washingtonpost.com  > Business > Special Reports > Fannie Mae

Futures of Fannie's CEO, CFO Unclear As Directors Meet

Regulators May Try to Oust Executives

By David S. Hilzenrath and Kathleen Day
Washington Post Staff Writers
Friday, December 17, 2004; Page E01

Fannie Mae's regulators would take steps to oust top executives, including chairman and chief executive Franklin D. Raines and Chief Financial Officer J. Timothy Howard, if the board of the government-chartered mortgage funding company doesn't remove them on its own, according to a source close to the situation.

With Fannie Mae preparing to make accounting corrections that could negate $9 billion of its profit since 2001, board members convened by telephone yesterday for more than an hour, but no actions were taken, said sources who declined to be identified because of the sensitivity of the ongoing deliberations. The board planned to meet again as early as this weekend.

Fannie Mae Chairman Franklin D. Raines, left, and J. Timothy Howard, the chief financial officer, testified at a House committee hearing in October. (Dennis Cook -- AP)

_____Steven Pearlstein_____
Baseball, AOL, Fannie: Raines Strikes Out My guess is that there will be plenty of quiet whispering around the punch bowl at the annual Raines Christmas party.
_____Related Coverage_____
Banks Scrutinize Their Accounting (The Washington Post, Dec 17, 2004)
Fannie Took the Shortcut (The Washington Post, Dec 16, 2004)
SEC Tells Fannie Mae To Restate Earnings (The Washington Post, Dec 16, 2004)
Fannie Supports New Regulator, But Wants a Say (The Washington Post, Nov 26, 2004)
More Fannie Mae Stories

Company spokeswoman Janice Daue declined to comment.

Raines's long-standing and energetic defense of Fannie's accounting practices crumbled Wednesday night when, at the behest of the top accountant at the Securities and Exchange Commission, the company agreed to correct past financial reports.

At an October congressional hearing on the company's accounting, Raines said the buck would stop with him if Fannie was found in error.

"I've always tried my best to ensure that our company does the right thing in the right way," Raines told lawmakers. "If, however, after a thorough review of all the facts, it is determined that our company made significant mistakes, our board and our shareholders will hold me accountable. And I'll hold myself accountable."

Fannie's primary regulator, the Office of Federal Housing Enterprise Oversight, had expressed doubts about the company's management in September, when it issued a report alleging that Fannie had ignored accounting rules it didn't like and manipulated estimates to achieve desired financial results. OFHEO last year forced the ouster of top executives at Fannie's direct competitor, Freddie Mac, amid similar accounting problems.

Yesterday, OFHEO spokeswoman Corinne Russell said the agency was working with Fannie Mae to address the impact the SEC-directed correction would have on the company's financial position "and on other areas within our responsibility."

The correction could require Fannie to record $9 billion of losses from financial contracts known as derivatives -- the net of $13.5 billion of losses and $4.5 billion of gains that the company had excluded from past earnings. That would leave Fannie with less than the minimum level of capital it must hold in reserve as a cushion against financial setbacks.

Because the SEC backed OFHEO's key findings on Fannie's accounting, the Justice Department will continue its ongoing investigation into whether top Fannie Mae executives manipulated earnings to trigger multimillion-dollar bonuses for themselves, a source said.

Former senator Warren B. Rudman, a Republican from New Hampshire who is leading an investigation of the regulators' allegations for Fannie's board, said in an interview that that review is "progressing with a lot of intensity and a lot of resources."

The company remains under investigation by the SEC, the Justice Department and OFHEO, which is examining additional accounting issues.

Fannie's stock fell $1.39 yesterday, to $69.30. In the bond market, news of the planned accounting correction had "a noticeable but minimal effect" on Fannie Mae's borrowing costs, increasing them slightly compared with those of Freddie Mac, said Walter Schmidt, who manages mortgage strategy and research at FTN Financial Capital Markets in Chicago.

Over the long run, Fannie's need to shore up its capital could put upward pressure on mortgage rates, but "by how much it's very difficult to say," Schmidt said.

Fannie borrows money by issuing bonds and uses those funds to buy mortgages from lenders, thereby giving them cash to make more loans. The accounting correction could lead Fannie to sell off a chunk of the more than $900 billion of mortgages and mortgage-backed securities it holds, said Jay Brinkman, vice president for research and economics at the Mortgage Bankers Association.

While the company kept its silence yesterday, some corporate governance specialists called for Raines's removal.

"I wouldn't invest in a company that Mr. Raines was running," said Gregory P. Taxin, chief executive of Glass, Lewis & Co., which advises institutional shareholders. "I think it's yet another shocking example of a company that professed publicly to have their house in order and yet had a substantial mess behind the scenes."

"I feel a little bit like the curtain was pulled in the Wizard of Oz and we see the small man behind the big image," said Sarah Teslik, a longtime advocate for institutional investors who has battled Raines over shareholder rights. "If this isn't enough for Frank Raines to offer his resignation . . . what is?"

Nell Minow of the Corporate Library, which rates corporations on the quality of their governance, called for the replacement of Fannie's audit committee, which is headed by Thomas P. Gerrity, a professor of management and former dean at the Wharton School. But Minow said the publicly available information did not support the immediate firing of Raines and Howard.

Raines's initial response to the OFHEO report might have provided "a short-term respite" for Fannie but now "raises further serious concerns about the credibility of his leadership," said Thomas J. Linsmeier, chairman of the department of accounting and information systems at Michigan State University.

"For them to be so far off on something like this is really in the current environment kind of shocking," said Patrick S. McGurn, executive vice president of Institutional Shareholder Services.

Staff writer Terence O'Hara contributed to this report.

© 2004 The Washington Post Company