[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]





                       DUE DILIGENCE IN MORTGAGE
                      REPURCHASES AND FANNIE MAE:
                   THE FIRST BENEFICIAL MORTGAGE CASE

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                      OVERSIGHT AND INVESTIGATIONS

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 10, 2005

                               __________

       Printed for the use of the Committee on Financial Services

                            Serial No. 109-7


                    U.S. GOVERNMENT PRINTING OFFICE
23-734                      WASHINGTON : 2005
_____________________________________________________________________________
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                 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
DEBORAH PRYCE, Ohio                  MAXINE WATERS, California
SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California          MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma             GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio                  DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair   JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                GREGORY W. MEEKS, New York
JIM RYUN, Kansas                     BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio           DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois         MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, Jr., North          HAROLD E. FORD, Jr., Tennessee
    Carolina                         RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois               JOSEPH CROWLEY, New York
CHRISTOPHER SHAYS, Connecticut       WM. LACY CLAY, Missouri
VITO FOSSELLA, New York              STEVE ISRAEL, New York
GARY G. MILLER, California           CAROLYN McCARTHY, New York
PATRICK J. TIBERI, Ohio              JOE BACA, California
MARK R. KENNEDY, Minnesota           JIM MATHESON, Utah
TOM FEENEY, Florida                  STEPHEN F. LYNCH, Massachusetts
JEB HENSARLING, Texas                BRAD MILLER, North Carolina
SCOTT GARRETT, New Jersey            DAVID SCOTT, Georgia
GINNY BROWN-WAITE, Florida           ARTUR DAVIS, Alabama
J. GRESHAM BARRETT, South Carolina   AL GREEN, Texas
KATHERINE HARRIS, Florida            EMANUEL CLEAVER, Missouri
RICK RENZI, Arizona                  MELISSA L. BEAN, Illinois
JIM GERLACH, Pennsylvania            DEBBIE WASSERMAN SCHULTZ, Florida
STEVAN PEARCE, New Mexico            GWEN MOORE, Wisconsin,
RANDY NEUGEBAUER, Texas               
TOM PRICE, Georgia                   BERNARD SANDERS, Vermont
MICHAEL G. FITZPATRICK, 
    Pennsylvania
GEOFF DAVIS, Kentucky
PATRICK T. McHENRY, North Carolina

                 Robert U. Foster, III, Staff Director
              Subcommittee on Oversight and Investigations

                     SUE W. KELLY, New York, Chair

RON PAUL, Texas, Vice Chairman       LUIS V. GUTIERREZ, Illinois
EDWARD R. ROYCE, California          DENNIS MOORE, Kansas
STEVEN C. LaTOURETTE, Ohio           CAROLYN B. MALONEY, New York
MARK R. KENNEDY, Minnesota           STEPHEN F. LYNCH, Massachusetts
SCOTT GARRETT, New Jersey            ARTUR DAVIS, Alabama
J. GRESHAM BARRETT, South Carolina   EMANUEL CLEAVER, Missouri
TOM PRICE, Georgia                   DAVID SCOTT, Georgia
MICHAEL G. FITZPATRICK,              DEBBIE WASSERMAN SCHULTZ, Florida
    Pennsylvania                     GWEN MOORE, Wisconsin
GEOFF DAVIS, Kentucky                BARNEY FRANK, Massachusetts
PATRICK T. McHENRY, North Carolina
MICHAEL G. OXLEY, Ohio


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    March 10, 2005...............................................     1
Appendix:
    March 10, 2005...............................................    31

                               WITNESSES
                        Thursday, March 10, 2005

Donohue, Hon. Kenneth M. Sr., Inspector General, Department of 
  Housing and Urban Development..................................     3
Kennedy, John P., Associate General Counsel, Office of Finance 
  and Regulatory Compliance, Department of Housing and Urban 
  Development....................................................     7
Pollard, Hon. Alfred M., General Counsel, Office of Federal 
  Housing Enterprise Oversight...................................     9
Smith, Samuel III, Vice President, Single Family Operations, 
  Federal National Mortgage Association..........................     5

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................    32
    Kelly, Hon. Sue W............................................    34
    Harris, Hon. Katherine.......................................    35
    Wasserman Schultz, Hon. Debbie...............................    36
    Donohue, Hon. Kenneth M. Sr..................................    37
    Kennedy, John P..............................................    44
    Pollard, Hon. Alfred M.......................................    47
    Smith, Samuel III............................................    53

 
                       DUE DILIGENCE IN MORTGAGE
                      REPURCHASES AND FANNIE MAE:
                   THE FIRST BENEFICIAL MORTGAGE CASE

                              ----------                              


                        Thursday, March 10, 2005

             U.S. House of Representatives,
      Subcommittee on Oversight and Investigations,
                           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. Sue Kelly 
[chairwoman of the subcommittee] presiding.
    Present: Representatives Kelly, Kennedy, Garrett, 
Fitzpatrick, Davis of Kentucky, Oxley, Baker, Gutierrez, Moore 
of Kansas, Maloney, Cleaver, and Moore of Wisconsin.
    Mrs. Kelly. [Presiding.] This hearing of the Subcommittee 
on Oversight and Investigations will come to order.
    A bit of housekeeping before we actually begin. We are 
going to be called to the floor for a vote and the swearing-in 
of Doris Matsui, who won an election in California last night. 
So we will start the hearing, but I am going to have to recess 
the hearing temporarily for us to be able to do that. I wanted 
to explain that before we actually got into the deep of this.
    The committee is meeting today to hear testimony about the 
transfer of nonperforming financial instruments between First 
Beneficial and Ginnie Mae, with the knowledge of Fannie Mae. 
This transaction between a GSE, a wholly owned government 
corporation, and a private lender exposed taxpayers, investors 
and homeowners to harm and threatened the transparency and 
integrity of the financial networks that support homeownership 
in the United States.
    On December 22, 2004 I joined Chairman Ney and Chairman 
Baker in sending a letter to Fannie Mae requesting an 
accounting of its behavior in this case. The Office of Federal 
Housing Enterprise Oversight, the OFHEO, is now proposing new 
rules to require Fannie Mae to report its awareness of fraud 
and corruption. It should not take federal regulation to get 
Fannie Mae or any other well-run public company to exercise its 
responsibility as a corporate citizen to report possible 
wrongdoing and protect taxpayers. I am hopeful that this 
hearing will lead to better institutional controls within 
Fannie Mae and the industry in general, and government to 
prevent fraud and secure the safety and homeownership in the 
United States of America.
    I now yield to the ranking member of the subcommittee, the 
gentleman from Illinois, for an opening statement.
    Mr. Gutierrez. Good morning, and thank you, Chairwoman 
Kelly for calling this hearing today, ``Due diligence in 
mortgage repurchases and Fannie Mae: The first Beneficial 
Mortgage case.'' I have to say that it appears that the 
relationship with this institution was beneficial to no one.
    I have just started reading a book called ``Thank You for 
Smoking,'' by Christopher Buckley, a satire of the tobacco 
lobbyists, which they are currently making into a movie. I am 
told later in the book, a hearing is held in the Senate 
Committee on Hindsight. That is an easy shot at Congress. Most 
of us do what we do here necessarily in hindsight because we 
rarely are seeking to fix a problem that has yet to occur. 
While it is important for us to examine what happened, both in 
general here on the Oversight Committee, and in this specific 
instance at First Beneficial, it is even more important that we 
not spend all of our efforts in looking backwards. We must 
learn from these events and work to improve the landscape as we 
move forward with solutions, either through legislation or 
working with regulators or both.
    The fraudulent conduct at First Beneficial has been the 
subject of a court case. The criminals have been sent to jail. 
Fannie Mae has reorganized its operation and improved its 
information sharing, as indeed the entire industry did after 
September 11. They have provided some restitution to Ginnie 
Mae. OFHEO has recently issued a new proposed rule that would 
require GSEs to report possible mortgage fraud in a timely 
matter so that damage can be limited. It appears that we may 
need to amend the Bank Secrecy Act to ensure that GSEs are 
shielded from liability in this instance when they report 
potential fraud to their regulator or law enforcement bodies.
    I look forward to hearing from the witnesses regarding the 
lessons learned from the First Beneficial experience, and 
recommendations to detect and combat mortgage fraud as we move 
forward.
    I yield back the balance of my time.
    Mrs. Kelly. Thank you. Have you finished, Mr. Gutierrez?
    Mr. Gutierrez. Yes.
    Mrs. Kelly. Thank you.
    Mr. Fitzpatrick, you have no opening statement. Is that 
correct?
    I think we should begin with you, Mr. Donohue. If you have 
not testified before, there is a box on your table. When you 
start talking, that box will turn a green light on. When there 
is a yellow light, that means that you have one minute to sum 
up. With the red light, that means that you are asked to please 
sum up and end your testimony.
    I think we have time, depending on how long you talk, Mr. 
Donohue, I think we have time to start with you. Thank you. Mr. 
Donohue, please pull that microphone close to you and make sure 
it is on. I am not sure it is on. Push the button in front.

 STATEMENT OF HON. KENNETH M. DONOHUE, SR., INSPECTOR GENERAL, 
          DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

