Of all the stories to come out of the 2008 collapses of Fannie Mae and Freddie Mac, this one may be the most incredible: To this day, neither company has admitted that any of the numbers on its financial statements that year were wrong.
It seems the Securities and Exchange Commission won’t be doing anything to challenge that pretense, either, and that this may be by design. The SEC for years has been bending over backward to avoid accusing major financial institutions of cooking their books, even when it’s obvious they did. So much for upholding financial integrity.
Last week the regulator notified former Fannie Mae Chief Executive Officer Daniel Mudd that it may file civil claims against him. The allegations wouldn’t be about Fannie Mae’s accounting, though. They would focus on whether the government-chartered housing financier accurately disclosed to investors how much of its loans were subprime.
“The disclosures and procedures that are the subject of the staff’s investigation were accurate and complete,” Mudd said in a statement last week. He said he would submit a written response “that will make clear why the SEC staff should not pursue any action in this matter.”
There’s a pattern here. When the SEC in 2009 accused former Countrywide Financial Corp. CEO Angelo Mozilo of securities fraud, it claimed the lender’s management foresaw as early as 2004 that the company would suffer massive credit losses on the home loans it was making. The SEC’s complaint accused Mozilo of “disclosure fraud” for hiding such information from investors.
Yet if the SEC’s allegation were true, it would mean Countrywide had been overstating its earnings for years, by delaying the recognition of losses long past the point when management knew they were probable. That would be an accounting violation. The SEC never made that connection in its complaint, though, and clearly had made a decision not to. Mozilo later paid $67.5 million to settle the suit, without admitting or denying the regulator’s claims.
Similarly, when the SEC accused three former IndyMac Bancorp Inc. executives of securities fraud last month, it claimed they had made false and misleading disclosures about the company’s financial stability. IndyMac’s regulator, the Office of Thrift Supervision, by then had already admitted to letting the company backdate a capital contribution to its main banking unit in May 2008, so it would appear in the prior quarter.
That was a violation of generally accepted accounting principles, the Treasury Department’s inspector general said in a 2009 report. Yet the SEC didn’t identify any accounting errors at IndyMac. The company showed shareholder equity of $959 million, as of March 31, 2008. By July 2008, IndyMac had failed, costing the Federal Deposit Insurance Corp. $10.7 billion.
Likewise, last month Freddie Mac’s former chief financial officer, Anthony “Buddy” Piszel, said he received a Wells notice from the SEC, indicating the regulator might sue him. Piszel said the inquiry concerned “certain disclosure matters,” according to a press release by CoreLogic Inc., where he was CFO until Feb. 10. There was no mention of Freddie’s accounting. Freddie’s former CEO, Richard Syron, received a similar Wells notice last month.
That Fannie’s and Freddie’s books were a farce is beyond dispute. At the time they were placed into conservatorship, both companies had overvalued their deferred tax assets by billions of dollars. The bigger their losses got, the more their tax assets grew, based on the companies’ ludicrous claim that they would use all these credits to offset future tax bills because they would be wildly profitable for decades to come.
Both companies kept billions of dollars of paper losses on mortgage-backed securities out of their earnings and regulatory capital by labeling them as “temporary,” when it was obvious the declines were anything but that. They also claimed, falsely, to be adequately capitalized.
And they did it all in broad daylight with the full knowledge and approval of their regulator, the Federal Housing Finance Agency. That helps explain why the SEC is trying to dig up something other than accounting misdeeds as it tries to build cases against former Fannie and Freddie executives. The toughest challenge for the SEC will be finding violations that the government didn’t know about while they were going on.
The biggest beneficiaries of the SEC’s see-no-accounting-evil approach are the Big Four accounting firms. Freddie Mac is audited by PricewaterhouseCoopers LLP. Deloitte & Touche LLP audits Fannie Mae. KPMG LLP audited Countrywide. Ernst & Young LLP audited IndyMac.
As long as the SEC clings to the position that there were no errors in those companies’ financial statements, it can’t allege there was anything wrong with the firms’ audits. That helps shield the auditors from potentially crippling liability in private securities litigation.
It also limits the SEC’s ability to accuse any of the companies’ executives of fudging their numbers. And so the SEC has to resort to convoluted claims like the one against Mozilo, where Countrywide’s disclosures were false and misleading but somehow its balance sheet was pristine.
Mudd, now CEO at Fortress Investment Group LLC, said the disclosures that are the subject of the SEC’s investigation “were previewed by federal regulators, and have been issued in the same form since the company went into government conservatorship.” It shouldn’t surprise anyone if he’s right.
Too bad the SEC can’t sue some regulators along with him.
(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)
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