Fannie Mae Chief Executive Officer Franklin Raines might lose his job after the Securities and Exchange Commission (SEC) ruled that the company violated accounting rules, shareholders...
Fannie Mae Chief Executive Officer Franklin Raines might lose his job after the Securities and Exchange Commission (SEC) ruled that the company violated accounting rules, shareholders said.
Raines told Congress in October that he would take responsibility if the bookkeeping at the largest source of U.S. mortgage money was found to be flawed. Chief Financial Officer J. Timothy Howard also testified in defense of the accounting.
“I can’t fathom that Raines and Howard can survive this,” said Michael Mullaney, who owns Fannie Mae stock and bonds among the $10 billion he helps manage at Fiduciary Trust in Boston. “Before it was just an accounting issue and now it’s an accounting and credibility issue.”
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The Washington, D.C.-based, government-chartered company may have to restate earnings by $9 billion after SEC Chief Accountant Donald Nicolaisen said yesterday he “advised” Fannie Mae executives they should fix their derivatives accounting. Derivatives are financial contracts whose value is derived from debt, equity securities, currencies and commodities.
Fannie Mae Spokesman Chuck Greener declined to comment on Raines’ status with the company. Ann Korologos, the Fannie Mae director who is handling the board’s response to findings of accounting errors, didn’t return a phone call requesting a comment. The $9 billion figure was Fannie Mae’s estimate last month. Fannie Mae and Freddie Mac own or guarantee almost half the $7.6 trillion mortgage market.
Raines has told investors and legislators that his company’s accounting was sound in the 18 months since Freddie Mac, Fannie Mae’s smaller rival, disclosed that it understated earnings by $5 billion in order to reduce profit volatility.
Raines, 55, a Seattle native, former Rhodes scholar, investment banker at Lazard, Freres and budget director in the Clinton administration, told Congress on Oct. 6 that he only certifies company accounting “after receiving assurances that I can say with confidence that these documents fairly present, in all material respects, the financial condition, results of operations and cash flows of the company.”
Raines also told the House Financial Services Committee that he considered the SEC the “final authority” on accounting disputes and he would hold himself responsible for any major accounting mistakes.
“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,” he said.
The testimony followed a September report by the company’s regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), that accused the company of accounting errors. OFHEO said Howard “failed in providing adequate oversight.”
The tenure of Raines, Howard, and other top executives “are questions that are to be pursued,” said Rep. Richard Baker, R-La., the third-highest ranking Republican on the House Financial Services Committee.
The SEC ruling will strengthen efforts to create a stricter regulator for the company and the smaller Freddie Mac, Baker said, adding he plans to hold hearings on Fannie Mae’s accounting next month. Baker since 1998 has called for stronger federal oversight.
Rep. Barney Frank, D-Mass., the senior Democrat on the House Financial Services Committee, called the findings “serious and disturbing,” and said they show “there were deficiencies in the corporate governance.”
Sen. Richard Shelby, R-Ala., chairman of the Senate Banking Committee, said creation of a stricter regulator for Fannie Mae and Freddie Mac “will be the top priority” for his panel next year.
Raines has “lost his credibility,” said Rep. Christopher Shays, R-Conn., of the House Financial Services Committee. Shays’ district is home to the finance arm of General Electric, which is a competitor to Fannie Mae and Freddie Mac.
“Any time you are in charge of an organization that basically manipulated its accounting and did it for four years, you endanger not only investors, you endanger the employees as well,” Shays said.
“Raines said that he stood by the accounting so that puts him in a difficult position,” said David Dreman, chairman and chief investment officer at Dreman Value Management in Jersey City. Dreman owns more than 8 million shares of Fannie Mae, making it one of the company’s 25 largest investors.
Raines came across as being “arrogant” in his testimony to Congress, he said.
Dreman said he is holding onto his position because the stock is trading at less than 9 times earnings.
Fannie Mae stock fell $1.39 to $69.30 yesterday.
Freddie Mac in mid-2003 said it uncovered accounting errors that would cause it to restate earnings by about $5 billion for the previous three years. Soon after, the McLean, Va.-based company’s three top executives, including Chairman and Chief Executive Leland Brendsel, were ousted. The company’s shares are up 21 percent this year.
The SEC said Wednesday that Fannie Mae created its “own unique methodology” to determine whether its accounting for hedges complied with SFAS 133, a rule implemented in 2001 detailing how companies should account for changes in the “fair value” of derivatives.
Fannie Mae last month estimated it would have to report a $9 billion cumulative after-tax loss of the last three years if the SEC determined it erred in recording financial contracts designed to cushion against shifts in interests rates. The company had total net income of about $18.5 billion in 2001, 2002 and 2003 as housing sales set records.
Contrasting Raines’ assurances with SEC’s findings on accounting, Fannie Mae’s board is probably debating whether to remove Raines now or after the company meets a requirement by June to raise its minimum capital reserved by 30 percent, said Sean Egan, managing director of Egan-Jones Rating, a ratings company in Haverford, Pa.
Raines “is on his way out,” said Egan. “It is just a question of when that happens.”
Fannie Mae rewrote employment contracts for Raines, Howard and Chief Operating Officer Daniel 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.”
Raines became CEO on Jan. 1, 1999, taking over from James Johnson, who led the search for Democratic presidential nominee John Kerry’s vice presidential running mate.
The company makes money on the difference between their cost of capital and the returns on the mortgages they buy from banks and their other mortgage investments.
Bloomberg News reporter Catherine Dodge contributed to this report.