Protecting Fannie Mae

By John E. Sununu

For most Americans, Friday afternoons are filled with positive anticipation of the weekend. In Washington, though, Friday afternoons are when government officials dump stories they want to bury. (Good news is dropped on Mondays, so bureaucrats can talk about it all week.) So when the Securities and Exchange Commission chose a recent Friday to announce a lawsuit against six former Fannie Mae and Freddie Mac executives, it wasn't because the Obama administration wanted to draw attention to the action.

The White House spent tremendous political capital passing the Dodd-Frank financial-regulation law, and missed no opportunity to demonize Wall Street for its role in the financial crisis. The administration has blamed big banks, rating agencies, and the derivatives market, and the massive bill itself was sold as a way to prevent future crises. But the White House narrative and the bill itself completely ignore the two mortgage giants' role in the financial collapse.

Despite the White House's rhetoric, there have been no high-profile prosecutions of the supposed villains. When suits have been filed, the charges have had little to do with issues covered by Dodd-Frank or even Sarbanes-Oxley, another massive regulatory layer created in 2002.

Instead, it's the same story again and again: fraud. Misleading investors has been illegal for a long, long time. But because fraud at government-sponsored companies like Fannie and Freddie doesn't fit the White House line, unloading the story on a Friday was the logical choice.

The market boom of the 1980s produced archetypal corporate villains such as Ivan Boesky and Michael Milken. Their high-profile trials yielded significant sentences - three years for Boesky and 10 for Milken. Enron's Ken Lay and WorldCom's Bernie Ebbers filled the same role after the tech bust of 2001. Their fall was, in some ways, more spectacular; both were convicted of misstating earnings - acts of fraud that resulted in massive bankruptcies. Even Martha Stewart was sent to jail on obstruction-of-justice charges, with prosecutors arguing that it was necessary "to protect the integrity of the system."

Just scapegoats?

These personalities contrast sharply with mild-mannered Dan Mudd and Richard Syron, the two CEOs charged in the recent SEC complaint. Five years ago, I met with both separately over breakfast in the Senate Dining Room. At the time, both companies were still riding the housing boom.

They were cordial, but neither much appreciated my advice: Embrace tougher regulation. Sen. Chuck Hagel (R., Neb.) and I had written legislation to raise their capital standards, scale back their new business ventures, and limit the size of their investment portfolios. They didn't want to hear it. That doesn't make them criminals, but they had clearly embraced a business model that socialized potential losses while providing private returns.

The SEC alleges that they misrepresented risks in their investment portfolios to both Congress and the public. Mudd testified in 2007 that Fannie's exposure to subprime loans remained "relatively minimal." Syron said that Freddie hadn't "been heavily involved in subprime all along."

To the executives' chagrin, the SEC has chosen to let the companies off the hook by signing a "non-prosecution" agreement with both firms. That only bolsters the perception that the executives are just scapegoats.

Not bystanders

It may be dawning on political appointees at the SEC that decrying "greed" and prosecuting fraud are two very different things. Convictions require evidence, and in white-collar cases, that can be tough to find. Milken and Boesky were done in by sheer brazenness (big stock trades just days before merger announcements), and Lay and Ebbers by the scale of their fraud (WorldCom profits were misstated by more than $10 billion). Martha Stewart's obstruction conviction was built around a broker's sworn testimony that he passed an inside tip to her.

Yet the Obama administration, for lack of evidence or lack of confidence, has sought to settle cases against Goldman Sachs and Citigroup without going to trial. That approach may satisfy the SEC's desire to look productive, but it leaves more questions than answers. Why do these companies and their boards get a pass? Why haven't their lenders had to take any losses? The judge in the Citi case rejected the proposed deal, observing that "an application of judicial power that does not rest on facts is worse than mindless; it is inherently dangerous."

Despite that criticism, the suits against the Fannie and Freddie executives are also likely to end with a deal in some lawyer's office. They'll likely have to pay a fine, serve some probation, and face a few restrictions on their ability to work for financial firms in the future.

It would be better to have an honest trial that helps reveal the size and scope of the role Fannie and Freddie played in the financial crash. Like their CEOs, the companies weren't just bystanders; they turbocharged the engine. In 1999, when Fannie cut a deal with Countrywide's Angelo Mozilo to purchase big volumes of higher-risk loans, it sent a signal to everyone in the market: We are buying!

The rest is history, but it's not a story the administration is eager to tell.