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Fannie Mae's CEO fights for job amid scandal
Raines claims he's innocent
By James L. Tyson and Monee Fields-White
BLOOMBERG NEWS SERVICE
November 14, 2004
In September 2003, U.S. Treasury
Secretary John Snow urged Congress to get tough with Fannie Mae, the
giant mortgage company run by Franklin D. Raines. Snow said lawmakers
needed to create a strong federal regulator to scrutinize Fannie Mae,
which controls almost $1 trillion of U.S. home mortgages.
Raines, Fannie Mae's chief executive officer,
said he welcomed the idea. "Fannie Mae looks forward to working with
Congress and the administration to see the proposal enacted into law
this year," Raines told the House Financial Services Committee that
month.
Behind the scenes, Fannie Mae's Chicago office mobilized to gut Snow's plan.
"Hi everyone – We are reaching out for your
help!!" the office wrote to mortgage bankers in an Oct. 6 e-mail. The
note urged recipients to tell Congressional leaders to keep their hands
off Fannie Mae. Within days, the initiative died.
That's the kind of clout Fannie
Mae has wielded to thwart those who would bridle it. Now Raines, 55,
confronts an accounting scandal that has thrust his company into the
sights of regulators, Congress and the Treasury.
A Harvard-educated Rhodes
scholar and former budget director under President Bill Clinton, Raines
is struggling to contain the damage – and preserve his job. If Fannie
Mae falters, the impact may speed a rise in home mortgage rates,
threaten the housing market and end an era of rapid earnings growth for
investors who own $66.6 billion of Fannie Mae stock.
'Cookie jar'
The Washington-based Office of
Federal Housing Enterprise Oversight, which monitors Fannie Mae and its
smaller cousin, Freddie Mac, has accused Raines' company of accounting
abuses that enriched executives – among them Raines, who earned $20
million in 2003.
Fannie Mae used hidden "cookie
jar" reserves to smooth out reported earnings, OFHEO said in a Sept. 17
report. Fannie Mae improperly deferred $200 million of estimated
expenses in 1998 and executed a plan to record those expenses in
subsequent years, the regulator said. The move violated generally
accepted accounting principles, or GAAP, and enabled Raines and other
top executives to collect a combined $27.1 million in bonuses, the
agency said.
Testifying before a House panel that oversees financial services on Oct. 6, Raines said Fannie Mae had done nothing wrong.
"I have always tried my best to
ensure our company does the right thing in the right way," he said.
"And I believe to this day that we did." The most difficult thing,
Raines said, was explaining the controversy to his three daughters.
"That's hard," he said, his voice cracking.
The OFHEO report has unleashed a
storm in Congress and prompted the U.S. Justice Department to open a
criminal investigation. The U.S. Securities and Exchange Commission is
conducting its own inquiry, as is Ohio Attorney General James Petro.
Whether Fannie Mae deliberately
broke accounting rules, as OFHEO has argued, or reasonably interpreted
complex standards, as Raines has maintained, the fracas may upend the
company's executive suite, says David Dreman, chairman of Dreman Value
Management LLC.
"Top management of Fannie Mae
cannot survive this," says Peter Wallison, White House counsel for
President Ronald Reagan and now a fellow at the Washington-based
American Enterprise Institute.
Reverberations
Fannie Mae's days of galloping
growth may be over, says Orin Kramer, chairman of the New Jersey
Investment Council, which runs the state's $68 billion pension system.
The reverberations may ripple through the housing market, says Lawrence
White, a Freddie Mac director from 1986 to 1989. The chastening of
Fannie Mae may ultimately drive up mortgage rates by a quarter of a
percentage point, White says.
Former Treasury Secretary
Nicholas Brady says Fannie Mae has grown so large that the Treasury
itself should be placed in charge of monitoring the company. Fannie Mae
owes more money to more people than any U.S. borrower save the federal
government. Investors the world over hold more than $950 billion of
Fannie Mae debt, plus $1.38 trillion of mortgage securities guaranteed
by the company.
"When something gets to be that
big a part of the financial architecture, it only makes good sense for
it to report to an organization that understands what's at stake," says
Brady, who ran the Treasury from 1988 to 1993.
Fannie Mae stock stumbled after
OFHEO went public with its report on Sept. 22, falling 9.8 percent
through Oct. 12. The slide wiped out $2.4 billion of shareholder value.
Los Angeles-based Capital Group Cos. and Boston-based Fidelity
Investments – Fannie Mae's two largest stockholders, with a combined
17.3 percent stake – had lost an estimated $1.2 billion on their
investment as of Oct. 12, according to data compiled by Bloomberg.
The fallout in the financial
markets may have only just begun, says Dreman, who manages $11 billion.
"There could be an awful lot of damage; it could be a Pandora's box
that we have here," he says.
Fast growth
Since Raines became CEO on Jan. 1,
1999, Fannie Mae's earnings have grown at an unprecedented average
annual rate of 18 percent. That performance was fueled by a U.S.
housing boom that has lifted real U.S. home prices 36 percent since
1995, according to the Federal Reserve Bank of New York. The company's
assets ballooned to $1.01 trillion in 2003 from $575.17 billion in
1999, eclipsing the combined total of Bank of New York Co., Wachovia
Corp. and Wells Fargo & Co.
During that time, U.S.
homeownership has climbed to a record high of 68 percent, according to
the U.S. Department of Housing and Urban Development.
Friends and allies in Congress have sprung to Raines' defense, saying OFHEO's allegations are politically motivated.
"This hearing is about the
political lynching of Franklin Raines," Rep. William Clay, D-Mo., told
the House committee on Oct. 6.
Steve Pruzan, a Seattle lawyer
who has known Raines since high school, says that he talked to the
executive after his testimony and that Raines was holding up. "I know
Frank as well as any human being can know anyone, and for these
accusations to be out there, it's very upsetting," Pruzan says.
Raines and other Fannie Mae executives declined to be interviewed.
Some Fannie Mae supporters have
begun to reevaluate their allegiance. The Washington-based National
Association of Home Builders, for one, is reconsidering its
long-standing opposition to tighter regulation of Fannie Mae and
Freddie Mac, says NAHB CEO Jerry Howard.
Rep. Barney Frank, D-Mass., who
maintains the two companies play a vital rode in broadening
homeownership, says he was stunned at the Oct. 6 hearing when Rep.
Richard Baker, R-La., disclosed internal Fannie Mae figures showing
executives had collected bonuses totaling more than $245 million from
1998 to 2003.
The maelstrom has emboldened
foes in the corporate world and in the Bush administration who say
Fannie Mae and Freddie Mac's special status as so-called
government-sponsored enterprises, or GSEs, gives them unfair advantages over big banks and mortgage lenders.
"The recent Fannie revelations
have caused us to push even harder," says Michael House, executive
director of FM Policy Focus, a Washington-based lobbying group that's
funded by rivals of Fannie Mae and Freddie Mac. "I don't care whether
you're a child or a large financial institution – if you are not
properly regulated and disciplined, you are going to get out of hand."
Wayne Abernathy, assistant
Treasury secretary for financial institutions, says Fannie Mae and
Freddie Mac need to be watched closely to avoid disruptions in the
mortgage market. "We don't think there is adequate supervision to
ensure that now," he says.