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Archive for Thursday, December 23, 2004

Fannie Mae works to restore credibility

December 23, 2004

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— The forced departure of Franklin D. Raines as chief executive of Fannie Mae hardly ends the turmoil at the nation's second largest financial institution. Civil, criminal and congressional investigations are under way as the mortgage giant's interim managers begin what could be a lengthy process of cleaning up the books and re-establishing its credibility.

But in good news for consumers, analysts said Wednesday, Fannie Mae's troubles should not cause any disruptions in the nation's $8 trillion mortgage market.

Fannie Mae accounts for about 25 percent of the market.

"The impact on the average homebuyer will be imperceptible," said Mark Zandi, chief economist at Economy.com. "The mortgage market is very deep, large and liquid, with many global participants who will fill any void created by a less aggressive Fannie Mae."

Fannie Mae's board of directors announced Tuesday the departures of Raines and Chief Financial Officer Timothy Howard following intense negotiations.

The Office of Federal Housing Enterprise Oversight -- the company's chief regulator -- pressured the board to act after the Securities and Exchange Commission disclosed that the company must make accounting corrections that could erase $9 billion of past profit going back to 2001.

On an interim basis, Raines will be replaced by Daniel H. Mudd, currently the company's chief operating officer, while Robert J. Levin will serve as interim chief financial officer. Fannie Mae will work with an outside search firm to find permanent replacements.

The new executives face a daunting task of dealing with OFHEO's continuing investigation of the company's accounting practices as well as a civil investigation by the SEC and a criminal probe by the Justice Department. Shareholder suits have also have been filed against the company.

The restatement of up to $9 billion of past profits -- about one-third of the company's reported profits since 2001 -- could force the company to take a variety of actions to deal with what OFHEO described as a "significantly undercapitalized" balance sheet, meaning the regulators believe the company lacks the money to cover potential losses. Fannie Mae is second in size only to Citigroup Inc.

Analysts predicted Fannie Mae would consider numerous options for raising capital, ranging from selling off part of its mortgage portfolio to issuing more stock or cutting dividends.

Wall Street reacted with relief Wednesday to the management shake-up, pushing Fannie Mae's stock price up by as much as $3.46 from Tuesday's close. However, it gave back over half of those gains on profit-taking, finishing the day at $71.92, a gain of $1.57, or 2.2 percent, from Tuesday's close. The company's stock hit a 52-week low of $62.95 in September after the revelations about the extent of the accounting problems.

Analysts cautioned against believing that Wednesday's rally in Fannie Mae stock meant investors' concerns had been dealt with.

"The problem is that nobody is sure what is still lying in the weeds," said David Wyss, chief economist at Standard & Poor's in New York.

Finding out if there are other accounting issues that have yet to surface could take some time, with some analysts predicting Fannie Mae's books may not be fully corrected for two years.

Freddie Mac, Fannie Mae's smaller brother in the housing finance business, is still sorting through its own accounting scandal after disclosing in June 2003 that it had misstated earnings by $5 billion.

"Freddie Mac has said they will spend at least $200 million cleaning up all of their accounting problems and I think that is a very reasonable estimate for Fannie Mae as well," said financial analyst Bert Ely, a longtime critic of Fannie Mae's operations.

Congressional critics of both institutions vowed Wednesday to renew their efforts to clamp tighter regulatory controls on the two companies, saying the revelations should boost their chances of success.

"I cannot imagine any circumstances that would make a more dramatic change in the opinions of members of Congress than these circumstances," said Rep. Richard Baker, R-La., who is chairman of the House Financial Services' subcommittee that oversees the institutions.

Baker estimated that Fannie Mae had paid out bonuses totaling about $245 million since 2001 and he urged OFHEO to "take action to recapture all bonus payments from executives that were awarded based upon the faulty and deeply flawed earnings statements" from Fannie Mae.

Senate Banking Committee Chairman Richard Shelby, R-Ala., vowed to press ahead with his efforts to enact "comprehensive regulatory reform" that would deal with Fannie Mae, Freddie Mac and the Federal Home Loan Banks. They are all classified as government-sponsored enterprises, giving them a number of advantages over competitors in the mortgage market.

Congress created the institutions starting in the 1930s to guarantee an adequate pool of mortgages throughout the country. Fannie and Freddie buy mortgages from lending institutions, giving local institutions more money to make additional loans. They either hold the mortgages in their own portfolios or repackage them as mortgage-backed securities that are traded on financial markets.

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