain limited master servicing activities when these loans are securitized. These activities include assuming the ultimate obligation for the day-to-day servicing in the event of default by the primary servicer until a new primary servicer can be put in place and certain ongoing administrative functions associated with the securitization. As compensation for performing these master servicing activities, we receive the right to the interest earned on MBS trust cash flows from the date of remittance by the servicer to us until the date of distribution of such cash flows to MBS certificateholders, which we record in our consolidated statements of operations as “Trust management income.” <br /> <br />We record an MSA as a component of “Other assets” in our consolidated balance sheets when the present value of the estimated compensation for master servicing activities exceeds adequate compensation for such servicing activities. Conversely, we record a master servicing liability (“MSL”) as a component of “Other liabilities” in our consolidated balance sheets when the present value of the estimated compensation for master servicing activities is less than adequate compensation. We consider adequate compensation to be the amount of compensation that would be required by a substitute master servicer should one be required. We use market information to determine adequate compensation for these services. <br /> <br />We initially recognize an MSA at fair value. We subsequently carry the MSA at LOCOM and amortize it in proportion to net servicing income for each period. We record impairment of the MSA through a valuation allowance. When we determine an MSA is other-than-temporarily impaired, we write down the cost basis of the MSA to its fair value. We individually assess our MSA for impairment by reviewing changes in historical interest rates and the impact of those changes on the historical fair values of the MSA. We then determine our expectation of the likelihood of a range of interest rate changes over an appropriate recovery period using historical interest rate movements. We record an other-than-temporary impairment when we do not expect to recover the valuation allowance based on our expectation of the interest rate changes and their impact on the fair value of the MSA during the recovery period. We record amortization and impairment of the MSA as components of “Other expenses” in our consolidated statements of operations. <br /> <br />We initially recognize an MSL at fair value and subsequently amortize it in proportion to net servicing loss for each period. We increase the carrying amount of the MSL to fair value when the fair value exceeds the carrying amount. We record amortization and valuation adjustments to the MSL as components of “Other expenses” in our consolidated statements of operations. When we receive an MSA or incur an MSL in connection with a lender swap transaction, we consider that servicing asset or liability to be a component of the compensation we receive in exchange for entering into the guaranty arrangement. <br /> <br />We consider MSAs and MSLs recorded in connection with portfolio securitizations as proceeds received and liabilities incurred in a securitization, respectively. Accordingly, these amounts are a component of the calculation of gain or loss on the sale of assets. <br /> <br />The fair values of the MSA and MSL are based on the present value of expected cash flows using management’s best estimates of certain key assumptions, which include prepayment speeds, forward yield curves, adequate compensation, and discount rates commensurate with the risks involved. The risks inherent in MSAs and MSLs are interest rate and prepayment risks. Changes in anticipated prepayment speeds, in particular, result in fluctuations in the estimated fair values of the MSA and MSL. <br /> <br />Effective in 2007, we adopted the revised standard requiring mortgage servicing rights (MSAs and MSLs) to be initially recognized at fair value. The standard provides two measurement options for each class of MSAs and MSLs subsequent to initial recognition: (1) carry them at fair value with changes in fair value recognized in earnings or (2) continue to recognize periodic amortization expense and assess MSAs and MSLs for impairment or increased obligation consistent with prior standards. We identify classes of MSAs and MSLs based on the availability of market inputs used in determining their fair value. The availability of such market inputs is consistent across our MSAs and MSLs; therefore, we account for them as one class. In addition, the standard requires us to consider the fair value of servicing rights as part of the proceeds received in exchange for the sale of the assets for purposes of calculating the gain or loss from the sale. The adoption of the revised standard did not materially impact our consolidated financial statements because we elected not to measure MSAs and MSLs at fair value subsequent to their initial recognition. <br /> <br />Other Investments <br /> <br />We primarily account for unconsolidated investments in limited partnerships under the equity method of accounting. These investments include our LIHTC and other partnership investments. Under the equity method, we increase or decrease our investment for our share of the limited partnership’s net income or loss reflected in “Losses from partnership investments” in our consolidated statements of operations. Under certain circumstances we will increase our investment for additional contributions made to the partnerships and reduce our investment by distributions received from the partnerships. <br /> <br />For unconsolidated common and preferred stock investments that are not within the scope of the accounting standards for certain investments in debt and equity securities, we apply either the equity or the cost method of accounting. We use the equity method for accounting for investments in these entities where our ownership is between 20% and 50%, or where our investments provide us the ability to exercise significant influence over the entity’s operations and management functions. We use the cost method for investments in entities where our ownership is less than 20% and we have no ability to exercise significant influence over the entity’s operations. These investments are included as “Other assets” in our consolidated balance sheets. <br /> <br />We periodically review our investments to determine if an other-than-temporary loss in value has occurred. In these reviews, we consider all relevant information, including the recoverability of our investment, the earnings and near-term prospects of the entity, factors related to the industry, financial and operating conditions of the entity and our ability, if