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REVIEW OF THE RUDMAN

REPORT ON FANNIE MAE

HEARING

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

MARCH 14, 2006

Printed for the use of the Committee on Financial Services

Serial No. 109–77

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa 

RICHARD H. BAKER, Louisiana 

DEBORAH PRYCE, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

ROBERT W. NEY, Ohio 

SUE W. KELLY, New York, Vice Chair 

RON PAUL, Texas 

PAUL E. GILLMOR, Ohio 

JIM RYUN, Kansas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

VITO FOSSELLA, New York 

GARY G. MILLER, California 

PATRICK J. TIBERI, Ohio 

MARK R. KENNEDY, Minnesota 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

KATHERINE HARRIS, Florida 

RICK RENZI, Arizona 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

MICHAEL G. FITZPATRICK, Pennsylvania 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

BARNEY FRANK, Massachusetts 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

JULIA CARSON, Indiana 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

BARBARA LEE, California 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

WM. LACY CLAY, Missouri 

STEVE ISRAEL, New York 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

ARTUR DAVIS, Alabama 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

GWEN MOORE, Wisconsin, 

BERNARD SANDERS, Vermont

ROBERT U. FOSTER, III, Staff Director 

(III)

C O N T E N T S 

Page 

Hearing held on: 

March 14, 2006 ................................................................................................. 1

Appendix: 

March 14, 2006 ................................................................................................. 47

WITNESSES 

TUESDAY, MARCH 14, 2006

Rudman, Warren B., Partner, Paul, Weiss, Rifkind, Wharton & Garrison, 

LLP, accompanied by Daniel J. Kramer, Robert P. Parker, and Alex Young 

K. Oh, Partners; George Massaro, Vice Chairman, Huron Consulting Group; 

and Jeff Ellis, Managing Director, Huron Consulting Group ........................... 6

APPENDIX 

Prepared statements: 

Oxley, Hon. Michael G. .................................................................................... 48

Kelly, Hon. Sue W. ........................................................................................... 50

Hinojosa, Hon. Ruben ....................................................................................... 51

Kanjorski, Hon. Paul E. ................................................................................... 52

Rudman, Warren B. ......................................................................................... 54

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Baker, Hon. Richard: 

Standard & Poor’s Article ................................................................................ 100

(1)

REVIEW OF THE RUDMAN 

REPORT ON FANNIE MAE 

Tuesday, March 14, 2006

U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The committee met, pursuant to notice, at 2:00 p.m., in room 

2128, Rayburn House Building, Hon. Michael G. Oxley [chairman 

of the committee] presiding. 

Present: Representatives Oxley, Baker, Castle, Royce, Kelly, 

Feeney, Hensarling, Garrett, Pearce, Neugebauer, Price, McHenry, 

Campbell, Frank, Kanjorski, Waters, Maloney, Watt, Sherman, 

Moore of Kansas, Baca, Matheson, Davis of Alabama, and Cleaver. 

The CHAIRMAN. In early 2003, we were led to believe that the 

GSE’s were running smoothly with only a routine accounting restatement in progress at Freddie Mac. What we have learned since 

then is that Freddie Mac and Fannie Mae were involved in large 

scale misapplication of accounting standards and irresponsible corporate governance. OFHEO, Congress, and the American people 

were misled by the former leadership of these enterprises. The Federal Home Loan Bank system has had its own share of accounting 

and management problems. 

In 2004, Fannie Mae’s board turned for help to Senator Warren 

Rudman who, with his team of legal and accounting experts, has 

given us a report of both great quantity and quality. He has 

verified much of what OFHEO eventually uncovered, and the SEC 

subsequently confirmed, providing an in-depth understanding of 

the intent and motive behind the transactions reviewed. 

This voluminous report details widespread departures by senior 

management from GAAP accounting, largely to minimize earnings 

volatility and meet forecasts and, in 1998, to trigger maximum executive bonuses. Accounting systems were grossly inadequate and 

employees were unqualified. 

Senator Rudman found that management, ‘‘paid lip service to a 

culture of openness, intellectual honesty and transparency and discouraged dissenting views, criticism and bad news.’’ Arrogance is a 

descriptive term used more than once. There was clear disdain for 

OFHEO. 

Fannie Mae claimed to be in line with state-of-the-art corporate 

governance when in reality such standards were not being practiced. Failure to comply with Sarbanes-Oxley requirements of internal control over financial reporting is not an insignificant matter. 

This report is costing between $60- and $70 million on top of the 

$500 million Fannie Mae spent last year on its financial restateVerDate 0ct 09 2002 12:10 Oct 30, 2006 Jkt 030177 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 F:\DOCS\30177.TXT HFIN PsN: TERRIE
2

ment work, a job that is far from done. Fannie Mae must also pay 

the legal expenses of its former Chairman/CEO and CFO. 

The encouraging news, according to the Rudman report, is that 

Fannie Mae has undergone an extensive transformation in personnel and structure. There has been a dramatic shift in the ‘‘tone 

at the top.’’ The company has not waited until issuance of this report to begin making necessary changes. 

I welcome the effort that Chairman Steve Ashley and CEO Dan 

Mudd are making in this regard. What Senator Rudman and others have shown us occurred at the GSE’s over several years. While 

those responsible have left, it’s taking the GSE’s years to make corrections. We look forward to OFHEO’s final report on their special 

exam of Fannie Mae. We must learn from this experience. 

The Rudman report underscores that it’s time for a new combined regulator for the GSE’s, with the tools and funding needed 

to prevent abuses from developing and permit swift enforcement 

action if they do. H.R. 1461 provides strong bank regulatory-like 

powers in the vital areas of capital, portfolios, product approval, 

and receivership commensurate with the task of overseeing these 

large and complicated companies. H.R. 1461 passed the House 

overwhelmingly last October. I urge the Senate to act so that Congress can pass overdue GSE regulatory reform this year. 

Senator Rudman, we appreciate your work on this report and 

your appearance here today. I will be giving you a more formal introduction after the opening statements. 

I now yield to our friend from Massachusetts, the Ranking Member, Mr. Frank. 

Mr. FRANK. Thank you, Mr. Chairman. As a Member of the 

House who worked very closely with Senator Rudman, when he 

was in the Senate, on a wide range of issues from legal services to 

many others, I was very pleased when the Fannie Mae board had 

the good sense to engage him and give him carte blanche. 

And I would just say that those of us know him, and that’s pretty 

widespread in Washington, have such confidence in his integrity 

that we benefit from having a report that’s not being challenged. 

The merits of the issues can be discussed and we are very appreciative for that. 

I think we should make very clear what we are talking about 

here and that is a betrayal by some of those at Fannie Mae of their 

mission. And I think it’s important to make a distinction. High 

ranking individuals at Fannie Mae betrayed the trust. I am hopeful 

that appropriate action will be taken based on this report and elsewhere for recouping money and for other efforts. 

It is important, however, that we not let the housing mission of 

this entity suffer. This is a case where individuals misbehaved, 

some actively, some by not doing their jobs. But this is not something that ought to be used to undo the housing mission. 

In fact, I join the chairman in his call for the Senate to act on 

legislation. And I want to address one particular error that I keep 

reading about, frankly, in some of the press, and that is the assertion that the bill that came out of the Senate Committee is, in its 

regulatory structure, tougher in some ways and more comprehensive than the House bill. 

3

There is a difference between the bills with regard to an affordable housing fund. We have one, they don’t. There’s a difference between the bills concerning mandating a portfolio reduction. But in 

those parts of the two bills which deal with the regulatory structure, which replace OFHEO with a better armed, better equipped, 

better funded, and more comprehensive regulator, there is no difference. 

And some of what happens here is a double counting. We read 

stories that say, well, the Senate bill is tougher because it calls for 

the portfolio reduction and it’s got a tougher regulatory scheme. 

No, that’s only half true. It does call for the portfolio reduction but 

we should be very clear that, with regard to the regulatory structure, we have a very tough bill, one that indeed included everything that I was told people thought ought to be in there. 

I would commend to people the excellent letter from the chairman of the subcommittee who has been a longtime critic of the organization and whose criticisms of some of the leadership people 

has been vindicated by this report and other events. The letter he 

wrote to The Wall Street Journal—on today’s Wall Street Journal, 

and it makes it very clear that the regulatory structure is a good 

one. 

Which leads me now to join in the chairman’s plea. To the extent 

that we have had problems in the past, as this report shows here 

and to some extent, Freddie Mac, the best way to prevent the recurrence is to act on legislation. 

The two bills, the House bill and the Senate Committee bill, 

since the Senate hasn’t voted on it, are essentially the same with 

regard to enhancing the regulatory structure and those who would 

kill the bill this year because of their opposition to the affordable 

housing fund and because they have, I think, an ideologically based 

view that says we shouldn’t be giving housing an advantage in the 

capital allocation function and we ought to mandate a portfolio reduction, if they kill this bill they will leave in place a regulatory 

structure that hasn’t been adequate, not because of failings of the 

individuals. 

Everybody agrees that the problem has been the way it was 

structured. So that’s what’s at issue here. Will the Congress act on 

what would appear to be an agreement to enhance the regulatory 

structure or will ideological differences over Fannie Mae and insistence on cutting back on its housing goal lead to the demise of the 

bill, in which case we’ll be left with this inadequate situation. 

Last thing I want to say, there were two other issues here that 

deal with general corporate governance. Once again—and Fannie 

Mae certainly is not unique in this, nor Freddie Mac—incentive 

pay for the top executives, the CEO and the CFO, seems to me bad 

for two reasons. 

First of all, I have to ask them a question. If they’re making several million dollars a year, why in the world do we have to bribe 

them to do their jobs? None of us here get bonuses for doing our 

jobs. Giving top executives of major corporations extra money for 

doing their jobs makes no sense. These are very highly compensated people to start with and they shouldn’t have to be bribed 

to do the job right. 

4

It’s especially a problem when, because of the inherent ambiguities of some of these issues, these bonuses, based on hitting targets, become incentives to play games with the accounting. So this 

whole question of executive compensation demands attention. 

And finally, I am once again persuaded, as I read about the nonrole of the board of directors, that in too many American corporations the board of directors play the role that Murray Kempton, the 

great journalist, once ascribed to editorial writers, namely that 

they come down from the hills after the battle is over and shoot 

the wounded. 

There does not appear to be here, as there was not in many other 

cases, any reasonable assertion of authority by boards of directors. 

If I had been on the board of directors when this was happening, 

I would be examining very closely my failures to step in. Now, the 

board did step in later on. They did shoot the wounded and they 

hired Rudman to come and cart them away, and that was a good 

decision. But both with regard to the abuses inherent in incentive 

pay for top executives and the passivity of the board of directors, 

there are lessons here not just about Fannie Mae, but about corporate America. 

The CHAIRMAN. The gentleman’s time has expired. The gentleman from Louisiana, Chairman of the Capital Markets Subcommittee. 

Mr. BAKER. Mr. Chairman, I thank you for calling this hearing 

and your longstanding good work. I’m glad we have arrived at this 

point today. I certainly want to express my appreciation to the Senator and his colleagues for their longsuffering, detailed good work 

and I think it has been helpful in attempting to bring closure to 

a difficult chapter in American business history. 

I think it is also important to recognize that, among the 2,600 

pages of documents, it’s easy to get side-tracked into minutiae and 

detail and arguing about when this or that occurred and forget for 

the moment that the larger obligation is to ensure that the American taxpayer is not held accountable for the missteps of the administration of a GSE or two. 

If someone had 5 or 6 years ago predicted that both Freddie Mac 

and Fannie Mae would have large-scale dislocations of executives 

as the result of accounting missteps, no one would have thought it 

possible. In fact, the rating agencies, prior to and during the course 

of these discoveries, all claimed that both enterprises were at the 

highest pinnacle of their corporate governance activities. Indeed, 

this is a disappointing chapter to now conclude that all was not 

what it appeared. 

As we go forward, it’s my intention at the appropriate time to 

ask more detailed questions about the events of late 1998 and early 

1999 and who was engaged in making important decisions but for 

the moment I’m merely pleased to be part of this hearing, Mr. 

Chairman, and I appreciate your good work. 

I look forward to hearing the testimony of the witnesses we have 

today and know that, working together, we can get through this 

year possibly with the adoption of a new regulatory structure in 

place which gives not only the necessary professional skills but the 

financial resources to the regulator to be confident and to make asVerDate 0ct 09 2002 12:10 Oct 30, 2006 Jkt 030177 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 F:\DOCS\30177.TXT HFIN PsN: TERRIE
5

sessments and judgments about the professional conduct of these 

enterprises. 

It is the only way, in my opinion, that we can assure taxpayers 

and homeowners that they will continue to be well-served by these 

enterprises. 

I yield back, Mr. Chairman. 

The CHAIRMAN. The gentleman yields back. The gentleman from 

Pennsylvania, Mr. Kanjorski. 

Mr. KANJORSKI. Mr. Chairman, we meet this afternoon to review 

the recently-released report prepared by former Senator Warren 

Rudman at the request of the special review committee established 

by the Fannie Mae board of directors. This report examines the 

company’s problems related to accounting standards, internal auditing controls and corporate governance, among other things. 

As I have regularly noted at our past hearings in this area, it 

is important for our panel to conduct comprehensive and regular 

oversight over our housing government-sponsored enterprises to ensure that they fulfill their missions and operate safely and soundly. 

Today’s hearing is, therefore, not only timely but also appropriate. 

In compiling this report, Senator Rudman and his team of investigators left no stone unturned. As I understand, these experts reviewed more than 4 million pages of documents over a period of 17 

months. They also conducted in excess of 240 interviews. As we 

begin today, I want to thank Senator Rudman and his team. I 

greatly appreciate their diligence in these important matters. 

Their comprehensive report has helped me to understand what 

went wrong with Fannie Mae. In one of its most significant conclusions, this report identifies no new major accounting violations not 

already disclosed by Fannie Mae and the Office of Federal Housing 

Enterprise Oversight. In addition, while the report details many of 

the major corrective actions that Fannie Mae has taken to address 

these matters, it makes no significant recommendations about further actions needed to address the firm’s past shortcomings. 

Importantly, the report also observes that Fannie Mae has ‘‘undergone an extensive transformation both in personnel and structure’’ during the last year-and-a-half. It further finds that no member of the current management team knowingly participated in improper conduct. 

While this report provides some assurances to Congress, the 

American public, and investors that Fannie Mae is turning the corner by directly and forthrightly addressing its accounting, auditing, 

and governance problems, we still must complete legislative action 

to improve the oversight of all government-sponsored enterprises. 

It is in the public’s interest that we address these regulatory issues 

promptly and properly. 

As I said in March 2000 at our very first meeting in this long 

series of hearings on the oversight of government-sponsored enterprises, ‘‘we need to have strong, independent regulators that have 

the resources they need to get the job done’’. I can assure everyone 

that I continue to support strong world-class independent regulation for Fannie Mae and Freddie Mac. Such regulation will protect 

the continued viability of our capital markets and promote confidence in Fannie Mae and Freddie Mac. 

