Oct. 6 (Bloomberg) -- Fannie Mae Chief Executive Franklin Raines will tell a U.S. House panel the largest government- chartered mortgage buyer ``strongly'' disagrees with a report by its regulator that the company deferred expenses in 1998 so executives could obtain their maximum possible bonuses.

Raines will also tell the House Financial Services Committee today that the Washington-based company challenges the Office of Federal Housing Enterprise Oversight's conclusions that it used improper ``cookie jar'' reserves and broke accounting rules for hedging transactions.

``These accounting standards are highly complex and require determinations over which experts often disagree,'' Raines will say, according to an advance copy of his testimony obtained by Bloomberg News. ``The issues that have been raised by Ofheo will be taken up directly with the staff of the'' Securities and Exchange Commission, he will say.

The testimony from Raines, a 55-year-old former Rhodes scholar who joined Fannie Mae in 1999, may help determine whether Congress proposes increased oversight of Fannie Mae and Freddie Mac, which own or guarantee almost half the $7.3 trillion mortgage market.

``If Ofheo establishes that there was manipulation of accounting in order to get bonuses, that would be very serious,'' said Representative Barney Frank of Massachusetts, the senior Democrat on the House Financial Services Committee.

Chief Financial Officer J. Timothy Howard, who Ofheo called the ``chief architect'' of an accounting move that ``inappropriately'' deferred $200 million of expenses in 1998 to increase per-share profit, also will testify.

``This is a serious allegation, and we strongly disagree with it,'' Raines will say, according to the prepared remarks.

Testimony Schedule

A Fannie Mae spokesman, Chuck Greener, couldn't immediately be reached for comment after business hours. Shares of Fannie Mae are down 13 percent to $66 since Ofheo released its report on Sept. 22.

`It's going to be one of the toughest -- if not the toughest -- hearings Raines faces,'' said Morris Reid, who worked with Raines in the Clinton administration and is now managing director of Washington-based Westin Rinehart Group, which advises companies on public affairs strategies. ``Someone's got to be the fall guy,'' though it shouldn't be Raines, he said.

Ofheo Director Armando Falcon, 44, will testify first, at 10 a.m. Washington time. He will be followed by Raines, Howard, 55, and Ann McLaughlin Korologos, 62, the Fannie Mae director who is handling the response to Ofheo's report. Ofheo spokeswoman Corinne Russell declined to comment.

Books `Manipulated'

Republican Representative Richard Baker of Louisiana, chairman of a House Financial Services subcommittee on capital markets, said he'll ask Raines and Howard about the bonuses as well as a lack of internal controls cited by Ofheo. Raines allowed a management structure that gave Howard the ability to both set and meet financial targets, Ofheo said.

``It's just pretty clear the books were manipulated,'' Baker said. ``They didn't allocate the resources to the audit side that they did to the business-development side.''

Howard will say his accounting decisions were made in ``good faith,'' according to his prepared remarks obtained by Bloomberg News. Fannie Mae's auditor, KPMG, agreed that the accounting methods were within generally accepted accounting principles, or GAAP, Howard and Raines said.

``The matters to be reviewed relate to accounting judgments and not issues of risk management,'' he will say.

Government Ties

Fannie Mae and Freddie Mac were chartered by Congress to spur homeownership by acquiring mortgages from banks with the proceeds from bond sales. Until 2002, they were exempt from filing financial statements with the Securities and Exchange Commission. Freddie Mac spokeswoman Sharon McHale declined to comment.

Record sales of homes helped double their combined mortgage portfolios over the past five years, to $1.6 trillion. Fannie Mae had net income of $7.91 billion in 2003, up from $3.91 billion in 1999. Raines earned $20 million last year in base salary, bonus, stock grants and long-term incentive payments, an 8 percent increase from 2003.

Ofheo said it hasn't determined whether a restatement of past earnings is necessary. Ofheo referred its findings to the Justice Department, which is considering whether to conduct a criminal investigation, a person familiar with the matter said last week.

