Fannie Mae CEO faces mortgage bankers

October 26, 2004

Franklin Raines hit with only one accounting-related question

By Samantha Peterson
Inman News

SAN FRANCISCO—It must have been refreshing for Franklin Raines to be among friendly faces Monday morning.

Fannie Mae's CEO was greeted by applause and only one accounting scandal question during a session on Government-Sponsored Enterprises at the Mortgage Bankers Association's annual convention. Raines has faced harsh criticism and intense federal scrutiny since the Office of Federal Housing Enterprise Oversight last month released a scathing 211-page report revealing evidence of improper accounting at the company.

The report triggered a wave of shareholder lawsuits as well as a Congressional hearing and a formal investigation by the Securities and Exchange Commission.

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>>More But those realities were not part of Raines' prepared comments. Instead, he focused on the stability of the current housing market, emerging homeowner markets and the need for Fannie Mae to continue partnering with MBA and its members to keep mortgage funds flowing.

Raines spent much of his talk promoting the benefits of Fannie Mae to a standing-room-only crowd of mortgage bankers who appeared receptive to his message. They greeted him with enthusiastic applause, and pre-session conversations didn't focus on Fannie's accounting woes.

The only mention of the accounting mishaps occurred when moderator Regina Lowrie, MBA's 2005 chairwoman-elect, asked Raines whether he could comment on the situation with its regulator. The request drew nothing more than a few hushed whispers from audience members.

In answering, Raines recapped the situation, saying that OFHEO undertook a special examination of Fannie Mae, made the results public and that he and other executives appeared before Congress.

"We take these issues quite seriously," Raines said.

He said Fannie Mae has refrained from debating this topic in the press, and directed people to read the statements he made during the Congressional hearing held a few weeks ago as an example of how the company is responding.

Freddie Mac CEO Richard Syron also spoke during the session and mentioned his company's past accounting woes only briefly in the context of changes Freddie Mac is making throughout the organization.

"The changes go far beyond the accounting problems, which I think were the root of what brought me here," Syron said.

OFHEO's investigation into Fannie Mae initially stemmed from the recent accounting scandal at Fannie's corporate cousin, Freddie Mac, which understated profits by about $5 billion for 2000-2002 to smooth earnings and meet Wall Street expectations. The company paid a $125 million fine and ousted several top executives in 2003.

Both Fannie and Freddie are shareholder-owned but chartered by the U.S. Congress to maintain a constant flow of mortgage funds for the nation's housing market. The two corporations securitize and either resell or own a substantial portion of the outstanding home mortgage debt in the United States. The secondary market helps increase the liquidity of mortgage funds, which makes home loans more easily available to borrowers.

Fannie Mae is one of the largest financial institutions in the world, with $1 trillion in reported assets and $961 billion in reported debt as of Dec. 31, 2003.

OFHEO's report outlines misapplications of Generally Accepted Accounting Principles, or GAAP for short, that the federal regulator said were not isolated incidents, "but are pervasive and are reinforced by management," according to the report.

The report, presented to Fannie Mae's board of directors earlier this week, found that the company had used improper "cookie jar" reserve accounting – setting aside large cash reserves to reduce revenues in some years so they can be used in other years when the company needs them. The practice smoothes out a company's earnings, but can give investors an inaccurate view of a company's financial performance.

The housing office found other accounting problems, including at least one instance where the company deferred expenses to meet executive bonus targets. The problems differ in their specifics, but all "have emerged from a culture and environment that made these problems possible," according to the report.

"The matters detailed in this report are serious and raise concerns regarding the validity of previously reported financial results, the adequacy of regulatory capital, the quality of management supervision, and the overall safety and soundness of the enterprise," the report states.

Congressional members questioned Raines extensively earlier this month at a subcommittee hearing on OFHEO's report. During his testimony, Raines defended his company, saying Fannie Mae believes it followed generally accepted accounting principles and that its independent auditor, KPMG, reviewed the application of the company's accounting standards and concurred with them.

The SEC has launched a formal investigation into Fannie Mae because of the allegations outlined in the OFHEO report.

Copyright 2004 Inman News

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