[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
THE OFHEO REPORT:
ALLEGATIONS OF ACCOUNTING AND
MANAGEMENT FAILURE AT FANNIE MAE
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
CAPITAL MARKETS, INSURANCE AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
__________
OCTOBER 6, 2004
__________
Printed for the use of the Committee on Financial Services
Serial No. 108-115
97-754 WASHINGTON : 2004
_________________________________________________________________
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866)512-1800;
DC area (202) 512-1800 Fax: (202) 512-2250 Mail: Stop SSOP,
Washington, DC 20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana PAUL E. KANJORSKI, Pennsylvania
SPENCER BACHUS, Alabama MAXINE WATERS, California
MICHAEL N. CASTLE, Delaware CAROLYN B. MALONEY, New York
PETER T. KING, New York LUIS V. GUTIERREZ, Illinois
EDWARD R. ROYCE, California NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma MELVIN L. WATT, North Carolina
ROBERT W. NEY, Ohio GARY L. ACKERMAN, New York
SUE W. KELLY, New York, Vice Chair DARLENE HOOLEY, Oregon
RON PAUL, Texas JULIA CARSON, Indiana
PAUL E. GILLMOR, Ohio BRAD SHERMAN, California
JIM RYUN, Kansas GREGORY W. MEEKS, New York
STEVEN C. LaTOURETTE, Ohio BARBARA LEE, California
DONALD A. MANZULLO, Illinois JAY INSLEE, Washington
WALTER B. JONES, Jr., North DENNIS MOORE, Kansas
Carolina MICHAEL E. CAPUANO, Massachusetts
DOUG OSE, California HAROLD E. FORD, Jr., Tennessee
JUDY BIGGERT, Illinois RUBEN HINOJOSA, Texas
MARK GREEN, Wisconsin KEN LUCAS, Kentucky
PATRICK J. TOOMEY, Pennsylvania JOSEPH CROWLEY, New York
CHRISTOPHER SHAYS, Connecticut WM. LACY CLAY, Missouri
JOHN B. SHADEGG, Arizona STEVE ISRAEL, New York
VITO FOSSELLA, New York MIKE ROSS, Arkansas
GARY G. MILLER, California CAROLYN McCARTHY, New York
MELISSA A. HART, Pennsylvania JOE BACA, California
SHELLEY MOORE CAPITO, West Virginia JIM MATHESON, Utah
PATRICK J. TIBERI, Ohio STEPHEN F. LYNCH, Massachusetts
MARK R. KENNEDY, Minnesota BRAD MILLER, North Carolina
TOM FEENEY, Florida RAHM EMANUEL, Illinois
JEB HENSARLING, Texas DAVID SCOTT, Georgia
SCOTT GARRETT, New Jersey ARTUR DAVIS, Alabama
TIM MURPHY, Pennsylvania CHRIS BELL, Texas
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina BERNARD SANDERS, Vermont
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
JIM GERLACH, Pennsylvania
Robert U. Foster, III, Staff Director
Subcommittee on Capital Markets, Insurance and Government Sponsored
Enterprises
RICHARD H. BAKER, Louisiana, Chairman
DOUG OSE, California, Vice Chairman PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware GREGORY W. MEEKS, New York
PETER T. KING, New York JAY INSLEE, Washington
FRANK D. LUCAS, Oklahoma DENNIS MOORE, Kansas
EDWARD R. ROYCE, California MICHAEL E. CAPUANO, Massachusetts
DONALD A. MANZULLO, Illinois HAROLD E. FORD, Jr., Tennessee
SUE W. KELLY, New York RUBEN HINOJOSA, Texas
ROBERT W. NEY, Ohio KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona JOSEPH CROWLEY, New York
JIM RYUN, Kansas STEVE ISRAEL, New York
VITO FOSSELLA, New York, MIKE ROSS, Arkansas
JUDY BIGGERT, Illinois WM. LACY CLAY, Missouri
MARK GREEN, Wisconsin CAROLYN McCARTHY, New York
GARY G. MILLER, California JOE BACA, California
PATRICK J. TOOMEY, Pennsylvania JIM MATHESON, Utah
SHELLEY MOORE CAPITO, West Virginia STEPHEN F. LYNCH, Massachusetts
MELISSA A. HART, Pennsylvania BRAD MILLER, North Carolina
MARK R. KENNEDY, Minnesota RAHM EMANUEL, Illinois
PATRICK J. TIBERI, Ohio DAVID SCOTT, Georgia
GINNY BROWN-WAITE, Florida NYDIA M. VELAZQUEZ, New York
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
C O N T E N T S
----------
Page
Hearing held on:
October 6, 2004.............................................. 1
Appendix:
October 6, 2004.............................................. 145
WITNESSES
Wednesday, October 6, 2004
Falcon, Hon. Armando, Director, Office of Federal Housing
Enterprise Oversight, accompanied by Wanda Deleo, Chief
Accountant, and Christopher Dickerson, Chief Compliance
Examiner, Office of Federal Housing Enterprise Oversight....... 22
Howard, Timothy, Vice Chairman and Chief Financial Officer,
Fannie Mae..................................................... 76
Korologos, Hon. Ann McLaughlin, Presiding Director, Board of
Directors, Fannie Mae.......................................... 128
Raines, Franklin D., Chairman and Chief Executive Officer, Fannie
Mae............................................................ 73
APPENDIX
Prepared statements:
Baker, Hon. Richard H........................................ 146
Oxley, Hon. Michael G........................................ 148
Castle, Hon. Michael N....................................... 150
Clay, Hon. Wm. Lacy.......................................... 151
Ford, Hon. Harold E. Jr...................................... 152
Gillmor, Hon. Paul E......................................... 154
Kanjorski, Hon. Paul E....................................... 156
Miller, Hon. Gary G.......................................... 158
Falcon, Hon. Armando......................................... 160
Howard, Timothy.............................................. 169
Korologos, Hon. Ann McLaughlin............................... 171
Raines, Franklin D........................................... 176
Additional Material Submitted for the Record
Baker, Hon. Richard H.:
Letter to OFHEO Director Armando Falcon, Jr. with response,
November 4, 2003........................................... 183
Castle, Hon. Michael N.:
Letter to Financial Accounting Standards Board, October 5,
2004....................................................... 188
Frank, Hon. Barney:
``Deja Vu All Over Again, Thoughts on OFHEO's Special
Examination of FNM''....................................... 190
Barnes, Roger, former Manager of Financial Accounting, Fannie
Mae, prepared statement........................................ 197
Falcon, Hon. Armando:
Report of Findings to Date, Special Examination of Fannie Mae 223
Written response to Members questions posed during the
hearing.................................................... 434
Korologos, Hon. Ann McLaughlin:
Fannie Mae Board of Directors Work Plan in Response to OFHEO
Report on Special Examination.............................. 443
Raines, Franklin D.:
Core and GAAP Earnings Per Share............................. 447
THE OFHEO REPORT:
ALLEGATIONS OF ACCOUNTING AND
MANAGEMENT FAILURE AT FANNIE MAE
----------
Wednesday, October 6, 2004
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance,
and Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to call, at 10:03 a.m., in
Room 2128, Rayburn House Office Building, Hon. Richard H. Baker
[chairman of the subcommittee] presiding.
Present: Representatives Baker, Ose, Shays, Gillmor,
Bachus, Castle, Lucas of Oklahoma, Royce, Manzullo, Kelly, Ney,
Fossella, Biggert, Miller of California, Toomey, Capito, Hart,
Kennedy, Tiberi, Brown-Waite, Kanjorski, Sherman, Meeks,
Inslee, Capuano, Ford, Hinojosa, Lucas of Kentucky, Crowley,
Clay, McCarthy, Baca, Matheson, Lynch, Miller of North
Carolina, Scott, and Velazquez.
Also present: Representatives Oxley (ex officio), Frank (ex
officio), Watt, Waters, Davis of Alabama, Maloney, and Brown of
Florida.
Chairman Baker. [Presiding.] I would like to call this
meeting of the Capital Markets Subcommittee to order.
The Capital Markets Subcommittee meets today for the
purpose of receipt of a report from the Office of Federal
Housing Enterprise Oversight.
It is indeed a very troubling report, but it is a report of
extraordinary importance not only to those who wish to own a
home, but also as to the taxpayers of this country who would
pay the cost of the cleanup of an enterprise failure.
Although not intended to fuel the effort to bring about
regulatory reform, the analysis makes clear that more resources
must be brought to bear to ensure the highest standards of
conduct are not only required, but more importantly, they are
actually met.
For the record, I am not pleased and certainly not happy
about these revelations. I am saddened by the disclosures. In
all my years of inquiry in this matter, I was only in pursuit
of appropriate oversight. Never did I question whether the GSEs
were professionally managed to the highest standards of
business conduct. Now I do. The culture of mismanagement
described in the report must be eliminated and assurances
gained that the highest standards of conduct will be
consistently practiced.
I know there will be those who will still cling to the
belief that the issues raised are minor or that opinions may
differ on technical accounting standards. Some may still think
this is all a plot by the big banks to preserve market share.
The content of this report, in my view, cannot be legitimately
questioned. Utilizing the firm of Deloitte & Touche and the
staff of OFHEO, the director's report is delivered after review
of over 200,000 documents and e-mails, as well as hundreds of
interviews and depositions of current and former staff of
Fannie Mae.
The statement made in the first page of the executive
summary unfortunately sums up our circumstance: ``The matters
detailed in this report are serious and raise concerns
regarding the validity of previously reported financial
results, the adequacy of regulatory capital, the quality of
managerial supervision and the overall safety and soundness of
the enterprise.'' This finding, in my judgment, makes committee
action essential.
For the record, I should also note that the resistance the
GSEs have expressed toward enhanced housing goals. In light of
these revelations, their opposition now makes more sense than
ever. Should the proposals considered in this committee focus
clearly on the needs of first-time homebuyers actually become
law, the enterprises would have to allocate resources to those
goals at the expense of reduced earnings.
A reduction in earnings would reduce the likelihood of
paying out bonuses to executives. This same observation holds
true as to the regulator's decision to increase capital, and
Fannie's strong objections to such a requirement. We all know
that the enterprise is thinly capitalized, but the potential
effect of requiring a responsible capital level would adversely
affect earnings per share, and consequently affect the bonus
payments to executives.
I also wish to inform members of the committee of another
troubling incident, which I now choose to make public. About a
year ago, I corresponded with the director's office making
inquiry about the levels of executive compensation at the
enterprise for the top 20 executives. This is information that
had not been made public previously.
In a matter of days, Fannie Mae had engaged the services of
Mr. Ken Starr, legal counsel, for the purpose of informing my
staff and committee council of the potential consequences of
making that information public. It was made clear that civil
legal actions would be filed, I presume against me, if the
information were to be released.
At that time, I made the decision not to release the data
since there was no clear relevance to the reform effort under
way, not out of concern for any litigation that might be filed.
The realization that the disclosure of this information was so
sensitive to the enterprise never really fully impacted me
until I read the director's report. Now I understand why the
enterprise was so anxious not to have public disclosure of
compensation, ironically of an entity that was created by the
Congress and supported by the taxpayer.
Circumstances have now changed. As a direct result of the
abhorrent accounting practices, executives have been able to
award themselves bonuses I do not believe they earned and I do
not believe they deserve. For that reason alone, disclosure of
where the money went is highly appropriate.
At the conclusion of this hearing, I will release the
compensation information obtained from OFHEO and further, I
will forward a letter to the director requesting that all
compensation information for both enterprises be provided to
the committee for a period covering 10 years for all executives
that shared in any bonus distributions. This is now essential,
in that OFHEO has indicated that accounting manipulation has
impacted the financials on more than one occasion, therefore
placing the payment of bonuses in question.
I find this very troublesome business. Much is at stake.
The ability of this committee and this Congress to act will be
called into question. Notwithstanding the ultimate outcome, the
facts will remain and our duty will never be more clear.
Mr. Kanjorski?
[The prepared statement of Hon. Richard H. Baker can be
found on page 146 in the appendix.]
Mr. Kanjorski. Mr. Chairman, we meet today for what might
well be our last hearing this year. At our first hearing in
2004, we reviewed the special examination of Freddie Mac by the
Office of Federal Housing Enterprise Oversight. It therefore
seems fitting that we will bookend our hearings this year with
an evaluation of the findings to date of a similar examination
of Fannie Mae's accounting policies and practices.
The recently released preliminary report by the Office of
Federal Housing Enterprise Oversight includes a number of
significant charges. The report concludes that Fannie Mae has
failed to follow generally accepted accounting practices in two
key areas. They are the accounting of derivatives contracts and
the amortization of discounts, premiums and fees involved in
the purchase of home mortgages.
The report also raises concerns about the company's
organizational structure and its internal controls. These are
serious matters that merit our careful attention because
government-sponsored enterprises with their public
responsibilities and private capital have, in my view, a
special obligation to operate fairly, safely and soundly.
As we proceed today, I must urge my colleagues on both
sides of the aisle to demonstrate patience and caution when
approaching these matters. We should not leap to immediate
conclusions. The report on Fannie Mae is preliminary. It is
part of an ongoing process.
We should not overanalyze these findings because we do not
have all of the information. Fannie Mae's board, as I
understand, has already agreed to adopt a number of reforms
based on this initial report and it may ultimately implement
more. The Office of Federal Housing Enterprise Oversight
continues to examine the company's books. The Securities and
Exchange Commission, the arbiter of accounting standards for
Fannie Mae, is now studying these matters. In short, we need to
let this process work itself out.
We should also refrain from hyping these initial findings
in an effort to achieve some short-term gain. As we well know
from past experiences, our actions and statements on Capitol
Hill have the potential to rile the capital markets. They could
also raise the price of homeownership. We should therefore
practice caution, prudence and discretion.
My primary focus at today's hearing will be to determine
whether the issues raised in the preliminary report constitute
some form of systemic risk for Fannie Mae. I therefore intend
to ask each of the witnesses their perceptions regarding this
issue. I expect them each to offer me their candid assessments
of these matters.
As we proceed today, I also suspect that some of my
colleagues will return to the question of how best to modify
the regulation of government-sponsored enterprises like Fannie
Mae and Freddie Mac. As I said at our very first hearing on the
oversight of government-sponsored enterprises in March 2000,
``We need to have strong, independent regulators that have the
resources they need to get the job done.'' I can assure
everyone involved in these debates that I continue to support
strong, world-class and independent GSE regulation.
A strong world-class and independent regulator will protect
the continued viability of our capital markets and promote
confidence in Fannie Mae and Freddie Mac. It will also ensure
taxpayers against systemic risk and expand housing
opportunities for all Americans.
Like many of my colleagues, I was greatly disappointed last
year when the Bush administration rejected our bipartisan
efforts to create an independent regulator. Politics, in my
view, should play no role in financial regulation. It is
therefore my hope that when we revisit this issue in the 109th
Congress, we will continue to remain resolute and unwavering in
our bipartisan efforts to create a strong, independent and
world-class regulator with the powers and resources it needs to
get the job done.
In closing, Mr. Chairman, I commend you for your sustained
leadership in these matters and for convening this timely
hearing. The preliminary report by the Office of Federal
Housing Enterprise Oversight and its agreement with Fannie Mae
deserve careful review and public scrutiny. I consequently look
forward to hearing from our witnesses today.
[The prepared statement of Hon. Paul E. Kanjorski can be
found on page 156 in the appendix.]
Chairman Baker. I thank the gentleman for his statement.
Chairman Oxley?
Mr. Oxley. Thank you, Chairman Baker, for holding this
hearing on the recently released report from OFHEO's special
examination of Fannie Mae. You have followed these issues
closely and should be commended for your diligent oversight of
the GSEs. It is my hope that this hearing will highlight the
concerns raised in the OFHEO report and will help members get
to the bottom of the accounting and corporate governance issues
at Fannie Mae.
It is unfortunate that we are here today. After earnings
smoothing at Freddie Mac was discovered, the public and the
markets, and the members of the committee were assured that
there were no similar issues at Fannie Mae. The findings in
OFHEO's report, if accurate, are disturbing.
While we wait for OFHEO, and the Justice Department and the
Securities and Exchange Commission to complete their respective
tasks, the management and board of directors at Fannie Mae must
take real steps to address the issues and continue to cooperate
with regulators. The agreement between Fannie Mae and OFHEO is
a beginning of that process, but I seriously doubt it can be
the end.
Since the enactment of Sarbanes-Oxley 2 years ago,
corporate financial statements have become more transparent and
more reliable. There is no question in my mind that the act is
at least partially responsible for this progress. The CEO and
CFO certifications of financial statements have had a profound
impact on the reporting process.
Other provisions are working, too, such as the Public
Company Accounting Oversight Board's inspections regime,
strengthened and independent audit committees, officer and
director bars, the Fair Funds, expedited disclosures of insider
transactions, and internal control requirements, to name just a
few. That is not to say that we can legislate integrity in
every case, but we do have a sensible framework of incentives
and disincentives that will affect behavior.
The OFHEO report raises serious questions about whether
Fannie Mae has adequate internal control procedures, ultimately
one of the core aspects of Sarbanes-Oxley. The multiple and
conflicting duties of the chief financial officer, who we will
hear from this morning, calls into question whether there is
adequate separation between the risk-taking and control
functions.
In my view, section 404 is one of the most important parts
of the Sarbanes-Oxley Act. Internal control over financial
reporting consists of company policies and procedures that are
designed to provide reasonable assurance about the reliability
of a company's financial reporting and the preparation of
external financial statements in accordance with generally
accepted accounting principles. Failure to comply with its
requirements is not an insignificant matter. I am eager to hear
from the company's senior management officials on their
adherence to this critical provision.
Fannie Mae enjoys certain advantages in the marketplace not
afforded to other financial companies in order to serve a
public purpose. We have recently learned that the corporate
structure may have fostered an atmosphere in which senior
management may have had undue influence over accounting
policies and procedures, and that corporate earnings and
management compensation may have been manipulated.
OFHEO has worked hard in conducting reviews of the GSEs.
Director Falcon and his staff have been diligent in trying to
ensure that the GSEs receive the appropriate oversight. The
findings of this report, if correct, reinforce arguments for
the creation of a GSE regulator with the powers and authorities
granted to other financial regulators and commensurate with the
task of overseeing these large and complicated companies.
I was dismayed to learn that OFHEO was forced to resort to
issuing subpoenas this past July in order to obtain cooperation
with its investigation. It is my sense that if OFHEO had the
tools possessed by other regulators, this investigation would
not have reached the subpoena stage. If we had a GSE regulator
with the powers and authority of a world-class regulator, it is
possible that these problems at Fannie Mae would have been
remedied earlier and today's hearing would not be necessary.
The OFHEO report details problems ranging from possible
earnings manipulation to management structures that may not
have been in line with state-of-the-art corporate governance. I
am very concerned about the possibility that Fannie Mae claims
to have sound corporate governance standards, when in reality
these standards are not in practice.
Fannie Mae's board did the right thing in entering into an
agreement with OFHEO and beginning the process of remedying the
problems highlighted in the report. The OFHEO report is not
finished and it is my hope that Fannie Mae will cooperate with
this investigation as well as the other investigations
currently under way at the Securities and Exchange Commission
and the Department of Justice. Furthermore, I hope that this
situation does not develop into a war among accountants arguing
technical points that do not put to rest the issues raised in
the OFHEO report. We owe it to the housing market and to the
financial markets to quickly resolve all of the accounting and
governance uncertainties.
I want to welcome all the witnesses appearing before the
subcommittee today. I look forward to your testimony.
I yield back.
[The prepared statement of Hon. Michael G. Oxley can be
found on page 148 in the appendix.]
Chairman Baker. Thank you, Mr. Chairman, for your interest
and leadership in this matter.
Ranking Member Frank?
Mr. Frank. Thank you, Mr. Chairman.
First, I want to address a little history here. The
committee here was well on the way to adopting legislation that
would have enhanced the regulatory structure for Fannie Mae and
Freddie Mac. In the Senate, in fact, the committee actually
voted out a bill. There was some disagreement between the
parties over I think a relatively minor section over
receivership. I think that could have been worked out.
I believe we were well on the way, the chairman and I and
the staffs, to putting together a bill that would have enhanced
the regulator and could have passed. What stopped progress on a
new bill was the Bush administration's determination to go
beyond safety and soundness and into provisions that would have
restricted the housing function.
What is powerful here are not Fannie Mae and Freddie Mac,
but the interests of a majority of the members of this
committee in housing at two levels. First of all, in housing in
the conventional market, is very important, and the continuance
of Fannie Mae and Freddie Mac are important to that. We also
have a subset of issues involving affordable housing, and those
are very important to many of us.
What derailed the legislation was an insistence by the Bush
administration on going beyond safety and soundness and giving
the regulators, for example, particular power to say, well,
they are going beyond their charter in housing; they should not
do these new products. There were specific issues here that
transcended safety and soundness or went under it, but the
administration was seeking powers that were not related to
safety and soundness.
If they were to have dropped that, we would have a law
already signed and in place, because on the question of safety
and soundness regulation, there has not been a significant
dispute.
I will give you an example of what concerns me in this
regard. Many of us on this committee, contrary to what some
people think, were very aggressive in pushing Fannie Mae to
stay in the manufactured housing business in full fight when
they were talking about retrenching, and that was bipartisan--
the gentleman from Wisconsin, Mr. Green, myself and others,
because you will not get the kind of homeownership we want at
the right demographic.
As to safety and soundness, manufactured housing is an
example. I do not expect Fannie Mae and Freddie Mac to make as
much money as possible on every single entity. The attitude of
OFHEO towards manufactured housing is an example of why I am
concerned about making sure the regulator has safety and
soundness powers, but not general powers. In manufactured
housing, it was those of us on this committee, Democratic and
Republican who care about housing who pushed Fannie Mae to stay
in it.
When I wrote to the secretary of HUD to ask him to join us,
the answer was, several members did, he was much too busy for
that, his scheduler told us, and we could go talk to the head
of FHA. So that is the issue.
Finally, turning to this report, I have to say that I read
the director's testimony and I will talk to him about it again,
I regret what seems to me frankly almost boilerplate in his
report that says at the end of every specific, and this could
raise safety and soundness issues. It could, but nothing in
here seems to me that it does.
To the extent that people played games to get bonuses, I am
outraged. People making that much money, let me put it this
way, at the level of compensation of the top officers of Fannie
Mae, they should get bonuses if they rush into a burning
building to rescue a kid, maybe a cat, but not for doing their
job. I think it is unseemly of them to be getting bonuses in
the first place for doing what they are getting paid very well
to do.
To the extent that there was manipulation, that is very
wrong and should be penalized. But I have seen nothing in here
that suggests that the safety and soundness are at issue, and I
think it serves us badly to raise safety and soundness as a
kind of a general shibboleth, when it does not seem to be the
issue.
Last point, and Fannie and Freddie are to some extent
criticized from both ends. There was an article by Gretchen
Morgenson in the New York Times on Sunday that said the problem
is that they have done too much to bring housing to people who
really cannot afford it and should not be given this chance to
own the housing. Her article said the problem here has been
they have overextended by lending money to people who were
below the economic level that should be there.
On the other hand, they are criticized by the chairman of
this subcommittee for not doing enough for lower-income people.
Both obviously cannot be right. I think what we need to do is
to go forward as we were ready to do with a tougher safety and
soundness regulator, but in ways that do not impinge on
Fannie's and Freddie's ability to do a better job than they
have been doing with affordable housing and to continue to do
the job they have been doing with regard to housing in general.
Chairman Baker. Mr. Shays?
Mr. Shays. Thank you.
I am new to this committee and I was absolutely shocked
when we looked at Enron and WorldCom. The board of directors
did not do their job. The management did not do its job. The
employees did not speak out. The lawyers in the firm were
facilitators. The rating agencies did not do their job. It
scared the hell out of me, frankly.
We passed Sarbanes-Oxley, which was a very tough response
to that. And then I realized that Fannie Mae and Freddie Mac
would not even come under it. They were not under the 1934 Act.
They were not under the 1933 Act. They play by their own rules,
and I am tempted to ask how many people in this room are on the
payroll of Fannie Mae, because what they do is they basically
hire every lobbyist they can possibly hire. They hire some
people to lobby and they hire some people not to lobby so that
the opposition cannot hire them.
Fannie Mae has manipulated, in my judgment, OFHEO for
years. For OFHEO to finally come out with a report as strong as
it is tells me that has got to be the minimum, not the maximum.
I congratulate OFHEO for finally stepping up to the plate and
not being manipulated by the very organization they are
supposed to regulate.
I hear these arguments that Fannie Mae and Freddie Mac are
looking out for the interests of the homeowners, and they score
worse in helping minorities than the private sector banks under
the 1934 Act and the 1933 Act.
Fannie Mae and Freddie Mac are very generous to members of
Congress and very generous to the organizations of caucuses in
Congress. They do not have to disclose what they do. They do
not have to play by the same rules. They are going to crash if
this Congress does not wake up and do something about it.
I am absolutely shocked at the extraordinary tolerance that
has taken place in this Congress. This is just the beginning of
the story. What did OFHEO say? They said they have accounting
methods and practices that did not comply with generally
accepted accounting practices, employed an improper cookie jar
reserve in its accounting system, deferred expenses to meet
compensation targets, did not have proper corporate governance
controls in place.
We need to wake up and the sooner we do the better it will
be for Fannie Mae and Freddie Mac and all their investors, and
the better it will be for our government.
Chairman Baker. The gentleman yields back.
Mr. Scott?
Mr. Scott. Thank you very much, Mr. Chairman.
This is indeed an important hearing. I am very much
concerned about the direction that Fannie Mae is moving in.
Fannie Mae does an extraordinarily important function in our
society, unique among companies in terms of being a catalyst to
increase homeownership among middle-income and lower-income
individuals. So this is a very important hearing.
Last year, Freddie Mac, another corporation with similar
duties, had one of the largest corporate financial restatement
of earnings and saw the ouster of its top executives. Fannie
Mae representatives assured us then, on this subcommittee, that
their books were clean and that they should not be associated
with Freddie Mac's problems.
Now, we are meeting to discuss OFHEO's report, which shows
that Fannie Mae inappropriately reduced earnings volatility and
provided management with the flexibility to determine the
amount of income and expense recognized in any accounting
period. In 1998, the management at Fannie Mae needed an
earnings-per-share target of $3.23 in order to receive the
maximum bonus for the company. Due to the accounting schemes
used by Fannie Mae, the executives just hit the earnings-per-
share mark and they earned bonuses totaling nearly $6 million.
I think the general issue before the public and people all
across this country is simply, has the time come to decide if
companies that violate public trust should continue to receive
special treatment. I think the fundamental question here is,
why the Fannie Mae board believed it was appropriate to link
executive pay to earnings per share, and whether this
compensation scheme resulted in inappropriate incentives for
management.
Whether or not the reasons that the company altered
earnings was to achieve bonuses is not yet known. The report is
there and we have these hearings to get to the bottom of it. I
submit to you that we must get to the bottom of it so that we
can give Fannie Mae a clean bill of health. The Department of
Justice has opened up a criminal investigation into the
allegations of the report, and that investigation may clear up
the intent.
Congress should carefully review the OFHEO report because
the special examination is continuing and ongoing. Questions
have also been raised about OFHEO's ability itself.
Chairman Baker. Can the gentleman quickly wrap up?
Mr. Davis.--to act on this report and the method by which
the report was released.
I certainly look forward to the hearing from the panel's
testimony on the OFHEO report and Fannie Mae's report to
address the criticisms of its accounting practices.
Chairman Baker. I thank the gentleman. The chair to the
best of its ability will try to keep members' opening
statements to the requested 5-minute statement length.
Mr. Castle?
Mr. Castle. Thank you, Mr. Chairman.
The issue before us is an important one today. I share the
concerns of a lot of the other members who have spoken about
it, a number of the issues that are before us. It is vast and
it is disturbing and hopefully we can do something about it.
Frankly, I think we should have done something about it before
we started down this alley. Perhaps we can now.
I am going to keep my opening comments, Mr. Chairman, to
one issue that concerns me, in what appears to be multiple
interpretations of generally accepted accounting principles,
GAAP. In February 2004, OFHEO hired Deloitte & Touche to
examine the accounting policies of Fannie Mae.
Specifically, OFHEO's report finds fault with the company's
accounting treatment of, one, the amortization of premiums,
discounts and fees related to the purchase of mortgages and
mortgage-backed assets, understatement of accounting financial
standards, SFAS 91; and two, financial derivative contracts
under SFAS 133. KPMG LLP, Fannie Mae's auditor, has stated it
stands behind its audit work.
Fannie Mae has also stated they believe they were following
generally accepted accounting principles. I am concerned that
two different auditors would have different interpretations of
SFAS 91 and SFAS 133. Therefore, I have sent a letter to Robert
Hertz, chairman of the Financial Accounting Standards Board,
FASB, for their comments on SFAS 91 and 133, and whether these
standards need to be readdressed to remove any gray areas that
may exist.
If improper accounting has occurred, I question how these
accounting practices were allowed to occur and what was
management's knowledge of these actions. It bothers me greatly
to hear the allegation that accounting tricks were used to meet
specific earnings-per-share targets that resulted in vast
amounts of executive compensation to be paid.
I thank all of our witnesses for appearing before us today
and I hope we will have an exchange on the merits of what has
occurred and what needs to occur in the future. I welcome the
news that OFHEO and Fannie Mae have reached an agreement to
address the improper accounting and internal controls within
Fannie Mae. I strongly believe, however, that in light the
likely reforms achieved in the passage of the Sarbanes-Oxley
Act, we must again be prepared to act.
Mr. Chairman, I would ask unanimous consent to insert the
text of my letter to Chairman Hertz for the record. With that
unanimous consent, I will yield back the balance of my time.
Chairman Baker. I thank the gentleman. Without objection,
the letter will be included in the official record.
I am advised by staff that the opening statement period for
members is 3 minutes, not 5 minutes.
Mr. Clay?
Mr. Clay. Thank you, Mr. Chairman.
Mr. Chairman, we are rushing to judgment today. OFHEO has
released a preliminary report which has not been proven, but
leaked to the press. During the course of the examination,
Fannie Mae was not given the chance to respond to OFHEO
findings. Informal communications, which are at the core of the
GSE's oversight statute, were essentially ignored. At least one
former examiner of OFHEO questioned the political motivations
behind OFHEO's rush to judgment.
Mr. Chairman, we do not normally hold hearings on matters
before other investigations are complete. Internal findings are
normally discussed informally and remedies proposed. There are
other stages of this process that take place before a judgment
is rendered. Why circumvent the process? Why this hearing?
If I were a member of Fannie Mae's board, I would find the
environment very intimidating. Mr. Chairman, why is Senator
Shelby not holding a hearing on this preliminary report? After
all, the Senate Banking Committee reported out legislation on
the GSEs. Maybe this hearing agenda is about something more
than the accounting procedures at Fannie Mae.
As you know, Fannie Mae recently entered into an agreement
with OFHEO in which they focused on accounting, internal
control, and capital. Fannie Mae has agreed to increase
additional capital by 30 percent. I am not sure how the new
requirement promotes affordable housing. Within 45 days OFHEO
and Fannie Mae will implement additional internal controls. The
Securities and Exchange Commission, as is intended, should be
the final arbiter of GAAP. Why can't we let the SEC decide this
issue? Why must we rush past them?
This hearing is about the political lynching of Franklin
Raines. We have seen this happen too many times before. We are
to go out of session and the deed is to be done before the
election. Why can't we just say that this is the agenda? Let us
debate that issue on its own merit. Better still, let due
process take its course and let the chips then fall where they
may. That is, unless this is truly a witch hunt.
We are having a trial by OFHEO leaks, trial by newspaper
articles, and trial without due process. In this case, the
Senate has it right.
Chairman Baker. The gentleman yields back.
Mr. Royce?
[The prepared statement of Hon. Wm. Lacy Clay can be found
on page 151 in the appendix.]
Mr. Royce. Thank you, Mr. Chairman. I thank you for holding
this hearing on the OFHEO report allegations of accounting and
management failure at Fannie Mae, as it is called. I would like
to commend you, Mr. Chairman, for your continued leadership on
GSE oversight.
While there is no question as to where I stand on GSE
issues generally, the fact of the matter is the GSEs have a
special relationship to the government. After all, there are
not many institutions that share common characteristics with
Fannie Mae, such as a charter created by Congress, an exemption
from local taxation, an exemption from certain SEC registration
and fees, and an ability to borrow from the U.S. Treasury
Department under certain circumstances.
With this in mind, I believe that Fannie Mae and GSEs in
general have an important obligation to conduct operations to
the highest standard. As a member of this oversight
subcommittee, I expect Fannie Mae to be a role model to other
businesses as it fulfills its federally mandated mission.
Fannie Mae should be conducting operations in a safe and sound
way. In my view, this should include strong internal controls
in the risk management department, coupled with consistent and
conservative applications of accounting rules.
With its newly released report, the Office of Federal
Housing Enterprise Oversight has called into question many of
Fannie Mae's risk-mitigating practices. This is very troubling
to me and there is no doubt that OFHEO has placed the burden on
Fannie Mae to answer these allegations. As OFHEO has leveled
some very serious charges, I recognize that we do need to give
Fannie Mae the opportunity to respond. This hearing is part of
the process for this committee to learn more facts, and I
appreciate the participation of all the witnesses today.
In addition to our important oversight role in this
committee, I hope that we will move swiftly to create a new
regulatory structure for Fannie Mae, for Freddie Mac and the
Federal Home Loan banks. There is a very simple solution.
Congress must create a new regulator with powers at least equal
to those of other financial regulators such as the OCC or the
Federal Reserve.
I hope this committee will heed the advice of Chairman
Greenspan and the entire Board of Governors, the Federal
Reserve Staff, the U.S. Treasury Department, the OECD, the IMF
and countless others who have urged Congress to act.
Now, on the approach that was rejected by the Bush
administration and, by the way, was rejected by myself and many
others on this committee. Why was that approach rejected by the
Fed, by the Treasury? Because that legislation was not a true
effort at reform as it failed to address several of the key
issues that are essential to true reform of the regulatory
regime of the housing GSEs.
Specifically, that non-reform effort would have created a
regulator without the authority to raise capital standards,
without the authority to place an ailing GSE into receivership,
without the authority to oversee all aspects of a GSE's
operations, leaving much of this oversight at HUD.
Chairman Baker. Can the gentleman begin to wind up?
Mr. Royce. I will wind up right now by saying there is a
difference of opinion on which approach to take if we really
want a world-class regulator. I thank you again for the
opportunity for this hearing and for us to hear from these
witnesses today.
Chairman Baker. I thank the gentleman.
Mr. Baca?
Mr. Baca. Thank you very much, Mr. Chairman and Ranking
Members. Thank you for holding this hearing. I appreciate the
opportunity to hear from witnesses about these very important
issues.
These are very complex rules and it is possible that we are
not going to see a resolution until the issue is decided by the
SEC. As I understand it, there are three broad areas of inquiry
involving accounting, internal control, and capital. I would
simply say I am not going to pre-judge the issues, and that
before any stones are cast, we should see that there is
culpability. Judge not and not be judged.
Our country is a country of laws, and there is a process
that must be followed and respected. Make no mistake, we will
follow this process wherever it may lead. At the end of the
day, if anyone, and I stress anyone, has not respected the law
they will face the consequences.
Mr. Chairman, I think it is important that in rushing to
judgment that we not destroy an institution that is helpful in
providing assistance for first-time homebuyers and minorities.
Fannie Mae is an integral part of our economy and many of our
constituents have been able to realize the American dream of
homeownership due to its programs.
I am concerned that the regulators follow the procedure
that exists for investigating potential concerns in a way that
is consistent, and respectful of confidentiality and impartial.
We need to follow proper procedures in handling audits before
they go public. We should ensure that the process is fair. We
should ensure that the process is fair in getting the facts.
And that we engage in corrective action if there are any
deficiencies.
Like most of us have been involved in nonprofit
organizations where we had auditors that audited us. They come
back with a report. They give an opportunity to make
corrections if any are done. And all of us have been involved
in nonprofit organizations and on boards of directors. We know
the consequences if those procedures are not followed.
I think it is important that we keep the politics out of
what should be and historically has been a nonpolitical
process. It concerns me that OFHEO has been Fannie Mae's
regulator since 1992. OFHEO has been its regulator since 1992,
and all of a sudden issues are being raised. The regulators had
an opportunity in the past to address any concerns.
So we need to ask: What, if anything, has changed? This is
not about headhunting. It is about positive steps to correct
any problems. I look forward to hearing the witnesses.
I yield back the balance of my time. Thank you very much,
Mr. Chairman.
Chairman Baker. I thank the gentleman.
Mr. Ney?
Mr. Ney. Thank you, Mr. Chairman, and thank you for holding
the hearing. I also want to thank, of course, the witnesses for
appearing today. I look forward to hearing their testimony, as
I know everybody does, so without objection I will submit all
of my written statement for the record. I just have a couple of
comments.
OFHEO's recent report on the activities of Fannie Mae
asserts the company engaged in accounting practices that do not
comply with the generally accepted practices. Of course, it is
troublesome. In addition, the report raises concerns about
deferred price adjustments, derivatives and hedging activities,
internal control issues. I think the stopgap measure was a good
thing to implement.
According to OFHEO and what we have read, they are serious
and it raises concerns regarding the validity of previously
reported financial results. OFHEO's findings to date are
obviously very serious. Right now, if you would read the
accounts in the papers, it looks like the management of Fannie
Mae is basically looking at the fact of, in the media at least,
of making them a poster child for regulatory reform.
It is important to keep in mind, though, that the
examination is still in the process. So the newspapers and the
way people are looking at it is one thing, and the reality of
what we are going to find out today I think is important, and
the process that OFHEO will finish is obviously important, and
also the SEC is going to be the final arbiter of compliance
with the general accounting practices, and has not yet, as I
understand, offered its opinion on Fannie's accounting methods.
So that is another part of this puzzle I think that will be out
there for us to look at.
Of course, Fannie was chartered by Congress to create a
secondary market and improve the function of home mortgage
markets. I think that we can all agree that the United States
mortgage and credit markets are the envy of the world. A
strong, vibrant housing market is important to everybody.
There can be no doubt that we have to take some steps to
strengthen the GSEs by establishing a new world-class
regulator. How we do that and who is to be that regulator, I do
not know today. With the growing presence of GSEs in the
capital markets and the possible risks they pose to the
financial system, the cost of a safety and soundness regulator
would be a prudent step. But I want to add the big ``however.''
That ``however'' is we have got to proceed in this endeavor
with caution. It cannot be mixed with politics.
If we want to talk about politics or press reports or
lobbyists, maybe we ought to do a bill to ban lobbyists, then
we can have a rich Republican and a rich Democrat do the
lobbying for everybody. We could call them the 527s of
lobbying. So I think we take that kind of talk out of the
process because any new regulatory structure has to recognize
the importance of the GSEs to the secondary mortgage market.
Everyone agrees that strong regulatory oversight is
critical to maintaining public confidence in this remarkable
system. As I have said before, enhanced regulations for GSEs
should not impede their ability to support affordable housing
in America.
So I applaud the chairman for this hearing. I think we have
to state a public policy as we go down this road and do what is
right for the good of Americans, and to craft public policy
that ensures safety and soundness, but let's not throw in this
process the housing market to the wolves because that hurts the
average American.
Thank you, Mr. Chairman.
Chairman Baker. I thank the gentleman.
Ms. Inslee?
Mr. Inslee. Thank you.
I just wanted to follow up. Our ranking member talked
about, when you talk about evaluating this, we are looking at
soundness. It made me sort of think of our obligation of buying
a horse. You check its soundness. You check its teeth. You
check it for hoof rot. That is an important part of this
function here, to check on soundness of Fannie Mae.
But the problem to date has been some folks do not want to
check for soundness, check its teeth, check it for hoof rot.
They want to hobble the horse when it comes to being a main
stem of the housing supply in this country. Whatever comes of
these hearings, I hope that we keep in mind those two different
functions, that we ought to focus on soundness, but not allow
this what may be, and I do not know yet because I think you
should have the trial before the execution, but it may be very
unfortunate things that occurred, to hobble this very, very
important horse that is carrying the U.S. economy in
residential homes in this country.
Thank you.
Chairman Baker. I thank the gentleman.
Ms. Kelly?
Mr. Kelly. Thank you very much, Mr. Chairman.
I have no statement at this time. I look forward to these
witnesses.
Chairman Baker. Mr. Toomey?
Mr. Toomey. Thank you, Mr. Chairman. I want to congratulate
you for your long work in this hearing and for holding the
hearing today.
I just want to make one quick observation. Many folks have
already observed that there are considerable complexities in
the accounting issues that we are going to be addressing today.
I think it is important to make sure we make it very clear up
front, and not get bogged down in the complexities of some of
this accounting because the dispute here that is alleged, I
should say the allegation that is made by OFHEO, is not that
there is a dispute over the interpretation of ambiguous and
complex rules over which reasonable people could disagree, but
rather the allegation is that there has been a pattern of
invention of accounting policies and devices which
systematically and intentionally misrepresent financial
statements for the purpose of smoothing earnings and achieving
maximum bonuses.
Now, if these allegations are true, they are obviously
extremely disturbing and require I think major changes at
Fannie Mae. That is what we are going to be talking about and
hopefully shedding some light on today, not the arcane
interpretation of accounting rules, but whether or not
accounting rules were being set aside, and different policies
were adopted for purposes for which they certainly should not
have been.
I think that is what we need to focus on, Mr. Chairman. I
thank you for holding this hearing and I yield the balance of
my time.
Chairman Baker. I thank the gentleman.
Ms. McCarthy?
Mr. McCarthy. Thank you, Mr. Chairman.
I will hand in my statement. I certainly do appreciate
hearing from the chairman and the ranking members, but we are
into this hearing 45 minutes and we still have not heard from
the witnesses, and I personally think that we should be talking
to the witnesses, and then do our statements and ask questions.
With that, I yield back the balance of my time.
Chairman Baker. I thank the gentlelady.
Mr. Bachus?
Mr. Bachus. I thank the chairman.
First of all, chairman, there have been several remarks
made that we would have addressed these issues had it not been
for the Bush administration. It is my recollection that the
Bush administration actually urged this committee and this
Congress to take strong action and that at that time that was
in the sort of post-Freddie Mac. At that time, many of the
Democratic members accused the Bush administration of going on
a witch hunt against Fannie Mae of saying that things were
right at Fannie Mae, and that OFHEO was doing a wonderful job,
and that there was sufficient regulation, that this was simply
to accuse the Bush administration of wrong motives.
It was actually a combination of those in the Senate that
did not want to take action, and members of this committee that
disagreed with the Bush administration. One thing the Bush
administration was concerned about is the new products that
Fannie was offering, and they wanted Treasury to approve those
new products. It is my recollection that the minority members
almost to a person resisted those reforms.
I do think, and I commend Mr. Frank. Mr. Frank actually had
it right and more accurately when he said the Bush
administration wanted to go further than this committee. I
think that is absolutely true. And now all of a sudden, some of
the things that the Bush administration wanted to do it seemed
like they would have been very prudent things to have done.
So to try to, a month before an election, to try to somehow
create a smokescreen that the Bush administration had done
something wrong would be inaccurate and would not be factual.