6

By and large, the bill that passed the House last fall by a vote 

of 330 to 91 would accomplish these objectives. Before the 109th 

Congress completes its work, I hope that our colleagues in the Senate will consider their bill and that we can finally reach a resolution on these matters. 

Before yielding back the remainder of my time, I would be remiss 

if I did not note that, while Fannie Mae has cleared one hurdle 

with the release of the Rudman report in its ongoing efforts to restore accountability within the firm, other investigations by the Office of Federal Housing Enterprise Oversight, the Securities and 

Exchange Commission, the Public Company Accounting Oversight 

Board, and the Justice Department remain ongoing. 

The determinations of these experts will likely play an important 

role in influencing how we will ultimately proceed on any legislation during the remainder of the 109th Congress. If and when 

these entities complete their examinations, I also suspect that we 

will meet again to study their conclusions. In other words, and to 

paraphrase the work of Robert Frost, we have promises to keep, 

and may have miles to go before we sleep. 

In closing, Mr. Chairman, I commend you on your continued perseverance on these matters and I look forward to hearing from our 

distinguished witnesses. 

The CHAIRMAN. The gentleman’s time has expired. We now turn 

to our distinguished witness. Senator Rudman, welcome. 

Senator Rudman is a partner in the law firm of Paul, Weiss, 

Rifkind, Wharton & Garrison here in Washington, and served two 

terms in the United States Senate representing the great State of 

New Hampshire. Prior to being elected to the Senate, he served 6 

years as attorney general of that State. In recent years, Senator 

Rudman has been appointed to chair the Foreign Intelligence Advisory Board and the U.S. Committee on National Security 21st Century. 

Senator Rudman, again, welcome to the committee and congratulations on a comprehensive report. We appreciate your willingness 

to come before the committee and testify. I know you brought your 

expert team with you and I’ll let you introduce them. 

STATEMENT OF WARREN B. RUDMAN, PARTNER, PAUL, WEISS, 

RIFKIND, WHARTON & GARRISON, LLP; ACCOMPANIED BY 

DANIEL J. KRAMER, ROBERT P. PARKER, AND ALEX YOUNG 

K. OH, PARTNERS; GEORGE MASSARO, VICE CHAIRMAN, 

HURON CONSULTING GROUP; AND JEFF ELLIS, MANAGING 

DIRECTOR, HURON CONSULTING GROUP 

Sen. RUDMAN. Chairman Oxley, Congressman Frank, and members of the committee, first let me thank you for your gracious comments on the work that we’ve done. 

On behalf of this entire Paul, Weiss and Huron team that was 

involved in our engagement on behalf of the Special Review Committee of the Fannie Mae Board of Directors, we want to thank you 

for inviting us to participate in this hearing and sharing our results with you. 

Let me introduce you to the members of the team. We have Dan 

Kramer, Bob Parker, and Alex Oh from Paul, Weiss and George 

Massaro and Jeff Ellis from Huron. They are here because, as you 

7

will see as we develop your questions, we organized this into a series of discrete investigations. There were so many complex issues 

involved, so each of these people ran a number of teams, I coordinated the entire effort, and so as you ask your questions, I may 

well turn to some of them to be able to give you the full texture 

of the answers that you’re looking for, such as the one that Congressman Baker has indicated that he would ask later on. 

It’s unusual for attorneys to come before a Congressional committee to speak about a professional representation. In this instance, Fannie Mae’s board of directors, through its Special Review 

Committee, instructed us at the outset of our engagement to be 

open and transparent to governmental authorities. 

Since October 2004, we have provided weekly or bi-weekly briefings to the government agencies that have an interest in this matter, including OFHEO, the SEC, the United States Attorney’s Office for the District of Columbia and, of course, the Public Company 

Accounting Oversight Board. 

Under the instruction of the Special Review Committee and the 

board, the company has made the final report of this investigation 

public. In that spirit, we were encouraged by our client to accept 

your invitation to appear here today and assist the committee in 

any way that we can. 

I will divide my opening statement into four parts. First, I will 

describe our engagement on behalf of the Special Review Committee of Fannie Mae’s board, including the nature and the scope 

of this investigation. Second, I will describe our key findings, with 

some emphasis on the two most important accounting issues we 

considered: Fannie Mae’s implementation of FAS 91 and FAS 133. 

Third, I will summarize our findings regarding Fannie Mae’s corporate governance and internal controls with regard both to our 

findings concerning the company’s historical practices and to the 

significant changes that are underway at Fannie Mae today. I will 

conclude my statement with brief remarks on what our investigation did not cover. 

Our engagement on behalf of the Special Review Committee 

began in September of 2004. At that time, OFHEO was in the 

midst of a Special Examination of Fannie Mae’s accounting that 

began in the wake of the problems revealed at Freddie Mac in 

2003. 

In mid-September 2004, OFHEO issued a report of its findings 

to date that was critical of Fannie Mae’s accounting, principally in 

two areas: the accounting for premium and discounts on the company’s mortgage loan and mortgage-backed securities and the accounting for the derivatives Fannie Mae used to hedge the interest 

rate risk associated with its debt. The report also raised concerns 

about Fannie Mae’s systems and practices in the accounting standards, financial reporting, and internal control areas. 

Soon after OFHEO released its report, OFHEO and Fannie Mae’s 

board of directors entered into an agreement. Certain aspects of 

that agreement were unusual and also vital to an understanding 

of this report. In the agreement, the board agreed to undertake an 

internal investigation of the matters raised in the OFHEO report. 

The board also agreed to study and address the organizational, 

8

structural, internal controls, and governance issues that OFHEO 

had identified. 

In other words, the board undertook a dual track approach in 

which it tasked Paul, Weiss and Huron to conduct an internal investigation to determine what happened and, at the same time, the 

board commissioned an analysis of what remedial measures should 

be made promptly to address OFHEO’s criticisms. 

As a consequence of this dual track process, the recommendations that we would have made regarding Fannie Mae’s governance, internal controls, internal organization and the like either 

have been implemented already or are well underway. 

The agreement between OFHEO and the board provided the 

focus of our investigation but did not limit the scope of this inquiry. 

From the outset, Fannie Mae’s board and OFHEO encouraged us 

to conduct a broad review of the company’s accounting, financial reporting, governance, and internal controls policies and systems, 

and to follow the facts wherever they might lead. 

In February of 2005, OFHEO identified additional accounting 

and internal control issues at Fannie Mae and those issues were 

added to the scope of this investigation. Finally, the company identified new issues in a November 2005 Form 12b-25 filing with the 

SEC, and we considered those matters as well. The board placed 

no restrictions on our work and we received complete cooperation 

from the board and from the company’s current management. 

Early in our engagement, Paul, Weiss retained Huron Consulting 

Group, with the approval of OFHEO, as our forensic accounting experts. The accounting judgments in our report are Huron’s and we 

concur in those judgments. We appreciate and admire Huron’s important contributions to this investigation. 

The investigation took about 16 months. Our team, including 

Huron, reviewed over 4 million pages of documents and conducted 

over 240 interviews of 148 Fannie Mae employees or former employees. Unfortunately, Fannie Mae’s former chief financial officer, 

J. Timothy Howard, refused to cooperate in our investigation. 

We interviewed the company’s former controller, Leanne Spencer, on several occasions, but she declined to cooperate further after 

the company found that she had not produced certain documents 

from her files that were relevant to our investigation. 

Our key findings: 

Our report to the Special Review Committee is 616 pages long, 

and our executive summary, 31 pages. The three-volume appendix, 

which includes samples of documents that we discuss in our report, 

as well as submissions made by various executives, including Mr. 

Raines and Mr. Howard, add about 2,000 additional pages. In my 

view, anyone who wants a complete picture of our findings and 

analysis must review all of these documents carefully. With that 

caveat in mind, however, I believe that our principal findings can 

be summarized as follows. 

One. The accounting, financial reporting, and internal audit operations of the second largest financial services company in the 

country were inadequate both qualitatively and quantitatively. The 

resources dedicated to these functions were insufficient. Senior 

managers in critical accounting, financial reporting, and internal 

9

audit roles either were unqualified for their positions, did not understand their roles, or failed to carry out their roles properly. 

Two. Management’s interpretation of FAS 133, dealing with 

hedge accounting, departed from generally accepted accounting 

principles in a number of important respects. These departures 

from GAAP were not mere innocuous practical interpretations or 

modest deviations from a strict reading of the standard. In our 

view, the company’s hedge accounting conflicted with clear and specific provisions of the authoritative accounting literature. 

Moreover, the record shows that the company’s implementation 

of FAS 133 was motivated by a desire to remove volatility from reported earnings while avoiding both the substantial changes to the 

company’s business methods and the development of the complex 

accounting systems that otherwise would have been necessary to 

implement that standard properly. 

Finally, and most importantly, we found that the company’s significant hedge accounting practices were known to, and accepted 

by, the company’s outside auditor. 

Three. Management’s application of FAS 91, which concerns the 

accounting for premium and discounts on mortgages and mortgagebacked securities, also violated GAAP. Our most significant finding 

in this area concerned the circumstances surrounding the company’s decision to record $240 million of premium/discount amortization expense in 1998 when the company’s calculations showed 

that the expense was actually $439 million. 

We believe that there was no justification or rationale to support 

the recognition of only $240 million. Moreover, given other accounting entries and adjustments that the company made during this 

period, the evidence overall supports the conclusion that the company’s accounting decisions at that time were motivated by a desire 

to meet earnings-per-share targets and to achieve maximum bonus 

awards under Fannie Mae’s Annual Incentive Plan. 

Once again, it is important to note that Fannie Mae’s outside 

auditors were aware of these adjustments, although not necessarily 

of their motivation. 

Four. In our report, we address 16 separate accounting issues. In 

virtually every instance we examined, Fannie Mae’s accounting 

was inconsistent with GAAP. As we summarize in the executive 

summary of our report, management often justified departures 

from GAAP based on materiality assessments that were not comprehensive, on the need to accommodate systems inadequacies, on 

the unique nature of Fannie Mae’s business or on ‘‘substance over 

form’’ arguments. 

We found substantial evidence in a number of specific instances 

and overall that the company’s accounting and financial reporting 

policies and procedures were motivated by a desire to show stable 

earnings growth, achieve forecasted earnings, and avoid income 

statement volatility. 

However, with the exception of the one instance in 1998 that I 

referred to earlier, we believe that the evidence does not support 

the conclusion that these departures from GAAP were motivated by 

management’s desire to maximize bonuses in a given period other 

than the one that I have spoken of. 

10

Five. As an organizational matter, too much authority at Fannie 

Mae was concentrated in the former CFO. He had responsibility for 

management of the company’s portfolio, for its treasury operations, 

its accounting and financial reporting functions. The CFO also 

functioned as the company’s chief risk officer and had administrative responsibility for the internal audit function as well. 

The CFO and other senior managers operated within silos that 

had little interaction with each other and which therefore lacked 

a complete appreciation and understanding of the others’ roles and 

functions. In these circumstances, the checks and balances that 

would ordinarily exist in an organization of Fannie Mae’s size and 

complexity were largely non-existent. 

Six. Although Fannie Mae’s top management professed a desire 

to hear the view of subordinates and to value intellectual honesty, 

openness, and transparency, the culture at Fannie Mae discouraged criticism, dissenting views, and bad news. This applied to the 

areas of accounting and financial reporting, among others. 

One area in which senior management in the financial area was 

particularly sensitive was in achieving forecasted results. Even 

minor differences between forecasted and actual results appear to 

have caused great concern. 

Seven. Management tightly controlled the flow of information to 

the company’s board. In many instances, the information the board 

received in critical areas involving accounting, financial reporting, 

and internal controls was incomplete or misleading. 

In particular, we noted many instances in which management assured the board, often in the presence of its outside auditor, that 

the company’s critical accounting policies were consistent with 

GAAP. Management also assured the board that the company’s accounting and financial reporting systems were adequate and that 

the accounting and financial reporting functions had adequate resources, even when senior managers, according to testimony, were 

aware that such was not the case. 

Eight. The board relied heavily on senior management as well as 

the views of the company’s outside auditor. Until OFHEO began its 

Special Exam in 2003, and even in the wake of earlier announcements of substantial accounting problems at Freddie Mac, the 

board received assurances that Fannie Mae’s accounting was proper. 

Moreover, through 2002, OFHEO’s own reports to Congress on 

Fannie Mae gave the company high ratings, including high marks 

in such areas as corporate governance and the company’s implementation of FAS 133. 

Corporate Governance and Internal Controls. 

As I noted earlier, our investigation was part of a dual track 

process in which Fannie Mae’s board and management undertook 

significant reforms of the company’s governance, organization, and 

internal controls while our work was underway. 

We participated in these efforts at the board’s direction by sharing information, commenting on various proposals and making suggestions. In our report, we made findings regarding the company’s 

most significant governance, accounting, and internal control functions as they existed prior to 2004, and we also noted the significant changes that have taken place in each of these areas. 

11

I will briefly summarize our findings. 

Number one, the board. Fannie Mae’s board of directors endeavored to operate in a manner consistent with its fiduciary obligations and evolving corporate governance standards. The board was 

open to examination by third parties, including OFHEO, and it 

generally received high marks. 

The board, and particularly the audit committee, was sensitive 

to matters relating to accounting and financial reporting. The audit 

committee received regular assurances that the company’s accounting complied with relevant accounting standards. And I would parenthetically say that a reference to the full report will give you a 

full texture of some of the events that took place. 

The board has taken several significant steps since the release 

of the OFHEO report in September of 2004, including the separation of the chairman and the CEO positions, the establishment of 

a Risk Policy and Capital Committee to oversee financial and operational risk management, and the transformation of its Compliance 

Committee into a permanent committee with broad oversight in 

regulatory and compliance matters. 

Office of the Chair. Fannie Mae’s Office of the Chair, comprising 

the four most senior officers in a given time, suffered from functional and organizational problems. As noted above, a great deal of 

the authority and responsibilities for the company’s risk management, financial reporting, accounting, and internal control functions, as well as a substantial portion of the company’s business operations, was concentrated in the CFO. Senior management also 

exhibited and cultivated a culture of arrogance both internally and 

externally and perhaps, most of all, towards its regulator, OFHEO. 

There have been substantial changes in the past year at the senior management levels. Structurally, the Office of the Chair no 

longer exists. In particular, the functions previously overseen by 

the CFO are now divided among a number of different officers, including the chief financial officer, whose duties are more consistent 

with a CFO’s typical functions, a chief risk officer and a chief audit 

officer. 

We have received numerous reports from inside and outside the 

company that its attitude has changed materially towards a more 

open and cooperative approach to its regulators, to the Congress, 

and to the companies with which Fannie Mae deals. 

Office of Internal Audit or Auditing. We found that, prior to September 2004, the head of Internal Audit at Fannie Mae lacked the 

requisite expertise and experience to lead the internal audit operation at a company as large and as complex as Fannie Mae. 

Moreover, on more than one occasion, the head of internal audit 

took steps that suggested he did not fully appreciate his organization’s role within the company or his proper relationship with senior management. I would note parenthetically, the advent of Section 404 of Sarbanes-Oxley, which imposed a whole new layer of requirements on Internal Audit. 

