May 23, 2006
Fannie Mae to Pay $400 Million in Fines
By JEREMY W. PETERS, NYTimes

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Fannie Mae, the mortgage giant accused of inflating its earnings while rewarding executives with rich bonuses, reached an agreement with the federal government today to pay a $400 million fine.

Accusing former Fannie Mae executives of operating an "arrogant and unethical" corporate culture, federal regulators condemned the company in a report today that detailed a pattern of systematic financial manipulation at the company's highest levels.

"Senior management manipulated accounting; reaped maximum, undeserved bonuses; and prevented the rest of the world from knowing," James B. Lockhart, acting director of the Office of Federal Housing Enterprise Oversight, said in a statement.

In the report, the Office of Federal Housing Enterprise Oversight puts much of the blame on Fannie Mae's senior-most managers, namely former chief executive, Franklin D. Raines, who received $52 million in bonuses from 1998 to 2003 because of what was perceived at the time to be legitimate earnings growth.

As the report concludes, Fannie Mae's financial results during that time were "illusions deliberately and systematically created by senior management." The Officer of Federal Housing Enterprise Oversight said Fannie Mae created this elaborate facade by using a variety of improper accounting procedures, like shifting earnings to future years when financial targets for the current year appeared likely.

The federal agency also blamed Fannie Mae's board for allowing the financial mismanagement to go undetected by failing to scrutinize the business decisions of senior executives.

"Senior executives worked strenuously to hide Fannie Mae's operational deficiencies, significant risk exposures, and improper earnings management to smooth earnings from outside observers" the report said.

While the settlement will help Fannie Mae move past an embarrassing scandal that forced out some of the company's highest-ranking managers and has dented its political clout, today's report raises fresh questions about the current chief executive, Daniel Mudd, who has taken steps over the past two years to overhaul the company's business practices. Mr. Mudd, who served as chief operating officer when some of the company's most serious accounting violations were taking place, was known only to have had a minimal role in the scandal.

But today's report says that when three Fannie Mae employees expressed concern about the company's accounting practices in 2003, Mr. Mudd failed to follow up on the complaint.

As part of the settlement, Fannie Mae neither admitted nor denied wrongdoing. Mr. Mudd said in a statement that the company had changed. "We have all learned some powerful lessons here about getting things right and about hubris and humility," he said. "We also recognize that we have a long road ahead of us."

The Office of Federal Housing Enterprise Oversight also included a number of recommendations in its report for preventing further accounting abuses at Fannie Mae. These include limiting the company's future growth and developing new procedures for oversight of the board of directors.

But for Fannie Mae, the biggest change could come not to its organizational structure but to its political influence. Always one of Washington's major lobbying forces, experts said Fannie Mae's ability to sway legislators and resist Congressional oversight could be further diminished by the latest report.

"There's been a steady progression where Fannie Mae has ceased to be the unstoppable force that it was," said Jonathan Koppell, a professor of politics and management at Yale. "There's no doubt that the new report, which is a fairly stark indictment, brings Fannie down from the perch that it once occupied."

He added, "There's no doubt that their virtue is in question and their unassailability is gone."

Because of Fannie Mae's sheer size and reach into the American economy, however, there are limits to how much the company's clout could be curtailed, Mr. Koppell said. "Their business reaches into every Congressional district," he said. "Their welfare is intertwined with the welfare of millions of American homeowners. And so what they tell Congress is something that every member of Congress will continue to have to take seriously."

The report from the Office of Federal Housing Enterprise Oversight is the latest in a series of highly critical assessments of Fannie Mae's financial practices. In February, Fannie's board released a 616-page independent report, by a team of investigators led by former Senator Warren B. Rudman, concluding that the company's accounting practices in virtually all of the areas reviewed were not consistent with generally accepted accounting principles.

Fannie Mae's $400 million settlement is more than three and a half times the fine Freddie Mac, its smaller rival in the mortgage business, paid in 2003. In that case, federal regulators determined Freddie Mac understated earnings by about $5 billion from 2000 to 2002.

Fannie Mae Fined $400M for Bad Accounting

WASHINGTON, May 24, 2006 (AP Online via COMTEX) -- Federal regulators issued a blistering report about mortgage giant Fannie Mae on Tuesday, alleging accounting manipulation aimed at lining executives' pockets and lying to investors about smooth growth in profits and earnings. The government-sponsored mortgage company was fined $400 million and agreed to limit its growth.

