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Fannie Mae Accounting Report

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Annys Shin and Kathleen Day
Washington Post Staff Writers
Friday, February 24, 2006; 12:00 PM

Washington Post staff writers Annys Shin and Kathleen Day were online at Noon ET, Friday, Feb. 24 to discuss a report that blames some of Fannie Mae's former top executives for many of the mortgage finance company's accounting woes.

A transcript follows .

Read Today's Coverage:

Report Details Raines's Clout at Fannie Mae

Review Could Have Legal Ramifications

Growth of Financial Manager's Power 'Undermined' Checks and Balances

Report Finds Accounting Practices That Start at the Bottom Line

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Annys Shin: Welcome to today's chat. As you all know, Fannie Mae yesterday released a 2,000-plus page report on its $10.8 billion worth of accounting failures, that was commissioned by the board of directors. Former Senator Warren Rudman, who lead the investigation, looked into the allegations raised by the company's regulator, the Office of Housing Enterprise Oversight (OFHEO). But OFHEO is still doing its own investigation and will be releasing more findings later this year, hopefully. So there may be more news to come. In the meantime, let's talk about the Rudman Report.

Kathleen Day: The Securities and Exchange Commission, which regulates publicly traded companies, and the Justice Department are also investigating the company to try to determine if any current or former executives or directors have broken any laws.

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Arizona Bay, Az.: Yet another big corporation bilking the average-joe. What else is new? It won't stop (sorry to be a pesimist otherwise known as a realist)

Annys Shin: Well, you have got lots of company. I'm new to the corporate scandal beat. But I'm told by my more seasoned colleagues that corporate scandals tend to be cyclical. And for some reason people seem to forget about the last batch before the next batch hits. I'm sure that will cheer you right up!

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Ventnor, N.J.: How many employees were involved in expenses postponement?

Annys Shin: I would say at this point we don't have a precise figure. Rudman singles out former controller Leanne Spencer and former CFO Tim Howard for coming up with the idea and persuading CEO Frank Raines to approve it. There could be more people, but the report doesn't really go into it. Perhaps the OFHEO report will tell us more.

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Bethesda, Md.: What kind of fall-out might we expect from the report? I realize the report was commissioned by a former Senator but will there be more Congressional or SEC investigations or does this one stand as an "official report." In other words, what does the future look like for Fannie Mae?

Kathleen Day: Certainly the Securities and Exchange Commission and the Justice Department will investigate this----they have been waiting for Rudman to finish his probe, though they've been actively watching his progress. Now lawyers from both the SEC and Justice will become more active in their search for who at the company, if anyone, broke any laws.

Congressional committees too might look into Fannie Mae. But many lawmakers on the House and Senate banking committees that oversee Fannie Mae and its smaller rival, Freddie Mac,receive large campaign contributions from the two companies. In the past the two firms have wielded a big influence in Congress for that reason. But the two companies have become so big and lawmakers know the two have the potential to disrupt the economy if they faulter, so perhaps lawmakers will take a harder look.

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Chicago, Ill.: How come Fannie didn't have CPAs in the top financial officer/comptroller slots? this was like do-it-yourself brain surgery!

Kathleen Day: That's essentially what Rudman's report says and the company has promised its regulator and the public to do better, much better.

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Bethesda, Md.: Who at Fannie Mae do you believe may face legal troubles based on these reports.

Why do none of your articles describe Leanne Spencer's role in detail, it seems that she was Mr. Howard's go to person to get the numbers done.

Kathleen Day: She is mentioned prominently in many of our stories and certainly her actions will be scrutinized by federal regulators and prosecutors. But tim howard, the former chief financial officer, and Franklin Raines, the former chief executive and chairman, and former and current board members are ultimately responsible for how the company was run.

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Bethesda, Md.: What is the status of the former executives such as Franklin Raines? Were they allowed to keep their golden parachutes? Are there legal actions pending against them?

Annys Shin: Frank Raines, Tim Howard, Leanne Spencer and Fannie Mae are all facing shareholder lawsuits. And yes, Raines and Howard are not hurting for money. Raines gets a yearly pension of at least $1.3 million; Howard's pension is about $433,000. Raines, his wife and kids get free health insurance for life, and the company pays the premiums on a life insurance policy for Raines worth at least $2.5 million.

