Probe Into Fannie Mae, Freddie Mac Widens

District-based Fannie Mae said it "intends to cooperate fully."
District-based Fannie Mae said it "intends to cooperate fully." (By Jay Mallin -- Bloomberg News)
By Zachary A. Goldfarb
Washington Post Staff Writer
Tuesday, September 30, 2008

The government probe into Fannie Mae and Freddie Mac widened as the mortgage giants disclosed yesterday they are under investigation by the Department of Justice and the Securities and Exchange Commission.

The companies, which were seized by the government three weeks ago, said that the U.S. Attorney for the Southern District of New York and the SEC have opened investigations over accounting, disclosure and corporate governance matters relating to events dating to Jan. 1, 2007. A federal grand jury convened by the U.S. attorney issued subpoenas to the companies asking for documents, and the SEC directed the companies to preserve their records.

The companies, which received letters from authorities on Friday informing them of the probes, did not identify the documents investigators are seeking. District-based Fannie Mae said it "intends to cooperate fully with these investigations and inquiries." McLean-based Freddie Mac said it "will cooperate fully in these matters."

The SEC's investigation of Fannie Mae and Freddie Mac is "likely a pretty broad scope of review to see if they can find any evidence or allegations of misconduct by the executives," said Bryan J. Sillaman, who worked on a prior accounting probe of Fannie Mae as a lawyer in the enforcement division of the SEC. "At this point, it's probably not focused too much, and they're probably going to request a rather broad set of documents to see what executives may have known about the valuation of certain securities, and whether that's consistent with what they were disclosing to the public."

The probes come as the government is investigating a wide range of financial firms involved in the financial crisis. The FBI has also launched investigations into American International Group and Lehman Brothers. In all, the FBI is looking at 26 companies. In addition, the SEC has opened 50 probes into disclosure issues, stock sales by corporate insiders and the way housing-related investments were valued at banks, insurers and credit ratings agencies.

No major conviction has been obtained related to the financial crisis. A number of mortgage companies have agreed to multimillion-dollar settlements with authorities over bad lending practices, and two investment managers associated with Bear Stearns hedge funds that collapsed in the summer of 2007 have been arrested. In an agreement with the SEC and the New York attorney general, Wall Street firms have agreed to buy back billions in complex securities from investors.

Neither Fannie Mae nor Freddie Mac commented yesterday beyond the statements. The SEC and U.S. attorney's office also declined to comment.

Before the mortgage crisis, Fannie Mae and Freddie Mac agreed to pay hundreds of millions of dollars in fines related to their role in a pair of unrelated accounting scandals. The companies were just emerging from the cloud of those troubles when home prices began to fall and bad debts mounted, causing billions in losses that led in part to the government's takeover.

As the crisis unfolded, analysts and journalists publicly questioned some of the firms' accounting decisions; there is no evidence that these questions factored into the government investigations.

One question concerned a change in the way Fannie Mae disclosed information about foreclosures. Company executives said they were trying to be more transparent; an online report in Fortune magazine and some analysts suggested the changes might mean the company would face much higher losses.

When the reports surfaced last November, the news sent the company's shares diving. But the concern was short-lived and was not featured prominently among later discussions.

More recently, analysts and the press questioned how the companies calculated their capital -- a government-mandated financial cushion used to offset losses. For most of the year, the companies -- and their regulator -- said the companies had sufficient capital.

In the weeks leading up to the takeover, government examiners looking through Fannie Mae and Freddie Mac's books worried about what made up the capital the companies were claiming. For instance, they counted as part of their capital certain tax credits they were due.

But the tax credits could only be applied against profits. Since the companies were experiencing big losses, the tax credits had little immediate value.

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