The long-awaited report by the Office of Federal Housing Enterprise Oversight came as Fannie Mae, which has not filed an earnings statement since late 2004, corrects its accounting and struggles to emerge from an $11 billion scandal. The product of an extensive three-year investigation, the housing oversight agency's report is tougher in its criticism than an assessment ordered by Fannie Mae's board that was released in February.

The OFHEO review, involving nearly 8 million pages of documents, details what the agency describes as an arrogant and unethical corporate culture, calling Fannie Mae's image of company prestige and excellence a sham. It said Fannie Mae employees manipulated accounting so that senior executives could collect millions in bonuses from 1998 to 2004.

OFHEO and the Securities and Exchange Commission announced a $400 million civil penalty against Fannie Mae, the largest U.S. buyer and guarantor of home mortgages, in a settlement over the alleged accounting manipulation. Of that amount, the $350 million assessed by the SEC _ one of its biggest penalties ever in an accounting fraud case _ will go to compensate Fannie Mae investors damaged by the alleged violations.

The company also agreed to limit the growth of its multibillion-dollar mortgage holdings, capping them at $727 billion, and to make top-to-bottom changes in its corporate culture, accounting procedures and ways of managing risk.

Twenty-nine current and former executives and employees _ including former chairman and chief executive Franklin Raines and former chief financial officer Timothy Howard _ will be reviewed for possible disciplinary action or termination.

Daniel Mudd, the company's president and CEO, will lead the review. His conduct already has been examined by the board and found to present no problems, company officials said.

"It is very important that we look at Dan through the leadership that he has given this company over the last 18 months," Fannie Mae Chairman Stephen Ashley said during a conference call Tuesday with analysts. The review of Mudd "gives us no reason to express anything other than complete confidence in Dan Mudd's leadership of this company," he said.

Washington-based Fannie Mae neither admitted nor denied wrongdoing under the settlement but did agree to refrain from future violations of securities laws.

The report details a series of events in the fall of 2003 involving Mudd, who was then the chief operating officer, in which an employee named Michelle Skinner expressed serious concerns in an e-mail to him about the company's accounting. The issues were similar to those raised by then-Fannie Mae accountant Roger Barnes to other company officials about a month earlier. Mudd did not deal appropriately with Skinner's concerns and "missed an opportunity" to recognize potential problems, the report says.

That was a year before the OFHEO regulators brought to light Fannie Mae's accounting-rule violations and alleged earnings manipulation to meet Wall Street targets _ disclosures that stunned the financial markets. In December 2004, the SEC ordered the company to restate its earnings back to 2001 _ a correction expected to reach an estimated $11 billion. The Justice Department has been pursuing a criminal investigation.

Raines and Howard were swept out of office by Fannie Mae's board in December 2004.

"The image of Fannie Mae as one of the lowest-risk and 'best in class' institutions was a facade," James B. Lockhart, OFHEO's acting director, said in a statement as the report was released. "Our examination found an environment where the ends justified the means. Senior management manipulated accounting, reaped maximum, undeserved bonuses, and prevented the rest of the world from knowing."

The report also faulted Fannie Mae's board of directors for failing to discover "a wide variety of unsafe and unsound practices" and to act independently of Raines.

From 1998 to mid-2004, the smooth growth in profits and precisely hit earnings targets that Fannie Mae reported each quarter were "illusions" deliberately created by senior management using faulty accounting, the report says.

The Bush administration has been pushing for legislation to reduce the massive mortgage portfolios of Fannie Mae and its smaller government-sponsored sibling, Freddie Mac.

The report "shows that Fannie Mae's faults were not limited to violating accounting and corporate governance standards, but included excessive risk-taking and poor risk management as well," Randal Quarles, Treasury undersecretary for domestic finance, said in a statement. "OFHEO's findings are a clear warning about the very real risk the improperly managed investment portfolios of (Fannie Mae and Freddie Mac) pose to the greater financial system."

Fannie Mae said its board has read the report and is committed to making the changes required under the deal with the regulators.

"We are glad to resolve these matters. We have all learned some powerful lessons here about getting things right and about hubris and humility," Mudd said in a statement. "We are a much different company than before. But we also recognize that we have a long road ahead of us."

