Fannie Mae Death Watch Part I: Overview
Ross M. Miller
Miller Risk Advisors
October 4, 2004
While I was doing the promotional bit for my Enron book, I was often asked
what company would be the subject of my next post-mortem. Aware of my past
ties to General Electric, many of the questioners hoped I would answer
"GE," however, it shared none of Enron's key weaknesses. Unlike
the "anything goes" spirit of Enron, GE under Jack Welch had
numerous checks and balances in place. Furthermore, GE was financially
conservative, with Jack Welch at one point outright banning any use of
derivative securities after the Kidder, Peabody mess. I did, however, have
an answer to the "what's next" question. It was an answer that
no one liked: Fannie Mae.
While the mass media labors under the delusion that the
key players at Enron were, to quote the title of a competing Enron book,
"the smartest guys in the room," in all the time that I labored
in neighboring fields, I ran across Enron only once. That was at a
conference in honor of the late Fischer Black hosted by UCLA where a
colleague of mine at General Electric, David P. Greene, and I were invited
to present a paper on a new framework for risk management. Someone from
Enron was on the program as a "discussant," but only because the
company had purchased a slot as a corporate sponsor of the conference.
(Ironically, the other practitioner who earned his way onto the program
was from McKinsey, the consulting firm that took the credit for creating
Enron's business model.) There was, however, one firm that was big in the
risk business that never came up in any context. It was an intellectually
invisible company with an enormous presence in the marketplace called
This commentary is the first in what looks to be a long
series that examines the growing number of "red flags" sprouting
up around Fannie's business. I do not find it mere coincidence that the
key red flags have an eerie similarity to the early warning signs at
Enron. There is, however, one very important difference between Fannie Mae
and Enron. Enron was a business of modest size and even more modest
importance that appeared big because of the way that it accounted for its
trading businesses. Enron's collapse created a small hole in the U.S.
economy that was quickly plugged up.
Fannie Mae is a gigantic enterprise--one of the few that
might rate the designation "too big to fail." Not only does
Fannie have in excess of a trillion dollars on its balance sheet, more
frighteningly, it has more than a trillion dollars off its balance sheet.
And all of these trillions of dollars are managed by a CFO, Tim Howard,
who may have more chutzpah than Andy Fastow, Enron's legendary CFO. (It
should be noted that Mr. Howard along with other execs at Fannie Mae is
currently the subject of a criminal probe by the Justice Department. Andy
Fastow, on the other hand, will soon be serving a 10-year prison term.)
Whether or not Fannie Mae currently has a hole in it the
size of a hundred Enrons, I do believe that it can be
"dismantled" in a manner that causes the least possible
disruption to the U.S. economy and the housing market in particular.
Long-Term Capital Management, whose implosion in 1998 was supposed to
bring down the world's economy with it, not only survived being
"unwound," but generated sizable profits for those who unwound
it and who would be the first in line to unwind Fannie Mae. Fannie Mae, of
course, it is biggest proponent of the myth that the world would end
without them, and I will examine that myth in my next commentary, which
dissects Fannie's latest annual report.
My "death watch" on Fannie Mae has been
triggered by three events/revelations that are surprisingly high fidelity
echoes of Enron. I do not, however, see Fannie's demise as imminent; they
appear to have bought themselves a 270-day reprieve from their formerly
hapless regulator, OFHEO, short for the Office of Federal Housing
Enterprise Oversight, whatever that means. As for the senior management of
Fannie, there are already some in the media who see their departure in
coming weeks as a done deal.
The first echo of Enron is the mysterious departure of
Anne Mulcahy, CEO of Xerox, from Fannie's board of directors. Two days
after writing a letter that rearranged the terms of employment for
Fannie's top management (but still left them with giant loopholes to crawl
through), Anne found it no longer convenient to make the trip to
Washington, D.C. to attend board meetings and swapped her seat on Fannie's
board for one on Citigroup's, which is closer to her Stamford, Connecticut
office. Citigroup also stands to make billions of dollars on several
fronts should Fannie Mae be dismantled or legislated out of existence.
Anne Mulcahy gives us two Enron coincidences for the
price of one. At least if one is rather elastic on the notion of a
coincidence. Her departure with lame excuse recalls CEO Jeff Skilling's
sudden resignation from Enron. Her presence at Xerox during its major
accounting scandal reminds us that Andy Fastow was at Continental Illinois
when it collapsed. (Both Mulcahy and Fastow went on to greater glory
despite being at the scene of a train wreck.)
The second echo is the aforementioned Tim Howard,
Fannie's CFO. While I do not yet deem Mr. Howard as worthy of meeting the Fastow
Challenge for CFO creativity, he has already performed a deed that
mertis a Fastovian tip of the hat. It is standard practice for financial
companies to employ either a chief credit officer or chief risk officer to
provide an independent monitor of the company's financial health. Even
Enron had one, for all the good it did them. Ideally, the chief risk
officer reports to the board of directors so that he or she can provide
them with an independent source of control and information. Alternatively,
the chief risk officer may report directly to the chairman of the board.
Under no circumstances, however, should the chief risk officer report to
the CFO. Something about foxes and henhouses.
Tim Howard found an insanely clever way of controlling
the chief risk officer without having the chief risk officer report to
him. He was the chief risk officer. And Fannie's board and its regulator
apparently let him get away with this until it surfaced two weeks ago. Of
course, Howard's dual role was nowhere to be found in Fannie's various
spotty filings with the SEC. And given that Fannie appears to possess no
in-house risk management expertise, it should surprise no one that they
appeared not to have a chief risk officer. Still, having your CFO be the
chief risk officer is far worse than no chief risk officer at all.
The final echo is an accounting firm, KPMG, which has
been bought and paid for by the company whose books it audits. Or so it
would appear, even if Fannie and KPMG deny it. The meager millions that
KPMG makes for doing Fannie's book is supplemented by several times that
amount in consulting fees for "rendering opinions" and that sort
of thing. Standard and Poor's, which gave Fannie 9 out of 10 points for
corporate governance, even singled the relationship with KPMG as the sole
negative mark against the company. Enron, which would likely have also
scored close to 9 out of 10, showed that all it takes is a friendly
accountant and you are off to the races.
Of course, KPMG may have learned something from the
plight of Enron's auditor, Arthur Andersen. For one thing, there is no
evidence that KPMG signed off on Fannie Mae's glossy public version of its
annual report. (The customary signed "Independent Auditors'
Report" page is missing. KPMG did, however, sign off on Fannie's
10-K, the official version of the report filed with the SEC. If they are
lucky, they will live to regret it.) That annual report is the focus of
next week's commentary.
Copyright 2004 by Miller Risk Advisors. Permission
granted to forward by electronic means and to excerpt or broadcast 250
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