Report details influence of fallen chairman

WASHINGTON — Buried in the 2,652-page report on Fannie Mae that was released recently was the transcript of a speech a Fannie Mae exec planned to make invoking the name of Franklin Raines, former chairman and CEO of the embattled mortgage giant.

Sam Rajappa, who at the time worked for the Seattle native as the head of internal auditing, told his employees that under Raines they had a "moral obligation" to make money.

"Remember Frank has given us an opportunity to earn not just our salaries, benefits, raises ... but substantially over and above," for meeting financial targets, Rajappa planned to say in a 2000 address to his underlings.

"So it is our moral obligation to give well above 100 percent and if we do this, we would have made tangible contributions to Frank's goals."

Although the long-awaited review of Fannie Mae's $10.8 billion accounting meltdown found "no indication" that Raines knew the degree to which accounting rules had been ignored under his leadership, Raines' imprint is palpable throughout the massive document.

Problem-solver

A former director of the Office of Management and Budget and among the nation's most prominent black executives, Raines had a reputation as a master problem-solver and described at one point as a "superstar" and potential politician. But at Fannie Mae, he oversaw a "culture of arrogance" that, according to the report, undergirded the company's problems.

Through an attorney, Raines denied that he fostered the environment painted by the document, a 1 ½-year study authored by former Sen. Warren Rudman, R.-N.H., at the request of Fannie Mae's board. On the contrary, Raines sought to "create a leadership culture that focused on openness and good governance," his attorney said.

Raines said as much while still head of Fannie Mae, telling employees in a September 2003 memo that "our openness and intellectual honesty with each other helps to make us the quick, creative, fast, agile and successful company we are." The CEO added, "We need to be transparent and address the tough questions internally as well."

The company's reality, however, was apparently out of sync with that vision.

Employee surveys taken throughout Raines' time as chief executive — and referenced in the report — portray a corporate culture in which lines of authority were jealously guarded and the flow of information was far from free.

"Many folks are not willing/comfortable to tell senior management what they don't want to hear," said one employee in the legal department, according to the report.

Accounting questions

The report is one of several probes into Fannie Mae's problems, including Securities and Exchange Commission and Justice Department investigations into possible civil and criminal violations.

It said that much of the responsibility for Fannie's accounting problems rests with former Chief Financial Officer J. Timothy Howard and former company controller Leanne Spencer and specifically cited them for a plan to delay recording $200 million in expenses in 1998 so the company would meet its profit goals. The "motivation," the report concluded, was to trigger the payment of bonuses to top executives. But Raines signed off on the expense delay, too, and as chief executive later promoted Howard to the No. 2 spot in the company.

While the report suggests that Raines was not aware that many company practices violated standard accounting procedure, the episode may change the legacy that grew around Raines as he progressed from Seattle's Franklin High School to Harvard Law School to the center of Washington, D.C., society.

Howard's attorney, Steve Salky, said he and his client "reject the report's mischaracterization of Howard's motives and conduct." Spencer's attorney, David Krakoff, said he and his client "vigorously dispute the speculative allegations in the investigation by the special review committee."

Raines declined to be interviewed.

But in a written release, his attorney, Robert Barnett, said Raines "strongly believes that, as the leader of Fannie Mae, he should be accountable for what happened within the organization, regardless of his personal involvement or fault."

"A superstar"

Raines had the ideal mix of business and political credentials to lead the company. Responsible to investors hungry for returns, Fannie Mae is also closely watched by Congress and federal regulators because of its government-chartered role in the housing markets.

A lawyer by training and a longtime investment banker, Raines was familiar with the ways of D.C. after working in the Carter administration and, notably, helping negotiate a balanced-budget agreement in the Clinton years.

When President Carter was in office, "Frank made a number of presentations to the president," said former presidential aide Stuart Eisenstadt. "He did it with great aplomb. It took me a week to realize I had a superstar."

Raines had toyed with running for office, and at one point called former law-school classmate Kurt Schmoke, then mayor of Baltimore, to inquire what Schmoke's day was like.

Though Raines was an inspiring presence at a podium, by the time he became OMB director, he had lost interest in running for elected office. He was, at heart, an introvert.