The accounting manipulation tied to executives' bonuses occurred from 1998 to 2004, according to the report, a much longer period than was previously known. It "made a significant contribution" to Raines' compensation, which totaled more than $90 million from 1998 to 2003, the report says, including some $52 million directly tied to the company hitting earnings targets.

OFHEO levied a record $125 million fine in 2003 against Freddie Mac for misstating earnings - mostly underreporting them - by $5 billion for 2000-2002.

SEATTLE POST-INTELLIGENCER

What went wrong at Fannie Mae? Answer is 6.46
Sunday, June 4, 2006
By MARK TRAHANT, P-I EDITORIAL PAGE EDITOR

The answer is 6.46.

"You must have 6.46 branded in your brains. You must be able to say it in your sleep, you must be able to recite it forwards and backwards, you must have a raging fire in your belly that burns away all doubts, you must live, breathe and dream 6.46, you must be obsessed by 6.46," a corporate officer told his colleagues in the year 2000.

This was no ordinary company. It was Fannie Mae, a government-sponsored private company that helps banks finance mortgages, and the company vice president was not a cheerleader or a sales manager but the senior vice president in charge of internal audits.

"That tone at the top permeated all levels of Fannie Mae, and the $6.46, the Earnings Per Share goal, became the corporate mantra -- everything else was secondary to hitting the target," says a May 2006 special examination by regulators at the Office of Federal Housing Enterprise Oversight. Even Fannie Mae's auditor "fell under its spell."

And what a spell. "After all, thanks to Frank, we all have a lot of money riding on it," wrote the auditor. "Remember, Frank has given us an opportunity to earn not just our salaries, benefits, raises ... but substantially over and above if we make 6.46. So it is our moral obligation to give well above our 100 percent."

"Frank" is Franklin D. Raines, then the chairman and chief executive officer of Fannie Mae, and earnings of 6.46 per share was the answer to Raines' ambitious goal of a perfect corporate model, delivering profits to shareholders no matter what was happening in the economy. Fannie Mae was "best in class" -- delivering a "new global model" for financial soundness, transparency and market discipline.

The number 6.46 makes a great symbol for what the May report calls "promoting a false image."

But this story doesn't start with a number, it starts in 1970. Franklin Raines, a recent graduate of Seattle's Franklin High, was only 20 years old when President Nixon named him to a national board on the education of disadvantaged children. He was attending Harvard and was one of three youth who briefed the president on the "thinking and behavior of American youth." After Harvard, Raines went to Oxford as a Rhodes scholar before returning to Seattle as deputy director of Seattle's Model City Program.

A few years later Raines moved to the other Washington, working in the administrations of President Nixon, then, President Carter and eventually President Clinton as the director of the Office of Management and Budget.

Clinton called Raines a "brilliant" OMB director and said he understood why Raines (by then also a former investment banker) would take the Fannie Mae job in 1997 because it was a "wonderful, once-in-a-lifetime opportunity in the private sector."

The mix of government and private sector experience was the perfect image for Fannie Mae. "The message was: what is good for Fannie Mae is good for housing and the nation," the regulators' report said. "Senior executives used that image and their political influence to ensure that Fannie Mae operated under rules that differed from those applied to other corporations."

The May 2006 report said Raines made early decisions in his new job that "set an inappropriate tone at the top that permeated Fannie Mae throughout his chairmanship." The enterprise missed its earnings goal in 1997 by a wide enough margin to reduce compensation for the top managers, and it looked like it could happen again in 1998. The new top boss was determined not to let that happen -- a problem that only grew worse with a fall in interest rates and increasing mortgage prepayments as people refinanced. An accurate recording of that problem would have caused Fannie Mae to miss its Earning Per Share target -- and it would result in no bonuses for Fannie Mae leaders.

According to last month's report, Fannie Mae, after its books were closed, went back through the numbers and used a number of "cookie-jar" accounting tricks to improve the perception of its earnings. "Thus, from the very beginning of Mr. Raines' tenure as CEO, his goal was clear: EPS results mattered, not how they were achieved," the report said.

How big a deal was this misleading image?

"That corporate culture ultimately led to declines in the market value of Fannie Mae in the tens of billions of dollars," federal regulators wrote. The direct cost to Fannie Mae will exceed $1.3 billion in 2005 and 2006 alone.