    Mr. Donohue. Madam Chairwoman Kelly, ranking member 
Gutierrez, and other members of the subcommittee, good morning. 
I am pleased to have this opportunity to bring to the 
subcommittee's attention the facts surrounding a recent case 
developed by the HUD Office of Inspector General and other law 
enforcement agencies against First Beneficial Mortgage 
Corporation of Charlotte, North Carolina and its importance as 
an area of concern for government-sponsored enterprises, 
regulatory agencies and those that oversee these organizations.
    Of importance are the crimes of the owners and the 
associates of First Beneficial, but also important is the lack 
of due diligence by some to take action to mitigate harm 
against the government. For whatever reasons, Fannie Mae did 
not pass information on First Beneficial's transgressions to 
others, which allowed First Beneficial to continue to operate 
and to issue over $7.5 million in fraudulent mortgage-backed 
securities guaranteed by Ginnie Mae.
    On the easel is a flow chart of the case which shows in a 
compressed fashion the timeline of the events I will now 
discuss. Fannie Mae approved First Beneficial as a single-
family mortgage lender in 1995. In 1997, First Beneficial was 
approved to sell Title I loans. Title I loans are home 
improvement loans and manufactured housing loans. In 1998, 
Fannie Mae was noticing problems with the Title I loan program 
nationwide, and decided to review First Beneficial's loan 
portfolio. This review uncovered approximately $1 million in 
ineligible Title I loans to people without FHA-insured 
mortgages.
    During this review, First Beneficial was not truthful about 
whether the Title I loans were FHA-insured. At this time, 
Fannie Mae demanded that First Beneficial repurchase the 
portfolio, but First Beneficial did not have the funds to 
repurchase. Fannie Mae worked out a deal where they would 
purchase new pre-approved single-family loans from First 
Beneficial and apply the proceeds from the sale of these loans 
to repurchase the ineligible Title I loans. Fannie Mae placed 
an in-house suspension on First Beneficial at this time.
    After a few weeks, First Beneficial called Fannie Mae and 
said they had an investor who was willing to buy the bad Title 
I loans with a single cash payment. Accordingly, in September 
of 1998, First Beneficial paid Fannie Mae back the nearly $1 
million. At this point in 1998, Fannie Mae did become 
suspicious of First Beneficial's single-family loans as well, 
and began an inquiry into those it had purchased. They found 
that many loans were in the names of First Beneficial's owners 
and employees, and that should have caused Fannie Mae's 
concern.
    First Beneficial said the loans were investor loans and 
that they would repurchase them. On November 3, 1998, Fannie 
Mae wrote First Beneficial and said they would not purchase any 
more of these loans without prior approval. On November 19, 
1998, Fannie Mae received a telephone call from a financial 
crimes investigator with the North Carolina Banking Commission 
who told them that First Beneficial was making loans without 
insurance and that First Beneficial was trying to get Ginnie 
Mae to buy the loans. The investigator gave Fannie Mae the 
names of the two First Beneficial employees who confirmed their 
effort to sell loans to Ginnie Mae.
    Fannie Mae learned that First Beneficial had only two 
investor sources, Ginnie Mae and Fannie Mae. On November 20, 
1998, Fannie Mae suspended First Beneficial as a lender and 
called in the owner for a meeting. At this meeting, Fannie 
allegedly wanted to know more about the investors, but received 
no response from First Beneficial. Following this meeting, 
Fannie Mae did some review by taking the addresses of 
properties in the loan portfolio and going out to inspect. What 
they discovered was that many of the properties listed were in 
fact vacant lots. A check of the courthouse revealed that the 
main borrowers did not own the properties and that some were 
not even owned by First Beneficial.
    At this point, it is my understanding Fannie was not under 
any legal obligation to notify Ginnie Mae, OFHEO or any law 
enforcement agency such as the OIG of the FBI. However, I do 
believe that a good corporate citizen should have done so. As 
you can see, First Beneficial sold a pool of loans which were 
fraudulent to Ginnie Mae investors on December 11, 1998 in 
order to repurchase on December 18, 1998, the same fraudulent 
loans from Ginnie Mae. In late 2000, Ginnie Mae discovered 
these transactions through a subsequent compliance audit. 
Because Fannie Mae did not tell Ginnie Mae of the dubious 
scruples of these lenders, the original fraud to Ginnie Mae 
ballooned in costs to Ginnie Mae. By the time it was all said 
and done, the American taxpayer was defrauded out of 
approximately $38 million.
    Essential to the scheme was the requirement that First 
Beneficial provide a mortgage document to Ginnie Mae's document 
custodian. For example, there was a property listed at 9108 
Pleasant Ridge, Charlotte, North Carolina. The note appeared to 
be at first glance a normal mortgage note. In reality, there 
was no such mortgage and the signature belonged to a relative 
of the owner of First Beneficial. The collateral listed on the 
note was a vacant lot not owned by the stated mortgagor.
    Four primary defendants have been convicted and sentenced. 
Defendant McLean was sentenced to 21 years in prison and $23.5 
million in restitution has been ordered. Some might say this 
case is about a small amount or could be interpreted as a cost 
of doing business, particularly as it relates to the vast funds 
in the securities market. But you can see from the severe 
sentences that the court viewed this case as a serious matter. 
The full faith and credit of the United States stands behind 
Ginnie Mae and it is the integrity of the program that 
investors rely upon. No rule or regulation or law exists that 
made it incumbent on Fannie Mae to have told others about what 
they discovered. If they had, it may have saved taxpayers 
millions of dollars.
    Mrs. Kelly. Mr. Donohue, I reluctantly am going to have to 
ask you to sum up.
    Mr. Donohue. In sum up, Madam Chairman, I have spent some 
time with the Resolution Trust Corporation. During that time, 
we learned many different things from the failed savings and 
loans. One of the primary issues was the fact of the 
coordination effort that must exist between the regulatory 
agencies, between the enterprises, and between law enforcement 
and affected organizations. It seems to be the benchmark of 
this matter. As a result of that, I think that is, if I leave 
any thought here today, it is incumbent upon us to make sure 
that these types of matters do not happen again.
    I must say finally to thank my colleagues at the FBI and 
the IRS Criminal Division in the Department of Justice for 
their assistance in this case.
    Thank you.
    [The prepared statement of Hon. Kenneth M. Donohue, Sr. can 
be found on page 37 in the appendix.]
    Mrs. Kelly. I thank you very much. For the record, Mr. 
Kenneth M. Donohue, Sr., is the Inspector General from the 
Department of Housing and Urban Development.
    Thank you very much for your testimony.
    We have been called for this vote. I am going to 
reluctantly recess. I would imagine it will take us probably 15 
to 20 minutes, and then we will be back as soon as possible. 
Thank you for your patience.
    [Recess.]
    Mrs. Kelly. Thank you for your indulgence. We have a new 
Congresswoman.
    Mr. Donohue has given us his testimony. We now will hear 
from Samuel Smith, the Vice President of Single-Family 
Operations for Fannie Mae. John Kennedy is next, Associate 
General Counsel of HUD, representing Ginnie Mae; and Alfred 
Pollard, General Counsel of the Office of Federal Housing 
Enterprise Oversight, the OFHEO. Mr. Pollard is a veteran of 
Capitol Hill and on the faculty at Georgetown University School 
of Business.
    We welcome all three of you, and all four of you. We will 
continue with you, Mr. Smith.

 STATEMENT OF SAMUEL SMITH III, VICE PRESIDENT, SINGLE FAMILY 
       OPERATIONS, FEDERAL NATIONAL MORTGAGE ASSOCIATION

    Mr. Smith. Thank you, Chairwoman Kelly, ranking member 
Gutierrez, and members of the subcommittee.
    My name is Sam Smith. I am Vice President of Single Family 
Operations for Fannie Mae, and I have worked in Fannie Mae's 
Atlanta office since 1973. In my capacity as Vice President, I 
am currently responsible for the quality and underwriting of 
loans sold to Fannie Mae by lenders assigned to Fannie Mae's 
Eastern Business Center.
    I welcome this opportunity to speak on mortgage fraud 
generally and also about issues arising out of the First 
Beneficial Mortgage Company matter. I want to thank the 
subcommittee for holding this hearing and for inviting me to be 
here today. I have prepared a written statement that I request 
be made part of the official hearing record.
    Fannie Mae takes the issue of mortgage fraud very seriously 
and has taken many significant steps since 1998 to improve its 
anti-fraud efforts. First Beneficial was a case involving 
institution-level ``fraud for profit.'' Looking back upon the 
First Beneficial case with the benefit of 20/20 hindsight, 
there is no doubt we could have handled the lender relationship 
differently and better. As the Vice President in charge of the 
single family business for the Atlanta office at the time, I 
take full responsibility for my actions and for those of my 
team regarding First Beneficial.
    I have set forth in my written testimony a detailed account 
of my involvement in the First Beneficial case. Fannie Mae also 
engaged the law firm of Latham and Watkins to review how the 
matter was handled, and I would like to request that a copy of 
their detailed report, which was made available to the 
committee earlier this week, be made part of the record.
    Mrs. Kelly. With unanimous consent, so moved.
    Mr. Smith. Thank you.
    These documents outline in detail the chronology of the 
facts as we know them. I welcome the subcommittee's questions 
with respect to the materials and the actions the company took 
during this period. However, I would like to address one 
fundamental issue. The subcommittee's invitation to me asks 
whether Fannie Mae staff knew that First Beneficial was 
perpetrating fraud against Ginnie Mae in order to secure 
repurchase funds for Fannie Mae. As the Latham and Watkins 
investigation concludes, the answer is that we did not know. 
However, looking back on the totality of the facts and learning 
the information that came out in the trial of James McLean, at 
which I testified as a government witness, I regret that there 
were signs that we missed and that we did not take more 
rigorous steps to further investigate First Beneficial's 
activities in 1998.
    Under the policies and procedures now in place at Fannie 
Mae, I am confident that the First Beneficial matter would be 
handled much differently today. In 1998, when First 
Beneficial's loan issues arose, Fannie Mae's regional offices 
handled loan deficiencies and instances of suspected fraud on a 
case-by-case basis. Since that time, Fannie Mae's operations 
and policies have evolved with changes in the marketplace, and 
we have strengthened a number of our operations and anti-fraud 
policies.
    First, we have adopted a company-wide anti-fraud policy. We 
are also implementing enhancements to our internal operational 
controls to further clarify roles, responsibilities and 
notification requirements on fraud matters. These internal 
protocols will immediately elevate patterns that suggest 
possible fraud to senior management and to our legal and 
compliance offices.
    Second, Fannie Mae has changed its requirements for 
approving lenders as seller-servicers, and has moved to a more 
centralized approval process that can, among other things, 
focus on the needs of smaller lenders in meeting the seller-
servicer requirements.
    Third, as a result of changes in technology and in an 
effort to ensure consistency and leverage resources, the post-
closing file review of all loans sold to Fannie Mae has been 
centralized. We now employ a systematic sampling model to 
select both newly delivered and defaulted loan files for review 
every month. For every loan delivered to our company, lenders 
contractually represent and warrant that the loans meet our 
credit, documentation and underwriting standards. If a loan 
does not meet those standards, the lender knows it may be 
obligated to repurchase the loan, reimburse us for losses, or 
take other corrective action.
    This contractual repurchase obligation provides incentive 
for lenders to implement procedures for quality underwriting 
and is one of the ways Fannie Mae manages the safety and 
soundness of its investments, manages its charter compliance 
obligations, and discourages inappropriate loan underwriting of 
all types. We have also created an investigations team that is 
focused on mortgage loan fraud reviews and reporting.
    Fourth, Fannie Mae is undertaking extensive efforts to 
assist our lenders in detecting and combating fraud by 
developing and encouraging the use of fraud detection tools at 
the point of sale through our automated underwriting system, 
Desktop Underwriter.
    Finally, as noted above, fraud is an industry-wide problem. 
Fannie Mae is working cooperatively with OFHEO on its recent 
proposed regulation regarding mortgage fraud reporting. We have 
stated publicly that we will work with Congress, HUD and law 
enforcement agencies to establish an appropriate process for 
sharing information. In addition, we are working closely with 
others in the industry to confront this growing problem, 
including participating today in the Mortgage Bankers 
Association's summit on mortgage fraud. And we join with others 
in the industry in supporting legislative enactment through GSE 
reform legislation or otherwise of a requirement for mortgage 
fraud reporting, including a safe harbor from legal liability 
for reporters of potential fraud and an appropriate approach 
for increased information-sharing between government and 
industry.
    Thank you for inviting me here today, and I look forward to 
responding to your questions on these matters.
    [The prepared statement of Samuel Smith III can be found on 
page 53 in the appendix.]
    Mrs. Kelly. Thank you, Mr. Smith.
    Mr. Kennedy?