In addition, the internal audit group at Fannie Mae lacked adequate resources, particularly in recent years as the company grew 

in size and complexity and as the demands placed on internal auditors increased commensurately. 

12

The company has a new chief audit officer who reports to the 

audit committee, with a separate reporting line to the new CEO 

only for administrative purposes. The internal audit function has 

been separated from risk management, which is to be overseen by 

a chief risk officer, and the structure and resources of the internal 

audit group have been enhanced significantly. 

Office of the Controller. Prior to September of 2004, the controller’s office at Fannie Mae suffered from some of the same weaknesses as the internal audit function. Leadership at the top lacked 

the accounting and financial reporting expertise and experience one 

would have expected at a company like Fannie Mae, and the office 

as a whole lacked the resources necessary to handle many of the 

complex accounting and reporting issues that the company faced, 

particularly in recent years. 

The company’s systems in these areas were grossly inadequate. 

As I noted earlier in my remarks, the company historically has justified deviations from GAAP on the ground that it did not have the 

systems necessary for strict compliance. 

There have been significant changes in recent months. There is 

new leadership in the accounting and financial reporting areas, including individuals with substantial experience in public accounting or at large financial institutions. 

Certain functions, such as accounting policy and business forecasting, have been moved outside of the controller’s office. We understand that the company is increasing the resources dedicated to 

these areas, including both staffing resources and systems development resources. 

Ethics and Compliance. Fannie Mae’s compliance organization 

dates back at least 10 years. It has maintained a Code of Business 

Conduct and has supported an internal investigative unit, called 

the Office of Corporate Justice, to address employee complaints. 

In 2003, the company established an Office of Corporate Compliance to develop and monitor compliance plans for the company’s 

business units and provide training to employees. Our principal 

concern in this area was that the company’s chief compliance officer, a deputy general counsel, reported directly to the general counsel and worked on matters involving employee claims against the 

company. 

The compliance program thus suffered from at least the appearance of a conflict of interest. In addition, we believe that the program overall would have been better served by a chief compliance 

officer who had no other assigned duties. 

In 2005, Fannie Mae established an Office of Compliance, Ethics 

and Investigations, OCEI, to oversee the preexisting ethics and 

compliance functions as well as a new ethics unit. The new chief 

compliance officer who heads OCEI has a direct reporting line to 

the CEO and to the compliance committee of the board. 

Finally, I would like to conclude my statement with two observations on what our investigation did not cover. 

I know this committee and your counterpart in the Senate, as 

well as the Administration, are concerned about the size and composition of the Fannie Mae portfolio. This issue, which of course relates ultimately to safety and soundness matters, was well beyond 

the scope of our inquiry. Those who wish to draw conclusions as to 

13

that issue from the contents of our report are obviously free to do 

so, but that policy issue is well beyond the scope of our assignment. 

We have drawn no conclusions on that issue, nor do we have the 

expertise to address that issue. 

Moreover, as you well know, in the report and its appendices, we 

have laid out the facts that this 16-month investigation has produced. Where appropriate, we have been critical of Fannie Mae and 

we have assigned general and specific accountability where we believe that was warranted. The question of liability and culpability 

for the conduct we described is a matter for various government departments and agencies to decide, as well as eventually the courts. 

It would have been decidedly inappropriate for us to reach conclusions in those areas. 

Finally, Mr. Chairman, as you develop your questions, to the extent that there are documents that your committee is interested in 

that appear in the footnotes but are not in our current appendices, 

we will be happy to make those available for the record when requested. 

Thank you very much, Mr. Chairman. 

[The prepared statement of Senator Rudman can be found on 

page 54 of the appendix.] 

The CHAIRMAN. Thank you, Senator Rudman. We’re looking forward to a good series of inquiries from the committee. Let me 

begin. 

I have somewhat of a personal interest in Sarbanes-Oxley and I 

want to raise a couple of issues with you. Of course, Fannie Mae 

is a publicly traded company, subject to the requirements of the 

Act. In October 2004, I asked former Chairman & CEO, Frank 

Raines, whether, in his view, any of the law’s provisions or subsequent regulations had been violated or ignored, and he answered 

no. 

He talked about, ‘‘an entire process around certification so that 

we know exactly at the highest levels of the company what decisions were being made and by whom.’’ He went on to add that, ‘‘as 

a result of Sarbanes-Oxley, I have made a campaign in our company to go around and tell people, ‘if you think there is something 

wrong, raise your hand. Raise your hand and it will be looked at’.’’ 

What did you find in terms of application by Fannie Mae of the 

Sarbanes-Oxley Act? Was the corporate environment conducive to 

its application and what role did Mr. Raines and former CFO Howard play in that regard? 

Sen. RUDMAN. Let me say that Mr. Raines may have believed 

what he said. I have no way of knowing his state of knowledge. I 

can tell you—I’m going to ask Mr. Massaro and Mr. Ellis to comment—but I would tell you from my own experience and observations, both in practice and otherwise, that the implementation of 

Sarbanes-Oxley, Section 404, and all of the internal audit issues 

that raises, which lead ultimately to certification by CEO’s and 

CFO’s was grossly inadequate as were the systems. 

So that would be my simple answer. And if George or Jeff would 

like to fill in on that, they are experts on Sarbanes-Oxley. They’re 

actually our experts today on Sarbanes-Oxley. 

Mr. ELLIS. In terms of internal control environment, I think the 

report speaks for itself. The control environment was extremely 

14

weak. The application of accounting principles, we detected a number of items that is ongoing today. So I think that whatever the 

tone was set, it wasn’t sufficient to implement the change that 

would have been expected. 

The CHAIRMAN. In your testimony, Senator Rudman, you talked 

about the communication or lack thereof between the executives 

and the board. It does appear a lot of that was kind of a one-way 

street, that the board lacked sufficient quality information in their 

decision-making process. 

Was that because of this culture of arrogance or did it go beyond 

that? 

Sen. RUDMAN. This was a company that, in my view—and we say 

so in this report—was not terribly transparent outside of the tightly controlled area of the top executives of this company. We have 

example after example of the board not being given information 

that it should have been given, particularly—and I’m sure this will 

come out in questions that are posed here, particularly from what 

Mr. Baker said in his opening statement—as it relates to the 1998 

and 1999 issues and what the board was told and what they were 

not told. 

In addition to that, I think one of the most striking examples to 

me, having looked at all of the evidence that we produced and done 

some of the interviews and read all of them, the attitude towards 

the board was one of giving them what they thought they needed 

to and not much more. 

And a good example of that, which we cite in our report, is when 

the Freddie Mac issue broke. There is documentary evidence that 

the board attempted to look closely at Fannie Mae’s accounting to 

get some feel as to whether or not these same issues existed within 

the company, both in the audit committee, and at the full board 

level. 

The board was given assurances, in some cases with the outside 

auditors present, that in fact those problems were not shared by 

Fannie Mae, when subsequent investigation by OFHEO and eventually by us indicates that that was not accurate. Did they believe 

that? There is no way, Mr. Chairman, for me to get inside of people’s minds but it certainly is apparent to me that this board was 

not even given a hint of the severity of the problems, even when 

the Freddie Mac issue erupted. 

And any board member worth his or her salt would have been 

very concerned about it, as they were. But they were not given information that would have raised the kind of red flags—and I 

heard Congressman Frank’s opening statement and I respect his 

opinion but, you know, unless you have certain information at least 

given to you that gives you some indication that all may not be 

well, it’s very difficult for board members to plumb the depths of 

the complexities of accounting systems, and that’s what happened 

here. 

I’m sure had they all to do it over, they might do things somewhat differently. But based on the record and the evidence we 

have, we found that they were not dealt with transparently, in 

some cases they were misled, whether intentionally or negligently 

is impossible for me to determine. 

15

The CHAIRMAN. So in that case, basically, the alarm bells were 

heard—alarm bells in terms of Freddie Mac. Was it the board or 

a particular committee of the board? 

Sen. RUDMAN. It was the audit committee and the entire board. 

Not only were they given loud alarm bells, some of which they 

sounded themselves—you couldn’t help but do so if you read all the 

press that was coming up at that time—but in particular, it’s interesting—and we’ll get into this in subsequent questions—what happened with the writeoff I spoke of, which should have been $400-

some-odd million, was only $200-some-odd million and how the 

board was dealt with on that issue and why it was dealt with that 

way. 

So my best answer I can give you—after all, we only have evidence we can look at. We can have speculation but I can’t speculate. I have to say that this board was not given the kind of information that would have led to the kind of vigorous inquiry that one 

might expect from an audit committee or a full board. 

The CHAIRMAN. Thank you. My time has expired. The gentleman 

from Massachusetts. 

Mr. FRANK. I appreciate that and I should make clear that, based 

on what you said, I should have rephrased what I said about the 

board, if it gave the impression that I was talking about personal 

shortcomings on those board members. What I’m really more concerned about is the structural weakness of the board of directors 

in this situation. This is part of the problem. 

When we are told that we should not intervene too directly, either through the SEC or, you know, there are people who want 

Sarbanes-Oxley repealed, there are people who want it cut back 

substantially. And the argument has been that we should rely on 

the internal control mechanisms. 

And what I should have said—and I appreciate the corrective, 

that it’s not a criticism of the individual board members, but it 

does speak to the structural weakness of the board as an entity in 

corporate America. And here we had a case where they even had 

an outside regulator. Most corporations don’t have an OFHEO. And 

even with all of that, the board was rather easily put off. 

And so the question then, is, as a broader issue, should we be—

I mean, we’re going to—if the Senate will do something, we could 

pass a bill and we will have a very good regulator here. But in general, this is kind of an object—how easily a board of directors can 

be frustrated, even when it’s been alerted by something else. 

Do you have any ideas about what we should be doing going forward? 

Sen. RUDMAN. Well, I certainly do and I think they’re evolving. 

I think one of the results of Sarbanes-Oxley, which in my view is 

a positive impact, is that boards of directors in general and audit 

committees specifically are meeting a great deal more with outside 

auditors and internal auditors than they ever did before. 

I mean, it was not unusual for major company boards to meet 

four, five times a year, audit committees to meet about that time. 

Today, in most major corporations, audit committees meet at least 

every month or two, have a number of teleconferences with their 

auditors and their internal auditors. So the whole atmosphere has 

changed and people, because of Section 404 of Sarbanes-Oxley, 

16

have become far more inquisitive about what’s going on in the accounting of a company. Had that existed at the time, I think you 

might have had a different result. 

Mr. FRANK. Although even there we had a problem because you 

said they were inquisitive and they are, after all—many of them, 

sort of accountants. Should there be as a general rule, be some 

kind of staff allotment for the boards? In this case, they asked the 

right questions, they were alerted, they got stiffed, and they didn’t 

really have—including by the outside auditor, which is a disturbing 

fact. 

But should we try to institutionalize a little more help for them? 

Sen. RUDMAN. Well, I think you have. As you know, SarbanesOxley now makes it the job of the audit committee and the board 

to hire the outside auditors, rather than the company. So the audit 

committee has a far different relationship with outside auditors. 

That’s number one. 

Number two, most boards believe—and I think correctly so—that 

they have the right, and in fact do, hire special advisors to advise 

them on special subjects— 

Mr. FRANK. As you were, in fact, hired by the board here. 

Sen. RUDMAN. Exactly. 

Mr. FRANK. Question—two more. One—and obviously this is very 

disturbing what happened at Fannie Mae and it also happened at 

Freddie Mac. But I, again, want to separate the misdeeds of individuals, the misjudgments of individuals from the important public 

policy functions. As you review this, was there at ever any time 

an—what we’re told is, look, these are entities that some people 

think have a claim on the Treasury; they could implicate serious 

problems for the Federal Government. 

Was there at any time any threat to the safety and soundness 

of the entity? Was there a fiscal crisis, potentially, because of these 

abuses? 

Sen. RUDMAN. Well, I don’t think I can answer that other than 

this way. Obviously OFHEO thought there was a problem because, 

as you know, they made adjustments to the required capital of 

Fannie Mae soon after their—in fact, that was part of their September intervention, if you will, that resulted in our being hired. 

So shortly thereafter, Fannie Mae in fact changed its capital 

structure which leads me to the conclusion that OFHEO was uncomfortable because of the size of the changing in—or the writedown of the eleven billion in derivatives. They were uncomfortable 

with that so I assume they had a reason to— 

Mr. FRANK. But even in the inadequate state of the regulatory 

structure at the time, they did have the power to order corrective 

action. 

Sen. RUDMAN. Absolutely. 

Mr. FRANK. Last point, and this does not in any way exonerate 

or mitigate what Fannie Mae did, but there had been some question about the relative ease of following the accounting standards 

in question, particularly dealing with derivatives. 

Is there—again, we’re talking about preventing this from happening going forward. We’ve got some special rules and restrictions 

at Fannie Mae. Did you or any of your team come to any opinion 

17

about the accounting standards, particularly the one dealing with 

derivatives? 

Sen. RUDMAN. Are you talking about the 133 standard? 

Mr. FRANK. If I knew which number— 

Sen. RUDMAN. The one on hedge accounting and derivatives? 

Mr. FRANK. If I—yes. That one. If I knew the number, I would 

have told you. 

Sen. RUDMAN. I don’t know quite what you’re asking me about 

that particular— 

Mr. FRANK. Some people have said that part of the problem is 

that it’s a very difficult standard to apply, that it’s opaque, that 

it’s—and that part of—again, this doesn’t justify what they did because all their mistakes were in one direction. If it was simply a 

problem of being confused, the mistakes would have been more 

random. So with all the mistakes going one direction, the complexity isn’t the problem, but that this may have contributed to the 

ease with which they could cover it up. 

Sen. RUDMAN. Well, Congressman Frank, I don’t know about the 

ease of covering up. I want to answer your question very directly 

because, in preparing for this hearing today, that very question 

that you have asked was raised and I answered it this way, that 

there must be a better way to write accounting standards than the 

way they are written. It reminds me a lot of the Internal Revenue 

Code. It requires a battery of experts to even figure out what some 

of the things mean. 

Having said that, although that was a very complex standard, it 

was clear to us early on in this investigation that the strict requirements of FAS 133 were not met— 

Mr. FRANK. I agree. This is not a justification— 

Sen. RUDMAN. Now, are you asking was it easier to evade them 

or avoid them? I would say this, that any time documents like that 

can be written with greater clarity—and I believe the SEC and 

FASB are attempting to do that and have ongoing programs to do 

that—that would be in everyone’s interest because I can tell you 

that this is a very complex standard, although, to understand what 

happened here was not that difficult. 

The CHAIRMAN. The gentleman’s time has expired. The gentleman from Louisiana, Mr. Baker. 

Mr. BAKER. Thank you, Mr. Chairman. 

Senator, again, I appreciate your work. It’s really an incredible 

thing to try to read through. I wish I could say that I made it 

through all 2,600 pages, but I’ve gotten through the first 600, 

which, even that has been a challenge. 