Raines and other executives benefited from the perception of steady growth and profits. Raines' compensation went from $6.5 million in 1998 to $24 million in 2004.

Fannie Mae hasn't gotten the same sort of attention as Enron. But perhaps this scandal is more important because it reflects systemic issues about Corporate America. Where was the board of directors? Or, more important, where is the board of directors now?

Federal regulators said Raines as chairman tightly controlled what information went to the board. But then again the board didn't go out of its way to demand accountability. "Specifically, the board abandoned its check-and-balances oversight responsibilities; acquiesced in allowing management unbridled authority over its agenda, materials and minutes ... in fact the board allowed management to determine with little opposition the information it received and missed many opportunities for meaningful oversight," the regulators' report said.

The May report did not find a single example of board members questioning how Fannie Mae could meet its Earnings Per Share targets "so consistently and often to the penny."

When asked about this, the audit committee chairman told regulators that it had become a "general presumption that the nature of (Fannie Mae's) business allowed for fairly steady earnings per share growth."

It would be better if board members occasionally challenged basic assumptions about the nature of the business and act more independently from management.

That is difficult in a culture where there are tangible benefits to board service.

Fannie Mae board members could recommend grants to charities. Thomas P. Gerrity was Fannie Mae's audit committee chairman (he is no longer committee chairman, but still on Fannie Mae's board) and a professor of management at the Wharton School at the University of Pennsylvania. The Fannie Mae Foundation granted $687,500 to Wharton, the May report said. Another board member, H. Patrick Swygert, is president of Howard University, and that school received more than $225,000 in foundation grants since 2000, the report says.

Fannie Mae and the Office of Federal Housing Enterprise Oversight reached a "comprehensive settlement" changing the way the enterprise does its business. Some of those proposals tinker with the structure, looking at capital requirements, reporting lines and other operational issues. Stephen B. Ashley, Fannie Mae's chairman, said the settlement would end these issues. The board has even read the report -- and will "implement the terms of the settlement."

I think we need a broader look: Fannie Mae is a government-sponsored private company. What ought to be the public policy role here -- and how much say should the public have in its governance? Why is the same board of directors that presided over the Raines' era still in charge? When a company's governance misfires, shouldn't the board be held as accountable as the officers?

Raines took "early retirement" at 55 years old in 2004. One study suggests his retirement package could be worth as much as $25 million. Just weeks before the end of his term he told Congress that if the company made "significant mistakes" he hoped the board and shareholders would hold him accountable. "And I'll hold myself accountable," he added.

And what about the culture of 6.46? I think that number suggests we ought to demand that corporations -- especially one as important as Fannie Mae -- rethink the metrics they use to measure success.

"We are glad to have resolved these matters," Daniel H. Mudd, Fannie Mae's president and CEO, said in a news release. "We have all learned some powerful lessons here about getting things right and about hubris and about humility. We are a much different company than before. But we also recognize that we have a long road ahead of us."

The same could be said for Corporate America -- and what our nation requires as its standards for governance, accountability and compensation.

Mark Trahant is editor of the editorial page. E-mail: marktrahant@seattlepi.com

© 1998-2006 Seattle Post-Intelligencer

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Freddie Mac

Office of Federal Housing Enterprise Oversight

Securities and Exchange Commission

May 24, 2006
Regulators Denounce Fannie Mae
By ERIC DASH, NY TIMES

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Federal regulators said yesterday that financial results at Fannie Mae, the nation's largest buyer of mortgages, were "illusions deliberately and systematically" created by its top executives in an $11 billion accounting scandal.

The finding was in a blistering report by the Office of Federal Housing Enterprise Oversight, or Ofheo, after a 27-month investigation into Fannie Mae's corporate culture and accounting practices.

The company also agreed yesterday to pay $400 million to settle with Ofheo and the Securities and Exchange Commission.

The Ofheo report details the close involvement of Franklin D. Raines, the former chairman and chief executive of Fannie Mae  formally the Federal National Mortgage Association  in manipulating earnings and creating an "unethical and arrogant culture" at the top. Of the $90 million he was paid from 1998 to 2003, more than half, or at least $52 million, was tied to bonus targets that regulators say were reached by manipulating accounting.

Yesterday's settlement leaves the door open for the S.E.C. to go down the difficult road of retrieving any illicit gains from its former managers.

