On Wednesday, when Fannie Mae CEO Franklin Raines appeared before a House subcommittee to address allegations that he and his finance team had cooked the mortgage giant's books, he had three choices: One, he could do what other CEOs have done—take the Fifth (a prudent legal tactic, even for the innocent, albeit wimpy and unsatisfying). Two, he could claim he was shocked to discover that his finance department was staffed by hoodlums (also typical, even less admirable). Three, he could stand behind the accounting, his team, and his company, explain the decisions, and suggest that the allegations were wrong.
Raines chose option No. 3, which increased his personal risk and raised a for-now unanswerable question: Is he the perpetrator of an accounting crime, the target of a political witch hunt, or the victim of an overzealous bureaucracy?
The subcommittee collared Raines after Fannie Mae's regulator, the Office of Federal Housing Enterprise Oversight (or OFHEO), published a 211-page diatribe citing a litany of sins: "pervasive and willful" earnings manipulation, lax controls, perverse incentives, unjust bonuses. The press pounced, likening Fannie Mae to Enron, calling for Raines' head. The Securities and Exchange Commission launched an inquiry, the Justice Department a criminal investigation.
After years of scandals, such proceedings would hardly merit mention, except that Fannie Mae is no ordinary company and Raines no ordinary CEO. Created during the Depression to promote mortgage issuance and home ownership, Fannie is now, by one measure, the fourth-largest company in the country. It is also a "government-sponsored enterprise," and, as such, enjoys special privileges that most companies don't have. (Read more about this in " Moneybox".) This cushy status antagonizes Fannie's competitors, who argue, probably justifiably, that the advantage is unfair. Fannie doesn't help matters by paying its executives fat bonuses and hiding behind the universal appeal of its mission, declaring itself "in the American Dream business," and bludgeoning critics as "anti-housing."
If Fannie is in the American Dream business, Raines is the American Dream (until a few weeks ago, anyway). He grew up in Seattle, in a household of seven children. When his father lost his job, the 8-year-old Raines worked in a grocery store for $2 a week, and his mother scrubbed bathrooms at Boeing (three decades later, Raines was elected to Boeing's board).
Raines told the Seattle Post-Intelligencer that his parents provided "an example of people who worked for everything they got, every day meeting their responsibilities." He has, to put it mildly, continued the family tradition. In high school, Raines was student-body president, quarterback, and state debate champion. Between Harvard and Harvard Law, he attended Oxford as a Rhodes scholar. Professionally, he glided between government and the private sector, working for Nixon, Carter, and Clinton, becoming a partner at Lazard Freres and a vice chairman of Fannie Mae. Described as the Jackie Robinson of business, Raines' acceptance of Fannie's top slot in 1999 made him the first black CEO of a Fortune 500 company. He was mentioned as a possible vice presidential choice for John Kerry and a candidate for treasury secretary.
As Clinton's budget director, Raines negotiated the first balanced budget the government had approved in nearly 30 years. He accomplished this by doing what he has done since grade school: finding common ground. At Harvard, in an age of bitter divisiveness, Raines joined both the Young Democrats and the Young Republicans. This suggests a Clintonian desire to have it all ways, but also a mature pragmatism and a genuine eagerness to bridge divides. Twenty years later, in Washington, D.C., as he worked toward a budget compromise, Raines visited representatives from both parties, listening carefully, figuring out what each constituency wanted. After the budget deal, he became known as the best negotiator in town.
Raines emerged as a reassuring corporate face early in the wave of business scandals. As chairman of the Corporate Governance Task Force of the Business Roundtable, he spoke eloquently and intelligently about the lessons of Enron. When an accounting flamethrower torched sibling mortgage-giant Freddie Mac last summer—and Fannie felt the heat—Raines didn't hide. He didn't declare that Fannie was different. Instead, he carefully, patiently, explained why it was different. Asked whether Fannie had circumvented accounting rules or made accounting judgments that employees or auditors considered debatable, Raines replied unequivocally, "No" (a statement that the Justice Department will presumably hang him on if it determines the company did something wrong). Then, just as relevantly, he added:
I have seen a number of these sort of scandal fests before, where the issues become of vital importance that were not of any importance previously. Some people seem to be of the belief that if you manage your company with an eye to the accounting results, that that is somehow a suspicious activity. I don't know of any company that is not managed with an eye to what the accounting is going to say at the end of the period. So let's be very clear, every company undertakes business decisions with a view to, is this going to be recorded as a profit or a loss? That is a normal part of business.
