WASHINGTON – Fannie Mae (FNM), the nation's second largest financial institution, forced out two top executives as it struggles to deal with an accounting scandal which will likely force it to wipe out $9 billion in profits over the past four years.
Fannie Mae chief executive Franklin Raines (search) and J. Timothy Howard (search), the company's chief financial officer, stepped down Tuesday after lengthy negotiations between the Fannie Mae board and the company's chief government regulator, the Office of Federal Housing Enterprise Oversight (search).
In a statement issued late Tuesday night, Raines said he had decided to leave to fulfill a pledge he made during congressional testimony in October that he would take the blame if serious accounting problems were found at the company.
"By my early retirement, I have held myself accountable," Raines said.
A Fannie Mae statement announced that Howard had also resigned. The company said it had hired an executive search firm to find replacements for the two men.
The management shakeup was having a beneficial impact on the company's stock price as investors responded to signs that the Fannie Mae board was moving aggressively to deal with the company's problems. Fannie Mae stock rose $2.26, or 3.2 percent, to $72.61 Wednesday.
Industry and congressional sources, who spoke on condition of anonymity, said Fannie Mae's board had been pressured by OFHEO during tense negotiations over the past several days to demand the resignations of both Raines and Howard.
OFHEO Director Armando Falcon Jr. said in a statement that his agency had determined that Fannie Mae, the biggest player in the nation's $8 trillion mortgage market, had been left "significantly undercapitalized" because of its accounting problems.
He said the Fannie Mae board was to be commended for the steps it was now taking to address those problems. "We are encouraged that the board's announcement signals a new culture and a new direction for Fannie Mae," Falcon said.
A review by the Securities and Exchange Commission (search) determined last week that Fannie Mae must restate earnings back to 2001 because it violated accounting rules for derivatives — financial instruments used to hedge against interest-rate swings — and for some prepaid loans.
That restatement of earnings is likely to wipe out $9 billion — or about one-third — of Fannie Mae's profits — since 2001.
To make up the anticipated $9 billion shortfall, Fannie Mae probably would have to sell part of its portfolio of mortgages, raise fresh capital by issuing stock or cut dividends — and its spectacular growth of recent years could be curtailed. The company was ordered by the regulators in September to boost its capital cushion against risk by some $5 billion by mid-2005.
In addition to OFHEO's investigation, the SEC is continuing its own probe and the Justice Department is pursing a criminal investigation.
Fannie Mae, long a Wall Street darling, is the biggest buyer and guarantor of home mortgage loans in the United States and is the country's second largest financial institution behind Citigroup Inc. (C).
The revelations of accounting problems in September pushed Fannie Mae's stock down by 13 percent to a 52-week low of $62.95.
Fannie Mae said it would install Daniel Mudd, the company's chief operating officer, as interim chief executive. Fannie Mae board member Stephen Ashley will serve as non-executive company chairman.
Howard will be replaced on an interim basis as chief financial officer by Fannie Mae executive vice president Robert Levin, the company said. It said it had also dismissed it's auditing firm, KPMG, and had begun a search for a new auditing company.
Raines' abrupt departure represented a sharp reversal of fortune for one Washington's most influential and politically savvy figures. When he was selected to head Fannie Mae in 1999, Raines became the first black CEO of a major U.S. corporation.
Raines, 55, had been successful in fending off efforts by competitors and congressional critics to strip away some of the privileges the company enjoyed as a government-sponsored enterprise, which allowed Fannie Mae to borrow money at below-market rates because investors believed if the company ever got into financial trouble, the federal government would step in and bail it out.
However, a blistering report by OFHEO, which was made public in September, cast doubt on Fannie Mae's past earnings reports and even its financial soundness. OFHEO raised the possibility that the company had employed deliberate accounting maneuvers designed to meet earnings targets and thereby bring bigger bonuses to top executives.
Raines and Howard defended the company's accounting in sworn testimony at a congressional hearing in October.
In a statement, Rep. Richard Baker, R-La., the chairman of a House Financial Services subcommittee that oversees Fannie Mae, said: "Given the unbelievable statements Fannie executives made at our last hearing, this action was entirely necessary."
The problems at Fannie Mae were similar to accounting difficulties encountered by its smaller competitor, Freddie Mac, which emerged from its own accounting scandal and executive shake-up after disclosing in June 2003 it had misstated earnings by $5 billion.