Fannie Mae Fires Raines, Howard Over Accounting Flaws (Update1)
By James Tyson
Dec. 22 (Bloomberg) -- Fannie Mae, the largest source of money for the U.S. mortgage industry, fired Chief Executive Officer Franklin Raines and Chief Financial Officer J. Timothy Howard yesterday, five weeks after saying it may have to restate profit by $9 billion.
The firings come after both the U.S. Securities and Exchange Commission and the Washington-based, government-chartered company's federal regulator said Fannie Mae made mistakes in accounting for contracts designed to protect its more than $900 billion of securities from swings in interest rates.
Raines, who championed corporate responsibility after the collapse of Enron in 2001, became a target for the administration of President George W. Bush and some members of Congress, who want to increase regulation of the $7.6 trillion U.S. mortgage market.
``The faster the board acts, the better it is for the shareholders and for the relationship with the regulators,'' said David Dreman, chairman and chief investment officer at Dreman Value Management LLC in Jersey City, New Jersey. Dreman owns more than 8 million shares of Fannie Mae, making it one of the company's 25 largest investors.
Mudd Takes Over
Raines, a 55-year-old Harvard-educated Rhodes scholar and former budget director under President Bill Clinton, was replaced on an interim basis by Daniel H. Mudd, a vice chairman and chief operating officer, Fannie Mae said in a statement in Washington. Stephen B. Ashley, a Fannie Mae director and past president of the Mortgage Bankers Association, will take over as chairman from Raines.
Raines lost the confidence of many investors after 18 months of assurances, including testimony to Congress in October, that the company's accounting was sound. The Office of Federal Housing Enterprise Oversight, or Ofheo, Fannie Mae's regulator, said yesterday the company is ``significantly undercapitalized.''
Ofheo said in September that Fannie Mae made bookkeeping errors, a charge that Raines denied under oath to Congress in October. Raines then asked the SEC to make a ruling.
Raines's denials were ``a chink in their armor'' and ``tainted'' him in the eyes of investors, William Van Arnum, an analyst at Principal Financial Group in Des Moines, Iowa, said before the announcement. ``It's difficult to get out from under that cloud.''
Principal sold 12 percent of its 790,410 shares in the third quarter, according to regulatory filings.
Howard, KPMG
The board also accepted the resignation of Howard, 56, whom the regulator called the ``chief architect'' of the accounting policies, and fired auditor KPMG International. Chuck Greener, a Fannie Mae spokesman, declined to comment.
The report by Ofheo, the regulator, said Fannie Mae wrongly accounted for hedging transactions on its mortgage holdings, using improper ``cookie jar'' reserves, and deferring expenses in 1998 so executives could get their maximum bonuses.
Raines's ouster may remove an obstacle to efforts in Congress to create a stronger regulator for the company and Freddie Mac. The two companies together have more than $1.7 trillion of debt, exceeding either France or the U.K.
``Given the unbelievable statements Fannie executives made at our last hearing, this action was entirely necessary,'' Representative Richard Baker of Louisiana, the third-highest ranking Republican on the House Financial Services Committee, said in a statement yesterday.
Job for Congress
U.S. Representative Barney Frank of Massachusetts, the senior Democrat on the Committee, said the job of Congress next year will be ``to improve the regulatory system'' for Fannie Mae and Freddie Mac.
U.S. Treasury spokesman Robert Nichols also declined to comment on the board's decisions. ``The administration has long believed the GSEs need strengthened oversight,'' he said. Fannie Mae and Freddie Mac are known as government-sponsored enterprises, or GSEs.
SEC Chief Accountant Donald Nicolaisen said Dec. 15 he advised Fannie Mae executives they should fix their accounting for derivatives. Derivatives are financial contracts whose value is derived from debt, equity securities, currencies and commodities. Fannie Mae estimated in November that it would have a cumulative $9 billion after-tax loss for the last three years if the SEC ruled that it would have to fix its accounting.
SEC spokesman Matt Well declined to comment on the ouster of Raines and Howard. SEC accounting and enforcement investigations of Fannie Mae are continuing, he said in an e-mail reply to a request for comment. In October, Fannie Mae said federal prosecutors asked the company to preserve documents for their criminal investigation.
Above Threshold
While Fannie Mae will be undercapitalized, its critical capital level remains above the required threshold and Fannie Mae continues to meet its risk-based capital requirement, Ofheo said yesterday. As of Sept. 30. Fannie Mae had a $2.98 billion deficit in its core capital of $38.03 billion, Ofheo said.
If ``after a thorough review of all the facts it is determined that our company made significant mistakes, our board and our shareholders will hold me accountable and I'll hold myself accountable,'' Raines told Congress. ``That comes with being a CEO. I accepted the burden on the day I took the job, and I accept it today.''
Fannie Mae rewrote employment contracts for Raines, Howard and Mudd, 46, in the days before Ofheo's September report was released to allow severance payments to be withheld if they are fired for ``fraudulent actions.''
$20 Million Pay
Raines earned $20 million last year in base salary, bonus, stock grants and long-term incentive payments, an 8 percent increase from 2002.
``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,'' Raines said in a statement yesterday. ``By my early retirement, I have held myself accountable.''
Mudd is one of four members of the office of the chairman. Prior to joining Fannie Mae, he was president and chief executive officer of GE Capital, Japan, General Electric Co.'s largest operation outside the U.S., according to Fannie Mae's Web site.
He managed GE Capital Asia-Pacific from 1996 to 1999 and ran that business through the Asian financial crisis.
