Accounting fraud. Congressional investigations. CEO's being forced out. Investors losing tens of billions of dollars. We've seen all this before, but never have the stakes been so high...and never has the financial media been so quiet on such a serious topic.
Fannie Mae is the second largest financial institution in America (after Citigroup), the second-biggest borrower after the federal government, finances one of every five home loans in the country, and they are
tottering.
As part of a scandal that's been running nearly two years, Fannie Mae has "misstated earnings" to the tune of $10.8 billion. That's some tune.
So far, the Fannie fiasco has cost Chief Executive Officer Franklin Raines and several other top executives their jobs. The stock has dropped from nearly $80 a share to around $50 -- roughly $30 billion in lost value. And the company recently settled with the federal government and agreed to pay $400 million in fines, stemming from allegations the firm fiddled with the books to ensure bigwigs got performance bonuses.
To give you an idea of just how big this is, the Assistant
Treasury Secretary Emil Henry warned yesterday of what amounts to a financial armageddon.
"Unless the portfolios are hedged properly, in a period of significant interest-rate movement, there is a risk to the GSEs that their assets and liabilities will ... become broadly mismatched which can lead to insolvency." Henry likened the potential for GSE problems to the savings and loan crisis of the 1980s.
To put it bluntly, insolvency is
not an option that anyone wants to think about. The portfolios of Fannie Mae and Freddie Mac are more than $1.5 Trillion (an amount Enron and WorldCom combined couldn't even dream of).
How did we get here?
It started back in December 2004, when Fannie Mae announced $9 Billion in writedowns.
More accounting errors were found in November of 2005, and were quickly followed by evidence of "earnings smoothing" in February of this year.
Early on both the CEO Franklin Raines and CFO Timothy Howard were forced out of their jobs. An OFHEO (Office of Federal Housing Enterprise Oversight) investigation was launched in early 2005 (their report was released just a month ago). The SEC found evidence of improper accounting shortly thereafter, yet the new CEO of Fannie Mae, Daniel Mudd, still claimed that there was no need for tighter congressional oversight in April of 2005. This is the same guy who was told in 2003 that there was accounting fraud going on and he failed to tell the board of directors about it.
Congress ranted and raved, and in the end they have still not acted. Fannie Mae and Freddie Mac lobbied heavily to prevent more government oversight. Only last week did Congress finally launch some hearings about the "extensive financial fraud". One lawmaker now wants to know if Fannie Mae executives perjured themselves in front of Congress in 2004. Former CEO Raines refused to testify at these hearings.
Yet even now, Fannie Mae can't tell the government what its finances are.
The company announced in July 2002 it would voluntarily register its common stock with the SEC. It subsequently began filing periodic financial reports, but many of them were late, incomplete or not filed at all.
It has so far failed to file with the SEC annual reports for 2004 and 2005 and reports for the previous seven quarters.
Why does this matter to me?Fannie Mae is no average company. A federally chartered institution created during the Depression to provide more money for mortgages, it was spun off in the 1960s by Congress into a lucrative private company that still enjoys taxpayer-financed perks. It does not have to pay state and local taxes. It has a standing letter of credit from the U.S. Treasury. It is exempt from many of the reporting requirements of other public corporations. It can borrow money at lower interest rates than other companies can.
It also creates special risks. The company, which pours money into the housing market by buying millions of mortgages from banks, is crucial to the functioning of the economy. For that reason, taxpayers would almost certainly be called on to bail it out if it ever got into serious financial trouble. That makes an honest accounting of its profits, assets and liabilities a vital public trust.
You read that right. The American taxpayer could be asked to foot the bill if Fannie Mae goes under.
And let's not forget Freddie Mac. They had their
own scandal in 2003, where the CFO and COO were forced out of their jobs when it was learned that $5 Billion in earnings was misstated. Freddie Mac had to pay a $125 million fine.
But Fannie Mae's problems are much worse than Freddie Mac's. Freddie mearly did "earning smoothing" (something people have suspected Microsoft of doing for many years). Fannie Mae's actions was outright fraud of
at least $11 Billion, which has cost investors $25 to $30 Billion so far.
If that isn't bad enough, these problems could become critical in the coming months.
Fannie Mae and Freddie Mac had trouble keeping their books clean during the fat years of 2002-2005, when interest rates were low and the real estate market boomed.
Now interest rates are rising and the housing market is slowing. Nationwide the inventory of unsold houses has more than doubled over last year. Homebuilder confidence is at an 11-year low. Foreclosures are up everywhere. In some places they are reaching critical mass.
And remember - all this is happening with mortgage rates rising only about 1% off of multi-year lows. What happens if mortgage rates rise back to normal historic levels? And what happens if fraud at Fannie Mae can't be fixed while their portfolio turns sour in a nationwide real estate slump?
And most of all, where the H*LL is the national media on this?