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FINANCIAL CRISIS INQUIRY COMMISSION REPORT
the role of the GSEs and their market dominance,” the OCC report said, “they should
be industry leaders with respect to effective and proactive risk management, produc-
tive analysis, and comprehensive reporting. Instead they appear to significantly lag
the industry in all respects.”
“CRITICAL UNSAFE AND UNSOUND PRACTICES”
Paulson told the FCIC that although he learned of the Fed and OCC findings by Au-
gust , it took him three weeks to convince Lockhart and FHFA that there was a cap-
ital shortfall, that the GSEs were not viable, and that they should be placed under
government control. On August , FHFA informed both Mudd and Syron that their
firms were “adequately capitalized” under the regulations, a judgment based on finan-
cial information that was “certified and represented as true and correct by [GSE] man-
agement.” But FHFA also emphasized that it was “seriously concerned about the
current level of Fannie Mae’s capital” if the housing market decline continued.
Fannie’s prospects for increasing capital grew gloomier. Fannie informed Treasury
on August —and repeatedly told FHFA—that raising capital was infeasible and
that the company was expecting additional losses. Even Fannie’s “base-case earnings
forecast” pointed to substantial pressure on solvency, and a “stressed” forecast indi-
cated that “capital resources will continue to decline.”
By September , Lockhart and FHFA agreed with Treasury that the GSEs needed
to be placed into conservatorship. That day, Syron and Mudd received blistering
midyear reviews from FHFA. The opening paragraph of each letter informed the
CEOs that their companies had been downgraded to “critical concerns,” and that “the
critical unsafe and unsound practices and conditions that gave rise to the Enterprise’s
existing condition, the deterioration in overall asset quality and significant earnings
losses experienced through June , as well as forecasted future losses, likely re-
quire recapitalization of the Enterprise.” A bad situation was expected to worsen.
The -page report sent to Fannie identified sweeping concerns, including fail-
ures by the board and senior management, a significant drop in the quality of mort-
gages and securities owned or guaranteed by the GSE, insufficient reserves, the
almost exclusive reliance on short-term funding, and the inability to raise additional
capital. FHFA admonished management and the board for their “imprudent deci-
sions” to “purchase or guarantee higher risk mortgage products.” The letter faulted
Fannie for purchasing high-risk loans to “increase market share, raise revenue and
meet housing goals,” and for attempting to increase market share by competing with
Wall Street firms that purchased lower-quality securities. FHFA, noting “a conflict
between prudent credit risk management and corporate business objectives,” found
that these purchases of higher-risk loans were predicated on the relaxing of under-
writing and eligibility standards. Using models that underestimated this risk, the
GSE then charged fees even lower than what its own deficient models suggested
were appropriate. FHFA determined that these lower fees were charged because “fo-
cus was improperly placed on market share and competing with Wall Street and
[Freddie Mac].” 
