Disaster averted at Freddie and Fannie?

WASHINGTON - A potential financial disaster that could have shaken the housing market was averted because regulators discovered accounting failures at Fannie Mae and Freddie Mac, the new head of the agency that oversees the mortgage giants said Monday.
The government-sponsored organizations appear to have gotten the message that they need to reform, but it still will take years to repair their internal problems, James B. Lockhart said in an interview with The Associated Press.

"The housing market is so important to this country," said Lockhart, who has headed the Office of Federal Housing Enterprise Oversight for about two months. "And to have it built on what turned out to be a shaky foundation could have caused significant financial problems."

Problems were averted, he said, because the regulators acted to identify and order corrections at Fannie Mae and Freddie Mac, which together stand behind some 40 percent of the $8 trillion U.S. home-mortgage market.

"The good news is that it was caught in time and the remedies are starting to be in place, so that there was no major problem for the average American," Lockhart said.

Lockhart, a friend of Bush from prep school and college, became director of an agency whose previous leader had for years waged a quixotic battle against the two politically powerful companies. After serious accounting problems at Fannie Mae and Freddie Mac became known, a push by the administration to tighten the government reins on them gained ground in Congress.

Lockhart, 60, was executive director of the Pension Benefit Guaranty Corp., the federal agency that backs private defined-benefit pensions, in the administration of the first President Bush. He has worked in the private financial sector and was deputy commissioner of Social Security before taking his current job.

Like the White House and many lawmakers, he believes the mortgage holdings of Fannie Mae and Freddie Mac — totaling more than $1 trillion — should be reduced. He called legislation pending in the Senate "a very good starting point."

Fannie Mae, the second-largest U.S. financial institution after Citigroup Inc. and the second-biggest borrower after the federal government, is restating its earnings back to 2001 — a correction expected to reach at least $11 billion. The company was fined $400 million in a settlement in May with OFHEO and the Securities and Exchange Commission, one of the largest civil penalties ever in an accounting fraud case. It also agreed to make top-to-bottom changes in its corporate culture, accounting procedures and ways of managing risk.

The accounting failures and earnings manipulation at Washington-based Fannie Mae became known in September 2004 after the OFHEO regulators discovered them in a special review. No. 2 rival Freddie Mac had its own accounting crisis in mid-2003, when the company disclosed that it had misstated earnings by some $5 billion — mostly underreported — for 2000-2002 and ousted its top executives. Similarly, it was fined $125 million by OFHEO and ordered to make changes.

If either company should fail, there could be less money for consumers to borrow to get a mortgage, and interest rates on home loans could be forced higher.

Congress created Fannie Mae and Freddie Mac to inject money into the home-loan market. They buy mortgages from banks and other lenders and bundle the loans into securities for sale to investors worldwide.

"The risk has certainly been reduced by the remedial actions that the two management teams have put in place at our direction," Lockhart said. But it will take a number of years — two, three or more — for the two companies to get their financial houses fully in order, he cautioned.

In addition, he said, "There's still some arrogance in the culture. ... There are certainly people in both organizations that have retained and will retain some of that arrogance."

OFHEO's review found that current and former executives of Fannie Mae reaped hundreds of millions of dollars in bonuses in a deceptive accounting scheme from 1998 to 2004. Employees are said to have manipulated accounting to hit quarterly earnings targets so senior executives could pocket the bonus money.

Lockhart has promised that his agency will pursue some company executives to recover allegedly tainted bonus money if the Fannie Mae board fails to do so.