Fannie, Freddie Scrutiny Intensifies

Housing and Urban Development Secretary Alphonso Jackson told Congress Wednesday he will soon use his authority granted by the Federal Housing Enterprises Financial Safety and Soundness Act to begin a review of the government sponsored enterprises’ investments and holdings, with a focus on transactions labeled “other assets/other liabilities,” HUD announced.

“HUD’s primary concern is whether the GSEs’ investment activities are consistent with their charter authorities and public purposes and whether each is using the profits it derives as a government-sponsored enterprise for the purposes intended,” Jackson reportedly told congressional members.

“Increased regulatory awareness of investment activity is of particular concern where the transactions have no transparency on a GSE’s financial statement, as is the case with transactions classified as ‘other assets/other liabilities,'” he explained.

The Mortgage Bankers Association announced they strongly support HUD’s effort to ensure the GSEs are operating within their mission of helping low- and moderate-income individuals and families afford homeownership.

“The announced action by HUD is an important step in clarifying permissible GSE activities, it is an important step towards much needed transparency to ensure that the GSEs are using their benefits only for legitimate secondary mortgage market purposes,” said Kurt Pfotenhauer, MBA senior vice president for government affairs, in the written statement.

Last month, the enterprises’ regulator, the Office of Federal Housing Enterprise Oversight, said the “image of Fannie Mae as one of the lowest-risk and ‘best in class’ institutions was a facade,” after its examination of over two years concluded that Fannie’s senior management manipulated accounting and reaped maximum, undeserved bonuses without publicly disclosing such, and that it co-opted with internal auditors and stonewalled OFHEO.

OFHEO, which is part of HUD, detailed Fannie’s “arrogant and unethical” corporate culture from 1998 through 2004, including actions by former Fannie Chairman and Chief Executive Franklin D. Raines, in a 340-page report.

“From Treasury’s perspective, perhaps the most disturbing conclusion from the OFHEO report is that Fannie Mae was not able to manage the risks inherent in its outsized portfolio,” said assistant secretary for the Department of the Treasury Emil W. Henry Jr. in a prepared statement of his speech today at a real estate roundtable conference.

Henry said an important element of Fannie’s recent $400 million settlement with the SEC and OFHEO is the company’s promise to cap its investment portfolio at current levels. “We have no doubts about our authority regarding approving GSE debt, which we do on a regular basis, but we are rethinking the process by which Treasury uses that authority.”

In testimony today to the Senate Banking Committee, Acting OFHEO Director James B. Lockhart III cited a memo from the chief operating officer to the CEO discussing the need for change where he said, “The old political reality was that we always won, we took no prisoners,” according to a copy of the transcript released from the agency.

“We used to “be able to write, or have written rules that worked for us,” Fannie’s COO reportedly said.

Lockhart went on to say Fannie executives manipulated accounting to achieve the maximum possible bonuses, and held the board of directors accountable for failing to stay independently informed and uncover the accounting mess. He also blasted external audits performed by KPMG.

Raines, who Lockhart testified took home more than $90 million from 1998 to 2003, will not make an appearance in front of the committee as a witness today, the Wall Street Journal reported.

But Fannie’s current chairman, Stephen B. Ashley, did testify to the committee.

“The Fannie Mae of 1998-2004 portrayed in the final OFHEO report of its special examination is a far different company than was portrayed to the Fannie Mae Board by departed management, our former external auditor, and annual regular examination reports,” read a transcript of his statement provided by the Washington, D.C.-based secondary lender. “When we received OFHEO’s interim report, we acted immediately to examine and respond to its findings. Within a week of receiving the report, we reached an agreement on a process to resolve the issues raised by the report.”

Ashley added, “Since September 27, 2004, the full Board has met 43 times; Board Committees have met 146 times. Since January 1, 2005, I have met directly with the Director or Acting Director of OFHEO 17 times. As independent Chairman of Fannie Mae, I typically spend two to three days a week at the company, providing direct oversight.”

The roles of CEO and chairman have been separated, five new non-management directors have joined the board and another director is leaving, Ashley reportedly told congress.

OFHEO’s acting chief said Fannie executives achieved accounting manipulation through the misapplication of FAS 115, Accounting for Certain Investment in Debt and Equity Securities and FAS 133, Accounting for Derivative Instruments and Hedging Activities.

The GSEs have been under intense scrutiny by several regulators since Freddie’s accounting scandal broke out around mid-2003 and thereafter prompted investigation of Fannie.

This morning, the Journal said Fannie is expected to announce today that its own massive restatement is likely to be completed by the end of this year.

Lockhart noted that if OFHEO had been better funded and given stronger oversight powers, it could have possibly prevented many of the alleged accounting abuses.

The Treasury’s Henry said, “Indeed, one sad irony of this situation is that the two entities that impose some of the most systemic risk to our system are held to some of the lowest standards of accountability.”