The Politics of Fannie Mae

From National Review Online
Politics and the Fannie Mae Piggie Bank

by Byron York

excerpts:

On May 23, 2006, as a jury in Houston deliberated the case against top Enron executives Kenneth Lay and Jeffrey Skilling, a little-known regulatory agency in Washington, the Office of Federal Housing Enterprise Oversight (OFHEO), released a study with the dryly bureaucratic title “Report of the Special Examination of Fannie Mae.” The document received far less attention than the news from Enron, but its conclusions were stunning. In meticulous detail, it outlined a culture of corruption at the Federal National Mortgage Association — better known as Fannie Mae — that rivals the most serious corporate scandals in recent years. In this case, however, the main players are Washington insiders — some of them prominent veterans of the Clinton administration — and the scandal’s effects could ripple through Congress for years.

Fannie Mae is the biggest single source of money for mortgages in the United States. From 1998 to 2004, the years covered by the OFHEO investigation, it was headed by former Clinton budget director Franklin Raines, whose top management team included former Clinton Justice Department official Jamie Gorelick, sometimes mentioned as a future attorney general in a Democratic administration. During that period, the report says, Raines and his team grossly overstated Fannie Mae’s earnings — to the tune of $10.6 billion — for the purpose of paying themselves big bonuses. “By deliberately and intentionally manipulating accounting to hit earnings targets,” the report says, “senior management maximized the bonuses and other executive compensation they received, at the expense of shareholders.”

But the OFHEO report suggests that none of that mattered to Raines, who had been a top official at Fannie Mae in the early 1990s before leaving to join the Clinton administration and then returning to Fannie Mae as chief executive in 1998. According to the report, Raines became obsessed with propping up Fannie Mae’s earnings per share, or EPS, even if he had to use creative accounting to make it happen. Raines set a series of increasingly higher EPS goals that, if met, would trigger bonuses for the executive team that far surpassed what they received in salary.

Even though his salary never topped $1 million, Raines’s total compensation shot from $6.48 million in 1998 to $8.52 million in 1999, to $13.89 million in 2000, to $18.86 million in 2001, to $18.20 million in 2002, to $24.15 million in 2003, all on the strength of EPS bonuses. Investigators found that of the $90.12 million Raines was paid in that six-year period, more than $52 million came from EPS bonuses.

Gorelick’s situation was similar. OFHEO found that she took home $26.46 million in the period from 1998 to 2002 (she left in that year, so she wasn’t there for the entire period under investigation). Of that figure, nearly $15 million came from EPS bonuses.

Of course, it wasn’t legit. “Fannie Mae reported extremely smooth profit growth and hit announced targets for earnings per share precisely each quarter,” the OFHEO report says. “Those achievements were illusions deliberately and systematically created by [Fannie Mae’s] senior management with the aid of inappropriate accounting and improper earnings management.”

In other words, they cooked the books. And to make matters worse, according to OFHEO, when regulators began to catch on to what was happening, Raines and his team then “sought to interfere” with the OFHEO investigation by trying to get Congress to start up a separate probe of OFHEO. Fannie Mae also lobbied Congress to cut OFHEO’s funds unless it got rid of the top official in charge of investigating Fannie Mae.

That didn’t work, and, as a result of the investigation, Fannie Mae has agreed to pay $400 million in penalties. The company is now under criminal investigation by the Justice Department, and will likely be in trouble with the Securities and Exchange Commission, too. And there probably won’t be much more talk about Gorelick as attorney general should a Democrat win the White House in 2008.

But there still is the matter of cleaning up Fannie Mae. Senator Sununu and his colleagues on the Senate banking committee have been trying for two years to win approval of a bill that would create a new regulatory body for Fannie Mae and give that body the authority to crack down on the company’s riskier practices.

But the bill has faced a lot of opposition, mostly from Democrats. When Raines was still at Fannie Mae (he was forced out in 2004), he tried, in Sununu’s words, “to slow-walk the process. Frank Raines decided they were stronger and better and smarter than everyone else, so they would push back.” Democrats allied themselves with Raines and said they worried that reform might harm Fannie Mae’s ability to provide mortgages to low- and middle-income homebuyers. Sununu’s bill was approved in the banking committee last year, but only on a straight party-line vote.