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Wednesday, May 24, 2006

OFHEO Releases Fannie Mae Report

OFHEO has been investigating Fannie Mae for several years. Yahoo:
Federal regulators issued a blistering report about mortgage giant Fannie Mae on Tuesday, alleging accounting manipulation aimed at lining executives' pockets and lying to investors about smooth growth in profits and earnings. The government-sponsored mortgage company was fined $400 million and agreed to limit its growth.
OFHEO and the Securities and Exchange Commission announced a $400 million civil penalty against Fannie Mae, the largest U.S. buyer and guarantor of home mortgages, in a settlement over the alleged accounting manipulation. Of that amount, the $350 million assessed by the SEC -- one of its biggest penalties ever in an accounting fraud case -- will go to compensate Fannie Mae investors damaged by the alleged violations.
The OFHEO report (348 pages, pdf) can be found here. This is the executive summary:
Fannie Mae senior management promoted an image of the Enterprise as one of the lowest-risk financial institutions in the world and as “best in class” in terms of risk management, financial reporting, internal control, and corporate governance. The findings in this report show that risks at Fannie Mae were greatly understated and that the image was false.
• During the period covered by this report—1998 to mid-2004—Fannie Mae reported extremely smooth profit growth and hit announced targets for earnings per share precisely each quarter. Those achievements were illusions deliberately and systematically created by the Enterprise’s senior management with the aid of inappropriate accounting and improper earnings management.
• A large number of Fannie Mae’s accounting policies and practices did not comply with Generally Accepted Accounting Principles (GAAP). The Enterprise also had serious problems of internal control, financial reporting, and corporate governance. Those errors resulted in Fannie Mae overstating reported income and capital by a currently estimated $10.6 billion.
By deliberately and intentionally manipulating accounting to hit earnings targets, senior management maximized the bonuses and other executive compensation they received, at the expense of shareholders. Earnings management made a significant contribution to the compensation of Fannie Mae Chairman and CEO Franklin Raines, which totaled over $90 million from 1998 through 2003. Of that total, over $52 million was directly tied to achieving earnings per share targets.
Fannie Mae consistently took a significant amount of interest rate risk and, when interest rates fell in 2002, incurred billions of dollars in economic losses. The Enterprise also had large operational and reputational risk exposures.
• Fannie Mae’s Board of Directors contributed to those problems by failing to be sufficiently informed and to act independently of its chairman, Franklin Raines, and other senior executives; by failing to exercise the requisite oversight over the Enterprise’s operations; and by failing to discover or ensure the correction of a wide variety of unsafe and unsound practices.
The Board’s failures continued in the wake of revelations of accounting problems and improper earnings management at Freddie Mac and other high profile firms, the initiation of OFHEO’s special examination, and credible allegations of improper earnings management made by an employee of the Enterprise’s Office of the Controller.
• Senior management did not make investments in accounting systems, computer systems, other
infrastructure, and staffing needed to support a sound internal control system, proper accounting, and GAAP-consistent financial reporting. Those failures came at a time when Fannie Mae faced many operational challenges related to its rapid growth and changing accounting and legal requirements.
Fannie Mae senior management sought to interfere with OFHEO’s special examination by directing the Enterprise’s lobbyists to use their ties to Congressional staff to 1) generate a Congressional request for the Inspector General of the Department of Housing and Urban Development (HUD) to investigate OFHEO’s conduct of that examination and 2) insert into an appropriations bill language that would reduce the agency’s appropriations until the Director of OFHEO was replaced.
• OFHEO has directed and will continue to direct Fannie Mae to take remedial actions to enhance the safe and sound operation of the Enterprise going forward. OFHEO staff recommends actions to enhance the goal of maintaining the safety and soundness of Fannie Mae.
After Raines took over, things went downhill fast. Raines was a Clintonite. Jamie Gorelick also did a stint there. See this for some of the implications and connections:
Four days after the Business & Media Institute documented the media’s continuing whitewash of Democratic ties to the Fannie Mae accounting scandals, The Washington Post’s David Hilzenrath glossed over Democratic ties to the scandal, ignoring political contributions by then-CEO Franklin Raines and then-vice chairman Jamie Gorelick to liberal Sen. Paul Sarbanes (D-Md.), co-sponsor of the Enron-inspired Sarbanes-Oxley Act of 2002.
According to the Federal Election Commission Web site, both Raines and Gorelick donated regularly to liberal Democrats running for Congress.

The media went wild over Enron’s accounting scandal, but Fannie Mae was not just another Enron. It was much larger, with a cozy relationship to the federal government. “Fannie Mae will have to compensate for $11 billion in accounting errors. To put this in perspective, Enron overstated its earnings by $567 million: 5 percent of Fannie Mae’s fiasco,” The Business & Media Institute noted in its April 2005 study.
Also see this Washington Post article from 2004:
There are signs the gilt-edged resumes, and political futures, of three former Fannie executives have already been tarnished, because of findings they profited from manipulation of financial results in 1998. Former Fannie Mae chief James A. Johnson, who holds a top post in the Democratic presidential campaign and headed the Kennedy Center and the Brookings Institution; Smithsonian Institution Secretary Lawrence M. Small, who was Fannie Mae's chief operating officer; and Washington lawyer Jamie Gorelick, a former Fannie vice chairman, who has served as deputy attorney general, the Pentagon's top lawyer and a member of the 9-11 commission, joined Raines and Howard in receiving sizable bonuses that year. Regulators allege they were paid after the company improperly deferred other expenses.
No one knows yet the extent of the risks, because Fannie Mae hasn't been able to clean up its accounting yet. It may be a year or more. We may never know. This, as William Shatner would say, is big. Twenty-nine officers and former officers are under investigation.

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