I’m targeting specifically—and there are a lot of areas I really 

would like to talk about. Although the lack of information flow to 

board members was obvious from the report, it would seem to me 

from the environment in which the corporation found itself with 

Freddie Mac having difficulty with the regulator and Congressional 

criticism, it would have been a time that board members should 

have exercised the highest standard of fiduciary conduct only for 

their own self-interest much less for the corporation and taxpayer, 

but I don’t have enough time to do all that today. 

In looking—and I’m not asking you to review this; I’m reciting 

it for the record—on page 46 of the report relative to a memo from 

18

Ms. Spencer addressed to Mr. Raines on August 10, 1998, it states 

in part, priority one, the goal of making $3.21 per share the managed earnings target which just establishing as a corporate principle they were engaged in trying to manage that EPS figure at 

that time to meet street expectations. 

On page 49, there is referenced by Ms. Spencer an 8:00 a.m. 

meeting on Friday morning, January 8th, which for the record Mr. 

Raines does not remember participating in; however, Mr. Howard 

and Mr. Spencer discussed with Mr. Raines in that meeting from 

their view the amount of rollover which should occur and ultimately, according to their view, Mr. Raines then became comfortable with the recommendation to record only a $240 million 

catchup. 

In the hearing memo, which you had not had, I do not believe, 

on October 6, 2004, Mr. Raines stated that the report—and at that 

time he was alleging the OFHEO report, not your report—that the 

company willfully violated GAAP in order to maximize executive 

bonuses. He says, going on, upon reading of this allegation, I reviewed the relevant facts. We have no facts, no materials, nothing 

to support the allegations. Based on the facts as I understand 

them, the $240 million was arrived at as part of analysis conducted 

by accounting. 

Then in response to my question which was, was there any discussion in which you participated relative to the determination of 

the catchup amount, Mr. Raines stated on the record, no, I did not 

participate in determining the amount of catchup. That was done, 

as I mentioned, within our financial function. 

My first question, in light of your review and the facts you’ve accumulated, is it possible that the precision with which the 3.2309 

was achieved was a mathematical business miracle or do you have 

reason to believe it was a result of some accounting manipulation? 

Sen. RUDMAN. There’s no question in our mind, Congressman 

Baker, it was the subject of some manipulation. And to give you 

the full texture of that, Alex Oh did that whole section for me and 

I think you’d find her response most interesting because it wasn’t 

just the amount that was not written down. The amount that was 

written down then left them with an additional problem. There 

were a number of accounting— 

Mr. BAKER. There’s a couple of more steps I’d like to get to because in—unfortunately we’re not like the Senate— 

Sen. RUDMAN. Right. I would think she could answer that question briefly. 

Mr. BAKER. But let me do this, because I’m going on a train and 

I think it comes right to your station. When you—did you have reason to believe that audit differences with KPMG, although not discussed by management to the board, were usual and customary or 

would that have been characterized as an aberrant act where—I 

can understand an auditor having a dispute, you sit down, you try 

to work through it, ultimately you don’t have a formal audit difference recorded. The time of this happening, management knew, 

it was not translated to the board. And I’m building a reason for 

making these statements. 

Since they did not disclose the audit difference, and the audit difference now is not material simply because the actions were not 

19

GAAP-compliant, it’s not material because the amount in the overall business environment was so small, it is material and important 

merely because it enabled ultimately the ultimate bonus targets to 

be hit. 

As I understand it, the $200 million figure got you within the 

bonus subdivision at 3.22 but you weren’t home yet. The second income adjustment got you to 3.2285; your next-door neighbors, but 

you’re still not home. The third was 3.2309, which then triggered 

the $27 million payout in bonuses to the executives responsible for 

making these determinations. 

My question, and you may be the best person to respond, is, 

given this relevant set of facts that it wasn’t one unilateral act 

where you were having a technical dispute with your accountant, 

where you made adjustments still not resulting in the maximum 

target not being hit, where you had subsequent, although minor, 

intended acts resulting in executives being rewarded for earnings 

they did not achieve, is it clear that this was a manipulation of financials for personal remuneration? 

Sen. RUDMAN. In that instance the answer is yes, and I say that 

because when you look at each of these transactions that were accumulated, non-GAAP compliant, to reach this number, that’s the 

conclusion we reach as to 1998, 1999. 

Mr. BAKER. And at the level that the executives of Fannie were 

held from a corporate governance perspective—and by the way, Mr. 

Chairman, I just want to stick this Standard & Poors corporate 

governance rating, January 30, 2000—let me get my glasses 

quick—3, as part of the record for another purpose at a later 

time— 

The CHAIRMAN. No objection. 

Mr. BAKER. Thank you, Mr. Chairman. My point is that if it is 

pretty much acknowledged that these activities occurred, the next 

question that came to me is what do we do about it. On one hand, 

we have the regulatory necessity to build a corporate governance 

box going forward, but with regard to these specific actions, these 

fall into a different category. A new regulator won’t necessarily 

have the historical view we have. 

I believe it to be within the board’s authority to request or demand a repayment of bonuses earned when they in fact are not legitimately earned. I further believe that it’s the right of the regulator at OFHEO to disgorge such earnings if he has a finding that 

it was fraudulently obtained. Not asking you to discuss whether 

this constitutes fraud. I’m merely asking, are either of those 

courses open to consideration by the board or have you—and you 

may not be able to disclose if you’ve had those discussions with the 

regulator. 

Sen. RUDMAN. I’m glad to discuss it with you, Congressman 

Baker. We, number one, have not had those discussions with the 

board but I can tell you that obviously those options are open to 

the company. They are always open to the company. There’s much 

precedent for that. Whether the company decides, based on this report, to do that is obviously beyond our scope. 

I want to just say one other thing to you that’s important, and 

that is that I believe—and I’m going to have Mr. Massaro and Mr. 

Ellis correct me if I’m wrong—that there are now new standards 

20

about materiality and audit differences that are required to be reported to boards of directors. 

Will you comment on that, George, as to what I am referring to? 

Mr. ELLIS. Yeah. Subsequently, there are required communications with— 

The CHAIRMAN. Can you pull that microphone a little closer? 

Mr. ELLIS. I’m sorry. There are now subsequent communications 

with the audit committee that require the audit committee be provided with a list of unadjusted differences, so this would find its 

way to the audit committee in detail and that it’s been a requirement for several years. 

Mr. BAKER. I’ve exhausted my time. That’s the reason— 

Mr. FRANK. Will the gentleman just yield for 10 more seconds 

just so I could— 

Mr. BAKER. I want to jump to one more thing and then I’d be 

happy to yield. 

Mr. FRANK. Because I just want to express my agreement with 

him that they should get the money back, that there should be a 

request for that— 

Sen. RUDMAN. Congressman Baker, I just want to tell you that 

had that been in place, had that type of disclosure been mandatory 

at the time of this 1998, 1999 incident that you have very accurately described, then my sense is that there would have been a 

different outcome. 

Mr. BAKER. Well, all other corporate executives are now subject 

to rules of conduct which reward professionalism and penalize 

those things which are not within the rails. This is not within the 

rails and whatever action that needs to be taken to make compensation back to the shareholders, I think clearly it ought to be 

requested of the board and at appropriate time we will communicate with them and ask for your support of that recommendation. 

The CHAIRMAN. The gentleman’s time has expired. The gentleman from Pennsylvania. 

Mr. KANJORSKI. I don’t know whether to call you Mr. Chairman 

or Senator or the Honorable. 

In listening to your analysis, particularly of the regulator’s activities up until 2002, it seems to me you had the CFO, you had the 

internal auditing, you had the external auditor, and then you had 

the regulator in place. So you had four checks. 

How in the world did they miss what was happening that the 

regulator could complement them on good governance and complying with GAAP? 

Sen. RUDMAN. Well, Congressman, let me respond in this way. 

As far as the outside auditors were concerned, we of course were 

not tasked to investigate KPMG, although we did interview them 

and look at work papers and so forth, and my frank answer is that 

I don’t know how they reached the conclusion they reached, particularly in the area of FAS 133. That’s number one. 

As far as OFHEO was concerned—and I don’t think anyone presently at OFHEO would disagree with this, nor would former director Falcone—former director Falcone appeared before the Senate 

Banking Committee, in I believe it was 2004 or 2003—it was 

2003—and testified at that time that the adequacy of resources and 

competence at OFHEO during that period was less than what it 

21

should have been, and pretty much said to the Senate Banking 

Committee that our capacity to do our job at that time was not 

what it should have been. And I think that, to a large extent, overhangs all of the efforts of this committee and your counterpart on 

the other side of the Capitol to try to have a stronger regulator. 

There is no question that OFHEO blessed not only the accounting generally but, in 2002, blessed the FAS 133 accounting as well 

as the governance of the corporation generally. Mr. Falcone’s answer, which I take at face value, was that they did not have the 

capacity to do what they should have been doing at the time. I 

agree with that. 

Mr. KANJORSKI. And I understand that. That’s testimony in 2003. 

But by affirmative action, they complemented Fannie Mae in 2002 

and for 4 or 5 years prior to that, that they complied and they had 

excellent governance. If he didn’t have adequacy to make that judgment, why did he make that judgment? 

Sen. RUDMAN. Well, I can only say, Congressman, that it is up 

to this committee and the Congress as a whole to end up with a 

regulator that’s adequately funded and strong and competent. 

There is no question in the years leading up—and these problems 

at Fannie Mae didn’t start in 1998 or 1999. Some of them were 

more historic than that. 

The bottom line is that they, evidently, did not have the capacity 

to do the kind of in-depth examination that was required. As a 

matter of fact, as I’m sure you’re aware, it was only when they 

were allowed to hire an outside major accounting firm to help them 

with their special examination of Fannie Mae that they came to the 

conclusion which they have come to, which we essentially have confirmed in this report. 

Mr. KANJORSKI. Well, you’ve had an opportunity to look over the 

legislation this committee has passed through the House and the 

legislation that the Senate is putting together in regard to a new, 

stronger, world-class regulator. Do you think that we have now 

taken the appropriate action to create the type of regulatory body 

necessary so that this won’t happen in the future? 

Sen. RUDMAN. I believe you have and I think a wonderful model 

for the Congress is what has always been a highly respected government office, the Comptroller of the Currency. And when you 

look at what they do and how they do it and also certain parts of 

the Fed, that’s the model, it seems, and I think that’s the model 

you’ve tried to follow. 

Mr. KANJORSKI. Very good. I yield back the balance of my time. 

The CHAIRMAN. The gentleman yields back. The gentleman from 

California, Mr. Royce. 

Mr. ROYCE. Thank you, Mr. Chairman. I think the lesson today 

is that things can go wrong at the GSE’s and just as accounting 

can go wrong, so can other areas within the firm such as risk management. In the future, I think we have to recognize that it is possible Fannie Mae could make a mistake in managing its interest 

rate risk and could intentionally take more interest rate risk to 

meet their profit targets. 

And with these possibilities in mind and in light of the systemic 

risk that mortgage portfolios pose, I do not think the enormous interest rate risk consolidated in the hands of two GSE’s is worth 

22

any benefit that may or may not result. And I think that interest 

rate risk will continue to loom large until something is done about 

the size of these mortgage portfolios. 

As you noted on page 101 of your report, Fannie Mae’s outstanding debt grew dramatically during the 1990s commensurate 

with the growth in its portfolio. The ability to hedge that debt 

against interest rate risk was a substantial component of Fannie 

Mae’s risk management. Fannie Mae used derivatives to hedge the 

interest rate risk associated with its debt and the notional amount 

of its derivative portfolio also grew tremendously during the 1990’s 

and into the 2000’s. 

Now, given that Fannie Mae’s portfolio investment business was 

the central driver of earnings growth throughout the last decade, 

it appears that this became a prime area for manipulated earnings 

or for presenting more favorable GAAP financial results. 

If the retained portfolio was significantly smaller, do you think 

Fannie Mae would have had problems of similar scale? That would 

be my first question. And the second question would be, during the 

period covered by your report, a number of key accounting changes 

took place, most prominently FAS 133. In your view, did the size 

of Fannie Mae’s retained portfolio and its hedging strategy make 

it arguably too difficult or possibly too costly to implement these 

accounting changes properly? 

Sen. RUDMAN. Well, to take your questions in order, Congressman, number one, obviously, if you had a smaller portfolio you 

would have a smaller hedge portfolio, you would have less risk. So 

that’s obvious. 

The second question, I’m not sure from what I’ve looked at that 

the accounting policies developed would have been a great deal different unless the portfolio was so small that every match could be 

done on an individual basis. 

Mr. ROYCE. During the period covered by your report, is it fair 

to say that a central part of the company’s culture was focused on 

steadily increasing earnings, would you think it likely that operational decisions during this period, such as the decision on growing the retained portfolio were driven by the same considerations? 

Sen. RUDMAN. Well, I really don’t know if I can answer that. My 

sense is that the accounting policies in place, the systems in place, 

and the level of competence in place would not have been any different, although I suppose the scale of the issue they were facing 

would have been smaller. 

Mr. ROYCE. It seems to me that when Fannie Mae made the decision to dramatically grow the outstanding debt and then to hedge 

against that with the interest rate risk, with the derivatives, the 

reality was that that gave a certain opportunity for managed earnings. 

And one of the points that I have been making for some time is 

that to allow that type of interest rate risk on the books is—and 

I think my Senate colleagues have come to that same conclusion—

is to tempt people with an awful lot of opportunity to manage earnings. 

Sen. RUDMAN. The only comment I would make, Congressman, is 

that I would agree with you totally that the Fannie Mae financial 

management structure we found in place in 2004 certainly was not 

23

adequate to do what it was supposed to do. That is apparent with 

now, what, 18 departures from GAAP found in this report. 

Whether it is competent to do that today is something this committee will have to decide. 

Mr. ROYCE. Senator, thank you very much. I appreciate it. 

Thank you, Mr. Chairman. 

The CHAIRMAN. The gentleman’s time has expired. The 

gentlelady from California, Ms. Waters. 

Ms. WATERS. Thank you very much, Mr. Chairman. Thank you 

for this hearing. This is very important and I would like to thank 

the Honorable Senator Rudman for the work that he’s done with 

all of those who have contributed to getting this report so that we 

can begin to really, really, really understand what the problems 

are. 

Senator, I have this belief that following the problems with 

Freddie Mac, that Fannie Mae tried to do everything possible to 

avoid falling into the same trap. Certainly, an organization as big 

as Fannie Mae, with the resources that they have, with as many 

bright people as they had, would have wanted to clean it up and 

to get it right after Freddie Mac. It’s very difficult for me to believe 

that there would be any attempts to manipulate, to hide, to do 

something in the name of getting bonuses after the great exposure 

of the problem of Freddie Mac. So I want to know what has gone 

wrong. 

Now, I remember very vividly when Mr. Raines was before this 

committee, he said he had sought outside advice on FAS 133 and 

he had gotten that advice and they had used that advice. However, 

it seems that there are some questions about how to do it and it 

continues even until today. 

As I understand it, Freddie Mac still has accounting problems 

that they have to delay their 2005 reports; Fannie Mae does, too. 

