Fannie's stock price fell 6.6 percent yesterday, after the company released a statement summarizing the agency's findings, but before the agency made its 198-page report public. Shares closed at $70.69, down $4.96. The price of the company's mortgage-backed securities weakened slightly.
In response to the OFHEO findings, Fannie announced yesterday that it was setting up a panel of independent directors and hired former senator Warren B. Rudman. "The board takes the report seriously and is working with OFHEO to resolve these matters," Ann McLaughlin Korologos, the presiding director, said in a written statement. She also said the Securities and Exchange Commission has been conducting an informal inquiry "that includes issues raised in the OFHEO report."
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Last year, amid the scandal at Freddie Mac, Raines said Fannie had not done anything to circumvent accounting rules. "If we had, I would have violated the law in certifying our financial results," he said.
In a brief statement yesterday, Raines did not address the substance of the regulators' findings. Instead, he pledged that Fannie's management will assist the company's outside directors in responding to the regulators "in any way we can."
"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 regulators' report said. Regulatory capital is a financial cushion the company is required to maintain against potential losses.
The report added fresh fuel to a long-running debate over the way the government regulates Fannie and Freddie. The Bush administration and some members of Congress have been pushing for legislation to tighten regulation of Fannie Mae, but those efforts stalled this year amid policy disagreements and resistance from the companies.
"Investors have been fooled, homebuyers have been cheated, and taxpayers are at risk," said Rep. Richard H. Baker (R-La.), chairman of the House subcommittee on capital markets, calling on Congress to follow through on plans to establish a stronger regulator for Fannie Mae. "Fool us once, shame on you. Fool us twice, shame on us," Baker said.
The agency, which some lawmakers have criticized as ineffective and which has long complained that it was underfunded, had historically vouched for Fannie's safety and soundness. The findings released yesterday were the product of a special review by OFHEO, which in February hired the accounting firm Deloitte & Touche LLP to assist it.
Accounting rules can be subject to different interpretations, and some stock analysts predicted yesterday, in reports to their clients, that the examination at Fannie Mae could turn into a battle of accounting experts. Fannie is audited by KPMG LLP, which declined comment yesterday.
The report said that when Fannie didn't agree with accounting standards-setters, it disregarded their guidance "and accounted for the transactions the way they had originally proposed. This sheds some light on the culture and attitude within Fannie Mae -- a determination to do things 'their way.' "
The regulators said the company will need to devote considerable resources to determine the full magnitude of the accounting errors.
In the 1998 incident questioned in the report, Fannie reported paying bonuses to the following executives: chairman and chief executive James A. Johnson, who received $1.932 million; Raines, who then was chairman-designate, received $1.110 million; Chief Operating Officer Lawrence M. Small received $1.108 million; Vice Chairman Jamie Gorelick received $779,625; Howard received $493,750; and Robert J. Levin, who was executive vice president for housing and community development, also received $493,750. The executives either could not be reached or declined comment last night.
In 1999, Raines set a goal of doubling Fannie's earnings in five years. Last year, Fannie met that goal. Employees were rewarded through special stock options pegged to the five-year goal.
Financial performance has also influenced executive compensation in other ways. For example, the size of a bonus pool for Fannie executives in 2002 was based on "an aggressive earnings per share ('EPS') growth measure that Fannie exceeded," the company said in a report filed with the SEC.
Raines received $17.1 million of compensation in 2003, plus stock options the company estimated were worth $3 million when granted. Staff writers Kathleen Day, Terence O'Hara, David A. Vise and Albert B. Crenshaw and staff researcher Richard Drezen contributed to this article.