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Freddie Mac Problems Led to Tougher OFHEO

Report Says Approach Caused Divisions

By David S. Hilzenrath
Washington Post Staff Writer
Saturday, November 20, 2004; Page E01

Embarrassed at its failure to uncover accounting irregularities at Freddie Mac, a federal regulator resolved to become more aggressive in investigating accounting practices at Fannie Mae, another government-chartered mortgage finance company, according to a report made public yesterday.

The new approach led to divisions within the agency, according to a report by the inspector general at the Department of Housing and Urban Development, which quoted some employees as expressing concern that the leaders of the Office of Federal Housing Enterprise Oversight had become overzealous.


OFHEO Director Armando Falcon Jr. said he is pleased that the report found that he acted within his authority. (Larry Downing -- Reuters)

The investigation, requested by Sen. Christopher S. Bond, (R-Mo.), focused in large part on a leak to the press and included sworn interviews with OFHEO officials who were asked if they were confidential sources for reporters, including reporters at The Washington Post.

The report made no recommendation for disciplinary action and noted that prosecutors decided in August not to seek charges against anyone at OFHEO. The report said OFHEO Director Armando Falcon Jr. had broad discretion to release information about the agency's examinations.

The document released yesterday quoted Stephen A. Blumenthal, deputy director of the agency, as saying he believed that in the past the agency was afraid to be a tough enforcer and was more concerned about maintaining collegial relationships with the companies it regulated. "Well, that's all over now," he told investigators for the inspector general at the Department of Housing and Urban Development.

Blumenthal said he told agency examiners to "write those traffic tickets." He talked to his staff, the report said, about how announcements by public officials could hurt Fannie Mae's stock and help make the company "submit to the will" of the regulator.

The "evidence and testimony raises questions about the substance and credibility of certain OFHEO enforcement actions, and the motivation behind such actions," the report said.

Blumenthal alleged, according to the report, that the inspector general's investigation was "due to the animosity of Senator Bond" and one of Bond's staff members, and he questioned whether there was an attempt, at least on the part of the staffer, to "somehow chill or otherwise interfere with the investigation of Fannie Mae."

In September, OFHEO reported that it found pervasive accounting violations at Fannie Mae. Falcon testified before Congress that Fannie deliberately broke the rules. While defending its accounting, Fannie recently stated that if the Securities and Exchange Commission agrees with OFHEO, it could be required to book $9 billion of previously unreported losses.

Bond said in a prepared statement last night that the report "reveals that top OFHEO officials have misused their agency and abused the public trust."

Bond has had a long-running conflict with OFHEO. The senator has requested repeated investigations of the agency, has sought to limit its role and staffing over the years, and is trying to withhold $10 million of the agency's proposed $59 million budget until its director, Falcon, is replaced. Fannie Mae, with assets approaching $1 trillion, had revenue last year of $54 billion.

The Missouri senator, who chairs the subcommittee that oversees OFHEO's budget, has received thousands of dollars of political contributions from Fannie Mae employees, including chief executive Franklin D. Raines, a veteran of the Clinton administration.

Rep. Barney Frank (D-Mass.), who posted the report on a House Web site, said in a statement, "The senior management of OFHEO appears to have run roughshod over the judgment of professional staff and seriously compromised OFHEO's credibility as a financial regulator. . . . It is clear that a leadership change at OFHEO is overdue."

"I am pleased that a determination has been made that I followed the law, acted wholly within my authority as director, and that this is now a closed matter," Falcon said in a statement issued by a spokeswoman.

OFHEO was created in 1992 to oversee Fannie and Freddie, two of the nation's largest financial institutions. They were chartered by the government to buy home mortgages from lenders and ensure that they have enough cash available to make more home loans.

The events described in the inspector general's report can be traced to a phone call Blumenthal received late on a Friday afternoon in June 2003. Freddie Mac's top lobbyist was on the line with the stunning news that three of Freddie's top executives, including its chief executive, had resigned or been forced out.

Though OFHEO's public reports on Freddie had given its internal controls a clean bill of health, Freddie's new audit firm ultimately uncovered billions of dollars of accounting errors and distortions, and an investigation conducted for Freddie's board found that the company had engineered elaborate transactions to get around accounting rules.

Interviewed by the inspector general's office, Blumenthal recalled that OFHEO was humiliated. The agency's examiners were aware of problems at Freddie but didn't take action, he said. "They were being collegial."

Where the agency's examiners had been worried about having a working relationship with the companies they regulated, OFHEO's new attitude was "you're the cop on the beat. You whack them in the head with a nightstick," former OFHEO chief examiner G. Scott Calhoun told investigators. Calhoun left after the problems at Freddie came to light and told investigators he would have been unhappy working under the new approach.

The investigators examined the leak of a letter to the Wall Street Journal in February, in which Falcon faulted Fannie Mae's reliance on manual accounting systems.

According to the report, OFHEO spokeswoman Corinne Russell said she faxed a copy of the agency's February letter to the Journal at the direction of Falcon. She provided an e-mail she had written the same day supporting that version of events, the report said.

Falcon denied any involvement.


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