What’s wrong that these big agencies can’t seem to get it right? I 

can’t simply believe that they don’t want to, that somehow, given 

all of this, they’re trying to trick somebody or fool someone. What’s 

wrong with FAS 133, the interpretation of how it works? Did you 

get into that in this report? 

Sen. RUDMAN. We certainly did and it’s covered in detail and I 

can only tell you that it’s our opinion, and certainly Huron’s opinion, mainly, that as the SEC decided in December of 2004, that 

they got it wrong, completely wrong. And the reason for this massive restatement that you referred to in your comments is because 

they have a new outside auditor involved in what will be a year 

or maybe a two-year dive into the accounting and financials to be 

able to furnish certified financial statements to the— 

Ms. WATERS. Did they have an outside auditor that gave them 

counsel and advice on FAS 133 before? 

Sen. RUDMAN. Indeed. 

Ms. WATERS. And given that counsel and that advice, did they 

follow it? Did they use it as it was given to them, as it was advised 

to them? 

Sen. RUDMAN. Well, Madam Congressman, I would say this to 

you, that there is some question in our minds as to whether KPMG 

really understood how the FAS 133 accounting was being applied. 

They certainly were aware of what was being done but if they unVerDate 0ct 09 2002 12:10 Oct 30, 2006 Jkt 030177 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 F:\DOCS\30177.TXT HFIN PsN: TERRIE
24

derstood the detail, it’s not clear to me. And frankly, I don’t know 

how they approved it because it was fairly obvious to us and to the 

SEC that it was incorrect. 

Ms. WATERS. Well, my question is this. If you’re getting advice 

from an outside auditor—I don’t care whether you’re Fannie Mae, 

Bank of America, whomever you are, and you’re following that advice, and it appears that everybody is having the same problem 

with FAS 133, what then do you do? 

Sen. RUDMAN. Well, I know that since the SEC made its ruling, 

a number of major American companies have decided to restate 

their FASB 133 application— 

Ms. WATERS. How many other companies fall within this category? 

Sen. RUDMAN. I don’t know how many. I know several major 

companies. I have not followed— 

Ms. WATERS. Bank of America? I mean, who else? 

Sen. RUDMAN. I know General Electric made a public announcement— 

Ms. WATERS. General Electric? 

Sen. RUDMAN.—that they were doing some restatement. There is 

no question that FAS 133 was misapplied by a lot of people. The 

question you ask, however, goes to really another issue and that 

was what did the auditors know and to what depth did they understand the application. I don’t know. I cannot answer that question. 

Ms. WATERS. All right. Given the SEC’s evaluation and their conclusion about FAS 133, is it clear now that any firm or all firms 

can now follow the direction, the instructions of SEC and do a better job with this? 

Sen. RUDMAN. I believe so, Congresswoman, because it’s been 

very clear and there’s been other literature since that time as to 

how this should be applied. But I want to just come back earlier 

to something you said. There is no question that if you had Mr. 

Raines here today—and we interviewed him at length, for 8 hours 

or so—he would tell you that he relied on the outside auditors and 

his own financial people. That is his contention. 

Ms. WATERS. Did the outside auditors agree with Mr. Raines that 

they had given him the advice and information that he said they 

had? 

Sen. RUDMAN. Well, the outside auditors did in fact approve the 

financials for those years that this restatement is now being—covering the restatement, so I expect they must have. 

Ms. WATERS. All right. Well, I think that’s important for us to 

know. And I appreciate several things about the work that you 

have done. Number one, as my cursory review of it, it appears to 

be very, very detailed and a lot of work has gone into it. I also appreciate the fact that you made it very clear that you’re not here 

to answer the question about whether or not Fannie Mae is too big. 

You did not get caught up in whatever the confrontation is between 

FM Watch and Fannie Mae. You’re not in that mess. 

You’re here to talk about whether or not these accounting practices and some other things are followed; who was responsible; and 

the way that the accounting was done and other issues. So I thank 

you for clarifying that and I also thank you for not concluding that 

25

some people should go to jail, some people should have to repay. 

That’s up for others to determine. 

Your work is as objective and as well done as you could possibly 

do it, and I thank you for not letting people put words in your 

mouth. 

The CHAIRMAN. The gentlelady’s time has expired. 

Ms. WATERS. Thank you. I yield back the balance of my time. 

The CHAIRMAN. Mr. Garrett. 

Mr. GARRETT. Thank you, Mr. Chairman, and thank you Senator 

Rudman for being with us today to discuss your report. And after 

reviewing your report, I think it’s only increased my resolve that 

something has to be done on a number of fronts as far as regulation and also changes in other laws as well. 

Your report goes into quite a bit of detail as to how management 

pressed for specific earning levels to basically meet Wall Street’s 

expectations, in all of the so-called accounting areas either tried to 

hide financial losses or smooth over the system. I sit up here and 

I’m amazed, though, that to this day Fannie Mae does not still 

have current financial statements and they will not have them, as 

I understand, until the end of the year. 

If any other company in this country engaged in any of these 

practices and didn’t have those results, the investors in those companies would be trying to sell that stock as quickly as they possibly 

can. But because this entity has the backing or the implied backing 

of the U.S. Government, when this report came out people weren’t 

selling the stock; the stock actually rose and there, I think, is part 

of the problem. 

I think we could get three points out of this. First of all, after 

Enron and Worldcom, as we stated before, Sarbanes-Oxley was 

passed to try to prevent situations such as those but it was 3 years 

later that we found with Fannie Mae the exact same thing was allowed to occur. 

Your report seems to indicate that the board of directors, the auditing committee, the chairman, and independent auditors all met 

the current Sarbanes-Oxley’s requirements but they were still able 

to mislead everyone to a tune of $11 billion, or maybe more, since 

we don’t have their financials to this point. I think that should give 

everyone on this committee and this Congress pause, and give us 

an opportunity to go back and take a look at Sarbanes-Oxley as 

well to see how that has been implemented and whether other 

changes are made—necessary there as well. 

In addition, I find it amazing that had there not been a problem 

with Freddie Mac, that OFHEO would never have known anything 

was going on, would never have begun to look into Fannie Mae, 

and we might not be having this hearing today whatsoever. 

And finally, I find it interesting to note that, for all the expense 

of this report—and it was an expensive $65- or $70 million inquiry—that while we did spend a lot of time and discussion now 

on the accounting/mismanagement equation, there seems to be a 

lack or dearth of information with also operational problems. It’s 

my hope that those aspects will come out with further inquiry into 

the matter. 

Let me raise a couple of questions to you, then. Your report 

seems to go at great length but deals with—comes back with, in 

26

my mind at least, an ambiguity as to their accounting practices, as 

to why they occurred. At times the report suggests that it was incompetence or insufficient personnel or at other times it was intentional. I refer to your report, page 399, where it says, ‘‘with the exception of the 1998 accounting changes which is previously discussed, we see little evidence that any individual policy or the policies in the aggregate were designed or implemented to manipulate 

Fannie Mae’s financial statements’’. 

Everything that I’ve heard so far and everything that I’ve seen 

in the report seems on the face of it—that cannot be believed that 

this was just an incident—one incident that you can say that was 

intentional and the other cases it was just purely by incompetence 

or mismanagement. 

I don’t believe that if you looked only at those areas that you can 

just say it applied to that one case. I would ask you to look also 

and comment on the company’s handling of accounting derivatives 

as you do in the report. It would appear that if you look at the derivatives and the way that they were handled, it was intended—

it was an intentional action there as well to have a smooth rate of 

flow on the cash reports and resulted in the false application of 

FAS 133. This is exactly what occurred with Freddie Mac; they just 

did it in a slightly different way. 

So to come and say that it’s only the one instance where it’s intentional is—troubles me. It’s not—certainly suggests that this was 

the only instance where it was manipulated for a particular purpose. 

So I guess I would like to move it—the question to you, then, is 

were there other instances of that and were the operational deficiencies affecting the management decisions as to the earnings? For 

example, did the company, in other words, engage in unnecessary 

exposures in other areas that would smooth their exposures and 

smooth their earnings and what-have-you? And that would go to 

the question also as the portfolio— 

Sen. RUDMAN. I will let Mr. Parker answer one of the parts of 

your question. Let me say that I think what we’ve said in this report is that in terms of manipulating accounting for bonus targets, 

we did not find any evidence of that other than in 1998 and 1999. 

We have said consistently that meeting EPS targets was an obsession with this company and much of the accounting that was done 

was for that purpose, which is, I think, a little different from what 

you’ve said. 

I’d like Mr. Parker to address— 

Mr. GARRETT. So the purposes was purely a managerial style, 

we’re putting a target on the wall, we’re going to aim it, not for 

the fact that we’re going to get more pay at the end of the year, 

it’s just that this is what we’re going to aim for for the good of 

whatever else, we’re just going to aim for that target? 

Sen. RUDMAN. Congressman, if you want to believe that, that’s 

fine. All we can do—we have strong evidence for 1998 and 1999 

and that may be—you may be right. But we can only deal with evidence that we found. The evidence for 1998 and 1999 is clear, and 

we would not want to make assumptions or speculations. Others 

are free to draw different conclusions from the same facts. 

27

I want Mr. Parker to address one part of your statement, which 

I think is important. 

Mr. BAKER. And if I may, Mr. Garrett, your time has expired but 

the gentleman certainly can respond. 

Sen. RUDMAN. Brief response, Bob. 

Mr. PARKER. Yes, thank you. Congressman, you pointed out— 

Mr. BAKER. [presiding] You need to pull your microphone a little 

closer. We’re still not hearing you well. 

Mr. PARKER. Thank you. Congressman, you pointed out a sentence on page 399 and let me just clarify what now appears to be 

an ambiguity. 

The sentence that you read is from a chapter involving the accounting for certain affordable housing partnerships. What we were 

addressing in that sentence were the general policies—the general 

accounting policies regarding the affordable housing partnerships. 

In 1998, one of the accounting changes that was made coincidentally with the recognition of the $240 million in premium discount 

amortization adjustments was a change in accounting in a related 

area involving these affordable housing partnerships. So what we 

were trying to do in this sentence was make clear that our 1998 

conclusion stands but with respect to the accounting for the affordable housing partnerships generally, this was our finding. 

And of course, I concur with Senator Rudman’s remarks regarding the findings with respect to other accounting policies, some of 

which we do say that there were accounting decisions made to ensure stable earnings growth or other kinds of policies in that regard. 

Mr. BAKER. Thank you. The gentleman’s time has expired. 

Mr. Watt. 

Mr. WATT. Thank you, Mr. Chairman. Senator Rudman, obviously I haven’t read 1,700 pages of your report, but every report 

I’ve seen on it, and certainly the testimony that you’ve given today, 

indicates that you all have done a fantastic job of getting down in 

the trenches and figuring out what was going on, and you’ve certainly done a great job today in your testimony of laying it out for 

this committee. And my colleagues have asked some exceptionally 

good questions. 

I just have one question, really, and I don’t think it will take 5 

minutes, and maybe it will take somebody on your team to answer 

it. It’s an accounting question. On page 5, in number 3 of your prepared testimony, you talk about this $240 million of premium discount amortization expense in 1998 when it should have been $439 

million. That’s $199 million difference. 

I’m just interested in knowing what happens to that $199 million. Did it—as an accounting principle, does it get rolled to the 

next year or does it get forgotten about? What happens to that? 

Sen. RUDMAN. I will have Ms. Oh answer that for you, Congressman. 

Ms. OH. Under FAS 91, that $199 million was required to be recognized in 1998, so the entire $439 million should have been recognized— 

Mr. WATT. I understand that. I’m talking about when it wasn’t 

recognized, what happens to it. 

28

Ms. OH. What in fact happened here is Fannie Mae deferred it into 1999, and reduced the $199 million through periodic on top adjustments of regular $8 million entries per month. 

Sen. RUDMAN. All of which was not compliant with GAAP. 

Mr. WATT. Tell me what that means when you say on top adjustments because I—I mean, when I first heard about this, it seemed 

to me that if you got $199 million worth of difference in expense 

one year, you don’t recognize it one year, it just gets rolled to the 

next year. So it might benefit you one year but the next year it’s 

going to catch up with you. And if it doesn’t catch up with you that 

year, it’s going to catch up with you at some point unless something happens. So what I’m trying to figure out is what is this $8 million adjustment? Did that make it go away or did that just defer it into some 

subsequent year? Is it going to catch up at some point regardless 

of what you do? That’s what I’m trying to figure out. 

Ms. OH. I understand, Congressman. What happened here—

you’re right in your assumption that it eventually will catch up 

with you because you have to write off the $199 million in expense 

at some point. What happened here is under FAS 91, as interest 

rates change, you’re supposed to renew your calculations periodically. 

And what happened in 1999 is that the interest rates went back 

up and there was no further need to recognize an expense position 

on the catch-up. Nevertheless, the company continued to recognize 

the $8 million on top entries, which is equivalent to just writing 

off $8 million as expense every month because they were trying to 

create a reserve for future interest rate volatility that would generate additional catch-up. 

Mr. WATT. So within that 2-year period or within maybe a 5-year 

period, would you come out essentially the same place? 

Ms. OH. Well, that would all depend on the interest rates and 

mortgage holders prepayment— 

Mr. WATT. But if you were taking it as an expense, even if interest rates went up or down, you’re offsetting it against something 

that it wouldn’t otherwise have been offset against; isn’t that right? 

Ms. OH. Well, if you were to do a periodic assessment of the 

catch-up based on current interest rates, it may be that the expense position flips into an income position entirely so there’s nothing to offset against. 

Mr. WATT. Yes. Okay. All right. That’s the—I’ve been wondering 

about that $199 million. I could use it, so it kept me awake at 

night. 

Ms. OH. Glad I can help. 

Mr. WATT. Ever since I first heard about it, I’ve been worrying 

about it. 

Mr. FRANK. I don’t think the question has kept anybody awake 

this afternoon. 

Sen. RUDMAN. I think the important part, Congressman, is that 

it was not handled the way it should have been handled under— 

Mr. WATT. In that year. 

Sen. RUDMAN.—in that year— 

Mr. WATT. Are you saying that in subsequent years it wasn’t 

handled the way it should have been handled, either? 

29

Ms. OH. That’s correct. 

Sen. RUDMAN. That’s correct. 

Mr. WATT. Okay. All right. I’m not trying to finesse anything 

here. I’m just trying to figure out whether— 

Mr. BAKER. Would the gentleman yield on that point, just to 

make sure I’m getting—I don’t want to get confused here. The on 

top $8 million going forward was a reserve account against future 

volatility which was not GAAP compliant. 

Ms. OH. Right. 

Mr. BAKER. So even not rolling the $200 million was not GAAP 

compliant, but the on top calculation going forward is akin to a 

bank which cannot expand its loan loss reserve account for future 

volatility. That’s prohibited by the FDIC. So this is a customary 

understood business practice which they did not comply with. Is 

that fair? 

Ms. OH. That’s correct. 

Mr. BAKER. Is that okay? 

Mr. WATT. I appreciate the gentleman’s edification of that. It will 

help me to sleep better tonight. Thank you. 

Mr. BAKER. I got more where that came from. 