Fannie Mae last week agreed with Ofheo to boost its capital, and ``recalculate'' how it defers expenses and accounts for hedging transactions designed to protect its $895 billion mortgage portfolio from swings in interest rates.

``Some people have mistakenly concluded that the company's agreement with Ofheo constituted an admission by the company to the findings and conclusions of the report,'' according to Raines's prepared remarks. ``Let me clarify that is not the case.''

More Investigation Needed

Democrats such as Representative William Clay of Missouri who support Fannie Mae may need more convincing that Ofheo's charges merit action without a broader investigation.

``We have to have a world-class, top-notch, independent audit,'' said Frank Davis, a senior policy adviser to Clay on financial legislation. Clay is a member of the House Financial Services Committee.

The deferral of expenses allowed the company to earn $3.2309 a share, beating the $3.23 target, Ofheo said.

Without a deferral, the top six Fannie Mae executives wouldn't have received $5.9 million in bonuses, including $1.9 million for then Chief Executive James Johnson and $1.1 million for his named successor, Raines, Ofheo said. Johnson, who led the search for Democratic presidential nominee John Kerry's vice presidential running mate, didn't return calls for comment.

Ofheo's findings are ``an impetus to get something done'' in creating a ``world-class regulator,'' said Representative Paul Kanjorski, a Democrat from Pennsylvania who is a member of the House Financial Services Committee.

Last Appearance

Raines testified seven times before Congress since 2000, said Janice Daue, a Fannie Mae spokeswoman. He last appeared before the House Financial Services Committee on Sept. 25, 2003, after McLean, Virginia-based Freddie Mac said it manipulated accounting rules to understate net income by about $5 billion in an attempt to smooth earnings volatility.

``Fannie Mae must continue to operate under a regulatory regime that does not damage our ability to support homeownership,'' Raines told the committee a year ago. ``That damage can be incurred by changing our mission, status or charter, or through excessive or intrusive regulation.''

Freddie Mac ousted its top three executives, including Chairman and Chief Executive Leland Brendsel, after its accounting mistakes, and paid a $125 million fine.

`A Star'

Raines, a native of Seattle, became chairman and chief executive of Fannie Mae in 1999, after serving as director of the Office of Management and Budget in the Clinton administration. He also served under President Jimmy Carter. Both Clinton and Carter are Democrats.

``I've known Frank Raines for 28 years -- he was a star in the White House in the 1970s and he will be a star for years to come,'' said Orin Kramer, a general partner at investment firm Kramer Spellman LP in New York who helped recruit Raines to Washington.

Fannie Mae and Freddie Mac have dodged efforts to boost oversight as far back as 2000. A bill creating a new regulator under the Treasury Department that would limit their ability to enter into new business failed to win approval in the House Financial Services Committee in October 2003 after the Bush Administration said the new regulator wouldn't have enough breadth in its authority. Ofheo is a division of the Department of Housing and Urban Development.

Senate Efforts

Senator Chuck Hagel, a Nebraska Republican, Senator John Sununu, a New Hampshire Republican, and Senator Elizabeth Dole, a North Carolina Republican, sponsored a bill creating a new regulator with power over capital standards, new lines of business and other operations that won Senate Banking Committee approval on April 1.

The legislation didn't go to the full Senate for a vote because of disagreement over whether a regulator should have the power of receivership to sell assets in the event of default.

``There are all kinds of excuses people use to protect the status quo, but those excuses have quickly lost any force'' in Congress, Sununu said in an interview. He is a member of the Senate Banking Committee.

``I would just assume, based on the facts and reality, that we would be able to pass strong regulatory legislation that the president could sign'' in the early part of 2005, said Nebraska's Hagel. ``We cannot any longer look the other way.''

To contact the reporter on this story: Jeff Bliss in Washington at jbliss@bloomberg.net

Last Updated: October 6, 2004 08:01 EDT