GSEs: ain’t misbehavin’?
It’s been a long 2006 for the two GSEs, Fannie Mae and Freddie Mac.
No one to talk with/
All by myself/
No one to walk with/
But I’m happy on the shelf
The OFHEO report, explained
The story so far is here, and our comprehensive review may be found here:
· Part 1 Summary and introduction
· Part 2 Maximizing executive bonuses
· Part 3 Gaming the bonus formula
· Part 4 Turbocharging the balance sheet
· Part 5 Smoothing earnings with financial tricks
· Part 6 Suppressing criticism
· Part 7 What now? Why should taxpayers care?
Reversing the adage, the only good news they have had is no news — lack of any Congressional action on regulation. All the other news has been, if not affirmatively bad, certainly depressing:
1. 44 of the top 55 executives have left the company (7/17). That’s a huge turnover.
Senior executives at Fannie Mae are heading for the exits two years into a $10.6 billion accounting scandal that has no end in sight.
Last week, the company announced that its chief information officer, Julie St. John, would step down at the end of the year. Deputy general counsel Renie Y. Grohl, a 12-year veteran of Fannie Mae, is leaving in September. Barry Zigas, who was senior vice president for corporate and regulatory housing goals and joined Fannie Mae in 1993, left last month.
The recent departures are part of a steady outflow of top management at the company since federal regulators first determined two years ago that the company botched its accounting.
Since the end of 2004, 44 of the top 55 executive positions at Fannie Mae have changed hands and are now occupied either by people from outside the company or by a handful of insiders who have switched jobs, spokesman Brian Faith said.
Even after their departure, some of these people remain under a cloud:
At least 29 senior executives, including 15 who have left Fannie Mae, are under scrutiny for their possible roles in the accounting manipulation. Some may be forced to return bonus payments based on the faulty bookkeeping, under an agreement Fannie Mae signed with federal regulators in May.
2. Fannie Mae still is unable to file its SEC quarterly reports (8/9), although CEO Dan Mudd put a brave face on the matter by announcing that Fannie was on track to file by year-end.
The company did not request a five-day extension beyond the Aug. 9 due date, saying it would not meet that deadline either. Fannie Mae, the largest financer and guarantor of home mortgages in the country, said its restatement of past results due to accounting errors, and its review of internal accounting controls, has prevented the company from completing its second-quarter financial statements.
3. Workforce distracted. I have heard estimates that as much as 40% of Fannie’s work force is engaged in checking every one of its roughly 10,000,000 journal entries, for the financials restatement. When all the dust settles, the aggregate earnings over the multi-year interval are likely to be basically the same, but there will be revealed retrospective volatility, in contrast to the supremely confident smooth upward lines previously touted.
4. Justice declines corporate prosecution (8/25):
The Justice Department has told Fannie Mae that it does not plan to seek criminal charges against the company, an important step for the District-based mortgage funding giant as it tries to move beyond a multibillion-dollar accounting scandal.
Fannie Mae announced yesterday — and a Justice Department spokesman confirmed — that the nearly two-year-old criminal investigation of the company had ended. Coupled with settlements reached this year with two regulatory agencies, the decision clears Fannie Mae of prosecution for years of accounting mistakes that are costing hundreds of millions of dollars to correct.
The company still faces shareholder litigation over the value lost when the accounting problems were revealed and the stock price plunged.
And former Fannie Mae executives remain under scrutiny.
Current DC buzz suggests that prosecuting the company would punish the innocent and shield the guilty:
“When you fine the company, you’re fining the company’s shareholders,” Langevoort said. “You’re hurting a lot of innocent people.”
“I think generally deterrence really comes from prosecuting individuals and not from indicting and convicting legal entities that don’t feel real flesh-and-blood pain,” said
“Where am I?” “In a Congressional hearing.” “Whose side are you on?” “That would be telling.”
Indicting a corporation, as both Enron and Arthur Andersen found out, is a ticket to oblivion. One may therefore read Justice’s failure to prosecute as a reprieve for the entity.
The Justice Department is still investigating whether former Fannie chairman and chief executive Franklin D. Raines and former chief financial officer J. Timothy Howard committed perjury when they testified about the company’s accounting practices before a House of Representatives panel in 2004, said Channing Phillips, a spokesman for the U.S. attorney for the District of Columbia.
In addition, the Securities and Exchange Commission has not ruled out civil charges against individuals in the accounting matter, according to an SEC source, who spoke on condition of anonymity because it is SEC policy not to comment on pending investigations.
Unsurprisingly, morale is reputedly quite low.
5. Perjury has been suggested (6/7) by the Chairman of House Financial Services subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises:
The hearing yesterday before a subcommittee of the House Financial Services Committee follows the release last month of an OFHEO report that said Fannie executives had routinely manipulated the company’s accounting in recent years to maximize their bonuses. […]
During yesterday’s hearing, subcommittee Chairman Richard H. Baker (R-La.) said former Fannie chief executive Franklin D. Raines appears to have committed perjury when he testified about Fannie’s accounting before the panel in 2004. A spokesman for Baker, Michael DiResto, said Baker is considering referring the matter to the Justice Department.
“J’accuse
An attorney for Raines declined to comment on the allegation.
Later, Mr. Baker made the referral. The matter is pending.
6. Freddie Mac settles fundraising civil charges (4/19). From the Washington Post (link now unavailable):
Freddie Mac will pay a record $3.8 million fine to settle civil charges that it violated federal election law by using corporate resources to raise $1.7 million at political fundraisers, most of them for Republican members of Congress and many involving House Financial Services Committee Chairman Michael G. Oxley (R-Ohio).
Organized by then-Freddie Mac chief lobbyist Mitchell Delk, the effort pumped money into the campaigns of more than 50 politicians who had direct oversight of the government-chartered company or were considered supportive of it.
Against this backdrop, there is a bit of light comedy with this announcement, as reported in the Washington Post (8/2):
7. Freddie Mac agrees to limit growth (8/2):
Freddie Mac, the nation’s second-largest financier of home loans, has agreed to limit its growth until it resolves bookkeeping problems that continue to plague the company three years after a $5 billion accounting scandal.
Fannie Mae, Freddie Mac’s larger rival, has been operating under a similar portfolio cap since May. The District-based company has since asked OFHEO to allow it to increase its investment portfolio beyond the limit of $727.55 billion.
For how long will Freddie Mac exercise this commendable restraint?
The voluntary limit will expire once Freddie Mac resumes publishing regular quarterly financial reports, which it plans to do after it releases its 2006 full-year results sometime next year. Freddie Mac has not released a timely quarterly report since 2002.
In other words, Freddie Mac will not grow its portfolio until it can file proper reports; whereupon it can grow again as it has in the past.
Will there be binding legislation? It’s looking increasingly unlikely, since the GSEs’ matter has been deferred past the upcoming November elections:
The House in October passed a bill that would give a new regulator discretion over the size of the portfolios. In July 2005, the Senate Banking Committee approved a proposal that would restrict the types of assets the companies could hold. The full Senate has yet to vote on the measure.
Critics of Fannie Mae and Freddie Mac, including the White House, argue that the companies have grown so large that they present a “systemic risk” and threaten the stability of global financial markets. Supporters of the Senate bill have been engaged in an intense public campaign over the past several months in hopes of ending the stalemate before senators leave for August recess at the end of the week.
But they have yet to overcome concerns among Senate Democrats who have criticized the bill, saying it would have a “significant impact on the mission of the enterprises and cause damage to affordable housing markets.”
Would it?
