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Fannie Mae's Top Executives Leaving Firm

Raines, Howard Out Under Pressure

By David S. Hilzenrath
Washington Post Staff Writer
Wednesday, December 22, 2004; Page A01

Franklin D. Raines stepped down yesterday as chairman and chief executive of Fannie Mae, as the company's directors ended days of tense and emotional deliberations and bowed to pressure from regulators who wanted him out.

J. Timothy Howard, the company's longtime chief financial officer, also is leaving. Raines's departure was structured as an early retirement. Howard resigned.


Franklin D. Raines promised earnings growth when he became Fannie's CEO. (Chris Kleponis -- Bloomberg News)

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The departures come less than a week after the Securities and Exchange Commission directed the giant mortgage-funding company to make accounting corrections that could erase $9 billion of past profit.

The District-based housing finance company, which stands behind or owns a quarter of the nation's mortgages, faces a criminal investigation by the Justice Department; a civil investigation by the Securities and Exchange Commission; an ongoing probe of other accounting issues by its main regulator, the Office of Federal Housing Enterprise Oversight; and class-action lawsuits by investors. In addition, Fannie's board has hired outside lawyers to investigate the regulators' allegations.

The government-sponsored company has been on the defensive since September, when OFHEO alleged that Fannie had systematically manipulated accounting estimates, ignored accounting requirements it had lobbied unsuccessfully against and operated with weak internal controls that helped obscure the other problems. The report said Fannie Mae delayed booking $200 million of expenses in 1998, which allowed Raines and other top executives to receive millions of dollars in bonuses linked to Fannie's profit.

A source with knowledge of the board's recent deliberations described a sometimes painful debate. Raines, the source said, at times argued passionately that he had done nothing wrong.

Raines, 55, is one of the most prominent African Americans in corporate America. He rose from a family that supplemented work with welfare to become a Rhodes scholar, president of the Harvard University Board of Overseers, director of the Office of Management and Budget under President Bill Clinton and a leader of the Washington business community. His compensation last year, including $3 million in stock options, totaled about $20 million.

Fannie's federal regulator, however, demanded management changes, holding Raines responsible for a corporate culture that emphasized stable earnings at the expense of accurate financial disclosures. Sources said the regulator was determined to initiate a public proceeding to remove Raines if the board did not act.

The costs of an all-out fight with a federal regulator would be too great, Fannie's board ultimately concluded, so Raines was told he would have to go.

The board had decided by Monday evening to accept Howard's resignation. But its announcement was held up as directors continued to discuss different scenarios in which Raines would remain chief executive, including the appointment of an independent chairman.

In a statement, Raines said: "I previously stated that I would hold myself accountable if the SEC determined that significant mistakes were made in the Company's accounting. Although, to my knowledge, the Company has always made good faith efforts to get its accounting right, the SEC has determined that mistakes were made. By my early retirement, I have held myself accountable."

Ann McLaughlin Korologos, the presiding non-management director, thanked Raines and Howard for their "many contributions" and said the board "takes these steps today to move the company forward." The company also announced that the board's audit committee has dismissed KPMG LLP, the outside accounting firm that audited the financial statements Fannie will now correct.

Armando Falcon Jr., head of OFHEO, commended the board's action and said, "We are encouraged that the Board's announcement signals a new culture and a new direction for Fannie Mae."

OFHEO must still officially review the terms of departure for Raines and Howard. The agency last night declared Fannie Mae "significantly undercapitalized," a determination that gives the regulator additional powers over the company.

The 10-year-old agency has been testing its powers since the accounting scandal last year at its smaller rival, McLean-based Freddie Mac, when that company tried to let longtime chief executive Leland C. Brendsel retire with more than $50 million in compensation.

The regulator challenged that decision and has been in a court fight with Brendsel. A federal judge ruled in August that the agency was "simply overreaching" when it ordered most of Brendsel's payments withheld.

Fannie Mae announced several other changes. Board member Stephen B. Ashley, a former president of the Mortgage Bankers Association of America, will become non-executive chairman. Daniel H. Mudd, the company's vice chairman and chief operating officer, will serve as interim chief executive. And Robert J. Levin, executive vice president, will serve as interim chief financial officer while the company seeks permanent replacements.

Though it was not apparent at the time, Raines's downfall began in early 2003, when Freddie Mac disclosed that it had made billions of dollars in accounting errors. Ensuing investigations revealed that Freddie Mac executives had gone to elaborate lengths to make its earnings growth appear smooth.

Given the similar nature of the two companies, OFHEO decided to take a closer look at Fannie Mae's accounting. As that review got underway, Raines complained that Fannie was being unfairly tainted by its competitor's troubles, and he denied that Fannie had similar problems.

In its September report, OFHEO alleged that since a key accounting rule took effect in 2001, Fannie improperly excluded from earnings changes in the value of derivatives, complex financial instruments that can be used to speculate for profit or hedge against risk. Freddie Mac violated the same rule.

Howard, 56, who joined Fannie Mae in 1982 and had served as chief financial officer since 1990, oversaw Fannie's accounting.

At a congressional hearing in October, Raines pointed to the SEC as the authority on accounting matters and pinned his hopes on a favorable decision from the agency. Last week, the SEC's top accountant sided with OFHEO on questions of accounting policy, saying that instead of following the requirements, "Fannie Mae internally developed its own unique methodology."

On Capitol Hill, the scandal at Fannie Mae has reinvigorated efforts to create a more powerful regulator for Fannie and Freddie. Members of Congress and the Bush administration generally agree that the companies' primary regulator, OFHEO, is ill-equipped to oversee huge, complex institutions that could send shock waves through the economy and financial system if they ever foundered.

Fannie Mae, for example, has debts to bondholders of $957 billion, equal to about a fifth of the publicly held portion of the U.S. national debt. In addition, the company guarantees principal and interest payments on $1.9 trillion of mortgage-backed securities.

Raines's successor must add billions of dollars to Fannie's reserves, which will be below the company's regulatory minimum when it records the additional losses.

Established in the 1930s as the nation was emerging from the Great Depression, Fannie borrows money by issuing bonds and uses that money to buy mortgages from lenders, thereby giving the lenders cash to issue more loans. Fannie also packages mortgages into securities, attaching the company's guarantee that it will pay investors the principal and interest on the loans if the borrowers default.

Some corporate governance specialists were stunned by allegations that Fannie engaged in accounting manipulations years after the watershed scandals at Enron Corp. and WorldCom Inc. Those debacles inspired tough new legal penalties for accounting manipulations, served a warning to corporate bosses and seemed to bring about a change in the culture of America's boardrooms.

In the aftermath of Enron's collapse, Raines became a spokesman for the cause of good corporate governance. On behalf of the Business Roundtable, a group of chief executives of many of the nation's largest corporations, Raines led a task force that prescribed best practices for corporate leaders, and he publicly criticized executives who disclaimed responsibility for wrongdoing within their organizations.

Raines and Fannie Mae "have been so arrogant, not just to shareholders but so arrogant in Washington, that it's kind of a well-deserved comeuppance," said Sarah Teslik, former head of the Council of Institutional Investors.

But Arne Christenson, a former Fannie Mae executive who was before that a top aide to then-Speaker of the House Newt Gingrich, said Raines will be difficult to replace. "The thing about Frank is, he had a blend of business acumen and political savvy that was uniquely helpful to Fannie Mae," Christensen said.

"I'm sure he [Raines] would have preferred to have stayed, but things are the way they are," said attorney R. Timothy Columbus, a friend of Raines. "He did what he had to do."

Staff writers Jeffrey Birnbaum, Kathleen Day and Terence O'Hara contributed to this report.


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