Of course, it probably is not surprising either.
We have before us today OFHEO, and Fannie Mae and their
officers will be before us at a later date. My understanding of
this hearing is we are to examine OFHEO and you are to testify
as to the agreement that you have made with Fannie Mae as a
result of your study of their accounting practices, and that in
fact you found that they violated two important accounting
rules.
My questions would be, all this stuff that you have
discovered now, why wasn't it discovered 3 or 4 years ago,
since you have been the regulators for years and years. Why is
it suddenly coming to light?
Chairman Baker. Could the gentleman begin to wrap up?
Mr. Bachus. So I would simply say that I think there are
some tough questions for Fannie Mae, but I think there are also
some tough questions for OFHEO because I believe that if they
have done these things and you were the regulators, you should
have known before just the last few months. This should have
come to light.
Thank you.
Chairman Baker. The gentleman's time has expired.
Mr. Hinojosa?
Mr. Hinojosa. Chairman Baker, over the last 4 years, the
United States has suffered from immense job loss. We have
suffered from an increase in the number of people living in
poverty. We have witnessed an incredible and unsupportable
switch from federal budget surplus to an ever-growing budget
deficit.
We have also experienced a tremendous increase in the
national debt over the last 4 years. Overall, our economy has
not been performing very well during this period, with oil
prices exceeding $50 per barrel. In fact, to say that it has
been underperforming would be an understatement.
However, there is one sector of our economy that has been
performing well consistently, and that is the housing market.
It has served as the foundation of the U.S. economy since the
stock market declined many years ago. It is the one sector of
our economy to which we need to pay the most attention at this
time. We need to nurture it. We need to ensure that nothing we
do here in Congress harms it.
At this point, I think we need to keep our powder dry until
all the ongoing accounting and adequacy of its capital and the
quality of management investigations are complete. Then we can
see where everything stands once all the dust settles.
Having said that, Mr. Chairman and Congressman Kanjorski, I
look forward to hearing the testimony of all of today's
witnesses.
I yield back the remainder of my time.
Chairman Baker. I thank the gentleman.
Ms. Brown-Waite?
Ms. Brown-Waite. Thank you very much, Mr. Chairman. Thank
you for your leadership in providing this opportunity for the
committee to address this important issue.
I would also like to thank our witnesses for coming to the
committee this morning.
As Americans, we have heard in the past couple of years
about the Enron scandal and other corporate examples of
``cooking the books.'' As members of Congress and members of
this committee with oversight over the mortgage and housing
industries, it is imperative that we ensure that companies with
as much industry clout as Fannie Mae, are following generally
accepted accounting principles, or GAAP.
I was listening to Bloomberg the other day, yesterday as a
matter of fact, and I heard how much your stock has also
suffered. So there is obviously a rippling effect of this OFHEO
report. However, that being said, as committee members we have
to remember that the report released by OFHEO in September is
early in its preliminary stages. I think that there are more
accusations in this report than findings.
We certainly look forward to hearing how OFHEO completed
this report. We have had some heartaches with corporate
scandals in this country, but I do not think we should be
jumping to conclusions. While we are ensuring that Fannie Mae
is using honest GAAP-compliant principles, the committee also
needs to be certain that we are giving Fannie Mae a fair chance
to be heard.
Coming from Florida where our state was devastated by
hurricanes and where a lot of rebuilding is going to take
place, it is obviously important that we have the availability
of the funding for home construction that Fannie Mae regularly
participates in.
I look forward to hearing what our witnesses from Fannie
Mae have to say, and I want to again thank you, Mr. Chairman.
I yield back the balance of my time.
Chairman Baker. I thank the gentlelady.
Mr. Lucas of Kentucky?
Mr. Lucas of Kentucky. Mr. Chairman, I look forward to
hearing from the witnesses.
Chairman Baker. I thank the gentleman.
Mr. Lynch?
Mr. Lynch. Thank you, Mr. Chairman.
I am going to be brief. The one thing I do not want to
forget are the good things that Fannie Mae is doing. I hear
Enron talked about here this morning. This is not Enron. This
is not the Enron situation. These are clearly violations of
accounting principles, but let's not go overboard and make this
a criminal proceeding.
I am very interested in hearing exactly what the
differences in the accounting practices and how we can correct
them. But this should not be a witch-hunt. This should not be a
political exercise in punching people who have done a lot of
good things in this country providing housing opportunities for
a lot of people that need them. But clearly, we have to get our
house in order here.
Thank you, Mr. Chairman.
Chairman Baker. I thank the gentleman.
Mr. Gillmor?
Mr. Gillmor. I will enter my statement into the record.
Thank you, Mr. Chairman.
Chairman Baker. The member's statement and all members'
statements will be made part of the official record.
Mr. Miller?
Mr. Miller of California. Thank you. I would like to thank
you, Mr. Chairman, for your continued commitment to ensuring
the safety and soundness of the secondary market.
The question of impropriety has surfaced as a result of
allegations of accounting irregularities at Fannie Mae has sent
shock waves through the strong housing market. That market has
kept this nation going in recent years. The United States
housing market is the envy of the world. We enjoy the lowest
interest rates and the highest homeownership of any developed
nation in the world.
When Americans are homeowners, it spurs economic and
community development and provides residents with a sense of
pride in their community. Homeownership is the single largest
creator of wealth for most Americans. For this reason, it is
imperative that we work through this process to maintain a
strong housing market.
The GSEs have been at the forefront of creating affordable
housing opportunities for American families. In my district,
for example, Fannie Mae has created employer-assisted housing
programs for the city of Boreas Police Department to allow
police officers to live in the communities they serve. They
also helped to finance affordable housing initiatives in
Anaheim, California, and Anaheim is an extremely high-cost
housing area.
Across the district, they have been able to offer
innovative programs to allow those with blemished credit to
afford the dream of homeownership, to help seniors convert the
equity in their homes into cash to help them meet their needs,
and to help families and individuals with special needs become
homeowners.
All of this, in partnership with lenders, is intended to
meet the ever-growing need of our communities. As we address
deficiencies in GSE supervision, we must not lose sight of
Congress' original goal in chartering GSEs. The mission of
Fannie Mae and Freddie Mac is to provide stability and ongoing
assistance to the secondary market for residential mortgages,
and to provide access to credit and homeownership in the United
States.
As we move forward to make much-needed regulatory reform to
ensuring the safety and soundness of GSEs, Congress must be
unwavering in our commitment to help Americans achieve the
dream of homeownership and continue to ensure the accessibility
of mortgage funds at the lowest cost. We must completely
understand the implications of changes in the regulatory
structure in meeting the goals of the charter, being careful
not to inadvertently hinder the ability of GSEs to be
innovative in meeting the needs of potential homebuyers.
I believe Congress has ample evidence that OFHEO may not
have the experience necessary to appropriately regulate complex
financial institutions such as Fannie Mae and Freddie Mac.
OFHEO released annual reports that the internal and external
audit functions at Fannie Mae exceeded safety and soundness
standards and had the appropriate independence. How can we be
confident in such findings when OFHEO is now issuing a report
with very different troubling findings about the serious
accounting irregularities at Fannie Mae?
We must work to ensure a new regulatory regime under which
investors in the market can be confident that these companies
are sound and that their investment in America's housing
markets are safe. While there is no question that regulatory
change must be made to ensure that GSEs are held to the
absolute highest standard of ethical conduct, I urge my
colleagues to remain mindful that strong regulations provide a
means to achieve our ultimate goal of expanding the supply of
affordable housing credit across our nation.
Mr. Chairman, I again want to thank you for holding these
hearings. The goal of these two companies is so critical to our
economy. I look forward to working with you to ensure the
appropriate regulatory reforms are made.
I yield back.
Chairman Baker. I thank the gentleman.
Mr. Ford?
Mr. Ford. I am sorry. I do not have anything to say. I am a
believer that when you hold hearings, you should let the
witnesses talk.
So I welcome you all and look forward to hearing from you.
[The prepared statement of Harold E. Ford, Jr. can be found
on page 152 in the appendix.]
Chairman Baker. A commendable attitude.
We have two members who are not members of the subcommittee
today, but who are members of Financial Services. I would like
to recognize them at this time.
Ms. Waters?
Ms. Waters. Thank you very much, Mr. Chairman. I would ask
unanimous consent to make a brief opening statement.
Chairman Baker. Without objection, please proceed.
Ms. Waters. I appreciate the opportunity to be here today.
I must share that I feel like I am in another round in the
battle between FM Watch and the GSEs. FM Watch, financial
institutions that decided a long time ago to wage a political
war to reduce the GSEs' share of the mortgage market, and of
course I must say, Mr. Chairman, led by you.
OFHEO has gone from weak and ineffective to the extreme of
accusing Fannie Mae now of questionable accounting practices in
order to increase their bonuses. They have gone back to 1996.
That is a serious allegation. I hope they are prepared to prove
it. Obviously as we explore the safety and soundness issues
that are the subject of this hearing, all of us on the
Financial Services Committee must keep our eye on the housing
mission of the GSEs, particularly the affordable housing
mission that we have entrusted to Fannie Mae and Freddie Mac.
As we proceed, it is critical that we ensure any action that we
may consider not impair the housing mission of the GSEs.
Mr. Chairman, I note with interest that the 211-page OFHEO
report from Mr. Dickerson to Director Falcon that we will
explore in today's hearing still bears the following notation
on each page: special examination of Fannie Mae, privileged and
confidential disclosure, and/or duplication prohibited, even
though the OFHEO report was posted on the OFHEO Web site and
has been publicly available for almost two weeks.
Mr. Chairman, as I understand it, normally the examination
and regulatory process is a confidential process where the
regulator raises his concerns with the party being examined and
the regulator gives that party a full opportunity to respond
before determining whether regulatory action is required? I
note that when Director Falcon's September 20 letter expressing
concerns about Fannie Mae made the papers, the OFHEO report had
just been completed. By September 22, the September 17 OFHEO
report was publicly available, and by September 27, an
agreement had been signed between Fannie Mae and OFHEO. It
seems highly unlikely to me that the normal kind of regulatory
dialogue could have occurred within this timeframe.
So I hope that the witnesses will address whether the
regulatory process was proper, or whether there were public
disclosures outside the normal process for reasons having
nothing to do with safety and soundness. The September 7th
OFHEO report is fairly characterized as a work in progress. As
Mr. Dickerson notes in his transmittal memo to Director Falcon,
it contains the findings to date of the special examination of
Fannie Mae.
The report raises a number of highly technical and arcane
accounting issues, including issues concerning the treatment of
derivatives. Some of these issues appear to be controversial,
and may be disputed by Fannie Mae. These issues cannot be
easily summarized and they may not lend themselves to a brief
and simple response. I hope that we will have the patience to
give these issues the time that they may require.
Mr. Chairman, to my knowledge, apart from a few brief press
releases from Mr. Raines and Fannie Mae's independent director,
Mrs. Ann Korologos announcing the intention of Fannie Mae to
cooperate with the OFHEO investigation, and later announcing
the September 27 agreement between OFHEO and Fannie Mae, there
has been no in-depth public response by Fannie Mae to the
substantive allegations contained in the OFHEO report.
This is the first chance that our committee and the public
will have to hear Fannie Mae's response to these allegations,
and it will be good to hear their side of the story. I am
particularly concerned about the 30 percent capital set-aside
or surplus requirement because that takes a lot of money out of
the market for mortgages.
Thank you. I yield back the balance of my time.
Chairman Baker. I thank the gentlelady.
Mr. Watt?
Mr. Watt. Thank you, Mr. Chairman.
I just want to express my thanks to the chairman for
allowing members who are not part of the subcommittee to
participate in the hearing.
I think members of the subcommittee have expressed in
various ways a number of the concerns that I would have
expressed had I been a member of the committee. At the end of
the day, we want to make sure that Fannie and Freddie and
whatever other institutions are available to encourage and
support increased homeownership and housing in this country are
made stronger and more vibrant.
I also share a number of the process, due process and
fairness concerns that have been raised by various members of
the committee. So I am here to participate in this for those
reasons, because I am a supporter of housing for American
people and because I believe in fairness and process and due
process, and not convicting somebody before the process runs
its course.
I hope we will keep in mind both of those things, and I
appreciate the chairman allowing us to participate. I yield
back the balance of my time.
Chairman Baker. I thank the gentleman.
If there are no further opening statement by members at
this time, I would now proceed to recognize our first witness
for the hearing today.
Mr. Armando Falcon is the director of the Office of Federal
Housing Enterprise Oversight, who I understand today is
accompanied by Ms. Wanda Deleo, chief accountant, and Mr.
Christopher Dickerson, chief compliance examiner, Office of
Federal Housing Enterprise Oversight.
Before I proceed, I am reminded, I have a statement of Mr.
Roger Barnes, former manager of financial accounting, deferred
assets in Fannie Mae's controller division, submitted to the
committee and asked to be made part of the official record. If
there is no objection, I now move to incorporate that into our
hearing record.
[The prepared statement of Roger Barnes can be found on
page 197 in the appendix.]
By prior agreement with Mr. Kanjorski, we have determined
that given the gravity of the hearing content today, that all
witnesses should be asked to testify under oath, given the fact
that this is an investigative hearing.
Mr. Falcon, do you have any objection to testifying under
oath?
Mr. Falcon. Not at all, Mr. Chairman.
Chairman Baker. It is my understanding that you are
accompanied by staff. Will they be testifying and answering
questions during the course of your testimony today?
Mr. Falcon. They will not have testimony, Mr. Chairman, but
they will be available to the committee to answer any technical
questions about the report.
Chairman Baker. In that light, it would be my opinion and
advisable, should we solicit information from them, that each
of you take the oath. Do either of you have any objection to
testifying under oath if required by the committee?
Ms. Deleo. No.
Mr. Dickerson. No.
Chairman Baker. If that is the case, I would ask that you
now stand and raise your right hand and affirm the oath.
(WITNESSES SWORN)
Chairman Baker. Thank you. Each of you is now considered to
be under oath.
Mr. Falcon, I would recognize you. Given the importance of
your report, we customarily limit our witnesses to 5 minutes in
presentation. I would encourage you to summarize as best you
can, but should you find the need to exceed 5 minutes, I am
certain members of the committee would welcome a full and
complete discourse from you on this matter.
Please proceed at your leisure.
STATEMENT OF HON. ARMANDO FALCON, DIRECTOR, OFFICE OF FEDERAL
HOUSING ENTERPRISE OVERSIGHT
Mr. Falcon. Thank you, Mr. Chairman, and thank you Ranking
Members Kanjorski, Frank and Chairman Oxley, who was here
earlier, for inviting me to testify about OFHEO's special
examination of Fannie Mae. As always, my testimony reflects my
own views and are not necessarily those of the secretary of HUD
or the President.
Before getting to my comments on the report, I would like
to introduce two of my staff who you mentioned earlier. On my
right is Chris Dickerson, OFHEO's chief compliance examiner and
one of our derivatives experts. On my left is Ms. Wanda Deleo,
our chief accountant. Both are leading the work of the special
examination, and they are here to assist me in answering any
technical questions the committee may have about the report.
In July of last year, I announced that OFHEO would conduct
a special examination of Fannie Mae's accounting policies,
internal controls and financial reporting. While the special
examination continues, our safety and soundness mandate
requires that when we find problems, we move quickly to remedy
them, rather than wait until the entire examination is
complete. The report represents our findings to date and it
serves as the basis for the actions that we have taken.
The report raised such serious safety and soundness
concerns that we brought them to the immediate attention of the
board. To the board's credit, it became very engaged in the
examination and moved quickly to reach an agreement with OFHEO
on the plan of remediation. The agreement constitutes an
important first step towards resolving OFHEO's concerns and
ensuring safe and sound operations at the enterprise.
Let me now turn to the substance of the report. It
documents Fannie Mae's pervasive and willful misapplication of
generally accepted accounting principles, as well as critical
operational deficiencies. The report's findings have
implications in four areas of major concern to OFHEO: the
validity of Fannie Mae's previously reported financial results;
the adequacy of its regulatory capital; the quality of senior
management's supervision of the enterprise; and Fannie Mae's
overall safety and soundness.
The accounting violations cannot be dismissed as mere
differences of opinion in accounting rules. Fannie Mae
understood the rules and simply chose not to follow them.
Fannie Mae's development of improper accounting policies and
practices can be traced back to a corporate culture and
operating conditions characterized by the following: a desire
on the part of senior management to portray Fannie Mae as a
consistent generator of stable and growing earnings; an
ineffective process for developing accounting policies; an
operating environment that tolerated weak or nonexistent
internal controls; key person dependencies and poor segregation
of duties; incomplete and ineffective reviews by the
enterprise's office of auditing; an inordinate concentration of
responsibility rested in the chief financial officer; and an
executive compensation structure that rewarded senior
management for meeting goals tied to earnings per share, a
metric that can be and was subjected to senior management
manipulation.
The accounting problems at Fannie Mae that OFHEO has
uncovered relate mainly to FAS 91 and FAS 133. Let me briefly
describe each. FAS 91 governs the amortization of balances
related to mortgages and mortgage-related securities.
Management developed accounting policies and selected and
applied accounting methods to improperly reduce earnings
volatility related to amortization. Fannie Mae improperly
delayed the recognition of income to create a cookie jar
reserve that it could dip into whenever it best served the
interests of senior management. Those interests included
smoothing earnings and meeting earnings-per-share targets
linked to executive bonuses.
An important example of how this worked took place in 1998.
At that time, external events caused a plunge in interest
rates, which in turn added to an acceleration of mortgage pre-
payments. As a result, Fannie Mae faced a more rapid premium
amortization in the enterprise's mortgage portfolio than
expected. In December, management's own amortization models
specified that $400 million in premium amortization expenses
had to be recorded on Fannie Mae's books in 1998. However,
management decided to record only $200 million of the $400
million that year.
Fannie Mae deferred the remaining $200 million to 1999 and
recorded it incrementally throughout that year. KPMG, Fannie
Mae's outside auditor, decided the enterprise's action on this
matter as an ``audit difference,'' a term which means that KPMG
disagreed with Fannie Mae's action. Had Fannie Mae taken the
full $400 million charge in 1998, senior managers would have
lost their eligibility for any bonuses. That is because
incentive compensation depended on Fannie Mae realizing
earnings-per-share targets.
As it happened, the earnings-per-share target which would
secure senior management the maximum bonus could only be
reached if Fannie Mae recorded no more than $200 million of the
expenses in 1998.
The next year, Fannie Mae kicked off a challenge grant
initiative which promised to reward management for doubling
earnings in 5 years. To avoid facing amortization problems
similar to those in 1998, senior management began a prolonged
and concerted effort to develop policies for managing
amortization. The goal was to gain earnings flexibility and the
ability to minimize earnings volatility. In this regard, the
1998 violation was not a singular event. It represented a
continuous effort to artificially guarantee success in meeting
targets.
Let me now turn to FAS 133 and hedge accounting. FAS 133
requires that derivatives be marked to market and that changes
in fair value be included in earnings unless the derivative is
designated as and qualifies for hedge accounting. We have found
that Fannie Mae implemented FAS 133 in a manner that placed
earnings volatility and maintaining the simplicity of
operations above compliance with GAAP. These goals to an
inordinate degree influenced the development of Fannie Mae's
approach to hedge accounting.
The prerequisites for receiving hedge accounting treatment
include effectiveness assessment, ineffectiveness measurement
and proper hedge documentation. Because Fannie Mae has not met
these critical requirements, it should not receive hedge
accounting treatment for many of its derivatives. Instead,
proper accounting for such derivatives requires that their fair
value changes be recorded directly through earnings.
As a result of these issues and Fannie Mae's disregard for
complying with FAS 133, we are concerned about the validity of
the amounts Fannie Mae has reported in accumulated other
comprehensive income, the earnings the enterprise has presented
in prior quarters, and the adequacy of regulatory capital.
Let me state plainly that Fannie Mae's accounting was just
wrong, and must be fixed properly. The stakes are too high to
just forgive past sins. If any company, especially a government
sponsored enterprise, is allowed to get away with this type of
accounting misconduct, then no regulator can do its job and no
investor is safe. A regulator and an investor must be able to
trust the books and records of a company.
Regarding internal controls, OFHEO found that Fannie Mae
maintained a deficient accounting policy development process,
key person dependencies and poor segregation of duties, all of
which contributed in important ways to the enterprise's
problems. The details of these matters are addressed in the
report.
As I mentioned earlier, we took prompt and appropriate
action to address these serious problems. We entered into an
agreement with the board requiring that Fannie Mae implement
correct accounting treatments, hold the 30 percent capital
surplus, recalculate prior period financial statements using
correct accounting, appoint an independent chief risk officer,
and put in place policies to ensure adherence to accounting
rules and new internal controls.
I would also like to remind the subcommittee that the
special examination is continuing. If OFHEO discovers more
problems, we will take further action.
Finally, I would like to thank the leadership of the full
committee and the subcommittee for your support for our
funding. The current continuing resolution has placed severe
constraints on our ability to hire additional staff and employ
outside experts for the continuation of the Fannie Mae
examination. This could not come at a worse time for the
agency, and it once again illustrates the need to remove OFHEO
from the appropriations process.
Mr. Chairman and members of the subcommittee, I have tried
to summarize the report as best I could. I would like to ask
that it be placed into the record, and we are prepared to
answer any questions that the subcommittee may have.
[The prepared statement of Hon. Armando Falcon can be found
on page 160 in the appendix.]
Chairman Baker. Your full testimony and the report content
thereof will be included in the official record of the
committee.
Mr. Falcon, did you find that management of Fannie Mae had
adopted and implemented a strategy from a managerial
perspective to steer accounting reports for two important
goals. One is to present an image of very stable earnings to
the broader market; and two, to manage EPS calculations to
enable maximum bonus payments to be achieved for executives?
Mr. Falcon. Those are the findings contained in the report,
Mr. Chairman.
Chairman Baker. Did you find in at least one instance in
1998 that manipulation of accounting methods inconsistent with
GAAP resulted in an EPS calculation which enabled the bonus
payment to executives that they would not have been entitled to
if accounting practices consistent with GAAP had been utilized?
Mr. Falcon. That is the situation we described in 1998,
yes.
Chairman Baker. Is it correct that in reaching the
earnings-per-share trigger of $3.23 that the calculation of
3.23 in carried to the math resulted in a calculation of
3.2309. Is that correct?
Mr. Falcon. Yes.
Chairman Baker. Has it been established why the decision
was made to defer $200 million of a $400 million unexpected
expense was deferred from 1998 into 1999 and not any
alternative amount?
Mr. Falcon. We have not received an adequate explanation as
to why that was done. We do know that their external auditor
disagreed with that action that was taken.
Chairman Baker. Is it correct that in at least preliminary
response that the modeling utilized by the enterprise was
determined by management to be inaccurate and the feeling was
expressed that the $400 million expense was actually
overstated, and their view was that by deferring the $200
million it perhaps would more reflect economic reality?
Mr. Falcon. Their own internal modeling for amortization
clearly demonstrated that they had to take this $400 million
expense in 1998. It was their internal models that they were
relying on for amortization expensing.
Chairman Baker. But they believed that model to be
accurate?
Mr. Falcon. Yes.
Chairman Baker. Then there is no justification. My
understanding was the $200 million had been deferred because a
preliminary explanation is that the modeling was believed to be
inaccurate and had overstated the expensing. More importantly,
in the subsequent four quarters in 1999, the expensing did
occur, acknowledging the value, and in fact did not the
expensing require increases over the $200 million originally
calculated?
Mr. Falcon. Let me say something to that. I cannot speak to
what the company believed as far as this amortization in 1998.
I can say that we believe that it was not justified under
generally accepted accounting principles, and that $400 million
should have been recognized in 1998.
Chairman Baker. Is it correct that there are, because many
will allege or suspect to allege, that this was a one-time
dispute over arcane accounting methodologies? Their outside
audit, you indicated, agreed that the expense should not be
deferred and should be taken in 1998. Is that correct?
Mr. Falcon. Yes.
Chairman Baker. Isn't it correct that there were other
accounting irregularities identified in other reporting years
that placed the earnings calculation in question, and therefore
the subsequent bonus calculations resulting from those
earnings?
Mr. Falcon. I am sorry?
Chairman Baker. Let me restate. Is it correct that you
identified in the course of your examination other accounting
irregularities and inconsistencies in other reporting years
that placed the earnings for those years in question because of
the accounting methodologies utilized, and therefore would
result in placing the bonus payments made to executives in
question?
Mr. Falcon. Yes.
Chairman Baker. Going forward, I wish to reiterate that
this is an interim report, not a final report. You engaged the
services of Deloitte & Touche as an outside audit team to
assist your staff in reaching these conclusions. In the course
of that examination, you have reviewed, your staff, Deloitte &
Touche, in excess of 200,000 documents and e-mails over the
course of the past 8 months. In addition, hundreds of
interviews and depositions taken.
This report should be understood as a first step, not a
final step. As I understood in your opening statement, as you
discover additional information that should be brought to the
attention of the committee, you intend to do so. Is it
appropriate or can you comment today on where your next focus
of attention will take you within the enterprise's activities?
Mr. Falcon. I think I cannot at this time, Mr. Chairman,
but I can tell you that we do this as a two-step process here.
The first step in this review on these issues was to identify
whether or not----
Chairman Baker. Let me do this, Mr. Falcon. I hate to cut
you off, but my time has expired, and I am going to try to hold
other members to be accountable. I have one wrap-up question
that is important for me to ask.
Given the public statements to date by the executives and
board members of Fannie, and the testimony I have reviewed that
Fannie will proceed with today, in essence disputing all of
your findings, placing your accounting judgment in question,
the disputes with the opinion of your outside audit firm, the
fact that you have had to request the issuance of subpoenas to
get the enterprise to respond to your normal course of inquiry,
do you believe the culture of mismanagement at Fannie Mae will
change unless significant personnel alterations are required,
as they were at Freddie Mac?
Mr. Falcon. This comes down to a question of whether or not
we have sufficient confidence in management to promptly
implement the remediation plan that will be required to put the
company back fully on sound footing. The issues raised by our
staff in this report certainly do cause doubts about whether or
not there is sufficient confidence in management going forward,
such that there should not be management changes at the top of
the company.
We are currently considering that and we are having
discussions with the board about the issue of management
accountability and the confidence in current management.
Chairman Baker. I regret our time is so limited.
Mr. Kanjorski?
Mr. Kanjorski. Let me ask the first question right off. Is
there a systemic risk problem at Fannie Mae, in your opinion,
at this stage of the preliminary report that you have gone
through?
Mr. Falcon. I think that we have managed this process in a
way such that there is not substantial risk of a systemic
disruption. Through the actions we have taken, and through the
board's prompt action in agreeing with us on remedial actions,
we have precluded the possibility of systemic events.
Mr. Kanjorski. So we can inform the investing public and
others that hold securities of Fannie Mae, is there any reason
in the world that they should worry about the value or the
credibility of their securities?
Mr. Falcon. I am not quite comfortable talking about
recommending whether or not an investor should or should not
invest in this company.
Mr. Kanjorski. I am not asking you to make a
recommendation. Is there anything in your findings, in other
words, as a result of the audit differences that are being
attended to, and as a result of some of the accounting wrongs
that may have been uncovered through your investigation, is
there any reason to believe that there is a large loss of
equity or a question of Fannie Mae remaining solvent?
Mr. Falcon. In the worst-case scenario, the company could
be undercapitalized, below its minimum capital requirement, but
not to the extent that the company would be insolvent.
Mr. Kanjorski. Can you give us a maximum amount of
undercapitalization that you may have discovered? In other, the
need to infuse more capital, what would that amount be?
Mr. Falcon. Now that we have determined that the accounting
policies of the company were not consistent with GAAP, the next
step for us to take is to do an evaluation of the impact of
these improper accounting practices on past financial
statements, especially the impact of its large derivatives
portfolio possibly not being eligible for hedging accounting
treatment, which means the amounts in other comprehensive
income would have to flow back into the balance sheets through
earnings, and therefore be recognized.
We will not know this until we go through all of the
evaluation exercises. There are $12 billion in negative losses
in OCI, and if all of that were forced to move over to
earnings, the company could potentially take a hit of that
much. But we do not know, congressman, how much, if any of that
will move into the retained earnings portion of balance sheets
until we have worked with the company to come to those
determinations.
Mr. Kanjorski. Making the worst-case scenario assumption,
however, that does not constitute in your mind systemic risk?
Is that correct?
Mr. Falcon. Yes. The solvency of this company is not
threatened by the findings we have to date.
Mr. Kanjorski. Okay. I want to move you along because I
have a few questions.
I do not understand what you do as a regulator, but I
assume you examine auditors' reports. Is that correct?
Mr. Falcon. Yes.
Mr. Kanjorski. And I assume that audit differences, as you
indicated, how they handle the $400 million or the $200
million, showed up in a finding by the auditor to the
corporation that was a difference here of opinion and how this
should be accounted for. Is that correct?
Mr. Falcon. What we do----
Mr. Kanjorski. Not what you do. I want to know what papers
you examine. What I am asking you is did you examine the audit
report of 1998 and did there exist a finding indicating there
was a difference between the auditor and the corporate
leadership as to how this $400 million was accounted for?
Mr. Falcon. We were not aware of this audit difference
until we began this accounting examination.
Mr. Kanjorski. Why were you not aware of it?
Mr. Falcon. We have not traditionally looked at the work of
the external auditor to ensure that they were properly
certifying that the company's financial statements were
consistent with GAAP.
Mr. Kanjorski. Do you mean the regulator does not get the
outside audit report and examine it thoroughly before it
passes, or examines anything else in a corporation? I would
think that would be the first tool that you would look at.
Mr. Falcon. Let me ask our chief accountant about this
question, Mr. Kanjorski.
Ms. Deleo. We are certainly taking that approach at this
point.
Mr. Kanjorski. I am not worried about 2004. I am asking
about 1998. I am trying to get an essence of just what a
regulator does. The only prior experience that I have had
sitting on a board of a bank was that we would have external
audits and at the conclusion there would be an exit meeting of
all the differences or questions raised by the auditor that
would be presented to the audit committee.
It just seems rudimentary that if you are going to spend
hundreds of thousands or maybe millions of dollars to hire an
auditor, that all of that is laid out in the findings and the
differences, and that should be the first piece of paper the
regulator picks up and looks at because a lot of work has been
done and a very credible auditing company has made differences
in findings. In 1998, if we had picked up the audit report by
the external, outside auditor, was there a reflection of an
audit difference in how that $400 million was handled?
Chairman Baker. I would ask the gentleman that that be the
last question on this round.
Please respond, sir.
Mr. Falcon. Yes. We look at this, Congressman, as a team
effort. The safety and soundness of this company is dependent,
yes, on us doing our job properly. It is dependent on
management running the company properly, the board properly
overseeing the company, and the external auditor doing its work
to ensure that the financial statements are consistent with
GAAP. We look at the financial statements and the work of the
external auditor. I do not know where this audit difference was
reflected.
Mr. Kanjorski. I just want to follow this line of
questioning. You mean at this point in time you do not know
whether or not that was openly displayed in the outside audit
report?
Mr. Falcon. Let me ask Mr. Dickerson, please, Congressman,
to address this.
Mr. Dickerson. Congressman, we had testimony from the
controller and the CFO that there was this $200 million audit
difference between the firm and KPMG. We saw internal documents
from the company that there was approximately a $400 million
expense that was estimated.
Mr. Kanjorski. And it was listed as an audit difference by
the outside auditor in 1998.
Mr. Dickerson. Right. And we learned that through testimony
that we obtained from the CFO.
Mr. Kanjorski. It took you 6 years and depositions to
discover something that was on a concluded audit document as a
finding?
Mr. Falcon. We need to go back and find out if this was
included in any documents that were or should have been
provided to the agency. If we find that this was something that
was in some documents that we could have had access to, that we
should have had access to, then it points out a need for us to
strengthen our program.
I am not saying that the agency is completely without fault
here. We have more resources now, with an accounting staff. We
did not have an office of chief accountant until 2 years ago.
Ms. Deleo has just joined the agency very recently. But in
light of the Freddie Mac problems, I think it has highlighted a
need for this regulator to get heavily involved in accounting
issues because they do go to the heart of the safety and
soundness of our work. If we cannot rely on the books and
records of this company----
Mr. Kanjorski. Yes, but you do not read the books and
records of this company as a regulator. It does not matter. It
would just seem to me that this committee could call up and
subpoena the outside audit report of 1998 and I will be shocked
if a finding is not there mentioning this audit difference as
to how the money was handled. It should have been the first day
you arrive at the place, looking at the audit. You should know
what happened.
I am just worried about, we are calling you a regulator and
you are scaring hell out of me that you did not see that, and
everybody should have been alerted to that that sits on a
board, that you go through your audit findings. That is so
axiomatic. I guess in law school we used to call that Horn
book.
Chairman Baker. The gentleman's time has really expired, if
I may. I really want to try to hold members. We have much more
to do today. Please help me here to get through this process.
Mr. Castle?
Mr. Castle. Thank you, Mr. Chairman. Even by Washington
standards, this is an extraordinarily tangled web that we are
dealing with here and a little bit hard to follow to a degree.
Fannie Mae clearly has some questions to answer here. I am
worried that we have not given the regulators, OFHEO in this
case, sufficient assets to move ahead with what they have to do
in terms of their work. There are a lot of people hired on the
outside to try to hold all this off. Frankly, I think we have a
responsibility as a subcommittee and a committee right here to
do everything we can to get to the bottom of all of this.
Let me just start with this, if I may, Director Falcon. And
that is, as I understand it, you hired an outside auditor
recently. Did you not hire an outside auditor prior to that
time because of insufficient funds to do so?
Mr. Falcon. We have not hired an outside auditor to assist
us prior to the initiation of this special accounting
examination. That is right.
Mr. Castle. Was it because you had insufficient funds to do
so?
Mr. Falcon. We have been trying to. We have not undertaken
a special accounting review like this prior to this point. We
have not made the request, I guess, for the funds. But even if
we saw the necessity for it, we would not have had the funds
and we would have had to come to Congress for the additional
funding.
Mr. Castle. Let me ask you another question. Can you tell
me why, and I can only judge this through press statements of
my own accord. KPMG is standing by the company's financial
reports, even after your report, of course. Could this be
another example of just a difference of opinion as to the
application of GAAP, such as the one I understand you have with
this company with regard to their manufactured housing loans?
Or is it something else?
Mr. Falcon. We feel very strongly that these are black and
white accounting issues. These are not issues of
interpretation. They are not issues where reasonable people can
disagree. We have taken prompt, strong action in trying to deal
with this because we do think they were clear violations of
accounting principles.
Mr. Castle. So i.e. KPMG then in standing by this is at
fault in terms of the clear accounting principles which exist.
Is that what your statement is basically?
Mr. Falcon. If they are standing behind this accounting
treatment, then yes, they are wrong as well.
Mr. Castle. Do you have sufficient powers to carry out your
responsibilities? I know there has been a lot of discussion
about changing agencies and all the things that we should do,
but I am worried about what you can do now in terms of cease
and desist orders, other regulatory powers which you need, the
funding which you need in order to carry out your
responsibilities to make sure all this is handled correctly.
This is of overwhelming significance, and I think for you
to be shortchanged in any of these categories would be a
terrible error. Can you detail for us where there may be needs,
or if there are not needs at all?
Mr. Falcon. I think there are several key areas where we
would like the same powers that are given to every other safety
and soundness regulator. It begins with the authority to assess
for budgetary needs outside the appropriations process, to have
independent funding. It begins with flexibility in a variety of
areas, including capital requirement setting. Every other
regulator has that.
It includes issues like independent litigating authority,
the ability to freeze the pay of any executives where we find
potential wrongdoing. We recently had an opinion in district
court saying that we do not have the same authority that other
regulators have. So there are quite a few areas where we just
need strengthening across the board, including general safety
and soundness powers.
Mr. Castle. Changing the subject, I wrote down a couple of
comments, and I do not know if I wrote them down correctly, of
course. Correct me if you see otherwise, but that you made in
your opening statement. You said that Fannie Mae understood the
rules, but chose not to follow them.
Mr. Falcon. Yes.
Mr. Castle. What do you mean, Fannie Mae? Do you mean their
board of directors, their officers? What do you mean by Fannie
Mae in that circumstance? And are the rules that you are
referring to accounting rules or something beyond anything that
has been discussed here today?
Mr. Falcon. What we mean is, this is not a matter where the
rules were too complex and the company did not understand them.
It is not a matter where they made a good-faith effort to try
to comply with the rules. They did not comply with rules that
they clearly understood.
Mr. Castle. Accounting rules?
Mr. Falcon. Accounting rules.
Mr. Castle. That they clearly understood. And when you say
``they,'' you are referring to whom?
Mr. Falcon. Those responsible in the company for setting
accounting policy consistent with GAAP.
Mr. Castle. So it could be officers or it could be
directors or a combination of the two or something of that
nature?
Mr. Falcon. Yes.
Mr. Castle. Okay. And then you said it is just plain wrong
and must be fixed and not overlooked. I assume that is just a
follow-up to what you had said earlier in this particular area.
When you say ``fixed,'' if a mistake was made, do you mean
going back and just correcting the accounting principles? Or is
there something further that needs to be done to so-called
``fix'' their problems?
Chairman Baker. That would have to be the gentleman's last
question.
Please respond, sir.
Mr. Castle. Thank you, Mr. Chairman.
Mr. Falcon. It means making sure that the proper accounting
policies are put in place going forward. If there was an impact
on their financial statements going backward, that it would
mean that there would be a need to correct those financial
statements going backwards. That is an issue that we are
working with the SEC on.
Mr. Castle. Thank you, sir.
Chairman Baker. I thank the gentleman.
Ranking Member Frank had to step out. Just for the
committee's purpose, I have committed on his return to
recognize him in the proper order for his questions.
Mr. Clay, you are up next.
Mr. Clay. Thank you, Mr. Chairman.
Mr. Falcon, when you and members of OFHEO's staff conducted
interviews and received company documents, why was Fannie Mae
not allowed to question their witnesses on the record?
Mr. Falcon. They were allowed to participate in those
sessions. I am not aware if they requested such opportunity,
but the interviews of their employees were held at our request
in order to gather information about the company's accounting
policies and practices and internal controls.
Mr. Clay. Why were Fannie Mae officials not provided the
opportunity to respond to findings or conclusions reached by
OFHEO during the course of the examination?
Mr. Falcon. I think because we followed a regular order
here. We followed an accepted practice of regulators. Faced
with findings of significant accounting misconduct by senior
management and dealing with a management that is resistant to
regulation, that same management team responsible for this
accounting misconduct, any regulator would have done what we
did, take this directly to the board.
Mr. Clay. Is this due process?
Mr. Falcon. This is safety and soundness regulation which
requires prompt action to ensure that the company does not get
into financial difficulties.
Mr. Clay. Is this the way you have handled internal
investigations in the past?
Mr. Falcon. Other than the Freddie Mac special accounting
review, this is only the second special examination that we
have conducted. On more routine matters like our ongoing annual
risk-based examination of the enterprises, we do have that type
of a give and take, but this was a different situation.
Mr. Clay. In May and June of 2003, OFHEO published its 2002
annual report giving both companies, Fannie Mae and Freddie
Mac, more than satisfactory grades on accounting and internal
controls. You and your agency were pretty embarrassed when
issues were discovered at Freddie Mac. Were you so determined
to not let this happen again even if it meant denying Fannie
Mae fundamental fairness that is routinely provided to banks?
Mr. Falcon. No, congressman. I have testified before this
committee before that I had no reason to believe that this
company was engaged in any kind of accounting improprieties
like Freddie Mac. But given the fact that questions were being
raised about whether or not the same problems existed at
Freddie Mac, I thought it appropriate to go in and take a look
at Fannie Mae. So we did. I am as disappointed as I think you
are that the company has engaged in this type of conduct. But
the findings are what they are, and we have taken action.
Mr. Clay. Let us go back to the process, then. Examiners
discuss preliminary concerns and possible findings with
regulated entities. Would it not have been fair to do this with
Fannie Mae, to sit down and have a discussion with them?
Mr. Falcon. We did have a discussion, but it was with the
board, congressman. Like I said, this was a situation where we
have findings of serious accounting misconduct by management
and we have that same management being resistant to our efforts
to deal with these issues, noncompliance with our efforts to
examine the company such that we had to go to the Justice
Department and ask for a court enforcement of our subpoena. In
such situations, any regulator would have gone directly to the
board, brought the matter to the board's attention, and sought
immediate action to ensure the safety and soundness of the
company.
Mr. Clay. You did not provide Fannie Mae with a draft
examination report. Banks are given an opportunity to respond
before finalizing an examination report or discussing matters
with their company's board. Why not Fannie Mae in this
instance?
Mr. Falcon. We do that. In the course of our normal
examination of the company, we do that. But as I have said,
this is a different situation.
Mr. Clay. And you claim that they were hostile to the
examiners. In what way?
Mr. Falcon. They were resistant to compliance with our
request for documents and we had difficulty in scheduling their
employees for interviews. We eventually had to move to taking
statements on the record, rather than having informal
interviews of employees. We had to move to the issuance of
administrative subpoenas. We had to ultimately try to get those
subpoenas enforced in court.
Mr. Clay. Don't you think that all interests are best
served by ensuring that all relevant data is available to OFHEO
and that there are no misunderstandings of relevant facts?
Mr. Falcon. I am sorry, Congressman. That all relevant data
is available to----
Mr. Clay. To your agency and there are no misunderstandings
of relevant facts.
Mr. Falcon. Yes.
Chairman Baker. That will need to be the gentleman's last
question. His time has expired.
Mr. Clay. Did he answer?
Chairman Baker. He did respond, I believe ``yes.''
Mr. Clay. Thank you, Mr. Chairman.
Chairman Baker. I thank the gentleman.
Chairman Oxley?
Mr. Oxley. Thank you, Mr. Chairman.
Director Falcon, 3 years ago our committee was heavily
involved in the accounting scandals surrounding Enron and
WorldCom and others. We saw, based on our hearings and
evidence, manipulation of earnings, corporate governance
failures, raiding of corporations by their executives in order
to pad their own wallets.
After reading your report, it seems that you are alleging
many of the same problems now exist at Fannie Mae. As you know,
the Sarbanes-Oxley Act was formulated to prevent future Enrons,
but has been repeatedly criticized in some quarters as being
too tough on corporations. Do you believe that Sarbanes-Oxley
has been a useful tool in your investigation? And do you
believe that Fannie Mae's executives were in violation of the
Sarbanes-Oxley Act?
Mr. Falcon. I think it has been a very useful tool, Mr.
Chairman, because the spirit of Sarbanes-Oxley is
accountability, accountability of management and accountability
of boards in corporate governance issues. Here we have a
situation where because of the requirements of Sarbanes-Oxley,
I think the board has stepped up to try to begin to fulfill its
responsibilities. They have worked with us well in coming to an
agreement. We are working on developing a good relationship
going forward to address any future problems.
The provisions like certification certainly are beneficial.
There is much at stake when an executive certifies compliance
with the provisions of Sarbanes-Oxley. It has been a very
useful tool for the agency, because we also have safety and
soundness standards that our patterned off of Sarbanes-Oxley as
well.