STATEMENT OF JOHN P. KENNEDY, ASSOCIATE GENERAL COUNSEL, OFFICE 
OF FINANCE AND REGULATORY COMPLIANCE, DEPARTMENT OF HOUSING AND 
                       URBAN DEVELOPMENT

    Mr. Kennedy. Chairman Kelly, ranking member Gutierrez and 
distinguished members of the committee, I am John P. Kennedy, 
associate general counsel for finance and regulatory compliance 
at the Department of Housing and Urban Development, and Senior 
Counsel to Ginnie Mae. I have been at HUD for approximately 35 
years.
    I am going to start this story from my point of view in 
terms of the Ginnie Mae involvement in this matter in late 
August of the year 2000. In a scheduled compliance first audit 
of First Beneficial, the auditor, Deloitte and Touche, started 
to get some indications that the records at First Beneficial 
were giving indications of serious problems. Ginnie Mae 
immediately put together what we call a default team, and 
deployed that team to Charlotte, North Carolina.
    At that same time, Ginnie Mae was in a position to declare 
default under the guaranty agreement with First Beneficial, and 
that was the purpose of the team's going there. It became 
apparent almost immediately that it was not just a contractual 
enforcement case. The initial findings, the draft findings of 
Deloitte and Touche made it clear to us that we had a potential 
criminal matter. At that point, immediately the Department of 
HUD, the General Counsel's office in Ginnie Mae, started to 
cooperate in working with the U.S. Attorney, not the Civil 
Division, the Criminal Division, in order to give them whatever 
technical assistance that we could to proceed with the criminal 
case. The IG was also notified and immediately deployed its IG 
investigators, not auditors, investigators to Charlotte, North 
Carolina to assist in the investigation.
    Probably the telling fact for us was that we noticed that 
we looked at 42 properties and determined that 37 of the 
properties were either vacant properties or properties under 
construction, clearly, not a case where you could have a 
mortgagor that would be appropriate for an FHA-insured mortgage 
in a Ginnie Mae pool.
    So at that point, we were mostly providing assistance to 
the U.S. Attorney to prepare the search and seizure warrant for 
the records of First Beneficial. Within a period of a little 
over 3 days, the Ginnie Mae team went from a contractual 
enforcement case to assistance on a criminal matter, and a 
search and seizure of the records. On the same day that the 
search and seizure warrants were issued, Ginnie Mae also 
delivered its default letter. That happened on the same day and 
Ginnie Mae declared them in default and in essence took over 
the bank accounts, the records and all records pertaining to 
the mortgages in the pools.
    At the same time, on literally day two of that, the 
attorney that was representing Ginnie Mae at that point, was 
looking at the public records to identify all assets, personal 
and real, of First Beneficial and its principals for the 
purposes of seizing those records to ultimately to satisfy any 
losses that would pertain to Ginnie Mae in the pools.
    The FBI, HUD's IG and the IRS, of course, then conducted a 
lengthy and extremely tedious and detailed investigation of the 
operations of First Beneficial. The outcome of that, as you 
know and has been stated, are convictions and terms of 21 years 
for the principals.
    In a rather unusual situation, Ron Rosenfeld, the President 
of Ginnie Mae, actually flew to North Carolina to attend the 
sentencing hearing. Obviously, this was a case of significance 
to Ginnie Mae. A large financial loss did occur because of the 
actions or, or inaction of First Beneficial. It is the only 
time in my 35 years that I have seen a President of Ginnie Mae 
actually go to a sentencing hearing and present his testimony 
to make sure the judge understood the gravity of this case.
    I would also note, and I do not think it has been mentioned 
yet, that the accountant for First Beneficial was also indicted 
and convicted. That becomes relevant because when you have a 
situation where the chief operating officer and the accountant 
worked together in a scheme to defraud, it is going to make it 
difficult for everybody. It is going to make it more difficult 
for people to find that fraud. But that case was handled, the 
IG assisted in that, and the person has been convicted and is 
serving a sentence of one year under a plea agreement.
    At that point, when all of the criminal action was over, 
that is when we started focusing, ``we'' Ginnie Mae and OGC, 
started focusing on well, how do we recover the monies for 
Ginnie Mae. They suffered extensive losses. We started looking 
at different theories and different opportunities for capturing 
monies that were a part of the criminal conspiracy. Let me just 
say that on January 16, 2004, I visited main Justice, the 
Department of Justice, Mike Hurd, Civil Fraud Section, and we 
started thinking about different theories under which we could 
recover monies.
    As I said in the very beginning, we had identified all of 
the assets of First Beneficial, and that is roughly $8 million. 
I should say that in that regard, we identified 100 parcels of 
property, 20 bank accounts, 7 vehicles, a boat and the personal 
residence of the owners of the company. All of that was 
available to us in a forfeiture process. That has since, 
through the U.S. Attorney's office, come to fruition, and 
$300,000 has been paid already to other victims, and at the end 
of the day the remaining monies of that $8 million will come to 
Ginnie Mae to satisfy that.
    More importantly, I think, we started looking at the facts 
that were available to us from the criminal case. When we 
looked at the facts surrounding Fannie Mae's behavior, it 
occurred to us that possibly that might be an avenue that we 
could look at. That was the purpose of my visit to the 
Department of Justice, and over a period of months, we ended up 
working with them, an incredible effort on the part of the 
Department of Justice and the U.S. Attorney's office, Paul 
Taylor specifically in the U.S. Attorney's office, a criminal 
forfeiture case was filed. The outcome of that, as you already 
know, was that Fannie Mae looked at that. They looked at the 
evidence surrounding that that was available to them, and 
elected to pay $7.5 million, which included $1 million in 
interest.
    In terms of the acts or omissions of Fannie Mae, my look at 
the evidence convinced me that at a minimum they either did 
know or should have known that Fannie Mae was going to be the 
ultimate victim of this fraud scheme that they did not report.
    [The prepared statement of John P. Kennedy can be found on 
page 44 in the appendix.]
    Mrs. Kelly. Thank you, Mr. Kennedy.
    Mr. Pollard?