Shares of Fannie Mae closed yesterday at $70.35, down 6.3 percent for the year. The shares were about $74 each at the end of 1998, just before Raines took over as chief executive. They were at $70.48 in extended U.S. trading.
Limited Damage?
``Everyone wanted to believe that Raines was going to come out of this unscathed,'' said Michael Mullaney, who owns Fannie Mae stock and bonds among the $10 billion he helps manage at Fiduciary Trust Co. in Boston. The shares may ``fall to $68, something like that, but I think it will be pretty contained.''
The departures were ``necessary for Fannie Mae to move forward toward addressing more serious capital issues,'' said James Shanahan, an analyst at Wachovia Securities Inc. in Baltimore, in a research note today. Shanahan rates Fannie Mae shares ``market perform.''
The extra yield investors demand to own Fannie Mae's 4 5/8 percent notes maturing in October 2014 rather than Treasuries has shrunk to 41 basis points from 56 basis points on Oct. 1. A basis point is 0.01 percentage point.
``I'm staying away'' from Fannie Mae debt, said Akira Takei in Tokyo at Fuji Investment Management Co., which oversees about $9.1 billion. ``I believe more bad news will come out of Fannie Mae.''
Fannie's Earnings
The company makes money on the difference between its cost of capital and the returns on the mortgages it buys from banks and their other mortgage investments. Fannie Mae is the second-largest debtor in the U.S. behind the government.
Fannie Mae's earnings have grown at an average annual rate of 18 percent under Raines. The performance was fueled by a U.S. housing boom that has lifted home prices 36 percent since 1995, according to the Federal Reserve Bank of New York.
Fannie Mae's assets rose to $1.01 trillion in 2003 from $575.17 billion in 1999, eclipsing the combined total of Bank of New York Co., Wachovia Corp. and Wells Fargo & Co. During that time, U.S. home ownership climbed to a record high of 68 percent, according to the U.S. Department of Housing and Urban Development.
Testifying in 2002 about the collapse of Enron Corp., Raines told lawmakers: ``It is wholly irresponsible and unacceptable for corporate leaders to say they did not know -- or suggest it is not their duty to know -- about the operations and activities of their company, particularly when it comes to risks that threaten the fundamental viability of their company.''
Ethics Group
Raines was part of a group of executives including Pfizer Inc. Chief Executive Hank McKinnell who this year created an institute for corporate ethics at the University of Virginia.
In 2003, the smaller Freddie Mac ousted its three top executives, including Chairman and Chief Executive Officer Leland Brendsel, after uncovering accounting errors that caused the company to restate earnings by about $5 billion for the previous three years.
Freddie Mac's shares have risen this year after the company hired Richard Syron, the former head of the American Stock Exchange and president of the Federal Reserve Bank of Boston, as chief executive officer.
Raines, born in Seattle, was one of six children of Ida and Delno Raines. The family lived in a house that Delno, who was a maintenance worker for the Seattle parks department, built with his own hands in the city's Rainier section. Ida cleaned offices at Boeing Co., a company that would one day name her son Frank to its board.
Harvard Scholarship
During his senior year at Franklin High School, Raines won a scholarship to Harvard College. One of his professors, the late Daniel Patrick Moynihan, later became urban affairs adviser to President Richard Nixon and a Democratic senator from New York.
Moynihan hired Raines in 1969 as a White House intern and, at the age of 20, Raines briefed the president on campus unrest. For his senior thesis, Raines wrote about welfare. His 1971 Harvard yearbook lists him as chairman of the student Democrat association and a member of the young Republicans.
In 1975, Stuart Eizenstat, chief domestic policy adviser for President Jimmy Carter, hired Raines and named him associate director of the Office of Management and Budget.
Just before Carter lost the 1980 election to Ronald Reagan, Raines joined Lazard Freres & Co. Raines, who specialized in municipal finance, rose to general partner from vice president in six years.
Fannie Mae's former chief executive, James Johnson, hired Raines in 1991 as vice chairman to lead Fannie Mae's legal, credit and finance policies.
Back to Government
Raines went back to the government in 1996, when Clinton named him director of the OMB. With Treasury Secretary Robert Rubin, Raines led the negotiations with Congress to balance the federal budget for the first time since 1969.
Republicans in the Senate Banking Committee and House Financial Services Committee plan next month to reintroduce legislation granting a new regulator power to alter capital standards, reject new lines of business, and control other operations at the two companies.
Raines has said he objects to any legislation that would raise the cost of borrowing for homeowners.
Fannie Mae and Freddie Mac spent $11.7 million during the first half of 2004 lobbying against increased oversight, according to Washington-based PoliticalMoneyLine, a nonpartisan group that tracks campaign finance and lobbying. The companies between them spent more than any single company to influence policy makers, according to PoliticalMoneyLine.
Risk Management
Howard, a native of San Francisco, joined Fannie Mae in 1982 as chief economist and became its chief financial officer in 1990. He was responsible for risk management, credit policy, accounting, strategic planning, capital account management and investor relations, according to Fannie Mae's Web site.
He previously served for five years as senior financial economist at Wells Fargo Bank in San Francisco.
Howard received a master's degree in economics and a bachelor's degree in economics, magna cum laude, from the University of California, Los Angeles. He is also a trustee and member of the executive committee of the Washington Opera, and a member of the board of the Wharton Financial Institutions center at the University of Pennsylvania.
Howard's compensation, including salary and bonus, was $1.8 million last year, a 40 percent increase over the $1.28 million he earned in 2002 and four times his $445,000 of earnings in 1993, according to SEC filings.
To contact the reporter on this story: James Tyson in Washington at at
[email protected]
Last Updated: December 22, 2004 04:32 EST