Mr. Oxley. How does your job working with the regulated
entity, that is Fannie Mae, and in the context of Sarbanes-
Oxley regarding the SEC, explain to the committee a little bit
about how, as a technical matter, that works?
Mr. Falcon. We are working with the SEC. Now that Fannie
Mae is a registered company under the 1934 Act, they are
covered by Sarbanes-Oxley. We are working with the SEC. We have
shared with them all of our findings. We are sharing our
documents with them, everything that they have requested. We
have a shared interest here. Our interest is safety and
soundness. The SEC's interest is investor protection. We are
each working to make sure that our missions are fulfilled here.
Sarbanes-Oxley has encouraged that kind of interagency
cooperation between the safety and soundness regulator and the
SEC to make sure that both interests are properly served.
Mr. Oxley. Director Falcon, Fannie Mae is one of the
largest users of derivatives in the world. As such, Fannie Mae
should be well versed with the rules related to FAS 91 and FAS
133. Is it your understanding that Fannie was aware of the fact
that their accounting was not GAAP compliant, but they chose
not to comply because, to do so, would be too burdensome and
costly? Or is it your opinion that Fannie Mae made a material
misapplication of the GAAP rules?
Mr. Falcon. I think it is both, Mr. Chairman. One, they
wanted to maintain the accounting principles that they thought
were best suited to the company. At the same time, they
willfully did not apply accounting rules properly. This is an
important point because it was not just a matter of these rules
being too complex for this large, very sophisticated company.
They understood the rules. They chose not to follow them.
These accounting principles have to mean something, Mr.
Chairman, and they should apply to every company equally. No
one gets special treatment. What we have done in this report is
to highlight the issues of how the company has not complied
with some very critical accounting rules. The company will not
get special treatment from us. I do not think anyone should
give it special treatment in making sure it complies with all
accounting principles.
Mr. Oxley. The Sarbanes-Oxley Act clearly spells that out.
So you are saying that basically this was a selective effort on
the part of Fannie to use accounting principles that would
benefit them, as opposed to what we would consider to be
generally accepted accounting principles as enunciated by the
FASB and ultimately the rules set up by Sarbanes-Oxley and the
SEC and the Public Company Accounting Oversight Board.
Mr. Falcon. That is right. They simply did not comply with
GAAP because compliance with GAAP would have shown more
volatility in their quarterly financial statements than they
would have liked. So through the misapplication of GAAP, they
were able to project an image of the company of smooth
earnings, which conveys to the markets less risk than is
actually there because of the volatility of strict compliance,
of proper compliance with GAAP.
Mr. Oxley. Okay. So the issue is a selective interpretation
of GAAP. I would assume that Fannie will come before the
committee later today and argue that basically it was a
difference of opinion over those issues, and that they were
clearly compliant with the GAAP and that you had a different
interpretation as to whether that was procedurally correct. How
would you respond in advance to almost certainly they will be
testifying to?
Mr. Falcon. It would not surprise me, Mr. Chairman, that
that would be their position. We have found, not just our chief
accountant and her staff, but also Deloitte & Touche, we have
found that these are clear violations of generally accepted
accounting principles. They are not situations where a company
can say that they may have been aggressive; they may have been
consistent in spirit. No, these were noncompliance with GAAP.
We would not have come to the very firm conclusions we did
in this report and not have taken prompt corrective action were
it not for the fact that these were clear violations of GAAP.
If any company were allowed to engage in this type of
accounting misconduct, then no investor could rely on the books
and records of the companies and their financial statements.
Mr. Oxley. This will be my last question, Mr. Chairman.
As you know, in Sarbanes-Oxley we specified that insider
stock sales, instead of the traditional 40-days recording
requirement, would now be made in real time, that is within 24
hours of that sale. Did your investigation look into insider,
that is corporate executives, stock activities? If so, what did
it tell you?
Mr. Falcon. We have been monitoring the sales of
individuals within the company. We are just now beginning to
shift our focus into other areas like that. Our first objective
here was to assess compliance with GAAP in these two critical
accounting areas, and now move to remedy those problems and get
to valuation issues. But issues like the insider stock sales
are something that we have been monitoring and perhaps we will
come back and give you a report on that.
Mr. Oxley. It would seem to me at least that perhaps would
be the SEC's role because the Act required them, the insiders
who sell stock, to report that on the Web site at the SEC. And
so, I would assume that at least the SEC would assume that
particular role and that OFHEO would be secondary in that
regard. Is that correct?
Mr. Falcon. Yes. They are publicly disclosed, and the SEC
would have a role in that.
Mr. Oxley. They would have the primary role, would they
not, under the law?
Mr. Falcon. They would have a primary role, but safety and
soundness requires that we also take action. There is some
overlap. Safety and soundness requires that we also take action
when we see violations. It is important that we do coordinate
with the SEC in areas where there is overlap.
Mr. Oxley. The purpose, of course, of the provision, as
Chairman Baker knows and others on the committee, was to
provide more transparency in real time because perhaps if we
had that on the books during the Enron case, some of those
insider sales would have put up a lot of red flags,
particularly when the employees were locked down and not able
to sell their shares. So that is why I wanted to bring that
point up, the idea of the immediacy of it and the transparency
of it hopefully, at least at some point, will provide some
deterrent to that kind of behavior, including perhaps smoothing
out earnings or making earnings look better than they really
are.
With that, I yield back.
Chairman Baker. I thank the chairman.
Mr. Scott?
Mr. Scott. Yes, thank you, Mr. Chairman.
Mr. Falcon, there have been some questions raised as to the
timing of the release of your report. Could you describe the
manner in which this report was released, the timing of it?
Were there systematic leaks to the press? Were they internal?
And the affected parties such as Fannie Mae were aware of your
findings before they were released to the press?
Mr. Falcon. We have kept a tight lid on this as we have
gone through the process. The first communication we had about
this report as we got to the end of it was on Friday, the day
before we met with the board, I do not remember the exact date,
congressman, but we did contact the company and asked that the
board assemble itself so that we could present the report to
the board.
We did not release the report to anyone prior to that date.
The first time we released the report outside the agency was to
the board at that date. We did have on the Friday before that
Monday meeting, some conversations with other agencies just to
make them aware of what we were finding and how we were going
to proceed.
Then once we went to the board on Monday, the week
progressed with discussions between us and the board about
proper remedial action.
Mr. Scott. Let me ask you this, then, at what point did you
release it to the press in that order of events? When exactly
did you do that?
Mr. Falcon. We did that on Wednesday. I had a commitment to
the board that we would not release the report as long as they
objected, and we were in the process of working out the terms
of this agreement to take care of remedial actions. On
Wednesday, I had a meeting with a couple of the board members.
They said that given the intense interest in this, they no
longer had any objections, and given the fact that there was
also some expression raised from members of Congress about go
ahead and put the report out there, I exercised my judgment and
said, okay, then we will go ahead and release the report.
Mr. Scott. Okay. Did you consult with the Securities and
Exchange Commission or FASB prior to making the report's
findings public, as to whether or not Fannie's accounting was
consistent with GAAP?
Mr. Falcon. We spoke to the SEC about this on the Friday
before we went to see the board. Prior to that time, we did not
seek their opinion about this. Because we viewed these issues
as clear violations and the company clearly understood these
rules, we did not. If we felt that this involved a gray area
and we needed some guidance about what the rules required and
whether or not the company was meeting those rules, then we
would have certainly sought guidance from the SEC.
Mr. Scott. Okay. Two little points here. How are the
problems with accounting for derivatives at Fannie, how do they
compare with what you have found with the examination of
Freddie Mac? Are they the same? Same abuses?
Mr. Falcon. We have seen the same cultural issues. We have
seen the same motivations in terms of smoothing earnings. Some
role in compensation issues. So certainly much of that appears
to be consistent between the two companies.
As far as the actual magnitude of any impact on the
company's financial statements, I really do not have an answer
for that until we complete this next phase of the process,
which is to assess the impact on past financial statements.
Mr. Scott. Why do you think that Fannie Mae altered their
earnings? What was the underlying purpose from your report?
Mr. Falcon. The primary rationale as we see it was a strong
desire that the company had to present itself to the public and
investors as a company which had very smooth and consistent and
reliable earnings growth. The only way to do that was to
develop these accounting practices which allowed them to smooth
out the volatility which exists in this line of business.
Mr. Scott. Do you think that this activity was generated on
the part of Fannie Mae so that they could increase their
compensation package?
Chairman Baker. That would need to be the gentleman's last
question. His time has expired.
Please respond, sir.
Mr. Falcon. It certainly appears that way to us. Given this
one instance in 1998 and given the fact that for the next 5
years bonuses were continually tied to earnings per share as a
metric. That metric was being manipulated in order to create
smooth earnings. It certainly appears that way to us.
Mr. Scott. Thank you very much, Mr. Chairman.
Chairman Baker. I thank the gentleman.
Mr. Shays?
Mr. Shays. You are almost becoming a sympathetic figure,
and your organization. I mean, you have issued a report and you
are getting attacked on the report. You are being questioned
why you did not do a better job sooner, and yet your
organization has not been given the authority or the power by
Congress to do the job it needs to do.
And frankly, I do think you needed to show a little more
energy, which you are starting to do. I am seeing the result of
that. When did you give them the report? When did you talk to
them? Why didn't you find out sooner? Instead of having members
of this Congress try to find out what the hell they did.
One of the things that I find somewhat astounding is, are
you saying to this committee that you actually had to issue
subpoenas against this organization or consider it or threaten
it to get information you are entitled to get?
Mr. Falcon. We issued administrative subpoenas to get
information that we needed for this special examination, yes.
Mr. Shays. Why would you have to issue administrative
subpoenas? Why can't you just ask for it?
Mr. Falcon. We did initially, but we did not get sufficient
compliance, certainly not timely compliance, partial
compliance. Therefore, we felt the only way to solve that
problem was to move toward administrative subpoenas.
Mr. Shays. So the bottom line is, not only have you found
this company not in compliance, you are telling us they
resisted in your initial efforts to find out what was going on.
They resisted your efforts to do your job. Isn't that correct?
Mr. Falcon. That was our feeling and that is why we moved
toward the more formal processes.
Mr. Shays. And you have stated to us that these findings
are very serious, correct?
Mr. Falcon. Yes.
Mr. Shays. Are investors impacted? Isn't it possible that
investors, based on reports, will have made decisions that were
based on faulty information?
Mr. Falcon. Unfortunately, that very much is the case when
you have financial statements issued under accounting practices
that are not consistent with GAAP. GAAP is there to ensure
consistency of reporting across quarters so that you have the
ability to compare a company's performance from quarter to
quarter. If you do not have correct compliance with GAAP, then
you do not have that comparability from quarter to quarter and
can judge a company's performance over time.
Through these catch-up provisions the company had under FAS
91, it allowed it to minimize earnings volatility and that
comparability that investors need.
Mr. Shays. And didn't it also enable them to say they were
a low-risk enterprise?
Mr. Falcon. The lack of volatility certainly conveyed that
impression.
Mr. Shays. Now, having discovered what you have discovered
without the cooperation of the organization, are they accepting
your findings or resisting your findings?
Mr. Falcon. I feel like the board has been cooperative in
working with us to address these findings.
Mr. Shays. Right. And they said that they will change their
behavior, correct?
Mr. Falcon. They said they would change their behavior
going forward. They are going to do the calculations for us
going backwards so we can assess the magnitude of the incorrect
accounting in prior periods.
Mr. Shays. What concerns me is, when Mr. Raines comes and
testifies, he is not going to give us the feeling that he gets
it. Why do you think that is the case?
Mr. Falcon. I cannot speculate on that. I just know that
our findings, we feel very strongly about what we found. A lot
of work has gone into this. It does not surprise me that the
company would continue to stand behind its accounting, but the
fact is it is wrong.
Mr. Shays. It is wrong, and there is not going to be any
doubt about the fact that it is wrong. Now, their auditor was
paid $3 million in a $1 trillion firm. Doesn't that raise some
question about their capability, the auditor's capability to do
the job, with a $1 trillion operation?
Mr. Falcon. We are now focusing more on the work of the
external auditor. We have had concern about potentially
excessive reliance by the external auditor on the internal
audit function and internal policy-setting by the company, but
that is something for further review now that we have completed
this step in the process.
Mr. Shays. I congratulate you on the work you have done. I
congratulate you for trying to protect the public. I
congratulate you for showing courtesy to the company, meeting
with them first before this report was issued. But the bottom
line is, what really matters is what your report says and how
they deal with it. I am somewhat appalled and maybe even a
little shocked that you would have had to use subpoenas to get
information to do your job. I thank you for going to that level
to ensure that you could get your information.
Chairman Baker. The gentleman's time has expired.
Ranking Member Frank?
Mr. Frank. Thank you, Mr. Chairman.
Let me say, I was pleased and I understand what the
gentleman said. I guess, if your feelings have been hurt. I am
sorry. I did not think anybody here was of that sensitivity. I
was pleased to join with the chairman in objecting to the
appropriations committee to level-fund you going forward, but
we thought that was the best thing we could do was to get you
more money, and the chairman of the committee and I jointly
protested the decision of the Appropriations Committee, but
being in the minority we do not get to make those
appropriations decisions, but we were certainly supportive of
that.
I did have a couple of questions. This is important about
how this was done, because I think there is a problem that a
perception could be created before we can establish a reality
that could be damaging. Now, you told the gentleman from
Georgia how you went about telling people, et cetera. But there
was a newspaper report over that weekend I think quoting the
chairman of the subcommittee. He said he had been briefed on
the content of the report. We on our side, on the Democratic
side, heard nothing until we read about it in the paper. Was
the chairman briefed and is it appropriate to brief one side
and not tell the other?
Mr. Falcon. That would be certainly not appropriate and not
consistent with the way I would like to deal with this
committee, congressman. We did not brief any member of the
committee. Unfortunately, the press just reported that
inaccurately.
Mr. Frank. Wait. Stop. The press mis-reported it. All
right. Maybe that will make it into the reports of today's
proceedings.
So the report that the chairman had been briefed was an
error on the part of the press. He was not briefed.
Mr. Falcon. Yes.
Mr. Frank. Okay.
Chairman Baker. Would the gentleman yield? I just want to
confirm. I do not know where the report generated. I was not
either by SEC or OFHEO given any advance information.
Mr. Frank. Okay. I appreciate that. I would just caution
people, and we now have an agreement from all parties that the
assertion that OFHEO had briefed the chairman of this committee
was a mistake in the press. If that is the only mistake the
press has made in this, that would be quite extraordinary.
Let me ask you, similar. There was one report in one
newspaper that you had made a referral of a criminal matter to
the Justice Department. Is that accurate?
Mr. Falcon. We have not made a formal criminal referral.
All we have done is given a copy of the report to them.
Mr. Frank. To everybody. So that means you have not made a
criminal referral as that is defined.
Mr. Falcon. Right. We have not made a formal referral.
Mr. Frank. Okay. That is another one again. I think the
suggestion that there was a criminal referral is it seems to me
quite misleading. I am glad we were able to clear that one up.
Now, on the question of the substance, Fannie Mae has
agreed to a 30 percent increase in their capital. Is that
correct, as a result of your conversations with them?
Mr. Falcon. Yes.
Mr. Frank. How did you arrive at the decision to make it 30
percent? My understanding is, as I read this, the smoothing out
of earnings, if that happened, to give people more pay is
outrageous, but it does not seem to me to implicate in any way
the safety and soundness. A smoothing out means up one and down
another. It does not affect certainly the overall economic
position.
Then the question is the derivatives and the hedge
accounting. The potential misstatement there is I guess part of
the reason that you asked for the 30 percent increase in
capital because it might have been a misstatement.
But my understanding is you have come to no conclusion as
to what the amount of a potential misstatement was. Is that
correct?
Mr. Falcon. That is correct.
Mr. Frank. Could it have been an under-estimate as well as
an over-estimate?
Mr. Falcon. Potentially.
Mr. Frank. So what we know is that you disagreed with the
way they did them. I was struck, and I would ask unanimous
consent to put in the record here a very interesting report,
September 27th from Merrill Lynch, Thoughts on OFHEO's Special
Examination of FNM.
They note, for instance, with regard to the derivative
issue and the potential problem, the market value of these
derivatives, just like that of straight fixed-rate debt, is how
you correlate it with interest rates. When the rates fail,
these derivatives show losses. When rates rise, they show
gains. My understanding is rates are probably going to be going
up in the next time period, so they are more likely to show
gains than losses.
Since you have not been able to quantify this and in fact
you are not clear whether this is going to be a gain or a loss,
where did the request for a 30 percent increase in capital come
from? How did you decide it had to be a 30 percent increase?
Mr. Falcon. It is because of the management and operations
risk, as well as the uncertainty about their financials.
Mr. Frank. But how did you calculate 30 percent? What were
the figures?
Mr. Falcon. We took the 30 percent because the risk-based
capital standard requires a 30 percent add-on for management
and operations risk, but there is not that add-on in the
minimum capital standard. We decided that given the weaknesses
we found in internal controls, uncertainty of financial
statements, we decided----
Mr. Frank. And the 30 percent, you said that is the
requirement. That was a preexisting figure that you decided
applied here?
Mr. Falcon. That is in the statute.
Mr. Frank. Okay. Again, I think we ought to be clear. The
decision to require a 30 percent increase in capital was not
based at all on any calculation on the extent to which the
capital might have been impaired, but was a borrowing from the
statute or an application from the statute of what happens when
you find management risk.
Thank you, Mr. Chairman.
Chairman Baker. I thank the gentleman.
Mr. Royce?
Mr. Royce. Thank you, Mr. Chairman.
I would like to learn a little more about FAS 133. One of
the things I want to know is whether Fannie Mae and Freddie Mac
apply FAS 133 in a similar manner, or is one more conservative
and more consistent than the other? Another question, as I
understand it, FAS 133 went into effect in 2000 or 2001, and to
qualify for hedge accounting your derivatives have to perfectly
match what they are hedged against when they are booked, and
you have to document that. If you do that, then you are allowed
to use hedge accounting.
One of the questions I would have is, if they were not
perfectly matching was it because in your findings, was it
because Fannie Mae did not have the expertise or the ability to
do that? Or did they and they simply decided not to for some
reason? I was wondering why the auditor, KPMG, did not pick
this up. This is not one of the examples that they originally
cited, unless it is and I do not know it and you could let me
know that.
The other question I have is, how material was this? How
great were the irregularities? I know it says it has to
perfectly match, but I do not know from your report the extent
that this was off, and therefore requiring this long-haul
accounting approach rather than the hedge accounting. Maybe you
could help me out so I could better understand what is at issue
here.
Mr. Falcon. Sure. On the technicalities of this 133, my
chief accountant is much more qualified than I am, fortunately,
to get into the details of that. She can address the difference
between how Freddie Mac did it and how Fannie Mae did it.
Mr. Royce. Let us start with that, because I am interested
if there is a considerable difference in approach. Let me just
hear that out in terms of a more conservative or consistent
approach by one of the GSEs over the other.
Ms. Deleo. Actually, before Freddie's restatement, the
application of 133 between the two companies was substantially
different. Of course now after the restatement, because of a
number of things that happened during that process, they are
different. You really cannot make that comparison.
Mr. Royce. You cannot make that comparison because they
were applying a completely different approach in terms of how
they were going to value the portfolio on the risk?
Ms. Deleo. I guess I would not say completely different,
but substantially different.
Mr. Royce. Could you help me out and just indicate if
initially one approach, in your view, was more conservative and
more consistent than the other in terms of the two GSEs here?
Ms. Deleo. In both instances, there were misapplications.
They were just mis-applied in different ways.
Mr. Royce. I see. Okay, well that answers my first question
to some extent. Go ahead, Mr. Falcon.
Mr. Falcon. Mr. Dickerson, if you don't mind, would like to
add to that, congressman.
Mr. Dickerson. Freddie Mac had a program where they were
applying their derivative hedges directly to the mortgages on
their books. That was one difference. Fannie Mae has chosen to
apply almost all of their derivatives to specific liabilities
on their balance sheet. That is one big difference between
Fannie and Freddie.
Mr. Royce. Okay. And let's go to the question of why the
auditor, why KPMG did not pick this up. We are going back to
the first year that they would have to comply. Did that auditor
at the time feel they had complied with the standards that
would allow hedge accounting? Or did they simply not test for
that? Do we know? I would be interested in that.
Mr. Falcon. We are now looking into the determinations of
KPMG on these matters. But let me make clear that the
responsibility for compliance with accounting rules primarily
rests with the company. It is not sufficient to simply say that
the auditors signed off.
Mr. Royce. I understand that. I wonder, did the company at
the time feel it was in compliance? I guess your argument would
be, listen, if it has to match perfectly, then the company knew
it was not matching perfectly by definition if they are using
estimates. But I do not know the details here to know how far
off they were. That is what I am trying to elicit, is a greater
understanding of the specifics of this.
Ms. Deleo. Let me address that. Just backing up a second,
let's talk about 133 because I think it will help in the
context. One-thirty-three in principle is really a very simple
pronouncement because it basically says you need to mark to
market your derivatives. But it goes ahead to say that if you
qualify for hedge accounting, and what we are looking at there
is that you are going to go through and make an assessment test
to see if the derivatives are highly effective. If they are
highly effective, then you need to measure for ineffectiveness.
So that is kind of the second step. If they are not highly
effective, you cannot use hedge accounting.
Then in addition to that, there are some exceptions in 133,
very rule-based and very specific, that say if you have matched
terms, which they do not actually have, and there are very
specific criteria that you must meet to do that, then in that
case there is no ineffectiveness. They are perfectly effective
if the terms are matched. So you would not have to do the
assessment test and you would not have to measure
ineffectiveness. That is the problem. It is that they moved to
that last very specific area and they simply do not qualify
under that.
Mr. Royce. One last question. Is that because they do not
in your opinion have the ability or the expertise to do that?
Ms. Deleo. They fully understood the rules. That is not in
doubt. Their systems are not capable at this point of doing
what we are calling long-haul accounting, doing the assessment
test and the measurement of ineffectiveness. They could have
built systems to do that, but that was not done.
Mr. Royce. I see.
Chairman Baker. The gentleman's time has expired.
Mr. Royce. This really has helped me understand.
Mr. Chairman, thank you.
Chairman Baker. I thank the gentleman.
Mr. Hinojosa?
Mr. Hinojosa. Thank you, Mr. Chairman.
Director Falcon, I understand that your report hinges on
the accounting work of Deloitte & Touche. My question is, what
was your cost to retain Deloitte & Touche for the 8-month
period that you said they worked for you?
Mr. Falcon. Let me clarify, congressman. This work is and
the judgments in it are the product of OFHEO. Deloitte assisted
us in this work and they support the findings, they agree with
the findings in this report as well, but this is the work and
the judgments of OFHEO. They did assist us, but I do not want
to pass anything off to them. This was our judgment.
Mr. Hinojosa. So it was your judgment, and they have signed
off on the OFHEO findings. Correct?
Mr. Falcon. Yes, congressman.
Mr. Hinojosa. You also mentioned that you did not speak to
nor review the working papers of KPMG accounting firm while
preparing this report. It seems to me that it is less than
clear, then, that Deloitte has signed off on your OFHEO
findings.
Mr. Falcon. Deloitte fully supports the findings and
conclusions of this report. They also view these accounting
issues as very clear-cut violations and not matters of
interpretation.
Mr. Hinojosa. Aren't the views of the KPMG auditors
critical to your report? They are a very reputable firm. They
do the work for my company.
Mr. Falcon. They are reputable. KPMG may disagree with us,
but it is not unlike Arthur Anderson. They supported everything
Freddie Mac did until that got corrected.
Mr. Hinojosa. I yield back the balance of my time.
Chairman Baker. I thank the gentleman.
Mr. Ney?
Mr. Ney. Thank you, Mr. Chairman.
Following a little bit in the line of the question the
gentleman just asked, I think the one thing that has to be,
from your opinion from what I have heard, it has to be pretty
well-grounded would be the strength of the comment that OFHEO
has made that the company willfully did misapply GAAP. Now, at
the end of the day, the chairman of the SEC does make that call
whether that statement will be accurate in his view. I am not
saying your statement is necessarily inaccurate.
If that happens and the SEC says something, and I am not
asking you to speculate on what they are going to say, but if
that happens and you have said one thing and the SEC says
another, is there any type of discussions? Do we have the
mechanics in place in the law that allows discussions back and
forth between OFHEO and SEC to say, wait a minute, we think
this and SEC says that. I know the SEC is the final decision
maker on it, but is there any mechanism in current law that
would allow a debate or a point of view to be discussed in case
there are two separate opinions?
Mr. Falcon. I think the way this would work is the SEC
would determine what is appropriate for purposes of the
disclosures that are filed as required by the SEC. We also rely
on the financial statements of the company and its books and
records in assessing the safety and soundness of the company
and capital adequacy of the company.
If we see fit that the books and records are inaccurate and
need to be changed for purposes of our capital requirements or
for purposes of assessing their safety and soundness throughout
our examination program, then we would take appropriate action
utilizing our safety and soundness authority and they could do
what they thought was appropriate for purposes of their
disclosures that they require.
Mr. Ney. When you presented it to the Fannie Board, the
fact that they willfully misapplied general accounting
practice, one, what was the reaction, the statement made back
to you by Fannie's board? Two, with the auditing firm, KPMG,
what was their discussion with you, KPMG's, about their work
papers or why they advised Fannie to do this?
Mr. Falcon. KPMG was not in the meeting with the board when
we sat down with the board and presented our report to them.
The board did hear the entire presentation. They were all
present either in person or by telephone, and they have taken
this matter very seriously. Like I said, to their credit they
moved quickly to reach an agreement with us to assure that
safety and soundness concerns were properly addressed.
Mr. Ney. If KPMG signed off on this and advised Fannie, and
then if OFHEO has not had any discussion or your staff with
KPMG as to why they advised Fannie, has Deloitte & Touche had a
discussion or looked at the work papers as to why KPMG advised
Fannie to do it this way?
Mr. Falcon. We are now beginning work on the process of
assessing KPMG's work papers, having discussions with KPMG. In
addition, just as we are bringing in the SEC into these matters
surrounding financial disclosures and their adequacy, we are
also speaking with the Public Company Accounting Oversight
Board about the adequacy of the external auditor's work in this
regard.
Mr. Ney. I just wondered on the process, and it was verging
on the gentleman's question before, it seems that at some point
in time Deloitte & Touche would have to have a conversation
with KPMG to see why they would advise this, and look at their
point of view because it is a pretty stern statement that it
has been willfully misapplied. KPMG I would assume at some
point in time, even though you are not to phase two of this,
there would be discussions between auditing firms and
yourselves to at least hear their point of view of why they
would tell Fannie, yes, this is acceptable.
Mr. Falcon. We will have those discussions. Let me ask Mr.
Dickerson to talk about it. He knows more about what happened
in the past and what we will do going forward.
Mr. Ney. I know you are going to have those discussions,
but Deloitte is sitting there in a way, saying yes, this is
misapplied general accounting practices. I just want to
understand why there was not a previous conversation to give
them a comfort level of why, and before this whole report came
out. That is one thing I would question.
Mr. Falcon. We at OFHEO have requested work papers from
KPMG and have talked with their partners about getting those
work papers. We have actually received some of those work
papers and have reviewed ourselves, OFHEO examiners, some of
the work papers in coming to the conclusions that are in our
report. It is important to note that the report represents the
views of OFHEO, so it is most important for the examiners at
OFHEO and the office of the chief accountant to be comfortable
with what KPMG has done.
Mr. Ney. Mr. Chairman, my time has expired. At some point
in time down the road, I would like to get your opinion of what
tools you would need if you were to become the regulator for
the future.
Thank you, Mr. Chairman.
Chairman Baker. I thank the gentleman.
Mr. Capuano?
Mr. Capuano. Thank you, Mr. Chairman.
I would like to ask just a few general questions about FAS
133, which obviously I am not terribly familiar with, a little
bit, but not terribly familiar with. As I understand it, it is
a relatively new regulation. Is that correct?
Mr. Falcon. It went into effect in 2001.
Mr. Capuano. So relatively new in these kinds of things. Am
I right to understand that between the regulations and the
guidelines and the rules relative to it, it comes to about 900
pages, give or take. Is that a fair estimate?
Mr. Falcon. Yes, Congressman.
Mr. Capuano. So it is a relatively new 900-page regulation.
In the normal course of events of any new accounting
standards, any changes in GAAP, any changes in FAS or any of
these things, am I right to understand, again, not just in
banking or not just in GSEs or anyplace else, but in every day,
including individuals and everything else, when something new
like this comes out that is clearly long, clearly complicated,
clearly important, and clearly has very important
ramifications, isn't there a normal period of time in which the
people who are affected by whatever the rule or regulation is,
plus the auditors and the accountants who interpret it, isn't
it a fairly common thing to have a period of time where people
may interpret things differently, and the systems, through the
industry, the regulators, the courts, the IRS, whoever it might
be, the SEC, then over time tends to take different approaches
to the same rule and regulation and say, well, wait a minute,
we know you took different approaches, but this is not right
and this is not right, and little by little they come to a
consensus.
Is that not a normal situation?
Mr. Falcon. I think that grace period you are describing
occurs prior to the effective date of the implementation of the
rule. This rule did go through many years of discussion, many
years of debate and analysis. It had a delayed effective date.
Even after it was supposed to become effective, I think it was
delayed for an additional year.
Mr. Capuano. I understand that. I understand how rules are
made, but even after rules are made, are you telling me that in
the normal course of events that every FAS, every GAAP rule is
then implemented perfectly by everybody in lock-step with no
disagreement, no discussion, no need to then clarify different
things that happen in a 900-page report?
Mr. Falcon. The rules apply as of the effective date of the
rule.
Mr. Capuano. I understand the rules apply, but how are they
interpreted? You are telling me they are clear, concise and
unequivocal on all counts every time there is a change in the
FAS, every time there is a change in GAAP? I have to tell you,
that is not my experience and I do not think that is the
experience of any accountant or auditor in the country. It is
not the experience of the IRS, the SEC or you.
So I understand how rules are made, but I also know that
once rules are made there is still a period of time afterwards,
not a set period of time, that different people read different
things differently and interpret things differently with good
will. So the thinking that somehow you set a rule and that is
it, well, if that is the case we do not need courts. We do not
need the IRS. We certainly do not need the tax court for any
interpretations because we have thousands and thousands of tax
rulings, and this is really just one implementation of it.
I would obviously disagree, or I am not sure that you
answered the question, but clearly it takes time to work these
things out.
I guess in the normal course of events, absent different
issues, and not all the time, is it not a normal circumstance
where many entities within the rules of GAAP, within the rules
of various FAS's and other accounting procedures and tax
procedures, try to on occasion smooth out earnings? Is that not
something that happens here and there in the business world?
Mr. Falcon. If it happens, it is wrong. It is not proper to
try to smooth out earnings by violating accounting rules.
Mr. Capuano. I did not say violate it. You did not hear the
question. Within the rules of accounting, within the rules
allowed by various regulators, there are times and certain
situations that it is allowed.
Mr. Falcon. If it is within the rules of accounting, it is
not improper.
Mr. Capuano. That is what I asked. So within the rules, the
concept of smoothing out earnings in and of itself is not a
violation, understanding fully well that there are times that
it is wrong, there are times that it is not, and that is what
the debate is about is whether these rules are right or wrong.
I also wonder, are you chasing KPMG at this point in time,
or are you just kind of letting it float at the moment?
Mr. Falcon. No, we are starting, as we said, to obtain the
work papers of KPMG and we will discuss with them their
assessments.
Mr. Capuano. Okay. It strikes me again, and I know this is
very complicated and I understand that, but if they had the
opportunity to make these decisions, and what they did, as I
understand it, and again correct me if I am wrong, is in their
reports they simply cited it as an audit difference.
For those who do not understand, an audit difference does
not stop the process. They could have said it was a material
weakness. Nobody in their right mind wants a material weakness
noted on their annual report, and hopefully even understaffed
you would have found something that was cited as a material
weakness in an annual report. They did not cite it as a
material weakness. Am I wrong?
Mr. Falcon. No, it was just an audit difference.
Mr. Capuano. So then KPMG as an auditor has said,
basically, look we do not necessarily agree, but it is a minor
point. Here it is in the footnotes, and we will move on.
Chairman Baker. This will have to be the gentleman's last
question. His time has expired.
Mr. Capuano. Thank you, Mr. Chairman.
Again, I guess I will just finish by simply stating that
clearly there are some serious questions. You have raised
serious concerns, and if you turn out to be right, there will
be some serious ramifications of it, but I still think that
some of the concerns and some of the comments that have been
made here today are kind of jumping the gun and putting the
cart before the horse relative to allowing people to make a
determination of what was right and what was wrong; what was
willful and what was simply just a difference of opinion in the
ordinary course of business.
Mr. Toomey. At this time the chair will recognize the
gentlelady from New York.
Mr. Kelly. Thank you very much.
I appreciate the fact that you have delivered a partial
report. It has been very interesting reading. One of the things
I am troubled by and I see repeatedly in the report is that
there are people carrying double roles within the structure of
Fannie Mae. I understand that the OFHEO has been asking the
chairman of the board and the CEO of both the GSEs to separate
people into separate functions. For instance, Janet Honeywell,
her job was forecasting as well as financial reporting.
There are numerous examples, starting on page 158, going on
through, are people, first of all, who are not CPAs that were
doing financial structuring and analysis. And secondly, they
were auditing their own work essentially. My question to you
is, Freddie Mac apparently has agreed to separate roles.
Apparently, Fannie Mae has not. Are they in the process of
working with you to try to do that? Can you talk to us about
why you think this is a healthy thing to do? What is ongoing
with regard to OFHEO working with Fannie Mae to make sure that
there is a separation of duties?
Mr. Falcon. We do think it is important that key functions
be separated so that there is not a conflict of interest or
that someone with an incentive to meet some goals also has the
ability to manage the accounting of those goals such that they
are met.
So we have taken action, going to Freddie Mac to make sure
there was proper separation of offices and functions and
individual responsibilities. The board of Fannie Mae has agreed
with us to create a separate chief risk officer. We found that
the individual responsible for setting goals in this instance
was also responsible for making sure that they were met.
We are looking at other issues as well. We have a pending
corporate governance rule amendment which would separate the
function of the chairman of the board and the chief executive
officer. Freddie Mac has already agreed to do that, and once
this rule is implemented it will also provide the same for
Fannie Mae.
Mr. Kelly. I want to go back to page 160 of your report. I
do not know how to pronounce Sam Rajappa. I do not know how to
pronounce that last name.
Mr. Falcon. That would be Rajappa.
Mr. Kelly. It is Rajappa. Thank you. There is a statement
in here by Tim Howard noting that Sam Rajappa reports directly
to the chairman of the audit committee, but for the last I
think year and a half, maybe 2 years, he has reported on a
dotted line basis to me.
In reading your report, I could not quite figure out who
had a straight firm line and who had a dotted line, because it
looked to me like a lot of these things were being mixed
responsibilities. Jeffrey Guliana had a dual responsibility.
There is one name after another here where I do not see a solid
structure, but rather an informal structure. I would like you
to expand on what you have found with regard to this, because I
am not sure exactly who was the person that was signing off on
the bottom line here.
Mr. Falcon. That is a good question. We found that this was
a big weakness in the way these accounting policies were being
set. There was not a clear process in place. There were no
accounting controls. There was not even adequate documentation
about what the accounting policies were and the roles in
formulating these accounting policies.
Let me ask Mr. Dickerson, who can speak very well to these
internal control issues, to elaborate further.
Mr. Dickerson. Right. We found, for example, in the
amortization area that there was one individual who was in
charge of the modeling and accounting for amortization. That is
a weak segregation of duties. We found, you mentioned Ms.
Pennewell, who was in charge of financial reporting and
financial planning, so she had opportunities at least to help
meet through accounting financial goals that her group had
earlier set.
Mr. Kelly. Is there now in place a structure, because I
understand from Mr. Falcon, from what he just said, that that
structure has not really been changed much, and it is still
unclear to me. Have you established with them now a clear line
of who reports to whom?
Mr. Falcon. It will take a little time to fix all of these
problems, to do the reorganization within the company and
create the positions and select individuals for the positions.
But this is something covered by the agreement with the board,
and we are going to move as expeditiously as possible to get
these fixes in place.
Mr. Kelly. Thank you.
Chairman Baker. The gentlelady yields back.
Mr. Lynch?
Mr. Lynch. Thank you, Mr. Chairman.
I was late in the hearing, but I do want to thank you for
coming here today and helping the committee with its work. I
know you have had a rough time with some of my colleagues, but
I do not think there is anybody here that questions your good
intentions to help us with this process. That is the position I
take. You are good to do your work and we need you to do it
really well, and I am sure that is going to happen.
However, this is the political side of the table, so some
of us up here are going to twist and use your information to
help us grind an axe with Fannie Mae or others, or to defend it
as I will intend to do. But that is not to discount the good
work that you are doing.
I do want to rebut a couple of things, and I want you to
work with me here. I have heard Enron, Enron, Enron a bunch of
times here. Quite frankly, the chairman of the subcommittee did
a wonderful job in helping the committee with its work in that
case, but even the chairman of the full committee has brought
that specter to bear in comparing what has happened at Fannie
Mae to Enron.
I just want to ask you, we had the Enron situation. We had
a house of cards there, a financial house of cards where there
was no strength to the underlying business. They had a very
unsound business model. We had serious problems in the
underlying business. Is that what you see here? Is that what
you see here?
Mr. Falcon. The business model of the company remains
sound.
Mr. Lynch. Remains sound.
I do not have much time. That is just one thing I wanted to
get out there.
Mr. Falcon. Okay.
Mr. Lynch. We had 19 criminal indictments. We had 96
criminal charges. We had 78 fraud counts against the people who
were running Enron. Is that what we have here? Or is it more in
the line of noncompliance with accounting standards?
Mr. Falcon. We have deferred any opinions, resolutions of
any criminal conduct to the Justice Department. We have
referred to the corporate fraud task force our report. We are
cooperating, giving information to the U.S. attorney upon
request about anything we found and documents that we have
about this. Beyond that, we are not forming judgments about the
criminality of this, and we have not made any criminal
referrals to the Justice Department.
Mr. Lynch. Thank you. In terms of the gross manipulation
that occurred in the California power market by Enron in which
investors and employees lost their pensions and their life
savings. Is that what we are looking at here or is it something
different?
Mr. Falcon. I think until the entire review is over, I
would withhold maybe broad categorical statements about this.
Certainly, what we have found to date raises serious concerns
with us about the company's proper accounting, as well as their
internal controls, doubts about safety and soundness, prior
financial statements. If we find that this type of conduct
shows up in other areas that we have yet to begin to review,
then it would become much more serious than even it is now.
Mr. Lynch. So you are saying they could be defrauding the
public and the investors and the employees just like Enron? Is
that what you are saying, that this could be one of those
cases?
Mr. Falcon. No. I do not know. I have no----
Mr. Lynch. You just said there was a sound business model
here.
Mr. Falcon. Exactly, a sound economic business model. But
as far as any criminal intent or any desire to break laws for
some criminal purpose, I do not know. I cannot speak to that.
Mr. Lynch. Okay. Thank you.
Thank you, Mr. Chairman.
Chairman Baker. I thank the gentleman.
Mr. Toomey?
Mr. Toomey. Thank you, Mr. Chairman.
What I would like to do is address this question of whether
we are really talking about a difference of interpretations of
ambiguous rules, or whether we have something that is really
pretty objective. While this gets a little bit complicated, I
think it is manageable, I hope within 5 minutes. Let me see if
I can walk through what I understand to have gone wrong with
respect to FAS 91. Tell me where I go wrong on this.
First of all, Fannie Mae buys assets that trade at premiums
and discounts. Correct? Some of these assets have prepayment
features.
Chairman Baker. Mr. Toomey, I hate to interrupt your train,
but I will let you re-start.
Just by way of announcement for members, I understand we
will have a series of two votes. It would be the chair's
intention upon recessing for those two votes that we would
recess the committee for 30 minutes to give members and
witnesses a chance to refresh themselves. That would mean we
would return here, let's just say 1:30 p.m. We would proceed
with Mr. Toomey's comments and questions, and then break at
that point, just so all members are advised, 1:30 p.m.
If you would like, you can proceed now, or at your leisure;
if you want to come back. Either way.
Mr. Toomey. I would like to proceed when we get back.
Chairman Baker. Okay. Great. The committee will stand in
recess until 1:30 p.m.
[Recess.]
Chairman Baker. At this time I would like to reconvene the
hearing of the Capital Markets Subcommittee.
At the time the committee recessed, Mr. Toomey had been
recognized to proceed, and at this time I recognize the
gentleman for 5 minutes.
Mr. Toomey. Thank you, Mr. Chairman.
I would like to take up where we left off on this
discussion about whether what we have seen with Fannie Mae has
been a willful misrepresentation of certain income and expense
accounts, or whether it is just the difference in
interpretation of an inherently complex and ambiguous
accounting laws.
It seems to me the allegations being made by OFHEO, which
frankly seem very well substantiated, are very clear: It is the
former. This is a willful, conscious misrepresentation.
And in fact, KPMG agrees with you and not with the company
when they cite this irreconciled item. Is that correct?
Mr. Falcon. Yes, the $200 million----
Mr. Toomey. The $200 million--number one, their auditors
agree with you, not with the company, with respect to this
treatment.
Now, I would like to get to the substance of what this
treatment is about with regard to FAS 91.
As I understand it--and please correct me when I go wrong
here--my understanding is that when a financial services firm
such as Fannie Mae buys assets at either premiums or discounts,
some of which have prepayment features, they are required to
amortize the premiums and the discounts over a projected life
of the asset, which is determined in part by estimating
prepayment rates and other things.
My question for you is: When those assumptions are made,
the model is employed and an amortization schedule for premium
or discount is arrived at, is that not a very precise figure?
Mr. Falcon. Yes.
Mr. Toomey. So it is not a range, it is not a ballpark,
there is a number. And if you carry it out far enough it goes
right to the penny. Is that correct?
Mr. Falcon. Yes, Congressman.
Mr. Toomey. And then my understanding further is that when
the next quarter comes around, interest rates very often will
be different than what was projected in the previous quarter,
and that requires a reassessment.
And part of that reassessment is a very precise--it is a
new number, and the company is required to catch up, if you
will, on the previous errors that come to light, errors with
respect to how reality differed from what was projected in the
previous quarter. Is that correct?
Mr. Falcon. Yes. We are required to make those adjustments.
I would not use the term ``catch up'' in the same sense that
the company called what they were doing a catch-up.
Mr. Toomey. Okay, but they are required to make an
adjustment, to affect the cumulative difference between what
was projected and what in fact occurred in economic reality,
and that, too, is a very precise number. Is that correct?
Mr. Falcon. Yes.
Mr. Toomey. And the rules, do they say that despite the
fact that a precise number is calculated, you do not have to
really use that number? Does FAS 91 give any discretion about
what number you use?
Mr. Falcon. Let me ask our chief accountant.
Ms. Deleo. No.
Mr. Toomey. It does not. Does FAS 91 suggest that you can
round this number to some degree?
Ms. Deleo. No.
Mr. Toomey. Okay, it does not allow that.
I am looking the testimony from Mr. Raines and from Mr.
