As Washington donnybrooks go, it doesn't get any bigger than this.
The company, housing lender Fannie Mae, is the biggest in the region, with nearly $1 trillion in assets and gobs of outstanding debt held by pension funds and banks and even foreign central banks, all of which crave its implicit U.S. government guarantee. Its executive suite and board of directors are packed with the politically well connected, while its lobbying muscle is so formidable it has been able to fend off a concerted effort to rein in its growth and profitability by the White House, the Federal Reserve and the Republican leadership on Capitol Hill.
But now Fannie is reeling. A stinging report issued by its once-obscure regulator, the Office of Federal Housing Enterprise Oversight, alleged that top Fannie executives manipulated accounts to inflate and smooth earnings in an effort to boost the stock price and earn big bonuses. The regulator accuses the company of having lax internal controls and insufficient capital to back up its massive financial risk-taking, while ignoring the warning of a whistle-blowing employee no longer on the payroll. The report, prepared by Deloitte & Touche and Stanley Sporkin, a longtime enforcement director at the Securities and Exchange Commission, has now prompted criminal and civil probes by the Justice Department and the SEC.
With Fannie stock in a tailspin and politicians demanding resignations, Fannie directors moved quickly into damage-control mode. The agreement hammered out with OFHEO requires Fannie to add $5 billion in capital over the next nine months, appoint an internal auditor and chief risk officer independent of the chief financial officer, and get prior approval for any dividend distribution. The three top officers, including chief executive Franklin Raines, agreed to amend their employment contracts to make it easier for them to be fired for cause. Former senator Warren Rudman, Washington's favorite Mr. Fix-it, was deputized to lead the obligatory in-house investigation.
Although OFHEO was sweeping in its condemnation of Fannie's competence and ethics, the accounting issues involved are devilishly complex, involving rules that run 800 pages and require auditors to make dozens of subjective judgments. At a House hearing this week, Raines and other executives are expected to stand by their accounting. But it could be a year or more before the SEC, the final arbiter in these matters, can pass a final judgment -- plenty of time for Fannie to shape a political and legal settlement that ensures its profitable survival while avoiding disruption to housing and credit markets.