I hope we don't get to the position where someone says, have you ever thought about two alternatives, one of which would have a more favorable impact on you and the other would have a less favorable; that somehow that is suspicious. It is not suspicious. It is the normal course of conducting a business, any business, not just a business like Fannie Mae.
But as Raines could have predicted, what looked like normal accounting a few months ago is now being viewed as a suspicious. The press and public are quick to accept the findings of regulatory investigations as gospel. In Wednesday's hearing, Rep. Richard Baker, R-La., declared Fannie's accounting practices "abhorrent." Few who read the newspapers probably imagine that they could have been otherwise.
And maybe they are abhorrent. Maybe Raines got greedy. Maybe, as the story usually goes, he was so drunk on success, money, and power that he considered himself above the law. Maybe after a lifetime of hard work, he cut corners. Maybe … or, maybe, more likely, he is the same man of discipline, intelligence, honor, and integrity that a half-century of actions and words suggest. If so, we need another explanation for the Fannie proceedings and the assault on Raines.
The simplest, and most conspiratorial, is that the Fannie investigation represents a Republican payback for Enron and Halliburton. Conservatives are delighting in the gutting of Raines and Fannie Mae—a Democratic boss of a Democratic-leaning company. Former Fannie CEO James Johnson, who got some of the bonuses OFHEO criticized, has also been shortlisted as a possible Kerry treasury secretary. The accounting investigation, if nothing else, has probably made both Raines and Johnson untouchables to a Democratic president.
But there is also a bureaucratic explanation for the scandal. Accounting rules are complex and the regulators who enforce them are fallible. Pressures and incentives can shape the judgments of regulatory employees just as they shape the judgments of executives. The agency investigating Fannie, OFHEO, is still scarred from the whipping it received for missing the Freddie Mac debacle, and Congress is perpetually threatening to move its regulatory responsibility elsewhere. Does this explain OFHEO's harshness? Who knows. But there is no better way to address a reputation for weakness and ineptitude than to start throwing charges around.
Practically no company is safe from a determined, powerful government opponent. OFHEO has concluded that Fannie manipulated earnings. Well, every company manipulates earnings (the polite word is "manages")—the only question is to what degree. OFHEO has concluded that Fannie established a "cookie jar" of reserves. Well, every company establishes reserves—the only time investors usually hear about them is when they run out. OFHEO has concluded that "If other companies used Fannie Mae's logic in applying accounting principles … there would be no comparability of financial results … even within the same industry." Well, every company makes different accounting choices, and there is often little comparability of companies in the same industry. These findings by themselves are not evidence of dishonesty. They are evidence that Fannie—and Raines—operate in the real world.
Business, like politics, is about compromise. Every dollar of profit is a dollar that could have been given to a customer through a price discount or paid to a vendor or employee. The popular perception of accounting rules is that they are binary: yes or no, right or wrong. In fact, accounting is often open to as wide a range of interpretation as interior decorating. One of the two rules that OFHEO has accused Fannie of violating, for example, is so complicated that a manual describing how to apply it is hundreds of pages long. If Raines and Fannie had to answer only to OFHEO, perhaps they would account for their derivative portfolio differently. But they also have to answer to Fannie's shareholders, customers, and employees.
Given Raines' track record, it seems unlikely that, as OFHEO argues, Fannie "pervasively and willfully" misapplied accounting rules. It's possible, of course, but another scenario seems more likely: Raines and the company believed that their choices were ethical, and the alleged wrongdoing is a matter of interpretation.
True to character, Raines has taken responsibility for Fannie's decisions, and, true to character, if the SEC decides that those decisions were intentionally improper, he will probably fall on his sword. In the meantime, he deserves the benefit of the doubt.