Paul R. Berger, an associate director of enforcement at the S.E.C., said: "The action that we took today addresses the company itself, and should the commission bring actions against individuals, one of the remedies it could seek is the disgorgement of ill-gotten gains. Our investigation is continuing at this time."

And Ofheo has given Fannie Mae's board 60 days to determine whether current and former employees named in the report should be fired or return any "unjust enrichment." But it put the onus on the company to get the money back.

The report also raised questions about the current chief executive, Daniel H. Mudd. While chief operating officer under Mr. Raines, Mr. Mudd listened as employees expressed concerns about Fannie Mae's accounting practices during an informal 2003 meeting, but in the view of the regulator, did not adequately follow them up.

Mr. Mudd, in an interview yesterday, said he did not consider the matter to be "an investigation" at the time, but in hindsight, "I absolutely wish I had handled it differently."

In a conference call with investors yesterday afternoon, Stephen Ashley, Fannie Mae's chairman, said the board was aware of the situation when it named Mr. Mudd as chief executive last year and "gives us no reason to express anything but complete confidence in Dan Mudd's leadership."

The settlement with regulators will temporarily limit Fannie's mortgage portfolio at the 2005 level of $727 billion, halting its main engine of its growth until Ofheo determines that accounting and risk management controls are up to snuff.

The agreement also specifically barred Mr. Raines and the former chief financial officer, J. Timothy Howard, from ever working for Fannie Mae again.

A lawyer for Mr. Raines said in a statement that the former chairman "has repeatedly stated that he never authorized, encouraged, or was aware of violations of Generally Accepted Accounting Principles (GAAP) at Fannie Mae for the purpose of smoothing earnings, reaching bonus targets, or for any other improper reason."

"Nevertheless," he continued, "Mr. Raines promised in October of 2004 that he would hold himself accountable if it was determined that Fannie Mae misapplied accounting rules."

A lawyer for Mr. Howard declined to comment.

Under the settlement, Fannie Mae will pay civil penalties of $50 million to the government and $350 million to a harmed shareholders' fund within the next 10 days.

For Fannie Mae, the Ofheo report and the regulatory settlement were considered important steps in moving beyond the nearly $11 billion accounting scandal that led to a major management reshuffle and a severe shakeup in its corporate culture. The company has spent more than $1 billion to improve its internal controls, trying to get its financial house in order so it can issue revised financial reports and remain on the New York Stock Exchange.

"This report is strong medicine," Mr. Mudd said during the conference call. "It is what Fannie Mae needed, and strong medicine is what we received today."

He was characteristically upbeat about Fannie Mae's ability to have the portfolio limits lifted, but gave little hint of how long it would take.

In trading yesterday, Fannie Mae shares closed at $50.72, up 45 cents, but they are down 28 percent from when Mr. Raines left as chief executive in December 2004.

"I think that people are actually taking this to mean that Ofheo's issues are behind them," said Josh Rosner, an independent financial services analyst with Graham Fisher & Company. "I think that is the wrong answer, the wrong approach and the wrong interpretation.

"Really, what it means is that Fannie's fixing of their problems is going to take a lot more money and a lot more time than anyone had anticipated. And as they fix their problems, it will necessarily make it harder for them to execute going forward."

Ofheo's findings could also provide a jolt of momentum for new laws sharply limiting Fannie Mae's mortgage portfolio holdings and could create a tougher regulatory environment for all government-sponsored enterprises  a position the Bush administration strongly supports.

A Treasury under secretary, Randal Quarles, said: "The portfolios grew to their present size as a result of earnings and earnings management, not as a result of their public mission" to promote low-income housing. If anything, this underscores the need for a comprehensive legislative solution and one that empowers the regulator by not just giving it authority, but a clear legislative mandate."

In July, the Senate Banking Committee approved a tough measure on a party-line vote while the House passed a less restrictive bill late last year. Now, with time running out on this year's Congressional calendar, the prospects for passing new legislation are dimming.

Ofheo's lengthy report  based on more than 7.6 million pages of documentation and hundreds of interviews with Fannie Mae executives, employees and outside lawyers and accountants  came after the regulatory agency released their preliminary findings in September 2004.

