Simultaneously, the federal government anticipated pushback from lenders who would point out that these were high-risk loans and required greater returns. However, lenders were evaluated for their CRA commitment, which included their creativity in granting the loans. In addition, lenders faced prosecution by the Justice Department for discrimination in lending if their loan portfolios did not include a sufficient number of CRA loans. All the while, Fannie Mae served as the purchaser for these loans, eventually packaging them and selling them as securitized mortgage pools. The CRA loans had borrowers with less equity, higher default rates, and more foreclosures. There was also an exacerbating effect of this false sense of security on the part of the high-risk borrowers about their mortgages. Because these risky borrowers were not really anteing up the actual cost of their homes (and remember, these were folks who had never had a mortgage before, had bad credit histories, and may not have had much in the way of financial literacy), they overextended and overspent in other areas. In short, they were maxed out in all areas because they were lulled into a false sense of financial security with such a low mortgage payment. Because Fannie Mae owned or guaranteed half of the \(\$ 12\) trillion mortgage debt in the United States, any problems with those mortgages could and did lead to a financial crisis for Fannie, the U.S. stock market, and the economy \({ }_{.}^{88}\) Then-Federal Reserve Chairman Alan Greenspan warned of the looming problems at Fannie Mae in 2005. He testified before Congress, "The Federal Reserve Board has been unable to find any credible purpose for the huge balance sheets built by Fannie and Freddie other than profit." \({ }^{39}\) Others, including St. Louis Federal Reserve Chairman William Poole, warned that the huge debt load rendered Fannie and Freddie insolvent.

Fannie Mae's policies on amortization, a critical accounting area for a company buying and holding mortgage loans, were developed by the chief financial officer (CFO) with no input from the company's controller. Fannie Mae's amortization policies were not in compliance with GAAP (generally accepted accounting principles). \({ }^{101}\) The amortization policies relied on a computer model that would shorten the amortization of the life of a loan in order to peak earnings performance with higher yields. Fascinatingly, the amortization policies were developed because of a mantra within the company of "no more surprises." \({ }^{102}\) The philosophy was that in order to attract funding for the mortgage market, there needed to be stability that would attract investors. The officers at the company reasoned that "volatility" was a barrier to accomplishing its goals of a stable and available source of mortgage funds for homes. When the computer model was developed, the officers reasoned that they were simply adjusting for what was "arbitrary volatility." However, "arbitrary volatility" turned out to be a difficult-to-grasp concept for those outside Fannie Mae. \({ }^{103}\) Further, the volatility measures and adjustments appeared to have a direct correlation with the EPS goals that resulted in the awards to the officers. Even those within Fannie Mae struggled to explain to investigators what was really happening with their adjustments........................

Discussion Questions 1. Consider the ethics recognition that Fannie Mae received and the reasons given for those awards. Then consider that Fannie Mae was rated by Standard \& Poor's on its corporate governance scoring (CGS) system as being a 9 , with 10 being the maximum CGS score. Fannie Mae received a 9.3 for its board structure and process. \({ }^{144}\) What issues do you see with regard to these outside evaluations of companies that relate to governance and ethics? Is there a difference between social responsibility and ethics? Is there a connection between good governance practices and ethics?
2. List the signals that were missed in Fannie Mae's devolution. Were they missed or ignored? Evaluate the actions of Mr. Barnes and Fannie Mae's response to him. \({ }^{145}\)
3. What observations can you make about incentive plans and earnings management? Incentive plans and internal controls?
4. Why was dealing with the volatility not the issue? Why were the changes in the numbers necessary?
5. Evaluate the pep talk of the vice president of risk operations and its effect on Fannie Mae's culture. Are there some ideas for your credo that stem from the conduct and responses of various executives at Fannie Mae? Did Mr. Mudd carry that culture forward in his positions on risk?
6. The theory of moral hazard holds that failure is a necessary part of an economic system. Where would this theory have applied in preventing the demise of Fannie Mae? Be sure to look at all aspects of the case in providing your answer. Now apply the theory of moral hazard to those who walk away from their mortgages. Angelo Mozilo is the former CEO of Countrywide Mortgage, a company that sold all of its mortgages to Fannie Mae and, as noted, was a major lender to Fannie Mae officers and board members. At his deposition in a lawsuit brought against him by a mortgage insurer, he was asked, "After all the foreclosures and ruined lives and lawsuits, do you have any regrets about the way you ran Countrywide?" Mr. Mozilo's response about the role of his company in the market collapse was as follows:
This is a matter of record. The cause of the problems of foreclosures is not created by Countrywide. This is all about an unprecedented, cataclysmic situation, unprecedented in the history of this country. Values in this country dropped 50 percent. This is not caused by any act of Countrywide. It was caused by an event that was unforeseen by anyone, because if anybody foresaw it, you would never have insured it, we would never have originated the loan. And it spread across the world. Any judgment made on a foreclosure - on a loan being made is because values deteriorated.
And for the first time in the history of this country, people decided that they were going to leave their homes because the value of their home was below the mortgage amount. Never in the history of this country did that ever happen, and that could never have been assessed in the risk profile. These people didn't lose their jobs. They didn't lose their health. They didn't lose their marriage. Those are the three factors that cause foreclosure. They left their homes because the values went below the mortgage. That's what caused the problem.
So, I have no regrets about how I-how Countrywide was run. It was a world-class company. So your tirade about foreclosures and lawsuits is nonsensical and insulting. Countrywide did not cause this problem. We made no loans in Greece. We made no loans in Ireland. We made no loans in Portugal. This is a worldwide financial crisis that was totally a shock to the system. \({ }^{146}\) What is Mr. Mozilo's view on walking away? Does he take responsibiltie for the loans?