Financial Regulatory Reform

A Case Study You Won’t Believe

President Obama’s speech at Federal Hall in New York City on Monday “will focus on the need to take the next series of steps on financial regulatory reform to ensure what happened a year ago…doesn’t happen again and cause the type of havoc that we’ve seen in our economy,” said White House spokesman Robert Gibbs.

Hopefully, in considering the Obama administration’s proposed financial regulatory revamp, Congress will take note of, learn from, “and ensure the following doesn’t happen again.” In Buffett’s words:

“For a case study on regulatory effectiveness, let’s look harder at the Freddie and Fannie example. These giant institutions were created by Congress, which retained control over them, dictating what they could and could not do. To aid its oversight, Congress created OFHEO in 1992, admonishing it to make sure the two behemoths were behaving themselves. With that move, Fannie and Freddie became the most intensely-regulated companies of which I am aware, as measured by manpower assigned to the task.

On June 15, 2003, OFHEO (whose annual reports are available on the Internet) sent its 2002 report to Congress – specifically to its four bosses in the Senate and House, among them none other than Messrs. Sarbanes and Oxley. The report’s 127 pages included a self-congratulatory cover-line: “Celebrating 10 Years of Excellence.” The transmittal letter and report were delivered nine days after the CEO and CFO of Freddie had resigned in disgrace and the COO had been fired. No mention of their departures was made in the letter, even while the report concluded, as it always did, that “Both Enterprises were financially sound and well managed.”

In truth, both enterprises had engaged in massive accounting shenanigans for some time. Finally, in 2006, OFHEO issued a 340-page scathing chronicle of the sins of Fannie that, more or less, blamed the fiasco on every party but – you guessed it – Congress and OFHEO.”
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Warren Buffett, 2008 Letter to Berkshire Hathaway Shareholders

P.S. Remarkably, the principal, if not sole, responsibility of over 100 OFHEO employees was to oversee the operations of Fannie Mae and Freddie Mac.

Hopefully, Congress will ask Buffett for his testimony and/or written recommendations.

To add insult to injury, read Gretchen Morgenson’s recent article in the New York Times, excerpted below:

“With all the turmoil of the financial crisis, you may have forgotten about the book-cooking that went on at Fannie Mae. Government inquiries found that between 1998 and 2004, senior executives at Fannie manipulated its results to hit earnings targets and generate $115 million in bonus compensation. Fannie had to restate its financial results by $6.3 billion. Almost two years later, in 2006, Fannie’s regulator concluded an investigation of the accounting with a scathing report. “The conduct of Mr. Raines, chief financial officer J. Timothy Howard, and other members of the inner circle of senior executives at Fannie Mae was inconsistent with the values of responsibility, accountability, and integrity,” it said.

That year, the government sued Mr. Raines, Mr. Howard and Leanne Spencer, Fannie’s former controller, seeking $100 million in fines and $115 million in restitution from bonuses the government contended were not earned. Without admitting wrongdoing, Mr. Raines, Mr. Howard and Ms. Spencer paid $31.4 million in 2008 to settle the litigation.

When these top executives left Fannie, the company was obligated to cover the legal costs associated with shareholder suits brought against them in the wake of the accounting scandal. Now those costs are ours. Between Sept. 6, 2008, and July 21, we taxpayers spent $2.43 million to defend Mr. Raines, $1.35 million for Mr. Howard, and $2.52 million to defend Ms. Spencer.……

An additional $16.8 was paid in the period to cover legal expenses of workers at the Office of Federal Housing Enterprise Oversight, Fannie’s former regulator. These costs are associated with defending the regulator in litigation against former Fannie executives….

A spokesman for the agency said it would not comment for this article.”
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Gretchen Morgenson, They Left Fannie Mae, but We Got the Legal Bills, New York Times, September 6, 2009