  STATEMENT OF ALFRED M. POLLARD, GENERAL COUNSEL, OFFICE OF 
              FEDERAL HOUSING ENTERPRISE OVERSIGHT

    Mr. Pollard. Madam Chair, ranking member Gutierrez, and 
members of the subcommittee, I am pleased to represent the 
Office of Federal Housing Enterprise oversight as you conduct 
these hearings. Director Falcon has given clear instructions to 
the staff, the General Counsel's office and our examiners, to 
deploy the needed resources to address matters relating to 
mortgage fraud involving Fannie Mae and Freddie Mac, including 
any misconduct by employees.
    OFHEO as a safety and soundness regulator does not enforce 
criminal laws. OFHEO refers violation of criminal laws to 
federal or state agencies with appropriate jurisdiction for 
their review and action. Like bank regulators, however, OFHEO 
does inquire into the conduct of business operations, 
particularly to assure safe and sound practices. Criminal 
conduct by or against an enterprise clearly is a threat to safe 
and sound operations.
    OFHEO has been fortunate to be one of the agencies to be 
made a member of the President's Task Force on Corporate Fraud 
led by Deputy Attorney General James Comey. This includes the 
Justice Department, U.S. Attorneys, the SEC, CFTC, IRS and 
others. We have learned much about fraud remediation and that 
inures to our benefit in seeking to enhance our efforts at 
fraud prevention. In other words, fraud prosecution has 
relevance for fraud prevention.
    OFHEO has been active in working on mortgage fraud. In the 
past, we have sponsored seminars on mortgage fraud that 
included some of our colleagues at the table today, and has 
even provided a training program for the FBI at their Quantico 
facility. Now, OFHEO has undertaken initiatives to improve 
mortgage fraud reporting and to address deficiencies that exist 
in enterprise operations and systems.
    OFHEO has proposed, for public comment, a rule that will 
require the enterprises to report on possible or actual 
mortgage fraud, to do so in a timely manner and to create the 
training programs and operating systems necessary to meet those 
obligations.
    The finalization of a rule on reporting mortgage fraud and 
the implementation of a reporting regime should improve overall 
reporting, lead to earlier intervention to avoid fraud, and 
permit OFHEO to expeditiously introduce needed changes to 
enterprise operations.
    I would note that we are well aware of the challenges in 
implementing a rule that provides OFHEO the information needed 
to do its job, while being operationally smooth at the 
enterprises and permitting them to meet their mission. I do not 
see any obstacles to addressing and meeting those challenges 
and we will work with the enterprises, as well as with 
regulators and law enforcement personnel.
    As the public comment period is open on the rule, I will 
not discuss the rule in any greater detail as we must await 
those comments and give them due consideration prior to 
issuance of a final rule and implementing the formal reporting.
    As this subcommittee well knows, the enactment of the Bank 
Secrecy Act and the use of suspicious activities reports have 
important elements in law enforcement, likewise for regulators. 
Banks today have SAR forms and supporting instructions on a 
wide range of consumer and business fraud. The instructions 
highlight key forms of practices that should raise concerns. 
The enterprises, engaging in a narrower band of business 
activities, will require the creation of forms and instructions 
by OFHEO tailored to their businesses and at the same time 
generating information needed by us and by law enforcement.
    It is my hope that the enterprises will respond favorably 
to the mortgage fraud proposal, and I believe we can work to 
achieve a goal of moving as close as possible to a fraud free 
zone at the GSEs. Realistically, this subcommittee knows full 
well that fraud may be deterred, but not fully prevented. We 
are committed to making sure the deterrence is as strong as 
possible.
    You have heard comments on the Bank Secrecy Act, on the 
need for safe harbor and other provisions. OFHEO believes that 
would be useful. The General Counsel's office is looking in to 
a procedure where OFHEO would share information it develops on 
mortgage fraud with other government agencies. I would note we 
have benefited greatly from the expertise, information and 
views provided by the Treasury Department, Financial Crimes 
Enforcement Network, Federal Bureau of Investigation, and the 
U.S. Attorney. Coming from the private sector and hearing of 
jurisdictional squabbles, I can report in this instance strong 
cooperation among agencies, and I am pleased to have the 
commitment of these experts as we move forward toward a final 
rule and implementation.
    On First Beneficial, I will note in my remaining 20 
seconds, that we are currently reviewing changes that Fannie 
Mae has undertaken to determine if those changes are adequate, 
but as well to see if enhancements are needed. In particular, 
we believe that a strong set of guidance documents, backed by a 
strong and centralized compliance regime, is essential 
regardless of whether a business model provides for centralized 
or decentralized operations.
    In sum, both enterprises should strive for best practices 
in seeking to avoid mortgage fraud and a strong, aggressive 
program aimed at prevention and detection is imperative for 
safe and sound operations.
    Again, I appreciate the opportunity to appear before you.
    [The prepared statement of Alfred M. Pollard can be found 
on page 47 in the appendix.]
    Mrs. Kelly. Thank you very much, Mr. Pollard.
    Just so you gentlemen know, your full written statements 
will be made part of the record.
    Mr. Donohue, following your examination of the facts that 
surrounded the First Beneficial matter, would you consider 
Fannie Mae's internal controls to be adequate in identifying 
and reporting fraud?
    Mr. Donohue. Well, first of all, as you well know, I have 
no statutory authority over Fannie Mae as far as what they are 
proposing to do, but I have made comments, as was discussed by 
the OFHEO representative, as far as the new proposed 
regulation.
    Mrs. Kelly. I thank you very much. If you have suggestions, 
we would like to work with you.
    I have reached over here, because I have a sworn statement 
from Mark Heimbach, Special Agent, United States Department of 
Housing and Urban Development. He is from your office. In this 
sworn statement, he discusses something that I am going to talk 
with you, Mr. Smith, about. You say you regret your lack of 
knowledge about this. According to this, Mark Heimbach says 
prior to Fannie Mae receiving these transfers, Fannie Mae 
officials were aware that the source of these funds was Ginnie 
Mae and that the McLeans had repaid this money to Fannie Mae 
simply by re-selling the fraudulent loan packages to Ginnie Mae 
and thereby defrauding that entity.
    That is a sworn statement, sir. I know you regret the lack 
of knowledge, but apparently someone there had knowledge. To 
that end, Mr. Baker and Mr. Ney and I sent a letter to Fannie 
Mae in December of 2004 asking if Fannie Mae was aware of any 
other instances where an entity of the Federal Government was 
sold fraudulent loans held at one time by the enterprise. In 
its response, Fannie Mae exempted loans that it assigned to the 
Federal Government in connection with insurance claims. Why did 
Fannie Mae's Atlanta office employees fail to inform, and what 
do you know about that statement that I just gave you? What can 
you tell us about the fact that you, in the response, exempted 
loans that you assigned to the Federal Government in connection 
with insurance claims?
    Mr. Smith. Well, as the Latham and Watkins support shows, 
there was an e-mail message from Debra Brown to me and a few 
other people at Fannie Mae which had an attachment. The 
attachment described some conversations that Debra Brown had 
with the North Carolina Banking Commission, along with two 
employees, or two people that represented themselves as 
employees of First Beneficial. In that attachment to that e-
mail message there was a reference, a couple of references, to 
First Beneficial's intention to sell loans to Ginnie Mae.
    Now, I do not recall seeing that e-mail message or the 
attachment until much later, actually in 2001, after Fannie 
Mae's records had been subpoenaed by the government as it was 
preparing its case against James McLean. Fannie Mae responded 
to the subpoena and gave the government all of our records. 
Government attorneys came to Fannie Mae's office in Atlanta and 
asked me about that e-mail message. I was shocked at the time 
to see those references in the attachment to the e-mail 
message. I do not remember seeing the e-mail message or the 
attachment in 1998.
    I do recall discussions with my staff and especially with 
Debra Brown, about the phone calls that she had from the North 
Carolina Banking Commission and the two employees, but the 
focus of those discussions was that the North Carolina Banking 
Commission and the two employees were pointing to activities at 
First Beneficial that they felt were improper. I do not recall 
at the time any discussions about Ginnie Mae. In fact, the 
Latham and Watkins report interviewed a number of people, some 
of whom have left Fannie Mae years ago, but who were there at 
the time of this situation. None of us recall any conversation 
about the reference to Ginnie Mae.
    So yes, in retrospect, now looking at the facts, the file 
does show that there was in an attachment to a single e-mail 
message a reference to Ginnie Mae, but none of us at Fannie Mae 
can recall ever discussing that or having knowledge that James 
McLean intended to sell loans to Ginnie Mae. In fact, in 
October of 2000, when I received a copy of HUD's letter to 
First Beneficial suspending or terminating them, I can recall 
shock and disbelief that a small lender like First Beneficial 
Mortgage had even been approved to do business with Ginnie Mae. 
That was the first revelation that I had, the first information 
that I can remember when I first became aware that First 
Beneficial had been involved with Ginnie Mae.
    Mrs. Kelly. Yet the testimony of Debra Brown indicates that 
on or about November 19, 1998, she took a call from a man named 
Warren Harper, the federal crimes investigator with the North 
Carolina Banking Commission. To sum up that testimony, the 
indication in that conversation was that they were trying to 
get Ginnie to buy loans now. They were trying to buy them out 
of Fannie to Ginnie. So there was someone there who was an 
employee who Debra Brown seemed to know about it. I would like 
to ask you, Mr. Donohue, if you would respond to what Mr. Smith 
just said.
    Mr. Donohue. I think I misunderstood your question before. 
I would love to respond. It is my feeling, in looking over the 
record myself and reviewing and speaking to our investigative 
personnel, it certainly does appear to be the preponderance of 
the facts in my mind that Fannie knew that these securities 
were destined to Ginnie Mae based on these comments, based on 
the North Carolina investigator, and based on the 
correspondence that went on discussion with regard to other 
people that provided testimony.
    So my feeling is, to answer your question, yes I do believe 
that reasonably so there was a preponderance that Fannie knew 
that these were destined for Ginnie, and as a result, as I have 
been quoted, I felt they should have notified Ginnie as 
appropriate.
    Mrs. Kelly. Thank you very much.
    I am out of time. I will turn to Mr. Gutierrez.
    Gentlemen, I wanted to let you know that we have been 
joined by Chairman Oxley. I am delighted to see him here as 
well.
    Mr. Gutierrez?
    Mr. Gutierrez. Thank you.
    Thank you, gentlemen, for your testimony this morning. I do 
not think we are going to figure out when Fannie Mae knew or 
whether they knew exactly, because it just seems to me that if 
Mr. Donohue is correct, then Mr. Smith lied to the FBI and to 
the U.S. Attorney's office. We have his sworn testimony here. 
He also lied at trial. I do not know of any investigation of 
the Federal Government into Mr. Smith or the collusion. I mean, 
it would have to be a pretty broad-based conspiracy at Fannie 
Mae, not only between Mr. Smith and Mr. Smith and other former 
employees and current employees at Fannie Mae. They all have to 
be in collusion. I am not trying to say that they cannot do 
that, but given the extensive investigation that has been done. 
As a matter of fact, then, the Federal Government had Mr. Smith 
testify on their behalf against First Beneficial.
    So I guess the Federal Government might have thought then 
that he was lying and used him as a witness in the case against 
First Beneficial. I am not a lawyer. I am just listening to the 
testimony of everyone here today.
    So I think there is certainly enough reason to suspect that 
Fannie Mae should have known better, that they should have been 
more judicious, because as I look at this, and I will just ask 
anybody, when Fannie Mae went to First Beneficial, and said 
First Beneficial, you know, we just can't. We want you to 
repurchase this portfolio that we have with you. It was not 
