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Cut Fannie's Holdings, Critics Say

By Annys Shin
Washington Post Staff Writer
Saturday, February 25, 2006

Critics of Fannie Mae yesterday renewed calls to rein in the company and its smaller rival, Freddie Mac, following the release of former senator Warren B. Rudman's report on the mortgage finance company's $10.8 billion accounting scandal.

Though the report documented no new problems, the critics said, Rudman's detailed account of widespread accounting violations makes it important to adopt a tougher set of regulations for the company.

Senate Banking Chairman Richard C. Shelby (R-Ala.) said the report in particular emphasizes the need for Fannie to be forced to cut the size of its mortgage investment portfolio, an important source of profit that has grown so large that some analysts think it could destabilize the country's financial markets if the company were to fail.

"Many of these issues arose because of the large retained portfolio held by Fannie Mae," Shelby said. "While a portfolio of this size is not a critical component in achieving their housing mission, it did serve as a mechanism to allow Fannie Mae to ensure earnings growth. I remain committed to passing a strong . . . regulatory reform bill this year."

Fannie Mae is chartered by Congress to keep money flowing into the housing market by buying mortgages from banks and other lenders.

Fannie Mae shares closed yesterday at $56.07, down $1.07, or 1.9 percent, though shares ended the week up slightly.

Legislation to create a stronger regulator for both companies has been stalled in Congress since last fall because of disagreement over whether to force the companies to shrink their investment holdings of mortgages and mortgage-backed securities. The House has approved a new set of rules that Shelby and the Bush administration consider too weak; a Senate version of the legislation is awaiting a final vote.

The report, prepared at a cost of more than $60 million, portrayed former chief financial officer J. Timothy Howard and former controller Leanne G. Spencer as focused on reaching earnings targets and willing to bend accounting rules to meet those goals. Lawyers for the two former Fannie officers have rejected that finding.

While the report found no evidence that former chief executive Franklin D. Raines knew the extent to which his company had strayed from standard accounting practices, it faulted him for creating a "culture that improperly stressed stable earnings growth." Raines's lawyer has also rejected the reports' characterization of his leadership.

The House Financial Services Committee has scheduled hearings on the report for March 14.

Critics of the company were angry over recent remarks by Fannie Mae chief executive Daniel H. Mudd about plans to help finance $10 billion in construction loans. Groups such as the Financial Services Roundtable, which represents large banks that compete with Fannie Mae, have asked the company's regulators to review whether the program is within the bounds of Fannie Mae's charter.

The Rudman report has given them new reason to complain.

"It is inconceivable that a fraud of this magnitude, so amply documented in this 2,700 page report, went completely undetected by Fannie Mae's regulator the Office of Federal Housing Enterprise (OFHEO) and Fannie's Board for years. . . . Fannie Mae operated with impunity because it had nothing to fear from its regulator," W. Michael House, executive director of FM Policy Focus, said in a statement. FM Policy Focus is backed by several big banks that compete with Fannie and Freddie.

Paul Miller, an analyst for Friedman, Billings Ramsey Group Inc., was among several analysts who were skeptical that the report would be enough to break the legislative stalemate.

"While the report reveals many accounting violations, the Rudman report may not be a catalyst that pushes the Senate into portfolio limitations favored by Senator Shelby. We still believe that the odds for . . . reform this year are slim," Miller wrote in a research note Thursday.

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