Howard, and it talks about how this estimation process is
imprecise. In fact, it is not imprecise at all; it is very
precise.
It is subject to future revision, but at the point in time
in which it is calculated, it is perfectly precise. Is that
correct?
Ms. Deleo. That is correct.
Mr. Toomey. The alleged imprecisions are used in Mr.
Raines's testimony as a justification for creating a range. In
fact, the range has nothing to do with this calculation. Or
does it?
Ms. Deleo. No, the range does not have anything to do with
it.
Mr. Toomey. The range was a perfectly arbitrary invention
of the company, it seems to me. Is that your opinion?
Ms. Deleo. Correct.
Mr. Toomey. And the range of $100 million, plus or minus,
from these adjustments is not even contemplated, much less
allowed, under FAS 91, is it?
Ms. Deleo. There is nothing under FAS 91 that would allow
for a range.
Mr. Toomey. So it is not as though there is a range that is
allowed and there is a dispute over how much. There is no such
concept.
But you make a further allegation, if I understand it
correctly, which is that not only is it simply and very
straightforwardly wrong to not report the full number precisely
as calculated, which Fannie Mae has done, but that there was a
policy within company systematically not to report the precise
number, but rather to have this cushion that you describe as a
cookie jar, which served the purpose of evening out income. Am
I correct to understand that?
Ms. Deleo. You are correct.
Mr. Toomey. Some seem to suggest that this is not really
material, you know, Fannie Mae is a big company, you know, it
has got a lot of income. But this range that they created was
$100 million. Right?
Ms. Deleo. Plus or minus 1 percent, but it basically rounds
to $100 million.
Mr. Toomey. And it was not an effort to round this number;
it was derived from a totally different set of calculations
regarding total--my time has expired. I just want to make the
point.
A plus or minus variation here of $l00 million, what does
Fannie Mae roughly earn in a quarter? What is the total income
in a quarter?
Mr. Dickerson. Probably in the neighborhood of a billion.
Mr. Toomey. About a billion.
Chairman Baker. I would say $150 million, probably.
Mr. Toomey. So we are talking over 10 percent of the
reported income in a given quarter.
Mr. Dickerson. Actually it could work out larger than that.
Mr. Toomey. And it could work out larger than that.
So by virtue of the sheer magnitude, I do not understand
how someone can say it is material.
But I would further argue that I am not sure the
materiality applies as a concept when you are dealing with a
systematic misrepresentation of the numbers. I do not think
that is allowed regardless of how big the misrepresentations
are. Is that correct?
Ms. Deleo. I would completely agree with that.
Chairman Baker. Your time is expired. It has been most
helpful. I appreciate your insights, Mr. Toomey.
Mr. Meeks?
Mr. Meeks. Thanks, Mr. Chairman.
Let me make sure--I think that it has put some things in
context, especially with reference to some of the process.
I think it is a matter of fact, I think you would agree
with me that plenty of people do not like Fannie Maes or
Freddie Macs for that reason, their current status in the
market. People wanted to change it.
Before your report came out there was talk from this
committee and from others in the private company that one did
not like the status that Fannie Mae had. You would agree with
that--right?--the status that Fannie Mae and Freddie Mac
currently has in the market?
Mr. Falcon. No, Congressman, I do not support privatization
of these companies.
Mr. Meeks. I did not ask you that. I did not ask you
whether you do or not.
I said I think that we could all agree that we know from
either some of your prior testimony, there are individuals in
some movements that have been afoot that did not like the
status of Fannie Mae and Freddie Mac had within the market. You
could agree with that.
Mr. Falcon. Only certain individuals----
Mr. Meeks. And is it also true that in fact you, when you
came here previously to testify on other occasions, many
individuals on this committee were very critical of you and
challenged your ability to be able to relate to the largest
financial entities in this country. Is that not correct?
Mr. Falcon. Yes, Congressman.
Mr. Meeks. In fact, they were so upset with you at that
particular time, there were bells put forward that indicated
that they may need to create a new regulator for the GSEs. Is
that not also correct?
Mr. Falcon. Yes.
Mr. Meeks. And it is also true that this is a special
examination, a special examination actually departed from what
is standard financial institutional examination procedures. Is
that not also correct?
Mr. Falcon. No.
Mr. Meeks. This was not a special examination?
Mr. Falcon. Yes, it was a special examination, yes.
Mr. Meeks. All right. And under ordinary procedures, would
it not also be a situation whereas, you know, there were
questions in regards to some of the regulations that you were
overseeing that Fannie Mae, or whoever you are investigating,
would have had the opportunity to address those issues prior to
the issuance of the report.
Mr. Falcon. Any examination follows a pattern where if it
is a normal examination, like our annual risk-based
examination, there will be, depending on severity of the issues
that are found, you could have, would have give and take
between the management.
But this was a special examination, or it was situation
where there were serious concerns raised about the conduct of
management in this area of accounting and internal controls----
Mr. Meeks. And some of that is subjective. Because as we
indicated, I think that when someone was talking before, the
person that is clearly talking about FAS 133F and FAS 91, the
ultimate determination is going to be made by the SEC, and
there could be a question whether discretion, whether or not--
because we do not know, you know, it could be a difference of
opinion between you and the SEC. We do not know that yet.
Right now what you are putting out is just more
allegations.
And what I am talking about, when I start talking some
irregularities, I am talking about--well, you know, even
Senator Bond talked about the leaking of evidence or leaking of
letters to the Wall Street Journal, other press. That is not
standard. That does not happen under those circumstances. Is
that a common procedure, to leak evidence and letters?
Mr. Falcon. Congressman, we did not release this report
prior to the board agreeing with us that they did not have any
objections to this report being put into the public domain. I
received a letter from members of Congress in fact urging me to
do so.
I had a commitment to the board not to release this report
while we in these discussions. But once they no longer
objected, I decided to do so.
Mr. Meeks. But even before they objected, things were
leaking out. And I do not know if Congress had ever asked for
it, but things were leaking out before--at one time and
previously.
So it has not been the usual type of investigation here,
with things leaking, to give a hint of something or other. It
seems to me that it is just curious to me that this is
happening.
Well, OFHEO itself was threatened with reference to being
replaced by a regulatory agency.
But let me just go to someplace else, because you make
strong allegations. And, you know, sometimes you throw things
out there. I know, I used to be a prosecutor. And it is very
dangerous. And you made some allegations, strong allegations,
that, you know, I do not know where the evidence--I have not
heard the evidence of it.
But, again, coming from the background that we are talking
about, with reference to the pressure that was put on OFHEO by
others and members of this committee about doing certain
things, and all of a sudden I see this report coming out, I see
things that are being leaked out.
And then you make some charges that a lot of this is being
done because of executive bonuses. That is a very serious
charge. And I don't know exactly how you back this up. Can you
just tell me? How do you back this up?
Mr. Falcon. It is our judgment, based on the evidence we
saw, that this company in 1998, in that instance, when you look
at the circumstances, the company deferred this $200 million of
expenses in disagreement with this external auditor, and the
evidence seemed to us that it was in order to meet these
compensation bonus targets.
Chairman Baker. The gentleman's time is expired. Did you
have a wrap-up?
I thank the gentleman.
Mr. Bachus?
Mr. Bachus. Thank you.
Director, derivatives have been used to hedge risk and
actually have been used successfully. In this case, you have
talked about this particular derivative contract had not been
approved for hedging. Is that right?
Mr. Falcon. Their derivatives portfolio, they were
classifying all but about $43 million of the notional value of
their derivatives portfolio as eligible for hedge-accounting
treatment, which means any changes in market value would flow
through other comprehensive income and not through the----
Mr. Bachus. To flow to the----
Mr. Falcon. Yes.
Mr. Bachus.----to the underlining security of whatever it
was hedged to, whatever the derivative was based on?
Mr. Falcon. Whatever change in value occurred in the
derivative wouldn't flow through earnings to the balance sheet,
but rather would go through other comprehensive income.
Mr. Bachus. Okay. Did that affect Fannie Mae from a safety
and soundness standpoint, in your opinion?
Mr. Falcon. I think, overall, everything we find in this
report does raise concerns about the company's safety and
soundness. We have found practices that are inconsistent with
safety and soundness, practices about not complying with
accounting rules, not having accurate financial disclosures,
not having the appropriate internal controls.
The report has great detail, I believe, on the reasons why
we have expressed concerns about the company's safety and
soundness.
Mr. Bachus. Just assuming that they had applied with the
FAS 133 in their risk management, do you believe that Fannie
overall has made the right economic and risk management
decisions in terms of protecting its portfolio from market
risk?
Mr. Falcon. They use their derivatives to hedge against the
interest rate risk associated with this retained portfolio that
they manage. And their use of these derivatives is proper to
hedge risk. We are not questioning their use of derivatives to
properly manage the interest rate risk that they face.
What we are seeing here is a lack of compliance with the
accounting rules. We are also looking at other things related
to this derivatives portfolio. This is just the beginning of
what we have determined. These are our findings to date. And we
will continue to look at issues raised.
They use--their policy is to use derivatives only to hedge
risk and not to speculate. That is also our safety and
soundness standard.
Mr. Bachus. How long----
Mr. Falcon. But we are looking at it to make sure there
weren't transactions that were inconsistent with that policy.
Mr. Bachus. Okay. How long--I mean, you have been critical
of their internal controls and of some of their accounting
practices. How long have these practices been going on and
these lack of internal controls, in your opinion?
Mr. Falcon. The internal controls--I guess we found that--
the policies on FAS 91 date back to 1998 and on 133 date back
to 2001. So certainly these weaknesses that allowed these
improper accounting policies to be put in place certainly go
back as far as that.
Mr. Bachus. Now, you are examining them on a regular and
constant basis, right?
Mr. Falcon. Yes.
Mr. Bachus. Why did you just now discover those things? Why
did it take this long?
Mr. Falcon. We look at many issues related to credit risk,
interest rate risk, management and operations risk, a wide
variety of areas of a company's risk profile.
This is an area where, very recently, as a result of the
Freddie Mac accounting problems, we decided to go and take a
very close, detailed look at Fannie Mae. We have not, prior to
this point, conducted such an in-depth examination focused on
one area of the company.
Our examination program assesses their risk and risk-
management practices across a wide range of risk. Focusing in
narrowly on this subject has uncovered problems that the
broader review has not uncovered previously.
Mr. Bachus. Okay. One final. Did you all consult with--now,
KMPG was their outside auditor, right?
Mr. Falcon. Yes.
Mr. Bachus. And Deloitte & Touche, you all used them to do
your audit, right?
Mr. Falcon. Yes.
Mr. Bachus. Is that right? Have you all consulted with KMPG
about your findings?
Mr. Falcon. We have begun the process of obtaining KPMG's
work papers, discussing this with KPMG. But we have not gone
down a path of trying to--management and the company is
ultimately responsible for ensuring that the company's policies
and practices in the accounting area are consistent with GAAP.
Mr. Bachus. But you were totally unaware that they were
doing all this until just recently?
Mr. Falcon. We have not conducted an in-depth accounting
exam like this previously.
Mr. Bachus. Had you criticized their internal controls
prior to this? You are their regulator, right? And internal
controls would be a basic part of--for instance, who signs off,
who within the company signs off on these derivative contracts
and their treatment? Had you questioned those in the past?
Mr. Falcon. I would have to go back and look at our
previous examination reports. But if we did, in fact, identify
these problems in the past, we hadn't conducted this type of an
in-depth examination before.
Mr. Bachus. You probably should have, right?
Mr. Falcon. I would have liked to have done it previously,
yes, now that we know what we know.
Chairman Baker. One more question, sir.
Mr. Bachus. On September the 20th, you were meeting with
the Fannie Mae board. You all were going to present to them
your findings, is that correct?
Mr. Falcon. Yes.
Mr. Bachus. And you had not made that known to the public
at that time, had you?
Mr. Falcon. Right.
Mr. Bachus. And I know everybody was waiting on that
meeting. And then that morning I recall picking up The Wall
Street Journal and seeing it pretty much laid out as to what
you all's report was going to show in detail. That is a
violation of your own rules, isn't it?
Mr. Falcon. Right. We did not authorize--I did not
authorize the release of any information about what we were
about to do at the board. All I can tell you is, the Friday
before that Monday, we did bring some other federal agencies in
the process in an effort at interagency cooperation to let them
know what we had found and what we were about to do. Now, that
Friday we had also had discussions with some board members, in
order to get them to convene the meeting for Monday.
Mr. Bachus. But somebody disclosed what was then nonpublic
information. I know that is a violation of you all's guidelines
and every agency's. I think your guideline 105 prohibits the
disclosure of nonpublic information regarding a regulated
entity and actually provides civil and criminal penalties. So
somebody would have had to violate that guideline, would they
not?
Mr. Falcon. If it was someone in the company, within the
agency----
Mr. Bachus. Or in another agency, then they would have----
Mr. Falcon. Well, our guideline only applies to us. If you
are citing our guideline, it only applies to OFHEO and not----
Mr. Bachus. Have you done anything to identify--or, were
you concerned about that, when you saw that that nonpublic
information had been disclosed in violation of your own rules
and regulations?
Mr. Falcon. I am always concerned about information that
shows up in the public domain----
Mr. Bachus. Have you all tried to identify the individual
or individuals who violated these rules?
Mr. Falcon. I am not sure, Congressman, what shows up in
the newspaper, whether it is conjecture, speculation. There is
an insatiable rumor mill that circulates around everything----
Mr. Bachus. Actually, it was specific in what they----
Mr. Falcon. It is hard for me to discern what is
speculation and what is based on a leak and what is based on
some authorized release of information.
Mr. Bachus. You saw that report. It was pretty apparent
that they had to have inside information.
Mr. Falcon. I have seen speculation about what we might do
for months and months now, based on what knowledge people had
about what we did with Freddie Mac.
Mr. Bachus. Okay.
Chairman Baker. Mr. Bachus, you have used almost twice your
time. You are, like, 5 minutes over.
Mr. Bachus. I am sorry.
Mr. Frank. And you are not going to get an answer, no
matter how you ask, so you might as well move on.
[Laughter.]
Chairman Baker. Let us see, Mr. Watt, I think you are next.
Ms. Waters is next?
Okay. Ms. Waters?
Ms. Waters. Thank you very much, Mr. Baker.
Mr. Falcon, you have been before this committee before. And
you were pretty much on the hot seat on more than one occasion,
where you were accused of not doing a good job, not exercising
your oversight responsibility, of being incompetent.
And I think a number of members you talk with following
those hearings, where you not only ask for support but try to
make the case why OFHEO should remain. Is that true?
Mr. Falcon. No, I have actually supported a regulator with
all the authorities and powers and resources to do his job,
even if it means abolishing my agency.
Ms. Waters. Did you seek support for yourself and for your
agency following the criticism that was reaped upon you in this
committee? Did you talk to any members of Congress?
Mr. Falcon. Oh, yes, I have----
Ms. Waters. All right, thank you.
I would also like to know a little bit more about what has
happened since the time that you came under such criticism and
how you got to this point. You talked about when you first
decided that you were going to do this investigation on Fannie
Mae.
Did you at any time talk with any members of Congress
during the time of this investigation about what you were
doing, seek any advice, get any suggestions, any members or
their staffs? You are under oath.
Mr. Falcon. I recall questions from various members of
Congress in the Senate who----
Ms. Waters. Did you talk to any members of Congress or
their staffs about this investigation, seeking advice, getting
advice, accepting suggestions, hearing suggestions about this
investigation?
Mr. Falcon. Asking advice about--not for the purposes of
trying to get advice from a member of Congress about what we
should look at----
Ms. Waters. So you did talk with some members of Congress
or their staffs while you were in the process of this
investigation. Is that correct?
Mr. Falcon. Yes.
Ms. Waters. All right. Did any member of Congress or their
staff offer support for OFHEO or you in exchange for
suggestions or give you ideas about how you ought to approach
this investigation?
Mr. Falcon. Absolutely not.
Ms. Waters. Did you report to the chairman of this
committee, this subcommittee, or the chairman of the overall
committee or the ranking member of this committee at any time
during this investigation about what you were doing?
Mr. Falcon. Absolutely not.
Ms. Waters. Let me go one by one.
Did you, at any time, report to the chairman of this entire
committee, Mr. Oxley, about what you were doing?
Mr. Falcon. About the--no. But----
Ms. Waters. About the investigation, anything that you were
doing or undertaking in the investigation.
Mr. Falcon. No.
Ms. Waters. Did you, at any time, talk with Mr. Baker about
whatever was going on in the investigation? Did you seek
advice, did you get any advice, did you have any conversations
with him about the investigation?
Mr. Falcon. I have not sought any advice, any guidance
about how to--from any member of Congress----
Ms. Waters. Did you talk with Mr. Baker----
Mr. Falcon. No.
Ms. Waters.--about the investigation at any time or his
staff?
Mr. Falcon. No. It would have been improper for me----
Ms. Waters. That is all I want to know. Did you talk with
Mr. Baker or his staff at any time during this investigation in
any shape, form or fashion, whether it was seeking advice, just
hearing advice, advising about what you were doing? That is all
I want to know. Did you? Yes or no?
Mr. Falcon. Let me answer the question. I did speak to
several members of Congress about the investigation, about the
need for funding for the investigation----
Ms. Waters. But I specifically asked about Mr. Baker at
this point.
Mr. Falcon. Oh, Mr. Baker, yes, and other members of
Congress----
Ms. Waters. All right. Thank you.
Mr. Falcon.----including other senior members of the
committee about the investigation and my need for resources to
keep this thing going.
Mr. Frank. Would the gentlewoman yield?
Ms. Waters. Yes, I will yield to the gentleman from
Massachusetts.
Mr. Frank. I just want to make clear that I was never told
or any way informed. My understanding was the Republican
leadership was informed before this broke that this was about
to break. But I want to make it clear: No one on the Democratic
side received any notice. And I do believe there was,
unfortunately, notice on the Republican side in advance.
Ms. Waters. Taking back my time, this is not simply about
notifying about this hearing. This is about what was going on
in the investigation, how it was being approached, what was
being done.
Were you talked to at any time?
Mr. Frank. No. As I said, I didn't even get the notice that
others got that it was happening, and so we had never heard
anything.
Ms. Waters. Okay. Then that is well made.
Now, did you discuss the 30 percent reserve with any
members of Congress and get a suggestion about that amount
prior to concluding that that was the amount that should be in
reserve?
Mr. Falcon. No.
Ms. Waters. Did you talk with any staff member?
Mr. Falcon. No.
Ms. Waters. This, again, based on the questioning of Mr.
Barney Frank, was an amount that you came up with but that
amount was not based on any calculations, any research that
would indicate that this would be the proper amount in reserve.
You did not have any supporting documentation for that, is that
correct?
Mr. Falcon. We arrived at the 30 percent requirement
because we thought that was prudent from a safety and soundness
standpoint, given the weaknesses in management and operations,
given the uncertainties of the financial statements----
Ms. Waters. I am asking about your documentation. Did you
pull it out of the thin air? Did you pull it out of air? Did
you have some documentation? Did you have something to compare
it with? How did you get the 30 percent?
Chairman Baker. And that would need to be the--if I may,
that would need to be the lady's last series of questions.
If you would respond, because the gentlelady has exceeded
her time significantly. Would you please respond to the
gentlelady's question?
Mr. Falcon. Congresswoman, we based--I based that decision,
using my judgment about what was appropriate, prudential in
order to ensure the safety and soundness of this company. Given
the uncertainties about their balance sheets, given the
operational weaknesses, there was precedent for this with
Freddie Mac, I took action that I thought was essential to make
sure that this company, that its safety and soundness was
ensured.
And we arrived at 30 percent because there is a 30 percent
management and operations risk in the statute for risk-based
capital, so we simply applied the same standard to the minimum
capital.
Ms. Waters. You had no documentation.
Thank you. I yield back the balance of my time.
Chairman Baker. Mr. Watt?
Mr. Watt. Mr. Chairman, Mr. Davis from Alabama has a bill
on the floor and I would like to defer to him, if it is okay.
Chairman Baker. Oh, I am sorry, Mr. Manzullo, you have been
patiently waiting.
I should go to Mr. Manzullo first, and then I will come
back to Mr. Davis.
Mr. Manzullo. Thank you.
I am reading page 11 about the actual amount of the
bonuses.
Mr. Johnson got a $1.9 million bonus on a salary of
$966,000; Mr. Raines, $1.1 million bonus on a $526,000 salary;
Lawrence Small, $1.1 million on a salary of $783,000; Jamie
Gorelick, $779,000 bonus on a salary of $567,000; Timothy
Howard, $493,000 on a salary of $395,000; and Robert Levin,
$493,000 bonus on a $395,000 salary.
These are annual bonuses. Is that not correct? Every year
they have a bonus?
Mr. Falcon. Yes.
Mr. Manzullo. And so this is what they make. This is just
for 1998. Is that correct?
Mr. Falcon. That was the amount of the AIP award and bonus.
Mr. Manzullo. What you see on page 11 is nothing less than
staggering. Because you state that the earnings-per-share
range, the minimum payout is $3.13, the maximum was $3.23, with
a target of $3.18.
And just by happenstance, coincidence, you could almost say
on your terms that for Fannie Mae to pay out the maximum amount
in annual incentive payment awards in 1998, the earnings per
share would have to be $3.23. It is below the $3.13 minimum
payouts threshold, no bonus would occur.
And then you state, remarkably, the 1998 earnings-per-share
number turned out to be $3.23 and nine mills, a result that
Fannie Mae met the EPS maximum payout goal right down to the
penny, and that if they had used the correct accounting
practices--which you say in your testimony, accounting
violations cannot be dismissed as mere differences of
interpretation, Fannie Mae understood the rules and simply
chose not to follow them, but if Fannie had followed the
practices, there would not have been a bonus that year. Is that
not correct?
Mr. Falcon. That is right, Congressman.
Mr. Manzullo. Well, what are you saying here? Are you
saying this is coincidence? Or did somebody cook the books to
come up with $3.23 and nine mills so they got the maximum
payment.
Mr. Falcon. I think what we are saying is, there are very
strong appearances that the management did, in this instance,
improperly defer $200 million of this $400 million expense to
the next year for the purposes of achieving these bonus
targets.
Mr. Manzullo. So the main purpose was so they could get
their bonuses. That is what you just said.
Mr. Falcon. Yes, in addition to the appearances of
smoothing earnings.
Like I said, this was the beginning of the implementation
of their catch-up in their FAS 91 accounting policies which
allowed them to utilize this amount to project smooth earnings
over time.
Mr. Manzullo. I find this staggering. This is absolutely
astonishing when the oversight organization says that Fannie
Mae projected its earnings and did its accounting practices for
the reason so that the executives could get the maximum amount
of their bonus. That is your conclusion?
Mr. Falcon. That certainly how it appears to us, yes.
Mr. Manzullo. And did you look at bonuses for any other
years besides 1998?
Mr. Falcon. We have information about the bonuses for the
years--yes, and it actually included the information that was
given to Chairman Baker.
Mr. Manzullo. Can you tell us what the bonuses were for
subsequent years to 1998?
Mr. Falcon. I believe for the top five individuals, it is a
matter of public record because of the disclosures under the
securities laws.
Mr. Manzullo. Were they similar amounts, do you recall
offhand?
Mr. Falcon. I believe they were similar, yes.
Mr. Manzullo. Did your research, investigation, look at any
other years besides 1998 to see if you came up with similar
conclusions?
Mr. Falcon. We have not to date, I believe, found a
transaction like the one in 1998, which was deferred to another
year with the fact of resulting in full bonuses as opposed to
no bonuses.
We have not yet found a similar type transaction in similar
years, in subsequent years, but we certainly do see the fact
that the policy of managing their earnings occurred over time
at the same that their Challenge Grant Initiative was put
forward.
Mr. Manzullo. So this is all based upon the fact that you
are paid according to the--you get your bonus according to the
earnings per share, regardless how you get those.
Mr. Falcon. That is the metric that is contained in their
compensation program.
Chairman Baker. Mr. Manzullo, you have expired your time,
but you have one wrap-up.
Mr. Manzullo. I do have one final question that speaks for
itself.
I believe on page 12 that says that if they had done the
correct accounting method there would not have been a bonus
that year.
Mr. Falcon. Yes, that is right.
Mr. Manzullo. Thank you.
Chairman Baker. I thank the gentlemen.
Mr. Davis?
Mr. Davis. Thank you, Mr. Chairman.
Let me thank my friend from North Carolina for yielding.
Mr. Falcon, when Mr. Lynch was questioning you earlier, you
said something that really caught my attention. You said that
you wanted to avoid making any broad and categorical statements
until the investigative process was complete.
Do you remember saying that?
Mr. Falcon. Yes.
Mr. Davis. That sounds like a good goal, and I think that
is exactly the stance that one would want from someone in your
position.
So in light of that, let me ask you about several
observations that you have made and see if they meet the
standard that you set out.
Mr. Manzullo asked you a number of questions and others
have asked you questions about the motivation for the expenses,
and you said fairly directly that you think that the motivation
was to pave the way for bonuses, or to create an appearance of
earnings to justify bonuses.
Is that not a pretty broad and categorical statement on
your part?
Mr. Falcon. It is.
Mr. Davis. And second of all--if I can continue, as my time
is limited--you made the observation or response to someone's
questions--where you were asked rather point blank: Would it be
in the interest of Fannie Mae if there was a change in the
management structure?
Do you recall those questions?
Mr. Falcon. Would it be in the interest----
Mr. Davis. You asked if it would be in the interest of
Fannie Mae if there were a change in the management structure.
Mr. Falcon. Yes, we had that.
Mr. Davis. And I think your answer was in the affirmative
that it would be. Do you recall that?
Mr. Falcon. I think what I said was, we were going to
assess--that the question before us was whether or not we had
sufficient confidence in this management team going forward,
trust that they could properly implement this plan of
remediation and have the confidence of both us and the board
going forward to properly run this company in compliance with
all the rules and regulations.
Mr. Davis. You had various questions about the management
structure.
Mr. Falcon. Yes, yes, I did.
Mr. Davis. Is that not a pretty broad and categorical
statement to raise questions about the management structure?
Mr. Falcon. It is.
Mr. Davis. Furthermore, you make a pretty broad statement
in your report--in fact, I think I am quoting from you--that
there was a pervasive and willful misapplication of GAAP in two
critical areas.
Is that a quotation from your report?
Mr. Falcon. Yes.
Mr. Davis. Is the reference to a pervasive and willful
misapplication a pretty broad and categorical statement?
Mr. Falcon. It is, about these two accounting areas.
Mr. Davis. So let me put this in perspective, because I
agree with your honesty in all four of those answers, those are
very broad statements.
One of the things that has been raised by several of my
colleagues on this side of the aisle has to do with: As I would
characterize it, does OFHEO have the appropriate level of arms-
length relationship that is needed with Fannie Mae?
Several of my colleagues have made the point, and I make
the point to you now, that as I understand the mission of
OFHEO, it is to be a regulator, it is to assess the safety and
soundness of the institution that you are regulating.
The SEC has the responsibility of making judgments about
whether accounting fraud occurred.
This body has the responsibility of making judgments about
the proper policy course.
And the Justice Department has the responsibility of making
proper judgments about whether a criminal act has happened.
Have I gotten the division of labor just about right, from
what you know?
Mr. Falcon. There is some overlap----
Mr. Davis. There is some overlap, but do I basically have
it right?
Mr. Falcon. Yes.
Mr. Davis. A concern that I have--and I want to give you a
chance to respond to it--but a concern that I have is you are
making very specific, what you have correctly acknowledged,
broad and categorical judgment about the management of this
institution, about the willfulness of practices that may or may
not be in controversy.
You have imputed various motives to the people running the
organization.
You went to the board and put a 48-hour ultimatum on them
without having any specific regulatory authority to put that
kind of ultimatum on them.
That sounds like some kind of an invisible line has been
crossed. That sounds to me as if you have gone from being a
dispassionate regulator to someone who is very much involved
and has a stake in this controversy.
And I will follow up on Ms. Waters's point because I think
it is very well taken: Her observation is that the political
context surrounding your investigation was that serious doubts
were being raised about OFHEO.
In fact, frankly, doubts were raised about your leadership
of OFHEO. And all of a sudden, the response to that is to
produce an enormously critical report.
My concern is that OFHEO has jumped off the fence--where it
should be, if it is a dispassionate regulator--and has somehow
gotten involved in the business of taking a side in this
controversy.
Now, I will give you a chance to respond to that.
Mr. Falcon. Well, Congressman, I appreciate the time to
respond.
The categorical statements that I was referencing to with
Mr. Lynch was, he asked me to make a broad categorical
statement as to whether or not we had Enron-like fraud going on
with this company.
Mr. Davis. No, sir. You said that you had a problem with
making broad and categorical statements. And your instinct is
right.
The reason--and I will make this my last point--the reason
that you do not want to make broad and categorical statements I
suspect is because the ultimate concern of OFHEO ought to be
the safety and soundness of Fannie Mae.
Is it possible that by casting all of these dispersions and
all of these doubts upon the board at Fannie Mae, and upon the
structure of Fannie Mae, that you potentially are weakening
this institution in the market, that you are potentially
weakening the housing market in this country?
Are those possible consequences from the very broad and
sweeping generalizations you have made about this institution?
Mr. Falcon. Well, first off, we may disagree on this, but
it was not what I was telling the congressman about the type of
categorical statements----
Mr. Davis. No, please answer the last question that I asked
you.
Chairman Baker. And if you would, sir, begin to wrap up----
Mr. Davis. I will, and then I will wrap up on just a point,
but I do not want you to answer any question other than the one
I just asked you, because our time is so limited.
Is it possible and is it a reasonably foreseeable
consequence that these kinds of amputations, these kinds of
insinuations about the board, could end and of themselves
damage the safety and soundness of Fannie Mae by weakening its
position in the market? Is that possible?
Mr. Falcon. Our actions are all designed for the safety and
soundness of this----
Mr. Davis. Is that possible?
Mr. Falcon. If we did our job properly perhaps, but we have
not.
Congressman, let me just say, I understand your politics
running all the issues.
Mr. Davis. No, I am just asking----
Mr. Falcon. We are just trying to do our job as a
regulator. You can question my motives, my judgment, even my
qualifications----
Mr. Davis. That is not the question I am asking.
With all due respect, Mr. Chairman, that is not the
question I am asking.
Mr. Falcon.--but that will not change the contents of this
report.
Mr. Davis. Is it possible that the market standing of
Fannie Mae could be weakened by your testimony?
Chairman Baker. Please be responsive to him.
Mr. Falcon. It is possible. And if does----
Mr. Davis. Thank you, you have answered my question.
Mr. Falcon.----course of actions we have taken, it is
because of what the company has done, as we have outlined in
this report.
Chairman Baker. The gentleman's time has expired.
Ms. Hart, did you now have questions? Ms. Hart?
Ms. Hart. Thank you, Mr. Chairman.
We have been watching this drama play out a little bit. As
you know, the committee has considered a number of different
proposals that actually would change your position, as far as
being the regulator for GSEs.
And one of the things that I know during this debate that
you have been seeking--and I think it is important--is to
separate the roles of chairman of the board and CEO at both
Fannie and Freddie. And I know that Freddie has agreed to do
this, but from my understanding, up to this moment, Fannie Mae
has not agreed to do this.
Can you tell us, first of all, as far as the agreement that
you have with them goes, is there anything involving that in
the agreement that you have with them and why you think that is
important to have that separation happen?
Mr. Falcon. The agreement does not specifically cover the
separation of the chair and CEO positions. It does require a
review of the organizational structure to address issues of
possible conflicts in different positions and functions.
We do have a corporate governance rule pending which would
separate the position of chair and CEO. And we have proposed
that and are moving toward a final rule on this because we
found that, based on the situation at Freddie Mac, that this
was just best corporate practice for these government-sponsored
enterprises.
We found that the board could not properly fulfill its role
as overseer over management as long as the CEO was also the
chairman of the board of the company. And so, we entered an
agreement with Freddie Mac, whereby they agreed to separate the
positions.
And I must say that, to the board's credit, that didn't
take much persuasion. I think they saw that this was
appropriate in themselves. And so, they took this step. And
with this corporate governance rule being in place, soon I
hope, we will then require the same thing of Fannie Mae.
Our report on Freddie Mac certainly highlights the need for
a government-sponsored enterprise which has imperfect market
discipline to have a separation of these positions.
Ms. Hart. If that is such an important point, why is your
instruction in the agreement with Fannie so general?
Mr. Falcon. Well, because we intend to deal with this
through our corporate governance regulation, while the overall
issues about organizational structure get addressed by the
board and us.
Ms. Hart. Okay. I yield back. Thank you, Mr. Chairman.
Chairman Baker. Thank you, Ms. Hart.
Mr. Watt, in the interim Mr. Crowley appeared, and he was
ahead of you.
Mr. Crowley?
Mr. Crowley. Thank you, Mr. Chairman.
Thank you, Mr. Falcon, for being here today, and thank you
all for testifying.
I just want to go back a little bit of ways in the hearing.
I was in the back room prior to the break for votes when Mr.
Shays was asking you a number of questions. And in response to
a question from Mr. Shays, you suggested, at least as I
interpreted it, that investors could be harmed by the actions
taken by Fannie Mae.
Could you tell me where that is in your report? Do you have
that in your report?
Mr. Falcon. I think potential harm exists because of
inaccurate financial statements being issued by the company.
Mr. Crowley. Is that an observation of yours, or is that in
the report itself?
Mr. Falcon. It is in the report.
Mr. Crowley. Where in the report is that?
Mr. Falcon. The fact that we think that the company has
issued inaccurate financial statements as a result of these
accounting practices? I would have to go through and find the
exact----
Mr. Crowley. If you don't mind, I would like to know, if
you can. Maybe your staff can let my staff know where in the
report that is.
Mr. Falcon. Absolutely.
Mr. Crowley. Just on Mr. Davis's line of questioning, which
I thought was excellent, what effect do you think this report
will have on the mortgage market?
Mr. Falcon. I think what we have seen to date is that the
mortgage market has functioned well. There is continued
liquidity being moved into the mortgage market. And despite
Fannie Mae's problems, as found in this report, there haven't
been any real disruptions in the mortgage market.
Mr. Crowley. Do you anticipate there will be any
disruptions in the mortgage market because of this report?
Mr. Falcon. As long as the markets and the public see that
we are working to take prompt corrective action----
Mr. Crowley. Yes or no?
Mr. Falcon. No.
Mr. Crowley. No, you do not.
Do you believe that this report shows any evidence that
Fannie Mae may be departing from its mission of increased
homeownership through making homeownership more affordable in
this country?
Mr. Falcon. The report did not address that point.
Mr. Crowley. For example, I know Mr. Raines has pledged to
create 6 million new homeowners, including 1.8 million minority
homeowners, by 2014. Do you believe this goal may be threatened
now because of this report?
Mr. Falcon. I don't think----
Mr. Crowley. I am going to ask Mr. Raines the same
question, but----
Mr. Falcon. As long as the company is maintaining its
adequate capital, as long as we have taken proper steps, along
with the cooperation of the company, I think we will minimize
any damage to their ability to meet their affordable housing
goals.
Mr. Crowley. Let me finally--thank you. Let me finally ask
you, while there are some things in this report that are
damaging, in the text itself, it is the SEC, I believe, and not
OFHEO that has the final say over whether or not Fannie Mae
must restate past earnings. Is that correct?
Mr. Falcon. Yes. Ultimately the SEC has to decide whether
their statements issued pursuant to laws were accurate.
Mr. Crowley. And some have argued to me that there is more
than an even chance that the SEC may disagree with the most
damaging allegations, such as accounting or derivatives and
delayed recognition of expenses. Is that correct?
Mr. Falcon. I guess some have predicted that. I cannot
speak to what others might predict. All I know is that we find
these issues to be very clear violations of GAAP. And we feel
confident that once the SEC takes an objective look at this,
that they will come to the same conclusions that we have and
that Deloitte & Touche has.
Mr. Crowley. Thank you.
Mr. Frank. Would the gentleman yield to me?
Mr. Crowley. Yes, I will. I yield to the gentleman from
Massachusetts.
Mr. Frank. I thank the gentleman.
And I appreciate the answers, Mr. Falcon, you gave to Mr.
Crowley. But it makes me even more disturbed that you, both in
your written statement and again, sort of threw ``safety and
soundness'' around almost like kind of boilerplate.
I think you just accurately answered the questions that,
no, if everything works out as we expect it to, there are no
threats, et cetera, this--you seem to be saying, ``Well, these
are in areas which could raise safety and soundness problems.''
I don't see anything in your report that raises safety and
soundness problems. Your answers to Mr. Crowley certainly
didn't indicate that there were.
How does this raise safety and soundness problems, other
than the kind of, frankly, almost ritualistic saying, ``Well,
these are areas where safety and soundness could be implicated
presumably if it went far enough''?
But I think it is irresponsible--let me be very clear--on
the basis of this report and what you have concluded so far--I
mean, we have earnings smoothed out. With regard to
derivatives, you have told you me you cannot even say at this
point whether they have under-reported or over-reported
earnings.
How does this threaten the safety and soundness, what you
have uncovered, of Fannie Mae?
Mr. Falcon. Just the very fact that we have serious doubts
about the accuracy of the financial statements and their books
and records, the very fact that we have identified very serious
internal controls----
Mr. Frank. Well, let me ask a question. Does any accuracy
threaten the safety and soundness? That is what bothers me.
There is a quality and a quantity issue here.
There are inaccuracies that can be disturbing, and if they
led to inappropriate compensation, I would be very unhappy. But
the notion that any inaccuracy implicates safety and soundness,
I think, based on what you have said here, where you cannot
even conclude--you have said you cannot even quantify any
potential amount of loss. To throw ``safety and soundness''
around in that thing I think really is, for a regulator,
irresponsible.
Mr. Falcon. Well, I think internal controls are a very
serious safety and soundness concern. A breakdown or a lack of
internal controls----
Mr. Frank. Do you think the safety and soundness is at risk
right now?
Chairman Baker. Mr. Crowley, that will have to be your last
question. If you can wrap up.
Mr. Frank. He accepts that.
Mr. Crowley. That was my first question, as a matter of
fact.
Mr. Frank. Yes, I mean, you have just told Mr. Crowley it
didn't implicate safety and soundness. Does it, your report,
what you have reported?
Mr. Falcon. No, I think our report absolutely does
implicate safety and soundness.
Mr. Frank. Is the safety and soundness at risk now?
Mr. Falcon. Are they at risk of becoming insolvent right
now? No. We have an agreement with the board in place that will
address these problems, provide an adequate capital cushion. We
think we----
Mr. Frank. That is the answer. The rest is just rhetoric.
Chairman Baker. The gentleman's time is expired once over.
Mr. Ose?
Mr. Ose. Thank you, Mr. Chairman. I yield 15 seconds to Mr.
Shays. And I am counting.
Mr. Shays. Thank you.
I would just like to say to you, Mr. Falcon, what you have
done is you have exposed illegal activity on the part of Fannie
Mae, and you are being criticized for exposing it. If they have
a safety and soundness problem, or if the markets are impacted,
it will only be impacted based on what Fannie Mae did.
And I just want to congratulate you. You have more courage
than I realized you had, because the messenger is being shot
and not the person who did the wrongdoing. I have seen it here
in this committee, and I am pretty outraged by what I am
seeing.
Congratulations for what you have done.
Ms. Waters. Would the gentleman yield?
Mr. Ose. Let me ask my--it is my time.
Ms. Waters. Would the gentleman yield?
Chairman Baker. It is Mr. Ose's time, and I think he wants
to reclaim it.
Mr. Ose. I do want to reclaim it.
Ms. Waters. Oh, he is reclaiming his time?
Mr. Ose. Mr. Falcon, I follow this stuff very carefully
because, having weathered the storm on the games-playing that
took place in some of the energy companies, I am very, very
sensitive to what might be occurring in the financial markets
underpinning the housing market.
If I understand correctly, there are questions as to the
validity of the numbers on an ongoing basis within the
enterprise known as Fannie Mae.
Now, Fannie Mae's securities are held as tier-one capital
by any number of additional institutions. My concern here is
not so much the direct impact but perhaps the indirect impact
that might manifest itself as a result of manipulation of
earnings.
Could you speak to that issue? In other words, the
secondary impact, if you will, outside of Fannie Mae, is that a
possible consequence for banks holding Fannie Mae's securities
as tier-one capital?
Mr. Falcon. The banks holdings in the debt of Fannie Mae--
if there is some--might have undue concentration in Fannie Mae
debt as a percentage of the total capital, if the problems were
not addressed quickly with Fannie Mae such that we remedied the
concerns that we have found, I think the bank regulators might
have some concern about the devaluation in what is being held
as capital of some financial institutions.
Mr. Ose. This is exactly the point that I think OFHEO
properly has made, is that this issue is not constrained to the
enterprise we know as Fannie Mae. This issue goes beyond the
enterprise we know as Fannie Mae. That is why it is so
important that the numbers that Fannie Mae reports accurately
reflect the enterprise's activity. If they do not reflect the
enterprise's activity, there are significant adverse effects
outside the enterprise that we would end up being called upon
to deal with.
That is why I am, frankly, pleased to see you bring this to
our attention. I am troubled by what I hear. I am looking
forward to the witnesses that follow you. And I thank you for
your work.
Chairman Baker. Would the gentleman yield?
Mr. Ose. And I yield to the Chairman.
Chairman Baker. I would just like to point out to the
gentleman, there is approximately 8,400 insured federal
depository institutions. Of that number, in excess of 3,000
institutions hold 100 percent, not 50, not 70, 100 percent or
more of their required tier-one capital in GSE securities.
It is of extraordinary consequence we fully understand that
the financials are indeed accurate, because an impairment in
the issuance of debt, it would not require the insolvency of an
enterprise, merely an impairment in the ability to issue debt.
If the regulator increases capital requirements, where are they
going to go to raise the capital?
So I think the gentleman has raised an excellent point I
think heretofore has not been recognized. I thank him for
yielding.
Mr. Ose. I yield back the balance of my time.
Chairman Baker. Mr. Watt?
Mr. Watt. Thank you, Mr. Chairman. And again, thank the
Chairman for allowing the nonmembers of the subcommittee to
participate.
I think I may be the last questioner, so I want to try to
follow up on a couple of things. Number one, Mr. Bachus, I
believe it was, asked about the leak the morning of the day you
met with the Fannie Mae board.
My question to you is, are you undertaking any internal
investigation to determine whether that leak was inside your
shop at present?
Mr. Falcon. I will.
Mr. Watt. Are you presently, or you are planning to in
light of the comments that were raised today?
Mr. Falcon. Yes.
Mr. Watt. Okay.
Mr. Falcon. And I guess I would also ask----
Mr. Watt. That is all I need to know.
Second, you made reference in response to questions that
Ms. Waters asked to at least some conversations with members of
Congress leading up to the time that you had the meeting with
the board of Fannie Mae.
Would you be kind enough to provide to the chairman and the
ranking member of this subcommittee a list of those contacts
and the contents of those contacts? I don't expect you to have
that with you today, but would you provide that to the chairman
and ranking member?
Mr. Falcon. Sure, Congressman.