any, to influence the management of the entity. <br /> <br />Commitments to Purchase and Sell Mortgage Loans and Securities <br /> <br />We enter into commitments to purchase and sell mortgage-backed securities and to purchase single-family and multifamily mortgage loans. Commitments to purchase or sell some mortgage-backed securities and to purchase single-family mortgage loans generally are derivatives. Our commitments to purchase multifamily loans are not derivatives because they do not meet the criteria for net settlement. <br /> <br />For those commitments that we account for as derivatives, we report them in our consolidated balance sheets at fair value in “Derivative assets, at fair value” or “Derivative liabilities, at fair value” and include changes in their fair value in “Fair value losses, net” in our consolidated statements of operations. When derivative purchase commitments settle, we include their fair value on the settlement date in the cost basis of the security or loan that we purchase. <br /> <br />Regular-way securities trades provide for delivery of securities within the time generally established by regulations or conventions in the market in which the trade occurs and are exempt from application of the derivative accounting literature. Commitments to purchase or sell securities that we account for on a trade-date basis are also exempt from the derivative accounting requirements. We record the purchase and sale of an existing security on its trade date when the commitment to purchase or sell the existing security settles within the period of time that is customary in the market in which those trades take place. <br /> <br />Additionally, contracts for the forward purchase or sale of when-issued and to-be-announced (“TBA”) securities are exempt from the derivative accounting requirements if there is no other way to purchase or sell that security, delivery of that security and settlement will occur within the shortest period possible for that type of security, and it is probable at inception and throughout the term of the individual contract that physical delivery of the security will occur. Since our commitments for the purchase of when-issued and TBA securities can be net settled and we do not document that physical settlement is probable, we account for all such commitments as derivatives. <br /> <br />Commitments to purchase securities that we do not account for as derivatives and do not require trade-date accounting are accounted for as forward contracts to purchase securities. We designate these commitments as AFS or trading at inception and account for them in a manner consistent with that category of securities. <br /><br />Derivative Instruments <br /> <br />We recognize all derivatives as either assets or liabilities in our consolidated balance sheets at their fair value on a trade date basis. We report derivatives in a gain position after offsetting by counterparty in “Derivative assets, at fair value” and derivatives in a loss position after offsetting by counterparty in “Derivative liabilities, at fair value” in our consolidated balance sheets. <br /> <br />We offset the carrying amounts of derivatives (other than commitments) that are in gain positions and loss positions with the same counterparty, as well as cash collateral receivables and payables associated with derivative positions in master netting arrangements. We offset these amounts because the derivative contracts have determinable amounts, we have the legal right to offset amounts with each counterparty, that right is enforceable by law, and we intend to offset the amounts to settle the contracts. <br /> <br />We determine fair value using quoted market prices in active markets when available. If quoted market prices are not available for particular derivatives, we use quoted market prices for similar derivatives that we adjust for directly observable or corroborated (i.e., information purchased from third-party service providers) market information. In the absence of observable or corroborated market data, we use internally-developed estimates, incorporating market-based assumptions wherever such information is available. For derivatives (other than commitments), we use a mid-market price when there is a spread between a bid and ask price. <br /><br />We evaluate financial instruments that we purchase or issue and other financial and non-financial contracts for embedded derivatives. To identify embedded derivatives that we must account for separately, we determine if: (1) the economic characteristics of the embedded derivative are not clearly and closely related to the economic characteristics of the financial instrument or other contract; (2) the financial instrument or other contract (i.e., the hybrid contract) itself is not already measured at fair value with changes in fair value included in earnings; and (3) a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative. If the embedded derivative meets all three of these conditions we elect to carry the hybrid financial instrument in its entirety at fair value with changes in fair value recorded in earnings. <br /> <br />Effective in 2007, we adopted a new accounting standard and we elected fair value measurement for certain hybrid financial instruments containing embedded derivatives that otherwise require bifurcation. We also elected to classify some investment securities that contain embedded derivatives as trading securities, which includes buy-ups and guaranty assets arising from portfolio securitization transactions. As we adopted this standard prospectively, it had no impact on our consolidated financial statements on the date of adoption. <br /><br />Collateral<br /><br />We enter into various transactions where we pledge and accept collateral, the most common of which are our derivative transactions. Required collateral levels vary depending on the credit rating and type of counterparty. We also pledge and receive collateral under our repurchase and reverse repurchase agreements. In order to reduce potential exposure to repurchase counterparties, a third party custodian typically maintains the collateral and any margin. We monitor the fair value of the collateral received from our counterparties, and we may require additional collateral from those counterparties, as we deem appropriate. Collateral received under early funding agreements with lenders, whereby we advance funds to lenders prior to the settlement of a security commitment, must meet our standard underwriting guidelines for the purchase or guarantee of mortgage loans.