Accounts scandal costs mortgage giant $640m

WASHINGTON - Mortgage finance giant Fannie Mae will pay a US$400 million ($640 million) fine after a probe of its US$11 billion accounting scandal blamed management, the board and an "arrogant and unethical" culture for huge profit manipulation.

A scathing report from Fannie's regulator, the US Office of Federal Housing Enterprise Oversight, said employees massaged earnings to trigger bonuses for executives. The board contributed by failing to act independently, the report said.

"They were flat out wrong, or to use the proper regulatory phrase, they were managing Fannie Mae in an unsafe and unsound manner," said James Lockhart, acting director of the regulatory agency, known as Ofheo.

"The image of Fannie Mae as one of the lowest-risk and best-in-class institutions was a false facade. Our examination found an environment where the ends justified the means," he said.

The 340-page report laid out a litany of accounting problems and failures by Fannie Mae's executives, including present chief executive Daniel Mudd.

It said Fannie used its power in Washington to lobby Congress in an effort to interfere with the federal examination of the company's accounting problems. Even after serious accounting problems surfaced, the company failed to take steps to address them, the report said.

The regulator's findings went well beyond a previously issued report from an investigator hired by Fannie that largely insulated current management and the board from blame. Instead, Ofheo painted a picture of an aggressive company that created "illusions" of steady financial success to boost compensation.

"Congress created Fannie Mae to expand homeownership by increasing mortgage financing," said Christopher Cox, chairman of the Securities and Exchange Commission. Fannie Mae describes itself as an instrument of national policy and as a private company with a public mission."

"For that reason, today's announcement is especially bitter because it underscores a breach of trust," Cox said.

While the report was highly critical, its release did not unveil any new, material accounting errors.

That helped Fannie's stock climb in Tuesday's afternoon trade, up 45 cents, or 0.9 per cent, to end at $50.72.

Still, the accounting errors are likely to lead to one of the largest profit restatements in US corporate history, said Linda Thomsen, director of the SEC's enforcement division.

Critics of Fannie Mae, and its sibling company Freddie Mac, jumped on the report to renew their calls for Congress to advance legislation that would stiffen oversight of the Government-sponsored enterprises.

"This report makes it clear that Congress must refocus the GSEs on their mission and minimise their ability to take advantage of their special status by abusing their charter," said Senate banking committee chairman Richard Shelby, an Alabama Republican.

The Treasury Department said the report should get the legislation, now stalled in the Senate, moving again.

"The prospects for legislation are good, and the prospects for legislation in the near term are good," Treasury Undersecretary Randal Quarles told reporters at a briefing.

Fannie's $400 million fine settles matters with Ofheo and the SEC, including fraud charges.

The company did not admit or deny any wrongdoing.

However, the settlement does not affect any action that may be taken against individuals, and the SEC is likely to file charges against former CEO Franklin Raines, Lockhart said.

Ofheo asked Fannie to pursue the disgorgement of former executives' compensation. The agency found US$52 million of Raines' US$90 million in compensation was linked to earnings.

As part of the settlement, Ofheo froze Fannie's mortgage portfolio - the holdings that have become the central focus in the legislative debate on Capitol Hill.

- REUTERS