Mr. Watt. Okay. Now, let me kind of zero in on the bottom
lines, as I have gathered them, and contrary to what Mr. Shays
is saying, I am not second-guessing whatever conclusion the
study. But I do have some problems with the timing of the
release of this information.
Is it correct that you have not concluded whether the
derivative conduct that you describe in your report either
resulted in an overstatement or an understatement of Fannie Mae
earnings?
Mr. Falcon. Right. The next step----
Mr. Watt. Okay. Just, is that correct?
Mr. Falcon. Yes.
Mr. Watt. Okay. And, now, since we have separated out that,
we don't know what the financial consequence of that is.
Let me go to the primary thing that I want to get at, and
this is at the bottom of page three of your statement. Right
near the next-to-the-last sentence there you say, ``Fannie Mae
improperly delayed the recognition of income to create a
'cookie-jar' reserve that it could dip into whenever it best
served the interest of senior management.''
Now, the word ``cookie-jar'' makes it sound pretty small,
but in actuality, the specific incident you are talking about
related to $400 million in 1998. Is that correct?
Mr. Falcon. Yes.
Mr. Watt. And what you are saying is that in 1998, Fannie
Mae made a decision to recognize only $200 million of that and
then amortized the rest of it over 1999. Is that the bottom
line on what you are saying?
Mr. Falcon. Yes.
Mr. Watt. Now, is it also then true that for 1997 and prior
years, there would have had to be an understatement of revenue
or income for Fannie Mae in order for Fannie Mae to have been
able to create this ``cookie jar''?
I mean, is that not what this means when you say they
improperly delayed the recognition of income. Does that not
mean that in some years to prior to 1998, they did not
recognize income so they understated income. Is that not what
that means?
Mr. Falcon. I do not believe so. I would like to have my
chief accountant to explain to you, but I think it was just a
function of----
Mr. Watt. Yes, well, tell your chief accountant to tell me
what this means.
Mr. Dickerson. The ``cookie jar'' is really a Securities
and Exchange Commission term of art for----
Mr. Watt. I do not care about the term itself, but you
cannot create a reserve in a cookie jar without having created
some consequences to prior earnings. Is that correct, Ms. Deleo
or whoever it is that is going to answer it?
Mr. Dickerson. Congressman, our analysis and our special
examination did not go back beyond----
Mr. Watt. I understand that. That is not the question I am
asking. But you cannot really determine whether there was an
overstatement or an understatement of earnings over time at
Fannie Mae without going back beyond 1998, can you?
If they were creating a reserve that was supposed to level
out earnings, they had to understate at some point and
overstate at some point. Is that not correct?
Mr. Dickerson. Well, Congressman, our examination found
that there was $400 million----
Mr. Watt. I understand that. I have acknowledged that. I
went through that in some detail and you went through it some
detail.
The question I am asking is: In order to create the cookie
jar reserve, would there not have had to be an understatement
of income at some point just as there was an overstatement of
income at some point?
Chairman Baker. And someone please try to answer his
question. The gentleman's time has expired.
Mr. Watt. I thought it was a pretty simple question myself.
Mr. Dickerson. It was after this experience in 1998 that
Fannie Mae implemented policies to create these cookie jar
reserves beginning in 1999----
Mr. Watt. How can you say that and you did not even look at
1997? You do not know whether the cookie jar was already there
or not, do you?
Mr. Dickerson. I cannot really speak to the years before
1998, sir.
Mr. Falcon. Congressman, I think what you are getting at
is: Was this there in 1997 and they just carried it forward or
something to that effect.
This $400 million showed up in 1998 as a result of the
change in interest rates and the amortization----
Mr. Watt. Well, what did they offset it against if there
was not already a reserve? And how did they get the reserve if
there was not already understated income at some point, or
overstated income at some point?
I am just trying to figure out--I mean, this is a balancing
act, right? And the objective is to smooth out earnings. Is
that not right?
Mr. Falcon. This came up as a result of a change in
interest rates and a change in the amortization of the expenses
related to the mortgages.
So it is not something that is necessarily what you are
suggesting. It is more of a factor of the models showed that
they----
Mr. Watt. But is it necessarily what you are suggesting?
That is the question.
Chairman Baker. With that, the gentleman's time really has
expired.
Mr. Director, would you care to respond to his last
comment?
Mr. Falcon. No, Mr. Chairman.
Mr. Frank. For something clear cut, that is pretty hard to
explain.
Chairman Baker. Mr. Director, on behalf of the committee I
wish to express our appreciation for your courtesy with your
appearance here today and for the work you do.
I know that, given the difficulty of this issue and strong
opinions held by members from many perspectives, that the
criticisms that you took today may be difficult for you and
your staff to accept, given the length of time and the amount
of effort you have put into production of this report.
I want to express our appreciation publicly for your
effort, and be assured that our work going forward, like yours,
will not stop with today's hearing.
Thank you very much, sir.
Mr. Falcon. Thank you.
Chairman Baker. At this time I would like to ask our second
panel participants to come forward, when it is possible.
At this time the committee welcomes our next two witnesses:
Mr. Franklin D. Raines, chairman and chief executive officer of
Annie Mae, and Mr. Timothy Howard, vice chairman and chief
financial officer of Fannie Mae.
Gentlemen, by prior agreement with Mr. Kanjorski, it was
determined that all witnesses appearing here today will testify
under oath. Do either of you have any objection to testifying
under oath?
Mr. Raines. No, sir.
Mr. Howard. I do not.
Chairman Baker. The chair also is required to advise you
that the rules of the committee and of the House entitle you to
be advised by counsel. Do you desire to be advised by counsel
during your testimony today?
Mr. Raines. No, sir.
Mr. Howard. Nor do I.
Chairman Baker. In that event, let me ask you to rise and
raise your right hand to affirm the oath.
(WITNESSES SWORN)
Consider yourself sworn in, gentlemen. Thank you.
Mr. Raines, we would certainly proceed with your opening
statement first. Your official statement of course will be made
part of the record.
Normally we request that witnesses try to make their
statement in 5 minutes. However, given the nature of the report
in question and the importance to your organization, certainly
we would want you to proceed as you deem appropriate.
Mr. Raines. Well, thank you, Mr. Chairman.
STATEMENT OF FRANKLIN D. RAINES, CHAIRMAN AND CHIEF EXECUTIVE
OFFICER, FANNIE MAE
Mr. Raines. My name is Frank Raines. I am the son of Ida
and Delano Raines. I grew up in Seattle, went to public school,
graduated from college and law school. I am a brother, a
husband, a father and friend.
For all but two of the last 25 years, I have been in the
financial services business, and those 2 years I served our
nation as the director of the Office of Management and Budget.
I am now the chairman and CEO of Fannie Mae. And Fannie Mae
is the nation's largest source of funds for homeownership and
rental housing for low-, moderate-and middle-income Americans.
We like to say we are in the American dream business.
I introduce myself in this way not because I am a stranger
to this committee, but because I do not recognize the person,
colleagues or company that someone described this morning.
But I nevertheless hope that I can make a contribution to a
constructive dialogue this afternoon.
I do thank you, Chairman Baker, and I thank Ranking Member
Kanjorski, and Chairman Oxley and Ranking Member Frank for the
opportunity to be here.
We appreciate this opportunity to answer your questions
about issues raised in the September of 2004 report by OFHEO of
a special examination of Fannie Mae.
I would like to begin by noting that this is the first
opportunity that Fannie Mae and its board are taking to respond
in an official forum to the allegations set forth in the OFHEO
exam report.
We take this report seriously.
Out of respect for the regulatory process and for OFHEO, we
have sought with great diligence to follow an orderly process
throughout the special examination, which is ongoing.
We have chosen not to respond ad hoc to questions about the
exam report's content or conclusions. Instead, we will provide
our responses in the appropriate forums, including through the
boards independent review to the Securities and Exchange
Commission and to the Congress.
So I appreciate that the committee has provided this forum
today.
Some people have mistakenly concluded that the company's
agreement with OFHEO constitutes an admission by the company to
the findings and conclusions of the report.
Let me clarify that this is not the case. The agreement
itself states that the company was not admitting or denying any
wrongdoing as a result of signing the agreement.
Fannie Mae respects the role of OFHEO as our safety and
soundness regulator. The strong oversight OFHEO provides is
critical, given Fannie Mae's significant role in the U.S.
housing finance system and the financial system as a whole.
In our view, from a decade of experience working with
OFHEO, I believe that our overall safety and soundness regime
makes Fannie Mae a better company.
OFHEO has more examiners per regulated company than any of
the bank regulators.
OFHEO's risk-based capital standard is a model for
financial institutions globally and goes farther than new risk-
based capital models being proposed for financial institutions
with more complex operations than Fannie Mae.
The best financial institutions will tell you the same
thing. They welcome the exam process because it fosters
cooperation in making the institution the best that it can be.
A confidential and cooperative examination process builds
confidence, both the regulators confidence in the company, but
also the company's confidence in its own safety and soundness.
Now, while this special examination unfortunately departed
from standard financial institution examination procedures, our
obligation remains the same: to make adjustments needed to
respond to OFHEO's concerns, just as any financial institution
would do with respect to its regulator.
That is why the company, led by our board, promptly entered
in to a regulatory agreement with Director Falcon to make
changes to our accounting, capital and internal controls and
organization.
And let me thank our board members, particularly our
presiding director, Ann Korologos, for their dedication and
efforts on behalf of Fannie Mae in the past 16 days. Their
diligence made it possible to quickly set forth an orderly
process to resolve the concerns raised by the OFHEO report.
In conjunction with the agreement, the board's independent
review committee has hired the law firm of Paul, Weiss,
Rifkind, Wharton & Garrison to conduct an independent
investigation, led by former Senator Warren Rudman, of all the
allegations in the special examination report.
The issue of whether our implementation of FAS 91 and FAS
133 was consistent with generally accepted accounting
principles remains with the SEC.
This agreement and these measures are important steps
toward addressing the matters raised in the OFHEO report and a
way to move forward. Adopting these measures will make Fannie
Mae stronger and even better able to pursue our mission and the
business that fuels our mission.
That mission, after all, is our central function. Congress
chartered Fannie Mae to expand access to homeownership for low-
and moderate-income Americans, and we are committed to that
mission.
Earlier this year we announced the commitment to create 6
million first-time homebuyers, including 1.8 million minority
first-time homebuyers, over the next decade, and to do our part
to raise the minority homeownership rate to 55 percent and
beyond.
By quickly reaching agreement with OFHEO where we could, we
are able to maintain our mission focus.
For those that may be concerned that some of these steps,
particularly the 30 percent capital surcharge, will constrain
our mission activities, let me say this: Fannie Mae will do
everything in our power to meet our commitments to expanding
homeownership and affordable housing while also doing
everything in our power to try to meet the requirements of the
agreement.
Before I close, I would like to touch on the issues raised
by the OFHEO report concerning our implementation of the
accounting standards FAS 133 and FAS 91. These accounting
standards are highly complex and require determinations over
which experts often disagree.
First, the report alleges that in 1998 the company
willfully violated GAAP in order to maximize executive bonuses.
These are serious allegations. They concern events that
occurred almost 6 years ago.
Importantly, I would note that the OFHEO report does not
cite any documents or witnesses to support these allegations.
Upon reading of this allegation in the report, the company
undertook to assemble the relevant facts. And we have learned
of no facts and no other materials that support the allegation
that the decision about the amount to book was related to
bonuses.
Based on the facts as I understand them, the $240 million
estimate was arrived at as part of an analysis conducted by our
accounting and financial staff, independent of any
considerations of compensation. Additionally, this analysis was
documented at the time and was disclosed to and fully discussed
with our independent auditor.
We intend to turn all of this factual information over to
the independent committee of the board and its outside counsel
for review.
Second, the report alleges that we misapplied GAAP with
respect to two accounting standards, FAS 91 and FAS 133. We
believe we applied those standards in accordance with GAAP, and
our independent auditor, KPMG, reviewed our application of
those standards and concurred.
Fannie Mae has previously issued and filed with the SEC
financial statements that reflect the accounting and financial
statement presentation that OFHEO has alleged to be
inappropriate. Those financial statements were certified by me
and by our chief financial office, Tim Howard, after a thorough
process and audited by our independent auditor, KPMG.
Fannie Mae has not withdrawn those financial statements,
and KPMG has not withdrawn its opinion that those financial
statements were prepared consistent with GAAP in all material
respects.
Rather, the issues that have been raised by OFHEO will be
taken up directly with the staff of the SEC, which ultimately
has the final authority over GAAP.
Our accounting staff has repeatedly determined that our
policies and practices with regard to FAS 91 and 133 are
reasonable and in accord with GAAP. And KPMG has issued
unqualified opinions on our financial statements, and that
remains their position today.
In fact, when I certify our financial statements, I certify
that these documents fairly present, in all material respects,
the financial condition, results of operations and cash flows
of the company. That is a very serious statement, and I take it
very seriously.
We engage in a rigorous due-diligence process before I ever
put pen to paper and make that certification. I only certify
after receiving assurance that I can say with confidence that
our financial statements fairly present, in all material
respects, the financial condition, results of operation and
cash flows of the company.
Mr. Chairman, no one is more interested in a full and open
examination of these issues than I am. I cherish this company.
I believe in the mission that Congress challenged Fannie Mae to
carry out. And I am inspired by the 5,000 women and men who
come to work every day trying to help lenders help people get
into homes.
Most of all, I believe that Fannie Mae's biggest challenge
ahead is helping the financial system and mortgage industry to
meet the growing and changing housing needs or our growing and
changing nation.
This decade is expected to produce 30 million more
Americans, who will create 13 million to 15 million new
households. Minorities will represent 80 percent of that
growth. And as a result, we estimate that 46 percent of future
first-time homebuyers will be minorities and immigrants.
Serving their housing needs will require new ideas and
innovations in mortgage financing. And we look forward to
helping the industry with this challenge.
Given this public mission for which Congress created us and
as an instrument of national housing policy, Fannie Mae expects
and welcomes OFHEO's rigorous oversight to ensure that we are
safe, sound, solid and stable for the long run. As I said the
last time I appeared before this committee, strong oversight is
in the best interest of Fannie Mae, our shareholders, financial
markets and homeowners.
I want to make one thing very clear. I have always tried my
best to ensure that our company does the right thing in the
right way. And I believe to this day that we did.
If, however, 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 will
hold myself accountable. That comes with being a CEO. I
accepted that burden on the day I took the job, and I accept it
today.
Thank you, Mr. Chairman and members of the committee. And I
look forward to answering any questions that you may have.
[The prepared statement of Franklin D. Raines can be found
on page 176 in the appendix.]
Chairman Baker. Thank you, sir, for your statement.
Our next witness is Mr. Timothy Howard, vice chairman and
chief financial officer of Fannie Mae.
Please proceed at your leisure, sir.
STATEMENT OF TIMOTHY HOWARD VICE CHAIRMAN AND CHIEF FINANCIAL
OFFICER, FANNIE MAE
Mr. Howard. Good afternoon, Ranking Member Frank,
Chairman----
Chairman Baker. Make sure that mic is on, or pull it a
little closer. We can't hear you the way we should.
Mr. Howard. Is it on now?
Chairman Baker. Yes, sir. Thank you.
Mr. Howard. Good morning--or good afternoon, I should say.
Thank you for inviting me to be here today.
I joined Fannie Mae in 1982 when the company was in the
midst of a severe financial crisis brought on by flaws in its
interest rate risk management. Under the leadership of David
Maxwell, we were able to turn the company around and establish
the solid financial footing that has enabled Fannie Mae to
reliably provide hundreds of billions of dollars in affordable,
fixed-rate mortgage financing to millions of low-, moderate-and
middle-income Americans.
I consider it a privilege to have been able to devote the
past 22 years of my career to this company and its mission.
Throughout this time, I have tried my absolute best to do the
right thing for the homebuyers Fannie Mae helps to serve, the
employees I lead and the investors who have placed their trust
in our company.
All of my judgments regarding accounting issues were made
in openness and good faith, with the goal of providing
investors with the most meaningful and understandable
information possible.
When accounting issues arose, I worked with the head of my
accounting policy group, who I know to be knowledgeable and
highly respected in the industry. I also made certain that any
accounting approaches we adopted were reviewed with our outside
auditor.
I had a clear objective in guiding Fannie Mae's
implementation of the two accounting standards that are at
issue in the OFHEO report: FAS 133 and FAS 91. And that was to
preserve the accuracy and utility to investors of our financial
statements by reporting on what I honestly believed were the
true economics of our business.
At all times, I believe that the accounting applications we
adopted were within the boundaries defined by GAAP, as
interpreted and understood by our accounting experts both
inside and outside the company.
We filed financial statements with the SEC that were fully
audited by KPMG, and as Frank said, Fannie Mae has not
withdrawn these financial statements, and KPMG has not
withdrawn its opinion that those financial statements were
prepared consistent with GAAP in all material respects.
FAS 133 is widely considered to be the most complicated
accounting standard ever issued. Its implementation had the
potential to greatly reduce the clarity and utility of Fannie
Mae's financial statements.
We recognized this challenge from the outset, but we did
not attempt either to circumvent the standard or to violate
GAAP to deal with it. Instead, we developed a separate earnings
measure, core business earnings, to convey to investors our
financial results in the absence of FAS 133.
FAS 91 requires that we estimate the average lives of the
mortgages in our portfolio to determine the rates at which
premiums or discounts on these mortgages should be amortized
into our income statement.
By definition, this estimation process is imprecise. From
the inception of FAS 91 in the late 1980s, we have used ranges
to address this imprecision in estimating mortgage pre-
payments. KPMG concurred with our use of a range.
Ultimately the SEC will resolve the issue as to whether our
implementation of FAS 133 and FAS 91 is consistent with GAAP.
This is entirely appropriate. And I look forward to receiving
the results of their review.
It is important to note, however, that the matters to be
reviewed relate to accounting judgments and not issues of risk
management. Financially, Fannie Mae is as strong as ever, and
our ability to carry out our mission remains intact.
I look forward to responding to your questions on these
matters.
[The prepared statement of Timothy Howard can be found on
page 169 in the appendix.]
Chairman Baker. Thank you, sir.
Mr. Raines, prior to the decision being executed to defer
the $200 million in expenses in the end of 1998 into the
quarters of 1999, were you consulted or did you have knowledge
of that proposed transaction?
Mr. Raines. Mr. Chairman, first, let me be clear. There was
no decision made to defer any expense from 1998 to 1999.
Second--and Mr. Howard can go into greater detail into how
the process actually occurs--but we did not make any deferral.
I was part of a discussion, as I always am as the CEO, in our
closing process in which the decisions made in our financial
area with regard to the calculation of the catch-up provision
was discussed. But the determination of that was made through
our normal process of closing our books.
Chairman Baker. So you did----
Mr. Raines. But Mr. Howard will be able to give you more
detail.
Chairman Baker. Sure. So that you were involved in a
discussion about the amount of catch-up required. And your view
is that was that a customary process, not a decision made with
regard to this specific expensing item.
Mr. Raines. That was a discussion that we would have at the
end of each period, discussing a variety of issues related to
closing the books of any given year.
Chairman Baker. Were there any discussions related to the
consequences of that expense treatment in relation to the EPS?
Mr. Raines. No.
Chairman Baker. When did you first realize that the
earnings-per-share figure would be $3.23?
Mr. Raines. The first time that I would know what the
earnings figure would be is when our controller would have
closed the books and done all of the analyses necessary to
determine what the final results are and then that would be
reported to me. That would be after any decision that was made
with regard to the catch-up provision.
Chairman Baker. Was there any discussion in which you
participated relative to the determination of the catch-up
amount?
Mr. Raines. No, I did not participate in determining the
amount of the catch-up. That was done, as I mentioned, within
our financial function, which is their job.
Chairman Baker. I know you are knowledgeable of the Fannie
Mae's Challenge Grant Initiative--I believe that was something
that was organized in your administration in 1999--which
initiated executive incentives for increased earnings.
Is it your view, or is it correct to assume that, including
the $27 million of 1998 bonuses that were not part of the
Challenge Grant Initiative, because it was implemented I
understand in 1999, that went forward from 1999 to 2003, that
the total amount of bonuses granted by Fannie to those entitled
slightly in the excess of $245 million?
Mr. Raines. Mr. Chairman, I do not understand what you just
said. Let me explain to you why.
Chairman Baker. I will clarify the question for you.
In 1998, the bonuses reported were $27 million. And I can
give you the figure for each year.
In 2003, the total amount of bonuses was $65 million, the
yearly aggregate, the amount of bonuses each year, per year,
1998 through 2003, and that comes out to be $245 million.
If you are not familiar with that number----
Mr. Raines. I did not understand what the question was.
Chairman Baker. Did that help?
Mr. Raines. You told me what the facts were about bonuses.
The Challenge Grant has nothing to do with bonuses. The
Challenge Grant has absolutely nothing to do with bonuses.
Chairman Baker. It does in a sense. Challenge Grants
incentivizes executives to enhance the growth of the
corporation's profitability, based on the corporation's
profitability the EPS has calculated. The calculation of the
EPS then determines whether the bonus trigger is hit.
In light----
Mr. Raines. You just crossed the line again.
The Challenge Grant has to do with stock options. It has
nothing to do with bonuses.
Stock options were granted to every Fannie Mae employee.
Every employee of Fannie Mae was given a grant and would only
vest if the company doubled its earnings over 5 years, and then
it would vest over a delayed period if it did not.
So the Challenge Grants have nothing to do with bonuses.
Chairman Baker. Well, let me clarify, then.
In 2002, Fannie Mae paid out a total of $51 million in
bonuses of which $12.4 million was paid to the top executives.
I have a chart that is going up here now that shows total
compensation.
Since we have talked about restricted stock awards, we have
talked about stock options, and we have talked about bonuses,
that chart characterizes what was awarded in 2002 based upon--
what? If it was not earnings per share, per stock options, if
it was not earnings per share or restrict stock awards, am I
misunderstanding that the bonuses were not calculated based
upon the earnings-per-share number?
Mr. Raines. Again, Mr. Chairman, I think you are mixing two
or three things together.
Chairman Baker. I may be, but let's go through the detail--
--
Mr. Raines. I would like to be helpful.
Chairman Baker. I know.
Mr. Raines. Let me try to answer the question----
Chairman Baker. I will give you the right question that I
would like to have answered, if it is possible: Did the $3.23
earnings-per-share determination in 1998 trigger the payment of
bonuses to executives?
Mr. Raines. Yes.
Chairman Baker. Thank you.
Does the earnings per share have any effect on any of the
other benefits awarded that are displayed on this chart, either
the restricted stock grants or the options?
Mr. Raines. Well, Mr. Chairman, this is your chart. This is
the first time I have seen your chart. It has information on
this chart that was provided to our regulator as confidential
information, that it was information that is protected, in our
belief, by the laws of the United States.
But be that as it may, now that you have displayed it
before the committee, if I can answer your question.
Chairman Baker. Sure, but to answer your legal point, I
have the absolute right to display it, despite Mr. Ken Starr's
threats to the contrary, in the context of a committee hearing
discussing the policy of Fannie Mae's compensation.
Mr. Raines. Mr. Chairman, I am going to answer your
question.
Chairman Baker. Well, please proceed.
Mr. Raines. I am just pointing out the legal status of this
information.
If we go across your chart, salary has nothing to do with
earnings per share. Salary is established at the beginning of
the year.
Chairman Baker. I understand that.
Mr. Raines. The second line you have is bonus. Those, in
all these years--if I am correct, looking at this because it is
very small type--is based on earnings per share, but not
entirely.
Because individual employee bonuses also have a performance
factor involved in them. And so the earnings that they would
earn is not just based on EPS, but there are also on their
performance.
Fringe benefits have no relationship at all.
Chairman Baker. I was not raising that issue here.
Mr. Frank. Mr. Chairman, are we all going to get this much
time?
Chairman Baker. I will be happy to cut him off if you would
like for me to.
Mr. Frank. I would like to go with the 5-minute rule.
Chairman Baker. In order to move ahead, let me recognize
Mr. Kanjorski.
Mr. Bachus. Mr. Chairman, does he have a copy of this,
other than reading off the chart?
Chairman Baker. I have just recognized Mr. Kanjorski.
Mr. Frank. I understand that. I wondered why Mr. Bachus was
talking, then.
Mr. Bachus. I understand, Mr. Chairman----
Mr. Frank. Well, Mr. Kanjorski has the floor. Let us go to
Mr. Kanjorski.
Chairman Baker. Mr. Kanjorski has the time. He does have
the information that came from Fannie Mae.
Mr. Bachus. I did not know if he had this table before----
Mr. Kanjorski. I do not have that chart. I think it is only
on one side?
Chairman Baker. Can we have it distributed?
It is being distributed now.
Mr. Kanjorski. Well, shall I wait and hold my time so I
would have the same information that the other side of the
aisle has in their possession?
Chairman Baker. Let me give you mine.
Mr. Kanjorski. Well, thank you very much.
Mr. Bachus. What I am saying is, do these two gentlemen
have this----
Mr. Kanjorski. Do all the members on our side of the aisle
have it?
Mr. Bachus. He is indicating that he does not have it.
Chairman Baker. Time out. Hold up.
Ms. Waters. I have not seen it.
Chairman Baker. Hold up one moment. We will make sure that
staff distributes it to every member----
Ms. Waters. And to the panel.
Mr. Kanjorski.----reproduction costs of the committee, are
we over the allotted budget amount?
Mr. Frank. Mr. Chairman?
Ms. Waters. Parliamentarian query: Is this illegal or is it
legal? I mean, there was a legal question raised here. Is it
illegal for us to have this information? Can we display or not?
Chairman Baker. No, Ms. Waters, it is not illegal.
Mr. Kanjorski. Not for us.
Chairman Baker. Not in the course of the committee
consideration. I would not have released it had it not been. I
have had it for over a year.
Mr. Frank. Mr. Chairman?
Chairman Baker. Mr. Frank?
Mr. Frank. I have another appointment, but if the gentleman
from Pennsylvania wanted to study this, I would be glad to go
now and have him go after.
Chairman Baker. Would Mr. Kanjorski like to yield his time
to Mr. Frank?
Mr. Kanjorski. Actually, Mr. Frank, I am not going to use
this at all. As a senior member of the committee, I am smart
enough to----
Mr. Bachus. Mr. Chairman, I am just saying, I still do not
think that the panelists have this table----
Chairman Baker. Your point is well taken, Mr. Bachus. It
will be delivered. Thank you.
Mr. Bachus. But as we question them, I just----
Chairman Baker. I said your point is well taken. It will be
delivered. Thank you.
Mr. Kanjorski. You mean there were not sufficient copies
produced for the committee members.
Chairman Baker. Let me put it this way: I wanted to make
sure I released this information. I am accountable for its
release, and I put it into the public forum pursuant to my
rights as chairman, subject to a response from the regulator,
and I wanted to make sure that I did not get criticized for
leaks. And we had all these accusations that people got
advanced information inappropriately before it was publicly
released.
I have now publicly released it. I am accountable for that
decision.
Ms. Waters. Will the gentleman yield?
Chairman Baker. And every member of the committee,
everybody in the room has access to it.
Mr. Kanjorski. Let me make a point, because I was very
tough on the regulator, and I intend to be tough on Mr. Raines
and Mr. Howard.
But, Mr. Chairman, may I point out that you obviously had
to seek legal opinion as to whether or not you are violating
the law by distributing this document.
And may I just say that opinion is opinion. You found a
lawyer that gave you an opinion contrary to Mr. Kenneth Starr.
And for the last time I recall, was not Mr. Kenneth Starr
really most accomplished attorney in another proceeding----
Mr. Frank. If the gentleman would yield----
Chairman Baker. That is opinion.
Who is recognized? Mr. Kanjorski and Mr. Frank.
Mr. Kanjorski. Mind if I take it now, Barney? Let me take
the 5 minutes. Do I have 5 minutes?
Mr. Frank. I have been trying to get to regular order. I am
glad----
Chairman Baker. Thank you, Mr. Frank. Please keep your
members in order, we will be fine.
Mr. Kanjorski?
Mr. Kanjorski. Maybe this goes to Mr. Howard and not to Mr.
Raines, but either one of you, feel free.
When Mr. Falcon was before us, the regulator, he talked
about discovering for the first time the smoothing of earnings
in 1998. And the transaction that he describes as a $400
million item that should have been in but it was reduced to
$200 million, but that it was cited somewhere in an audit
difference.
I wanted to find out whether--and that was done by your
outside auditors, as I understand at that time were KPMG. Is
that correct?
Mr. Howard. Yes, it is.
Mr. Kanjorski. Am I being incorrect when I said to Mr.
Falcon that that would have been a finding or a difference in
the audit that had to be resolved at the exit audit with either
the board or management?
Mr. Howard. Mr. Kanjorski, it typically would have been
identified by the auditor and discussed with the audit
committee, and it was.
Mr. Kanjorski. Now, that document, although it was not the
final audit, something appeared in the final audit that would
have reflected that working document draft, that there were
audit differences expressed by your account.
Mr. Howard. It was mentioned in the accountant's report.
Mr. Kanjorski. In the final audit.
Mr. Howard. Yes.
Mr. Kanjorski. And the final audit, it seems to me, in
1998, were not only an internal document for the corporation,
but that was provided and should have been provided to all the
shareholders if they wanted it. Is that correct?
Mr. Howard. It typically is summarized in our annual
report. The audit itself is not provided to shareholders.
Mr. Kanjorski. Is it a secret document and not allowed to
be read or understood by the regulator?
Mr. Howard. Not to my knowledge.
Mr. Kanjorski. I am trying to gather: What in the hell does
the regulator do when they regulate only two entities, and the
first document they start with is not the outside audit, and
particularly go to audit differences? Is that not what they
talked to you about?
The new auditor found some audit differences there, and we
want to know how you played it and to pass on whether you did
it in conformity with the regulator's position that you acted
properly.
Mr. Howard. Well, Mr. Kanjorski, I did spend a full day
being interviewed by the special committee. They had an
opportunity to ask me about this incident. I believe I could
have put it in context that would have made it more
understandable to them. They did not ask me.
Mr. Kanjorski. No, I am just trying to understand: What
does the regulator do if he does not start out with audit
differences?
Mr. Howard. I cannot answer that.
Mr. Kanjorski. It seems to me----
Mr. Raines. The actual document you are referring to has
been, in my understanding, provided to OFHEO. The working
papers have already been provided to OFHEO.
Mr. Kanjorski. But in 1998, did he have access to that
document?
Mr. Raines. Yes.
Mr. Kanjorski. I am trying to figure out whether we really
should get worried here and that we have not had close
regulation, whether it is Fannie Mae or Freddie Mac, if they
are not looking at some base document that would reflect audit
differences from your outside auditor to see what adjustments
were made and why, and then that being footnoted in the final
audit report.
What happened here? Why 6 years went by and the regulator
did not say, ``1998, there was a little dispute between the
outside auditor and the inside auditors in regard to how we
treat this $400 million, or $200 million, adjustment.''
Mr. Howard. Well, Mr. Kanjorski, I would say there was not
even a little dispute. The outside auditor had recorded an
audit difference similar to this each prior year on our
treatment of this so-called catch up adjustment on FAS 91. This
was not unusual, it was not new.
Mr. Kanjorski. Well, what do we have to do, in terms of the
committee, in authorizing a new regulator, or whatever powers
we give a new regulator, so they do not come in here and say 6
months or 6 years later that there was this difference that
supposedly then affects bonuses and compensation and all these
things, but that they did not see it when it was about as clear
as a battleship in the Potomac would be?
Mr. Raines. Mr. Kanjorski, I am not sure there is anything
that the Congress needs to do.
It is my belief, it is my understanding, that our examiners
have had access to this information over all these years and
simply have not made any comment about them.
So I do not think this is a matter of finding a secret
document that have not seen before. I believe that the
examiners had access to all----
Mr. Kanjorski. I am not suggesting that there was secrecy.
I am just getting worried about how superficial was the
regulatory authority on your institution and Freddie Mac if
they miss something that would have jumped out, audit
differences.
Here is your outside auditor saying that, and obviously the
regulator did not look at it.
Mr. Raines. I guess what I am saying is, I do not know that
they missed it back 6 years ago. The question is: How is it
being characterized? The characterization may have changed.
Mr. Kanjorski. Let us go to that point.
From that time in 1998 until now, it is your testimony, as
I understand it, that KPMG had worked out and resolved in their
mind, giving a full opinion letter on the audit, how it was
treated in 1998 and how prior to that and how subsequent to
that, that type of an adjustment was treated.
Mr. Raines. Yes. In fact, I can read to you what they said
to our audit committee in 1999 regarding 1998.
They said: The principal area of estimates and judgments in
Fannie Mae's financial statements, including the amortization
of premium and discount, KPMG did not identify any areas within
the financial statement that they believe include unreasonable
estimates.
That is what they said to our audit committee regarding
1998, having made that audit exception.
Mr. Kanjorski. Well, their new auditor went in this last
year, and did he find or did they find an audit difference
there that they did not agree with, the opinion of your
auditor?
Mr. Howard. Mr. Kanjorski, let me add one additional fact,
and that is, after 1998 we worked to develop a specific method
that limited the amount of the catch-up adjustment that we
could allow not be recorded in a given year.
Once we put in place that procedure, which was the end of
the year 2000, KPMG no longer recorded any size catch-up
adjustment as an audit difference, provided it remained within
the range that was set by our policy.
Chairman Baker. Now, if the gentleman has one more and
then----
Mr. Kanjorski. Yes, I would like both of you to answer this
question. It is a very simple question.
Is there anything of a systemic risk problem at Fannie Mae?
Mr. Howard. Absolutely not, in my judgment.
Mr. Raines. No, sir. And the report doesn't indicate any,
because all of our risk management practices are working very
well and the company is very strong.
Mr. Kanjorski. Thank you, Mr. Chair.
Chairman Baker. Thank you, Mr. Kanjorski.
Mr. Shays, you are up.
Mr. Shays. I told your staff that I would like to listen to
some of the questions before I begin mine.
Chairman Baker. Mr. Royce?
Mr. Royce. Okay, thank you, Mr. Chairman.
In my opening statement, Mr. Howard, I said that, in my
view, Fannie Mae has a moral obligation to conduct its
operations to the highest standard of business practices. Do
you agree with me on that?
Mr. Howard. Absolutely.
Mr. Royce. Well, the question I would like to ask is, has
Fannie Mae acted in a way consistent with that belief? Does
Fannie Mae have strong internal controls? Does Fannie Mae
conservatively and consistently apply accounting rules?
Mr. Howard. I believe we do conservatively and consistently
apply accounting rules. We exercise judgment in applying them
to practical business situations, as is consistent with good
accounting practice.
As far as the moral tone, I believe that we have an
entirely honorable, decent staff, full of integrity, who have
had a very difficult time in the past two weeks, seeing
themselves characterized in a very unfavorable way.
Mr. Royce. I understand that. But there was an audit
difference with your outside auditor----
Mr. Howard. An audit difference is simply a notation. It is
not a direction for us to change the way we account for the
transaction in question. That is a fact.
Mr. Royce. Well, the question I have there is, when OFHEO
began the process of going back through the books--and in my
view, OFHEO obviously has not been a very effective regulator.
If they were exercising proper oversight, this issue would have
surfaced in a timely matter and we would not be dealing with it
now.
Mr. Howard. I am sorry, which issue?
Mr. Royce. The FAS 133 issue.
The other question I wanted to ask you was along the lines
of what I asked Director Falcon. To follow up on that question,
how does Fannie Mae's application of FAS 133 compare to other
major financial institutions? Did you apply the standard the
same way?
Mr. Howard. Well, Congressman Royce, I believe we made one
major step that is different from most institutions. And that
is that we realized that in order to faithfully implement FAS
133 in a fashion that did not make our income statements harder
for investors to interpret and while still permitting us to use
the hedging techniques that enable us to manage our interest
rate and other risks, we needed to develop a supplemental
earnings measure that adjusted for the effects of FAS 133.
FAS 133 adds an element of fair value accounting to what
otherwise is a historical cost-income statement. And mixing
those two concepts makes an income statement unintelligible to
investors. We did not want that. We did not want to stop
hedging. And we did not intend to undertake sham transactions
to smooth out the effects of FAS 133.
So we developed a supplemental earnings measure called core
business earnings that we publish to this day. I do not know of
another institution that has followed that lead.
Mr. Royce. Okay. I thank you, Mr. Howard.
Thank you, Mr. Chairman.
Chairman Baker. I thank the gentleman.
Mr. Frank?
Mr. Frank. Thank you, Mr. Chairman.
First, I have to say to Mr. Raines and Mr. Howard, if it
was--and I take the chairman at his word; I do not believe you
would have done anything illegal--but if there had been any
questions, there shouldn't have been. I think it is perfectly
appropriate for this to be public.
I am a strong supporter of Fannie Mae and Freddie Mac, but
you are not simply another private corporation. There is a lot
of government involvement. I think this is entirely
appropriate.
And, Mr. Chairman, I would have maybe given it to them in
advance.
And I did have one question. There is either a mistake
here, or there are either two people in managed capital or
there is one person in managed capital who is getting twice.
[Laughter.]
But other than that, I think, yes, it is entirely
appropriate.
And let me add to this. This is not directly relevant,
but--and here I would say that this is a problem with regard to
American corporations in general.
You gentlemen work very hard and you do good work, but I do
not understand why in the world you need bonuses. At the level
of compensation you get, we ought to be able to count on you to
do your very best without any kind of incentive. And I would
hope you would set a good example.
If your salary is too low, raise your salary. But I think
incentive bonuses, particularly if they are connected to stock
options--and there is no evidence of it happening here, with
regard to stock options--but with stock options, top executives
are given a perverse incentive.
If either one of you runs into a building that is on fire
and rescues a baby, get a bonus. But doing your job, not at all
level--my level, your level--I think that is a mistake. And to
the extent that they are performance-related, we leave
ourselves open.
If you want to comment on that at the end, you can do that,
but I would just ask some questions now, because, to the extent
that there was smoothing out that might have been affected by
this--well, let me ask, because that is the major question.
Was the fact that bonuses were somehow dependent on certain
earnings a factor in the treatment of earnings? And if you did
not mean it consciously, might it have affected you, do you
think? Mr. Howard?
Mr. Howard. If you are referring to the incident reported
in the OFHEO report for 1998, as Mr. Raines mentioned, we have
been looking into that. And so far we have determined that the
amount that was determined to be accurately recorded in 1998
was determined as a result of a process that was run in----
Mr. Frank. I am going to your motives. You both deny that
trying to hit a certain amount so you could get your bonuses
was a factor to any extent in your decisions? I think it is
important to just ask you that question.
Mr. Howard. Yes, in coming up with that number, yes, we do
not----
Mr. Raines. We both deny that.
Mr. Frank. You both deny that?
Mr. Howard. Yes.
Mr. Frank. Okay, I think it is important to get that.
Next question is, in your reading of these--and I will
repeat what I said previously, that accounting for derivatives
does seem to me--and I know Mr. Falcon said, ``Well, it is very
clear-cut,'' but as Mr. Watt asked Mr. Falcon and his two chief
aides a fairly straightforward set of questions, it got less
and less clear to me and it did not appear to them to be as
clear-cut.
And I will say, my sense is accounting for derivatives
ranges somewhere between alchemy and astrology. You are accused
of being on the alchemy end.
And that as they have gone over it with you, have they
pointed out--and Mr. Falcon said no, but is there any decision,
first of all, whether you are considered by them to be guilty
on the whole now of under-reporting, of over-reporting? Do you
know whether they think you over-reported or under-reported?
Mr. Howard. I do not.
Mr. Raines. No, we can't tell from reading the report.
Mr. Frank. So they have not even concluded whether you
over-reported or under-reported.
I did notice the Merrill Lynch report said, given this
category, that it was a situation of the sort where when
interest rates rose, there would probably be gains, and when
interest rates dropped, there would probably be losses.
Mr. Howard, is that accurate?
Mr. Howard. Well, there is a certain type of derivative
that we use, which, when interest rates fall, it declines in
value and, when interest rates rise, it rises in value.
Mr. Frank. What percentage of the contested derivatives are
in that category, do you know?
Mr. Howard. To be honest, Mr. Frank, I am not sure which
derivative transactions----
Mr. Frank. Okay. To the extent that they are there,
obviously we would expect there to be an increased rather than
a decrease in the near term.
Mr. Howard. If interest rates rise.
Mr. Frank. So, now, when you agreed with them to increase
your capital by 30 percent--I am going to ask you what your
sense was. Mr. Falcon has acknowledged that since they had not
come to any conclusion as to whether you had under-reported or
over-reported, the 30 percent was certainly not based on any
estimate of to what extent your capital might have been
impaired.
In other words, there were no numbers there. It was simply
that in the statute there is a 30 percent figure that is there,
really, for somewhat other purposes, not for dealing with
accounting for derivatives. And he borrowed it because it had
some reality.
Did you get any indication why 30 percent was chosen other
than that?
Mr. Raines. To be clear, the agreement was negotiated by
our board.
Mr. Frank. Oh, okay. So we have to ask Ms. Korologos.
Mr. Raines. And my understanding is this is the number that
the director wanted.
Mr. Frank. And as he said, it is not based on any--we have
to be very clear. The 30 percent was not based on any analysis
of inadequacy of capital. It was not based on any conclusion
that the capital had been impaired.
Again, to the extent that there was inappropriate smoothing
out, that is wrong, and it is being looked into. It should be
corrected. But worst case, it does not seem to me that anything
has been suggested that jeopardizes your going forward as a
corporation.
Mr. Falcon disappointed me, as I told him, when he
acknowledged to Mr. Watt and others, to me, that there was no
threat to solvency, no remote threat to solvency that he talked
about, but said somehow safety and soundness was implicated.
In their conversations with you, has anything been adduced
to suggest that you are going to have to curtail, to some
extent, your activities or that the investors are somehow at
risk? Mr. Howard or Mr. Raines?
Mr. Howard. Not in conversation with me directly.
Mr. Raines. No, sir. There have been no conversations that
we were at risk, other than what is included in their report.
There is the issue of how we get to the 30 percent
additional capital. And there obviously are some people who
would prefer that we reduce what we do in the market----
Mr. Frank. Right. And that is my next question, which is,
you know, HUD--and I will finish in just----
Chairman Baker. I just want to keep regular order, as you
suggested.
Mr. Frank. I understand. I am just trying to keep up with
you, Mr. Baker. You are my role model.
Chairman Baker. Start earlier.
Mr. Frank. Thank you.
We had HUD last year not exercise its right to increase
your goals. As you know, HUD had the right, a year before, to--
last year they could have promulgated an increase in your
affordable housing goals that would have taken effect this
year. They didn't do it. It was an oversight, according to the
secretary; they forgot to do it.
Now they are talking about increasing. And I certainly want
to see an increase in the amount of affordable housing. But
obviously if your overall activity shrinks, we are in trouble
because, if I am correct, your affordable housing goals are not
absolute but they are percentages of your overall activity.
So the question is, what will the effect of the 30 percent
additional capital be on your reaching an absolute amount, in
terms of affordable housing?
Mr. Raines. The answer is, we don't know yet. We have a 45-
day period to come up with a capital plan, under the agreement,
which we will do.
