Subprime scandal: ex-Fannie Mae, Freddie Mac execs accused of fraud

The SEC filed a civil fraud lawsuit Friday against six former top executives at Fannie Mae and Freddie Mac, saying they misled investors about the subprime-loan risks they faced.

Six former top executives at the housing giants Fannie Mae and Freddie Mac misled investors about the subprime-loan risks they faced, the Securities and Exchange Commission alleged in a civil fraud lawsuit Friday.

Those charged include the men who were chief executives of these government-chartered mortgage enterprises. Daniel Mudd headed Fannie Mae and Richard Syron led Freddie Mac as the housing boom ended and the financial crisis began.

The lawsuit is significant because some finance experts have sharply criticized the federal government for failing to prosecute more executives who may have contributed to the financial meltdown, and because the future of Fannie and Freddie is now a matter of hot political debate.

"Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was," said Robert Khuzami, SEC's enforcement director, in filing the suit in New York. "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."

Fannie and Freddie play a major role in the US housing market, providing guarantees for the safety of loans that conform to their standards. Banks and other mortgage lenders are able to issue so-called conforming loans and resell them in bundles to investors (who then reap a stream of income from monthly mortgage payments).

By doing this, the companies have cultivated a broad supply of credit for housing, keeping the mortgage market moving even as other private firms were pulling back during the crisis.

But the firms are oddball entities. Before the crisis, they were publicly owned companies, seeking to show profits and strength to their private shareholders. But they also operated with a Congress-derived mandate to play their unique role in the US mortgage business.

The lawsuit alleges that, when it came to talking to their own shareholders, the six executives played down the financial risks. In the end, by late in 2008, Fannie and Freddie were placed under federal conservatorship. They continue to operate, but their long-term future is a matter that Congress will need to address in the coming year or so.

Fannie and Freddie both entered into agreements with the government on Friday, accepting responsibility without admitting or denying the charges. The government-controlled companies also agreed to cooperate with the SEC on the cases against the former executives.

The Justice Department has opened up probes into Fannie and Freddie but has not charged anyone with a crime.

In a statement released through his attorney, Mr. Mudd said the lawsuit "should never have been brought" and said the government reviewed and approved all the financial disclosures of the company.

"Every piece of material data about loans held by Fannie Mae was known to the United States government to the investing public," Mudd said. "The SEC is wrong, and I look forward to a court where fairness and reason – not politics – is the standard for justice."

Mr. Syron's lawyers said the case was "without merit" and said the term "subprime had no uniform definition in the market" at that time.

According to the lawsuit, Fannie told investors in 2007 that it had roughly $4.8 billion worth of subprime loans on its books, or just 0.2 percent of its portfolio. The SEC says that Fannie actually had about $43 billion worth of products targeted to borrowers with weak credit, or 11 percent of its holdings. The suit cites similar numbers for Freddie.

SEC documents on Friday quoted a Freddie Mac legal counsel warning the firm's CEO in May 2007, "We should reconsider making as sweeping a statement as we have 'basically no subprime exposure.' " In a speech, Syron still used the line, "basically no subprime exposure," according to the SEC.

So far, the companies have cost taxpayers almost $150 billion – the largest bailout of the financial crisis. They could cost up to $259 billion, according to its government regulator, the Federal Housing Finance Agency.

In July, Citigroup paid just $75 million to settle similar civil charges with the SEC. The company's chief financial officer and head of investor relations were accused of failing to disclose more than $50 billion worth of potential losses from subprime mortgages. The two executives charged paid $100,000 and $80,000 in civil penalties.

Such lawsuits are just part of America's coming to terms with the financial crisis.

Finance experts say that fraud played a role in the housing bubble and crisis, but that other causes were also prominent.

The Financial Crisis Inquiry Commission, tasked by Congress to determine the causes of the crisis, reached a split verdict.

Its report cited failures of corporate governance and ethics. But it also cited broader problems such as failed risk-management practices.

"The crisis was a result of human mistakes, misjudgments, and misdeeds," the report said in part.

• Material from wire services was used in this report.