<br /><br />Cash Collateral<br /><br />We pledged $5.4 billion and $15.0 billion in cash collateral as of December 31, 2009 and 2008, respectively, related to our derivative activities. For derivative positions with the same counterparty under master netting arrangements to the extent that we pledge cash collateral, we remove it from “Cash and cash equivalents” and net the right to receive it against “Derivative liabilities at fair value” in our consolidated balance sheets as a part of our counterparty netting calculation. Additionally, we pledged $5.4 billion and $5.3 billion in cash collateral as of December 31, 2009 and 2008, respectively, related to operating activities and recorded this amount as “Other assets” or “Federal funds sold and securities purchased under agreements to resell” in our consolidated balance sheets. <br /><br />We record cash collateral accepted from a counterparty that we have the right to use as “Cash and cash equivalents” in our consolidated balance sheets. Cash collateral accepted from a counterparty that we do not have the right to use is recorded as “Restricted cash” in our consolidated balance sheets. We primarily net our obligation to return cash collateral pledged to us against “Derivative assets at fair value” in our consolidated balance sheets as part of our counterparty netting calculation. We accepted cash collateral of $4.1 billion and $4.0 billion as of December 31, 2009 and 2008, respectively, of which $3.0 billion and $330 million, respectively, was restricted.<br /><br />Non-Cash Collateral<br /><br />We classify securities pledged to counterparties as either “Investments in securities” or “Cash and cash equivalents” in our consolidated balance sheets. Securities pledged to counterparties that have been consolidated as loans are included as “Mortgage loans” in our consolidated balance sheets. As of December 31, 2009, we had pledged $1.1 billion in available-for-sale (“AFS”) securities and $1.9 billion in HFI loans which the counterparty had the right to sell or repledge. As of December 31, 2008, we had pledged $720 million of AFS securities, which the counterparty had the right to sell or repledge. We did not pledge any HFI loans to counterparties as of December 31, 2008. <br /><br />The fair value of non-cash collateral accepted that we were permitted to sell or repledge was $67 million and $141 million as of December 31, 2009 and 2008, respectively, none of which was sold or repledged. The fair value of non-cash collateral accepted that we were not permitted to sell or repledge was $4.2 billion and $13.3 billion as of December 31, 2009 and 2008, respectively. Additionally, we had accepted non-cash collateral related to our HCD business of $2.1 billion and $10.6 billion as of and December 31, 2009 and 2008, respectively, that we were not permitted to sell or repledge.<br /><br />Our liability to third-party holders of Fannie Mae MBS that arises as the result of a consolidation of a securitization trust is fully collateralized by the underlying loans and/or mortgage-related securities.<br /><br />When securities sold under agreements to repurchase meet all of the conditions of a secured financing, we report the collateral of the transferred securities at fair value, excluding accrued interest. The fair value of these securities is classified in “Investments in securities” in our consolidated balance sheets. We had no repurchase agreements of this type outstanding as of December 31, 2009 and 2008.<br /><br />Hedge Accounting <br /> <br /><br />In 2008, we implemented fair value hedge accounting with respect to a portion of our derivatives to hedge, for accounting purposes, changes in the fair value of some of our mortgage assets attributable to changes in interest rates. Specifically, we designated certain of our interest rate swaps as hedges of the change in fair value attributable to the change in the London Interbank Offered Rate (“LIBOR”) for certain multifamily loans classified as HFI and commercial mortgage-backed securities (“CMBS”) classified as AFS. <br /><br />We formally document at the inception of each hedging relationship the hedging instrument, the hedged item, the risk management objective and strategy for undertaking each hedging relationship, and the method used to assess hedge effectiveness. We use regression analysis to assess whether the derivative instrument has been and is expected to be highly effective in offsetting changes in fair value of the hedged item attributable to the change in the LIBOR. <br /> <br />When hedging relationships are highly effective, we record changes in the fair value of the hedged item attributable to changes in the benchmark interest rate as an adjustment to the carrying amount of the hedged item and include a corresponding amount in “fair value losses, net” in our consolidated statements of operations. For commercial mortgage-backed securities classified as AFS, we record all other changes in fair value as part of AOCI and not in earnings. For multi-family loans, all other changes in fair value are not recorded. If a hedging relationship is not highly effective, we do not record an adjustment to earnings. We amortize adjustments to the carrying amount of hedged items that result from hedge accounting through interest income in the same manner as other components of the carrying amount of that asset. <br /> <br />We discontinue hedge accounting prospectively when (1) the hedging derivative is no longer effective in offsetting changes in fair value of the hedged item attributable to the hedged risk, (2) we terminate or sell the derivative or the hedged item, or (3) we voluntarily elect to remove the hedge accounting designation. When we discontinue hedge accounting, we continue to carry the derivative instrument on our consolidated balance sheets at its fair value with changes in fair value recognized in current period earnings. However, we no longer adjust the carrying value of the hedged item through earnings for changes in fair value attributable to the hedged risk. We voluntarily elected to cease all hedge accounting during 2008. <br /> <br />Debt <br /> <br />We classify our outstanding debt as either short-term or long-term based on the initial contractual maturity. We report deferred items, including premiums, discounts and other cost basis adjustments, as basis adjustments to “Short-term debt” or “Long-term debt” in our consolidated balance sheets. We re-measure the carrying amount, accrued interest and basis adjustments of debt denominated in a foreign currency into U.S. dollars using foreign exchange spot rates as of the balance sheet date and report any associated gains or losses as a component of “Fair value losses, net” in our consolidated statements of operations. <br /><br />We classify interest expense as either short-term or long-term based on the contractual maturity of the related debt. We amortize and report premiums, discounts and other cost basis adjustments through