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were downgraded and by , all the tranches had been downgraded. Of all mort-
gage-backed securities it had rated triple-A in , Moody’s downgraded to
junk. The consequences would reverberate throughout the financial system.
FANNIE MAE AND FREDDIE MAC:
“LESS COMPETITIVE IN THE MARKETPLACE”
In , Fannie and Freddie faced problems on multiple fronts. They had violated ac-
counting rules and now faced corrections and fines. They were losing market share
to Wall Street, which was beginning to dominate the securitization market. Strug-
gling to remain dominant, they loosened their underwriting standards, purchasing
and guaranteeing riskier loans, and increasing their securities purchases. Yet their
regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), focused
more on accounting and other operational issues than on Fannie’s and Freddie’s in-
creasing investments in risky mortgages and securities.
In , Freddie changed accounting firms. The company had been using Arthur
Andersen for many years, but when Andersen got into trouble in the Enron debacle
(which put both Enron and its accountant out of business), Freddie switched to
PricewaterhouseCoopers. The new accountant found the company had understated
its earnings by billion from through the third quarter of , in an effort to
smooth reported earnings and promote itself as “Steady Freddie,” a company of
strong and steady growth. Bonuses were tied to the reported earnings, and OFHEO
found that this arrangement contributed to the accounting manipulations. Freddie’s
board ousted most top managers, including Chairman and CEO Leland Brendsel,
President and COO David Glenn, and CFO Vaughn Clarke. In December ,
Freddie agreed with OFHEO to pay a million penalty and correct governance,
internal controls, accounting, and risk management. In January , OFHEO di-
rected Freddie to maintain more than its minimum capital requirement until it
reduced operational risk and could produce timely, certified financial statements.
Freddie Mac would settle shareholder lawsuits for million and pay million
in penalties to the SEC.
Fannie was next. In September , OFHEO discovered violations of accounting
rules that called into question previous filings. In , OFHEO reported that Fannie
had overstated earnings from through by billion and that it, too, had
manipulated accounting in ways influenced by compensation plans. OFHEO made
Fannie improve accounting controls, maintain the same capital surplus imposed
on Freddie, and improve governance and internal controls. Fannie’s board ousted
CEO Franklin Raines and others, and the SEC required Fannie to restate its results
for through mid-. Fannie settled SEC and OFHEO enforcement actions for
million in penalties. Donald Bisenius, an executive vice president at Freddie
Mac, told the FCIC that the accounting issues distracted management from the
mortgage business, taking “a tremendous amount of management’s time and atten-
tion and probably led to us being less aggressive or less competitive in the market-
place [than] we otherwise might have been.” 
