TOPICS > Economy

The Mortgage Giant Fannie Mae Accused of Deception and Mismanagement

May 23, 2006 at 1:15 PM EDT

JIM LEHRER: Now, the continuing tale of alleged deception and mismanagement at mortgage giant Fannie Mae. Jeffrey Brown has our story.

JEFFREY BROWN: A $400 million dollar fine and a scathing report on a, quote, “arrogant and unethical corporate culture.” Today was a bad day for Fannie Mae, the publicly-traded company that also has a government charter and plays a huge role in the nation’s home mortgage-lending market.

The company’s accounting practices have been under investigation and have already led to the resignation of several top managers. The latest salvo comes from the Office of Federal Housing Enterprise Oversight, a government regulator. Its acting director, James Lockhart, joins me now.

Welcome to you.

JAMES LOCKHART, Office of Federal Housing Enterprise Oversight: Good evening, Jeff.

JEFFREY BROWN: Before we begin on today’s charges, this is an important but little understood company. Tell us briefly: What is Fannie Mae and what does it do?

JAMES LOCKHART: Well, Fanny Mae and its cousin, Freddie Mac, basically buy mortgages from banks and other mortgage originators, guarantees them, and then on-sells them to investors around the world. Between these two companies, they represent about 40 percent of the mortgage market in the United States.

JEFFREY BROWN: And it is a strange hybrid, is it not, a publicly-traded company but with a government charter and oversight from folks — you?

JAMES LOCKHART: Right. They’re probably two of the largest financial institutions in the world. Yes, they’re public companies, but they also have a government charter, and we regulate them in a way to try to promote safety and soundness.

Manipulation from 1998-2004

JEFFREY BROWN: Now, in today's report, you're looking at the manipulation of funds from 1998 to 2004, some of this for personal gain, compensation. Tell us what happened.

JAMES LOCKHART: Well, the previous management of Fannie Mae set earnings-per-share targets. And every quarter, they manipulated -- or every year, they manipulated the earnings to hit those numbers because their bonuses were based on them. And every year, they got their maximum bonuses.

And they did it -- in good years, they actually hid profits. And in bad years, they took a cookie jar approach and took some out of a cupboard somewhere.

JEFFREY BROWN: You said in your release, "Fannie Mae's executives were precisely managing earnings to the one-hundredth of a penny to maximize their bonuses."

JAMES LOCKHART: That's correct.

Possible criminal charges?

JEFFREY BROWN: So that's very minute, but there's so much money floating around that that adds up to a lot of money?

JAMES LOCKHART: It adds up to a lot of money. And basically, what was happening there is that they managed it to the hundredth a penny but ignored the rest of the company. They weren't investing in systems, risk management, controls. And as a result, they did serious harm to the company, while lining their own pockets with these ill-gotten bonuses.

JEFFREY BROWN: The example you have in your report is former CEO Franklin Raines who earned $90 million from 1998 to 2003. Your report says that, of that, $52 million was from achieving these targets.

JAMES LOCKHART: Yes, $52 million from the bonuses, and probably a lot of the other salary was related to their performance and earnings. And, yet, they were basically fraudulently attained, as the SEC said today.

JEFFREY BROWN: Fraudulently. So is anybody trying to get it back? Does he, do others face criminal charges here?

JAMES LOCKHART: We have asked the company to go after them to try to get the money back. If the company fails, we will do it. The SEC, Chairman Cox made it very clear today that they're going to continue to pursue those individuals.

JEFFREY BROWN: Possible criminal charges, Department of Justice involved?

JAMES LOCKHART: We have been talking to the Department of Justice, and the Department of Justice is aware of what's going on, and it will be up to them. But both the SEC and they are looking at this.

JEFFREY BROWN: Now, part of your agreement today, you demanded an overhaul of what you call this arrogant corporate culture. What does that mean? What are you demanding?

JAMES LOCKHART: Well, we're really demanding sort of a top-to-bottom look at this company. The board of directors didn't have proper oversight. We want to strengthen the board of directors. We want to strengthen the management team. We want better risk management. We want a better internal auditor.

This whole company's culture needs to be changed. Their accounting systems are probably a couple years away from being in good shape. They don't have the proper internal controls.

So it's a long-term process, and management will be working with us to try to fix it as soon as possible.

Not admitting any wrongdoing

JEFFREY BROWN: The man at the company said today that it was not admitting or denying wrongdoing. Are they cooperating with you now? Can the kind of reforms you're talking about take place under current management?

JAMES LOCKHART: We are cooperating. We have examiners in there every day looking at what's going on. We're continuing to examine these companies. The management team understands the problems; they understand that they have serious risk management and systems problems.

JEFFREY BROWN: Now, the other side of this that you've touched upon is more of a systemic company risk-taking that your report aims at, and they have agreed -- the company has agreed to limit its growth of its mortgage holdings. What exactly does that mean?

JAMES LOCKHART: Well, they really have two businesses at Fannie Mae. One is to guarantee the mortgages and sell them to someone else in packages. The other is actually to buy the mortgages and keep them in their own portfolio, and that portion we have put a cap on. We have frozen that.

And one of the reasons, again, is because we don't think that they have the systems and capabilities today to continue to grow.

Changes in regulatory system?

JEFFREY BROWN: Given how important they are in the housing market, does this have an impact on their ability to play that role?

JAMES LOCKHART: No, I don't think it will, because they can continue to guarantee mortgages. And, in fact, I would almost argue the other way around. We need to make sure that this company is the world-class institution it claimed to be in the past, so we need to strengthen their controls.

JEFFREY BROWN: So you don't see an impact on the wider housing market from these actions?

JAMES LOCKHART: No, I don't. And in the long term, I think it will be beneficial.

JEFFREY BROWN: What about the regulatory system here? Was there a failure of oversight from your agency? You weren't there, I understand, but this went on for a number of years. Who was watching? Who's supposed to be watching? Did the system not work?

JAMES LOCKHART: Well, OFHEO, the agency, is a very little agency facing two of the largest institutions in the world. I think there was a failure from the standpoint that we didn't spend enough time investigating, we didn't have enough investigators. We've learned a lot from that, and we're much more involved.

JEFFREY BROWN: Do you see any changes in the regulatory or legislative system coming now?

JAMES LOCKHART: Well, one of the recommendations from the report today -- and I agree and endorse it -- is that we need to work with the House and Senate to get legislation to reform this system. We need to strengthen OFHEO as a regulator. We need to look at the growth of these companies and the use of the implicit guarantee of the United States government.

JEFFREY BROWN: And, finally, some perspective here for people watching. Why does this matter, for the folks who aren't in your agency or at the company, how they govern themselves, how they do their numbers?

JAMES LOCKHART: Well, I think it matters, because these two institutions represent 40 percent of the housing market in the United States, and housing is such an important part of the American economy.

And so we really need to strengthen their capabilities; we need to make sure that they're operating in a safe and sound way, so that we can protect the American people.

JEFFREY BROWN: All right, James Lockhart, thank you ver