Panel II of a Hearing of the Capital Markets Subcommittee of House Committee on Financial Services - The OFHEO Report

Federal News Service October 6, 2004 Wednesday

HEADLINE: PANEL II OF A HEARING OF THE CAPITAL MARKETS SUBCOMMITTEE OF THE HOUSE COMMITTEE ON FINANCIAL SERVICES SUBJECT: THE OFHEO REPORT: ALLEGATIONS OF ACCOUNTING AND MANAGEMENT FAILURE AT FANNIE MAE

CHAIRED BY: REPRESENTATIVE RICHARD H. BAKER (R-LA)

WITNESS: FRANKLIN D. RAINES, CHAIRMAN AND CHIEF EXECUTIVE OFFICER, FANNIE MAE; JIM HOWARD, EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, FANNIE MAE

BODY:

BREAK IN TRANSCRIPT

REP. MEEKS: Thank you, Mr. Chairman. Mr. Raines, Mr. Howard, this may come as a surprise to you, but some people just don't like Fannie Mae's current status in the market, and that's pre-OFHEO's report, et cetera. In fact, this may be a surprise that when OFHEO came here, Mr. Falcon, once before, many members of this Congress criticized them severely and threatened to put them out of business, in fact wanted a new regulatory agency to come in. So some people understand your statements, Mr. Raines, about you don't understand certain things, but let me just let you in on a surprise: Some people don't want you in business-they don't like the success that you've accomplished by putting people with decent roofs and homes and roofs over their heads. Some people just don't like that. And so that might be a surprise to you.

In fact, let me ask: Prior to this hearing that we had where OFHEO was threatened, had there been an occasion or anytime before where OFHEO may have examined Fannie Mae and noted any irregularities or discrepancies in any kind of accounting standards? And I wonder how did they work with you in the past before we had all of these secrets coming up where people don't like what you do?

MR. RAINES: Well, prior to the issuance of this special examination report, all of our exams from OFHEO found that we met or exceeded safety and soundness standards-and that's going back to when OFHEO first organized itself back in I think 1993. So we had never had an outstanding-to my knowledge, never had an outstanding issue with OFHEO on accounting, internal controls, or any other issue. In the course of their examination, they would make recommendations to us, and you know we would adopt them. But when they finished their examinations, we have never had an issue prior to this examination report.

REP. MEEKS: Well, when they made those-when OFHEO was making those recommendations et cetera, in the past had it ever been shared with the press or members of Congress or put in the headlines of the newspapers? Had that ever happened before?

MR. RAINES: No, the examination reports remained confidential until OFHEO makes an annual report to Congress, usually released in June, and then it's made available. But all the examinations are held confidential. And in fact OFHEO has a regime for their examination function, their regular examination function, that holds these things confidential, and we have had very good experience with their regular examination process in that regard.

REP. MEEKS: So this is a relatively new phenomenon that has taken place now as far as your relationship with your regulator?

MR. RAINES: With regard to this special examination, this is very new.

REP. MEEKS: And let me ask-and I know that you have indicated in your testimony thus far that your board-and I understand had agreed to the 30 percent capital surplus because you want to show, you know, you're part of the markets and you're cooperating, et cetera. But I'm curious to know is there any other financial institution that does anything even close to 30 percent?

MR. RAINES: As a mandated surplus? Well, Freddie Mac has a --

REP. MEEKS: Other than Freddie Mac.

MR. RAINES: No, sir, I'm not aware personally of a financial institution that is otherwise solvent that is required to have a mandatory surplus by their regulator. But that's not to say it doesn't exist, but I'm just not aware of it.

REP. MEEKS: And, Mr. Howard, let me just ask you a question-it's my last question, and I'll yield the balance of my time, because I'm just trying to make sure that I understand. According to OFHEO, Fannie Mae misapplied FAS 981 by recognizing only $200 million against expenses for prepaid loans instead of $400 million. And of course you state that Fannie Mae's treatment was correct, and that KPMG agrees with you. Just explain to me why are you right and OFHEO wrong?

MR. HOWARD: Prior to 1998, any amount of this so-called catch-up adjustment, which again was the comparison we made after the fact between the amount that we had brought into income based on an old assumption of average life of the portfolio-remember, there are millions of loans in the portfolio-and a new average life. That difference we had kept track of, but never recorded in current period income. That was the catch-up adjustment.

In 1998, that dollar amount grew to a large size of expense-it was actually closer to $440 million-and we determined that some portion of that likely did represent a true economic cost. So we put together a group within the finance department of portfolio people and controller people to come up with a method of determining the best amount to best reflect true economic substance. The recommendation they made to me and to us at the senior management team was that $240 million was that right amount. So the remaining amount, which wasn't deferred, because it was an amount that never was recorded on the books in previous years-it was kept track of, and that was the audit difference-that turned out to be a judgment that ex poste proved to be correct, because next year we did not have an audit difference that was expense-we had one that was income. So the judgment in retrospect turned out to be correct. It was made as a part of a process that had integrity, and it was independent of any link to compensation.

REP. MEEKS: Thank you.

BREAK IN TRANSCRIPT