THERE’S EVEN A HERO  by John McLeod, 21Jul06

“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 [James Lockhart] of the agency that oversees the mortgage giants [OFHEO] said Monday [July 10, 2006].” (my emphasis)

That was the opening of the widely repeated AP wire story Mortgage Giants Avert Potential Disaster by seasoned GSE reporter Marcy Gordon. Gordon goes on to chronicle how Freddie Mac and then Fannie Mae paid enormous fines ($125m and $400m) and had to fire much of their top managements over accounting scandals measured in the billions. He quotes Lockhart as saying “[t]here’s still some arrogance in the culture. … There are certainly people in both organizations that have retained and will retain some of that arrogance.” and points to the OFHEO Annual Report to Congress (June 15, 2006) that “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.”

It sound’s like a tale of unrelieved greed and stupidity, but as usual it’s not quite that simple. There are many good people caught in the mix, and perhaps the most important of all is a true hero, Fannie Mae whistle-blower Roger Barnes. Despite what Lockart implies about institutional checks and balances, we have this single mid-level former accounting executive to thank for much of what we know now about how this GSE, America’s second largest financial institution behind only CitiBank, was operating over the last several years.

Lockhart may have passed over Barnes’ contribution in silence, but that was not the case in OFHEO’s landmark Report of Findings to Date [September 17, 2004] Special Examination of Fannie Mae.

“This report also details an investigation performed by the Office of Auditing into allegations of amortization accounting irregularities raised by Roger Barnes, a former employee in the Controller’s Department who left Fannie Mae in November 2003, and whose cooperation was important to our examination. The Special Examination found that Mr. Barnes’s allegations were substantive, and that the Office of Auditing failed to adequately investigate the problems surrounding the amortization process that he raised.” (OFHEO report 17Sep04, p 9, my emphasis)

Fannie Mae’s management fought this report’s findings for another three months until the SEC confirmed that about nine billion dollars of additional losses on financial derivatives would need to be recognized. That pretty well sealed the fate of much of Fannie’s top management team, the auditors, and many of the existing financial staff. On December 16, 2004, shortly after Fannie threw in the towel over the derivatives issue, USA Today published a fascinating in-depth look at Barnes: Fannie Mae whistle-blower feels vindicated by SEC decision, By Jayne O’Donnell.

“Roger Barnes, a former Fannie Mae accounting manager, leaped onto the national stage this fall when he accused the mortgage-finance giant of cooking its books and of retaliating against him for complaining about it.

Bolstered by his allegations, the agency that regulates Fannie Mae concluded that Fannie manipulated its earnings through ‘cookie jar’ accounting. Late Wednesday, the Securities and Exchange Commission said Fannie had indeed violated accounting rules and must restate earnings. Fannie says it will comply with the SEC’s request. A Justice Department criminal investigation continues.” (O’Donnell, 16Dec04)

O’Donnell and her co-contributor Thomas Ankner then go on to do an in-depth profile. You really need to open the above link and read about this yourself. Barnes grew up without indoor plumbing and fought racism and an almost inconceivabe list of challenges with simple grit, determination, and faith. His story is complex, and does not lack a dark side. Nevertheless, he displayed a level of integrity throughout his time at Fannie Mae (and earlier at Freddie Mac) that is truly astonishing. He even looks like an actor. Should we actually get out of this financial crisis, Barnes’ name will have to stand near number one in the list of those who made a necessary and positive contribution.

I’m looking forward to the movie.

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