We don't have a lot of choices. As you know very well, you
either can reduce the size of your activities or you can
increase the amount of capital that you have. If we have to
reduce the size of our activities, then the percentage made up
of the affordable housing goals will go down because we will be
doing less business.
Mr. Frank. So that arbitrary 30 percent might result in a
diminution in your affordable housing activity?
Mr. Raines. Well, if the capital plan requires us to reduce
our activities, yes, it would reduce the impact of the goals as
a result of our having made those choices.
Mr. Frank. Thank you, Mr. Chairman.
Chairman Baker. Thank you, sir.
Mr. Shays, did you want to go now?
Mr. Shays. No.
Chairman Baker. Mr. Ney?
Mr. Ney. Thank you, Mr. Chairman.
One of the issues I wanted to ask about is something I was
asking OFHEO today. It is on the generally accepted accounting
practices.
At the point in time, when they came in and said that there
was a willful violation of the accepted accounting practices, I
asked if in fact OFHEO had talked to the Fannie auditors and
whether Deloitte & Touche, in fact, had talked to your auditors
at that time, to see why those auditors recommended to you to
use certain accounting practices.
And I just wondered if you had any comment on that, about
should Deloitte & Touche sit down prior to this report, is what
I guess I am getting at. And that was the plan made with OFHEO.
Mr. Raines. Well, I believe that they should have sat down
with the auditors and asked them what was their view on these
issues, because our auditors have obviously been looking at
these issues for many years and they have an opinion on public
record as to how they have come out on that question.
So I believe that they should have sat down with them
before coming to the conclusions that they have come to,
because obviously KPMG has come to a different conclusion than
OFHEO has.
I don't know what the positions of Deloitte & Touche are.
The report doesn't tell us, and I think the director testified
that the findings in the report were OFHEO's. So I can't
comment on what the positions of Deloitte & Touche are on these
issues. We know what KPMG's positions are on the issues.
Mr. Ney. I will speak for what OFHEO said today. If I
recall correctly, OFHEO said that Deloitte & Touche concurred
with OFHEO.
And my follow-up question was, did Deloitte & Touche at any
point in time communicate with your auditors to see why? And I
wondered if, at any point in time, if Deloitte & Touche
concurred, had they at any point in time had any contact or
working papers of your auditors?
Mr. Raines. Not to my knowledge.
Mr. Howard. Nor to mine.
Mr. Raines. Not to my knowledge that there has been any
contact either by OFHEO or by Deloitte & Touche with KPMG to
explore these issues.
Mr. Ney. Thank you, Mr. Chairman.
Chairman Baker. I thank the gentleman.
Who is next?
Mr. Scott?
Mr. Scott. Thank you, Mr. Chairman.
Mr. Raines and Mr. Howard, your accuser, OFHEO, has spent
the better part of four hours this morning making some
extraordinary accusations. And I want to make sure that you
have ample opportunity to refute those accusations, a fair
amount of which is this: that essentially you all cooked your
books so that you could meet certain earnings targets so that
you could get bonuses.
And the chairman has passed down this sheet, and one look
at this sheet puts, in my estimation, some very strong, strong
incentives.
I think we owe you the opportunity to make sure that you
have the opportunity to refute that charge first.
And I know, Mr. Chairman, I have 5 minutes, if you will
allow me to get that question out, then I have two more
questions on the line of politics and process, but I want you
to answer that charge because I think that is at the center of
this hearing this morning.
Mr. Raines. Well, thank you for that opportunity.
This is a very serious allegation, and I deny that
occurred.
We have looked for the facts. There were no facts in the
OFHEO report. None. Other than their calculation that said,
``Oh, there seems to be if we subtract one number from another
you get this result.''
But we looked into the facts of what happened back 6 years
ago, and we found no facts that would support the allegation
that was included in the report.
Mr. Scott. Why, then, would OFHEO, in your opinion, make
that charge?
Mr. Raines. Well, Congressman, I do not know. This entire
examination has been unusual. It has been the most unusual
regulatory endeavor I have seen in the 30-some-odd years I have
been in this city.
And I have never seen the case where a regulatory agency
brought serious allegations against a company without asking
the company for a response in advance.
So I do not know. This has been something that is
inexplicable to me as to why they would follow this path. And I
do not believe there has been an adequate explanation of why
they followed this to this moment.
Mr. Scott. I asked your accuser this morning: When did they
make this report public and when they did inform you of the
report?
I would like to have your interpretation of those chain of
events.
Were you made aware and briefed on this report by your
oversight accuser prior to them making it public?
Mr. Raines. Let me walk you through the entire sequence
very quickly.
We began reading newspaper accounts that OFHEO was about to
finish a report. I personally called the director to talk to
him about him, to set up a meeting to talk about it.
I was unable to have a conversation with him about it or to
have a meeting with him about it.
On Friday, at about 4 o'clock Eastern Time, members of our
board were called and told that the director wanted them to
assemble on Monday, to meet with OFHEO officials to hear about
the report.
On Monday, four OFHEO officials came to Fannie Mae to brief
our outside directors, and at that same time they handed to
management a copy of the report.
They then proceeded to brief the board on Monday.
But as you know, much of the information about the report
was not only in the political press, but also was in the
financial press prior to that Monday.
Mr. Scott. Let me ask you: When did the board make the
decision to link, and they did actually make the decision to
link executive pay bonuses to earnings per share?
Mr. Raines. Fannie Mae has linked bonuses to earnings per
share for as long as I have been around the company. That goes
back to 1991. Tim Howard has been there longer than I have.
Mr. Howard. I cannot recall a year in which they were not
linked.
Mr. Raines. And indeed, virtually every company of which I
am aware links some part of their compensation to earnings per
share. So this is not an unusual thing; this is one of the most
common aspects of corporate----
Mr. Scott. Well, the point I wanted to get on the record
was: The linkage was made prior to you being chief executive
officer.
Mr. Raines. Absolutely, prior to my even being at the
company.
Mr. Scott. So this was not done on your watch. It was done
and it has been normal procedure to link----
Mr. Raines. Yes, sir.
Mr. Scott. Now, Mr. Howard, one point: You are the vice
chairman of the board----
Mr. Howard. Yes.
Mr. Scott.--you are the chief financial officer----
Mr. Howard. Correct.
Mr. Scott.----you are the supervisory person over internal
audit.
Mr. Howard. That is not correct. The internal auditor
reports directly to the chairman of our audit committee. He has
what is called a dotted-line relationship to me, which means I
am his internal point of contact in the company.
Mr. Scott. Do you not approve his salary?
Mr. Howard. I do not. I make a recommendation on his salary
to our senior management group, and his salary is determined
collectively in consultation with the chairman of the audit
committee.
Mr. Scott. But you do set the targets, financial targets,
for the year, you said.
Mr. Howard. The financial targets are set collectively by
the senior management team.
Mr. Scott. But you do have the authority to meet those
targets.
Mr. Howard. No, I do not.
Mr. Scott. Oh, you do not. That is good to know, because
there have been some reports that you did.
Mr. Howard. There have been lots of things that have been
said incorrectly.
Mr. Scott. That is why I want to make sure that you have
ample opportunity to refute. This is a very serious hearing.
I think the future, the jeopardy of Fannie Mae is at stake.
And I want to make sure we give you ample opportunity to answer
every one of these charges.
Mr. Howard. If I may take advantage of that opportunity and
just be very clear in what we are saying, there is no linkage,
to my knowledge, of compensation to the determination of what
the catch-up charge would be in 1998.
We found no evidence of a linkage of that to compensation
decisions for 1998.
Mr. Scott. Thank you.
I yield back the balance of my time, Mr. Chairman.
Chairman Baker. I thank the gentleman.
Chairman Oxley?
Mr. Oxley. Thank you, Mr. Chairman.
Mr. Raines, welcome back.
I am sorry if I am plodding over old ground, but I just got
back in the committee room.
Mr. Raines, I wanted to ask you in regard to the Freddie
Mac issue: You stated that Freddie Mac to make its GAAP
earnings less while Fannie Mae--this is your quote--reported
and explained the volatility. The OFHEO report finds that
Fannie Mae misapplied GAAP, due to among other things,
managements desire to portray Fannie Mae as a consistent
generator of stable and growing earnings.
I guess the question occurs: What is the difference, in
your case, between Freddie and Fannie in that regard?
Mr. Raines. Mr. Chairman, they tried to get me with no
chart. I had to have one. And this simply illustrates the major
point.
That is our reported earnings. That is what we are accused
of having made stable.
And if this was what we are trying to make stable, we did a
very bad job of trying to stabilize our reported earnings.
And that is really the big difference between what Freddie
Mac admitted they did and what we are accused of.
Freddie Mac was accused of trying to straighten out that
orange line, and that they entered into transactions to
straighten out the orange line. That is the GAAP earnings line.
And then they said, yes, that is what they did.
And what we did instead was, we have two ways of reporting
the earnings. We simply report the volatility in GAAP, and we
say,''Here's another way to calculate it in core. You the
investor now have both ways to calculate it.''
So I am not exactly sure what is meant by the accusation
that we were smoothing earnings, because FAS 133 is not even
included in core--the impact on net income is not even included
in core business earnings.
So that is why we have a little difficulty understanding
what the accusation is.
But the difference between us and Freddie Mac is that OFHEO
is saying we have misapplied accounting standards. They link us
smoothing; we do not understand what that means.
Freddie Mac said they were trying to smooth.
Mr. Howard. Mr. Chairman, as you can see from the chart,
even the core business earnings line is not particularly smooth
in recent years. So whether it is GAAP, which we made no
attempt to change with transactions that were not economic, or
core business earnings, the allegations of transactions to
smooth earnings, or accounting manipulations to smooth earnings
does not appear to be substantiated by the actual earnings
results.
Mr. Oxley. Let me also ask both of you: On your Web site,
you claim that the hedge accounting treatment for each
individual transaction is determined and documented in writing
before you enter into that transaction.
And furthermore, you say it cannot subsequently be changed.
The OHFEO report disagrees with that assessment, citing
instances where there was no contemporaneous hedge
documentation as well as instances where staff created hedge
designations retroactively.
Do you disagree with those allegations?
And does FAS 133 not require full documentation for
transactions----
Mr. Howard. First of all, Chairman, there are two separate
issues, which I will address separately.
The first set of documentation that you were referring to
was documentation of hedge transaction types.
Before we can enter into any given hedge transaction type,
we have a hedge policy developed that is worked out by our
accounting policy group, that is within our controller's
department, but independent of other groups.
So all they do is accounting policy. And that accounting
policy is reviewed with the outside auditors.
So before we do a single individual transaction, we have an
agreed-upon derivatives or hedging policy.
Now, where the difference of viewpoint in the OFHEO report
arises is over agreement on whether individual transactions
were documented sufficiently. We believe they were and
therefore qualify for hedge accounting.
OFHEO, in certain instances, contends they were not and
therefore these transactions may not qualify for hedge
accounting.
Mr. Oxley. Does the report cite specifics? And if so, are
there disagreements on the specifics? Or is this a
generalization?
Mr. Howard. The report cites specifics. I am not intimately
familiar with those specifics since I do not deal with them at
that level.
Mr. Oxley. Mr. Raines, do you have any comments?
Mr. Raines. Again, I do not know about the individual
specifics in the report, but their general position is that our
way of documenting, with the combination of contemporaneous
paper documentation plus automated systems, they believe does
not meet their test.
We believe it does meet the test of GAAP.
Mr. Oxley. And finally, in my opening statement I talked
quite a bit about the application of the Sarbanes-Oxley Act in
this particular case.
You of course are a publicly traded company and are subject
to the requirements of the act as well as regulations therein.
Is there anything in your estimation to give any indication
that any of the provisions of the act or the subsequent
regulations had been violated or ignored?
Mr. Raines. No, sir, I do not know of any. In fact, I think
the act has been very helpful to us, because one of the reasons
that we have documentation on a lot of these things is because
we are going through the process as required by the Sarbanes-
Oxley Act. That is why we have, as I described in my written
testimony, this entire process around certification so that we
know exactly at the highest levels of the company what
decisions were being made and by whom.
And also I can tell you, as a result of the Sarbanes-Oxley,
I have made a campaign in our company to go around and tell
people, ``If you think there is something wrong, raise your
hand. Raise your hand, and it will be looked at that.''
That has been our policy and that continues to be our
policy, and I have to say, the direct growth from the reforms
that were brought in by Sarbanes-Oxley.
Mr. Oxley. Thank you.
Thank you, Mr. Chairman.
Chairman Baker. I thank the chairman.
Mr. Clay?
Mr. Clay. Thank you, Mr. Chairman.
And thank you, Mr. Raines and Mr. Howard for being here.
Mr. Raines, in May of this year, Dow Jones International
News reported that Senator Kit Bond, Republican from Missouri,
was so critical of OFHEO's leaks to The Wall Street Journal
that he asked HUD's inspector general to examine OFHEO's
practice of handling confidential information with the media.
This morning I asked Mr. Falcon a question such as: Why did
the examiners not discuss preliminary concerns of possible
findings with Fannie Mae? Why was Fannie Mae not provided a
draft report? And why did Fannie Mae not have the opportunity
to respond to findings?
I question why the process for handling these findings was
altered and done differently for Fannie Mae. I find this to be
inconsistent and a rush to judgment.
In informal conversations with the executives from Wall
Street and individual large brokerage houses, I get the feeling
that the markets are not worried about the safety and soundness
of Fannie Mae, as OFHEO says that it is. But of course, the
markets are not political. I do not see due process being
carried out with respect to Fannie Mae.
Do you have an opinion on this, Mr. Raines?
Mr. Raines. Well, Mr. Clay, as I testified, you know, we
are a regulated company. We recognize we are a regulated
company, do everything we can to work cooperatively with our
regulator. And we will continue to do that regardless of what
has happened with regard to this special examination. They have
a job to do and we have a job to do.
By the same token, I don't believe that because we are a
cooperation that we are not due due process. And I think we
have a long tradition in this country of providing due process
even to people who have done the most heinous things. They have
been accorded due process. And that is all we have really asked
for thus far is give us the opportunity to state our case and
let us take these issues to someone who can resolve them.
Now there have been many issues like this resolved by other
regulators, banking regulators, without newspaper headlines.
The issues that relate to FAS 91 and 133 we can discuss
forever, but the SEC is going to decide.
And in my view, there is no reason the issues couldn't have
just been taken directly to the SEC before any examination was
completed and just ask them what is the answer. Then we
wouldn't be having a debate here about, you know, whether or
not the regulations embodied in this book are simple.
A regulation that has 172 interpretations that have come
out since it was--we wouldn't be having that debate if we had
done the simple step of going to the SEC, in which we would
have joined in and said what is the answer? And then we would
all know what to do going forward.
Mr. Clay. I know that Fannie Mae has agreed to the increase
in capital and how much in dollars is that increase?
Mr. Raines. We don't have an exact estimate, but if you
look back at the most recent periods it would require something
in excess of $3 billion.
Mr. Clay. Okay. I commend the company for this and for
agreeing to other changes that will make for better
transparency. Nevertheless, how would this almost $3 billion
have been used were it not required for capital? I mean will
the housing mission be affected adversely by this increase? And
will it help the housing mission?
Mr. Raines. Congressman, the honest answer is I don't know
yet. We have 45 days to come up with a capital plan, but we
don't have a lot of choices. And it could require us to reduce
our activities because we have only 270 days to come up with
the $3 billion. And that is just one of the issues we are going
to have to struggle through.
So, it is possible it could require us to reduce our market
activities to achieve the goal.
Mr. Clay. I thank you for your response.
Mr. Chairman, that is all for me. I yield back the balance.
Chairman Baker. I thank the gentleman.
Ms. Kelly?
Ms. Kelly. Thank you, Mr. Chairman.
I have very little time, Mr. Raines. And I would appreciate
it if you could answer my questions within a yes, no format. I
really appreciate the presence of both of you before the
committee today.
Mr. Raines, which member of the executive management team
is responsible for risk management, accounting, on-balance
sheet mortgage portfolio, business planning, tax, investor
relations and internal audit? Do you have one member who----
Mr. Raines. There is no one responsible for all those
things unless you are thinking of me. But there is no one
person responsible for all those things.
Ms. Kelly. Well in the OFHEO interview with Tim Howard he
said he had those portfolios.
Are you aware that, as the director of financial
accounting, Jeff Guliana has responsibility for modeling
critical accounting estimates, as well as reporting and
accounting for model results? Just give me a yes or a no
please.
Mr. Raines. I think the answer is yes.
Ms. Kelly. Thank you.
Are you also aware that a senior vice president for
financial reporting and planning, Mrs. Janet Pennewell, is
responsible for reporting net income, as well as forecasting
what net income will be? I just need a yes or a no, sir,
please.
Mr. Raines. Ms. Kelly, sometimes when you phrase it in a
way that is not exactly right giving you a yes or a no may be
misleading to you. So----
Ms. Kelly. Well, that is in the OFHEO report in that way.
So, I just----
Mr. Raines. That may well be----
Ms. Kelly. Is that true? I mean does this woman have--does
she report net income, as well as forecast what the net income
will be? That is what I read in this report.
Mr. Raines. If you put it that way, no.
Ms. Kelly. Okay.
Mr. Raines. But, I was trying to be helpful, but if you put
it that way, the answer is no.
Ms. Kelly. I am sorry. I have a bill on the floor and I
have to get back over and I have to get through this because I
really need answers to my questions.
Are you aware that a senior vice President for the
operations risk, Sam Rajappa, was, and is still, apparently
responsible for auditing his prior work as controller? Just a
yes or a no, please, sir.
Mr. Raines. No, he is not responsible for auditing his
prior work as controller.
Ms. Kelly. Okay. That is, again, that was in his interview,
that is apparently what he said he was doing in the OFHEO
report. Mr. Rajappa says he was employed as Fannie Mae
controller from 1994 to the end of 1998, which was the time
period where earnings manipulations to trigger executive
bonuses is alleged.
Were you aware that that arrangement was a clear
contradiction of the IAA standards relative to the auditor
independence? Did he assume that he was doing this and he
wasn't?
Mr. Howard. I can actually help there. Mr. Rajappa was
moved in as head of operations risk but the auditor at the time
was a man named Jack Wassen. Mr. Wassen was the company's
auditor. Mr. Wassen reported to Mr. Rajappa. So there was no
violation of that standard at the time.
Ms. Kelly. Thank you.
Mr. Howard. You are welcome.
Ms. Kelly. According to, again, the OFHEO report, Mr.
Rajappa reports to you, Mr. Howard, is that true?
Mr. Howard. I have been chief financial officer for 14
years. For the first----
Ms. Kelly. Sir, I just need a yes or no answer.
Mr. Howard. No.
Ms. Kelly. He is not now or has he ever?
Mr. Howard. No, he reports to the chairman of the audit
committee. He does not report to me.
Ms. Kelly. Okay. What about the members of the executive
committee? Do you meet, and according to what the OFHEO
interview shows, the executive team met to cooperatively set
salary and bonus for Mr. Rajappa, as well as Mr. Rajappa being
available to audit the executive team. That is what is in the
report. I just need to know from either one of you a yes or a
no.
Mr. Raines. This is very hard to give yes or no answers
to----
Ms. Kelly. I understand that, sir----
Mr. Raines. But----
Ms. Kelly.----but I have a very limited time.
Mr. Raines. I understand, but the implication of my giving
you an answer that is incorrect is so great that I refuse to
take the risk without telling you what the real answer is.
The answer is that the compensation for everybody in the
company, including mine, is in part determined by our executive
team. We have in process where lots of people are involved in
setting the compensation. So, the answer is yes, but that is
not an unusual thing.
Ms. Kelly. Okay.
Mr. Raines, as the CEO of a major company this committee
and I believe the American people, investors, taxpayers and
homebuyers, expect you both to know about these operations and
to be so intricately involved in the decisions and processes of
the company that questions like mine could be able to be
answered with a quick yes or no. There needs to be bright lines
for who is reporting to whom and who is doing what.
When I read this OFHEO report I did not see bright lines.
If there are bright lines, sir, I would hope that perhaps you
could get us a construct of exactly what they are. If they do
not agree with OFHEO so be it. But it would be important for us
to know how you have Fannie Mae structured because I believe
quality and transparency is what the American people deserve.
Thank you. I yield back the balance of my time.
Chairman Baker. I thank the gentlelady.
Mr. Baca?
Mr. Lynch?
Mr. Lynch. Thank you, Mr. Chairman.
Well, I don't have a bill on the floor and I have plenty of
time. So, if either of you gentlemen would like to expand on
the previous yes/no answers in any respect, feel free to do so
right now. As someone who has grown up in public housing, I
have a real investment in Fannie Mae's mission. And I see the
good work that you do.
Let me just--you know, the previous speaker mentioned that
she saw no bright lines in this OFHEO report. This is 200
pages. I just want to ask you again, just to be sure in my own
mind, did OFHEO sit down with you and interview you, Mr. Raines
or Mr. Howard in preparation of this, this examination of your
corporation, of Fannie Mae?
Mr. Raines. They did not interview me.
Mr. Howard. They did interview me on two occasions; one to
discuss impairments on certain types of securities, and one was
a more general interview.
Mr. Lynch. Okay. And what about sitting down with your
auditors, did they sit down with your auditors about this
report?
Mr. Howard. Not to my knowledge.
Mr. Raines. I do not believe that they have interviewed our
auditors. But to be clear on your question, since they have
done the--finished the report, they have not talked to us
either about the content of the report.
Mr. Lynch. Well it is not surprising then that there would
be no bright lines in this and that some of these accounting
rules are fairly complex and one would certainly understand how
there might be differences of interpretations as you have
pointed out.
In your own minds as the CFO and CEO, is this a usual
relationship with a regulator that they would go around you and
not sit down extensively with you to try to bring you into
compliance with a GAAP that they thought you were in
noncompliance with?
Mr. Howard. For me it is an unusual relationship.
Mr. Raines. Congressman, I would agree that it is an
unusual relationship. I did note in Director Falcon's testimony
that he gave a reason why he felt the necessity to go around
senior management he said was the lack of cooperation by senior
management. And if I could address that issue, I would----
Mr. Lynch. I would like you to.
Mr. Raines.----be delighted.
We had our first meeting with OFHEO with regard to this
special examination on January 7. Since that date we produced
427,466 pages of documents, in 67 different document
productions and 14 different requests, answering 425 questions.
We also provided 966,367 pages of e-mail and e-mail
attachments.
We have even provided on three different occasions, our own
consultant to go to OFHEO to help OFHEO with their technology
in managing their searching of our e-mails. We had 100 people
working for 4 days to respond to just one of their e-mail
requests.
We have made Fannie Mae people available 47 times to be
interviewed as part of this process. Now we provided to them
the working papers of KPMG and quite a bit of other
information.
I met with Director Falcon and told him, or informed him
that if there were any problem with Fannie Mae's cooperation in
this examination call me directly. And I have received no such
call. Now, the most inflammatory statement I guess is the one
that says that the--that our cooperation was so bad that it
required subpoenas to be issued and then subsequently the
Justice Department was called upon to perhaps enforce those
subpoenas.
First, with regard to the issuance of subpoenas, my
attorneys were told by OFHEO staff that the issuance of
subpoenas was not related to a lack of cooperation but that
they were doing this simply to get people on the record.
Secondly, with regard to the Justice Department, both in-
house and outside counsel for Fannie Mae spoke to the Justice
Department about OFHEO's referral to it regarding enforcement
of one subpoena relating to e-mail and the Justice Department
indicated that this was an issue that they expected to be
worked out between OFHEO and Fannie Mae without any involvement
of the Department or the courts.
So, with regard to our cooperation, I think it has been
overwhelming. The subpoenas, as we were told, had nothing to do
with lack of cooperation. And the Justice Department has
indicated that they believe that this was an issue that could
and should be resolved between OFHEO and Fannie Mae and it was
resolved. All of the material requested by OFHEO has been
provided to them.
Mr. Lynch. Thank you. And thank you for clearing that up.
Is there anything else you would want to add in terms of not a
one-word answer, yes or no, but anything else that you feel
that you need to clarify?
Mr. Raines. There is one other point I would like to make,
and it is an issue I think bears a broader discussion and that
is the notion that in corporations there should be silos and
that people should have one function, another function, and
another function and they should never have any of these
brought together. In fact, the practice of corporations is to
bring together these things at a high level.
Mr. Howard is a vice chairman of Fannie Mae. He is one of
the three most senior executives. So, of course he has many
people who report to him. Otherwise, everyone would have to
report to me and that wouldn't be a very functional
organization.
So it is not unusual to have these reporting relationships.
Indeed, there are many surveys that show that people bearing
the CFO title quite often have risk management reporting to
them, quite often have the balance sheet, the management
reporting to them, quite often have internal audit reporting to
them.
So, although it was characterized as being unusual, it is
actually usual, and, in his role as the vice chairman, his
duties are far beyond simply being the CFO, and it is quite
appropriate that he have a large part of the company reporting
to him.
Mr. Lynch. Okay. Thank you, gentleman.
Thank you, Mr. Chairman.
Chairman Baker. Mr. Toomey?
Mr. Toomey. Thank you, Mr. Chairman.
I would like to get to the specifics of one of the
allegations with regards to FAS 91 in particular. As we all
understand, FAS 91 deals with the methodology by which a firm
is required to amortize premiums and discounts. In the case in
question, I believe specifically the situation arises in which
these premiums and discounts have to be amortized over
securities that have prepayment features.
There are requirements under FAS 91, as I understand it,
that you do the calculation, you then amortize a very precise
amount quarterly over an assumed future remaining life of a
given security, and then, when the next quarter comes around,
you need to reanalyze this.
Interest rates very often will, in fact, be somewhat
different than they were projected to be or assumed to be in
the modeling in the previous quarter, and you then redo the
amortization essentially.
You do this prospectively, but you also do it historically,
so to speak, with an adjustment to the current quarter, which
is intended to capture the cumulative historical difference
between what was estimated in the past and what reality has
shown.
My concern and my understanding and the testimony of OFHEO
is that FAS 91 requires that you come up with a precise number
and that number be entered in that given quarter, and my
concern is that you developed a policy whereby you did not use
that number. You created a considerable discretion, in fact,
over what number you would use within a range.
I would like for you to explain to me where it is in FAS 91
that you are authorized to not use the number that the model
comes up with and confirm, if you will, that it is, in fact,
that methodology about which KPMG said they have an audit
difference with Fannie Mae.
Mr. Howard. Mr. Toomey, I would be happy to address that.
In estimating the rate at which we amortize premiums and
discounts, one has to make a number of assumptions on----
Mr. Toomey. Understood.
Mr. Howard.----interest rates and prepayment sensitivities.
By making assumptions that are reasonable but different, one
can come up with different sets of very precise numbers, and I
understand you have to choose one, and we do that.
So, when interest rates change, we will by practice reflect
that new estimate in the rate at which we amortize purchases at
the premium going forward because those adjustments take place
over time.
Where we have used in the past a range or a threshold to
determine at what point we have sufficient certainty around the
estimates that we are making between the numbers that we
recorded historically and the numbers a new set of assumptions
would indicate we should have recorded historically, we have,
as a matter of policy, since FAS 91 was first implemented, had
some latitude around zero, typically plus or minus $100
million, but more than that.
Mr. Toomey. My point is, does FAS 91 authorize that?
Mr. Howard. According to our accounting policy team and
KPMG, it does. KPMG----
Mr. Toomey. Then why does KPMG have a difference on that
issue?
Mr. Howard. KPMG had a difference prior to 1998 because we
did not have a defined policy in place that governed how much
latitude we could have--let me finish, please--before we made
an automatic adjustment.
Once we put that policy in place and limited the amount or
the size of that range, KPMG removed its audit difference,
therefore confirming our view that the treatment of this
estimate retroactively--not prospectively, but retroactively--
was, indeed, consistent with GAAP, and this is something that
the SEC will look at, and they will give us their view.
Mr. Toomey. Yes. Oh, they will. But you have not cited
anything in FAS 91 that says you are allowed to use a number
other than what your model comes up with.
The other thing that raises concern about this is the
exchange in memos between yourself and others seems to suggest
that there was a conscious ongoing effort to manage this
amount. This is a large amount. $100 million on a quarterly
report out of earnings of $1 billion or so, thereabouts,
suggests a very substantial percentage of this.
Mr. Howard. Congressman, let me be very clear. My intent in
getting involved in the development of the policy was to ensure
that the numbers we were reporting to investors was as clear
and as meaningful as they could possibly be.
I will give you an example of how I thought about this. For
the five years from 1999 through last year, our net interest
income averaged about $2 billion per quarter. Now investors are
looking for changes in our net interest in come for evidence of
how fast our business is growing.
A net interest income amount of $2 billion in one quarter,
growing at 10 percent per year annualized, will be roughly
$2.05 billion in a quarter. If we are growing at 15 percent
annualized, it will be $2.075 billion. So the difference
between 15 percent growth and 10 percent growth in a single
quarter is $25 million.
If we adopt a policy that causes us to make these random
adjustments based on our estimates of prepayments, collapsed
over a number of years going back into a single quarter that
is, say, $70 million, we have worsened the quality of our
financial statements by adding a spurious number--this is our
view. I am not asking you to agree with it--that is bigger than
the discernment investors are trying to achieve in looking at
our quarter-to-quarter financials.
I made the judgment. Accounting does not only permit but
also encourages practical applications and judgments in
financial reporting. This, in my view, was a good judgment
because it preserves the integrity and the quality of our
published financial statements.
Mr. Toomey. Well, I see my time has expired. I have to say
I am very skeptical about this methodology, in particular this
catch-up mechanism, this range, using this discretion in terms
of how much income you show, and it is such a substantial
portion of total income.
Mr. Howard. It is not discretion. Let me be clear: It is
not discretion.
Mr. Toomey. Well, the report quotes people in your firm who
describe it as discretion.
Mr. Howard. For a small period of time historically, we had
discretion. After the policy was locked in the middle of 2002,
there has been no discretion from that point forward.
Mr. Toomey. Well, you are directly contradicting what some
people from your firm are saying in the OFHEO report in terms
of the discretion that remained after the policy was adopted.
Mr. Howard. After the policy was adopted in December 2000,
in the middle of 2002, we eliminated any potential for
discussion by changing the policy. So we now have an agreement
with KPMG that we will use no additional discretion in doing
the FAS 91 amortization post December of 2002, and that is a
fact. OFHEO may not have picked that up.
Mr. Toomey. So, since 2002, you have ceased and desisted
using this methodology that you used before.
Mr. Howard. What happens is when our catch-up adjustment is
within the size limited by the guidelines, roughly plus or
minus 1 percent on net interest income and 2 percent on
guarantee fees, we do not make any adjustments at all. So that
is not discretion.
When it is outside that, we book to the edge of the range
and no further. That is not discretion either.
Mr. Toomey. And the establishment of the range, the
methodology and the amounts of these ranges, these were all
developed and established by you. This is not under the
direction of FAS 91.
Mr. Howard. Well, by the company.
Mr. Toomey. By the company.
Mr. Howard. Yes, that is correct. They are consistent with
FAS 91.
Mr. Toomey. Well, that is what we are going to find, the
SEC's opinion on that.
Mr. Howard. You are absolutely right.
Mr. Toomey. Yes.
Chairman Baker. I thank the gentleman.
Mr. Baca?
Mr. Baca. Thank you very much, Mr. Chairman.
Let me ask this question of Mr. Raines or Mr. Howard, and
either one of you can respond.
OFHEO has been the regulator since 1992. Is that correct?
Mr. Howard. Yes.
Mr. Baca. That is 12 years. During this 12 years, their
responsibility is not only to audit you. Is that correct?
Mr. Raines. Well, they examine us. They have an annual
examination.
Mr. Baca. And during that examination, if they find any
deficiencies, is it their responsibility to let you know of any
deficiencies, methodologies or other that you are following
that you should not be following? Is that correct?
Mr. Raines. Yes, that would be their responsibility.
Mr. Baca. In this particular case, did they ever come back
and tell you in terms of standard practices or procedures or
deficiencies that you had to talk to either one of you two with
regard to these issues?
Mr. Raines. Yes, not until we saw the special examination
report.
Mr. Baca. Isn't that a normal practice for any accounting
firm or auditing firm, to basically sit down with the CEO or
the chairman to discuss any deficiencies or procedures or
process that they are not following? Is that normal standard?
Mr. Raines. It is a standard, and we did sit down with them
each year. In fact, their chief examiner met with our board and
presented the results of their exam, and none of these issues
were included in any of those exams over any of those years.
Mr. Baca. And in any of those years, did they ever sign off
in terms of your methodology or procedures or methods that you
used?
Mr. Raines. Well, you might want to talk about the FAS 133
exam.
Mr. Howard. Yes. From what I can recall, when we
implemented the process for FAS 133, along with the systems,
OFHEO did do a review of those processes and systems and said
that it met or exceeded safety and soundness standards.
Mr. Baca. That meant they had to have signed off, right?
That said that you are following directions, and they did not
come back and tell you that you needed to follow a different
one or the methodology that you are using is now different. Is
that correct?
Mr. Howard. I would not know how to characterize it. They
would have to do the characterization. I can tell you what they
did.
Mr. Raines. But did they do it?
Mr. Howard. Did they?
Mr. Raines. Did they come back and tell us to do something
different?
Mr. Howard. No.
Mr. Baca. Okay. Thank you.
This morning, the regulators allegated that Fannie Mae did
not respond to the initial request for information and that it
had to issue a subpoena. Can you give us your version of the
events leading to this release of the information?
Mr. Raines. Congressman, we have been very responsive to
OFHEO over this period, specifically relating to subpoenas. Our
attorneys were told that the use of subpoenas did not relate to
a lack of cooperation, but that this was because OFHEO wanted
to move from informal interviews to having them on the record.
That is what we were told at the time that the first subpoenas
were issued because we said to them, you know, ``There is no
need for this. We will produce the people, and we will produce
the documents.'' They said they wanted to move----
Mr. Baca. So you were willing to be cooperative with them
and willing----
Mr. Raines. We were willing and we were cooperative
providing hundreds of thousands of pages of material and almost
a million pages of e-mail to them as the result of their
requests.
Mr. Baca. Did OFHEO personally contact you regarding the
preliminary findings, either one of you?
Mr. Raines. No.
Mr. Howard. Not me.
Mr. Baca. It seems odd that they would not contact you.
Yet, you know, they have gone to the media and they have gone
everywhere else. But yet they should have followed, practiced
standard procedures, which is a total violation.
Maybe we should have them on the audit out here versus you
guys in terms of not following practice or not following the
laws that are in place.
Where do you think the process will go from here?
Mr. Raines. Congressman, this process has been so unusual,
I cannot tell you. I can tell you what we are doing.
Our board has negotiated an agreement with OFHEO, which we
are going to faithfully follow and put into effect within the
timeframes as agreed to between the director and our board.
We are also going to be cooperating with the independent
counsel that our board has appointed to look into all of these
allegations and to see if we can find out what the facts are,
and so we will cooperate with them.
We will be attempting to take the two big accounting
issues, FAS 91 and FAS 133, directly to the SEC and ask them to
give us resolution on those so we can see, and, if we are
right, then we are right, and, if we are wrong, we will make
whatever changes the SEC tells us to make, and we will also
cooperate with any law enforcement agency that is attempting to
look at these allegations.
They are very serious allegations, they have to be looked
at, and I am delighted that today, for the first time, we are
allowed to at least partially give our point of view. But,
certainly, the independent counsel will be looking at every
document and every person and doing a very thorough review, and
we look forward to that.
Mr. Baca. Thank you.
I served on numerous boards, and, usually, when an audit is
done by any accounting firm, they usually come up with the
recommendations, the deficiencies, recommendations for
improvements.
You usually give that nonprofit organization an opportunity
to correct those deficiencies before any kind of action is
taken, and I am just really appalled at the kind of action that
has occurred out here without first discussing it with either
one of you two in terms of any corrections or actions that need
to be taken. If there was a difference in terms of methodology,
accounting system, what needed to be done, it seems like they
would have approached you.
So, hopefully, we will comply with both the laws that are
in place right now in terms of standard practices that need to
be done.
And, Mr. Chairman, I realize that my time has expired, but
thank you very much.
Chairman Baker. Mr. Bachus?
Mr. Bachus. Thank you.
Chairman Raines, we are talking about these financial
reporting issues in a lot of the discussion, whether, you know,
you violated FASB rules or not, but did these issues, I mean,
first, undermine your creditworthiness?
Mr. Raines. Well, I have to say, Congressman, that since
this report has come out, we have been put on credit watch, and
one of our credit ratings was dropped, went down as a result of
this report.
So a report like this from a regulator has serious
consequences in the capital markets. You know, our stock price
dropped by $14 billion as a result of this report coming out in
the way it did.
So, yes, this report has a very, very big impact on how we
do our business from our debt costs to our credit ratings to
our stock price.
Mr. Bachus. Okay, but you are not in jeopardy of meeting
your ordinary course of business, your obligations and that?
Mr. Raines. No, the fundamental economics of the company
has not changed.
Mr. Bachus. Okay.
Mr. Raines. The company is in fine shape. The only thing
that has changed is this report.
Mr. Bachus. Yes, when creditworthiness changes, your credit
rating changes, you are put on credit watch. Obviously, that
has implications not only for the housing market, but for the
general economy as a whole.
Mr. Raines. Yes.
Mr. Bachus. I think what we had discussed this morning is
you heard Director Falcon say you all were uncooperative, but
you have rebutted here pretty clearly, and, you know, so we
have a difference of opinion on that.
The other thing, which a gentleman just mentioned, is he
says he used best regulatory practices in this special
investigation. You have been in government business for a long
time. Is this normal? Is this the best practices for other
government regulators? How would they have typically handled
things as opposed to how OFHEO did?
Mr. Raines. Well, Congressman, when I was in the government
as the director of the Office of Management and Budget, one of
my duties was to oversee regulatory matters throughout the
federal government, and I have never seen a proceeding like
this. In all of my time, I have never seen a proceeding like
this.
The financial regulators are given special powers, very,
very strong powers. They can put a financial company out of
business if they choose to. And because they are given those
special powers, they exercise them very carefully.
Quite typically, a financial regulator in this
circumstance, taking everything OFHEO has said at face value,
as being true, that financial regulatory would have managed
this without one headline, and they would have done it entirely
confidentially.
They would have resolved the issue, and, at the end, the
resolution would have been announced, and this has happened
many times. The Fed, the OCC, the OTS have had to do this with
financial institutions.
So, if we take everything they said as being exactly right,
I do not know of any financial regulator who would have done it
this way. I have never heard of a special examination report
being made public.
Mr. Bachus. Well, it certainly has been on the public
stage, the entire process.
CFO Howard, do you want to comment?
Mr. Howard. No.
Mr. Bachus. Oh, okay. I am sorry.
Let me ask you this. You know, you all have basically said
that most of what they have, I think, accused you all of doing
you had not done or that they had not, at least before now,
asked you to change your internal controls, very strange, and
you are defending your practices, I think, by and large.
That being the case, why did you all enter into this
September 27 agreement? I mean, you know, if they were not
right, why would you have sort of consented to do what they
asked you to do? And I know that you did not acknowledge any
wrongdoing, but you took some pretty drastic measures, and one
might say, ``Why would you have done that?"
Particularly, one thing you have done is you have agreed to
this capital surplus of 30 percent of minimum capital reserve,
which if followed could, you know, restrict your activities
which could negatively impact the financial markets. So I would
just say is there an explanation for that.
Mr. Raines. Well, yes, there is. Our board gave tremendous
consideration to this, and there are several points, I believe,
that they wanted to make.
The first point was to acknowledge that we are a regulated
company, and, if our regulator has concerns, whether we agree
with them or not, they have to be taken quite seriously. So
they wanted to demonstrate that on every issue they could agree
to that they would reach an agreement.
Second is that the agreement preserves the issues on which
we do not agree, and those are to go to the appropriate place.
Third is that we are mindful of the markets, and the idea
that a company as large as we are would be seen to be having
some kind of ongoing battle with their regulator struck us as
to be contrary to our mission, and we did not want to take the
risk of undermining our mission by appearing to be in an
ongoing battle with our regulator.
So the board had to make a judgment. I know some people
took that agreement as being an admission of guilt. I think it
was a demonstration of leadership by our board that put our
mission first as opposed to our reputations or our feelings or
our gut, all those other things that they could have put first.
They put the mission first, and I think that is admirable, and
I applaud them for doing it.
As I mentioned before, financial regulators are very
powerful entities. They can put you out of business, and so it
is imperative for the board to ensure that we have a
functioning relationship with our regulator on an ongoing
basis.
Mr. Bachus. Can I----
Chairman Baker. Can you wrap up? Yes, sir.
Mr. Bachus. This is my final question. This will be for
you, CFO Howard.
Can you outline for us the exact steps that must be
followed under FAS 133 for a derivative contract to receive
hedge treatment and also whether Fannie departed from common
industry practice in establishing an effective hedge?
Mr. Howard. We, first of all, do not believe we did depart
from practice, and, importantly, OFHEO has not contested the
fact that the transactions that we have entered into are
economically effective.
Mr. Bachus. Right.
Mr. Howard. What they are talking about is whether we have
met the criteria for hedge accounting. The requirements differ
according to the nature of the transaction.
For the derivative transactions at issue, you must first
identify the transaction as being a certain type of hedge, with
documentation. We believe we have done that. OFHEO has raised
some questions over technicalities around the documentation.
The second thing that has to happen, again, in types of
transactions we have undertaken, is we need to have a high
degree of effectiveness. It is called in the literature
``perfect effectiveness,'' which can be assumed. We have
assumed perfect effectiveness on these hedges because, in our
view, that we have buttressed by periodic testing, there is a
very, very small amount of ineffectiveness.
Even though I recognize that minimal ineffectiveness and
perfect effectiveness are not the same thing, our reading of
the accounting literature, buttressed by KPMG notes it is
making a practical application in a business context that is
permissible, and that is what we have done.
Mr. Bachus. Well, then it is my understanding that there is
no question that any of these activities undermine the safety
and soundness. In fact, some of them are prudent business
practices except where they may have violated, you know,
financial reporting standards.
Mr. Howard. And we do not think we have.
Mr. Bachus. I think that is really the issue, not whether
you have engaged in any dangerous----
Mr. Raines. Right. In fact, these hedges are all designed
to reduce risk.
Mr. Howard. Exactly right.
Chairman Baker. The gentleman's time has expired.
Mr. Meeks?
Mr. Meeks. Thank you, Mr. Chairman.
Mr. Raines, Mr. Howard, this may come as a surprise to you,
but some people just do not like Fannie Mae's current status in
the market, and that is pre-this OFHEO's report, et cetera. In
fact, this may be a surprise, that when OFHEO came here--and
Mr. Falcon--once before, many members of this Congress
criticized them severely and threatened to put them out of
business, in fact, wanted a new regulatory agency to come in.
You know, I understand your statements, Mr. Raines, about
you do not understand certain things, but let me just let you
in on a surprise. Some people do not want you in business. They
do not like the success that you have accomplished by putting
people with decent homes and roofs over their head. Some people
just do not like that. And so that might be a surprise to you.
In fact, let me ask. Prior to this hearing that we had
where OFHEO was threatened, had there been an occasion or any
time before where OFHEO may have examined Fannie Mae and noted
any irregularities or discrepancies in any kind of accounting
standards?
