It was an ambush.
Instead of saluting Falcon for fighting corruption and reckless lending by America’s largest backer of home loans, the Democrats on the committee insulted him, harassed him and questioned his motives. They told him to back off.
As risks grew. Armando Falcon blew the whistle on dangers at Fannie Mae and Freddie Mac. Democrats pretended to see no problem. And four years later, the oceans of bad loans at Fannie and Freddie hit every shore like a tsunami.
In 2004, the Democrats were especially angry that Falcon had just found Fannie Mae’s bookkeeping so faulty that he ordered Fannie Mae to increase its capital reserves -- money it could not touch -- by 30 percent to a total of $40 billion.
They were not kind to the regulator.
* Rep. Maxine Waters: “Mr. Falcon, you have been before this committee before. And you were pretty much on the hot seat on more than one occasion, where you were accused of not doing a good job, not exercising your oversight responsibility, of being incompetent.”
* Rep. Gregory Meeks: “You make strong allegations. And, you know, sometimes you throw things out there. I know. I used to be a prosecutor. And it is very dangerous.”
* Rep. Artur Davis: “That sounds like some kind of an invisible line has been crossed. That sounds to me as if you have gone from being a dispassionate regulator to someone who is very much involved and has a stake in this controversy.”
* Rep. Lacy Clay: “Why can’t we let the SEC decide this issue? Why must we rush past them? This hearing is about the political lynching of [Fannie Mae CEO] Franklin Raines.”
* Rep. Barney Frank: “I don’t see anything in your report that raises safety and soundness problems…. To throw ‘safety and soundness’ around in that thing I think really is, for a regulator, irresponsible.”
This wasn’t a hearing. It was a hushing.
Piggy bank. Since the early 1990s, the Democrats had used Fannie Mae and Freddie Mac as their personal slush fund for pay-offs and favors. They kept the two lending companies (called government-sponsored enterprises) under constant pressure to back home loans to low-income borrowers who couldn’t possibly pay them back. The Democrats also looked to Fannie and Freddie for generous campaign contributions.
Franklin Raines, a Democrat and former OMB director for President Clinton, was Fannie Mae’s chief executive officer in 2004, and the Democrats wanted to keep him there. But Raines was in trouble because it had become clear that Fannie Mae’s management had rigged profit numbers -- “smoothed” them -- to assure Raines and other top executives of big bonuses even in the weak years.
Meanwhile, the Republicans also were taking Fannie Mae and Freddie Mac’s campaign money. Freddie Mac even paid off Newt Gingrich after he retired from Congress, to muffle his skepticism. Congressman Christopher Shays, in 2004 a new member of the House Financial Services Committee, seemed to be the only member of Congress sufficiently alarmed by the mounting financial dangers to point out the conflicts and corruption.
Armando Falcon. Shays saw Armando Falcon as a hero. The other Republicans saw Falcon as a helpful public servant, but they felt no urgency to act on his warnings. The Democrats saw Falcon as an intruder cutting off their money. To the Democrats, this man was a party pooper.
Falcon’s official title in 2004 was Director of the Office of Federal Housing Enterprise Oversight. In the hearing, that office is called OFHEO. In the hearing excerpts, check out what the Democrats thought of Falcon and his OFHEO. And be sure to read what Shays said at the end.
CONGRESSWOMAN MAXINE WATERS, Oct. 6, 2004:
WATERS: I note that when Director Falcon’s September 20  letter expressing concerns about Fannie Mae made the papers, the OFHEO report had just been completed. By September 22, the September 17 OFHEO report was publicly available, and by September 27, an agreement had been signed between Fannie Mae and OFHEO. It seems highly unlikely to me that the normal kind of regulatory dialogue could have occurred within this timeframe.
So I hope that the witnesses will address whether the regulatory process was proper, or whether there were public disclosures outside the normal process for reasons having nothing to do with safety and soundness. …
I’m particularly concerned about the 30 percent capital set-aside or surplus requirement because that takes a lot of money out of the market for mortgages.
WATERS: Mr. Falcon, you have been before this committee before. And you were pretty much on the hot seat on more than one occasion, where you were accused of not doing a good job, not exercising your oversight responsibility, of being incompetent.
