At Freddie Mac, Chief Discarded Warning Signs

By CHARLES DUHIGG
The New York Times
Published: August 5, 2008

The chief executive of the mortgage giant Freddie Mac rejected internal warnings that could have protected the company from some of the financial crises now engulfing it, according to more than two dozen current and former high-ranking executives and others.

That chief executive, Richard F. Syron, in 2004 received a memo from Freddie Mac’s chief risk officer warning him that the firm was financing questionable loans that threatened its financial health.

Today, Freddie Mac and the nation’s other major mortgage finance company, Fannie Mae, are in such perilous condition that the federal government has readied a taxpayer-financed bailout that could cost billions. Though the current housing crisis would have undoubtedly caused problems at both companies, Freddie Mac insiders say Mr. Syron heightened those perils by ignoring repeated recommendations.

In an interview, Freddie Mac’s former chief risk officer, David A. Andrukonis, recalled telling Mr. Syron in mid-2004 that the company was buying bad loans that “would likely pose an enormous financial and reputational risk to the company and the country.”

Mr. Syron received a memo stating that the firm’s underwriting standards were becoming shoddier and that the company was becoming exposed to losses, according to Mr. Andrukonis and two others familiar with the document.

But as they sat in a conference room, Mr. Syron refused to consider possibilities for reducing Freddie Mac’s risks, said Mr. Andrukonis, who left in 2005 to become a teacher.
“He said we couldn’t afford to say no to anyone,” Mr. Andrukonis said. Over the next three years, Freddie Mac continued buying riskier loans.

Mr. Syron contends his options were limited.

“If I had better foresight, maybe I could have improved things a little bit,” he said. “But frankly, if I had perfect foresight, I would never have taken this job in the first place.”
Mr. Andrukonis was not the only cautionary voice at Freddie Mac at the time. According to many executives, Mr. Syron was also warned that the firm needed to expand its capital cushion, but instead that safety net shrank. Mr. Syron was told to slow the firm’s mortgage purchases. Instead, they accelerated.

Those and other choices initially paid off for Mr. Syron, who has collected more than $38 million in compensation since 2003. But when housing prices began declining in 2006, choices at Freddie Mac and Fannie Mae proved disastrous. Stock prices at both companies have fallen by more than 60 percent since February, destroying more than $80 billion of shareholder value.

More than two dozen current and former high-ranking executives at Freddie Mac, analysts, shareholders and regulators said in interviews that Mr. Syron had ignored recommendations that could have helped avoid the current crisis. Many of those interviewed were given anonymity for fear of damaging their careers by speaking publicly.

Now, some outsiders are saying that Mr. Syron and the top executive at Fannie Mae — some of the highest-profile figures in the business world — should be replaced.
“The top people should be booted out, and replaced by executives who have the confidence of the markets,” said Janet Tavakoli, a finance industry consultant and observer of both firms. Large Freddie Mac shareholders, speaking on the condition of anonymity, echoed those sentiments.

Mr. Syron and the Fannie Mae chief executive, Daniel H. Mudd, defended their choices, saying in interviews that they did not anticipate that the housing market would decline so quickly and that they were buffeted by conflicting pressures.

“This company has to answer to shareholders, to our regulator and to Congress, and those groups often demand completely contradictory things,” Mr. Syron said in an interview.
Indeed, executives of both companies maintain that one of the reasons the firms hold so many bad loans is that Congress has leaned on them for years to buy mortgages from low-income borrowers to encourage affordable housing. In 2004, Freddie Mac warned regulators that affordable housing goals could force the company to buy riskier loans.

Others, however, dismiss that explanation. “Sure, it’s hard to deal with the pressures of Congress and shareholders and regulators,” said a former high-ranking Freddie Mac executive. “But that’s why executives get paid so much. It’s not acceptable to blame those pressures for making bad choices.”

In a statement, Freddie Mac said executives were unable to verify that Mr. Andrukonis’s memorandum existed, and that the company’s default and delinquency rates were substantially lower than other firms. “There is little to nothing that Freddie Mac could have done to prevent the losses that it is now incurring,” wrote company spokesman, David R. Palombi.
Mr. Mudd said the companies were victims of circumstance.

“You’ve got the worst housing crisis in U.S. recorded history, and we’re the largest housing finance company in the country, so when one goes down, the other goes with it,” he said. A Fannie Mae spokesman, Brian A. Faith, said that beginning in 2005, executives “sounded the alarm” about riskier loans and began limiting their purchases.

The depths of Freddie Mac’s problems are complicated by its long-planned, continuing search for a chief executive to replace Mr. Syron, who is expected to remain chairman. Two people who were approached — Kenneth I. Chenault of American Express and Laurence D. Fink of BlackRock — said they did not want to be considered for the position.

Some outsiders are surprised to learn that among the candidates the company is considering is Alan Schwartz, who headed Bear Stearns as it collapsed. Mr. Chenault, Mr. Fink and Mr. Schwartz could not be reached or declined to comment.