Mr. Hensarling. 

Mr. HENSARLING. Thank you, Mr. Chairman. And Senator, welcome to the committee. As a former aide to a certain former senator from Texas with whom you’re well acquainted, I recall fondly 

the days when half of America thought your first name was 

Graham. And even though this is the Financial Services Committee, and not the Budget Committee, I certainly want to thank 

you for your work as being one of the few successful Members of 

Congress to actually restrain the growth of the Federal budget at 

the expense of the family budget. 

Getting down to Financial Services business, obviously there’s 

been a lot of testimony and focus upon trying to level out the earnings volatility that Fannie Mae had and you speak of their kind of 

corporate culture. And I believe on page 6 of your testimony—let’s 

see—we found substantial evidence in a number of specific instances and overall that the company’s accounting and financial reporting policies and procedures were motivated by a desire to show 

stable earnings growth, avoid income statement volatility. 

As a former officer of an investment management firm that ran 

a hedged equity fund, I know through experience that the market 

does place quite a high premium on the smoothness of earnings, 

the lack of volatility. Was it within the scope of your investigation 

or do you have an opinion as far as Fannie Mae’s activities in artificially smoothing out their earnings, what did this mean to Fannie 

Mae? What did it do to their market cap? How was it valuable to 

them to engage in this activity? 

Sen. RUDMAN. Obviously when earnings are managed within the 

rules, they’re allowed to be managed. Many American corporations 

manage earnings through perfectly legitimate applications of 

GAAP. What we found was the way Fannie had in fact established 

reserves, managed earnings, was beyond GAAP. 

I think one of the interesting things about the work that we’ve 

done is that the company going forward has a whole new approach 

to accounting policy and I think I could probably predict with some 

30

certainty it will be a long time before Fannie Mae does any accounting acrobats to hit a particular target. I think they’d rather 

face the music in the year that it happened. And I think that is 

probably the good result of all that’s happened in the last few 

years. 

But earnings management in this country is not necessarily a 

bad word, as long as it’s done within legitimate bounds of GAAP 

accounting. We found 16 or 17 examples of non-GAAP accounting, 

particularly one we’ve just discussed with the Congressman who 

just left and with the chairman of the subcommittee. 

Mr. HENSARLING. In looking at your testimony, I read in virtually every instance we examined, Fannie Mae’s accounting was 

inconsistent with GAAP. In virtually every instance we examined. 

Harken to my colleague from New Jersey’s earlier questioning, but 

for the implicit guarantee of the Federal taxpayer given this type 

of accounting and given the quantity of the accounting 

misstatement, which appears to rival that of Enron and 

Worldcom—I’m expressing no opinion on any malevolent intent at 

this point—but, but for that implied taxpayer guarantee, do you 

have an opinion of what would have happened to Fannie Mae’s 

market cap or how they would have been punished in the marketplace when this discovery was made? 

Sen. RUDMAN. Well, I can’t answer that in any authoritative way. 

I think it’s fairly obvious that if a company is supposed to earn a 

certain amount according to the financial markets and it doesn’t 

meet the targets, that generally is not healthy for the stock of the 

company and the capitalization normally goes down. 

One of the reasons that companies try to maintain stable earnings is to try to maintain a stable stock price with some growth. 

Obviously that is one of the things that we found happened here. 

Mr. HENSARLING. Senator, like many other members of this committee, I have yet to wade through the roughly 700-page report and 

2,000-page addendum and in the interest of candor I’m unlikely to 

do that. 

My last question, since I’m running out of time here, is we’ve had 

representatives previously, I believe, of Fannie Mae who’ve testified that they are capable of hedging their interest rate and prepayment risk of their mortgage-backed securities, which I believe 

is now roughly an $800 billion portfolio. 

Is it a fair reading of your report that there were many instances 

when that often was not true? 

Sen. RUDMAN. George, do you want to take that? 

Mr. HENSARLING. Have I finally stumped the man? 

Sen. RUDMAN. I’m going to let Mr. Ellis take that because he 

looked at that particular issue. 

Mr. ELLIS. I think what we found is we found issues with the accounting for their derivatives. We did not find anything that would 

indicate that economically they had entered into bad transactions, 

transactions that did not economically hedge their portfolio. But 

again, it was really looking just at the accounting issues and how 

they applied the accounting guidance in FAS 133. 

Sen. RUDMAN. And I want to just follow up if I may, Mr. Chairman. You know, it’s very important that the market understand 

what the true value is of these portfolios and that’s the reason that 

31

FAS 133 was adopted so that in fact there was an assessment of 

value each year. You know, people talk about the $11 billion restatement. That doesn’t necessarily—that doesn’t tell you how 

much will eventually be written off, if any. It has much more to 

do with the timing of when those—how those affected the income 

statements over the years that are covered by the restatement, 

which is why it’s going to take a year-and-a-half or 2 years to figure it all out. 

Mr. HENSARLING. Thank you, Senator. I see my time is up. 

Mr. BAKER. Let me just—I hate to keep doing this but on clarifying that issue that the gentleman from Texas was just raising, 

there was at one time an issue relative to their duration gap. They 

had self-imposed bans of 90 days and they got out to 14 months. 

Just as a broad brush, you did not get into the issue of duration 

gap. 

Sen. RUDMAN. We did not. 

Mr. BAKER. Okay. Thank you very much. Mr. Davis. 

Mr. DAVIS. Thank you, Mr. Chairman. Senator, in the same interest of full disclosure, I’ve got to make it through Doris Kearns 

and Taylor Branch until I get to your 700 pages, so it may take 

me a while, too. 

Let me make an observation and get your reaction to it and let 

me frame it by saying that while I’m a 3-year youngster of this institution, I remember your work very well and you’ve had an enormously honorable career and you clearly continue that in the work 

that you do now and you make an interesting point that one can 

be in the U.S. Senate and simply decide to be a good, thoughtful, 

effective member and never get obsessed with running for President of the United States. So I thank you for the power of that example. 

Let me tell you, I think, the one criticism that I think could be 

advanced frankly of this report, and I mean this as constructive 

criticism. Obviously, as you know, this report will carry an enormous amount of weight because of the power and the throw weight 

of your reputation and the power of your law firm and its reputation. 

There’s no question this was a thorough, incisive, and detailed 

report. There’s every reason to believe that the SEC and the Justice Department will take this document seriously. Obviously the 

Justice Department and the SEC are in the process of making an 

evaluation as to liability, as to culpability and, in the real world, 

this is perhaps something that will inform their judgment. 

Having said that, there’s a little bit of a pattern that I can see 

in the opening statement that I suspect is contained in the report 

of being a little bit indiscriminate in the use of the word management. Obviously we have two players whose reputations are at 

stake: Mr. Raines and Mr. Howard. You make the observation that 

Mr. Raines was interviewed for 8 hours; you make the observation 

Mr. Howard declined to be interviewed. 

Look at page 7, for example, of your opening statement. It says— 

Sen. RUDMAN. Of today’s statement— 

Mr. DAVIS. Today’s statement. Paragraph 6 says, ‘‘although 

Fannie Mae’s top management professed a desire’’—and you talk 

about the culture of suppressing dissenting viewpoint, it’s a refVerDate 0ct 09 2002 12:10 Oct 30, 2006 Jkt 030177 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 F:\DOCS\30177.TXT HFIN PsN: TERRIE
32

erence to top management. In the next paragraph, paragraph 7 

says, ‘‘management tightly controlled the flow of information to the 

company’s Board’’. Then, a few sentences later, ‘‘in particular, we 

noted many instances in which management assured the Board’’ of, 

in effect, falsities, frankly, regarding GAAP compliance. 

Then paragraph 8, ‘‘the Board relied heavily on senior management’’. To a layman reading all of this, to a lawyer reading all of 

it, top management may imply Mr. Raines and Mr. Howard; management may imply them or someone else. It’s very hard to read 

the report and necessarily follow that particular track and that’s 

something that strikes me as a concern. 

Someone reading this could make certain assumptions about Mr. 

Raines that could be erroneous, or could make certain assumptions 

about Mr. Raines and Mr. Howard together that could be erroneous. Do you take that concern as a valid criticism of this report? 

Sen. RUDMAN. I think when you read the entire 616 pages, it becomes clear as to who we are talking about. We are talking about 

senior management of this company which covers, you know, the 

top four, five or six people who changed from time to time during 

this period, 1998 to today. We are certainly talking about the CEO 

who was also chairman at that time, and the CFO. We are talking 

about certain people who had major management roles, although 

not in the office of the chairman, in various control functions, audit 

functions. That’s who we’re talking about. 

When we talk about senior management or top management, 

we’re talking about probably about eight to ten people at the most, 

and if you read the report, as I’m sure you eventually hopefully will 

get a chance to do on a long flight somewhere, you will find that 

it is not hard to identify who we are talking about. 

One of the things we tried to do, Congressman, in this report is 

we only could deal with evidence, both testimonial and documentary. And if we could not support with a footnote, with a document, 

what we have said, we didn’t say it. We put a heavy burden on ourselves to make sure we were fair to everybody but we had no constraints on us and we said whatever we felt ought to be said, and 

I’ll stand on that. 

I would agree with you that maybe it would be clearer if each 

time you used the word management or top management you put 

out a string of names who we’re talking about, but I think if you 

look at the report itself you’ll find it’s self-explanatory. 

Mr. DAVIS. Let me ask a quick question because time is running 

out. The observation that there are instances in which management assured the board that the accounting policies were GAAPcompliant, did you come across any direct evidence that Mr. Raines 

participated in those assurances to the board? 

Sen. RUDMAN. We have made an affirmative finding in this report that although we ultimately hold Mr. Raines responsible for 

a series of errors that are outlined in numbers one through eight 

of today’s statement, we could find no evidence, testimonial or documentary, from anyone or any place that Mr. Raines knew that 

what was being suggested to him by his own accountants and his 

own internal people was non-GAAP compliant and he stated that 

repeatedly during his 8 hours of testimony. Now, that’s all we have 

to go on. 

33

Mr. DAVIS. And if the Chair would indulge me a little bit with 

just a couple of quick questions. 

The first one is obviously you’ve testified very correctly about 

OFHEO’s inadequacies, the lack of staffing and so on. Did you—

and I’ll ask you for quick answers because of time. Did you come 

across any direct evidence that anyone at Fannie Mae had affirmatively misled OFHEO regarding the accounting standards and 

GAAP-compliance? 

Sen. RUDMAN. No, I don’t believe we came through evidence of 

active misleading of OFHEO or anyone else. 

Mr. DAVIS. And the last question, if the Chair would indulge— 

Mr. BAKER. Yes, it’s the last question. 

Mr. DAVIS. Last question— 

Sen. RUDMAN. Although I want to say that there is evidence 

you’ll see in the report of not maybe going forward and getting further articulation on FAS 133, which maybe they should have done. 

There’s also a question as to how much they revealed in certain instances to their outside auditors, and we say that as well. 

Mr. DAVIS. Last question. Obviously one of the primary issues 

from a policy standpoint is what the Congress should do with respect to the capital requirements, portfolio limitations. You make 

it very clear in your report and in your testimony today that the 

only concern of your investigation had to do with issues that don’t 

relate to safety and soundness and that implicitly suggests that—

well, let me frame the question a slightly different way. 

A lot of the momentum behind the portfolio changes and behind 

the changes in capital purport to be related to safety and soundness. The argument is that we need to do these things to create 

a stronger safety and soundness structure. I think it’s important 

that your report seems to indicate that you wouldn’t weigh into 

that, you wouldn’t take a stand on the side of that position and 

argue that the portfolio and the capital changes need to be made 

for safety and soundness reasons. 

Sen. RUDMAN. I think our report does bear on safety and soundness in terms of the financial structure because obviously without 

a good financial structure, you’re not going to have safety and 

soundness; good numbers might not mean anything. 

As far as the issue of the composition, the character, the size of 

the portfolio, I’ll only say this: that there are people in this country 

who are economists and risk managers and risk experts that can 

give testimony to this committee or the Senate committee as to 

their assessment of what this risk is and I’m sure the Chairman 

of the subcommittee, now presiding this afternoon, knows who 

those people are. 

We do not consider ourselves to have the expertise to offer any 

kind of a reasonable opinion. And I was in the Senate, Congressman. I offered a lot of opinions in which I had no expertise. I don’t 

have that liberty anymore. 

Mr. DAVIS. It’s a requirement of being in the Congress, Senator. 

Mr. BAKER. The gentleman’s time has really now expired. 

Mr. Campbell. 

Mr. CAMPBELL. Thank you, Mr. Chairman, and thank you, Senator. 

34

We talked a lot about reducing the earnings volatility and the objective of smoothing earnings. Sometimes when that’s your intent, 

there is a motivation to understate earnings in addition to the motivation to overstate earnings. A lot of what we’ve heard about 

today is overstating earnings relative to GAAP. 

Did you find examples of both overstatements and understatements? 

Sen. RUDMAN. Yes, there was. And the report indicates there 

were years where there were certain holdbacks because they felt 

the following year might need more income. Yes. The answer is yes. 

Mr. CAMPBELL. If, then, you take all the overstatements and understatements and offset one against the other, though, there’s an 

overall general overstatement, I gather, of earnings and it’s not 

simply just a smoothing exercise that involves misreporting the 

earnings in one period or another. 

Sen. RUDMAN. Well, I think that’s exactly what Deloitte & Touche is now engaged in. The reason, as the chairman referred to, 

that there is a restatement is nobody really knows the answer to 

that question. They have to go through the derivative portfolio and 

then through a whole number of accounting issues. 

You may have noticed that yesterday Fannie Mae announced 

they had found other accounting issues; not major issues, but other 

issues. Not surprising. I expect there will be more of that and when 

that is all done and a statement is delivered to the SEC and certified, then that will answer your question. We have no way of 

knowing that answer. 

Mr. CAMPBELL. At this point we just don’t know if it’s merely 

misstating within a period or if in fact the current balance sheet— 

Sen. RUDMAN. And the SEC— 

Mr. CAMPBELL.—is improperly stated. 

Sen. RUDMAN. The SEC is very concerned about what you report 

in a period because that is what the market reacts to. 

Mr. CAMPBELL. Obviously. No, I understand that. I’m just trying 

to understand whether there’s a pattern of continuously overstating 

earnings or whether there’s this smoothing pattern and you’ve indicated it appears to be more the smoothing pattern. 

Sen. RUDMAN. I cannot say and we won’t know that for another 

year. 

Mr. CAMPBELL. But we don’t know where we are. Okay. One 

other question relative to the earnings per share and the bonuses 

relative to earnings per share. Those earnings per share bonuses 

included the chief financial officer and the controller whose primary responsibility it is to determine the earnings per share number? 

Sen. RUDMAN. There are a large number of people, 20 or 25, that 

were in that pool and it certainly included those people. 

Mr. CAMPBELL. Including those people— 

Sen. RUDMAN. Oh, yes. 

Mr. CAMPBELL.—in accounting and finance— 

Sen. RUDMAN. Right. Right. 

Mr. CAMPBELL.—primary responsibility it was to determine that 

number. 