When he was tapped to run Fannie Mae in 1998, he inherited a company shaped by his two predecessors, David Maxwell and James Johnson. Maxwell saved the company from bankruptcy in the early 1980s. Johnson turned the company into a political and business juggernaut.

Fannie Mae was created by Congress to make money available for home loans by buying mortgages from banks and other lenders. For decades, it held mortgages until they were paid off. But after a spike in interest rates in the late 1970s and early 1980s nearly pushed Fannie Mae into bankruptcy, it began pooling more mortgages into securities and selling them.

Under Johnson, the company began keeping more mortgages and mortgage-backed securities for investment purposes, a lucrative but potentially risky strategy because it left the company susceptible to interest rate swings.

By the time Raines took over in 1999, Fannie Mae's investment portfolio had more than doubled in value, to $523 million in five years.

As a government-chartered enterprise, Fannie was always vulnerable to attempts to reign it in through legislation. Under Maxwell and Johnson, the company learned to thwart such attacks using an extensive political machine underwritten by the company's growing profit.

At its peak several years ago, Fannie Mae's network of more than 50 partnership offices hosted thousands of public events with elected officials each year.

But it was a hard machine to wield with finesse.

In contrast to his cerebral and diplomatic style as OMB director, Raines at Fannie Mae adopted the sometimes overbearing style the company had become known for under Johnson, according to lawmakers, housing-industry executives and others.

In 1996, after the Congressional Budget Office issued a report saying Fannie Mae's low borrowing costs were little more than a subsidy from the federal government, Raines personally dressed down CBO officials in a closed-door meeting.

Shortly after he became chairman of the Fannie Mae board, he stunned a group of mortgage insurers, telling them they were headed the way of buggy-whip makers.

Under attack

It wasn't that Raines had become more combative. During his tenure, Fannie Mae faced more intense scrutiny than it had under Johnson.

Around the time Raines was chosen to be chairman, Fannie Mae made an overture to get involved in life insurance. Not long after, its sister company, Freddie Mac, made an ill-fated attempt to get into the mortgage-insurance business.

Both events prompted several large banks, which had been customers of Fannie Mae and Freddie Mac but increasingly felt like their competitors, to form their own advocacy group, FM Watch. Ideological critics, who thought the sheer size of Fannie Mae and Freddie Mac posed a threat to the financial system, also stepped up their attacks.

Raines, who often emphasized intellectual honesty and open debate, became more intractable, several former colleagues said.

It was an attitude that permeated the company, said Roger Barnes, a former Fannie accounting manager whose allegations of accounting irregularities were largely born out by federal regulators and Rudman's report.

Concerns raised

When Barnes raised his concerns with Fannie officials, "They said: 'Intellectually you don't know what you're talking about. ... You're intellectually inferior or out to destroy the mission,' " he said in an interview.

At different points in Raines' term, colleagues tried to persuade him to change the company's tone.

"If we're such a great employer, why aren't we facing the reality of the hard questions and the poor ratings that come in some of the employee surveys? We make a sport, it seems, of paying consultants a lot of money, bringing them in, baiting them, laughing at them and then kicking them out," Daniel Mudd, who was then chief operating officer, said in a speech at a July 2000 officer's retreat. Mudd replaced Raines as chief executive.

If such warnings didn't register with Raines, it may be because he thought he had already built an open culture. Under Johnson, town-hall meetings with employees were highly scripted.

Raines tried to relax them and instituted other changes, such as brown-bag lunches and executive "gab sessions" with employees. That seeming open-mindedness had limits.

When the company's regulator, the Office of Federal Housing Enterprise Oversight, launched a special examination of Fannie Mae in 2004, Raines, as well as Howard, "did not respect OFHEO's views and treated OFHEO dismissively," board member Kenneth Duberstein told investigators working on the board report.

In October 2004, Raines said OFHEO's preliminary report, which accused the company of massive accounting errors, had "no facts."

By December, however, the SEC had endorsed OFHEO's findings, and Raines quickly agreed to retire.

That fall, he had conceded in talking points for a speech to his fellow executives that Fannie's culture had not served it well.

"We may have believed our own PR a little too much," Raines' talking points read. "We allowed ourselves to be arrogant. We thought we had a lot to teach and little to learn from others."