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Fannie Mae Report Is Long, but It's Not the Whole Story

Now I don't know about you, but I suspect there's a wee bit of fanny-covering going on here.

Let's start with the directors. If, after Enron and WorldCom, any director who actually believed that there had been no earnings management at Fannie Mae -- or any other major company, for that matter -- ought to immediately check into the Betty Ford Gullibility Clinic. And it would have taken only a five-minute call to the Office of Federal Housing Enterprise Oversight for a vigilant director to determine how little cooperation regulators were getting from Fannie's legal pit bulls.

At the same time, if E&Y and Wilmer Cutler had raised concerns about Fannie's accounting policies, I doubt they would have sat by silently in 2004 and 2005 as Fannie officials repeatedly invoked their good names in fending off criticism. In fact, they gave the answer they thought management and the board wanted to hear, collected their fees and are now scrambling to defend their reputations.

As I was reading through that and other chapters of the Rudman report, I had a nagging feeling that I had read the story before. And then I realized where: in a management book about blowups of other once-successful corporations, written by Sydney Finkelstein, a professor at Dartmouth's Tuck School of Business.

Finkelstein's insight is that big corporate mistakes aren't caused by stupidity, or venality, or by an unexpected bit of bad luck. Nor are they the result of flawed strategy or inability to execute, although those may sometimes appear to be the cause.

Rather, Finkelstein says, the most spectacular corporate failures occur in companies that are so blinded by their own competence and past success that they instinctively tune out legitimate outside criticism. Inside, a positive can-do culture tends to snuff out criticism, dissent or negative feedback. Executives at these companies tend to be obsessed with the company's image, underestimate major obstacles, assume they have all the answers and stubbornly rely on what worked for them before.

The reasons behind most corporate collapses, according to Finkelstein, entail the deep-seated psychological need people have at all levels of a company to belong and get along, to rationalize what has already been done or decided, and to put off loss or failure.

"From what I know about Fannie Mae, it certainly fits the pattern," Finkelstein told me yesterday.

So if you want to know how Fannie Mae misstated its earnings and ran itself off the rails, Warren Rudman's 2,652-page report is probably as good a guide as you're going to get. If you want to know why it happened, save yourself some time by reading Sydney Finkelstein's 290-page "Why Smart Executives Fail."

Steven Pearlstein can be reached

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