Sen. RUDMAN. Exactly. 

35

Mr. CAMPBELL. Did you in your analysis make a—well, is the 

company still paying on that basis—still paying earnings per share 

bonuses as they were? 

Sen. RUDMAN. They have changed radically— 

Mr. CAMPBELL. To? 

Sen. RUDMAN.—to a system that blends a number of metrics. 

They did that with our help and with consultants that they hired 

to try to change the methodology for awarding incentive bonuses. 

And I will just take 30 seconds of your time, Congressman. 

Mr. CAMPBELL. Please. 

Sen. RUDMAN. It’s very interesting to me the evolution of this 

whole subject. You all recall that during the 1990’s there was a lot 

of upset in the Congress about executives being paid when their 

companies performed poorly, and that was a legitimate complaint. 

Now, they decided to change and they figured the best target was 

an EPS target because that was the purest expression of how the 

company was doing. We now find the problem with that is that 

there are all these accounting shams and ways to make adjustments from year to year that could make those targets more 

achievable. 

So what Fannie, recognizing that, did was to bring in an entirely 

new compensation consultant. They worked with us to find out 

what we were developing from the past history, and developed a 

compensation system which has been fully disclosed to OFHEO and 

I’m sure available to this committee if it’s interested. 

Mr. CAMPBELL. One last question, if I may. I’m actually a CPA; 

I don’t know how many there are on this committee but there 

aren’t a lot, but this is very complicated stuff. And derivatives are 

very complicated and accounting for derivatives is even more complicated. 

To what degree do you think that this is more incompetence or 

under-education—you alluded to that earlier, that there is at least 

some of that wherein people were not qualified to review and make 

these decisions—versus some kind of intentional act? 

Sen. RUDMAN. That’s always hard to determine based on the evidence you have, and of course we don’t have the right of subpoena 

and so, you know, there are some people, one in particular, I would 

have liked to have talked to who we didn’t. But my observation 

would be that, number one, it was a very difficult standard to interpret but the way they interpreted it was just flat out wrong and 

we say that in the report. 

This was not some innocuous interpretation. It was very clear to 

the SEC several months after this inquiry started back in 2004 

that they weren’t on even the right page in their interpretation and 

it was our conclusion as well. 

Mr. CAMPBELL. Thank you very much. Thank you, Mr. Chairman. 

Mr. BAKER. The gentleman’s time has expired. Mr. Cleaver. 

Mr. CLEAVER. Thank you, Mr. Chairman. Senator Rudman, I am 

very impressed with your great and exhaustive investigation and 

I think everyone here has mentioned how much you are revered 

around this place. I think it is important for us to know what went 

wrong with Fannie Mae and of course we must make whatever 

changes we can or take some curative action. 

36

But having said that, and now moving forward, this committee 

approved what I consider to be a major change in Fannie Mae’s 

portfolio that would allow 5 percent of profits to provide for badly 

needed affordable housing and we, at this particular juncture in 

the history of our Nation, need that passed more than ever if you 

consider what’s going on in the Gulf Coast area. 

Do you think that these changes that we are proposing, which 

are still over in the Senate, are acceptable ways for Fannie Mae 

to deal in some areas that they have not previously touched? 

Sen. RUDMAN. Congressman, you know, I would like to answer 

your question but I really—I’m not in a position to, not because I 

don’t want to but because I don’t have an opinion. The only part 

of the legislation I have looked at very closely, both the Senate and 

the House side, is the legislation in terms of strengthening the regulator, which I fully concur with. 

As far as these policy issues as to how the investments ought to 

be made, what should be done with portable housing, with low income housing, how the portfolio ought to be adjusted, I really don’t 

have an opinion because I truly don’t know. 

Mr. CLEAVER. That’s the problem. We shouldn’t have had a Senator—I could have probably tricked somebody else into answering 

the question. I really didn’t think you were going to answer. 

Sen. RUDMAN. Well, somebody at this table may have an answer 

but I don’t. 

Mr. CLEAVER. I’ll go to them; it’s probably too late, now. I was 

just very much interested in whether or not you thought that 

Fannie Mae could actually—that the legislation that came out of 

this committee was actually legislation that was helpful to Fannie 

Mae and would be beneficial to the country, and I understand your 

answer. 

But going back, you—in the report you said that the information 

flow to the board was tightly controlled by management. Now, is 

that different than any Corporation, any eleemosynary institution, 

even the Congress? I mean, to some degree we are a board of directors and we don’t get information— 

Sen. RUDMAN. Well, that’s a whole different— 

Mr. CLEAVER.—tightly controlled—but, yeah, that’s another—but, 

you know, I’m concerned—it seems to me that we have an issue 

here that is more related to character than systems and if that is 

the case, then there may be some people whose character flaws are 

spilling over on some others who don’t deserve to be painted with 

this broad brush that I think many people in the country now have 

of the top people in Fannie Mae. 

Sen. RUDMAN. Congressman, let me just refer to your question 

broadly. There is no question for a lot of years in this country 

boards of directors generally were not terribly active. They tended 

to be tightly controlled by the company, they were not independent. 

That’s all changed. 

It changed—actually, it started to change before Sarbanes-Oxley; 

it’s changed in a major way since Sarbanes-Oxley. And today, the 

overwhelming number of companies are moving towards more 

transparency in terms of the board and boards have more responsibility and more accountability than they had before the events of 

37

Sarbanes-Oxley and other civil litigation that has taken place since 

that time. 

So I think that Fannie Mae certainly was not the only company 

that tightly managed information flow but I will say that there 

were certain aspects of disclosure to the board which were described in this report which I thought were rather egregious in the 

sense that they should have been more informed than they were. 

Mr. CLEAVER. I yield back the balance of my time, Mr. Chairman. 

Mr. BAKER. I thank the gentleman. Ms. Kelly. 

Ms. KELLY. Thank you, Mr. Chairman. 

Senator Rudman, were you aware of the First Beneficial case before you were hired by Fannie Mae? 

Sen. RUDMAN. First Benef— 

Ms. KELLY. The First Beneficial case. Were you aware of the 

First Beneficial case before you were hired by Fannie Mae? 

Sen. RUDMAN. I was not personally aware of that case. 

Ms. KELLY. Did you have the opportunity to review that case 

during your investigation? 

Sen. RUDMAN. I seriously doubt it unless it had to do with something that we were looking at. Is this something up in the Philadelphia area? 

Ms. KELLY. It was a major fraud case, sir, and it involved Fannie 

Mae, and I’m curious about how a major fraud case involving 

Fannie Mae would not be within your remit to examine how the 

internal controls and safety of soundness of the company. 

Our review of the case in my committee found that Fannie Mae’s 

behavior in this case was motivated by wanting to hit compensation targets for regional executives. It might be a good thing if 

there’s somebody else at this desk who could answer that question. 

Sen. RUDMAN. I don’t think anyone here can. You can understand, Congresswoman, that we were given a scope to look into. We 

had a lot of information to look at. What year was that case decided? 

Ms. KELLY. 1998 to 2002. 

Sen. RUDMAN. Yes. We had no knowledge of that case, nor was 

there any information about that case produced to us. And I might 

say that we put out a major bit of notification to the company and 

anyone else who was interested to be in communication with us 

and many people were, but nobody informed us about that case. 

We’re unaware of it. 

Ms. KELLY. Senator Rudman, perhaps you could comment on the 

compensation culture at Fannie Mae during that time, 1998 to 

2002. 

Sen. RUDMAN. Well, what we have said in the report is that the 

events of 1998 and 1999, as I’ve testified before here previously, led 

to managing and earnings targets through improper accounting 

procedures which also one of the motivations was to maximize bonuses under the incentive plan for that year. We did not find that 

activity in terms of specifically bonus targets in the years thereafter. 

Ms. KELLY. The vice president of Fannie Mae for the region at 

the time of this particular case I’m talking about was a man named 

Samuel Smith, III. He was promoted from regional vice president 

38

for single family housing to national vice president of single family 

housing in spite of his having presided over Fannie Mae’s relations 

with the First Beneficial case—with First Beneficial. 

It seems—my question now is whether or not Fannie Mae has 

sufficient controls on officer promotion within the company to prevent that kind of behavior from being rewarded in the future. 

Sen. RUDMAN. Congresswoman, I would say the answer to that 

is, frankly, I don’t know but it certainly seems to me the sort of 

thing you ought to communicate to the company since you obviously have extensive knowledge of the issue. Understand, our investigation was based on a set of challenges referred to us by 

OFHEO from its September and February issuances to the company and thus to us and we looked at those issues. 

Had someone brought that issue to our attention and had it had 

relevance to what we were doing, we certainly would have looked 

at it. Neither of those things happened. 

Ms. KELLY. So if I understand you correctly, OFHEO did not ask 

you to take a look at any of these cases other—they gave you a 

straight portfolio and you did not look beyond that portfolio; is that 

correct? 

Sen. RUDMAN. Only—well, they gave us a portfolio but we had 

full ability to look beyond the portfolio but it would have had to 

come within the portfolio of what we looked at. For instance, it certainly did not come in within any of the accounting issues. We had 

16 accounting issues to look at. I doubt that what you’re talking 

about is an accounting issue. 

Ms. KELLY. Sir, I just wanted to ask you, because I clearly didn’t 

understand—it sounded to me like it was they gave you a portfolio 

and you looked at the portfolio but you were able to look outside 

the portfolio but if it wasn’t in the portfolio you couldn’t look at it. 

I didn’t quite understand what you were trying to tell me. 

Sen. RUDMAN. Well, let me try to be clear, Congresswoman. I’m 

sorry for being obscure. If you look in the report and the supplements, you will find two communications from OFHEO, one in September, one in February. They define the scope of work they wish 

us to look at. Had any of that information related to the case you’re 

talking about, we certainly would have looked at it. Evidently, it 

didn’t. 

Also, I might point out, there are a number of litigation matters 

Fannie Mae has been involved with over the years and unless they 

had some relevance to what we were doing, we certainly did not 

look at them. 

Ms. KELLY. Well, in this instance, sir, the—what happened was 

Fannie Mae sold bad mortgages to the Federal Government. It 

would have been a good thing to take a look at. I’ve run out of 

time. Mr. Chairman, you may want to pick that up. 

Sen. RUDMAN. Mr. Parker might have an additional response on 

that issue. Bob? 

Mr. PARKER. Congresswoman, if I understand—I believe I now 

recognize the matter you’re referring to. If I understand, I believe 

it was down in North Carolina. And the matter arose and was 

being investigated. If my recollection is correct, there were issues 

of that sort that were raised during the scope of our investigation. 

In other words, the matter was broached and was looked into durVerDate 0ct 09 2002 12:10 Oct 30, 2006 Jkt 030177 PO 00000 Frm 00042 Fmt 6633 Sfmt 6633 F:\DOCS\30177.TXT HFIN PsN: TERRIE
39

ing our investigation and was being looked at, as I recall, by other 

government agencies. So that is not something we decided to duplicate or to bring within our scope at that time. 

Ms. KELLY. But you did not mention it in your report. 

Sen. RUDMAN. No. 

Mr. PARKER. No, because we didn’t do any activity with respect 

to it. 

Sen. RUDMAN. If a governmental agency were actively involved in 

an investigation, we certainly would not refer to that in our report. 

That would not be appropriate for us to do. 

Mr. BAKER. The gentlelady’s time has expired. Mr. Price. 

Mr. PRICE. Thank you, Mr. Chairman. Senator, I appreciate you 

coming today. I also want to lend my voice to those who have recognized your service, past and present, and I’m honored to have 

you before the committee and recognize your budgetary work that 

you’ve done in the past and I appreciate it so much. I also want 

to thank your colleagues for joining us today. This is a remarkable 

indictment, truly, I think, that we see before us. I appreciate your 

candor and it’s very sobering information. 

I have a couple of specific questions. The first relates to the information that you and your colleagues had available to you as it compared to the information available to the four levels of review that 

have already been talked about, the CFO, the internal auditor, the 

external auditor and the regulator. 

On page 5 of your prepared remarks, item number two talks 

about FAS 133. The interpretation ‘‘departed from generally accepted accounting principles’’ or GAAP ‘‘in a number of important respects. These departures from GAAP were not mere innocuous 

practical interpretations or modest deviations from a strict reading 

of the standard’’. And then the final sentence there, ‘‘and importantly we found that the company’s significant hedge accounting 

practices were known to, and accepted by, the company’s outside 

auditor’’. 

My question would be, do you believe that those four levels of review had the same information that you had available to you with 

which to determine whether or not the practices were appropriate? 

Sen. RUDMAN. Well, I certainly know that OFHEO has had access to all of that because, not only have they had the right of 

course under their special examination to gather that documentation and that information and do a number of interviews, but we 

have on an ongoing basis been supplying them with information 

since October of 2004. 

I have to believe, from the minutes we’ve looked at and from the 

emails we’ve looked at, that the manager of the company had consultations with its inside and outside auditors on these issues and 

I assume—since all of the documents that we’ve received are from 

their files, I assume they had access to those documents. 

Mr. PRICE. And there’s been some allusion earlier to a ‘‘ease of 

covering up’’ and I can’t remember whether it came from the panel 

or whether it came from up here. Do you have an opinion as to 

whether or not there was an active covering up of what was going 

on or— 

Sen. RUDMAN. On the contrary. I go back and I look at the testimony before Mr. Baker’s committee by Mr. Raines and Mr. HowVerDate 0ct 09 2002 12:10 Oct 30, 2006 Jkt 030177 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 F:\DOCS\30177.TXT HFIN PsN: TERRIE
40

ard, which Mr. Baker has referred to. They were quite open in 

their beliefs at that time and they had stated them rather clearly. 

I don’t think that—if there was, we didn’t find evidence of it. We 

found evidence of mismanagement, incompetence, incorrect interpretation of rules, but not anyone trying to hide that other than, 

in our opinion—and hiding wouldn’t be the right word—not being 

at a level of transparency with the board of directors that I think 

is consistent with good governance. 

Mr. PRICE. Right. That leads to my next question. You had a 

number of items throughout your prepared testimony. As an organizational matter, too much authority at Fannie Mae was concentrated in the former CFO. Checks and balances were non-existent. The information the board received in critical areas was either 

incomplete or misleading. 

Would you offer an opinion as to whether or not you believe the 

changes that have been put in place at Fannie Mae currently are 

satisfactory to correct the problems that you—and the structural 

problems that you identified? 

Sen. RUDMAN. I believe they are, for two reasons. Number one, 

because in my dealings with the management of the company since 

the new management took over, I have found them to be very open, 

very transparent and, frankly, a bit on the humble side compared 

to the prior management. 

Secondly, and even more important, I’ve looked carefully at the 

backgrounds of each of the individuals hired in these new positions 

and they’re all very high level people with great backgrounds. Now, 

does that say they can’t make mistakes? I’m sure they can. But the 

probability of these kinds of mistakes with this team it seems to 

me is far less likely. 

Mr. PRICE. So that would lend credibility to the comment that 

was made earlier that this was a character flaw and not a systems 

flaw. Is that— 

Sen. RUDMAN. I think it was both. I’m not sure I’d use the word 

character. I think it was a competence flaw and a systems flaw. 

