Legal Fees Mount at Fannie and Freddie
Dennis Cook/Associated Press
Franklin Raines, Fannie Mae's former chief, and J. Timothy Howard, former financial officer, shown testifying in 2004.
By GRETCHEN MORGENSON
Published: February 22, 2012
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Taxpayers have advanced almost $50 million in legal payments to defend former executives of Fannie Mae and Freddie Mac in the three years since the government rescued the giant mortgage companies, a regulatory analysis has found.
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In that time, $37 million has gone to three former Fannie Mae executives accused of securities fraud, according to the analysis by the inspector general of the Federal Housing Finance Agency, which oversees both companies. Acting as their conservator, the agency is charged with protecting taxpayers from further losses at Fannie Mae and Freddie Mac. Those losses now stand at $183 billion.
Although the legal costs for the former executives are a small fraction of the companies’ mortgage losses, it is imperative that the housing agency move to limit these fees, said Steve A. Linick, inspector general of the agency.
“F.H.F.A. and Fannie Mae believe that their options are limited in paying current legal fees for former officers and directors,” Mr. Linick said in a statement. But he called for greater oversight. The legal costs are the responsibility of taxpayers because of contracts struck by the companies before they collapsed. Those agreements, which are typical in corporate America, state that legal fees incurred by executives defending against lawsuits will be advanced by the companies. If a court or jury rules that officials breached their duties or acted in bad faith, the officials will have to repay the advances.
But with legal outlays since 2004 reaching $99.4 million for Franklin D. Raines, Fannie Mae’s former chief executive; J. Timothy Howard, former chief financial officer; and Leanne G. Spencer, former controller, it seems unlikely that the taxpayers will ever recover the money even if some or all of them are found liable. The three former executives were accused of a comprehensive accounting fraud that the company’s former regulator said was aimed at maximizing their bonuses.
The inspector general’s report noted that the legal contracts could have been repudiated when the companies were taken over in September 2008. They were not, though, and taxpayers have covered the costs since then. Taxpayers are also bearing the cost of recent lawsuits by the Securities and Exchange Commission against the top executives who were running the mortgage companies when they failed.
“The inspector general’s report on legal fees clearly demonstrates the need for continued Congressional oversight over these entities,” said Representative Randy Neugebauer of Texas, chairman of the House Financial Services subcommittee on Oversight and Investigations. “I strongly agree with the inspector general’s findings that at the end of the day, much more needs to be done to ensure that the enterprises and the F.H.F.A. are accountable to the taxpayer and that a strategic plan is implemented to control costs.”
The agency has submitted a plan to Congress that calls for shrinking Fannie and Freddie so that they guarantee a smaller share of the nation’s home loans.
Under the plan, released on Tuesday, borrowers would begin paying slightly higher fees, helping private lenders compete.
The agency recommended significant fixes to some of the lax mortgage industry practices that have generated so many problems since the real estate bubble burst. For example, agency officials called for the standardization of loan servicing practices to ensure that the financial institutions administering mortgages owned by others treat borrowers and investors fairly.
Among its suggestions, investors in mortgage-backed securities would receive extensive details about the kinds of loans in the pools well before they are issued. The housing agency also tackled executive compensation, which has generated severe criticism. The 2012 compensation program, for example, eliminates bonuses at the companies, the housing agency said. Future pay will consist only of salary, with much of it deferred. These amounts may be reduced if performance criteria are unmet by the executives.
There were no recommendations in the housing agency’s proposal regarding the rising legal bills for former executives. They were the subject of heated Congressional hearings in February 2011. Since then, Fannie Mae and Freddie Mac have moved to control the fees, the report noted. For instance, the companies have set up policies to avoid duplicate legal representation and to monitor legal expenses to determine if they are reasonable.
But the efforts are uneven. Fannie Mae, for example, questions bills for depositions if more than one lawyer attends representing former officials; Freddie Mac does not, the report noted.
More significant, the housing agency has not independently validated the processes used by Fannie and Freddie to monitor the legal services provided to their former executives or the amount of the bills that are paid.
The inspector general’s report suggested several ways that the housing agency could limit the mounting legal costs. Among the suggestions were writing new agreements that would reduce the obligations for future payments, and using directors’ and officers’ insurance to control legal outlays.
Responding to the report, agency officials agreed to pursue the suggestions made by the inspector general. They said that the agency would “continue its efforts at cost controls and will work expeditiously to seek greater standardization in the administration of such legal costs by the enterprises.” The agency also promised to provide the inspector general with a summary report of those efforts in June.
A regulation issued by the housing agency last July places claims arising from successful litigation against Fannie and Freddie at the bottom of the repayment priorities if the companies are reorganized, the report noted. But the regulation is facing a legal challenge, and many people consider it unlikely that the companies will ever earn enough to repay the taxpayers and emerge from conservatorship.
A version of this article appeared in print on February 22, 2012, on page B1 of the New York edition with the headline: Legal Fees Mount at Fannie and Freddie.
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