And I think a number of members you talk with following those hearings, where you not only ask for support but try to make the case why OFHEO should remain. Is that true?
FALCON: No, I’ve actually supported a regulator with all the authorities and powers and resources to do his job, even if it means abolishing my agency.
WATERS: Did you seek support for yourself and for your agency following the criticism that was reaped upon you in this committee? Did you talk to any members of Congress?
FALCON: Oh, yes, I have...
WATERS: All right, thank you.
I would also like to know a little bit more about what has happened since the time that you came under such criticism and how you got to this point. You talked about when you first decided that you were going to do this investigation on Fannie Mae.
Did you at any time talk with any members of Congress during the time of this investigation about what you were doing, seek any advice, get any suggestions, any members or their staffs? You are under oath.
FALCON: I recall questions from various members of Congress in the Senate who...
WATERS: Did you talk to any members of Congress or their staffs about this investigation, seeking advice, getting advice, accepting suggestions, hearing suggestions about this investigation?
FALCON: Asking advice about -- not for the purposes of trying to get advice from a member of Congress about what we should look at...
WATERS: So you did talk with some members of Congress or their staffs while you were in the process of this investigation. Is that correct?
WATERS: All right. Did any member of Congress or their staff offer support for OFHEO or you in exchange for suggestions or give you ideas about how you ought to approach this investigation?
FALCON: Absolutely not.
WATERS: Did you report to the chairman of this committee, this subcommittee, or the chairman of the overall committee or the ranking member of this committee at any time during this investigation about what you were doing?
FALCON: Absolutely not.
WATERS: Let me go one by one.
Did you, at any time, report to the chairman of this entire committee, Mr. Oxley, about what you were doing?
FALCON: About the -- no. But...
WATERS: About the investigation, anything that you were doing or undertaking in the investigation.
WATERS: Did you, at any time, talk with Mr. [Committee Chairman Richard] Baker [a Republican] about whatever was going on in the investigation? Did you seek advice, did you get any advice, did you have any conversations with him about the investigation?
FALCON: I have not sought any advice, any guidance about how to -- from any member of Congress...
WATERS: Did you talk with Mr. Baker...
WATERS: ... about the investigation at any time or his staff?
FALCON: No. It would have been improper for me...
WATERS: That is all I want to know. Did you talk with Mr. Baker or his staff at any time during this investigation in any shape, form or fashion, whether it was seeking advice, just hearing advice, advising about what you were doing? That is all I want to know. Did you? Yes or no?
FALCON: Let me answer the question. I did speak to several members of Congress about the investigation, about the need for funding for the investigation...
WATERS: But I specifically asked about Mr. Baker at this point.
FALCON: Oh, Mr. Baker, yes, and other members of Congress...
WATERS: All right. Thank you.
FALCON: ... including other senior members of the committee about the investigation and my need for resources to keep this thing going. …
WATERS: This is not simply about notifying about this hearing. This is about what was going on in the investigation, how it was being approached, what was being done.
Were you talked to at any time?
FALCON: No. As I said, I didn't even get the notice that others got that it was happening, and so we had never heard anything.
WATERS: OK. Then that is well made.
Now, did you discuss the 30 percent reserve with any members of Congress and get a suggestion about that amount prior to concluding that that was the amount that should be in reserve?
WATERS: Did you talk with any staff member?
WATERS: This, again, based on the questioning of Mr. Barney Frank, was an amount that you came up with but that amount was not based on any calculations, any research that would indicate that this would be the proper amount in reserve. You did not have any supporting documentation for that, is that correct?
FALCON: We arrived at the 30 percent requirement because we thought that was prudent from a safety and soundness standpoint, given the weaknesses in management and operations, given the uncertainties of the financial statements...
WATERS: I’m asking about your documentation. Did you pull it out of the thin air? Did you pull it out of air? Did you have some documentation? Did you have something to compare it with? How did you get the 30 percent? …
FALCON: Congresswoman, we based -- I based that decision, using my judgment about what was appropriate, prudential in order to ensure the safety and soundness of this company. Given the uncertainties about their balance sheets, given the operational weaknesses, there was precedent for this with Freddie Mac, I took action that I thought was essential to make sure that this company, that its safety and soundness was ensured.