because they had done something illegal. Otherwise, it seems to 
me Fannie Mae would have turned them over for criminal 
prosecution. They said it does not fit our underwriting 
guidelines; you do not have proper documentation; you have 
shoddy paperwork here; we do not want these loans.
    And indeed, we have the gentleman from First Beneficial, 
the former CEO, saying to Fannie Mae, we will get the money 
from subprime lenders; we will get the money from these people. 
That is the testimony at trial that that is where you are going 
to get the money. So there were other reasons given for the 
testimony.
    So if there was no criminal, and I have not read anything 
in the record that Fannie Mae knew of any criminal involvement 
or activity of First Beneficial, that this was an underwriting 
issue and that they did not want to keep these loans, and they 
were asking them to basically give their money back to Fannie 
Mae, and saying we do not want these loans, and they have to go 
out and get those loans. Otherwise, it would seem to me that 
they would know about it.
    So as I look at this, I guess my question is, Mr. Smith, 
what would happen differently today, corporation, bank, First 
Beneficial, you have $7.5 million in loans or money owed to 
you. How would you do things differently today and what changes 
have been made to do things differently today so that another 
governmental agency, Ginnie Mae, or as a matter of fact, any 
others, they are all insured by us, that you would not be able 
to take loans and simply allow someone else to take them up?
    Mr. Smith. Certainly, there is an extreme heightened sense 
of awareness at Fannie Mae about all matters pertaining to 
fraud. Fannie Mae has implemented a corporate-wide anti-fraud 
policy in writing that requires every employee when they have 
knowledge or suspect fraud, to take action and report it.
    We have also centralized our lender approval process into a 
single office that will allow that office to better focus on 
the needs of smaller lenders and to properly judge those 
lenders and their qualifications to be Fannie Mae-approved 
lenders. We have also centralized our review of individual 
files in our Dallas office. We have implemented some models 
which are designed to try to target for review those files that 
would perhaps have some indicators of irregularities.
    Also in the Dallas office we have created a fraud 
investigation team that when they pick up on the potential for 
fraudulent activity, they will do investigations and find out 
exactly what is going on. We have also implemented in our 
automated underwriting tool, Desktop Underwriter, some fraud 
detection tools designed to help our lenders at point of sale 
spot potential fraudulent activity.
    Mr. Gutierrez. Let me just ask you a follow-up question, as 
my time has expired. Does Fannie Mae expose itself to liability 
when it reports possible fraud that turns out to be botched 
paperwork? Could Fannie Mae be sued for libel?
    Mr. Smith. That has certainly been on my mind when I have 
dealt with some of these issues. When we were working with 
First Beneficial, First Beneficial represented that the 
ineligible loans were due to misunderstandings and poor 
management. If I had, on my own, taken actions that were 
inappropriate in retrospect, and in fact if James McLean's 
claims had been valid and he could prove----
    Mr. Gutierrez. Let me just say this. I do not want to go 
over. The gentlelady has been very kind with me this morning. 
Let me just say that there are those of us in Congress and 
across the country that count on Fannie Mae to do the kind of 
work that allows people to purchase homes and to rebuild 
neighborhoods. Let me just say that while I believe you, I 
certainly think that Fannie Mae needs to do a lot. I want you 
to do well.
    I look at the record. I can see there are mistakes. But 
even when you make a mistake, you made a mistake. I think you 
admit you made a mistake and there are consequences to 
mistakes. And we do not want you to make these mistakes any 
further because they harm the American public and the American 
investing community, and they harm the goals and the purposes 
that Congress when they enacted and made you what you are 
today, and gave you the authority to do what you do today.
    So let me just say that I believe you, but I can understand 
why others might not. I certainly hope that in the future you 
take much more aggressive action when you see that loans, these 
were suspicious loans that you did not want in your portfolio. 
Before you get rid of something, and you say I do not really 
want this, that you figure out how to just not get harmed by 
what you do not want.
    Thank you very much for your testimony this morning.
    Mrs. Kelly. Thank you, Mr. Gutierrez.
    Mr. Oxley?
    Mr. Oxley. Thank you, Madam Chairwoman. Thank you for your 
leadership on this important issue.
    Mr. Smith, it is my understanding that in 1998 once a 
lender was approved to sell Title I notes, you would cease 
further due diligence regarding the underlying basis for the 
loans, and instead, Fannie would rely on the lender's approval 
status and assurances outlined in your contract for sale. Was 
this substantially the standard operating procedure then?
    Mr. Smith. Yes. After a lender becomes approved, we rely on 
lender warranties. The lender by selling loans to Fannie Mae 
warrants that the loans meet Fannie Mae's standards.
    Mr. Oxley. And what role at that point did the Fannie Mae 
headquarters play when the fraud was detected?
    Mr. Smith. The regional offices back in 1998 handled 
repurchase issues, matters involving ineligible loans, 
investigations, pretty much on its own and was under no 
obligation to inform the Washington office or seek advice from 
Washington unless we felt it was necessary.
    Mr. Oxley. Could you take the committee through the 
structured changes that have been made structurally so that if 
the same set of facts were presented today it would be handled 
differently? The reason I raise that is I just came from a 
panel discussion over at the Georgetown Law Center with Senator 
Sarbanes. He made an excellent point in terms of what we 
describe as structural changes in the corporate structure to 
make certain that the Enron and the WorldCom do not happen 
again. Obviously, some of these things like we are talking 
about today, we talk about after the fact. The damage has 
already been done.
    The goal, of course, was to provide necessary internal 
controls in the law so that this would be detected early on. 
From your perspective, what has Fannie done to provide the kind 
of internal controls, checks and balances necessary in the 
future?
    Mr. Smith. As a result of Sarbanes-Oxley 404, we have 
developed and implemented a formal company-wide anti-fraud 
policy that requires that any employee who suspects fraud or 
wrongdoing report that fraud up through appropriate channels. 
We have certainly all at Fannie Mae, we all have a heightened 
sense of awareness about all issues pertaining to fraud.
    We have centralized lender approvals in our Chicago office 
to really focus on the lender approval process to ensure that 
the lenders that we approve have the appropriate capabilities 
that Fannie Mae would require. We have also centralized our 
post-purchase loan file reviews in our Dallas office, and we 
select the files that we want to review with some models we 
have developed that would prompt Fannie Mae to ask that those 
files that contain certain risk factors be the files that we 
request from the lender for review.
    We have also created in the Dallas office a fraud team. By 
having the file reviews in a single office instead of the five 
offices, it is a little bit easier to spot trends of fraud 
across many lenders. There could be a real estate professional, 
an appraiser or a real estate broker that is involved in some 
improper arrangements, but if that professional or broker is 
involved with several lenders, each lender only sees a small 
piece of the arrangement. But by having Fannie Mae's one office 
look at the file reviews, we can better spot whenever there is 
a real estate professional or a broker that is feeding to a 
number of lenders loans that are improper. The fraud team helps 
us do that.
    Mr. Oxley. You say that is in Dallas?
    Mr. Smith. That is in our Dallas office which we call the 
National Underwriting Center.
    Mr. Oxley. And how many personnel do you have on that? 
Obviously, you have some sophisticated software to aid those 
folks in their endeavors.
    Mr. Smith. I do not know the number. I think the number of 
people, I am speculating that the number of people in the 
Dallas National Underwriting Center could be 150 to 200 total. 
This fraud team I am speaking about has a director and a staff 
of several. I do not specifically know the number.
    Mr. Oxley. And they have the necessary technology to be 
able to follow those leads?
    Mr. Smith. They investigate issues and do whatever they 
need to do.
    Mr. Oxley. What is the role of modern technology? Are these 
just basically gumshoes that follow the paper trail? Or do they 
have a sophisticated computerized operation?
    Mr. Smith. I really do not know. I am not involved in that 
operation. I really do not know.
    Mr. Oxley. Okay. Thank you.
    Thank you, Madam Chairman.
    Mrs. Kelly. Thank you, Mr. Chairman.
    Mr. Cleaver?
    Mr. Cleaver. Thank you, Madam Chair.
    Either Mr. Donohue or Mr. Kennedy, we deal with this in 
every aspect of government and life now, and I want to bring it 
to you in the same way we deal with it in other arenas. It 
appears as if more and more cases of fraud are uncovered every 
year. The question is, is that due to the fact that we have a 
much better, far more sophisticated system of detection? Or are 
we simply having more and more fraud, and that it is 
significantly higher than it was in previous years? I mean, how 
many cases of fraud does Ginnie Mae encounter each year, or 
Fannie Mae for that matter?
    Mr. Donohue. That is a very good question, sir. I think the 
answer to that is both. I think what I have seen is in 
different areas, the queue seems to be, as the cooperation and 
the reporting from these GSEs or the regulatory departments to 
the respective appropriate federal law enforcement agencies 
address these issues. So I think the first answer is I think 
better cooperation, communications, we are getting more cases 
we might not have seen in the past.
    I will comment to you, however. I have spoken to outside 
counsel of various banking institutions. One of the things they 
tell me is this. They tell me that often in the industry that 
at times the industry is reluctant to pass this information on, 
on criminal matters and on civil litigation, because of the 
costs involved and so on. Cases involving bad publicity can 
come out of these matters.
    What I try to do and encourage upon them is to try and make 
sure they pass that information on because my graves concern, 
as I found out when I was at the RTC, is the very people that 
perpetrate these crimes go on to another one and go on to 
another one and go on to another one. So I think that is the 
benchmark with regard to it.
    Do I think there is better reporting? Yes, I do. Do I think 
coordination is better? Yes, I do. And we have our own task. We 
work very closely with the FBI and ourselves in doing many of 
these cases as well. I, as you well know, my jurisdiction rests 
with the FHA and Ginnie Mae and Fannie Mae, unless it has a 
relationship to it.
    Mr. Cleaver. What happens if someone makes an accusation 
that is proven untrue? I mean, if someone, for example, goes 
out and says I have reason to believe that fraud is taking 
place here or there, and it is investigated and it is found to 
be untrue. What happens to that person? Are they liable? Are 
they going to lose their job? Do they end up in court?
    Mr. Donohue. The way it comes to us, when it finally comes 
to us, of course we are looking at the notion about the 
evidentiary aspect to it. We study the case, look at it, and 
investigate the case entirely, which is within our full 
jurisdiction, and present that matter to the U.S. Attorney's 
office for the outcome. Typically with cases involving us, when 
the person is found to be, I should say, not prosecuted or 
declined prosecution, we attempt to notify those people, let 
them know the fact that the case has been resolved or will not 
be criminally adjudicated. It then does take a civil component 
to it. The Federal system has a way to be able to deal with 
those matters. But I think the question as far as the liability 
issue needs to be directed to these other folks here.
    Mr. Kennedy. If I may in terms of, from the Ginnie Mae 
perspective. Clearly, if you look at this case, First 
Beneficial, there are lessons to be learned from it. Almost 
immediately, within a matter of days, Ginnie Mae looked at the 
case and rather than go through a rulemaking process to change 
their procedures, they instituted immediately a process whereby 
all issuers were looked at and compared in terms of a profile 
to see whether or not there were indicators in the files that 
suggested that an issuer might have problems.
    But I think we should be clear about one thing. As soon as 
Ginnie Mae found out that there were loans in the files for 