The report accused Fannie Mae executives of using improper "cookie jar" reserves and deferred expenses to smooth earnings and meet profit targets. That, in turn, prompted hearings on Capitol Hill, an investigation by the Justice Department that is continuing, and ultimately, the departures of Mr. Raines and Mr. Howard in December 2004.

Around the same time, Fannie Mae's board commissioned a team of outside lawyers and investigators, led by former Senator Warren B. Rudman, to conduct a similar review.

In February, their findings were released in a 616-page report that concluded that Fannie Mae's accounting practices in virtually all the areas examined were not consistent with generally accepted accounting principles.

Yesterday's Ofheo report, however, took a far more critical tone, painting a portrait of executives who deliberately and intentionally manipulated earnings to increase their bonuses and a frequently conflicted board that largely stood by."We all agreed on the accounting issues," the acting director of Ofheo, James B. Lockhart, said. "We really looked at the motivations and came to some different conclusions."

Among them, he said was that senior management was involved in earning manipulation year in and year out, and they made sure that reported earnings equaled the maximum for their bonus in every reported year from 1998 to 2004.

But the Rudman report traced many of the violations to two former top executives, Mr. Howard and the controller, Leanne Spencer. It stopped short of Mr. Raines.

Ofheo's investigation placed him at the center of the company's accounting problems by fostering an arrogant and unethical tone at the top.

The Ofheo report also offered evidence suggesting that Fannie Mae's senior management sought to interfere with Ofheo's special examination by directing its lobbyists to use their ties to Congressional staff members. The Rudman report did not.

Michael J. de la Merced contributed reporting to this article.

Report: Fannie Mae Manipulated Accounting

LINK

WASHINGTON, May 24, 2006 (AP Online via COMTEX) -- Federal regulators issued a blistering report about mortgage giant Fannie Mae on Tuesday, alleging accounting manipulation aimed at lining executives' pockets and lying to investors about smooth growth in profits and earnings. The government-sponsored mortgage company was fined $400 million and agreed to limit its growth.

The long-awaited report by the Office of Federal Housing Enterprise Oversight came as Fannie Mae, which has not filed an earnings statement since late 2004, corrects its accounting and struggles to emerge from an $11 billion scandal. The product of an extensive three-year investigation, the housing oversight agency's report is tougher in its criticism than an assessment ordered by Fannie Mae's board that was released in February.

The OFHEO review, involving nearly 8 million pages of documents, details what the agency describes as an arrogant and unethical corporate culture, calling Fannie Mae's image of company prestige and excellence a sham. It said Fannie Mae employees manipulated accounting so that senior executives could collect millions in bonuses from 1998 to 2004.

OFHEO and the Securities and Exchange Commission announced a $400 million civil penalty against Fannie Mae, the largest U.S. buyer and guarantor of home mortgages, in a settlement over the alleged accounting manipulation. Of that amount, the $350 million assessed by the SEC _ one of its biggest penalties ever in an accounting fraud case _ will go to compensate Fannie Mae investors damaged by the alleged violations.

The company also agreed to limit the growth of its multibillion-dollar mortgage holdings, capping them at $727 billion, and to make top-to-bottom changes in its corporate culture, accounting procedures and ways of managing risk.

Twenty-nine current and former executives and employees _ including former chairman and chief executive Franklin Raines and former chief financial officer Timothy Howard _ will be reviewed for possible disciplinary action or termination.

Daniel Mudd, the company's president and CEO, will lead the review. His conduct already has been examined by the board and found to present no problems, company officials said.

"It is very important that we look at Dan through the leadership that he has given this company over the last 18 months," Fannie Mae Chairman Stephen Ashley said during a conference call Tuesday with analysts. The review of Mudd "gives us no reason to express anything other than complete confidence in Dan Mudd's leadership of this company," he said.

Washington-based Fannie Mae neither admitted nor denied wrongdoing under the settlement but did agree to refrain from future violations of securities laws.

The report details a series of events in the fall of 2003 involving Mudd, who was then the chief operating officer, in which an employee named Michelle Skinner expressed serious concerns in an e-mail to him about the company's accounting. The issues were similar to those raised by then-Fannie Mae accountant Roger Barnes to other company officials about a month earlier. Mudd did not deal appropriately with Skinner's concerns and "missed an opportunity" to recognize potential problems, the report says.