And I wonder how did they work with you in the past before
we had all of these secrets coming out that people do not like
what you do?
Mr. Raines. Well, prior to the issuance of this special
examination report, all of our examinations from OFHEO found
that we met or exceeded safety and soundness standards, and
that is going back to when OFHEO first organized itself back
in, I think, 1993.
So we had never, to my knowledge, had an outstanding issue
with OFHEO on accounting, internal controls or any other issue.
In the course of their examinations, they would make
recommendations to us and, you know, we would adopt them. But
we have never had an issue prior to this examination report.
Mr. Meeks. Were you willing to make those? When OFHEO was
making those recommendations, et cetera, in the past, would
that have been shared with the press or members of Congress or
put in the headlines of the newspapers? Has that ever happened
before?
Mr. Raines. No, the examination reports remain confidential
until OFHEO makes an annual report to Congress, usually
released in June, and then it is made available, but all of the
examinations are held confidential, and, in fact, OFHEO has a
regime for their regular examination function that holds these
things confidential, and we have had very good experience with
their regular examination process in that regard.
Mr. Meeks. So this is a relatively new phenomenon that has
taken place now as far as your relationship with your
regulator.
Mr. Raines. With regard to this special examination, this
is very new.
Mr. Meeks. I know that you have indicated in your testimony
thus far that your board, I understand, had agreed to the 30
percent capital surplus because you want to show, you know, you
are part of the market and that you are cooperating, et cetera.
But I am curious to know is there any other financial
institution that does anything even close to 30 percent.
Mr. Raines. As a mandated surplus? Well, Freddie Mac has
a----
Mr. Meeks. Other than Freddie Mac.
Mr. Raines. No, sir. I am not aware personally of a
financial institution that is otherwise solvent that is
required to have a mandatory surplus by their regulator, but
that is not to say it does not exist. I am just not aware of
it.
Mr. Meeks. And, Mr. Howard, let me just ask you a question.
This will be my last question--and I will yield back the
balance of time--because I am just trying to make sure that I
understand.
According to OFHEO, Fannie Mae must supply FAS 91 by
recognizing only $200 million against expenses for prepaid
loans, instead of $400 million, and, of course, you state that
Fannie Mae's treatment was correct and that KPMG agrees with
you. Just explain to me why are you right and OFHEO wrong.
Mr. Howard. Prior to 1998, you know, any amount of this so-
called catch-up adjustment, which, again, was the comparison we
made after the fact between the amount that we had brought into
income based on an old assumption of average life of the
portfolio--remember there are millions of loans in the
portfolio--and a new average life. That difference we had kept
track of but never recorded in current period income. That was
the catch-up adjustment.
In 1998, that dollar amount grew to a large size of
expense--it was actually closer to $440 million--and we
determined that some portion of that likely did represent a
true economic cost. So we put together a group within the
finance department of portfolio people and comptroller's people
to come up with a method of determining the best amount to best
reflect true economic substance.
The recommendation they made to me and to us as the senior
management team was that $240 million was that right amount. So
the remaining amount, which was not deferred because it was an
amount that never was recorded on the books in previous years--
it was kept track of, and that was the audit difference--that
turned out to be a judgment that ex-post proved to be correct
because next year we did not have an audit difference that was
expense. We had one that was income.
So the judgment in retrospect turned out to be correct. It
was made as a part of a process that had integrity, and it was
independent of any link to compensation.
Mr. Meeks. Thank you.
Chairman Baker. The gentleman's time has expired.
Mr. Shays?
Mr. Shays. Thank you, Mr. Chairman.
Mr. Raines, I have a lot of respect for you. I think that
you are one of the best budget directors. You are very
articulate. I liked your opening statement, the buck stops with
me. We do not hear that enough, and I thank you for that.
My problem with Fannie Mae is I feel it is a bully in the
marketplace that exercises its incredible advantages and does
not want to play by the same rules that everyone else plays by,
and I think you know that is what I think.
I think that your not being under this 1933 Act and then
voluntarily agreeing to be under the 1934 Securities Act--
voluntarily--to me is a bit arrogant. I think you should be
willing to be under those laws.
I think to suggest that you should have a weak regulator
like OFHEO, and, when we wanted to strengthen it, you had
objected to strengthening it, I have a problem with that.
So I am not surprised by what is happening right now.
When you say, ``Well, OFHEO never did this before, and we
played by their rules,'' they were a very weak regulator.
I am not pleased to learn that you have given $245 million
worth of bonuses in the last five years. That is aside from
stock options. So I have a bit of a problem with that.
But I am particularly curious as to why OFHEO needed to
have subpoenas in order for them to do their job. Why did they
have to get subpoenas? So, if you would just tell me that, I
would start off with my questions with that.
Mr. Raines. Well, I will just answer your subpoena
question.
Mr. Shays. Yes.
Mr. Raines. There are a lot of other things there, but----
Mr. Shays. I know that, but that is my time. You have had
your time.
Mr. Raines. With regard to the subpoenas, our lawyers were
told by OFHEO staff that they were issuing subpoenas not
because of any lack of cooperation by Fannie Mae, but because
they wanted to move the interviews from being informal
interviews to interviews on the record with someone there
keeping a record of exactly what was told. That is what we were
told contemporaneous with the issuance of the subpoenas.
Mr. Shays. Can I just say to you I am a little concerned
with that answer because it seems to conflict with what we had
been told. So I just--and you are under oath--want to make
sure.
Are you suggesting that there was no requirement whatsoever
for them to get subpoenas, that you, as soon as they asked for
this information, you, Fannie Mae, voluntarily provided this
information? Is that your testimony?
Mr. Raines. That is my testimony.
Mr. Shays. Is that your testimony, Mr. Howard, as well?
Mr. Howard. To the best of my recollection, yes.
Mr. Shays. Okay. To the best of your recollection. In other
words, this information was asked for, and you voluntarily were
going to provide it, but, instead, they said, ``Oh, by the way,
we want to go and get subpoenas.''
Mr. Raines. We were actually in the process. We had been
doing this for quite a while. The special exam had been going
on for a while before the first subpoena was ever issued. We
had been providing thousands of documents, providing people,
providing e-mails.
Mr. Shays. Okay. Did you provide the information they
wanted, not what you wanted?
Mr. Raines. Yes. We had provided every piece of information
they wanted, and we told them they would get that with or
without subpoenas.
Mr. Shays. Okay, but I think it is important to put on the
record because the information is that they had to get
subpoenas to get this information.
Mr. Raines. Well, I have testified very clearly that that
is inaccurate.
Mr. Shays. Okay. Let me ask you, besides the bonuses, you
offer stock options as well?
Mr. Raines. We are a shareholder-owned company, and we pay
according to what our statute provides, which----
Mr. Shays. Is that a yes?
Mr. Raines. We pay comparably to other companies, and we
use stock options among the various things in our executive
compensation.
Mr. Shays. Do you dispute the amount of $245 million over
the last five years as bonuses? That is a lot of money. It is a
quarter of a billion dollars. Nodding the head does not get
transcribed.
Mr. Raines. Well, I have to go calculate the number. It is
a number that is calculable, and I do not know what the number
would be.
Mr. Shays. Do you think it is in the ballpark?
Mr. Raines. It could be.
Mr. Shays. Yes.
Mr. Raines. But you say it is a very large number. In the
last five years, we have also probably had after-tax income of
$30 billion. So our executive compensation----
Mr. Shays. I know you are a very successful company.
Mr. Raines.----is a tiny, tiny percentage of our revenue,
and it is a tiny percentage of our profit.
Mr. Shays. Why should banks have to set aside between 6
percent and 8 percent of their portfolio and you guys are in
the range of about 3 percent?
Mr. Raines. Banks should do that because they have much
more risky portfolios. Banks are allowed to invest in a wide
range of assets. We can only invest in single-family and
multifamily homes.
Mr. Shays. So it is your testimony that you do not need to
have more because you do not feel any of your investments
potentially could go sour?
Mr. Raines. If none of them would go south----
Mr. Shays. No, you set aside a certain sum in case the
market starts to go bad, and the residential marketplace is
very volatile, and you have about 3 percent of your portfolio
set aside. If a bank gets below 4 percent, they are in deep
trouble. So I just want you to explain to me why I should be
satisfied with 3 percent.
Mr. Raines. Because banks do not--there are not any banks
who only have multifamily and single-family loans. I think if
you check, banks are now arguing that their capital for those
loans should only be 2 percent or less. I mean, that is the
argument they are making right here in Washington today, that
these assets are so riskless that their capital for holding
them should be under 2 percent.
Mr. Shays. Fine, but let me just ask you this question
because OFHEO was asked this. Before OFHEO issued its report,
did any of you speak to any people in the press or with any
members of Congress about their report?
Mr. Raines. We did not know anything about their report. We
had never seen their report.
Mr. Shays. When did you see their report?
Mr. Raines. We saw their report on Monday.
Mr. Shays. Did you know of the report? Did you know the
contents of the report?
Mr. Raines. No, we had no knowledge of the content of the
report. In fact, I had been calling the director. I had a
meeting scheduled with the director to discuss the progress on
the special examination, which he canceled. I had three calls
into him to discuss it because of the press reports that we had
seen, and I never talked to him.
Mr. Shays. I thank the chairman. Just to verify, we are not
playing a word game here of a draft of the report.
Mr. Raines. The report was handed to management as OFHEO
officials walked into a meeting with our board, literally
handed to us as they walked in.
Mr. Shays. And you were not given a draft earlier or a
working draft or anything like that?
Mr. Raines. We saw nothing.
Mr. Shays. So the answer to your question is you never
spoke to any member of Congress before this report was issued
or the press about this report before it was issued?
Mr. Raines. About the contents of the report?
Mr. Shays. About the report.
Mr. Raines. Well, if we are going to be this--we never saw
the report!
Mr. Shays. I did not ask that. I want an answer to the
question because I had been told that Fannie Mae had been
speaking to reporters and press about this report before it was
issued.
Mr. Raines. About the content? Is that what you are asking?
The content--are you--I want to be very clear here.
Mr. Shays. Not the content. Just concerns that there was
going to be a report that came out, et cetera, et cetera, et
cetera, and----
Mr. Raines. We have talked about concerns. Yes, we have
talked about concerns about the report that we had been reading
about in the paper. Yes, indeed. The press was calling us. When
they were reporting OFHEO is about to do a report, they asked
us, ``What is your reaction?'' and we said, ``We do not know
anything about that.''
Mr. Shays. And that is the extent of your contacts? You did
not initiate any?
Mr. Raines. Why don't you give me the example and then I
can tell you what----
Mr. Shays. No, no. I do not want to give an example. I do
not want to give you an example. I want to know if you all
affirmatively went out to the press to engage them in a
dialogue about this report which you say you have not seen.
Chairman Baker. And that will have to be the gentleman's
last question because your time has expired.
Mr. Shays. The answer is a yes or no. Did either you or
your organization do that?
Mr. Raines. Look, I do not understand what you mean by
engaged. No doubt----
Mr. Shays. No, you do not want to answer the question.
Mr. Raines. No doubt we talked to the press about the
report we had not seen. No doubt that someone in Fannie Mae
talked to the press about a report we had not seen because we
were getting asked questions about a report we had not seen.
Some questions indicated that they knew more than we did.
Mr. Shays. And the question I asked, though, which you
could be responsive to--and I would appreciate it--is: Did you
affirmatively interact with the press or actively contact the
press about this report, not respond?
Chairman Baker. And that is the gentleman's last question.
Mr. Raines. I am not trying to be difficult.
Mr. Shays. The answer is a yes or no.
Mr. Raines. I am not trying to be difficult, Congressman,
but you are asking me the question, did we ever call a reporter
and mention it? Probably, but not because we had seen the
report.
Mr. Shays. Thank you. I hear you. I hear you.
Mr. Raines. Okay.
Chairman Baker. The gentleman's time has expired.
Ms. Waters?
Ms. Waters. Thank you very much.
I just wanted to clear up a little something here. I find
the information about the bonuses very interesting, and I am
sure that it will cause a lot of discussion, but that is not
really why we are here today.
You raised a question earlier, Mr. Raines, about this being
proprietary information. Do you still think that this is
proprietary information that has been released, after you have
seen what we have?
Mr. Raines. My concern about proprietary information solely
goes to not the five people at the top because our information
is public, but we have people trying to recruit away our people
every day. Every day, we have recruiters coming to Fannie Mae
trying to recruit our people away.
This is a road map as to how to go about recruiting Fannie
Mae employees. This is private information about people who are
not public officials, who are not senior officials, and now
this is being made public for reasons I do not understand.
Ms. Waters. Well, the reason that I asked is that our
chairman did indicate that he had a legal opinion. I do not
have a copy of that legal opinion. I do not think there is
anything in writing. I think that his conclusions were drawn
based on some constitutional reference.
I just wanted to make sure that it is your understanding
that it is proprietary information so that I can continue my
follow-up and my investigation to find out whether or not
proprietary information has been released. But you do think it
is proprietary?
Mr. Raines. My only goal here was to not waive any rights
we have.
Ms. Waters. All right.
Mr. Raines. We continue to maintain whatever rights we have
asserted. I did not want to waive that by sitting here and not
saying something that was being revealed.
Ms. Waters. Okay. That is fine. And I think I know what to
do with that.
I know you have repeated this any number of times, but I
think it is very important for you to repeat part of an answer
that you had given earlier, relative to this business about
subpoena and information from OFHEO about you had been forced
somehow to answer questions.
Part of your information had to do with the Justice
Department and the fact that they had been contacted. What was
the Justice Department's response to OFHEO's request to be
involved in this in some way?
Mr. Raines. The Justice Department response was that they
indicated that this was an issue that they expected to be
worked out between Fannie Mae and OFHEO and that they did not
believe that there was a need for any involvement of the
department or the courts in working it out.
Ms. Waters. Excuse me one second, my colleague, Mr. Shays?
My colleague, Mr. Shays?
The question that you asked about whether or not they had
been forced through a subpoena to cooperate or to answer
questions, there was one portion of his answer that you were
not privy to. You were not in the room. I just asked him to
repeat it. You were being distracted. I would like to ask him
to report that again.
The Justice Department had been contacted to ask to be
involved in some way with this investigation. What did the
Justice Department say, Mr. Raines?
Mr. Raines. Let me read to you specifically so you have the
statement that has been approved.
``Both in-house and outside counsel for Fannie Mae spoke to
the Justice Department about OFHEO's referral to it regarding
enforcement of one subpoena relating to e-mail, and the Justice
Department indicated that this was an issue that they expected
to be worked out between OFHEO and Fannie Mae without any
involvement of the department or the courts.''
Ms. Waters. Okay. Thank you very much.
I also would like to inquire----
Mr. Shays. I do not know what that means. I do not know
what the means, so if you would----
Ms. Waters. Okay. On my time now.
Mr. Raines. I think what that means is----
Ms. Waters. Excuse me. This is my time. You may not answer
him on my time. He can get some additional time.
Let me just ask you is it true that you absolutely had not
seen this report until they came to the boardroom with the
report.
Mr. Raines. That is true. I did not see the report until
they went into the boardroom, and they then handed a report
with my name on it, an envelope with my name on it, saying,
``This is your copy of the report.''
Ms. Waters. Were you ever told why it was important to come
before the board with such haste? From the time the report
supposedly was finalized and to the time that they came to the
boardroom, did you ever hear why it was so important to get
that board organized so that they could receive this report?
Were you ever explained to why it happened that way?
Mr. Raines. It was not explained to me. I can believe you
are going to have our lead director testifying before you. She
can also answer whether it was ever explained to her.
Ms. Waters. Did you ever hear that the timing of the board
meeting had anything to do with the fact that there was a
desire to have this hearing prior to the recess--congressional
recess? Did you ever hear any of that discussion?
Mr. Raines. I did not hear that.
Ms. Waters. All right. Finally, let me just ask you this.
Obviously, Fannie Mae is a very sophisticated organization
with a lot of smart people doing big, big business, and it is--
I cannot understand why you would be involved in any activity
that could easily be unveiled that was incorrect accounting
practices or anything else with some kind of investigation. You
have testified as to your accounting practices and your
understanding of what is expected of you.
Finally, when Fannie Mac was investigated, did this raise
some kind of red flag, and, even though you felt that what you
were doing, you were doing it correctly, that you were on solid
ground, did you say, ``Well, let us look at ours again, too, to
see if there is anything here.'' I mean, I would have done
that, and I want to know did you two did that?
Mr. Raines. We did, indeed, do that. We engaged outside
counsel, we engaged accounting, we looked at everything that
was alleged about Freddie Mac to see did Fannie Mae have the
same problems, and our conclusions were that we did not, and,
to this day, no one has alleged that we had the same problems
that Freddie Mac had. These issues that are in the OFHEO report
are brand-new issues to Fannie Mae and they are new to our
relationship with OFHEO.
Ms. Waters. And, by the way, I am going to ask you
something that you may not want to answer.
Since all of this has been made public, I read an editorial
in The Wall Street Journal that talked about the fact that
there had been an investigation and that editorial almost
jumped to the conclusion that there must be something wrong,
and, therefore, the investigation, even though there had not
been a response, there must be something wrong, and even though
they did not explore it fairly, they came to the conclusion
that you would not be fit to be the treasurer of the United
States of America.
What does the speculation about your being perhaps asked at
some point in time--should certain people win the presidency,
what does that have to do with your work now have to do with
whether or not you should be asked to be the treasurer of the
United States of America. Have you heard that discussion at
all?
Mr. Raines. I have heard that discussion. As you know, I
have been around this town a long time. It is very said. It is
very sad to me if any consideration of politics goes into
something like this. My service in the government, you know,
has been, I think, service.
You know, I have never run for office, and I have never
sought to be a political figure. You know, I have responded
when a President of the United States has asked me to respond,
and that--I have been asked twice and I have responded twice to
that case.
More than me, my colleague, my former boss, Jim Johnson,
has been brought into this, and let me say something about that
directly. He, too, has been mentioned as a potential person to
be in a future administration. We have done a look at the 1998
incident that has been alleged by OFHEO, and we have found no
acts that would relate to Jim Johnson whatsoever.
Indeed, he was not the CEO when these decisions were made.
I was. And so any implication that Jim Johnson had something to
do with this is just totally without factual base. It shows
what happens in these kinds of frenzies.
I have to tell you the thing that bothers me far more than
this treasury thing--far more--is explaining to my kids. That
is hard.
Ms. Waters. Well, I----
Mr. Raines. It is hard when your daughter feels she needs
to say to her dad, ``I support you.'' I am supposed to be
supporting her. That is hard.
Ms. Waters. Well, we are going to be out of here when we go
on recess, and all of this talk is going to fester. You have
not had an opportunity to respond.
You have not been questioned. You have not had an
opportunity to explain. Most of the members up here on this
panel do not understand accounting practices. They are learning
a lot for the first time today.
What this could potentially do is in some way damage your
reputation because these allegations are being made without
your having an opportunity to respond.
Chairman Baker. Ms. Waters, your time has long expired. Can
you wrap up, please?
Ms. Waters. Yes, I will wrap this up. What would you ask
this committee to do in the interest of fairness that would in
no way accept OFHEO without the opportunity for the kind of
response that is always allowed in this kind of setting? What
would you ask this committee to do?
Mr. Raines. Ms. Waters, what I would ask the committee to
do is to insist with all the agencies within your oversight
they operate within----
Chairman Baker. Excuse me.
Ms. Waters. I was trying to hear him.
Chairman Baker. I thought your time had expired. Please
proceed.
Ms. Waters. Yes.
Mr. Raines. What I would ask this committee to do is to
insist for all the agencies within your oversight that they
operate under the commonly accepted rules of due process and
fair play. I would also like your support to get a resolution
on these issues that the SEC would give us an answer.
You know, we did not come here to say today we are perfect
or even that we know that we are right. We are simply saying we
approach this with a businesslike approach, with honesty and
integrity, and if we are wrong, we will make the changes. If we
are right, you know, then we will go forward.
All we have asked is that the proper process be used. The
answers will come out of the proper process. That is the only
request that we are making, is that at least give us the
minimal rights that we would expect to be given to any other
company, to any individual, any organization.
Chairman Baker. The gentlelady's time has long expired. We
do have a number of other members wishing to be heard.
Mr. Ose?
Mr. Ose. Thank you, Mr. Chairman.
Mr. Howard, am I correct in understanding you are the chief
financial officer for Fannie Mae?
Mr. Howard. Yes, you are.
Mr. Ose. Am I correct in understanding that questions of
how to treat income or expense at Fannie Mae--that decision
would at least go through your office?
Mr. Howard. It would typically be discussed with me,
depending on the level of importance.
Mr. Ose. At what level of importance do issues come to your
office for a final determination?
Mr. Howard. That determination is made by the people who
bring them to me.
Mr. Ose. Is there typically a threshold dollar amount?
Mr. Howard. No. It is usually how unusual, new the issue
is.
Mr. Ose. In terms of such unusual or new situations, are
you the final arbiter of such decisions?
Mr. Howard. Again, it is situational. In some cases, it
could be the chairman, whoever that may have been, it could be
me.
Mr. Ose. Now I recognize that the report in question today
covered a period prior to Sarbanes-Oxley being in effect.
Mr. Howard. Yes.
Mr. Ose. Is that your understanding also? So it predates
our passage here on the Hill of that particular----
Mr. Howard. Parts of it do. Yes, that is correct.
Mr. Ose. All right. Does the audit committee of the board
of directors get involved in these questions?
Mr. Howard. Which questions?
Mr. Ose. Questions of a new or unusual set of circumstances
having to do with how to treat income or expense.
Mr. Howard. Again, it would depend on the situation.
Sometimes they are briefed on it. They are typically not
consulted for a decision.
Mr. Ose. The audit committee is not consulted for a
decision of any nature related to this kind of a situation? It
is just given to them as a fait accompli?
Mr. Howard. It is. I am attempting to recall an instance
where the audit committee may have been consulted in advance on
a financial decision. I cannot recall one.
Mr. Ose. So, in effect, what you are saying is that the
audit committee does not set the standards for the decisions.
The recommendation is given to them and they will either say
yea or nay?
Mr. Howard. Well, no, we typically do not even do that. We
will report on the financial condition of the company,
significant accounting issues. Anything that we think ought to
be brought to their attention for review, we will bring to
them.
They can comment on them, they can ask us to do things
differently, but we do not ask them for a decision because they
typically do not have the level of expertise to make decisions
at that level of detail.
Mr. Ose. I just want to make sure I understand it. Implicit
in your answer is that such decisions are therefore made at the
management level, rather than the board level.
Mr. Howard. That is correct.
Mr. Ose. Okay. So the final arbiter for such decisions is
your office?
Mr. Howard. It, again, depends on the decision. It could be
the comptroller. It could be the level below the comptroller.
It could even be at a level below that.
Mr. Ose. So the decisions may be made within perhaps the
operating units of Fannie Mae.
Mr. Howard. Not accounting decisions. They would not be
made within the operating units. Accounting policy decisions
are made by the accounting policy person, transactional
decisions that have accounting ramifications are made in the
units, but the results are reviewed and assessed by people in
the comptroller's department.
Mr. Ose. And then they are run past you as CFO for final
sign-off or rejection.
Mr. Howard. It depends on the issue. Most of them do not
come to me for that step.
Mr. Ose. Mr. Chairman, we may have the wrong guy here to
ask these questions on the accounting rules or modifications.
I am curious whether or not you do play a role in making
decisions as to what is or is not treated as an expense in one
case or an income issue in another.
Mr. Howard. Typically not.
Mr. Ose. And you are also testifying that the audit
committee of the board of directors is not involved in those
decisions either.
Mr. Howard. Not asked to make them. Informed of them.
Mr. Ose. Now you are CFO. Am I correctly advised that you
are CPA trained?
Mr. Howard. You are incorrectly advised. I am not a CPA.
Mr. Ose. You are not a CPA. Okay.
Let me ask a different set of questions, if I might.
Actually, this goes to Mr. Raines. Prior to this hearing, did
you or any of your agents or employers or counsel visit with
any members of this subcommittee about the substance that we
were going to discuss here?
Mr. Raines. Yes.
Mr. Ose. Did you or any of your agents or employers or
counsel provide questions to members of this subcommittee for
the purpose of having those questions posed to witnesses during
this hearing?
Mr. Raines. I believe we talked to members about or staff
about questions that they might want to pose, yes.
Mr. Ose. Okay. The only reason I ask that question is that
Mr. Falcon, I think, was asked on the previous panel to provide
to the committee a record of all such contacts that he may have
had with the committee or his agents or employees. I am asking:
Will you provide the committee a similar record of all such
contacts to this committee regarding this hearing?
Mr. Raines. My answer is I do not know. I mean, we will
have to talk to our counsel and others.
Mr. Falcon is a government employee. He is running a
government agency. There are laws that relate to the ability of
a government employee to lobby the Congress, and I assume that
that is what the inquiry was to Mr. Falcon.
We are not a government agency. We are not prohibited from
lobbying the Congress, but I would certainly take under
advisement your request, and we will get back with you with an
answer.
Mr. Ose. I am going to take that as a no, Mr. Chairman.
Thank you.
Mr. Frank. Mr. Chairman?
Chairman Baker. Yes, Mr. Frank?
Mr. Frank. Mr. Chairman, we have a colleague now on the
committee, the gentlewoman from Florida, Ms. Brown, who is very
interested in this and a student of Fannie Mae and its
activities, and I would ask unanimous consent that she be
allowed to enter a statement into the record of this hearing.
Chairman Baker. Without objection.
Mr. Davis, you are recognized.
Mr. Davis. Thank you, Mr. Chairman.
Mr. Raines, I had planned to go in a different direction,
but I want to follow up on Mr. Ose's comments for a moment. You
have been in D.C. for how many years as a----
Mr. Raines. I have lived here for about 20-some-odd years.
Mr. Davis. Okay. But in terms of your work at OMB and your
work at Fannie Mae, you have been a part of the institutional
layers in this town for a while, have you not?
Mr. Raines. Yes, sir.
DAVIS; And you have seen your share of congressional
hearings, I assume, over the course of time?
Mr. Raines. Yes, sir.
Mr. Davis. Is it a fairly common practice, Mr. Raines, for
almost every single entity that comes before this committee to
have some consultation or talk with members of Congress or
staffers before their folks testify?
Mr. Raines. Yes, sir. I typically did that when I was in
the government, and I have done it since I have been out of the
government.
Mr. Davis. And that is not an unusual or insidious practice
in any way?
Mr. Raines. No way.
Mr. Davis. And just one final point on this: You were asked
by Mr. Ose if you or Mr. Howard had talked to your attorneys.
Are you aware from newspaper reports that there is a Department
of Justice probe in this matter?
Mr. Raines. I am aware of that from the newspapers.
Mr. Davis. And based on your professional experience, Mr.
Raines, is it not commonplace that if someone is a potential
subject even, much less a target, of a Justice Department probe
that they would probably be out of their mind if they did not
talk to a lawyer?
Mr. Raines. Yes, sir. You are right.
Mr. Davis. And especially if you are about to give public
testimony under oath, wouldn't the prudent thing be to talk to
a lawyer?
Mr. Raines. Yes, sir.
Mr. Davis. Okay. Let me move to a much more important set
of questions. One of the things that OFHEO is criticizing, as
you know, is the structure of management at Fannie Mae, and
they are questioning the structure of responsibilities, and
there is some argument that there should be a greater
separation of certain job descriptions.
Mr. Howard, you understand that is one of the subjects
here.
Mr. Howard. I do.
Mr. Davis. How long has OFHEO been in existence?
Mr. Raines. The Congress created them in 1992. They
actually, I think, came into existence in 1994.
Mr. Davis. Okay. The structure that they are questioning or
raising issues about--how long has it been in place at Fannie
Mae?
Mr. Raines. A version of the current structure has been in
place since 1991 when I joined the company.
Mr. Davis. Okay. At any point prior to September of 2004
has OFHEO raised any questions about the structure or the
alignment of job responsibilities at Fannie Mae?
And I will ask both of you that question.
Mr. Raines. Not to my knowledge.
Mr. Davis. Mr. Howard?
Mr. Howard. Nor to mine.
Mr. Davis. And, as far as you know, has OFHEO been aware of
that structure for the whole 12 years of its existence?
Mr. Raines. Yes, sir.
Mr. Howard. It could have been.
Mr. Davis. And has OFHEO given you any explanation of why
they did not raise questions in the previous 12 years?
Mr. Raines. No.
Mr. Howard. No, sir.
Mr. Davis. Does it suggest to you the fact that if they did
not raise questions in the previous 12 years, they probably did
not think it was a matter worth questioning?
Mr. Howard. I do not know.
Mr. Raines. That would be speculating. They asked us lots
of questions over the period of time, and, as far as I know,
this has not been an issue with them.
Mr. Davis. Neither of you was in the room when I had a
chance to question Mr. Falcon earlier, but I want to ask you
for a reaction to some observations that I made.
As I understand OFHEO, their task is to oversee the safety
and soundness of Fannie Mae. Am I correct in that
understanding?
Mr. Raines. Yes.
Mr. Howard. Yes.
Mr. Davis. One of the concerns Ms. Waters has raised, that
I have raised and other members of the committee have raised is
that it appears that OFHEO has crossed some line into simply
being a neutral and dispassionate analyst or neutral and
dispassionate observer of what the institution does, to having
a very strong set of opinions about the institution.
Is that the impression the both of you have?
Mr. Raines. Congressman, I think that there has been an
evolution in their thinking that they believe that they either
have the authority to or have the need to be more directive as
to how we carry out our responsibility.
Mr. Davis. Now, Mr. Raines, for the relationship to work
shouldn't there be some arm's length between OFHEO and Fannie
Mae?
Mr. Raines. Yes, I believe we should run the company and
they should examine the company.
Mr. Davis. Is that relationship or that desirable
relationship undermine if OFHEO somehow becomes an advocate and
if they appear to have developed their own agenda with respect
to the future of Fannie Mae?
Mr. Raines. Well, I think it does raise serious questions
of who is ultimately responsible for the outcomes. I mean, if
we are doing what they say then who is to be held accountable
for what happens?
Mr. Davis. Okay. Let me ask you one final set of questions
because our time is so limited. The ultimate mission of OFHEO
is to preserve the safety and soundness, correct?
Are either of you concerned that by issuing a public
condemnation of Fannie Mae and its practices, a public
condemnation of the management structure, a public condemnation
of its accounting in advance of the SEC doing it, are either of
you concerned that that could somehow jeopardize Fannie Mae's
status in the market and that that could, in its own right,
have an impact on safety and soundness?
Mr. Howard. I am very concerned about that.
Mr. Davis. Could you elaborate on that, Mr. Howard, for a
minute?
Mr. Howard. Certainly. The markets respond to--as Mr.
Raines mentioned earlier, regulators have enormous power and
they are perceived by investors, particularly international
investors, to have such power. And most regulators do not make
pronouncements of the nature that we saw over the last two
weeks without very serious convictions that those are true.
Mr. Davis. One final question, if the chair will indulge me
just a few extra seconds, one of the things that we have heard
about is the fact that OFHEO went to the board of directors and
essentially put a 48-hour ultimatum in place.
Do you know of any authority that OFHEO has to give an
ultimatum to the board of directors with its course of action?
Is there any statutory authority for that?
Mr. Raines. I don't know of any such authority, no.
Mr. Davis. And to your knowledge, did OFHEO give any
explanation of why it was so time sensitive that the board of
directors move forward?
Mr. Raines. I believe what they said to the board was that
they thought the matters were serious and they wanted to test
the seriousness of the board in responding to the report.
Mr. Davis. Is it within OFHEO's charter to test the
seriousness of the board of Fannie Mae? Is that written
anywhere in their charter of their job description? That sounds
like a fairly political purpose, doesn't it? Or a little bit of
an agenda based purpose; we want to test the seriousness of the
board.
Chairman Baker. If you can, make that your last question
because we do have others and we have another panel too.
Please respond if you choose.
Mr. Raines. No, I am unaware of any specific statutory
reference to that.
Chairman Baker. The gentleman's time is expired.
Mr. Castle?
Mr. Castle. Mr. Chairman, thank you very much.
I don't want to get into this, it is funny how you think
you are going to ask one line of questions and then you hear
something else and you immediately want to follow up on that.
I don't necessarily agree with Mr. Davis, for whom I have
tremendous respect I might add, on--or even the answers to some
of that. I mean, it seems to me OFHEO has a real role in all of
this and to me, I mean, I agree with you, Mr. Raines, in sort
of the role of examining.
But I think when they examine and there is something that
with which they don't agree I think they have some
responsibility actually to make it public. I think you would
agree with that. In fact, it shows in your testimony, your very
good testimony, here today.
I mean I am one of those who worries about Fannie Mae. I
think, you know, you have good people running it and that kind
of thing, but, frankly, it is very large, some of the practices
I think are a little marginal. I worry about this perception
the Congress will back up whatever Fannie Mae does. I just
think there are a lot of issues.
I think the regulatory issue is very important though. And
somehow or another we have lighted a fire under OFHEO who I
would have written off a year ago and all the sudden they got a
tiger by the tail type thing. I don't know what is right or
what is wrong. But, I just want to make sure that Fannie Mae is
being run correctly because it is very, very important. And I
worry about the safety and soundness of that.
But, on the other hand, hey look, we are all running for
office right now. We are criticized daily by our opponents. So
a little criticism can't be the end of the world. And perhaps
if it is justifiable criticism and changes are made, perhaps
that is positive. I look at your testimony----
Mr. Raines. Congressman, if you are being accused of
committing a crime it is a little bit different.
Mr. Castle. Well, right. But, you know, I am not--the jury
is out on all of this right now. But the whole point is that
some review I think is essential.
For example, if you look at page two of your testimony you
have made several changes as a result of what OFHEO has done,
at least as I understand it. You go through the first, second
or third and I don't need you to go through all the details,
but you go through all the things that you have done, the
building up the 30 percent capital surplus, the chief risk
officer, et cetera, et cetera, some probably more important
than others. And I couldn't begin to tell you, which you
probably could.
But these are changes which you have pretty well agreed to,
perhaps not totally willingly, but you have looked at it and
you have made the decision that these are things you probably
should do that would benefit you that you did not do of your
own accord but you did because of the OFHEO--because OFHEO was
involved or is that correct?
Mr. Raines. Congressman, we don't look for things to
disagree with OFHEO.
Mr. Castle. Right.
Mr. Raines. Many of these things we would have been willing
to do if OFHEO had approached us in a different way. So this
isn't an issue of everything OFHEO says is wrong and everything
we say is right.
Indeed, I think the fundamental flaw, if I could say what
the fundamental flaw is in our relationship with OFHEO, it is
not created by OFHEO. It is created by the fact that the OFHEO
examination process does not have the same legal protection
that the bank examination process has. And that has a negative
effect on the entire relationship.
Bank examiners are not allowed to make public bank
examinations, even if they are requested by a member of
Congress.
Mr. Castle. I want to go to another line of questioning. I
am not going to parse that or argue it too much, except to say
that I think there are certain powers that OFHEO, perhaps,
should have that they don't have and perhaps there are others
that they have that they should not have.
I just think I want to get it straightened out. I mean, my
sense is that you all have been sort of back and forth on
whether there should be a successor to OFHEO or not. I hope
that somehow or another when this is all said and done we can
get this whole oversight, overview, examination, regulatory
aspect of it correct.
Mr. Raines. I agree.
Mr. Castle. Because I just think that is important for all
of us. That is my goal and I hope we can get great cooperation
on that.
Let me go on to this whole business of 98 because I don't
totally understand it. But my understanding is when all this
happened you were CEO, is that correct? Mr. Johnson moved on
and you were CEO?
Mr. Raines. I became CEO at the beginning of 1999.
Mr. Castle. 1999. So this happened at the end of 1998?
Mr. Raines. No, it would have happened in 1999. The books
are closed in January. So I would have been CEO.
Mr. Castle. Okay. Well, with respect to--this change really
bothers me and I don't know if this is something that has been
stated. There is no proof of it and I don't know whether it is
correct or not, so this may even be hypothetical rather than
practical. But, it concerns me that if, according to the
report, and dug it out, and it was filed by OFHEO.
I am sorry, according to the testimony, which we had today
by Mr. Falcon it basically states that the amortization models
of management were $400 million, however management decided to
record only $200 million that year and then spread the rest
over the next year, which allowed bonuses to be paid.
My question is, is there any record of that or is that just
something that happened? Did they look at minutes of meetings
or e-mails or anything to make that determination?
I mean, that, frankly, does have overtones to it that we
can speculate on how serious they might be. But I think we all
would agree it would be pretty serious if, indeed, a decision
was made to put extra--to violate a standard accounting
procedure and to put extra money into a different year to
resolve the--or to lessen the----
Mr. Raines. It is a very serious----
Mr. Castle.----keep the gains high the year before.
Mr. Raines. It is a very serious allegation. The report
states no facts. It doesn't cite one piece of paper. It doesn't
cite one witness who says that that decision was tied to
compensation.
As I mentioned earlier, we actually launched an effort,
once we heard this allegation, we launched an effort to go and
look at the facts. And if you look at the facts as to how this
occurred we have found no facts that indicate that this
decision was tied to compensation.
Mr. Castle. Did you find any facts--I know my time is
almost up and I have 15 second I have to yield to Mr. Shays.
But did you find any facts that would indicate the decision is
in violation of standard accounting procedures? That is what
they are stating. That is a pretty serious allegation.
Mr. Raines. No. We didn't find any of those facts either.
Our auditors looked at the decision at the time.
Mr. Castle. Right.
Mr. Raines. And they approved the financial statements and
they reported to the audit committee that there were not
estimates that they believed were unreasonable.
Mr. Castle. But KPMG apparently found an audit difference
on this, as I understand it, a term which KPMG, this according
to his testimony again, disagreed with Fannie Mae.
Mr. Raines. There was an audit difference. This is what is
called a subjective difference, which means that there are
different ways to do it, but when it came to the board, and the
board--and they would have to report to the board, were there
any estimates by management that they felt were unreasonable,
their answer was no.
Mr. Castle. So the decision was made, there was an
adjustment made and then the question becomes is what was the
behind that decision and whether or not it met good accounting
practices or good corporate practices.
Mr. Raines. And we looked at the contemporaneous records
and you can see in the contemporaneous records, in fact, that
the calculations that OFHEO is relying on were not possible
because no one knew what the EPS number was on the date that
this decisions appears to have been made. So this false
precision of just getting there exactly was impossible to know
because the books hadn't been completely closed for several
more days.
So that is what I am saying. We have looked at the facts.
There appeared not to be any facts to back this up. And if
OFHEO has facts that back up, you know, we would be delighted
to see them.
Chairman Baker. The gentleman's time has expired.
Mr. Castle. I was supposed to give 15 seconds to Mr. Shays.
Chairman Baker. Well, let me suggest this, I had one more
question and I had not had an opportunity to speak to Mr.
Howard, if everybody wants to take 2 minutes, let us constrain.
Mr. Shays. I wonder if I could go now because I have a----
Chairman Baker. We would be happy if you would leave now.
Mr. Shays. Would the gentleman yield?
Chairman Baker. I am sorry, you want to say something
first, I didn't understand your request. Yes, I would recognize
the gentleman.
Mr. Shays. Thank you.
I just want to put on the record, Mr. Raines, that in
communicating after your comment about the subpoenas to the
office of compliance, they said they had requested thousands of
documents and some of these documents simply were not coming.
They got concerned about it. They particularly wanted e-mails.
And only after they provided a subpoena request did the e-mails
start flowing.
And in conversation with Justice they basically said
Justice said it wasn't necessary because now the e-mails were
flowing, which is not uncommon in Congress when we issue a
subpoena. Sometimes the threat of the subpoena provides that
information from flowing.
And I just want to also say that the reason why this
information is public and you don't want it to be public now is
they felt this was so serious that this information shouldn't
be suppressed. And I happen to agree with them on that account
as well.
Mr. Raines. Well, if I might.
Mr. Shays. I thank the gentleman for yielding.
Mr. Raines. If I might?
Mr. Shays. Sure.
Mr. Raines. Fist of all, what I gave you was what the
contemporaneous statement was, not what is being said today,
but what was said at the time the subpoenas were issued.
Mr. Shays. Right. They didn't need it because you were now
complying.
Mr. Raines. No, at the time the subpoenas were issued, not
the time they went to the Justice Department, the time the
subpoenas were issued, they told us they were not doing it
because we were not cooperating. So, that, I think, is a very
important distinction.
Mr. Shays. They are saying that they were no longer
necessary because after the subpoenas were provided that there
started to be more information flowing, that is----
Mr. Raines. That is a Justice Department issue. That is not
why they issued the subpoena in the first place. That is
where----
Mr. Shays. So there is a disagreement that we are going to
have to nail down.
Mr. Raines. Yes.
Mr. Shays. You have your opinion, they have their opinion.
Mr. Raines. I think that is exactly right. But the second
issue on why this was made public, the exact same kind of
examinations go on with big banks, small banks, thrifts,
without special examinations being published. So there are
other ways to do this. This is an anomaly. OFHEO is the only
financial regulator who does not have the----
Mr. Shays. You are under the 1934 act.
Mr. Raines. I am sorry?
Mr. Shays. You are under the 1934 act, public disclosure.
Mr. Raines. No, their examination has nothing to do with
the 34 act. It is solely to do with the banking laws. Under the
banking laws, examinations are secret. And that helps the
relationship between examiners and the bank because they can
have very free flowing discussions. OFHEO doesn't have that. It
is not their fault. They have very good examiners. We are not
quibbling with that.
But the process is not a good process. We think the process
that exists between examiners and the examinee is best
referenced to looking at how the OCC has that work. And that is
what we strive for. We are going to work with OFHEO to see if
we can get there. But they do have this one disability that is
not their fault, which is their examinations are going to be
made public and that has a negative effect.
Mr. Shays. What I would like you to do, though, is work
with Congress to get a stronger enforcement process. That is
what I would like.
Chairman Baker. Your time is expired, Mr. Shays.
Mr. Kanjorski, did you have a follow-up?
Mr. Kanjorski. You know, a part of what we have to
ultimately do is come up with a new regulatory scheme here. And
I have been listening to this testimony and I was thinking
since we have a regulator for two entities, you know, why can't
we make an in-resident meat inspector, if you will, that is
down at your place 24 hours a day or however necessary.
But when you have these exit strategies where something
like an audit difference comes up, wouldn't it be more likely
to end up without disputes or problems if the regulator sat in
and knew what the issue was on the rulings so that they don't
miss it?
Mr. Raines. Congressman, we actually have 40 OFHEO
examiners resident at Fannie Mae. And so we do have them in
close proximity. And we do believe that our examiners are aware
of the closing process and of the findings of our auditor. That
has never been hidden from our examiners.
Our normal examining process, I believe, has worked well.
Our only difference is how the special examination has worked.
It is not about the normal examination process.
Mr. Kanjorski. But why didn't somebody in the normal
examination process be sitting in, to know what this audit
difference was in 1990?
Mr. Raines. My personal belief is--and I will go check--my
personal belief is that our examiners were aware of this.
Mr. Kanjorski. Well, you ought to examine your records and
get the worksheets and see whether--somebody should have been
there, to know that that was discussed, that the issue was
resolved in one way or another and obviously acceptable to the
regulator.