And we arrived at 30 percent because there is a 30 percent management and operations risk in the statute for risk-based capital, so we simply applied the same standard to the minimum capital.
WATERS: You had no documentation.
CONGRESSMAN GREGORY MEEKS, Oct. 6, 2004:
MEEKS: I think that we could all agree that we know from either some of your prior testimony, there are individuals in some movements that have been afoot that did not like the status of Fannie Mae and Freddie Mac had within the market. You could agree with that.
FALCON: Only certain individuals...
MEEKS: And it also true that in fact you, when you came here previously to testify on other occasions, many individuals on this committee was very critical of you and challenged your ability to be able to relate to the largest financial entities in this country. Is that not correct?
FALCON: Yes, Congressman.
MEEKS: In fact, they were so upset with you at that particular time, there was bills put forward that indicated that they may need to create a new regulator for the GSEs. Is that not also correct?
MEEKS: And it is also that this is a special examination, a special examination actually departed from what is standard financial institutional examination procedures. Is that not also correct?
MEEKS: This was not a special examination?
FALCON: Yes, it was a special examination, yes.
MEEKS: All right. And under ordinary procedures, would it not also be a situation whereas, you know, there were questions in regards to some of the regulations that you were overseeing that Fannie Mae, or whoever you are investigating, would have had the opportunity to address those issues prior to the issuance of the report.
FALCON: Any examination follows a pattern where if it is a normal examination, like our annual risk-based examination, there will be, depending on severity of the issues that are found, you could have, would have give and take between the management.
But this was a special examination, or it was situation where there were serious concerns raised about the conduct of management in this area of accounting and internal controls...
MEEKS: And some of that is subjective. …
Right now what you are putting out is just more allegations.
And what I’m talking about, when I start talking some irregularities, I’m talking about -- well, you know, even Senator Bond talked about the leaking of evidence or leaking of letters to the Wall Street Journal, other press. That is not standard. That does not happen under those circumstances. Is that a common procedure, to leak evidence and letters?
FALCON: Congressman, we did not release this report prior to the board agreeing with us that they did not have any objections to this report being put into the public domain. I received a letter from members of Congress in fact urging me to do so.
I had a commitment to the board not to release this report while we in these discussions. But once they no longer objected, I decided to do so. …
MEEKS: Let me just go to someplace else, because you make strong allegations. And, you know, sometimes you throw things out there. I know, I used to be a prosecutor. And it is very dangerous. And you made some allegations, strong allegations, that, you know, I do not know where the evidence -- I have not heard the evidence of it.
But, again, coming from the background that we are talking about, with reference to the pressure that was put on OFHEO by others and members of this committee about doing certain things, and all of a sudden I see this report coming out, I see things that are being leaked out.
And then you make some charges that a lot of this is being done because of executive bonuses. That is a very serious charge. And I don’t know exactly how you back this up. Can you just tell me? How do you back this up?
FALCON: It is our judgment, based on the evidence we saw, that this company in 1998, in that instance, when you look at the circumstances, the company deferred this $200 million of expenses in disagreement with this external auditor, and the evidence seemed to us that it was in order to meet these compensation bonus targets.
A year earlier, at the Sept. 25, 2003, House Financial Services Committee hearing on corruption at Freddie Mac, Congressman Meeks was no less hostile to Falcon:
MEEKS: I am just pissed off at OFHEO [Falcon’s oversight office] because if it wasn’t for you I don’t think that we would be here in the first place. …
Now the problem that we have and that we are faced with is maybe some individuals who wanted to do away with GSEs [Government-Sponsored Enterprises like Fannie Mae and Freddie Mac] in the first place, you have given them an excuse to try to have this forum so that we can talk about it and maybe change the direction and the mission of what the GSEs had, which they have done a tremendous job.
There has been nothing that was indicated is wrong, you know, with Fannie Mae. Freddie Mac has come up on its own.
The question that then presents is the competence that your agency has with reference to deciding and regulating these GSEs.
And so I wish I could sit here and say that I am not upset with you, but I am very upset because what you do is give, you know, maybe giving a reason to, as Mr. [Congressman Charlie] Gonzalez said, to give someone heart surgery when they really don’t need it, they need something else. …
So why and what can you say now so that we don’t destroy the mission of these GSEs that are creating home ownership? Why should I have confidence, why should anyone have confidence in you as a regulator at this point?