That was a year before the OFHEO regulators brought to light Fannie Mae's accounting-rule violations and alleged earnings manipulation to meet Wall Street targets _ disclosures that stunned the financial markets. In December 2004, the SEC ordered the company to restate its earnings back to 2001 _ a correction expected to reach an estimated $11 billion. The Justice Department has been pursuing a criminal investigation.

Raines and Howard were swept out of office by Fannie Mae's board in December 2004.

"The image of Fannie Mae as one of the lowest-risk and 'best in class' institutions was a facade," James B. Lockhart, OFHEO's acting director, said in a statement as the report was released. "Our examination found an environment where the ends justified the means. Senior management manipulated accounting, reaped maximum, undeserved bonuses, and prevented the rest of the world from knowing."

The report also faulted Fannie Mae's board of directors for failing to discover "a wide variety of unsafe and unsound practices" and to act independently of Raines.

From 1998 to mid-2004, the smooth growth in profits and precisely hit earnings targets that Fannie Mae reported each quarter were "illusions" deliberately created by senior management using faulty accounting, the report says.

The Bush administration has been pushing for legislation to reduce the massive mortgage portfolios of Fannie Mae and its smaller government-sponsored sibling, Freddie Mac.

The report "shows that Fannie Mae's faults were not limited to violating accounting and corporate governance standards, but included excessive risk-taking and poor risk management as well," Randal Quarles, Treasury undersecretary for domestic finance, said in a statement. "OFHEO's findings are a clear warning about the very real risk the improperly managed investment portfolios of (Fannie Mae and Freddie Mac) pose to the greater financial system."

Fannie Mae said its board has read the report and is committed to making the changes required under the deal with the regulators.

"We are glad to resolve these matters. We have all learned some powerful lessons here about getting things right and about hubris and humility," Mudd said in a statement. "We are a much different company than before. But we also recognize that we have a long road ahead of us."

The accounting manipulation tied to executives' bonuses occurred from 1998 to 2004, according to the report, a much longer period than was previously known. It "made a significant contribution" to Raines' compensation, which totaled more than $90 million from 1998 to 2003, the report says, including some $52 million directly tied to the company hitting earnings targets.

OFHEO levied a record $125 million fine in 2003 against Freddie Mac for misstating earnings _ mostly underreporting them _ by $5 billion for 2000-2002.

Key Features of Report on Fannie Mae

LINK

May 23, 2006 (AP Online via COMTEX) -- Key findings of a report on mortgage giant Fannie Mae released Tuesday by the Office of Federal Housing Enterprise Oversight:

_Fannie Mae's senior management promoted an image of the company as one of the lowest-risk financial institutions in the world and the "best in class" in terms of risk management, financial reporting, internal financial controls and corporate governance _ an image that was false.

_Many of the company's accounting policies and practices didn't comply with standard accounting principles, and it had serious problems of financial reporting, internal controls and corporate governance. The accounting errors resulted in Fannie Mae overstating its income and capital in financial reports by an estimated $10.6 billion.

_From 1998 to mid-2004, the company reported smooth growth in profits and hitting of per-share earnings targets each quarter. Those achievements were illusions deliberately created by senior management with the help of faulty accounting.

_By deliberately manipulating accounting to hit earnings targets, senior management maximized the bonuses and other compensation they received, at the expense of shareholders. The manipulation contributed significantly to the compensation of former chairman and chief executive Franklin Raines, which totaled more than $90 million from 1998 to 2003 _ including some $52 million directly tied to hitting earnings targets.

_Fannie Mae's board contributed to the problems by failing to be sufficiently informed, to act independently of Raines and other senior executives, to exercise its oversight responsibilities, and to discover a wide variety of unsafe and unsound practices.

_Senior management didn't make investments in accounting and computer systems and staffing needed to support a sound internal control system and accurate financial reporting. The failure to do so came at a time when Fannie Mae faced many operational challenges stemming from its rapid growth and changing accounting requirements.

_Senior management tried to interfere with OFHEO's review of the company's accounting by directing Fannie Mae's lobbyists to use their ties to congressional aides to improperly produce an official request for the inspector general of the Department of Housing and Urban Development to investigate the agency's conduct of the review. The lobbyists were able to get a provision into an appropriations bill calling for punishing OFHEO by reducing its budget until the agency's director was replaced.

Copyright (C) 2006 The Associated Press. All rights reserved.