interest expense using the effective interest method usually over the contractual term of the debt. Amortization of premiums, discounts and other cost basis adjustments begins at the time of debt issuance. We re-measure interest expense for debt denominated in a foreign currency into U.S. dollars using the monthly weighted-average spot rate since the interest expense is incurred over the reporting period. The difference in rates arising from the month-end spot exchange rate used to calculate the interest accruals and the weighted-average exchange rate used to record the interest expense is a foreign currency transaction gain or loss for the period and is included as either “Short-term debt interest expense” or “Long-term debt interest expense” in our consolidated statements of operations. <br /> <br />Trust Management Income <br /> <br />As master servicer, issuer and trustee for Fannie Mae MBS, we earn a fee that reflects interest earned on MBS trust cash flows from the date of remittance of mortgage and other payments to us by servicers until the date of distribution of these payments to MBS certificateholders. We included such compensation as “Trust management income” in our consolidated statements of operations. <br /> <br />Fees Received on the Structuring of Transactions <br /> <br />We offer certain re-securitization services to customers in exchange for fees. Such services include, but are not limited to, the issuance, guarantee and administration of Fannie Mae REMIC, stripped mortgage-backed securities (“SMBS”), grantor trust, and Fannie Mae Mega® securities (collectively, the “Structured Securities”). We receive a one-time conversion fee upon issuance of a Structured Security that varies based on the value of securities issued and the transaction structure. The conversion fee compensates us for all services we provide in connection with the Structured Security, including services provided at and prior to security issuance and over the life of the Structured Securities. Except for Structured Securities where the underlying collateral is whole loans or private-label securities, we generally do not receive a guaranty fee as compensation in connection with the issuance of a Structured Security, because the transferred mortgage-related securities have previously been guaranteed by us or another party. <br /><br />We defer a portion of the fee received upon issuance of a Structured Security based on our estimate of the fair value of our future administration services. We amortize this portion of the fee on a straight-line basis over the expected life of the Structured Security. We recognize the excess of the total fee over the fair value of the future services in our consolidated statements of operations upon issuance of a Structured Security. However, when we acquire a portion of a Structured Security contemporaneous with our structuring of the transaction, we defer and amortize a portion of this upfront fee as an adjustment to the yield of the purchased security. We present fees received and costs incurred related to our structuring of securities in “Fee and other income” in our consolidated statements of operations. <br /><br />Income Taxes <br /> <br />We recognize deferred tax assets and liabilities for the difference in the basis of assets and liabilities for financial accounting and tax purposes. We measure deferred tax assets and liabilities using enacted tax rates that are expected to be applicable to the taxable income or deductions in the period(s) the assets are realized or the liabilities are settled. We adjust deferred tax assets and liabilities for the effects of changes in tax laws and rates on the date of enactment. We recognize investment and other tax credits through our effective tax rate calculation assuming that we will be able to realize the full benefit of the credits. We reduce our deferred tax asset by an allowance if, based on the weight of available positive and negative evidence, it is more likely than not that we will not realize some portion, or all, of the deferred tax asset. <br /><br />We account for income tax uncertainty using a two-step approach whereby we recognize an income tax benefit if, based on the technical merits of a tax position, it is more likely than not (a probability of greater than 50%) that the tax position would be sustained upon examination by the taxing authority, which includes all related appeals and litigation. We then recognize a tax benefit equal to the largest amount of tax benefit that is greater than 50% likely to be realized upon settlement with the taxing authority, considering all information available at the reporting date. We recognize interest expense on unrecognized tax benefits as “Other expenses” in our consolidated statements of operations. <br /> <br />Stock-Based Compensation <br /> <br />We measure the cost of employee services received in exchange for stock-based awards using the fair value of those awards on the grant date. We recognize compensation cost over the period during which an employee is required to provide service in exchange for a stock-based award, which is generally the vesting period. We recognize compensation cost for retirement-eligible employees immediately, and for those employees who are nearing retirement, over the shorter of the vesting period or the period from the grant date to the date of retirement eligibility. <br /> <br />Pension and Other Postretirement Benefits <br /> <br />We provide pension and postretirement benefits and account for these benefit costs on an accrual basis. We determine pension and postretirement benefit amounts recognized in our consolidated financial statements on an actuarial basis using several different assumptions. The two most significant assumptions used in the valuation are the discount rate and the long-term rate of return on assets. In determining our net periodic benefit cost, we apply a discount rate in the actuarial valuation of our pension and postretirement benefit obligations. In determining the discount rate as of each balance sheet date, we consider the current yields on high-quality, corporate fixed-income debt instruments with maturities corresponding to the expected duration of our benefit obligations. Additionally, the net periodic benefit cost recognized in our consolidated financial statements for our qualified pension plan is impacted by the long-term rate of return on plan assets. We base our assumption of the long-term rate of return on the current investment portfolio mix, actual long-term historical return information and the estimated future long-term investment returns for each class of assets. We measure plan assets and obligations as of the date of our consolidated financial statements. We recognize the over-funded or