FALCON: Congressman, OFHEO did not improperly apply accounting rules; Freddie Mac did. OFHEO did not try to manage earnings improperly; Freddie Mac did. So this isn’t about the agency’s engagement in improper conduct, it is about Freddie Mac. Let me just correct the record on that.
We don’t review the accounting practices of the two companies. That is the role of the independent outside auditor. But we are going to begin to look at that going forward. …
MEEKS: You are saying that [new regulatory authority] then will give you the ability to catch any problems that may be in accounting -- or otherwise? I mean, we have got to look for -- and any other kind regulatory or record-keeping at any GSEs so that the American people can have confidence that there is stability and soundness -- and safety and soundness in the principles, in the practices of the GSEs.
You are saying that is the sole piece that you need?
FALCON: I have been asking for these additional authorities for four years now. I have been asking for additional resources, the independent appropriations assessment powers.
This is not a matter of the agency engaging in any misconduct.
And, yes, I think it would be better if the agency had additional resources, so that we could hire the types of people that we need, given the different activities we are going to be doing now. It is not the role of the safety and soundness regulator to look at the application of GAAP [Generally Accepted Accounting Practices] with the GSEs’ [Fannie Mae and Freddie Mac’s] books. That is the role of the auditor.
And as we have more resources, we are going to hire the type of people so that we begin to do that. And hopefully, we will try to catch these types of activities. These activities, by their nature, are concealed.
It is not easy for anyone to try to catch them. But with the resources, we are going to try.
CONGRESSMAN ARTUR DAVIS, Oct. 6, 2004:
DAVIS: Mr. Falcon, when Mr. [Congressman Stephen] Lynch was questioning you earlier, you said something that really caught my attention. You said that you wanted to avoid making any broad and categorical statements until the investigative process was complete.
Do you remember saying that?
DAVIS: That sounds like a good goal, and I think that that is exactly the stance that one would want from someone in your position.
So in light of that, let me ask you about several observations that you have made and see if they meet the standard that you set out.
Mr. [Congressman Donald] Manzullo asked you a number of questions and others have asked you questions about the motivation for the of expenses, and you said fairly directly that you think that the motivation was to pave the way for bonuses, or to create an appearance of earnings to justify bonuses.
Is that not a pretty broad and categorical statement on your part?
FALCON: It is.
DAVIS: And second of all -- if I can continue, as my time is limited -- you made the observation or response to someone’s questions -- where you were asked rather point blank: Would it be in the interest of Fannie Mae if there was a change in the management structure?
Do you recall those questions?
FALCON: Would it be in the interest...
DAVIS: You asked if it would be in the interest of Fannie Mae if there were a change in the management structure.
FALCON: Yes, we had that.
DAVIS: And I think your answer was in the affirmative that it would be. Do you recall that?
FALCON: I think what I said was, we were going to assess -- that the question before us was whether or not we had sufficient confidence in this management team going forward, trust that they could properly implement this plan of remediation and have the confidence of both us and the board going forward to properly run this company in compliance with all the rules and regulations.
DAVIS: You had various questions about the management structure.
FALCON: Yes, yes, I did.
DAVIS: Is that not a pretty broad and categorical statement to raise questions about the management structure?
FALCON: It is.
DAVIS: Furthermore, you make a pretty broad statement in your report -- in fact, I think I'm quoting from you -- that there was a pervasive and willful misapplication of GAAP in two critical areas.
Is that a quotation from your report?
DAVIS: Is the reference to a pervasive and willful misapplication a pretty broad and categorical statement?
FALCON: It is, about these two accounting areas.
DAVIS: So let me put this in perspective, because I agree with your honesty in all four of those answers, those are very broad statements.
One of the things that has been raised by several of my colleagues on this side of the aisle has to do with: As I would characterize it, does OFHEO [Falcon’s oversight office] have the appropriate level of arms-length relationship that is needed with Fannie Mae?
Several of my colleagues have made the point, and I make the point to you now, that as I understand the mission of OFHEO, it is to be a regulator, it is to assess the safety and soundness of the institution that you are regulating.