which there was a piece of vacant property, no house, no 
mortgagor, we do not tend to characterize that as an 
irregularity. It was clear to us that given that set of facts, 
we had a fraud case. I think that at this point Fannie Mae 
would view that same set of facts the same way. It is not a 
question of irregularities and the loans are not eligible for 
the pool. It is a question of these are fictitious mortgages.
    I think that clearly Fannie Mae has indicated their desire 
to raise the expectations, even within their own offices, that 
can find those kinds of cases. That is not an irregularity. I 
should say, and I will say it here, that based on Ginnie Mae's 
immediate change in its procedures, another case was 
discovered, very similar. Immediate action was taken to suspend 
their approval as a Ginnie Mae issuer. That was done because 
they acted quickly based on the facts before them. It is a good 
example of how it can work and how it should work. Those 
matters were referred to the IG and to the enforcement folks.
    Mrs. Kelly. Thank you very much.
    Mr. Cleaver. Thank you, Madam Chair.
    Mrs. Kelly. Mr. Garrett?
    Mr. Garrett. Thank you, Madam Chairman, and thank you, 
gentlemen for being with us this morning.
    As with much of what we do here, as was said, it is 
appropriate that we examine this, and it is good that the barn 
door is now being closed after the horse got out. Of course, we 
are trying to go forward from there.
    Let me take a step back and look at the big picture. Fannie 
Mae obviously exists as different from other financial 
institutions, and that is because it has a status as a creation 
of Congress. Because of that, Fannie Mae has special benefits 
that are not available to other financial institutions, such as 
having that line of credit from the Department of Treasury, the 
exemption from state and local corporate income taxes, and the 
perception that your securities are backed by the Federal 
Government, and until recently, an exemption from the 
registration with the SEC.
    So the big question that I think people will be asking is, 
is it in your opinion that you as a responsible corporate 
citizen with all of these added advantages that you have, with 
relationship to the Federal Government, that you silence when 
you discovered a major fraud fell below what is an appropriate 
conduct for a corporation that has this connection to the 
Federal Government?
    Mr. Smith. At the time, and we are looking back with 20/20 
hindsight, at the time, James McLean, when I confronted him 
with these irregularities and I explained that the loans sold 
to Fannie Mae were not eligible for sale to Fannie Mae, that 
they did not meet our requirements, Mr. McLean stated that the 
errors were due to poor management and a poor understanding of 
Fannie Mae's requirements. Given the fact that First Beneficial 
was such a small lender, it was credible to me that 
misunderstandings might have occurred and that the 
misunderstandings might be corrected through additional 
training for First Beneficial and that the loans sold to Fannie 
Mae, the ineligible loans, that breach of contract could be 
cured by James McLean repurchasing the loans from Fannie Mae.
    Certainly, when I look back now and with the heightened 
sense of awareness about all matters pertaining to fraud, I 
think Fannie Mae clearly could have done a better job in how it 
handled that situation.
    Mr. Garrett. Mr. Donohue indicated that, from your 
experience, and you have seen cases of fraud, that the entity 
does not do it once. They do it, I think you said, over and 
over and over again in different circumstances. So again back 
to you, Mr. Smith, in essence do you feel that everything 
occurred as it did, and you basically got your money back. Was 
there no obligation then to ensure that First Beneficial would 
not try to simply push these bad loans off onto some other 
unsuspecting investor and not to allow the fraud to continue to 
perpetuate itself as Mr. Donohue indicates is often the track 
record of these?
    Mr. Smith. It was my belief at the time that the problems 
were due to a small lender making poor judgments and not 
understanding Fannie Mae's requirements.
    Mr. Garrett. Okay.
    Mr. Smith. It was only when I got a copy of HUD's 
termination letter where Ginnie Mae was terminating First 
Beneficial, that I became aware of the fact that James had even 
been involved with Ginnie Mae, and it became apparent to me at 
that time, looking back, that the issues we had uncovered might 
have been more than simple misunderstandings.
    Mr. Garrett. And you have just said twice now that it was a 
small lender. In your earlier testimony, I think you said that 
you were shocked at how small a lender they were and that they 
were approved to do business with Fannie Mae.
    A couple of questions. Have you done an investigation? Have 
you looked to see whether there are other similarly situated 
small lenders that shocked you that they are doing business 
with Fannie Mae? Are there others that you think you need to 
make a review on going forward? Are there policies in place 
that you make sure that it does not occur again at 
inappropriately sized lenders?
    I guess it goes to the ``also'' question. Is any of this 
driven by the fact that, are any of the occurrences here as far 
as approving of these lenders, or are any of the facts as far 
as the miscues, if you will, as far as seeing what was 
occurring with them, tied to the fact that compensation 
packages were maybe tied to whether or not we are going to 
approve these numbers of small lenders, or compensation 
packages were tied to the fact that these loans would continue 
to go through?
    Mr. Smith. In my earlier remarks when I spoke about being 
shocked, what I was referring to was when I got HUD's 
termination letter I was shocked that a small lender like First 
Beneficial, who had been selling single loans to Fannie Mae, 
not selling groups of loans and doing mortgage-backed 
securities. My shock was that a small lender like First 
Beneficial could have been doing business with Ginnie Mae.
    I am the person at Fannie Mae that actually approved First 
Beneficial to become a seller-servicer. I knew that he was a 
small lender, and we at Fannie Mae in fact tried to provide 
James McLean and First Beneficial with extra training to help 
them really understand how to do business with Fannie Mae. So 
if I said earlier, if I said I was shocked that First 
Beneficial was Fannie Mae-approved, I meant to say Ginnie Mae.
    Mr. Garrett. Okay.
    Mr. Smith. On the issue of compensation, back in 1998, as 
best as I can recall, I personally had about 40 goals that I 
was held accountable for and that would influence my bonus. 
Only one of those goals in any way in my opinion touched on 
this kind of an issue. That goal was to hold Fannie Mae's 
overall credit losses, it was either at the same point or 
slightly less than the previous year. That was a national goal, 
not a goal for the Atlanta office or for lenders in North 
Carolina.
    However, looking back on this situation in 1998, the vacant 
lot loans were discovered in December of 1998, and even if the 
loans had not been repurchased, Fannie Mae would not have 
foreclosed on those loans, until sometime in 1999, and we would 
not have realized any losses, actual losses on those loans 
until we had sold the real estate and then booked the loss and 
that probably would have occurred in 1999. During this period 
of time, none of the decisions I made about First Beneficial 
were influenced by matters of compensation.
    Mr. Garrett. I see my time has expired. Thank you.
    Mrs. Kelly. Thank you, Mr. Garrett.
    Mr. Baker?
    Mr. Baker. Thank you, Madam Chair.
    I want to go at a couple of underlying principles here as 
to their being no obligation to report, as a beginning point. 
The conclusion reached, Mr. Donohue, in your prepared 
testimony, the last line indicating there needs to be the view 
that there was a systemic weakness that needs to be addressed, 
and had there been better communication these problems perhaps 
would not have occurred. If we go to Fannie Mae's Web page and 
go to their code of business conduct, we go to page four of the 
code of business conduct, employees must report any violation 
of the code or related, it goes on and on.
    If we go to page 14 of the code, they must obey the spirit 
and letter of all laws and regulations in every area in which 
they do business. We must support commitment to conduct our 
business with all government officials at the highest ethical 
standard. The possible consequences of violation of the 
established code is termination. That is element one. If we go 
to the D.C. Bar standard for ethical conduct and we look at a 
lawyer's obligation to report another's questionable conduct to 
the D.C. Bar, it is very clear and forthright that one attorney 
conducting enterprise with another must report to the bar on 
matters of ethical concern.
    If we go to the Sarbanes-Oxley act and look at Section 404 
requirements, if we go to an executive summary I have gotten 
off the SEC Web page, must report accurately all financial 
data. I am skipping over details, just for the sake of mercy. 
If we go to the requirements to disclose, if there is a 
material weakness existing at year-end, it must disclose this 
fact. I would suggest that by December of 1998, someone should 
have figured out there was a material weakness in the financial 
review process and made, as required under Section 404, the 
required disclosures, which were not made.
    If I got to the Department of Justice Web page and look at 
a recent decision relative to the Riggs Bank, and quoting from 
the Department of Justice finding, ``the financial enterprise 
was obligated to take steps to ensure that its services would 
not be utilized for illegal purposes,'' and it goes on.
    My point in bringing all these to your attention is there 
were clear, legal, regulatory, statutory obligations on the 
part of someone within this enterprise when they knew that 
their assets, which were fraudulently represented, were to be 
sold to another governmentally related enterprise. My first 
question is, when, based on your observations, did officials at 
Fannie have constructive knowledge of the material facts of the 
disposition of assets to Ginnie Mae? Prior to closing or after?
    Mr. Smith. During the period of time in 1998, I did not 
believe that what we were looking at were fraudulent 
activities.
    Mr. Baker. Let me interrupt and go on to the facts then. As 
I understand it, First Beneficial offered to repurchase the 
entire portfolio of $35 million. That offer was not accepted by 
Fannie. In December, Fannie then demanded a repurchase of a 
package of loans valued at $4.8 million. Somebody had to do due 
diligence at that point, to sit across the table, look at 
documents, and make determinations.
    It was then subsequent to that determination, 60 days 
later, in February, the vacant lot transaction to which you 
refer, an additional repurchase of $1.7 million of the 17 lots 
was demanded. Obviously at that point, someone made the 
determination in Fannie's organization, these are bad things; 
we have to get them off our books. What really troubles me 
about the last quarter of 1998 was that was the quarter in 
which the $200 million of expenses was deferred into 1999, then 
repaid as affecting that earnings-per-share target.
    Now, it is just a question. I am not making an allegation. 
Somebody needs to make an examination of these facts, one, to 
determine when Fannie officials knew, when judgments were made 
to sell these assets to Ginnie, and did they know prior to the 
execution of that sale that Ginnie was the recipient. The fact 
that subsequent to examination by the inspector general, a 
consent order and agreement was reached for the payment of a 
fine of $7.5 million says to me somebody knew something or else 
we would not have levied a fine of $7.5 million equal in value 
to the repurchase value of that portfolio.
    But yet to my knowledge, no individual or group of 
individuals was held personally accountable despite the clear 
regulatory and statutory obligations leading up to termination 
of those employees for obviously fraudulent conduct. Is there 
any explanation?
    Mr. Smith. I was the senior person on the spot at the time, 
and I did not believe that this was fraudulent activity. I 
believed that what we had was a small lender that had----
    Mr. Baker. I know it was a small lender that was trying to 
dupe Fannie Mae. That is obvious, and apparently they 
succeeded. There were no internal controls at any point in this 
process which would have led a reasonable man to conclude that 
there was something to it? Let me go at it a different way. Why 
did you reject the $35 million repurchase offer and simply 
select the handful of what now appears to be fraudulent 
transactions to rescind?
    Mr. Smith. Our research had revealed that the entire 
portfolio was not a bad portfolio.
    Mr. Baker. Yes, your research. That means somebody looked 
at it, and made an examination. You went document-by-document, 
loan-by-loan. That was knowledge. Somebody made a business 
decision, and you made the business decision to dump the 
fraudulent stuff on somebody else.