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St. Louis, Mo.: I'm curious on what your background/expertise is on financial accounting. The Rudman report shows that people need to be qualified, what are your qualifications for reporting on $11 billion in accounting issues?

Kathleen Day: I have an mba in finance but the fact is, financial reports are meanst to serve the general investing public. Questions based on common sense goe a long way to understanding what was and wasn't done at this company and the others whose accounting problems have been exposed over the last four years. High-paid ceos and cfos often try to justify their large salaries by making the language of business so hard to understand that they make folks believe only such highly paid people can decifer what's going on. Fannie's problems show that's simply not true. Many people feel the company and many others could pay ceos and cfos and other top people half of what they do and get better peopel and results.

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Washington, D.C.: Does the company have any plans for lay-offs to offset the shortage in earnings, and possibly the cost of this report?

Annys Shin: As far as I know, no, though it has cut back on its contributions to its foundation. Fannie Mae, unlike Enron, is not any where near going bankrupt. In fact, in order to complete its restatement, it's hired more than 2,000 consultants, not to mention all the lawyers involved. So it looks like more people are actually getting work because of the scandal.

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Alexandria, Va.: Congress wants no part of this scandal. The Republicans want to quash tales of corporate greed, and the Democrats -- usually so eager to expose such happenings -- don't want to do anything to harm Fannie Mae. Do you ever expect congressional hearings?

Kathleen Day: Some long-time critics of the companies think that the House and senate banking committees will eventually become so embarrassed or worried that they might eventually do something to make the companies more accountable.

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For Ms. Shin: Do you and your husband have a bet to see who gets more questions today? Is your target # handicapped since you are up against Hax?

Annys Shin: Either you are a really loyal Washington Post reader, or, I suspect, one of our friends.

(By the way, the writer is referring to my husband, Dan Steinberg, and his blog on the Olympics for the Post called Tales from Turin.)

He's a lot better this than I am. So I wouldn't even try to beat him on line. Besides, what's in it for him? I guess if I won, I could win a "Passion Lives Here" banner. But if I bet and lost, what could I give him? A copy of the Rudman Report?

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Seattle, Wash.: What I still find amazing is that even after all this, Fannie Mae's Board of Directors still allowed Frank Raines to walk away with a lifetime pension of something like $110,000 per month! What is the average worker in America supposed to think about corporations when they see someone who clearly hurt the company and shareholders in the long run being "rewarded" by making more money every month than most Americans make in a year for doing NOTHING?

Kathleen Day: Raines when he was CEO along with many other ceos across the country have fought hard to kill efforts to make boards of directors, who are set executive pay, more accountable to vestors, whose money the board is supposed to be safeguarding. The SEC under the Bush administration has backed away from the agency's own proposal to make it easier for shareholders to nominate board members. Raines and others argued that would lead to special interest nominees getting on boards and that they would disrupt a company's day-to-day operations. But critics counter the real special interest here are the highly paid executives, who often control boards rather than vice-versa, and in effect set their own pay.

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Fairfax, Va.: If we were to compare and contrast these revelations with what happened at Freddie a couple of years back, do we see any similarities?

Kathleen Day: The similarities are many. But one big difference is that once the problems of Freddie came to light, the board there acted quickly to replace the CEO and other top officials on whose watch the problems developed. In Fannie's case, the board allowed Raines and Howard to stay on for months and continue to investiors that nothing was wrong at Fannie.

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Rockville, Md.: A lot of these issues seem to be go back to 1998...

is there any criticism on why it took OFHEO so long to find these issues?

Annys Shin: The company raises this issue often. But OFHEO and critics of the company would argue that OFHEO for years was understaffed and underfunded. Fannie Mae and Freddie Mac were not regulated as closely as other big financial institutions, even though they were comparable in size. The weak internal controls that Rudman and OFHEO turned up show the consequence of poor regulation. Congress finally granted OFHEO more resources after the accounting problems at Freddie surfaced so it could do its probe of Fannie.

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Bethesda, Md.: Do you know if the Lawrence Small who's listed in one story as receiving a bonus in 1998 is the same Lawrence Small who now heads the Smithsonian Institution?

Annys Shin: He sure is.

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Washington, D.C.: Does this report increase or reduce prospects for the Administration getting its way on GSE reform?

