The Securities and Exchange Commission is going after former top executives at Fannie Mae and Freddie Mac for allegedly committing securities fraud.
The mortgage giants had to be taken over by the government in 2008 and then propped up by taxpayers. The SEC says the officials misled investors about the firms' exposure to subprime mortgages.
Critics have accused the SEC of taking a perpetrator-free approach to the financial crisis, targeting corporate entities for wrongdoing instead of CEOs. But on Friday the SEC went to court and charged six former top executives, including former Fannie Mae CEO Daniel Mudd and former Freddie Mac CEO Richard Syron.
The charges allege that Mudd, Syron and the others misled investors by claiming that their companies had minimal holdings of subprime and other high-risk mortgages. Robert Khuzami, director of the SEC's Enforcement Division, said Freddie Mac made that claim in its annual report for 2006 when Syron was its CEO.
"In fact, the company had $141 billion of subprime exposure, representing 10 percent of its single-family portfolio as of Dec. 31, 2006," Khuzami said. By June 2008, Freddie's subprime exposure had grown to $244 billion.
Karen Petrou, of Federal Financial Analytics, says her company knew Fannie and Freddie were not disclosing all their subprime loans. "What we didn't know and what does surprise me is the magnitude of the differences. We knew they were wrong; we did not know they were howlingly wrong."
In Freddie Mac's case, she says, for a CEO not to know his company owned $244 billion in shaky mortgages would be equivalent to not knowing your company owned a major bank. Syron has not commented on the charges. But Petrou says the company's regulator, the Office of Federal Housing Enterprise Oversight, should have known, too.
"They didn't," she says. "That's appallingly clear, because if they had been effective regulators, we wouldn't have Fannie and Freddie in conservatorship costing the taxpayers $170-plus billion to date, and not counting the billions more to come."
The SEC's complaint against Daniel Mudd and the other Fannie Mae executives says they misrepresented the size of their firms' exposure to shaky mortgages, too. In 2007, the executives put the number at $4.8 billion, when it was really $43 billion, according to the SEC. Mudd's lawyer says his client "did not mislead anyone."
In a statement, Mudd said that the government-appointed executives who succeeded him had signed the same disclosures he did, but they're being held blameless so the government can sue individuals fired years ago.
Law professor John Coffee of Columbia University says the SEC should be congratulated for finally focusing on the wrongdoing of top executives.
"There needs to be individual corporate accountability on the part of these senior executives before we're going to get adequate deterrence and a greater chance of avoiding the next financial meltdown," he says.
Since this is a civil action, the executives will not have to go to jail if they're found guilty. They could have to pay financial penalties and be forced to return ill-gotten gains. Mudd and Syron made a total of more than $30 million between 2006 to 2008.