under-funded status of our benefit plans as a prepaid benefit cost (an asset) in “Other assets” or an accrued benefit cost (a liability) in “Other liabilities,” respectively, in our consolidated balance sheets. We recognize actuarial gains and losses and prior service costs and credits when incurred as adjustments to the prepaid benefit cost or accrued benefit cost with a corresponding offset in other comprehensive income (loss). <br /> <br />Earnings (Loss) per Share <br /> <br />Earnings (loss) per share (“EPS”) is presented for both basic EPS and diluted EPS. We compute basic EPS by dividing net income (loss) available to common stockholders by the weighted-average number of shares of common stock outstanding during the year. In addition to common shares outstanding, the computation of basic EPS includes instruments for which the holder has (or is deemed to have) the present rights as of the end of the reporting period to share in current period earnings (loss) with common stockholders (i.e., participating securities and common shares that are currently issuable for little or no cost to the holder). We include in the denominator of our EPS computation the weighted-average shares of common stock that would be issued upon the full exercise of the warrant issued to Treasury. Diluted EPS is computed by dividing net income (loss) available to common stockholders by the weighted-average number of shares of common stock outstanding during the year, plus the dilutive effect of common stock equivalents such as convertible securities, stock options and other performance awards. We exclude these common stock equivalents from the calculation of diluted EPS when the effect of inclusion, assessed individually, would be anti-dilutive. <br /> <br />Other Comprehensive Income (Loss) <br /> <br />Other comprehensive income (loss) is the change in equity, net of tax, resulting from transactions that we record directly to stockholders’ equity. These transactions include: unrealized gains and losses on AFS securities and certain commitments whose underlying securities are classified as AFS; deferred hedging gains and losses from cash flow hedges; unrealized gains and losses on guaranty assets resulting from portfolio securitization transactions; buy-ups resulting from lender swap transactions; and change in prior service costs and credits and actuarial gains and losses associated with pension and postretirement benefits in other comprehensive income (loss). <br /> <br />As of December 31, 2009 and 2008, we recorded a valuation allowance for our deferred tax asset for the portion of the future tax benefit that we more likely than not will not utilize in the future. We established no valuation allowance for the deferred tax asset amount related to unrealized losses recorded through AOCI on our AFS securities. We believe this deferred tax amount is recoverable because we have the intent and ability to hold these securities until recovery of the unrealized loss amounts. <br /><br /></p><p>Servicer and MBS trust receivable and payable<br /><br />When servicers advance payments to MBS trusts for delinquent loans, we record a receivable from MBS trusts and a corresponding liability to reimburse the servicers. We recover these amounts from MBS trusts when the loans subsequently become current, or we include the amount as part of our loan basis upon purchase of the loan from the MBS trust or our acquired property basis upon foreclosure.<br /><br />When principal and interest remittances and prepayments have been received from borrowers by servicers but not yet remitted to us or MBS trusts, we record a receivable from servicers and a corresponding liability to MBS trusts. The unscheduled payments are remitted to the MBS trusts in subsequent months.<br /><br />We record a liability to fund the purchase of delinquent loans or acquired property from MBS trusts. For MBS trusts where we are considered the transferor, when the contingency on our option to purchase loans from the trust has been met and we regain effective control over the transferred loan, we recognize the loan on our consolidated balance sheets at fair value and record a corresponding liability to the MBS trust.<br /> <br />Fair Value Measurements<br /><br />We estimate fair value as 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). When available, the fair value of our financial instruments is based on quoted market prices, valuation techniques that use observable market-based inputs or unobservable inputs that are corroborated by market data. Pricing information we obtain from third parties is internally validated for reasonableness prior to use in the consolidated financial statements.<br /><br />On April 1, 2009, we adopted the FASB standard on how to determine fair value when the volume and level of activity for the asset or liability have significantly decreased. The standard reaffirms that (1) the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction at the date of the financial statements under current market conditions; and (2) the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive. The application of this standard had no impact on our consolidated financial statements.<br /><br />When observable market prices are not readily available, we generally estimate the fair value using techniques that rely on alternate market data or internally developed models. These models use significant inputs that are generally less readily observable than objective sources. Market data includes prices of financial instruments with similar maturities and characteristics, duration, interest rate yield curves, measures of volatility and prepayment rates. If market data we need to estimate fair value is not available, we estimate fair value using internally-developed models that employ a discounted cash flow approach. <br /><br />We base these estimates on pertinent information available to us at the time of the applicable reporting periods. In certain cases, fair values are not subject to precise quantification or verification and may fluctuate as economic and market factors vary and our evaluation of those factors changes. Although we use our best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique. In these cases, a minor change in an assumption could result in a significant change in our estimate of fair value, thereby increasing or decreasing the amounts of our consolidated assets, liabilities, stockholders’ equity (deficit) and net income or loss. <br /><br />Fair Value Losses, Net<br /><br />Fair value losses, net, consists of fair value gains and losses on derivatives, trading securities, debt carried at fair value, foreign currency debt, and adjustments to the carrying amount of hedged mortgage assets. The following table displays the composition of “Fair value losses, net” for the years ended December 31, 2009, 2008 and 2007.