Kathleen Day: That depends on whether the bush white house really wants GSE reform-----the money Fannie and Freddie spend on lobbying is appreciated by Republicans and Democrats alike. by the way, for those wondering what gse stands for, it's government sponsored entity----that's what Fannie Mae and Freddie mac are, GSE created by Congress decades ago to buy home loans from lenders and thus giving the lenders cahs to make more loans. The process lowers the cost of borrowing money to buy a house but not necessarily the cost of buying a house---former Fed Chairman Alan Greenspan argued that if the cost of a home loan goes down, the price of a house simply goes up. The cost to the home buyer is the same.

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Bowie, Md.: Fannie Mae touts that earnings per employee is higher than most other companies in the US. Are their any plans to possibly hire additional employees so that each individual doesn't hold so much responsibility and daily tasks in such a large company. It seems to me that doing so much with so little employees could wear them a little thin.

Annys Shin: Since Raines and Howard left, the company has been overhauling its accounting and internal auditing staff. They've hired CPAs and a new CFO who is credited with cleaning up WorldCom's books after that company's accounting meltdown. So the company is making an effort to improve staffing and expertise in those areas.

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Washington, D.C.: One company mentioned in the report was Resource Bancshares Mortage Co. They got a payment for $35 million (page 20 of the summary report.) Who are they? Why did they get paid?

Kathleen Day: That transacton is very intersting and one regulators are surely scrutinizing. But the truth is the report's so big we like everyone else are just digging into this.

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Falls Church, Va.: Don't we know about this scandal because one accountant came forward with his concerns? Makes you wonder how many other companies are doing the same stuff, but have managed to stiffle all internal whistleblowers.

Kathleen Day: The Sarbanes-Oxley bill that Congres passed in the wake of the troubles at Enron and woldcom included a provision to strengthen protection of whistle blowers. President Bush tried to weaken the protections by taking a very narrow interpretation of the law, but Sen. Grassley, a republican, and Sen. Leahy, a democrat, who championed the provision, made it clear they would fight the White House over that interpretation and Bush backed off. there are some intersting non-profit, non-partisan websites on whistleblowing. Do a web search and check them out.

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Bethesda, Md.: In November 2005, Freddie Mac reported that a 2nd restatement was necessary - this time for a $220 million overstatement of profit for the 1st half of 2005. Freddie Mac further said that the "correction represents less than one percent of the company's $36.1 billion of reported regulatory core capital as of June 30, 2005." The Washington Post never objected to the fact that Freddie Mac's characterization of the error ("less than one percent ...") was a whitewash - the real difference was nearly 16% of previously reported income for the 1st half of 2005. Your editors (and OFHEO and SEC regulators) fell for the oldest accounting/statistical trick in the book - that is trying to analyze a "flow" by comparing it to a "stock." It would be similar to explaining that driving 70mph in a 15mph school zone for 10 minutes results in a difference that is less than 1% of the distance from DC to LA - it is simply the wrong analysis, but cleverly designed to confuse the public.

Given the obvious accounting trickery that continues to occur and the lack of understanding by the general public and regulators, what institutional changes are necessary to achieve true "transparency" in financial reporting?

Kathleen Day: It's not for the post to object----we can only write about what the SEC and justic department do, and they are still looking into Freddie. You should complain to them.

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Baltimore, Md.: I was an MBA classmate of Roger Barnes, the brave Fannie Mae accounting manager who first brought Fannie's improper accounting practices to light. Why has he been so overlooked in all this? The report yesterday totally backed up his claims, and yet the sections that dealt with him still had a prosecutorial instead of laudatory tone. The Enron whistleblower was named Time's "Person of the Year" -- Roger seems to be somehow tainted by his whistleblowing.

Annys Shin: I wouldn't say Barnes is "tainted," by his whistleblowing. OFHEO found him to be credible. And Rudman, regardless of its tone, vindicated him, not only on the accounting but the culture of the company. I think if you ask him, he himself is actually slightly uncomfortable with the whole "whistleblower" label. So it may also have to do with his own comfort level about being in the spotlight.

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Minneapolis, Minn.: What is your thought on the likelihood that SEC or DOJ reports will be damaging? When will they be out? And, what does this imply for Fannie's stock price?

Annys Shin: Hi. The SEC and DOJ aren't likely to release any reports. They're doing their own investigations to see whether there are civil or criminal charges to press.

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Washington, D.C.: Do you know who is paying the legal bills for Franklin Raines?

Annys Shin: I believe he is.