The SEC has the responsibility of making judgments about whether accounting fraud occurred.
This body has the responsibility of making judgments about the proper policy course.
And the Justice Department has the responsibility of making proper judgments about whether a criminal act has happened.
Have I gotten the division of labor just about right, from what you know?
FALCON: There is some overlap...
DAVIS: There is some overlap, but do I basically have it right?
DAVIS: A concern that I have -- and I want to give you a chance to respond to it -- but a concern that I have is you are making very specific, what you have correctly acknowledged, broad and categorical judgment about the management of this institution, about the willfulness of practices that may or may not be in controversy.
You have imputed various motives to the people running the organization.
You went to the board and put a 48-hour ultimatum on them without having any specific regulatory authority to put that kind of ultimatum on them.
That sounds like some kind of an invisible line has been crossed. That sounds to me as if you have gone from being a dispassionate regulator to someone who is very much involved and has a stake in this controversy.
And I’ll follow up on Ms. Waters’s point because I think it is very well taken: Her observation is that the political context surrounding your investigation was that serious doubts were being raised about OFHEO.
In fact, frankly, doubts were raised about your leadership of OFHEO. And all of a sudden, the response to that is to produce enormously critical report.
My concern is that OFHEO has jumped off the fence -- where it should be, if it is a dispassionate regulator -- and has somehow gotten involved in the business of taking a side in this controversy.
Now, I’ll give you a chance to respond to that.
FALCON: Well, Congressman, I appreciate the time to respond.
The categorical statements that I was referencing to with Mr. Lynch was, he asked me to make a broad categorical statement as to whether or not we had Enron-like fraud going on with this company.
DAVIS: No, sir. You said that you had a problem with making broad and categorical statements. And your instinct is right.
The reason -- and I’ll make this my last point -- the reason that you do not want to make broad and categorical statements I suspect is because the ultimate concern of OFHEO ought to be the safety and soundness of Fannie Mae.
Is it possible that by casting all of these dispersions and all of these doubts upon the board at Fannie Mae, and upon the structure of Fannie Mae, that you potentially are weakening this institution in the market, that you are potentially weakening the housing market in this country?
Are those possible consequences from the very broad and sweeping generalizations you have made about this institution?
FALCON: Well, first off, we may disagree on this, but it was not what I was telling the congressman about the type of categorical statements...
DAVIS: No, please answer the last question that I asked you. …
Is it possible and is it a reasonably foreseeable consequence that these kinds of imputations, these kinds of insinuations about the board, could in and of themselves damage the safety and soundness of Fannie Mae by weakening its position in the market? Is that possible?
FALCON: Our actions are all designed for the safety and soundness of this...
DAVIS: Is that possible? …
FALCON: We are just trying to do our job as a regulator. You can question my motives, my judgment, even my qualifications...
DAVIS: That is not the question I’m asking.
With all due respect, Mr. Chairman, that is not the question I’m asking.
FALCON: ... but that will not change the contents of this report.
DAVIS: Is it possible that the market standing of Fannie Mae could be weakened by your testimony? …
FALCON: It is possible. And if does it isn’t...
DAVIS: Thank you, you have answered my question.
FALCON: ... because of actions we have taken, it is because of what the company has done, as we have outlined in this report.
CONGRESSMAN LACY CLAY, Oct. 6, 2004:
LACY: Mr. Chairman [Congressman Richard Baker, Republican], we do not normally hold hearings on matters before other investigations are complete. Internal findings are normally discussed informally and remedies proposed. There are other stages of this process that take place before a judgment is rendered. Why circumvent the process? Why this hearing?
If I were a member of Fannie Mae’s board, I would find the environment very intimidating. Mr. Chairman, why is Senator [Richard] Shelby not holding a hearing on this preliminary report? After all, the Senate Banking Committee reported out legislation on the GSEs. Maybe this hearing agenda is about something more than the accounting procedures at Fannie Mae.
As you know, Fannie Mae recently entered into an agreement with OFHEO in which they focused on accounting, internal control, and capital. Fannie Mae has agreed to increase additional capital by 30 percent. I’m not sure how the new requirement promotes affordable housing. Within 45 days of OFHEO and Fannie Mae will implement additional internal controls. The Securities and Exchange Commission, as is intended, should be the final arbiter of GAAP [Generally Accepted Accounting Practices].