    Mr. Smith. Fannie Mae as a general practice relies on 
warranties made to Fannie Mae by sellers of loans to Fannie 
Mae.
    Mr. Baker. I understand that. When you have a bulk and you 
have thousands of transactions, you cannot sit down every day 
and look at every one of them, but when you have constructive 
knowledge there is something wrong and you sit down and do the 
examination and you refuse a $35 million offer to dump the 
whole portfolio, and selectively, selectively pick about $7 
million in transactions to rescind, there is your problem. 
Somebody had knowledge. Somebody made a business decision. 
Somebody decided we have to get rid of these. And it also, as 
an ancillary effect, impacted the bonus calculations and the 
earnings-per-share target for 1998.
    I have been way over time. I am sorry, Madam Chairman.
    Mrs. Kelly. Thank you very much, Mr. Baker.
    I do not think we have completed our inquiry right now, 
gentlemen, and I am going to initiate a second round of 
questions here.
    I have a question I would like to go back to, Mr. Smith, 
because I really did not get a clear answer from you. I would 
like to know, Mr. Baker, Mr. Ney and I sent a letter to Fannie 
in December of 2004, and I am going to repeat this question. We 
asked if Fannie Mae was aware of any other instances where an 
entity of the Federal Government was sold fraudulent loans held 
at one time by the enterprise. In its respond, Fannie Mae 
exempted loans that it assigned to the Federal Government in 
connection with insurance claims. I want to understand that. So 
will you answer me about why that was exempted in your response 
to our letter to you.
    Mr. Smith. I believe Fannie Mae's interpretation of your 
inquiry, especially as it pertained to First Beneficial, was 
targeted to the sale of loans back to First Beneficial or 
others, that might have been sold elsewhere. With First 
Beneficial, the Title I loans turned out not to be Title I 
loans at all, that there was never any insurance on the Title I 
loans. They were never loans that could have had a claim paid, 
and in fact Fannie Mae never received any claim payments on the 
Title I First Beneficial loans.
    Mrs. Kelly. Mr. Baker, would you like to jump in here?
    Mr. Baker. I thought you would never ask. Thank you, Madam 
Chair.
    I am going to go back to Mr. Donohue and the findings 
reached in your testimony as to enhanced communication would 
have resolved this problem. Do you believe that there was not 
an intentional decision, business decision made by executives 
at Fannie to dispose of these troubled assets? How do we come 
to the conclusion that if we had all gotten around the table 
and talked we would have not had this circumstance?
    Mr. Donohue. Sir, I am an investigator by my experience, 
and having listened to what you said carefully, I use the word 
``preponderance.'' It appears to me in my mind, looking at all 
the factors involved here, the fact being of a construction 
loan, the fact that at one point reference to Mr. Smith's 
comments, he indicated that they were denied access to First 
Beneficial to be able to review the files that they were 
investigating. There are a host of matters that come to mind 
here that tells me that it is reasonable for me to say that 
something was wrong, as indicated. And I think I have stated to 
that effect.
    Mr. Baker. Is the matter closed as far as you are 
concerned? I know Fannie wants to look forward, and we are not 
going to do this again, but are the facts relating to these 
transactions from your perspective a closed matter?
    Mr. Donohue. We consider it at this point a closed case, 
sir.
    Mr. Baker. Well, I can only express regret, and believe me, 
I have not had a lot of time to do this. I have only spent 
maybe the last day looking at the facts. I have come to a very 
troubled conclusion about what really transpired in moving 
these assets off Fannie's books to Ginnie Mae's, and the fact 
that they were as a corporation fined at a corporate level, and 
there was no personal accountability assigned to anyone is very 
troubling.
    Now, I know Fannie has recently gone through managerial 
changes and they are perhaps engaging the new folks to direct 
the ship in a different manner. But in any other enterprise, if 
this had been publicly reported, somebody would have had some 
consequences.
    Mr. Donohue. We worked closely with the U.S. Attorney's 
office in discussion about the case, but I want to point out as 
well that I do not have legal authority over Fannie Mae as far 
as the disposition of what they do. All I can do is work with 
the U.S. Attorney's office as far as the investigation, and at 
that point we felt the outcome of the case, the prosecution and 
the resolution of the forfeiture for this particular matter was 
addressed.
    Mr. Baker. I certainly understand. You are the fellow who 
digs up the facts and creates the presentation, and it is up to 
the U.S. Attorney's office to make judgments about how to 
proceed. I am not going to say anything about a U.S. Attorney. 
But I would certainly conclude that resolution in this matter 
was perhaps not well balanced and that is just my perspective.
    I yield back, Madam Chair.
    Mrs. Kelly. Reclaiming my time, I would like to ask this 
board a question. The state was asking for help when it called 
Fannie Mae. I would like to ask this board what happens now? 
What kind of a set-up is there available for Fannie Mae or for 
any entity to respond to a state when they ask for help? We can 
start with you, Mr. Smith.
    Mr. Smith. If we get a call from a state agency and they 
claim that fraudulent activity has taken place or is about to 
take place, then under Fannie Mae's corporate-wide anti-fraud 
policy, the employee receiving that call would be compelled to 
report that to the Office of Corporate Justice.
    Mrs. Kelly. Excuse me, Mr. Smith. Is that a new policy?
    Mr. Smith. That policy was enacted last year.
    Mrs. Kelly. So it is a new policy. It was not in place in 
1998.
    Mr. Smith. That is correct.
    Mrs. Kelly. And what have you done to inform your employees 
of that policy?
    Mr. Smith. It is my recollection that when we adopted that 
policy, an e-mail message was sent to every employee. The 
policy appeared on Fannie Mae's internal Web site, and managers 
were asked to be sure that all of their employees read and 
understood that policy.
    Mrs. Kelly. My time is up. I am going to turn now to Mr. 
Cleaver.
    Mr. Cleaver. Thank you.
    I think this question would go to Mr. Pollard, and I am 
going back to what I raised earlier. My colleague has talked 
about someone knew or someone possibly knew. The question that 
I want to deal with really relates more to whistleblowers. I 
maybe did not ask the question as clearly as I should have the 
last time. I want to know two things. One, do you think that 
whistleblowers are inhibited by providing information about 
some kind of fraudulent transaction because of what may happen 
to them, particularly if an allegation proves to be untrue? And 
then secondly, whether or not you think there is a need to 
amend the Bank Secrecy Act in order to try to provide some 
protection for GSEs who would give information about some kind 
of fraudulent transaction?
    Mr. Pollard. Mr. Cleaver, you addressed that to me. I will 
be happy to answer.
    First, we believe there is an obligation to report fraud, 
known fraud, to government officials at the time it happens. 
Secondly, and this is where people try and distinguish, is the 
concern about suspicion of fraud, that I might have a suspicion 
of fraud and be sued under the Fourth Amendment for liability. 
I do not want to take off my OFHEO hat, but if I can I will 
comment a bit on the Bank Secrecy Act.
    First, before the Bank Secrecy Act was enacted in 1970, 
there was an exception called the bank records exception that 
gave certain comfort to institutions that if they provided 
information to a government inquiry, they would be protected, 
particularly if a criminal investigation is involved. That line 
of cases ended with that sort of statement in the Donaldson 
case, because the Bank Secrecy Act was passed. In this 
committee, the Annunzio-Wylie bill added that protection, that 
safe harbor that parties have mentioned to you, that if you 
turn in someone on a suspicion and it turns out not to be 
correct, that you are given a safe harbor. You cannot be sued. 
Okay?
    So I think almost everyone that has commented to the 
committee has said indeed that the Bank Secrecy Act should be 
revised to include Fannie and Freddie. But what I would note is 
that OFHEO in its current actions, and I will put back on that 
hat, is looking to see what we can do to share information 
within the parameters of the law that would not raise liability 
for the enterprise. That is what I mentioned in my testimony 
that my office is looking into right now. So we are trying to 
see if the very concerns that are there can be alleviated 
through practices or procedures by the regulator as opposed to 
the company.
    Mr. Cleaver. Thank you, Mr. Pollard.
    Thank you, Madam Chair.
    Mrs. Kelly. Thank you very much.
    Mr. Baker?
    Mr. Baker. Thank you, Madam Chair.
    I just had one quick question to Mr. Pollard, in the light 
of the Inspector's comments. In your capacity as general 
counsel for OFHEO, do you view the matters relating to these 
circumstances now to be a closed case from your perspective?
    Mr. Pollard. No, sir.
    Mr. Baker. Great. And other than the revisions to the Bank 
Secrecy Act which you have just spoken to, are there other 
factors in statute which you think should be addressed in the 
current GSE regulatory reform act?
    Mr. Pollard. Our director has endorsed those legislative 
changes that you have put in, Mr. Chairman. I think in terms of 
other matters for us, I have in my written testimony something 
that goes a little beyond our jurisdiction, but I would simply 
mention that there may be additional items that will help the 
U.S. Attorney and the Justice Department. Of course, their 
expertise is what is important here, not mine.
    Right now, the banks have a wide panoply of provisions that 
facilitate pursuit of those fraudulent parties. I think our 
goal, as someone said, I forget which, one of the committee 
members said or someone, is will people just move. There is 
always going to be fraud, but we need them to move, move out of 
any enterprises. I believe some of those provisions on Bank 
Fraud Act Section 311, some of the ones on fraudulent 
transactions in mortgages that HUD has, for example, that if 
you engage in fraudulent transactions with them, that is a 
crime. That would be helpful.
    I want to be very cautious, Mr. Chairman. I would say that 
is sort of my opinion today, that it should be looked into. 
Your expertise and the Justice Department would be the critical 
players to me.
    Mr. Baker. I understand, you cannot enforce someone else's 
rules and regulations, whether it is Section 404 of the SEC 
Act, if it is the Department of Justice.
    Mr. Pollard. But we can sanction violations of those acts, 
however, if they occur. We have a proposed rule on corporate 
governance that will incorporate by reference provisions of the 
Sarbanes-Oxley law. I was asked why, and I said, to make very 
clear that once the SEC should determine this type of 
violation, that we too will have sanctions, and more 
importantly, we too will seek remedial steps within the 
enterprise, not merely to sanction them to penalize them. The 
SEC might do that. We also look to structural changes.
    Mr. Baker. I will formally follow up with a specific set of 
facts which I hope that your good office will examine and at 
the appropriate time report back.
    Madam Chair, did you wish me to yield to you?
    Mrs. Kelly. Mr. Chairman, you are out of time.
    Mr. Baker. Thank you.
    Mrs. Kelly. Thank you.
    We turn to Ms. Maloney.
    Mrs. Maloney. Thank you.
    Mr. Pollard, I am interested in your proposed rule on 
mortgage fraud. Can you explain how you plan to handle the 
information you receive from the GSEs under that proposed rule?
    Mr. Pollard. First, we will be working with them in terms 
of the actual implementation of the rule, trying to develop 
both the information systems, the forms, the instructions which 
are very important in these cases, telling people what you 
want, and to be candid, what you do not want, letting them know 
that people's names may have to be taken off at a certain 
point, ensuring that the information goes to elements of 
suspicious activities and the information received is in such a 
manner that may be useful to law enforcement.
    So all of that needs to be worked out. I think we are 
benefited by what has already taken place in the Bank Secrecy 
Act and with FinCEN, some of the lessons they have learned, the 
difficulties they have faced. Coming from the banking industry 
myself, at one point having viewed their side of it, I think we 
can work with them and with law enforcement to come up with a 
management of information that will run very smoothly.
    Mrs. Maloney. And how will you coordinate that information 
with that which you currently receive through the SARs 
mechanism?
    Mr. Pollard. We will not have a SARs. We will develop our 
