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Raines Falls at Fannie Mae

TSC Staff

Updated from 7:52 p.m.

Under pressure from regulators, Fannie Mae's board ousted its top two executives in the midst of a deepening accounting scandal.

CEO Franklin Raines and CFO Timothy Howard were forced out Tuesday. The move came as Fannie's regulator, the Office of Federal Housing Enterprise Oversight, issued a statement indicating that the company is "significantly undercapitalized," suggesting Fannie might not have the financial wherewithal to survive a market shock or similar event.

Raines, who long defended the company's accounting despite mounting evidence that it wasn't proper, issued a statement late Tuesday conceding that "mistakes were made" and saying he would assume responsibility as he had earlier promised.

"I have advised the Board of Directors today that I am retiring as Chairman and Chief Executive Officer of Fannie Mae," said Raines, who joined the company in 1999 after a stint with the Clinton White House. "I previously stated that I would hold myself accountable if the SEC determined that significant mistakes were made in the Company's accounting. Although, to my knowledge, the Company has always made good faith efforts to get its accounting right, the SEC has determined that mistakes were made. By my early retirement, I have held myself accountable."

According to Fannie's statement, issued late Tuesday, Raines retired and Howard resigned. However, news reports indicate the company was under growing pressure from regulators to shake up its management in the wake of findings that the company's books ran afoul of generally accepted accounting principles for four years.

The Washington-based mortgage giant named Stephen B. Ashley nonexecutive chairman, Vice Chairman and Chief Operating Officer Daniel H. Mudd interim chief executive, and Executive Vice President Robert Levin interim finance chief. The company hired executive search firm Spencer Stuart and dismissed auditor KPMG, which blessed the questionable numbers, as well.

The news comes less than a week after the Securities and Exchange Commission jolted the well-connected company by ordering a massive restatement of earnings going back four years. Fannie indicated it would comply with that order, a decision the company previously indicated would cost it to the tune of $9 billion.

At the time of the SEC ruling, speculation regarding the fate of Raines and Howard resumed swirling furiously on Wall Street. Both executives had defended the company's accounting before a growing chorus of congressional critics.

SEC Chief Accountant Donald Nicolaisen, in a statement released Dec. 15, said the government-sponsored company's accounting for 2001 through mid-2004 "did not comply in material respects" with accounting rules for derivatives, financial instruments used to hedge against interest rate swings, and for some transactions related to loans.

Fannie said this fall that a restatement could force it to report after-tax losses on its derivatives transactions of as much as $9 billion. The losses could cause the company to become severely undercapitalized, an event that potentially could force it to sell stock or assets to raise money.

The SEC findings came on top of a scathing report filed this fall by OFHEO. The office contended Fannie Mae deliberately violated accounting rules in an effort to smooth out quarterly earnings, meet financial projections and boost bonuses for its top executives.

OFHEO moved to tighten its control of Fannie's accounting after a similar accounting scandal at government-sponsored peer Freddie Mac resulted in a management shake-up and wide-ranging earnings restatement.

In September, after OFHEO issued its scathing report on Fannie's accounting missteps, the company reached an agreement with the regulator to boost the amount of capital it holds to protect it against losses and market swings.

On Tuesday, OFHEO indicated that last week's restatement bombshell would leave the company below key capitalization levels.

"The disallowed hedging treatments (SFAS 133) result in an estimated $9 billion cumulative reduction in core capital as of September 30, 2004 as disclosed by Fannie Mae," the regulator said. "This capital level places Fannie Mae below its minimum capital requirement and results in a classification of significantly undercapitalized. Fannie Mae's critical capital level remains above the required threshold and Fannie Mae continues to meet its risk-based capital requirement."

Fannie also pleged to undertake an investigation of the regulator's claims that the company's internal controls and management oversight weren't up to snuff.

"Fannie Mae is a great company deeply committed to its mission of expanding the dream of homeownership to all Americans and serving the nation's housing needs," said Ann Korologos, the presiding director of the nonmanagement members of the board. "We appreciate the many contributions of Frank Raines and Tim Howard, their devotion to Fannie Mae and their commitment to its mission. Fannie Mae's Board of Directors takes these steps today to move the company forward to serve its critical mission in a safe and sound manner."

In after-hours trading Tuesday, Fannie rose 8 cents to $70.43.