Why can’t we let the SEC decide this issue? Why must we rush past them? This hearing is about the political lynching of Franklin Raines.
CLAY: Mr. Falcon, when you and members of OFHEO’s [Falcon’s oversight office] staff conducted interviews and received company documents, why was Fannie Mae not allowed to question their witnesses on the record?
FALCON: They were allowed to participate in those sessions. I’m not aware if they requested such opportunity, but the sessions were held at our request of their employees in order to gather information about the company’s accounting policies and practices and internal controls.
CLAY: Why were Fannie Mae officials not provided the opportunity to respond to findings or conclusions reached by OFHEO during the course of the examination?
FALCON: I think because we followed a regular order here. We followed an accepted practice of regulators. Faced with findings of significant accounting misconduct by senior management and dealing with a management that is resistant to regulation, that same management team responsible for this accounting misconduct, any regulator would have done what we did, take this directly to the board.
CLAY: Is this due process?
FALCON: This is safety and soundness regulation which requires prompt action to ensure that the company does not get into financial difficulties.
CLAY: Is this the way you have handled internal investigations in the past?
FALCON: Other than the Freddie Mac special accounting review, this is only the second special examination that we have conducted. On more routine matters like our ongoing annual risk-based examination of the enterprises, we do have that type of a give and take, but this was a different situation.
CLAY: In May and June of 2003, OFHEO published its 2002 annual report giving both companies, Fannie Mae and Freddie Mac, more than satisfactory grades on accounting and internal controls. You and your agency were pretty embarrassed when issues were discovered at Freddie Mac. Were you so determined to not let this happen again even if it meant denying Fannie Mae fundamental fairness that is routinely provided to banks?
FALCON: No, congressman. I have testified before this committee before that I had no reason to believe that this company was engaged in any kind of accounting improprieties like Freddie Mac. But given the fact that questions were being raised about whether or not the same problems existed at Freddie Mac, I continued it appropriate to go in and take a look at Fannie Mae. So we did. I’m as disappointed as I think you are that the company has engaged in this type of conduct. But the findings are what they’re, and we have taken action.
CLAY: Let us go back to the process, then. Examiners discuss preliminary concerns and possible findings with regulated entities. Would it not have been fair to do this with Fannie Mae, to sit down and have a discussion with them?
FALCON: We did have a discussion, but it was with the board, congressman. Like I said, in a situation where we have findings of serious accounting misconduct by management and we have that same management being resistant to our efforts to deal with these issues, noncompliance with our efforts to examine the company such that we had to go to the Justice Department and ask for a court enforcement of our subpoena. In such situations, any regulator would have gone directly to the board, brought the matter to the board’s attention, and sought immediate action to ensure the safety and soundness of the company.
CONGRESSMAN BARNEY FRANK, Oct. 6, 2004:
FRANK: I have to say that I read the director’s testimony and I’ll talk to him about it again. I regret what seems to me frankly almost boilerplate in his report that says at the end of every specific, and this could raise safety and soundness issues. It could, but nothing in here seems to me that it does.
To the extent that people played games to get bonuses, I'm outraged. People making that much money, let me put it this way, at the level of compensation of the top officers of Fannie Mae, they should get bonuses if they rush into a burning building a rescue a kid, maybe a cat, but not for doing their job. I think it is unseemly of them to be getting bonuses in the first place for doing what they’re getting paid very well to do.
To the extent that there was manipulation, that is very wrong and should be penalized. But I’ve seen nothing in here that suggests that the safety and soundness are at issue, and I think it serves us badly to raise safety and soundness as a kind of a general shibboleth, when it does not seem to be the issue.
FRANK: I appreciate the answers, Mr. Falcon, you gave to Mr. [Congressman Joseph] Crowley. But it makes me even more disturbed that you, both in your written statement and again, sort of threw “safety and soundness” around almost like kind of boilerplate.
I think you just accurately answered the questions that, no, if everything works out as we expect it to, there are no threats, et cetera, this -- you seem to be saying, “Well, these are in areas which could raise safety and soundness problems.” I don’t see anything in your report that raises safety and soundness problems. Your answers to Mr. Crowley certainly didn’t indicate that there were.