own form. With the help of some of the folks I mentioned before 
you came in, Ms. Maloney, relating to the law enforcement 
personnel. We hope to develop a form that will be very useful 
to everyone, including enterprises in the long run.
    What I would note is our rule includes a provision that 
should another agency, Treasury or someone else, or the 
Congress passes Bank Secrecy Act reforms that requires another 
form, OFHEO will look at that form, and if it works we will 
accept that form.
    Mrs. Maloney. Do you believe that the procedures that 
Fannie has put in place internally will be more effective in 
detecting mortgage fraud in the future?
    Mr. Pollard. I would have to tell you that right now that 
is under our examination staff. We are reviewing them to 
determine if, first, they have fixed the problems of the past, 
and second, whether they should be enhanced. So I would not 
want to give you an answer to that today.
    Mrs. Maloney. Okay. Also, representing OFHEO, given the 
facts that were available at the time of this investigation 
with Beneficial, do you believe that Fannie Mae should have 
concluded that First Beneficial was engaged in deliberate 
fraud, and should that suspicion have been reported to you?
    Mr. Pollard. I think our major concerns were, in learning 
of this, was first, what were Fannie Mae's decisions about what 
constituted fraud or suspicious activities. I have heard a lot 
about ineligible loans. If you are passing all of your 
transactions through a sieve of is it ineligible under our 
standards, and not also passing them through is there 
suspicious activity, then they may not have considered them 
suspicious.
    In terms of reporting to us, we had a rather informal 
system of expecting major items to be reported to us. We are 
still investigating whether, and as Mr. Smith admitted, the 
regional office was so isolated and decentralized that they 
would have not reported to the Washington office, the 
headquarters, with whom we normally deal. So I guess my answer 
to your question is we are still investigating to get a solid 
answer to that.
    Mrs. Maloney. Okay. Who is representing Ginnie Mae? 
Anybody? Okay.
    Did the North Carolina authorities that contacted Fannie 
also contact you about their concerns?
    Mr. Kennedy. No, not at that time.
    Mrs. Maloney. They did not contact you?
    Mr. Kennedy. Not at the time that the case first was 
initiated.
    Mrs. Maloney. Okay. And what new procedures have you put in 
place to prevent the purchase of fraudulent loans, to prevent 
this happening in the future?
    Mr. Kennedy. Almost immediately after the case was referred 
to the U.S. Attorney's office in North Carolina, Ginnie Mae 
instituted an expedited process whereby instead of waiting, the 
previous policy that required a look at an issue within a year 
to see whether or not the documents were in the file, Ginnie 
Mae what we call a profile. The profile looked at each and 
every Ginnie Mae issuer to determine whether or not that issuer 
was within the normal ranges. For example, on the issue of 
mortgage insurance, the normal range is that after a period of 
time it was roughly 95 percent. Based on that kind of a review, 
this kind of fraud could not be repeated.
    Going back to the question of our involvement with bank 
examiners, if we ever receive a call that indicates that there 
is a potential criminal case, all Federal employees are under 
an obligation, under an executive order that I think was signed 
in 1990, that requires us to report that information to the 
investigation authority within HUD, which is the IG. In this 
case, that was done immediately, literally I think I got a call 
concerning the matter in New York, and within an hour I walked 
down to the IG one floor away and reported the information that 
I had gotten concerning the matter in New York, which had the 
appearance to me of a potential fraud. Potential, I did not 
know.
    It is not my job to investigate that, but it is my job to 
report that. That leads to investigations which then permits 
the agency at the end of the investigation, at the end of the 
criminal process, to initiate administrative sanctions under 
existing rules, under a statute passed by this Congress called 
the mortgagee review board that permits us to discipline 
lenders who violate the law or who violate the requirements of 
HUD.
    Mrs. Kelly. Thank you very much, Ms. Maloney. Your time is 
up.
    Mr. Davis?
    Mr. Davis of Kentucky. Thank you, Madam Chair.
    I have a question for the Inspector General. Just 
considering the magnitude of fraud that seems to be getting 
rooted out through various GSEs, hearing this is very 
disturbing to me. I was curious if you could share with the 
panel the loss to the American taxpayer in dollars.
    Mr. Donohue. In regard to this matter, sir?
    Mr. Davis of Kentucky. Yes.
    Mr. Donohue. Yes. The stated amount I believe is $32 
million in total losses, calculated by Ginnie Mae in this 
matter.
    Mr. Davis of Kentucky. How much of that has actually been 
recovered?
    Mr. Donohue. The forfeiture action is $7.5 million, and a 
number of forfeiture seizures against the defendants in this 
case total $15 million in recovery.
    Mr. Davis of Kentucky. Do you anticipate more to be 
recovered?
    Mr. Donohue. No comment, sir.
    Mr. Davis of Kentucky. Okay. Thank you.
    I yield back.
    Mrs. Kelly. Thank you, Mr. Davis.
    Mr. Pollard, in your statement on the very last page of 
your testimony for us today, you indicate that you were looking 
at Fannie Mae's operations to examine whether or not they were 
excessively decentralized and uncontrolled, lacked adequate 
reporting and quality control, failed to distinguish functions 
between business development and problem workouts, and 
generally did not hold regional offices sufficiently 
accountable, that they did not take effective action to remedy 
deficiencies that they discovered, or to act in a timely manner 
to end their relationship with entities.
    I would like you to elaborate on what you found if you can 
go beyond just those words.
    Mr. Pollard. I really have to leave it at that point based 
on my job and what the examiners do at our agency. What I would 
tell you is these subjects and some that have been provided to 
the committee in the letters from Fannie Mae and even in Mr. 
Smith's statement today, we are trying to go a bit deeper, a 
bit further in the operational side. For example, one of the 
things we mentioned today is whether individuals who are in 
charge of making loans or making business arrangements in this 
case are also the same ones who are supposed to fix them. In 
the banking industry, if you make a loan and it does not go 
well, that is okay, but you have a workout team that takes it 
up and tries to clean it up and maybe recover some of the 
money. They have additional obligations.
    So if you would bear with me today, I would simply say that 
I feel our exam, these are the topics that we are looking into, 
but since that is ongoing and we are interviewing people, I 
have to leave it at that point today.
    Mrs. Kelly. I would hope that you would get back to this 
committee when you discover an end-point in your 
investigations.
    OFHEO recently entered into an agreement with the Fannie 
Mae board of directors, and then the board I believe agreed to 
make significant improvements to the internal controls of the 
company. Is the activity that has been discussed before the 
committee this morning representative of the lack of internal 
controls that OFHEO has found?
    Mr. Pollard. First, I may comment that we have directed the 
board not only to undertake fixing internal controls, but to 
get outside help along with whatever help OFHEO will afford in 
this instance. So while we are looking at it ourselves, they do 
have additional parties. Our focus was on accounting. It is 
quite clear that controls of a general nature may affect what 
was going on in accounting. So we have, yes, identified all 
controls. Is this another example, a decentralization, a lack 
of control, even a lack of support for regional offices, as 
well as a lack of quality control emblematic of that? Yes, I 
believe so.
    Mrs. Kelly. Does anyone on this panel know, Mr. Smith, Mr. 
Donohue, Mr. Pollard, Mr. Kennedy, can you tell me whether or 
not Fannie Mae still is, among its 40 goals as Mr. Smith 
testified his bonus was tied to, is that still one of the 40 
goals of Fannie Mae, making sure that Fannie Mae does well so 
that they get more money as a bonus?
    I will take an answer from anyone.
    Mr. Pollard. I will answer in saying that it is a subject 
of our investigation, the level, is there a tie. But 
additionally, if an individual, as I said, is incented to make 
loans and to work them out, that may have a perverse incentive, 
without being specific that you should not have bad loans. It 
simply creates a situation where the two are sort of impossible 
to untangle. So we will be looking at compensation in this 
particular matter, and again that is the topic heading that we 
are following right now.
    Mrs. Kelly. Thank you.
    Anyone want to add to that?
    Mr. Smith. Well, certainly at Fannie Mae from my aspect, it 
is an important part of my job to ensure that we properly 
manage Fannie Mae's credit losses. The repurchase of ineligible 
loans is just a small piece of that. We also for any loan that 
goes toward foreclosure, goes seriously delinquent, we put 
forth great effort to work with the individual homeowner in 
loss mitigation efforts so that not only does Fannie Mae not 
have to take over the REO and sell the property and displace 
the homeowner, but we actively try to find a way to keep the 
homeowner in the property.
    So I would say that in reaction to your question, managing 
credit losses is a very important part of what Fannie Mae is 
focused on.
    Mrs. Kelly. Okay. I have a question for you, Mr. Kennedy, I 
am a little curious about. Why was Ginnie Mae purchasing 
conventional loans? That is not really their normal course of 
business, is it? How did this happen?
    Mr. Kennedy. No. The loans in question were not viewed by 
Ginnie Mae as being conventional loans. There were fraudulent 
certifications in paperwork submitted to Ginnie Mae indicating 
that the loans were in fact FHA-insured. As I indicated 
earlier, both the principal in First Beneficial, James McLean, 
and for example the auditor, they had misled, they had 
falsified the documents. They had submitted false certification 
and information to Ginnie Mae. Ginnie Mae was under the 
impression at that time, based on the information that was 
available, that they were in fact FHA loans.
    When the scheduled audit that Ginnie Mae scheduled with 
them was commenced in August of 2000, very quickly it became 
clear that there was a fraudulent situation here and immediate 
action was taken on the part of Ginnie Mae to correct that and 
to default the issuer for the very reason that the loans were 
not in fact FHA-insured. They have to be under the law to be in 
the Ginnie Mae pool.
    Mrs. Kelly. Thank you.
    I have one final question for you, Mr. Pollard. With regard 
to your proposed rule, will Fannie and Freddie be obligated to 
inform law enforcement agencies or other governmental 
organizations when fraud is discovered? Or is this just going 
to be a mere notice? Will there be a rational reason for the 
law enforcement people to follow up?
    Mr. Pollard. First, the rule does not provide for that. 
However, we are looking and working through what will be 
required in the instructions and to whom notice should be 
provided. First will be providing notice to us. As I mentioned, 
we are looking at what we can do to smoothly and at the same 
time afford protections to the enterprises and transfer that 
information. But we believe that when a fraud has been 
identified, there should be no inhibition on going to a state, 
federal, almost anybody you can contact in law enforcement and 
tell them there is a fraud.
    In this area of suspicious activities, that makes it a bit 
difficult, but again I believe that we will work through to 
some processes that may make that more doable. That is the best 
I can tell you at this time.
    Mrs. Kelly. I thank you.
    I think that what has occurred here this morning has been 
very interesting. I hope it makes a very clear statement that 
we in Congress expect the people who are operating government-
secured enterprises to have a moral and ethical obligation to 
the people of the United States not to defraud them and to root 
out fraud wherever there is a possibility of it. I think it is 
very clear.
    I thank all of you very much for your indulgence, for being 
here for such a long period of time. This has been an 
interesting hearing. The Chair notes that some members may have 
additional questions for the panel. They may wish to submit 
those questions in writing, so without objection the record 
will remain open for 30 days for members to submit written 
questions to these witnesses and to place their responses in 
the record.
    With that, this hearing is adjourned. Thank you very much.
    [Whereupon, at 12:13 p.m., the subcommittee was adjourned.]


                            A P P E N D I X



                             March 10, 2005


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