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Chicago, Ill.: It's my recollection that Freddie Mac also got in trouble for 'smoothing' earnings but I seem to remember that they were deferring significant GAINS so that their eventual accounting adjustment at least wasn't so painful. Nobody seems to mention that and classes the Fannie/Freddie problems as identical twins.

If all this accounting stuff (for derivatives -- options and the like) is so technically demanding, how come the lowly underpaid and stretched-thin bureaucrats at the OFHEO regular managed to get it right? They were roundly abused for their trouble.

Is Fannie's lobbying arrogance now really and finally over?

Kathleen Day: deferring gains or losses is sill an attempt to smooth earnings. The point was to dampen large swings up or down. Obviously they didn't want large losses, but what many people don't realize is many companies don't want large gains because that only sets the bar higher for the next quarter! Waht the Rudman report foudn, and the report by Jim Doty on Freddie Mac before that, was that at the two companies, steady earnings climbs were the goal, even if it distored the companies' financials.

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Anonymous: I used to work for Fannie Mae and I can offer the following commentary:

- After the Freddie Mac scandal, Fannie Mae had their yearly open meeting where anyone in the company could ask Frank, Tim, or anyone in senior management anything. Frank showed honest anger at the Freddie Mac execs. If you've ever seen him, you know he's quite mild-tempered so this really made an impression on me.

- That said ... and this is why I'm posting anonymously ... I know some DBAs who were asked to re-run older scripts against the database to see "what the numbers would look like" under prior year's regulations. In hindsight, it seems very, very obvious what was happening. But you really have to appriciate the change in corporate culture from the late 90s to early 2000s.

- When I joined, there was a proactive culture where people would go out of their way to help you. When I left, everything was (and according to my former co-workers still is) very passive agressive. If you see someone about to fall off a cliff, you don't help them. You wait for them to fall and tell management about it.

- I chuckled when I read the line in Annys Shin's article today: "Many folks are not willing/comfortable to tell senior management what they don't want to hear". HA! If I saw a problem I wouldn't have told LOWER management about it. There's always a chance the problem could correct itself and if you can't blame someone else for a problem, the messenger gets put up against a firing wall and shot.

But then I don't work there anymore and I'm clearly bitter. So take this with all the appropriate salt required.

Annys Shin: Would love to hear more. Please give me a call.

334-5465

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Vienna, Va.: With Sarbanes-Oxley, is jail time expected for these executives, including Raines and Howard?

Kathleen Day: The SEC and justice department will be looking into whehter former or current executives broke Sarbanes-oxley or any of a number of other laws, including those regarding securities fraud.

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New York, N.Y.: Do you have any insight or opinions on how the new CEO is doing?

Annys Shin: Well, the board wants him to make sure the restatement gets done, to change the culture of Fannie, and to improve relations with the company's regulator and with Congress.

So far, they seem to be happy with him, because they gave him a bonus for 2005.

Outside of the board, people think he's well-intentioned but it's still too soon to tell.

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Ventnor, N.J.: How many executives received inflated and incorrect bonuses? Will they be forced to return the additional money?

Annys Shin: In 2003, which is the only year I have data for, more than 700 members of management received bonuses. OFHEO, last I read, was checking into recapturing some of the money that went to executives that were forced to leave the company.

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Bethesda, Md.: Senator Shelby has promised legislation this year setting up a new regulator for the GSE (government sponsored enterprises). An issue that has stalled the effort is a proposal to limit the loans the GSEs can hold in portfolio. Did the Rudman report have anything to say about the "systemic risk" associated with loans held in portfolio?

Kathleen Day: I dont' think it weighed in on whether the retained portfolio (the loans Fannie mae keeps until maturity rahter than reselling in packages called mortgage-backed securities or MBAs) was good or bad per se, though it's so long I can't swear to it! But the thrust of the report was that the company failed to have adequate accounting technology and ppolices in place to properly keep track of the company's increasingly complex holdings and busineess.So in that sense it did weigh in. Critcs, including those at the FED and Treasury, for years have questioned whether the company could manage the risks associated with a growing retained portfolio. Franklin raines and tim howard always countered that the company had the msot sophisticated safeguards and risk-managements programs around. Now we know that isn't and wasn't true.

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Kathleen Day: Thanks to everyone who joined our chat. We have to go, but we would encourage any current or former employees with observations to contact us! This is a topic that's sure to be in the news for a while.

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