How does this raise safety and soundness problems, other than the kind of, frankly, almost ritualistic saying, “Well, these are areas where safety and soundness could be implicated presumably if it went far enough”?
But I think it is irresponsible -- let me be very clear -- on the basis of this report and what you have concluded so far -- I mean, we have earnings smoothed out. With regard to derivatives, you have told you me you cannot even say at this point whether they have under- reported or over-reported earnings.
How does this threaten the safety and soundness, what you have uncovered, of Fannie Mae?
FALCON: Just the very fact that we have serious doubts about the accuracy of the financial statements and their books and records, the very fact that we have identified very serious internal controls...
FRANK: Well, let me ask a question. Does any accuracy threaten the safety and soundness? That is what bothers me. There is a quality and a quantity issue here.
There are inaccuracies that can be disturbing, and if they led to inappropriate compensation, I would be very unhappy. But the notion that any inaccuracy implicates safety and soundness, I think, based on what you have said here, where you cannot even conclude -- you have said you cannot even quantify any potential amount of loss. To throw “safety and soundness” around in that thing I think really is, for a regulator, irresponsible.
FALCON: Well, I think internal controls are a very serious safety and soundness concern. A breakdown or a lack of internal controls...
FRANK: Do you think the safety and soundness is at risk right now? …
I mean, you have just told Mr. Crowley it didn’t implicate safety and soundness. Does it, your report, what you have reported?
FALCON: No, I think our report absolutely does implicate safety and soundness.
FRANK: Is the safety and soundness at risk now?
FALCON: Are they at risk of becoming insolvent right now? No. We have an agreement with the board in place that will address these problems, provide an adequate capital cushion. We think we...
FRANK: That is the answer. The rest is just rhetoric.
SHAYS: I would just like to say to you, Mr. Falcon, what you have done is you have exposed illegal activity on the part of Fannie Mae, and you are being criticized for exposing it. If they have a safety and soundness problem, or if the markets are impacted, it will only be impacted based on what Fannie Mae did.
And I just want to congratulate you. You have more courage than I realized you have, because the messenger is being shot and not the person who did the wrongdoing. I've seen it here in this committee, and I'm pretty outraged by what I'm seeing.
Congratulations for what you have done.
SHAYS: You are almost becoming a sympathetic figure, and your organization. I mean, you have issued a report and you are getting attacked on the report. You are being questioned why you did not do a better job sooner, and yet your organization has not been given the authority or the power by Congress to do the job it needs to do.
And frankly, I do think you needed to show a little more energy, which you are starting to do.
I’m seeing the result of that. When did you give them the report? When did you talk to them? Why didn’t you find out sooner? Instead of having members of this Congress try to find out what the hell they did.
One of the things that I find somewhat astounding is, are you saying to this committee that you actually had to issue subpoenas against this organization or consider it or threaten it to get information you are entitled to get?
FALCON: We issued administrative subpoenas to get information that we needed for this special examination, yes.
SHAYS: Why would you have to issue administrative subpoenas? Why can't you just ask for it?
FALCON: We did initially, but we did not get sufficient compliance, certainly not timely compliance, partial compliance. Therefore, we felt the only way to solve that problem was to move towards administrative subpoenas.
SHAYS: So the bottom line is, not only have you found this company not in compliance, you are telling us they resisted in your initial efforts to find out what was going on. They resisted your efforts to do your job. Isn't that correct?
FALCON: That was our feeling and that is why we moved towards the more formal processes.
SHAYS: And you have stated to us that these findings are very serious, correct?
SHAYS: Are investors impacted? Isn’t it possible that investors, based on reports, will have made decisions that were based on faulty information?
FALCON: Unfortunately, that very much is the case when you have financial statements issued under accounting practices that are not consistent with GAAP. GAAP is there to ensure consistency of reporting across quarters so that you have the ability to compare a company’s performance from quarter to quarter. If you do not have correct compliance with GAAP, then you do not have that comparability from quarter to quarter and can judge a company’s performance over time.
Through these catch-up provisions the company had under FAS 91, it allowed it to minimize earnings volatility and that comparability that investors need.