<br /><br /></p><table style="border-collapse: collapse; margin-top: 20px;"><tr><td height="14" width="19" align="left"> </td><td height="14" width="363" align="left"> <sup></sup></td><td height="14" width="10" align="center"><b> </b></td><td width="230" align="center" colspan="8" style="border-bottom: 1px solid #000000;" height="14"><b>For the Year Ended December 31, </b></td></tr><tr><td height="14" width="19" align="left"> </td><td height="14" width="363" align="left"><b> </b><sup><b></b></sup></td><td height="14" width="10" align="center"><b><u> </u></b></td><td width="62" align="center" colspan="2" style="border-top: 1px solid #000000;border-bottom: 1px solid #000000;" height="14"><b>2009 </b></td><td height="14" style="border-top: 1px solid #000000;" align="center" width="19"><b><u> </u></b></td><td width="71" align="center" colspan="2" style="border-top: 1px solid #000000;border-bottom: 1px solid #000000;" height="14"><b>2008 </b></td><td height="14" style="border-top: 1px solid #000000;" align="center" width="17"><b> </b></td><td width="61" align="center" colspan="2" style="border-top: 1px solid #000000;border-bottom: 1px solid #000000;" height="14"><b>2007 </b></td></tr><tr><td height="14" width="19" align="left"> </td><td height="14" width="363" align="left"> <sup></sup></td><td height="14" width="10" align="left"><b> </b></td><td width="230" align="center" height="14" colspan="8"><b>(Dollars in millions)</b></td></tr><tr><td width="382" align="left" height="17" colspan="2">Derivatives fair value losses, net<sup> (1)</sup></td><td height="17" width="10" align="right"> </td><td height="17" width="12" align="left">$</td><td height="17" width="50" align="right"> (6,350)</td><td height="17" width="19" align="right"> </td><td height="17" width="13" align="left">$</td><td height="17" width="58" align="right"> (15,416)</td><td height="17" width="17" align="right"> </td><td height="17" width="11" align="left">$</td><td height="17" width="50" align="right"> (4,113)</td></tr><tr><td width="382" align="left" height="17" colspan="2">Trading securities gains (losses), net <sup> (2)</sup></td><td height="17" width="10" align="right"> </td><td height="17" width="12" align="left"> </td><td height="17" width="50" align="right"> 3,744 </td><td height="17" width="19" align="right"> </td><td height="17" width="13" align="left"> </td><td height="17" width="58" align="right"> (7,040)</td><td height="17" width="17" align="right"> </td><td height="17" width="11" align="left"> </td><td height="17" width="50" align="right"> (365)</td></tr><tr><td width="382" align="left" height="17" colspan="2">Hedged mortgage asset gains, net <sup> (3)</sup></td><td height="17" width="10" align="right"> </td><td height="17" width="12" align="left"> </td><td height="17" width="50" align="right"> - </td><td height="17" width="19" align="right"> </td><td height="17" width="13" align="left"> </td><td height="17" width="58" align="right"> 2,154 </td><td height="17" width="17" align="right"> </td><td height="17" width="11" align="left"> </td><td height="17" width="50" align="right"> - </td></tr><tr><td width="382" align="left" height="17" colspan="2">Debt foreign exchange gains (losses), net <sup></sup></td><td height="17" width="10" align="right"> </td><td height="17" width="12" align="left"> </td><td height="17" width="50" align="right"> (173)</td><td height="17" width="19" align="right"> </td><td height="17" width="13" align="left"> </td><td height="17" width="58" align="right"> 230 </td><td height="17" width="17" align="right"> </td><td height="17" width="11" align="left"> </td><td height="17" width="50" align="right"> (190)</td></tr><tr><td width="382" align="left" height="17" colspan="2">Debt fair value losses, net <sup></sup></td><td height="17" width="10" align="right"> </td><td height="17" style="border-bottom: 1px solid #000000;" align="left" width="12"> </td><td height="17" style="border-bottom: 1px solid #000000;" align="right" width="50"> (32)</td><td height="17" width="19" align="right"> </td><td height="17" style="border-bottom: 1px solid #000000;" align="left" width="13"> </td><td height="17" style="border-bottom: 1px solid #000000;" align="right" width="58"> (57)</td><td height="17" width="17" align="right"> </td><td height="17" width="11" align="left"> </td><td height="17" style="border-bottom: 1px solid #000000;" align="right" width="50"> - </td></tr><tr><td height="18" width="19" align="left"> </td><td height="18" width="363" align="left">Fair value losses, net <sup></sup></td><td height="18" width="10" align="right"> </td><td height="18" style="border-top: 1px solid #000000;border-bottom: 3px double #000000;" align="left" width="12">$</td><td height="18" style="border-top: 1px solid #000000;border-bottom: 3px double #000000;" align="right" width="50"> (2,811)</td><td height="18" width="19" align="right"> </td><td height="18" style="border-top: 1px solid #000000;border-bottom: 3px double #000000;" align="left" width="13">$</td><td height="18" style="border-top: 1px solid #000000;border-bottom: 3px double #000000;" align="right" width="58"> (20,129)</td><td height="18" width="17" align="right"> </td><td height="18" width="11" align="left">$</td><td height="18" style="border-top: 1px solid #000000;border-bottom: 3px double #000000;" align="right" width="50"> (4,668)</td></tr></table><table style="border-collapse: collapse; margin-top: 20px;"><tr><td width="690" align="left" height="15" colspan="3">__________</td></tr><tr><td height="5" width="26" align="left"> <sup></sup></td><td height="5" width="627" align="left"> </td></tr><tr><td height="14" width="26" align="left"> <sup> (1)</sup></td><td width="627" align="left" height="28" rowspan="2">Includes losses of approximately $104 million in 2008 that resulted from the termination of our derivative contracts with a subsidiary of Lehman Brothers.</td></tr><tr><td height="14" width="26" align="left"> <sup></sup></td></tr><tr><td height="6" width="26" align="left"> <sup></sup></td><td height="6" width="627" align="left"> </td></tr><tr><td height="14" width="26" align="left"> <sup> (2)</sup></td><td width="627" align="left" height="28" rowspan="2">Includes trading losses of $608 million in 2008 that resulted from the write-down to fair value of our investment in corporate debt securities issued by Lehman Brothers. </td></tr><tr><td height="14" width="26" align="left"> <sup></sup></td></tr><tr><td height="6" width="26" align="left"> <sup></sup></td><td height="6" width="627" align="left"> </td></tr><tr><td height="14" width="26" align="left"> <sup> (3)</sup></td><td width="627" align="left" height="28" rowspan="2">Represents adjustments to the carrying value of mortgage assets designated for hedge accounting that are attributable to changes in interest rates.