Fannie Settles Fraud Charges for $400M

Fannie Mae last week agreed to freeze the size of its mortgage portfolio and pay $400 million in fines after federal regulators formally accused the GSE and former executives of orchestrating a massive accounting fraud that lasted at least six years.

In a long-awaited and damning report, the Office of Federal Housing Enterprise Oversight slammed management for manipulating accounting rules to trigger hundreds of millions in bonuses for senior executives from 1998 to 2004.

The Department of Justice is conducting a criminal probe of the company's accounting practices. The report details what OFHEO calls "an arrogant and unethical corporate culture" at the $700 billion company. Acting OFHEO director James B. Lockhart harshly criticized the GSE, noting, "The image of Fannie Mae as one of the lowest-risk and 'best-in-class' institutions was a facade."

OFHEO says senior management at the company pulled out all the stops to meet earnings targets and secure "ill-gotten" bonuses. Internal controls were corrupted and accounting systems were allowed to deteriorate, the regulator charges.

The new report documents how Fannie even tried to disrupt and stonewall the regulator's probe by persuading a powerful senator to instigate an investigation of OFHEO.

"Our examination found an environment where ends justified means," said Mr. Lockhart. "Senior management manipulated accounting, reaped maximum, undeserved bonuses and prevented the rest of the world from knowing about it."

Securities and Exchange Commission chairman Christopher Cox noted that Fannie's restatement of earnings from 1998 through 2004 would likely be the largest in corporate history. (Fannie Mae also is facing shareholder-related lawsuits that could eventually force it to pay close to $1 billion in damages, according to various estimates.)

Mr. Cox noted that Fannie Mae is a public company with a government charter and mandated housing mission. The $400 million settlement for accounting fraud charges is necessary to address its "egregious" conduct and "breach of trust," he said.

While $400 million is a hefty fine, Fannie's ability to generate growth and increase profits will be hampered by the portfolio limits. The agreement with regulators freezes its on-balance-sheet portfolio at $727 billion (its Dec. 31, 2005 level). The limit could be in place for several years.

Prior to this agreement, no one thought OFHEO had the power to impose portfolio limits on Fannie or its fellow GSE, Freddie Mac.

Allowing a GSE regulator to impose limits or require a reduction in the assets has stalled a GSE regulatory reform bill in the Senate for nearly a year. But OFHEO's "de facto" portfolio limit could open the door to a compromise, according to Mortgage Bankers Association senior vice president Kurt Pfotenhauer. "I am beginning to wonder if this approach could serve as a model for a compromise in the Senate," the MBA lobbyist said. (c) 2006 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com