Mr. Raines. And I will come back to you. I will check on
that. But my belief is that our examiners had been well
informed, and they have been very professional people. They
have been aware of each and every one of these accounting
decisions over the years, and they have exercised their
judgment on them in that process.
So, we are not--we have no complaints about the normal
examination process. We believe it has functioned. And they
have hired people who examined other large financial
institutions. They now have a new examiner in charge, who I
just met with, and he has met with our senior management. And
we are going to work with him to make sure we have the best
possible examination relationship that exists.
Chairman Baker. Mr. Castle, did you wish another 2 minutes?
Mr. Castle. I just have one comment, if I may, Mr. Raines.
I heard you say earlier, based on this level--the executive
officer compensation chart--that it is the road path, that
people will come and steal your employees.
I have seen the salaries. You don't have to worry about
Congress coming up and stealing any of your employees.
[Laughter.]
Mr. Raines. Having been a federal employee a couple of
times----
Mr. Castle. You know the problem.
Mr. Raines. I know the problem. I know it well.
Chairman Baker. Ms. Waters?
Ms. Waters. SEC has been referenced any number of times
here today. And I guess Mr. Falcon said that there were
overlapping responsibilities.
What is SEC doing now? Have you been examined by SEC in the
past, since 1998? What have they said about your accounting
practices? What part of this have they overseen, examined,
investigated since 1998, and what are they saying now?
Mr. Raines. Well, the SEC has been enormously cooperative
with us in our process of becoming a registrant. We are the
largest business ever to become a new registrant with the SEC.
They have never had an $800 or $900 billion entity do that.
They were very helpful in that process, in reviewing our
initial documents and giving us feedback. So, they have bent
over backwards to be helpful. I am enormously grateful to them
for that.
They have also worked with us on sticky accounting issues.
And we, like other companies, have presented accounting issues
to them and asked them for a judgment as to what the
appropriate accounting is and, again, they have been very
responsive in giving us answers.
We, of course, have implemented the answers that they have
given to us. So, we expect that the SEC will carry out their
function here. They are busy; they have a lot of things to do.
I don't know what their timetable may be----
Ms. Waters. Have they been in touch with you since this
information became public?
Mr. Raines. We have had contacts through counsel with the
SEC Enforcement Division. But also we have had contact not
through counsel--through business people--and with other parts
of the SEC. So we try to maintain good communications with
them.
It is my desire now--as it would have been my desire before
the report came out--that these accounting issues simply go to
the body who can solve them. Then we will have the answer. We
won't be having a debate about who is right and who is wrong.
There will be an answer and we will implement it and go
forward.
Chairman Baker. Gentlelady's time has expired. I only had
one further request of you, Mr. Howard. In order to better
understand your explanation and your responsibility with
regards to the $200 million expensing issue of 1998, I would
like to request a written response, which I will submit to you
at a subsequent time.
The reason for asking the question in the hearing is that
if your response would be pursuant to your oath taken during
the course of the hearing, which would establish some important
value to your written response.
The essence of the request will go to the manner in which
the expense amount was determined, why the figure was arrived
at, the chronology of that decision-making process, those who
participated, if it did not rise to your level.
As you represented earlier in the hearing today, there are
some financial decisions that come before you, some that do
not. We need to know if it did not, to what level did it rise?
Was this matter discussed among all executives? Did it go
before the board for at least an announcement or some
disclosure to the board?
Basically, a process by which we can be sure, as members of
the committee, we have gotten complete and full explanations as
to the elements that OFHEO has brought to our attention.
Please understand, in my capacity, I am presented with a
very contentious and volatile report. If I were to have left
Washington D.C. and gone home without addressing the elements
of this report, I can only imagine the criticisms that would be
leveled against this committee for its inaction.
Should the interim report plead OFHEO to take the next step
and issue some other yet unknown criticism, it certainly would
leave this Congress in a very untenable position as the entity
responsible not only for the creation of OFHEO but for creation
of Fannie itself.
I certainly hope that the future does not bring ill-advised
consequences to the institution, its ability to extend credit
to prospective homeowners or, even worse, to have consequences
for taxpayers.
My role is to examine, thoroughly examine, and I hope to
spring to speedy resolution all of these matters. I have no
interest in, nor motivation, to bring any adverse consequence
to the enterprise or to Freddie Mac and, I will continue,
however, to be the arm's length examiner of enterprise conduct
that we appear, in your view, not to have with OFHEO.
With that disclosure and no further comment, thank you. And
this panel is dismissed.
If our witness for our third panel is able to make it to
the desk, we would invite her to do so now.
Thank you very much for your participation.
Welcome the presiding director of the board of directors of
Fannie Mae, the honorable Ann McLaughlin Korologos. Is that
correct?
Ms. Korologos. That is right, sir.
Chairman Baker. It was previously determined by mutual
discussion that all those who would testify before the
committee in this proceeding would be asked to take the oath.
Do you have any objection to being sworn in?
Ms. Korologos. I do not.
Chairman Baker. If you would not, do you seek the advice of
counsel during your testimony?
Ms. Korologos. I do not.
Chairman Baker. If you would not mind rising and raising
your right hand, I will administer the oath.
(WITNESS SWORN)
Thank you very much. Please be seated. Consider yourself
sworn in and under oath.
As we have extended to all other witnesses in the course of
the morning and afternoon, we request that the presentation, if
possible, be limited to 5 minutes. Given the gravity of the
issue before the committee, however, we would certainly extend
any courtesy to you to proceed at your discretion.
Your official testimony will be made part of the record.
Please proceed.
STATEMENT OF HON. ANN MCLAUGHLIN KOROLOGOS, PRESIDING DIRECTOR,
BOARD OF DIRECTORS, FANNIE MAE
Ms. Korologos. Thank you, Mr. Chairman, and I hope I can
keep more or less to the 5 minutes. I know it has been a long
day, but I appreciate the opportunity to be here.
I would like to thank Chairman Oxley, Ranking Member Frank,
Chairman Baker, of course Ranking Member Kanjorski and members
of the Subcommittee.
My name is Ann Korologos and I am the presiding director of
Fannie Mae's board of directors. I also currently serve as
chair of the Nominating and Corporate Governance Committee and
on the board's Compensation Committee.
I am a shareholder-elected, independent director. I have
served in three Cabinet departments, including as secretary of
labor under President Ronald Reagan, and I headed the
Presidential Commission on Aviation Security and Terrorism,
specifically investigating the bombing of Pan American Airways
flight number 103.
The board of Fannie Mae appreciates this committee's
oversight of the company, of the board and of our regulator.
And I welcome the opportunity to speak on behalf of the board
about OFHEO's report to date on its special examination.
The board takes the issues raised by the OFHEO report very
seriously. We are here to do the right thing. By that I mean:
to OFHEO, the SEC and Congress, and to do so in a way that
protects the shareholders and restores the public's confidence.
In this way, the company can continue to fulfill its
critical housing mission: to use the financial flexibility of a
private company to pursue the societal goals of increased
homeownership.
As directors, we must meet our fiduciary duties of loyalty,
care and good faith. We do not take these responsibilities
lightly. These duties have meaning. They require us to gather
the facts, conduct an objective investigation and render
judgment based on the facts.
We must look at the issues in the report deeply,
thoughtfully and carefully, using whatever resources are
necessary. And we will be held accountable for how we meet our
responsibility.
The board, with independent counsel and independent
accountant, will investigate the issues in the report, and we
will work expeditiously. So I thank you for this opportunity to
speak on behalf of the board. We were moving fast before this
hearing, and I can share with you that we now are continuing to
do so, and we now know where we are going.
The board has participated through our audit committee, in
following the company's response to the examination since it
began over a year ago. We have received regular reports from
the audit committee on the examination's progress, as best it
could be understood.
On Friday afternoon, September 17, Director Falcon
contacted me to say that OFHEO wished to share its findings to
date with the outside directors of the board. I convened a
meeting of the board for the next business day, which was
Monday, September 20.
Every nonmanagement director attended in person or by
telephone. On that day, we received the written report and
OFHEO's senior staff made a presentation to the nonmanagement
directors and the company's outside counsel.
The staff also gave us a letter from the director and a
draft agreement, to be signed within 2 days, outlining actions
to be taken. In addition, the board was informed by management,
after that meeting, that they had received a call from the SEC
that these issues would be a part of an informal inquiry by
that regulator.
The board immediately began a series of meetings and
discussions with OFHEO over the week of September 20. I think I
either spoke or met with Director Falcon every day that week. I
assured Director Falcon that the board and the company would
work cooperatively with OFHEO and that we would address all
their concerns.
I also expressed the boards hope that our work together
would build a constructive relationship based on mutual respect
and trust going forward. I told him, however, that the board
could not, consistent with its fiduciary responsibilities, sign
a document in 48 hours.
On Tuesday, September 21, I advised the director that the
board had authorized the hiring of independent counsel, former
Senator Warren Rudman, and his law firm, Paul, Weiss, Rifkind,
Wharton & Garrison LLP, subject to OFHEO approval, to address
the questions raised by the OFHEO report.
I also advised the director that we would provide to him,
the next day, a draft work plan based on the actions required
by OFHEO's agreement. On Wednesday, Pat Swygert, a fellow board
member and President of Howard University, and I met with the
director and his senior staff at OFHEO offices.
We provided the draft work plan that was approved by the
board and, because so much of the report had been leaked to the
press by that time, I also advised the director that the
company did not object to OFHEO's public release of the report.
After reviewing the draft work plan, Director Falcon told
me later that evening that he thought the plan was substantive
and addressed each of the areas of concern raised by the
report. I have attached to my written statement a copy of this
draft work plan.
On Thursday, in a conversation with OFHEO's general
counsel, however, it became clear that OFHEO wanted a written
agreement to be signed by the board.
Therefore, at my direction, on behalf of the board the
company's counsel began meeting with OFHEO staff to reach such
an agreement. Discussion continued throughout the weekend, and
after additional board meetings, we and OFHEO announced the
September 27 agreement.
With the agreement completed, the thorough process to
address OFHEO's report is underway. Importantly, management has
pledged its cooperation to the board in effort and we will hold
them accountable to that pledge.
The details of the agreement are well known. The company
will move immediately to begin making a number of changes
including a capital surplus plan, accounting policy
modifications, internal control enhancements and other changes.
The board's independent counsel, Senator Warren Rudman and
his law firm were approved by OFHEO yesterday. Senator Rudman
will hire independent accountants, also subject to OFHEO
approval.
Senator Rudman's work will also be reported to the SEC. We
expect Senator Rudman to conduct his review as described in our
agreement with OFHEO and to report his findings to the board,
OFHEO, and the SEC
The company and its outside auditors have a disagreement
with OFHEO about some aspects of the implementation of FAS 91
and FAS 133. The agreement establishes a process going forward
to resolve these issues.
This board believes in accountability and objectivity. We
will not prejudge the outcome of this process, and I
respectfully ask you not to prejudge it, as well. We vigorously
share your concerns and want to get to the bottom of this.
We believe that we have built a sturdy, corporate
governance structure to be prepared for any challenge this
organization may face. How this board and the company handle
themselves when things go wrong is the ultimate character test.
We have benchmarked our governance against other companies.
Our nonmanagement directors meet as a group, without
management, every time the full board meets, and often in
between. These are candid, probing discussions.
Our standards for director independence more than meet
those of the New York Stock Exchange. Mr. Chairman, I would be
remiss not to comment on the article which questions the
board's independence in today's paper.
Two years ago, we applied the New York Stock Exchange
standards for director independence enhanced for our board's
accountability. We worked with our outside governance counsel,
Gibson, Dunn & Crutcher.
We developed a director questionnaire and a process for
matching directors' nonprofit and business connections with
corporate or foundation contributions or business
relationships.
For example, for a business relationship, a director is
considered not independent under these guidelines. We take a
five-year look back versus a three-year look back under the New
York Stock Exchange rules.
On an annual basis, an excess 2 percent of consolidated
gross revenues or $1 million, whichever is greater, would
determine independence. And for charitable organizations on an
annual basis, a $100,000 or 5 percent of gross revenues of the
charity or the non for profit, whichever is less.
The New York Stock Exchange permits charitable
contributions of any size and only requires disclosure of
donations in excess of $1 million or 2 percent of the
director's charities gross revenues.
In addition, no direct compensation other than director pay
is permitted under our guidelines although the New York Stock
Exchange permits directors to receive up to $100,000 per year
in other pay before they are no longer independent.
In addition, one director has a personal business
relationship issue, and that was brought to our attention some
months ago, and a decision on independence will be made at our
October Governance Committee meeting.
We have, therefore, regardless of reports in the press, I
think, applied both the spirit and the fact of the criteria for
independence and that that is put forth in the New York Stock
Exchange guidelines.
If the New York Stock Exchange, governance watchdogs or
anyone else wants to change those guidelines, you can be
assured that we would change ours and meet those requirements.
I thought I might offer to submit, for the record, the board
guidelines so that you would have them with this testimony.
If I may speak personally for a moment, I have known some
of you over the years from my experiences in both public
service and the private sector. And I think you know my
commitment to ensuring that our laws are upheld and the
institutions of our economy maintain the highest levels of
integrity.
There is only one way I know how to deal with such a
difficult situation: to speak the truth, to find the facts
without bias, to base judgments on those facts, and then to act
without hesitation. We must do the right think carefully and
deliberately. We must not rush to judgment or take actions in
haste today that we will have to correct tomorrow.
I will commit to you that the board is determined to follow
a process that will inspire confidence and restore public
trust.
Thank you, Mr. Chairman.
[The prepared statement of Hon. Ann McLaughlin Korologos
can be found on page 171 in the appendix.]
Chairman Baker. Thank you very much for your statement. Let
me quickly say that I have no question either about your
service as a board member nor any of the independent board
members.
Ms. Korologos. Thank you, Senator.
Chairman Baker. I do think, as you have stated, today's
problems present a challenge that will require decisive action
based on full knowledge and confirmation of all the facts.
What is problematic in the current environment is that, as
Mr. Raines was before the committee for some time this
afternoon, on a number of occasions in response to various
questions, he would state the report cites no facts, speaking
to OFHEO's report.
I find that troublesome with regard to coming to an
agreement that is in everyone's best interest. I will be the
first to say that no report is probably 100 percent accurate.
But I would also quickly observe that few reports are 100
percent incorrect.
I note that the board took rather quick and decisive action
in reaching this first agreement, which would seem to indicate
to me that there were some reasons the board came to a
conclusion that it was appropriate to enter into that
agreement.
Do you believe that OFHEO is a competent regulator?
Ms. Korologos. I don't know that I am equipped to make that
judgment. I had the opportunity to meet with the director about
8 months ago as chairman of the governance committee, which
turned out to be fortuitous. So, when I received the call, I
knew the director.
Generally speaking, boards don't involve themselves in this
detail with the regulator, frankly, at least not in the
companies I am involved in. More so, in financial, I can't make
that judgment.
Chairman Baker. Okay. Do you believe, knowing what you know
now from the substance of the report made available to you,
that the board has been advised sufficiently, frequently
enough, and to sufficient detail to have made appropriate
judgment in the matters of concern in the OFHEO report?
Ms. Korologos. Do you mean with regard to the agreement or
generally speaking----
Chairman Baker. Generally speaking in your capacity as an
individual board member, do you feel you have been given
sufficient information about the business judgments made by
management of the corporation today?
Ms. Korologos. I would say that the report raises issues
that clearly are serious. That is why, again, with OFHEO's
encouragement, through their agreement, we have retained
independent investigators, both on the accounting side and, as
you know, for some of these other issues.
So I don't want to prejudge anything by answering your
question.
Chairman Baker. And, my next question is not to lead you to
a statement that would be interpreted incorrectly.
I have read accounts from various independent board members
at different times making the statement that they have full
confidence in the judgments made by, and fully support the
current management. As you outlined, going forward, we need to
know all the facts, follow all of those facts to their end
conclusion.
As you encouraged the committee and others not to jump to
any presumptions before that process is finished, I would hold
that door open both ways; that we not rise to the defense of
all parties until we have come to a judgment as to everyone's
involvement, if there is found to be a substantive accounting
problem that was inconsistent with GAAP that led either to
shareholder value being depleted or reports to the markets of
incorrect financials.
I think it was clear from the testimony of Mr. Howard and
Mr. Raines. They first don't see a factual basis for the
allegations that have been made by OFHEO but, secondly, can't
make full judgment about the accusations until they have more
information.
Is it your view that the board, going forward, will reserve
judgment in all these matters whether it be positive or
negative?
Ms. Korologos. I think so, completely. I will say that they
have in the past and, if I might comment--since I am one of the
people who were quoted in the press--I think this is a good
forum to develop that because I wholeheartedly agree with you.
My statement asked that none of us prejudge, of course, and we
should be objective, and this board can be objective and is
objective.
When I called Frank Raines, the Chairman of the company, to
tell him I had received a call at 4 o'clock on Friday from the
director, his first response when I said I would convene a
meeting was, ``How can I help?'' That is a first-class CEO.
Consistently, over these weeks, management has asked, ``How
can we help?'' That is the spirit of cooperation that we have
with management in order to achieve all that we want to
achieve. That does not detract from our objectivity.
Many of us on the board have been there long enough to have
worked with management over many issues on a great company
achieving its mission. So, in that spirit, yes, certainly, we
have experiences.
I don't think that is mutually exclusive from the job that
we have laid out, and I commit to you our objectivity, our
unbiased tenacity to go forward and find out, if you will, the
other side of this report and see where it comes out.
Chairman Baker. Well at least an exploration of all the
allegations OFHEO makes should be thoroughly vetted and
conclusions reached. I hope that the findings are not as severe
as OFHEO has represented them to be, but we all have a duty to
find out.
Ms. Korologos. Absolutely.
Chairman Baker. And I thank you for that.
Mr. Kanjorski?
Mr. Kanjorski. Madam Secretary, am I correct that you have
been on the board at Fannie Mae for 14 years?
Ms. Korologos. Oh, you are making me older than I am.
Mr. Kanjorski. Eleven years.
Ms. Korologos. Ten years; just 11 this year, so 10 and a
half.
Mr. Kanjorski. So you predate Mr. Raines tenure.
Ms. Korologos. I do, sir.
Mr. Kanjorski. And you predate one of the issues that we
have had the regulator testify about today, the FASB 91 audit
difference that was reported in 1998. First of all, I would
like to test your memory.
Do you have any recollection at any time of your auditors,
management or the regulator talking to you or other members of
the board about this handling of the $400 million or $200
million in 1998 that has been the object of one of the charges
made by the regulator?
Ms. Korologos. I don't have a recollection. I presume it
would come through an Audit Committee report, and I can't
promise you that something was said but I don't remember
anything being said; no.
Mr. Kanjorski. I know very little about how regulators
operate and even less about how many analysts they have at your
agency. Mr. Raines tells me they have 40 in-house meat
inspectors. Pretty broad exposure.
Do you, in the last several weeks, in meeting with the
auditor and getting their report and meeting among the board
with your various experts that you have retained now, do you
have a sense as to whether or not there is a systemic risk
problem at Fannie Mae?
Ms. Korologos. I do not believe there is a systemic risk
problem at Fannie Mae nor have I been in any gatherings that
would lead me to believe that. I certainly would not have
signed on behalf of the company, the agreement, if I didn't
take into consideration the impact of the agreement, as well,
and also the capital plan that is being developed and the
likes.
So, no, I don't. I haven't heard that and I don't feel
that.
Mr. Kanjorski. Very good. One of the things that amazes me
is the regulator, in testimony earlier today, indicated, of
course, that OFHEO has been auditing or regulating since 1991.
And it is in 1998, one of the audits obviously had a finding
that was an audit difference as to how to handle this
particular transaction.
I was just struck why they didn't pick that problem up in
1998 or 1999 or any subsequent year that they had to deal with
that audit report; that is, that the regulator didn't pick it
up. It seems to me almost the first area that you would begin
to do your regulation, is to look at the outside audit report.
Has that struck you at all as being peculiar?
Ms. Korologos. I have to say I only learned that from these
hearings today. It strikes me the way it strikes you, sir. I
would think that would be certainly a first stop; maybe not the
last stop, but a first stop for a regulator.
Mr. Kanjorski. One of the things that we have been
struggling with over the last year and a half is to create an
independent, world-class regulator for Freddie and Fannie. We
thought we were going to come close to success not too long ago
but, for reasons that are in the atmosphere in Washington, that
didn't occur.
But, invariably, as a result of this investigation and the
Freddie Mac investigation and the testimony we received from
the regulator this morning, I am absolutely thoroughly
convinced that we have to do something to create a stronger,
more independent, world-class regulator; other than that, Mr.
Baker and myself are going to be remiss in carrying out our
responsibility.
But in starting that process, I am just at a loss as to how
something could happen in 1998 and be listed as a finding in an
audit report, and the regulator didn't ask anybody about it or
get any information about it or resolve the application of GAAP
rules to that particular finding.
It just blows my mind, and $200 or $400 million is a
significant amount of money, even in a huge institution like
Fannie Mae.
So, I am not sure that this was a wasted hearing from any
standpoint, because we heard, for the first time, really, that
process that the regulator has gone through. And I am not
casting aspersion to this point on Mr. Falcon because he was
not there, as I understand it, in 1998. He came subsequently.
But, apparently, we have done one poor job as federal
regulators, particularly of these two institutions. If nothing
else, we should get that straightened out. There has been a lot
of press, a lot of it bad, and as all of us know, it had some
impact on the stock of Fannie Mae.
Do you feel there is any reason, in your role on the board,
that going forth from this hearing, both the investing public
and the purchasers of your obligations should have any fear at
all as to the security and the position of Fannie Mae, that
their investments are secure?
Ms. Korologos. I don't feel so. I feel that the agreement
that we signed puts us on a very acceptable path to giving
strength and clarity and openness to the issues that have been
raised. I think that should be, I hope, assuring to the public.
That is part of what I think our responsibility is; to the
public--all the public, employees, investors, shareholders, the
like.
Mr. Kanjorski. Well, my sense of you--I should disclose for
the record, we had the occasion to meet yesterday--I can't
remember ever being more impressed even though we do differ
politically. But with your basic competency and capacity, you
certainly have won my faith that you are going to do a job and
how you have gone about it really impresses me.
I want to join my colleague, Mr. Baker. This is not the
happiest role we have to play, as members of Congress. But
quite frankly, the testimony of yourself today and the CEO, Mr.
Raines, and Mr. Howard, the CFO, and even the regulator gave me
a little bit more confidence that we are not dealing with
something that is dangerous here to the public or is terribly
disastrous to Fannie Mae.
But it is good that we get it over with and if you keep the
captain of that ship, you are going to let me sleep a lot
better. Thank you.
Ms. Korologos. Thank you, sir.
Chairman Baker. The gentleman yields back.
Mr. Scott?
Mr. Scott. Thank you very much, Mr. Chairman. I wanted to
go back to a line of questioning I started with Mr. Raines,
which I think gets to the fundamental problem that has been
brought before this committee, and that is that your board made
the decision to tie the compensation bonuses to earnings per
share.
Can you comment on that? I think it is very important that
I reaffirm Mr. Raines's comment that this preceded him because
I think there are several things that I am very concerned
about. One is the credibility of Mr. Raines, who runs that
department, which means the credibility of Fannie Mae.
This serves a very, very important constituency for all of
us across the country who are concerned about making sure we
have adequate housing, affordable housing for all income
levels.
But I would like to find out why that board felt it
believed that it was appropriate to link executive compensation
to earnings per share, and whether or not this move, this
compensation scheme, resulted in inappropriate incentives for
management?
I think that unless we can clear that and try to get some
common ground on that issue, especially as I mentioned, with
the chart that Mr. Baker has provided this committee--which I
am sure we are not the only ones who are going to see that
chart--it is going to show some stark comparisons between what
actual salary was and what those bonuses were.
So, there is certainly meat for incentives here. I think
this might be something we want to share. Could you give me
your comments on why this, you felt, was appropriate?
Ms. Korologos. I would be happy to. Again, I have only been
on the board since 1994 but, in both my experience at Fannie
Mae and many other corporate boards--in some case, where I am
also on comp committees--earnings per share was a very
acceptable incentive, if you will.
Generally combined with others, different companies did it
different ways. So you are not talking about a company that was
the only one. I wanted to make that clear.
Why was that? Well, in the late 1980s, early 1990s, the
acceptable philosophy for compensation besides always, in some
way being performance based, was to tie management to the
shareholder, and earnings per share was one way to do that.
Likewise, options, which we saw become out of favor and the
like. In a way, I would think we would all take comfort.
At Fannie Mae, it is a much more, even transparent process
than at other companies precisely because we are a GSE. Unlike
other public companies, the amount our executives make is
somewhat dictated by law, and the law states that OFHEO is
required to ensure that Fannie Mae's compensation programs are
reasonable and comparable with compensation for employment in
similar industries.
We use the comparability test of looking at peer companies
and the like and structuring not only the earnings-per-share
measurement, but in other aspects as well, both tangible and
intangible performance measures and the like.
So you generally have salary, you have bonus, you have long
term, you have short term kind of incentives. So you try and
strike a balance between financial and nonfinancial measures.
Earnings per share, for purposes of this report, seem to
have jumped out and your question is quite a legitimate one. I
would only say that it is becoming, in recent years because of
incentives leading, in some companies, to behavior that wasn't
intended to re-look at compensation. And there are a lot of
different mixes going on.
Mr. Scott. You have seen the report that was presented
before the committee----
Ms. Korologos. I actually did not see the paper that was
handed out yet. No, I have not.
Mr. Scott. But you are familiar with the bonus and the
structure and the comparison of base----
Ms. Korologos. Yes, very much so.
Mr. Scott. Do you stand by that? Do you feel that----
Ms. Korologos. I stand by what we did; yes, I certainly do,
and I think that I have found, again, my experience on a number
of other boards; it is always a work in progress. We use
outside consultants as well, is what I wanted to assure you.
So this is not something we plucked out of the air and
allowed to hang out there to be abused in any way, shape or
form.
Mr. Scott. Well I think this is very important to get on
the record because, as I said earlier, there have been some
very strong accusations made against Fannie Mae, and I want to
make sure you have a chance to respond to that.
If I may continue, in view of that, what changes, if any,
in corporate governance and some of these compensation policies
that the board is considering to address in relationship to the
issues that have been raised by this report and, again, I too
question the timing of it and I think there probably are some
motivations there.
People say politics isn't a part in that, but you really
can't take politics out of politics. I believe really, as a
result of today's hearings, that politics has certainly
manifested in what we have here.
But, having said all of that, OFHEO has given a report. Are
you going to make any changes in the way you operate and, if
so, in governance and in compensation, as a result of this
board and some of the issues that it has pointed out?
It runs the gamut of misapplied accounting rules, has kind
of stabilized the earnings, the inadequacy of the regulatory
capital, the deferred expenses. It just seems to me, do you
take this report, just say there is nothing here, or do you
take it and say here is what we are going to do to try to fix
this situation.
Do you give this report credibility?
Chairman Baker. And, Mr. Scott, that will have to be your
last question because you are well over time.
Ms. Korologos. Let me assure you, I think--two significant
things, perhaps. One, the agreement we signed itself permits
us--I think there are 32 or 33 issues there--working with
Senator Warren Rudman and the accounting people that he will
bring, to do a very deep dive, if you will, and look very
carefully at all of those issues, some of which may result in
change, some may not. I can't prejudge that.
So, that is the route for the report itself, in terms of
taking it serious, following all of the issues, both through
the agreement and the report itself.
Secondly, you ask if there will be changes in governance.
In terms of the company's governance and its organization, that
is a part of the agreement, and that will be addressed
accordingly.
In terms of corporate board governance, I said in my
statement, and I really do believe--but I am open always to
best practices and we follow these issues religiously--that we
are at a point, because of good governance, that we are able
to, one, get us this far to keep some stability and calm to a
process that I think is very important, to exercise our
fiduciary responsibilities in a thoughtful and informed way,
and organized ourselves previously to be able to participate in
the various teams that are going to be created to fulfill our
obligations under the agreement.
One board member has particular expertise in capital
markets and the like; Don Marron, formerly of Payne Webber, he
will be a very good team person. Another woman, Leslie Rahl, on
the board, is a derivatives expert; let her work on those
issues.
So, we are organizing ourselves with our expertise. So, I
think that is the corporate board governance piece. Whether
changes come for board governance from the report, I don't see
that right now but I am open to it, but I don't see that.
I think the third issue on compensation, however, obviously
we welcome any findings from the independent investigation that
address some of the allegations in that area.
As a member of the Comp Committee, we have been addressing,
as we look again, at comparables, at best practices, at the
structure of compensation, at those in our industry, how to
base the bonus plan on more than just earnings per share such
as risk and mission factors.
That is going to be forthcoming. So, that is a piece of
work that has already been going on but it has been going on
because of the marketplace, if you will, in executive
compensation.
Chairman Baker. The gentleman's time has expired. Ms.
Waters?
Ms. Waters. Thank you very much. Would you please give me
the correct pronunciation of your name?
Ms. Korologos. I would be happy to. It is all O's, and it
is Ko-ro-lo-gos.
Ms. Waters. Ms. Korologos. I would like to thank you for
coming here today.
I don't know how long you have been here but you may know
by now that some of the questions that I raised to Mr. Falcon
question the motive of the director as it relates to this so-
called investigation.
And I know sometimes that is not a nice thing to do, but I
know a lot of history about this ongoing political battle
between FM Watch and the GSEs and some of our members' role in
all of that.
I also know about the criticisms that were launched at
OFHEO and its past oversight or lack of the GSEs. So I have a
historical reference for many of the questions that I have
asked and some of the accusations that I have may have made.
Having said all of that, you entered into an agreement with
OFHEO without having a response from your organization. And it
appears that you entered into an agreement because you wanted
to show that you were cooperative, that you were not resisting
criticism, that if there were problems you wanted to solve
them.
It seems to me that is what you did, and you made that
decision knowing that some people would not understand that
this was not an admission of any kind of guilt or anything
else. But I think it is very important for that to be restated
time and time that, out of the spirit of cooperation, you
entered into this agreement.
Now, I have looked at some aspects of this agreement as
represented to us today. And what it appears is that you have
entered into agreement that you could easily enter into
because, as far as I am concerned, what is being asked of you
is not that difficult to begin with, and it may not require you
to do any changes at all. You may be correct in some of the
things that you are doing.
I don't see any timeframe or time guidelines on any of
these points made in the agreement that you should have
something done by a certain date, even though we are led to
believe this was an emergency.
The board had to be convened right away because these
serious accounting problems had been identified and unless you
do something right away, the safety and soundness of this
organization was at great risk.
But even when I look at the number one recommendation--
implement correct accounting treatments that will bring the
enterprise into compliance with SFAS 91 and SFAS 133--it didn't
say do this in 30 days, in 60 days, in 90 days.
It just puts it out there but nobody says--unless it is
someplace else--how the agreement will be made as to what the
correct accounting treatments are based on the fact that there
are some disagreements, perhaps, about the implementation of
SFAS 91 and 133. That is one example.
This other requirement--protect its existing capital
surplus and move to a targeted capital surplus equal to 30
percent of its required minimum capital--there is no emergency
relative to this requirement.
It didn't say that if you don't do this in 30 days, 60
days, 90 days, something terrible is going to befall this
agency. It didn't say that we have come up with this percentage
because this is what we have examined, this is what we have
looked at and this is the conclusion that we have come to based
on these facts.
And, of course, in the spirit of cooperation, you could
agree to that, because even though it potentially takes capital
away from being involved in some of these good things that you
may be doing, it doesn't really admit that something is wrong
with the surplus of the minimum capital requirements that you
have now--the 18 percent or whatever that is.
So, as I go down each one of these, some of them look a
little weak, they look like little smoking mirrors to say that
I did an investigation and so now I want you to undertake a top
to bottom review of your staff structure.
Duh, I mean, I think this is what you do all the time. And
as has been indicated, that even in the ongoing meetings that
you have, where people can raise questions, et cetera, et
cetera, you are doing this all the time.
So, having said that, would you confirm for me, your
understanding of why you entered into this agreement and
whether or not you believe that this means that you immediately
make great big changes because you were doing something wrong.
Or is this just an agreement to say, ``Okay. You want us to
look at this? We will be happy to look at it. We believe that
we are right and we believe that in the final analysis, we will
be proven right.''
Explain to us where you are coming from.
Ms. Korologos. I will.
Chairman Baker. And that would be the gentlelady's question
because her time has expired now. We would be pleased to hear
your response.
Ms. Korologos. Thank you, Mr. Chairman. Yes, it was a very
difficult, important period for the board to be presented with
an agreement and then, uncertain at the time, the importance of
the agreement, per say, because to sign it in 48 hours would
not have been possible responsibly.
When, however, we presented, based on the agreement, a work
plan, I was able to spend the days with management and say,
``What can be done? Let us break this apart and see what can be
done on the issues that were raised in the report.''
And it really came in sort of three chunks. There were the
accounting issues and, clearly as you heard in testimony today,
the SEC has a serious role there. There were the capital
issues, if you will and the capital plan.
Well that, again, we could bring the best brains together
and the talent and work with OFHEO and determine that. And
then, I guess you might say, we had also the organizational
issues and throughout, we had some very serious allegations
that could be addressed by an investigator that OFHEO
encouraged us to have.
So, as we broke it apart, we were able to develop a work
plan. Having done that that gave us some background, when I
understood from the director, or from counsel, they still
wanted an agreement and they wanted it really before Monday,
the 27th.
I think, in part, from what they told me in preparation for
the quarterly letter that they issue regarding our safety and
soundness. So that became an issue within the timeframe for
this agreement.
The counsels worked together with the board and with me,
particularly, on the elements of the agreement. And various
changes were made to your point, to make acceptable. There was
no way we were going to sign an agreement we couldn't deliver
on, number one.
And, number two, we were very eager to get this process
going so we could give answers to the public, to our investors,
to our shareholders, to the housing community. We had already
seen an economic impact because of the swirl and the fire storm
we are in.
But how can we stay thoughtful, see through the process of
developing an agreement that, one, was responsible, that would
further clarify, explain, investigate, in an open way, the
issues that had been raised--they were serious--and, at the
same time, to your point on timing, not commit to something we
couldn't achieve.
You will notice in the agreement--you are right--there are
various timeframes, but not necessarily a timeline for
delivery. There are 15 days to give the comprehensive plan and
seek approval or disapproval of OFHEO.
There are 45 days to have a counsel working for us and
conduct reviews. There is a compliance committee requirement
and the like. So, there were different timeframes, all of
which, in many cases, require OFHEO to approve or disapprove.
My hope is that we will be able to work with OFHEO so their
approvals will come in a timely way, too. I think that is an
important part of keeping going. We will be developing a
tracking system to monitor implementation and our progress.
Now, let me say that it is in our interest to be on two
paths here. One is to implement the agreement, the
investigation and do so expeditiously because we want to put
all of this behind. If there are changes to make, we are happy
to make them. If they are allegations that are proven, we need
to deal with it.
At the same time, the other track we are on is to run the
business. The most important thing we do in this very vibrant,
wonderful company with a fabulous public mission is to keep the
business going.
So, the more these issues hang around, if you will, I think
is irresponsible for the board not to set our own timelines and
make sure we can reach them.
That is my best answer to why we did the agreement, what
kind of appropriate pressure, if you will, we will keep on the
process and the special committee that we created to work on
this to oversee it.
The individuals within the company we are selecting to help
us there is to keep this moving because we really want to put
it behind us. But we want to benefit from the process and do
it. As I keep saying, we want to do it right the first time and
we want to do it thoughtfully.
So, we are not--I frankly don't want to come back before
this committee or our shareholders or our employees and say,
``Oh gosh, we didn't do a good job. We have got to redo it.''
Let us do it right the first time and I think the process we
set up will do that.
So, the timelines that will be developed to implement--I am
sure there will be some give and take, and that is appropriate
with the regulator, and what they think we can do in a certain
timeframe and what we think we can do.
I would expect in the spirit of cooperation we will work
out that tracking system and those timelines together.
Chairman Baker. Let me thank you, Ms. Korologos, for your
appearance here today and your testimony and also give you an
assurance.
Despite the view that the work in the committee may be
political in its nature, Mr. Kanjorski and I work very closely
together. Our work, especially in this arena, has been
bipartisan. We both share the view that strong regulatory
capacity is absolutely essential. And we will work as a partner
in this process to assist the board in achieving the desired
end result.
This does not mean it will be easy or that everyone will
always agree on all perspectives. But the public discussion is
a good thing, and bring it to speedy resolution is even more
important. I think by making the appropriate assurances of good
faith on all sides, that we can do something good for
homeownership as well as ensuring taxpayers they have no
potential liabilities in these matters.
Again, I thank you. I will ask unanimous consent to make a
part of the official record, the addendum and reports that you
cited in your testimony.
I have documents that were forwarded from OFHEO, the OFHEO
report itself, the blue book, and the letter of transmittal of
November 12, 2003, to me, of the chart. And I think that is all
of the remaining items that need to be officially made part of
the record without objection.
And let me express to all participants and my faithful
comrades who stayed until 6:11 this evening. Thanks for your
good work.
Our meeting stands adjourned.
Ms. Waters. Thank you very much, Mr. Chairman. And may I--I
don't know if I need unanimous consent request to make a
request of you relative to our future work.
I don't know if you plan on having more hearings anytime
soon, but my request would be that the responses that will be
given by Fannie Mae to this investigation be put together,
prepared in whatever fashion they are going to be and that we
use those same responses if we are going to have another
hearing.
My suggestion is that we not have a hearing until that is
done so that we are all working from the same information.
Chairman Baker. By way of disclosure for all interested
stakeholders, it would be my intent, at this time, to discuss
probably over the recess, regulatory reform. I don't know
whether there would be a proposal introduced for discussion
purposes, but it is not likely, in my view, that this committee
would reconvene its work until the next Congress.
With the hope, I think--the long hope for expectation that
this Congress will leave town this weekend. If that, in fact,
is the case, there would not be the prospect of an additional
hearing.
However, to acknowledge the gentlelady's point, at such
time as a hearing notice would be issued, I can assure you that
any information the enterprise would choose to make part of
that hearing process, we would certainly welcome. I would
formally ask the chair of the independent board members on any
report she would choose to provide to the committee, we would
be happy to receive.
And likewise, I am sure; there will be work of independent
members during the course of the recess to get us fully
prepared to consider whatever ramifications there are from the
pending study or regulatory reform or any other issue a member
might choose to bring before the committee.
Ms. Waters. Am I to understand that the Chairman is saying
that you possibly will be working on regulatory reform based on
the book that has been done by OHFEO already?
Chairman Baker. No. My view is I have been working on
regulatory reform all my life. That effort would just continue
into early next year. As you know, we had a proposal in this
committee which was very close to being adopted and for
whatever reason, did not get adopted.
The Senate has moved the proposal out of Senate Banking
Committee, which is now pending. It would be my hope that
given--let me take the side of the discussion from those who
have been critical of Mr. Falcon and OFHEO.
For those, it would appear it would be likely that you
would support a different regulatory structure. For those of us
who feel that enhanced oversight is good from a taxpayer
perspective, they would support a new regulatory structure.
I don't know anybody today on the committee who expressed
objection to the discussion of and passage of a new regulatory
structure. So, given that, I think it is our duty to take that
up early next year, and in the intervening months, anyone who
has suggestions or recommendations, they should be made known
and we can take them into consideration.
Ms. Waters. If I may, Mr. Chairman, I certainly agree that
you have been working on regulatory reform for a long time and
that the question of whether or not OFHEO was competent to do
this certainly has been discussed in this committee.
And some of us, who may have, at one time, supported OFHEO,
may be with you on your proposed changes. And what you would
like to do with the Treasury Department, I don't know.
But my real question is whether or not you anticipate
working on regulatory reform that will respond to some of these
allegations that have been surfaced by OFHEO, in the absence of
the response that I think we just desperately need to have from
Fannie Mae and they have not had the opportunity to present?
That is my question.
Chairman Baker. I don't see further action by this
committee until additional information is provided from both
perspectives. I think OFHEO would want the opportunity to
respond to the testimony today from Fannie Mae, and it is
evident that Fannie Mae would choose to give us more
information--the board members as well--as to their findings
and factual determinations of the OFHEO allegations.
So, I think both sides are going to be providing members
with a lot of information. I am trying to say to the
gentlelady, we won't act until there is something that
validates acting.
In the interim, we should be working on our regulatory
proposal to bring ultimate closure to this whole chapter.
Ms. Waters. I think I understand that Mr. Chairman. I guess
just to wrap this up, what I am really getting at is in the
regulatory reform that you have been working on for a long
time, we can reasonably anticipate what some of that is all
about.
But what I am not certain about is whether or not in that
regulatory reform I would look in there and see specific
references to this recent OFHEO investigation as it relates to
accounting practices that are yet undecided.
Chairman Baker. That level of analysis would be relegated
to the new regulator. I do not see the committee getting
engaged in anything other than the principles of oversight. And
as I have long said, an independent regulator properly funded
with the real authority to assess the enterprise's safety and
soundness.
That is it. It has always been the principles. And nothing
beyond that need be in legislation, and I think there are any
number of proposals I have had in prior sessions, which
describe in generality what we would be considering, and those
have no reference to the OFHEO analysis of today.
Ms. Waters. Thank you.
Chairman Baker. Mr. Scott?
Mr. Scott. So, Mr. Chairman, just to make sure we are
clear, there will be no movement whatsoever on any regulatory
reform until we have this rebuttal process from both OFHEO and
Fannie Mae to today's hearings.
Chairman Baker. Not exactly. What I said was there will be
no further action by this committee on this subject matter
until conditions warrant action by this subcommittee.
Assume, for the moment, if you wish to pursue this
discussion that OFHEO comes back with another troubling report
in the next 2 days or the next 2 months. Certainly, the
committee would want to receive that report and discuss the
findings.
I am not suggesting, however, we would move on a
legislative proposal in the next 5 days. There is certainly not
time to do so. It would likely be early next year; a reform
proposal introduced, would go through due process, all members
would be heard, and certainly the enterprises and all those who
have a stake in this matter would be given ample opportunity to
voice their opinion.
I don't know exactly the sensitivity that you and the
gentlelady are addressing. There is not going to be anything
introduced tomorrow that takes page 46 of this report and makes
it a new regulation. If that is what you are after.
Mr. Scott. You mentioned in the event that there may be
another report, is there any indication or evidence on your
part that OFHEO is contemplating or putting forward another
report?
Chairman Baker. Oh, no. Let me make it clear one more time.
I have no information that any other member does not have. I
have had no phone calls from anybody. I asked the director in
the public view today, ``Mr. Director, what is your next
step,'' hoping that that would send the signal that whatever he
told me, he was going to tell you.
Mr. Scott. Right.
Chairman Baker. That is all I know.
Mr. Scott. All right.
Chairman Baker. And when I know more, I will be happy to
share it and, in the meantime, I hope I don't see you all until
January.
Mr. Scott. Thank you.
Chairman Baker. If there is no further business for this
committee, we stand adjourned.
[Whereupon, at 6:19 p.m., the subcommittee was adjourned.]
A P P E N D I X
October 6, 2004
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