Mortgages: Finagling at Fannie Mortgages: Finagling at Fannie From the St. Louis Post-Dispatch – October 8, 2004 After years in blissful slumber, federal regulators last month suddenly sprang awake, leaped up and slapped Fannie Mae upside the head. Its executives
Mortgages: Finagling at Fannie
Mortgages: Finagling at Fannie
From the St. Louis Post-Dispatch – October 8, 2004
After years in blissful slumber, federal regulators last month suddenly sprang awake, leaped up and slapped Fannie Mae upside the head. Its executives were alleged to be rigging the profit numbers in order to earn big bonuses and keep the stock price up.
Unlike the evil-doings at Enron, Adelphia and WorldCom, the accounting sins alleged at Fannie Mae won’t be fatal to the corporation. In fact, Standard and Poor’s recently confirmed Fannie’s triple-A bond rating. But the loud crack of the regulatory slap turned heads in Congress, as well it should.
Fannie Mae – the Federal National Mortgage Association – is the main peg upon which hangs the American mortgage market. If Fannie Mae ever got into deep trouble, it would be much tougher to buy or sell a house in America, with miserable effects on the nation’s economy. To prevent that, the American taxpayer would have to bail out the company.
In recent years, Fannie has come to fancy itself as a go-go growth company with a hot stock. That, in itself, is dangerous. And now, the company faces allegations of book-cooking. Fannie needs some serious regulatory sitting-on, and Congress and the President should see that it happens.
When lenders make fixed-rate mortgages, they generally sell the loans to Fannie or its smaller rival, the Federal Home Mortgage Corp., or Freddie Mac. The two companies buy up nearly half the mortgages in America, providing lenders with the money to make more loans. Fannie now owns or guarantees $2.3 trillion in mortgages. If it falters, the whole mortgage funding system could suffer.
Fannie is watched over by the U.S. Office of Federal Housing Enterprise Oversight, an agency as obscure as it is miserably underfunded. That chintziness, combined with a bureaucratic fear of political dust-ups, made the office a snoozing watchdog for many years. It woke up when Freddie got into hot water over earnings manipulation last year, and four top executives were ousted. People began wondering if the oversight agency was doing its job.
Nothing growls so fiercely as a bureaucracy threatened, so the watchdog began sniffing around at Fannie Mae. In its report, the agency charged that Fannie kept a “cookie jar” of money in reserve. When real earnings weren’t up to par, Fannie executives dipped into the cookie jar to make them more palatable. More seriously, the agency says that Fannie manipulated accounting rules to pretty-up the earnings on its complex investments.
The main motive was to give the stock market predictable earnings, thus keeping the stock price up. But in at least one case, executives also cooked the books to meet the targets set for management bonuses, the agency said. That landed $1.9 million for then-CEO James Johnson and $1.19 million to then-CEO-designate Franklin Raines in 1998.
Fannie denies those allegations. But the accusations got federal prosecutors and the Securities and Exchange Commission nosing around, too.
The oversight agency also found a “deeply ingrained” culture of earnings manipulation, “dysfunctional and ineffective” accounting policies and “weak or nonexistent” operational controls.
That’s scary, considering the importance of Fannie Mae. More scary are concerns about the adequacy of Fannie’s capital. Capital is a cushion of money can absorb losses and prevent bankruptcy. After the agency’s report, Fannie agreed to boost its capital reserve by 30 percent. but that may not be enough.
It’s clear that Fannie and Freddie must be under the watch of a strong and well-funded regulator without the current agency’s tendency toward narcolepsy. The purpose of good regulation is to help keep the regulated on course and diagnose problems and solve them before they become catastrophic. Regulators must be corrective, but need not be punitive in helping Fannie and Freddie stay solvent.
The Treasury Department’s regulation of national banks may serve as a model. Federal examiners troop through banks every year and insist that problems be fixed. As a result, banks rarely fail.
It’s also clear that Fannie has too much clout in Congress. It has managed to fight off previous efforts to increase regulation.
It was quite nice to watch top Fannie executives hauled before a Congressional committee on Wednesday. They shouldn’t be allowed to talk their way out of tighter federal oversight.