</td></tr><tr><td height="14" width="26" align="left"> <sup></sup></td></tr><tr><td height="6" width="26" align="left"> <sup></sup></td><td height="6" width="627" align="left"> </td></tr></table><p>Reclassification and Adoption of New Accounting Pronouncements<br /><br />Pursuant to our January 1, 2009 adoption of the FASB standard requiring noncontrolling interests to be classified as a separate component of equity, we reclassified amounts related to noncontrolling interests in our consolidated balance sheet as of December 31, 2008. Amounts previously reported as “Minority interests in consolidated subsidiaries” are now reported as “Noncontrolling interest.” Additionally, amounts reported in our consolidated statement of operations for the year ended December 31, 2008 as “Minority interest in losses of consolidated subsidiaries” are now reported as “Net loss attributable to the noncontrolling interest.”<br /><br />We reclassified $6.5 billion from “Other assets” to “Servicer and MBS trust receivable” and $6.4 billion from “Other liabilities” to “Servicer and MBS trust payable” as of December 31, 2008 in our consolidated balance sheet to conform to the current period presentation. Also, we reclassified $7.0 billion and $814 million for the years ended December 31, 2008 and 2007, respectively, from “Investment gains (losses), net” to “Net other-than-temporary impairments” in our consolidated statements of operations to conform to the current period presentation. <br /><br />We reclassified $4.5 billion and $529 million, net of tax, for the years ended December 31, 2008 and 2007, respectively, from “Changes in net unrealized loss on available-for-sale securities” to “Reclassification adjustment for other-than-temporary impairments recognized in net loss” in our Consolidated Statements of Changes in Stockholders’ Equity (Deficit) to conform to the current period presentation. <br /><br />New Accounting Pronouncements<br /><br />Transfers of Financial Assets and Consolidation Standards<br /><br />Effective January 1, 2010, we prospectively adopted two new accounting standards that eliminated the concept of QSPEs and amended the accounting for transfers of financial assets and the consolidation model for VIEs. Under these new accounting standards, the consolidation exemption for QSPEs was removed. All formerly designated QSPEs must be evaluated for consolidation in accordance with the new consolidation model, which changes the method of analyzing which party to a VIE should consolidate the VIE. The current consolidation model is replaced with a qualitative evaluation that requires consolidation of an entity when the reporting enterprise both (1) has the power to direct matters which significantly impact the activities and success of the entity, and (2) has exposure to benefits and/or losses that could potentially be significant to the entity. <br /><br />The new accounting standards require the incremental assets and liabilities consolidated upon adoption to initially be reported at their carrying values. If determining the carrying amounts is not practicable, the assets and liabilities of the VIE shall be measured at fair value at the date the new standards first apply. However, if determining the carrying amounts is not practicable, and if the activities of the consolidated entity are primarily related to securitizations or other forms of asset-backed financings and the assets of the entity can be used only to settle obligations of the consolidated entity, then the assets and liabilities of the consolidated entity may be measured at their unpaid principal balances at the date the new standards first apply. For the outstanding MBS trusts we consolidated effective January 1, 2010, we initially recorded the assets and liabilities on our consolidated balance sheet at their unpaid principal balances, where applicable, as it is not practicable to determine their carrying values. Accrued interest, allowance for loan losses or other-than-temporary impairments have also been recognized as appropriate. In addition, other assets and liabilities which did not have an unpaid principal balance or were required to be carried at fair value have been be measured at fair value at adoption. <br /><br />The adoption of these new accounting standards will have a significant impact on the presentation of our consolidated financial statements beginning in 2010. Because the concept of a QSPE is eliminated, our existing QSPEs, primarily our MBS trusts, are subject to the new consolidation standards. Based on our analysis, we are required to consolidate the substantial majority of our MBS trusts and record the underlying assets (typically mortgage loans) and debt (typically bonds issued by the trusts in the form of Fannie Mae MBS certificates) of these trusts as assets and liabilities in our consolidated balance sheet. The consolidation of these MBS trusts onto our balance sheet will significantly increase the amount of our assets and liabilities. The unpaid principal balance amounts we consolidated related to MBS trusts increased both our total assets and total liabilities by $2.4 trillion effective January 1, 2010. <br /><br />In addition, consolidation of these MBS trusts will result in other changes to our consolidated financial statements. The most significant changes are:</p><table style="border-collapse: collapse; margin-top: 20px;"><tr><td height="21" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="21" style="background-color: #FFFFFF;" align="left" width="160"><b><u>Financial Statement</u></b></td><td width="320" align="left" colspan="2" style="background-color: #FFFFFF;" height="21"><b><u>Accounting and Presentation Changes </u></b></td><td height="21" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="63" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="63" style="background-color: #FFFFFF;" align="left" width="160">Balance Sheet</td><td height="63" style="background-color: #FFFFFF;" align="left" width="18">•</td><td height="63" style="background-color: #FFFFFF;" align="left" width="302">Significant increase in loans and debt and significant decrease in trading and available-for-sale securities</td><td height="63" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="84" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="84" style="background-color: #FFFFFF;" align="left" width="160"> </td><td height="84" style="background-color: #FFFFFF;" align="left" width="18">•</td><td height="84" style="background-color: #FFFFFF;" align="left" width="302">Separate presentation of the elements of the consolidated MBS trusts (such as mortgage loans, debt, accrued interest receivable and payable) on the face of