The Accounting Scandal at Fannie Mae

This is a partial transcript of "Special Report With Brit Hume," Dec. 22, 2004, that has been edited for clarity.

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BRIT HUME, HOST: When Franklin Raines (search) resigned this week as the head of Fannie Mae, it was a big financial story, the result of an accounting scandal, but it was a big political story as well and not just because the second biggest financial institution in America is located here in Washington.

For more on why, who better to ask than our own FOX News contributor, Jeff Birnbaum, who has been covering this story at The Washington Post.

So, Jeff, why is Fannie Mae’s troubles such a big political story?

JEFF BIRNBAUM, COLUMNIST, "THE WASHINGTON POST": Well, more than most, or almost every other company in the country, Fannie Mae (search) and its smaller sister Freddie Mac are very closely tied to the federal government. These are companies that buy big pools of mortgages and finances them to try to bring down the cost of mortgages for average, moderate, low-income families. This is done under a federal charter, because there’s a mission for these companies by the federal government to try to make homes more affordable for the average person.

HUME: Let me see if I understand how they do that. They go to banks that make mortgage loans and they buy the loans from the banks.

BIRNBAUM: That’s correct.

HUME: Thereby, the banks end up with the money paid back to them, with I presume, some interest.

BIRNBAUM: That’s right.

HUME: And then Fannie Mae holds the mortgages and collects the interest and the principal payments from the shareholders? Or do they sell them again?

BIRNBAUM: Well, they can sell them again. And they have all other sorts of financial arrangements, all with the idea of providing more money to the front — to the mortgage lenders.

HUME: And the reasons — in other words, the mortgage lenders end up with the money back that they’d loaned. So they have more money to lend out. How does Fannie Mae make any money?

BIRNBAUM: Because of their implied connection to the federal government.

HUME: Now, how does that benefit them?

BIRNBAUM: Well, because — though it doesn’t say so anywhere in black and white, a lot of the people who buy the securities from Fannie Mae believe that the federal government will back those securities, if Fannie Mae were ever to get in any trouble.

HUME: Doesn’t Fannie Mae raise money to buy these loans at a reduced rate giving them a competitive advantage over other people?

BIRNBAUM: There are a long list of advantages that the connection to the federal government gives Fannie Mae. But in effect, it gives them the highest rating of bond agencies; that is Triple-A. They can borrow money at a lower price to them as any company or country, for that matter. And so that gives them a huge advantage in borrowing at a very low rate. And they pass on a lot of those savings to those lending institutions, and they in turn provide plentiful mortgages to low and moderate-income families.

HUME: Frank Raines, who ran Fannie Mae, very very nice man, very successful, attractive man. He was the budget director under President Clinton, popular in Washington. What went wrong here?

BIRNBAUM: Well, in part, it wasn’t the politics that got Frank Raines in trouble, but the financing. The accounting in that company was called into question by its regulator.

HUME: There is some government agency that regulates them.

BIRNBAUM: That’s right.

HUME: And what happened?

BIRNBAUM: They looked at their books and they saw that Fannie Mae was accounting for expenses in ways that were not proper. The most flagrant was way back in 1998, where the company deferred accounting for expenses, about $200 million or so. And it had the effect of...

HUME: You mean they put it off from one year to the next?

BIRNBAUM: That’s right. Smoothing these kinds of expenses.

HUME: So the profits appeared to be bigger in 1998 than they otherwise would have been if they hadn’t deferred accounting these expenses against the profits.

BIRNBAUM: That’s right. Well, and it freed up money that could be used for, for example, providing bonuses, the full bonuses to the top executives at Fannie Mae, including Frank Raines. And they are already paid millions of dollars a year, very high compensation, as high as any other financial institution in the country.

And so that and the combination of other accounting mistakes, as found not just by this agency that overlooks Fannie Mae and Freddie Mac (search), but also, by the Securities and Exchange Commission. It’s so large an accounting problem, in fact, that Fannie Mae will have to restate its earnings, that is, reduce them by $9 billion over a 3.5-year period. That’s a lot of accounting error.

HUME: So why did it fall down — why did it come down so hard on Raines himself?

BIRNBAUM: Well, Raines in testimony before Congress just this fall, he said that he would be — he should be held accountable personally if the Securities and Exchange Commission finds that Fannie Mae’s accounting went awry.

HUME: He had personally vouched for their accounting being sound?

BIRNBAUM: And in fact, in the loss that followed the Enron scandal, Raines actually has to sign the earnings and vouch for them himself. And so for both a legal and public, in terms of public statement, Raines held himself personally accountable. And he had no choice really but to leave.

HUME: Critics of Fannie Mae and Freddie Mac as well, say that these companies shouldn’t have this attachment, this connection to the federal government. That it creates potential problems for government, and that they don’t need that to serve their function. What about that argument?

BIRNBAUM: Well, there are a lot of very high-placed people in the federal government who believe that. There are people like Secretary John Snow and Alan Greenspan, the chairman of the Federal Reserve, who believe that Fannie Mae needs to be more tightly controlled. And to make clear that this implied connection to the federal government is really not as tight a connection as most people assume.

HUME: Which would mean that if Fannie Mae got in trouble that the government wouldn’t necessarily bail it out.

BIRNBAUM: And there will be legislation in the coming year that may make that a little bit clearer, making Snow happy, but perhaps Fannie Mae not as happy.

HUME: You mean the Treasury Secretary Snow, right?

BIRNBAUM: That’s right.

HUME: So you think there’s a shot that this could pass.

BIRNBAUM: I think there’s an excellent chance that Fannie Mae will be separated slightly from the federal government in terms of regulation. And it will get an even tougher regulator than its current agency.

HUME: Jeff, thanks very much.

BIRNBAUM: Thank you.

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