Mr. PRICE. Okay. I’ve got very little time left but I did want to 

offer anybody the opportunity to make any recommendation regarding any other changes from a Congressional standpoint, a legislative standpoint that you all would recommend. 

Sen. RUDMAN. I have said consistently when asked that when 

this finally goes to conference, it’s vital that a strong regulator 

emerge. I think— 

Mr. PRICE. Anything else besides that? 

Sen. RUDMAN. No. 

Mr. PRICE. Does anybody have any other opinion regarding that? 

Sen. RUDMAN. Comments at all? No. 

Mr. PRICE. Thank you ever so much. I appreciate your service. 

Mr. BAKER. The gentleman’s time has expired. 

Mr. PRICE. Thank you. 

Mr. BAKER. Mr. Pearce. 

Mr. PEARCE. Thank you, Mr. Chairman. Thank you, Senator. Whenever the bonuses were written out, $27 million more or 

less, what string of employees participated in the bonuses? In other 

words, how deep in the organization did those go? 

Sen. RUDMAN. Alex Oh will answer that question. 

41

Ms. OH. The bonuses were distributed from Office of the Chair 

personnel down to senior vice president levels. 

Mr. PEARCE. And what was the largest bonus given? 

Ms. OH. I believe it was slightly less than $2 million for 1998 

and that’s just the AIP component. 

Mr. PEARCE. Was it within the scope of your study that you 

would look back through the history and see if there was a pattern 

of misstatements in order to achieve the bonus levels or are you 

just targeting this one experience? 

Sen. RUDMAN. We started in 1998. 

Mr. PEARCE. The line of questions that was coming from one of 

my colleagues is that if we somehow accounted for the stuff later, 

it might, really, no harm, no foul, with the exception that the company is $27 million lighter at the end of one process than it would 

be at the end of the other process. Is that more or less accurate? 

Ms. OH. I don’t believe we agreed with the questioner that— 

Mr. PEARCE. I understand, but that’s the drift. And even if we 

gave him the fact that the later sequence was not in accordance 

with GAAP principles—but even if we acknowledged that it might 

possibly have been, still you have defrauded the company out of 

$27 million up-front that is not recovered— 

Ms. OH. That’s correct. 

Mr. PEARCE. Yeah. So there is a foul even though we eventually—even if we eventually accounted for it, so even the premise of 

his question was— 

Mr. BAKER. Would the gentleman yield just for a moment? 

Mr. PEARCE. I appreciate that. I would let the gentleman achieve 

his own time, if he would. 

I would ask about the cooperation between the executives. How 

cooperative were they? In other words— 

Sen. RUDMAN. During our investigation? 

Mr. PEARCE. Uh-huh. 

Sen. RUDMAN. We have had absolute, total cooperation from the 

Fannie Mae board, from all of the new management, people that 

were still there that had been under the prior management. None 

of our requests were— 

Mr. PEARCE. Except Mr. Howard. 

Sen. RUDMAN.—we received everything we needed and, as you 

see, we did about four-and-a-half million documents. We’re still 

looking at documents to wind up our engagement but we’ve had as 

much cooperation as one could expect and it’s been fine. 

Mr. PEARCE. And then—with the exception of Mr. Howard. Mr. 

Howard was non-responsive. 

Sen. RUDMAN. Correct. I’m talking about the current management and I’m certainly talking about Mr. Raines and other employees of the company and former employees of the company. 

Mr. PEARCE. Did the chairman have an observation? 

Mr. BAKER. Yes, sir. I just wanted to give you some information. 

The 1998 to 2003 bonuses paid out was $245 million. 

Mr. PEARCE. Thank you. How much was Mr. Raines’s bonus? 

Mr. BAKER. In one year, $1.9 million. I can give you more detail 

but I’ve got it up here. 

Mr. PEARCE. Okay. That’s fine. I would look to receive that. 

42

Back on the gentlelady from New York, she was asking about First Beneficial. There was a pattern of $7.5 billion of loans that 

evidently were suspect that were sold into Fannie Mae and became 

a little bit messy, sold back and then maybe sold over to Ginnie 

Mae. In other words, they started making the rounds as bad loans 

have a tendency to do once no one can collect them. 

Did any of your introspection—any of your looking at the background of Fannie Mae deal with this sort of a problem that might 

be inherent in their operation? 

Sen. RUDMAN. We did not. It was not part of what we were 

doing. 

Mr. PEARCE. Generally one can— 

Sen. RUDMAN. I don’t believe that’s been settled yet, either. I believe that’s still pending. 

Mr. PEARCE. Generally one gets a feel for a corporation and its 

culture and for the practices. Would you think that you all studied 

enough about the culture at the company to realize if they would 

engage in practices that were a little bit suspect in the banking 

terms? 

Sen. RUDMAN. I think what we say in the report is this company 

had a level of—a tone at the top, a level of arrogance that believed 

that it was pretty hard for Fannie Mae to be wrong about anything. Their whole experience with OFHEO and with the Congress 

historically as we did our investigation indicated to us that they believed that they were right and they would push very hard to prove 

they were right, either to the Congress or to OFHEO, depending 

on the circumstances. 

Whether that led to accounting misstatements, I am in no position to say. What I can say is that the attitude of the company was 

not conducive to problem-solving. It was conducive to essentially 

defending its turf which it did rather successfully for a long time. 

Mr. BAKER. The gentleman may have one more—his time is expired, but one more question if you’d like. 

Mr. PEARCE. Well, that’s fine. I see the time has expired. Thank 

you, Mr. Chairman. 

Mr. BAKER. We’re going to start with a second round because Mr. 

Frank and I both have another not lengthy set of questions and it 

follows on to Mr. Pearce’s general observation. In looking at the 

significant volumes prepared by the counsel for Mr. Raines, there 

are the following sort of comments I want to get your reaction to, 

Senator. 

We submit that it is not appropriate based on the record in front 

of you to rely on an amorphous criticism of tone or culture in analyzing Mr. Raines performance. A retrospective conclusion that 

there must have been cultural deficiencies because incorrect results 

were reached will not stand in the scrutiny of future adversarial 

proceedings. 

Any attempt to portray Mr. Raines as having created an inappropriate tone or culture is unsupported. Although the record does not 

support an inference that Mr. Raines should be judged legally culpable for the events, his departure as chairman and CEO in the 

wake of the Office of the Chief Accountant’s determination regarding accounting has exacted accountability for the performance of 

the company regardless of legal fault. 

43

It seems to me that—I have a quote I believe it’s yours and I’m 

not certain—that—or at least a statement of the report—that Mr. 

Raines was found to have contributed to the culture that improperly stressed stable earnings growth. Is that a correct assessment 

of the report’s findings or to what extent was Mr. Raines truly the 

navigator of the ship in the culture that is troubling? 

Sen. RUDMAN. Well, Chairman Baker, you know, I fully appreciate the position that counsel for various individuals take. That is 

their position. And the reason we published all of that is we 

thought that the committee was—and the Fannie Mae board and 

the world was entitled to see their position. 

We obviously don’t agree with that characterization that he did 

not contribute to that. As a matter of fact, when you look at page 

5 of our executive summary, we find that he contributed to a culture that improperly stressed stable earnings growth and as chairman and CEO 1999 through 2004, he was ultimately responsible 

for the failures that occurred on his watch. 

There’s no question that he was a strong, driven, very competent 

presence and that he set the tone and there was no question in our 

mind that meeting these earnings targets was very important to 

Mr. Raines. 

Mr. BAKER. And given your background inquiries, even though 

Mr. Howard is described as a very independent and powerful CFO, 

it is still not probable that in a world of accounting decisions at the 

level that has been discussed, that that would not—if not counseled, at least informed would be the customary business practice 

as to the actions being taken before they would be executed? 

Sen. RUDMAN. Well, you know, Chairman Baker, I must say that 

that is one of the reasons we were very disappointed in being able 

to talk to Mr. Howard. We only have testimony from Mr. Raines 

and a lot of documents. And there is nothing in those documents 

that shows us Mr. Raines heavily involved in some of the financial 

decisions. 

Your assumption may be correct, but we don’t have a lot of evidence about that. I suspect that others may at some subsequent 

time. We don’t have any. 

Mr. BAKER. I thank you. Mr. Frank. 

Mr. FRANK. Thank you, Mr. Chairman. I’m very much concerned 

about where we go from here. And you’ve made some comments 

which I appreciate about the strength of the regulator that we have 

in this bill and you did note that a contributing factor to the problems was that, as Mr. Falcone noted, OFHEO was underfunded 

and under-resourced. 

Had the regulator of Fannie Mae and Freddie Mac at the time 

that this arose been the regulator that is contemplated in the bill 

that passed the House, does that in your judgment mean that what 

happened would have been less likely or at least caught earlier? 

Sen. RUDMAN. Well, as I said, I don’t like to speculate but, because we’re both New Englanders, Congressman Frank, I will indulge this speculation. 

It seems to me from the experiences I’ve had, both in private life 

and public life and serving corporate boards of various kinds and 

the work that I’ve done here at Paul, Weiss, that had this regulator 

had the depth of accounting expertise that it had when it engaged 

44

Deloitte & Touche to do a deep dive, if you will, on Fannie Mae’s 

accounting, that it is likely, in my view, that they would have uncovered some of the things that were uncovered in the 2004— 

Mr. FRANK. And just to close the loop, the bill that we have 

passed out of the House, does that, in your judgment, provide those 

resources and the likelihood of that being available to the regulator? 

Sen. RUDMAN. I think it probably does, but I would give you this 

caveat. I think any time a regulator like Fannie or the fed or the 

comptroller has an issue that could affect fundamentally large segments of the economy, it’s always good they can come back to the 

Congress and ask for additional funds for special assistance. 

Mr. FRANK. I appreciate it. But the structure would be appropriate. 

Sen. RUDMAN. It is. 

Mr. FRANK. There was some reference earlier—and I’m just interested in the magnitude of this—there was some reference comparing what you dealt with and examined to Enron and MCI. And 

in my judgment of both of those, we had just a woefully inadequate 

amount of revenue coming in. Was there that kind of problem at 

Fannie Mae? Is it comparable to Enron and MCI in the macro aspects? 

Sen. RUDMAN. That was not the problem. I’m very familiar with 

those matters not only from having read about them but I’ve talked 

to people who were involved actively in and I don’t think these are 

necessarily comparable. These are different kinds of issues. 

Certainly, our report does not find people actively engaging— 

Mr. FRANK. And not the order of magnitude of economic problem. 

Sen. RUDMAN. No. No. 

Mr. FRANK. One last question. It was rumored that there was an 

important Commission appointed and neither you nor Lee Hamilton was on it. Is that true? 

Sen. RUDMAN. That’s true. 

Mr. FRANK. I’m surprised to hear that. 

Mr. BAKER. The gentleman’s time has expired. Mr. Pearce, did 

you want to take another round? 

Mr. PEARCE. A couple more questions, pursuing just a little bit 

of the line of the questions that were just completed. 

It did not in your mind rise to the level of magnitude of Enron 

and that particular problem. They put Martha Stewart in jail for 

4,000 shares. Does it rise to that level? 

Sen. RUDMAN. I’m sorry, Congressman. I didn’t hear you. 

Mr. PEARCE. I said Martha Stewart was put in jail—in other 

words, we’re determining magnitude now. Enron was a larger magnitude, you said. Martha Stewart—I think there were 4,000 shares 

involved and she went to jail for obstruction and whether—and not 

telling whether or not she got some advance notice. So does this 

case rise to that magnitude? 

Sen. RUDMAN. You know, I don’t want to back into the question 

about culpability but I will just make the general observation that 

those cases involved the creation of entities that really didn’t exist, 

created conspiracies to move funds around for a very—purposes 

that were deleterious to the markets. 

45

We don’t find that kind of evidence here. We find a lot of very 

serious financial mismanagement and we find some manipulation 

of earnings in order to reach bonus targets in a particular year and 

a real concern with meeting targets every year. That was an obsession. But I think that’s a different level from what we’re talking 

about. 

Mr. PEARCE. Yes. Sure. Enron was the creation of other entities. 

But the HealthSouth, that was more of an accounting problem, 

WorldCom, again, was accounting fraud. So once you decide that 

you’re going to—once a culture decides it’s going to misstate, to 

manage the facts in order to get an outcome of $240 million bonus, 

and generally if you look at outcomes that accounting manipulation 

is designed for, usually there’s some payoff for the individuals who 

are willing to get involved in that and I guess at the end of the 

day how can we say that one accounting fraud is different and 

more substantial, less substantial than another. 

Because if you look, there seems to be a continuum at which the 

problem escalates. I can remember at one point Enron was a fairly 

straight oil and gas producer out in our particular area. But they 

then spun off the energy sector and got faster and faster players, 

saw more and more creases in the law, and then you could take 

a look at WorldCom, HealthSouth, Tyco, Commercial Financial 

Services. 

Again, got a lot of players here moving numbers pretty fast and 

it appears that they benefitted personally, which appears to be the 

case here. How would those cases differ? How would my linking of 

those cases I think be inappropriate, I guess is my question. 

Sen. RUDMAN. My answer would be that what someone in this 

government is going to have to decide, not me and not you, really, 

but someone in this government at the Department of Justice is 

going to have to decide whether or not any of these rise to the level 

of the kind of conduct you’re talking about. 

I truly don’t know the answer to it, Congressman. I don’t know. 

Mr. PEARCE. And I appreciate the straightforwardness of the answer because many of these things are very difficult. 

Mr. Chairman, I appreciate your indulgence. 

Mr. BAKER. I thank the gentleman. I’ll, for the record, bring us 

to closure today. I want to acknowledge that it is the board of 

Fannie Mae that engaged your firm and your team of experts to 

review and prepare an arms-length examination of a very troubled 

period of corporate performance. Thanks certainly on behalf of this 

committee and the chairman. 

I want to make clear that we are very appreciative for the diligence exercised, the quality of the report generated and the findings which will be, I believe, of significant help to us going forward 

as we attempt to construct a new regulatory structure to assure 

homeowners of access to low cost housing and to assure taxpayers 

that they will not be placed in untoward risk. 

You have performed a very valuable service and the committee 

is very appreciative, and we thank you for your time and participation here today. 

Sen. RUDMAN. Mr. Chairman, I thank you for those words and 

I want to express my appreciation to your staff, Mr. Butler in parVerDate 0ct 09 2002 12:10 Oct 30, 2006 Jkt 030177 PO 00000 Frm 00049 Fmt 6633 Sfmt 6633 F:\DOCS\30177.TXT HFIN PsN: TERRIE
46

ticular, for being so helpful in getting us organized to appear here 

before you. 

Let me also add I know there are a lot of footnotes in this report 

and some of your members may be interested in some of those footnotes, as you are. We will be happy to make them available. 

Mr. BAKER. Oh, we have your mailing address and we’re going 

to be good pen pals. Thank you. 

Our meeting is adjourned. 

[Whereupon, at 4:30 p.m., the committee was adjourned.] 

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