the balance sheet</td><td height="84" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="63" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="63" style="background-color: #FFFFFF;" align="left" width="160"> </td><td height="63" style="background-color: #FFFFFF;" align="left" width="18">•</td><td height="63" style="background-color: #FFFFFF;" align="left" width="302">Reclassification of substantially all of the previously recorded reserve for guaranty losses to allowance for loan losses</td><td height="63" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="63" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="63" style="background-color: #FFFFFF;" align="left" width="160"> </td><td height="63" style="background-color: #FFFFFF;" align="left" width="18">•</td><td height="63" style="background-color: #FFFFFF;" align="left" width="302">Elimination of substantially all previously recorded guaranty assets and guaranty obligations</td><td height="63" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="13" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="160"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="18"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="302"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="84" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="84" style="background-color: #FFFFFF;" align="left" width="160">Statement of Operations</td><td height="84" style="background-color: #FFFFFF;" align="left" width="18">•</td><td height="84" style="background-color: #FFFFFF;" align="left" width="302">Significant increase in interest income and interest expense attributable to the consolidated assets and liabilities of the consolidated MBS trusts </td><td height="84" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="119" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="119" style="background-color: #FFFFFF;" align="left" width="160"> </td><td height="119" style="background-color: #FFFFFF;" align="left" width="18">•</td><td height="119" style="background-color: #FFFFFF;" align="left" width="302">Decrease to provision for credit losses and corresponding decrease in net interest income due to recording interest expense on consolidated MBS trusts when we are not accruing interest on underlying nonperforming consolidated loans</td><td height="119" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="85" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="85" style="background-color: #FFFFFF;" align="left" width="160"> </td><td height="85" style="background-color: #FFFFFF;" align="left" width="18">•</td><td height="85" style="background-color: #FFFFFF;" align="left" width="302">Separate presentation of the elements of the consolidated MBS trusts (interest income and interest expense) on the face of the statement of operations</td><td height="85" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="63" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="63" style="background-color: #FFFFFF;" align="left" width="160"> </td><td height="63" style="background-color: #FFFFFF;" align="left" width="18">•</td><td height="63" style="background-color: #FFFFFF;" align="left" width="302">Reclassification of the substantial majority of guaranty fee income and trust management income to interest income</td><td height="63" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="105" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="105" style="background-color: #FFFFFF;" align="left" width="160"> </td><td height="105" style="background-color: #FFFFFF;" align="left" width="18">•</td><td height="105" style="background-color: #FFFFFF;" align="left" width="302">Elimination of fair value losses on credit-impaired loans acquired from the MBS trust we have consolidated, as the underlying loans in our MBS trusts will be recorded in our consolidated balance sheet</td><td height="105" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="13" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="160"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="18"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="302"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="42" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="42" style="background-color: #FFFFFF;" align="left" width="160">Statement of Cash Flows</td><td height="42" style="background-color: #FFFFFF;" align="left" width="18">•</td><td height="42" style="background-color: #FFFFFF;" align="left" width="302">Significant change in the amounts of cash flows from investing and financing activities</td><td height="42" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr><tr><td height="13" style="background-color: #FFFFFF;" align="left" width="83"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="160"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="18"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="302"> </td><td height="13" style="background-color: #FFFFFF;" align="left" width="25"> </td></tr></table><p>Although these new accounting standards do not change the economic risk to our business, specifically our exposure to liquidity, credit, and interest rate risks, the transition adjustment recorded to accumulated deficit as of January 1, 2010 to reflect the cumulative effect of adopting these new standards will affect our net worth. We estimate the decrease to our total deficit to be between $2 billion and $4 billion as a result of adoption effective January 1, 2010. The primary components of the cumulative transition adjustment recorded effective January 1, 2010 include the following: (1) for all of our outstanding MBS trusts that we consolidate, the reversal of the related guaranty assets and guaranty obligations; (2) for all of our outstanding MBS trusts that we consolidate, the reversal of amounts previously recorded in the reserve for guaranty losses for future interest payments on seriously delinquent loans; (3) for all of our investments in single-class Fannie Mae MBS classified as available-for-sale, the reversal of the related unrealized gains and losses recorded in AOCI; and (4) for all of our investments in single-class Fannie Mae MBS classified as trading, the reversal of the related fair value gains and losses previously recorded in earnings. The adoption of these new accounting standards will not significantly impact our required level of capital under existing minimum and critical capital requirements, which have been suspended by our conservator. FHFA directed us to continue reporting our minimum capital requirements based on 0.45%, and critical capital requirements based on 0.25%, of the unpaid principal balance of loans backing MBS held by third parties, notwithstanding the new accounting standards. <br /></p></div>
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