SHAYS: And didn’t it also enable them to say they were a low- risk enterprise?
FALCON: The lack of volatility certainly conveyed that impression.
SHAYS: Now, having discovered what you have discovered without the cooperation of the organization, are they accepting your findings or resisting your findings?
FALCON: I feel like the board has been cooperative in working with us to address these findings.
SHAYS: Right. And they said that they will change their behavior, correct?
FALCON: They said they would change their behavior going forward. They are going to do the calculations for us going backwards so we can assess the magnitude of the incorrect accounting in prior periods.
SHAYS: What concerns me is, when Mr. Raines comes and testifies, he is not going to give us the feeling that he gets it. Why do you think that is the case?
FALCON: I cannot speculate on that. I just know that our findings, we feel very strongly about what we found. A lot of work has gone into this. It does not surprise me that the company would continue to stand behind its accounting, but the fact is it is wrong.
SHAYS: It is wrong, and there is not going to be any doubt about the fact that it is wrong. Now, their auditor was paid $3 million in a $1 trillion firm. Doesn't that raise some question about their capability, the auditor's capability to do the job, with a $1 trillion operation?
FALCON: We are now focusing more on the work of the external auditor. We have had concern about potentially excessive reliance by the external auditor on the internal audit function and internal policy-setting by the company, but that is something for further review now that we have completed this step in the process.
SHAYS: I congratulate you on the work you have done. I congratulate you for trying to protect the public. I congratulate you for showing courtesy to the company, meeting with them first before this report was issued. But the bottom line is, what really matters is what your report says and how they deal with it. I’m somewhat appalled and maybe even a little shocked that you would have had to use subpoenas to get information to do your job. I thank you for going to that level to ensure that you could get your information.
SHAYS: I am new to this committee and I was absolutely shocked when we looked at Enron and WorldCom. The board of directors did not do their job. The management did not do its job. The employees did not speak out. The lawyers in the firm were facilitators. The rating agencies did not do their job. It scared the hell out of me, frankly.
We passed Sarbanes-Oxley, which was a very tough response to that. And then I realized that Fannie Mae and Freddie Mac would no even come under it. They were not under the 1934 Act. They were not under the 1933 Act. They play by their own rules, and I’m tempted to ask how many people in this room are on the payroll of Fannie Mae, because what they do is they basically hire every lobbyist they can possibly hire. They hire some people to lobby and they hire some people not to lobby so that the opposition cannot hire them.
Fannie Mae has manipulated, in my judgment, OFHEO for years. For OFHEO to finally come out with a report as strong as it is tells me that has got to be the minimum, not the maximum. I congratulate OFHEO for finally stepping up to the plate and not being manipulated by the very organization they're supposed to regulate.
I hear these arguments that Fannie Mae and Freddie Mac are looking out for the interests of the homeowners, and they score worse in helping minorities than the private sector banks under the 1934 Act and the 1933 Act.
Fannie Mae and Freddie Mac are very generous to members of Congress and very generous to the organizations of caucuses in Congress. They do not have to disclose what they do. They do not have to play by the same rules. They are going to crash if this Congress does not wake up and do something about it.
I am absolutely shocked at the extraordinary tolerance that has taken place in this Congress. This is just the beginning of the story. What did OFHEO say? They said they have accounting methods and practices that did not comply with generally accepted accounting practices, employed an improper cookie jar reserve in its accounting system, deferred expenses to meet compensation targets, did not have proper corporate governance controls in place.
We need to wake up and the sooner we do the better it will be for Fannie Mae and Freddie Mac and all their investors, and the better it will be for our government.
* * *EPILOGUE
By 2007, Fannie Mae and Freddie Mac had backed more than $1 trillion in high-risk loans, and in 2008, the loans were sinking into default by the hundreds of thousands. Financial markets collapsed.
One Democratic congressman later admitted he was in error to blindly endorse the reckless lending by Fannie Mae and Freddie Mac.
“Frankly, I wish my Democratic colleagues would admit that when it comes to Fannie and Freddie, we were wrong.” -- Congressman Artur Davis, Sept. 30, 2008.
On Election Day 2008, every Democrat on the House Financial Services Committee who sought re-election won re-election.