Mr. Syron joined Freddie Mac as chief executive and chairman in 2003, after the company revealed it had manipulated earnings by almost $5 billion. He came to Freddie Mac after serving as chairman of the Thermo Electron Corporation, a scientific instruments firm, and of the American Stock Exchange. An economist with a Ph.D. and the first in his family to graduate from high school, Mr. Syron was welcomed as an unpretentious but politically astute leader.
Mr. Mudd was promoted to chief executive of Fannie Mae the following year, after that company was also accused of accounting errors totaling $6.3 billion. His compensation has totaled more than $42 million.

By the time both men took over, the firms had perfected the art of making money by capitalizing on the perception they were implicitly backed by the government. That belief allowed Fannie and Freddie to borrow at relatively low rates and use those funds to buy mortgages as investments. The companies also collected fees in exchange for guaranteeing that borrowers would repay other home loans. By the end of 2007, the firms held mortgages worth more than $1.4 trillion combined, and guaranteed payments on loans worth $3.5 trillion more.

Both firms had sophisticated systems to hedge against risks. But they remained exposed to one unlikely, but potentially catastrophic possibility: a wide-scale decline in national home prices.
The only real protection against such a downfall was purchasing only the safest loans.

However, the companies were constantly under pressure to buy riskier mortgages. Once, a high-ranking Democrat telephoned executives and screamed at them to purchase more loans from low-income borrowers, according to a Congressional source. Shareholders attacked the executives for missing profitable opportunities by being too cautious. Mr. Syron and Mr. Mudd eventually yielded to those pressures, effectively wagering that if things got too bad, the government would bail them out.

“The thinking was that if something really bad happened to the housing market, then the government would need Freddie and Fannie more than ever, and would have to rescue them,” Mr. Andrukonis said. “Everybody understood that at some level the company was putting taxpayers at risk.”

Representatives of Mr. Syron and Mr. Mudd said the firms never made choices assuming the government would intervene. Both said they balanced shareholder and Congressional demands against market realities.

For years, the companies collected rich profits. But some executives grew increasingly concerned.

Mr. Andrukonis wrote his memo in 2004. At the time, he also briefed the risk oversight committee of the board of directors, but did not share his memo with them, he said. A member of that committee declined to return phone calls.

Soon thereafter, Freddie Mac’s head of capital compliance and oversight, Donald Solberg, counseled Mr. Syron to maintain a thick capital cushion, according to multiple people familiar with those discussions. Mr. Solberg continued making that recommendation until early 2007, when he left the company. Mr. Solberg declined to comment on his conversations.
Last year, Treasury Secretary Henry M. Paulson Jr. and the Federal Reserve chairman, Ben S. Bernanke, privately urged both companies to raise more money. At one point, Mr. Bernanke threatened to publicly scold the companies if they did not raise more cash.

Beginning in November, Fannie Mae raised $14.4 billion from shareholders over a six-month period. But Mr. Syron was more resistant. Freddie Mac raised $6 billion in preferred stock last year, but at a March conference in New York, Mr. Syron combatively dismissed suggestions he would raise more simply because officials told him to.

“This company will bow to no one,” Mr. Syron told a room of investors and analysts. Despite promises, the company has delayed a planned $5.5 billion stock sale. Because of that delay, the effective cost of raising funds has skyrocketed as the company’s share price has declined.
In a statement, Freddie Mac said Mr. Syron’s March comments focused on dilutive capital raising and that the stock sale was delayed because lawyers said it could not occur while the company was registering with the Securities and Exchange Commission. That process was finalized last month.

In 2007, as home prices were falling and defaults rising in some areas, people at both firms urged their chief executives to scale back on mortgage purchases. Fannie Mae shrunk its mortgage portfolio slightly.

Mr. Syron’s Freddie Mac, however, increased its portfolio by $17 billion.
That same year the companies posted combined losses of $5.2 billion. This year, they have announced losses of $2.4 billion, and analysts say they may lose an additional $24 billion or more.
Last month, after weeks of rumors and bad news, investors began dumping the companies’ shares, driving their stock prices down almost 60 percent apiece. The selling did not subside until Mr. Paulson unveiled a rescue plan with powers to inject billions of taxpayer dollars into the companies. That plan has not been activated, but the law, signed by President Bush last week, also gives the government sweeping new regulatory control over the firms.

“It basically worked exactly as everyone expected — when things got bad, the government came to the rescue,” said a second former high-ranking Freddie Mac executive. “But we didn’t expect it would come at the cost of a new regulator who now has the power to burrow into our business forever.”

In the last three weeks, the companies’ stock prices have recovered a small portion of their losses. Executives, however, remain concerned that more bad news could spark another panic.
Freddie Mac will report its second-quarter financial results Wednesday. Fannie Mae will release its results on Friday.

“I’ve had four other jobs as C.E.O., and I came out of them all pretty well,” Mr. Syron said.

“What I’m working for right now is to save my reputation.”

Eric Dash contributed reporting.