WASHINGTON – Former top executives of Fannie Mae and Freddie Mac were charged Friday in a civil suit by the Securities and Exchange Commission with lying to investors and Congress about the extent of the two mortgage giants’ subprime business during the mortgage meltdown.
The SEC said the executives, dismissed when the federal government took over the mortgage giants in September 2008, downplayed the companies’ holdings of risky subprime loans in presentations to Wall Street investors, public disclosures and congressional testimony by labeling the risky loans as “Expanded Approval Loans,” “Risk-Layered Loans,” “Caution Loans,” or MyCommunity Mortgages,” when, in fact, they dominated the subprime market at the time.
Many of those loans have gone sour, costing public shareholders in the two mortgage giants almost all of their investments and the federal government $140 billion so far to keep Fannie and Freddie operating in order to prop up the mortgage market.
"Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was," said Robert Khuzami, director of the SEC's enforcement division. "These material misstatements occurred during a time of acute investor interest in financial institutions' exposure to subprime loans, and misled the market about the amount of risk on the company's books.”
The suit charges the former executives with fraud and names as defendants former Fannie Mae CEO Daniel Mudd, Fannie’s former executive vice president for single family mortgages Thomas Lund; and its former chief risk officer Enrico Dallavecchia; as well as former Freddie Mac CEO Richard Syron; Freddie’s former executive vice president for single family guarantee Daniel Bisenius and former chief business officer Patricia Cook.
The SEC claims that while the Fannie and Freddie executives were minimizing their share of the subprime market the two mortgage giants were in fact dominating the market and buying subprime loans from all of the major originators, including Countrywide, Citigroup, JP Morgan Chase, GMAC, Ameriquest, and Flagstar Bank.
According to the SEC, Fannie and Freddie had conducted limited business in the subprime market since the 1990’s but began accelerating their subprime businesses around 2006 as they saw private label competitors beating them to it. Even while the mortgage market start its steep downfall in 2008 Fannie and Freddie were buying up much of the subprime paper on the market, the SEC suit claims.
The Fannie and Freddie charges come as regulators are trying to hold accountable some of the key figures in the financial meltdown. NCUA recently sued four of the biggest investment banks over risky mortgage-backed securities that helped fail corporate credit unions and is embroiled in a civil suit against former executives at WesCorp FCU, the $34 billion corporate failure. Several Federal Home Loan Banks have also sued Wall Street banks over their own MBS purchases.
But the Fannie and Freddie suits are significant because they give a different portrait of the two government-sponsored enterprises which insisted for years they had sound underwriting practices and held little exposure to the subprime market.
As part of the suit, both companies, which are now run by the federal government, agreed to settle the charges and to cooperate with the SEC investigation. The executives denied the claims and pledged to fight them in court.
Mudd, who is now chairman of hedge fund Fortress Investment Group, said the government regulator, known then as the Office of Federal Housing Enterprise Oversight, knew all along about Fannie Mae’s exposure to the subprime market. “The government reviewed and approved the company’s disclosures during my tenure, and through the present,” he said Friday. “Now it appears that the government has negotiated a deal to hold the government, and government-appointed executives who have signed the same disclosures since my departure, blameless—that that it can sue individuals it fired years ago.”
Lawyers for Freddie Mac’s Syron said the SEC case is fatally flawed because there was no hard definition for subprime at the time. “Simply stated, there was no shortage of meaningful disclosures, all of which permitted the reader to assess the degree of risk in Freddie Mac’s guaranteed portfolio,” they said in a statement.
