Domestic dispute: Fannie Mae is doing better than ever, but the man behind the "American Dream" faces tough criticism. (Cover Story).

2001 was a brutal year to run a business. Any CEO who led a company to record, knock-your-socks-off financial performance amid the twin gloom of recession and war, you'd think, would be showered with kudos.

Not so for Franklin D. Raines, chairman and CEO of Fannie Mae.

His Washington, D.C.-based corporation, formerly the Federal National Mortgage Association, achieved the kind of year most CEOs only dream about, even in good times. It set records in nearly every financial category. Earnings, which had averaged almost 15 percent annual growth for a decade, soared even higher--an astounding 21 percent. Net income also climbed at the same impressive rate, and taxable-equivalent revenues rose 30 percent to $10.2 billion.

Yet rather than taking bows for these glittering results, Raines finds himself fending off criticism.

As the nation's largest supplier of home-mortgage financing--it buys home loans from lenders and packages them for resale as securities, freeing up more funds for loans to home buyers -- Fannie Mae is under fire for not doing enough to support home ownership among African-American, Hispanic, low-income and other "under-served" borrowers. Critics also charge that the company is running up dangerously high debt, putting shareholders, and maybe even taxpayers, in jeopardy. Critics argue, too, that it accepts too many risky, sub-prime loans in which borrowers put little or nothing down and that in the post-Enron environment, it lacks sufficient financial transparency.

Too many government goodies?

As much as anything else, Fannie is accused of simply being too big and of benefiting too much from the federal government. To be sure, the company is gargantuan. It owns or holds in trust for investors one of every five mortgages in the United States, a dominance that worries some members of Congress and that has drawn comment from Federal Reserve Chairman Alan Greenspan.

Much to the consternation of competitors -- banks, lenders and mortgage insurers -- Fannie does get goodies from Washington. Notably, it is exempt from state and local income taxes, a benefit granted the company and its smaller sibling with a similar mission, Freddie Mac, when Congress changed their status from government agencies to shareowner-held firms in 1968 and chartered them as "government-sponsored enterprises." This status, competitors say, allows the two firms to profit unfairly from low borrowing costs because of the belief their bonds are backed by the government.

To Raines, all this flak comes with the territory. Controversy is nothing new to him. For two years before returning to Fannie Mae as vice chairman in 1998 -- he took the top job in January 1999 -- he was immersed in politics as President Clinton's director of the Office of Management and Budget.

Raines acknowledges that the criticism of Fannie is intense and rising. "We're very big and we're very successful," he shrugs. "But every successful company can expect a high level of criticism from competitors who are doing less well." Increasingly, competitors of big, successful companies are directing their complaints to Washington, he notes. "Look at other companies in similar situations as us, like Microsoft and AOL Time Warner. Their competitors can't compete in the marketplace, so they try to compete in the area of politics, regulation and legislation."

But in Fannie's case, at least, the critics "so far have found little sympathy" in the nation's capital, Raines insists. "Most members of Congress have taken the position that if it ain't broke, don't fix it."

Aging of America spurs housing market

Clearly, housing ain't broke. Thanks to record low interest rates -- which also help explain Fannie's spectacular performance -- 2001 was the best year in housing history. Housing starts were up 4 percent and home sales nearly 6 percent, cushioning the recession. "We played a part in that," Raines declares. He thinks the best is yet to come. "Housing will remain a powerful economic driver for at least the rest of the decade because the consumer need for housing is likely to surge," he predicts. This is due in part, Raines points out, to the country's changing population. It is growing and aging and older people are more likely to own homes.

Raines enjoys talking up housing, Fannie's role in it, and the company's 10-year, $2 trillion "American Dream" plan to boost home ownership among 18 million American families. He does a lot of such promoting in speeches. Yet responding to critics necessarily has become a high priority for him.

Avoiding confrontation and combat

"A big part of his job is political and involves answering criticism," observes Gary Gordon, managing director of UBS Warburg investment research firm. "It's always tough to be put on the defensive for something you've been doing well. All he can do is stand by Fannie's record and correct misstatements. He does it very well."

The drumbeat of criticism has hurt Fannie's stock price, Gordon notes. Even though the company posted its best year ever, its share price hit $79.48 at the end of last year--slightly lower than where it started in January at $84.75. Still, Wall Street is bullish. In April, 16 of 23 analysts surveyed by First Call/Thompson gave the stock a "strong buy" recommendation.

The political savvy gained in his White House years helps Raines blunt the criticism. But the lean, 53-year-old CEO brings other attributes to the task. "He's low key, understated and thoughtful," comments Vincent Mai, a longtime Fannie board member who is chairman of AEA Investors, a New York investment firm. "He's not combative or confrontational. Because he knows the business so well and is respectful of other people, he's particularly effective in putting out Fannie Mae's story."

It helps, too, that Raines is an artful debater. His skills on his high school debate team, in fact, lifted him out of boyhood poverty in Seattle, winning him a scholarship to Harvard. There he earned undergraduate and law degrees, en route to becoming a Rhodes scholar. He worked for the Carter Administration in OMB and White House posts in the late 1970s, then logged 11 years as a general partner at Lazard Freres & Co., a Wall Street investment bank. He joined Fannie in his first stint as vice chairman in 1991.

Relaxing in his airy office in Fannie's campus of Georgian buildings on Washington's upper Wisconsin Avenue, Raines patiently rebuts the criticism.

On charges that Fannie isn't doing enough to help underserved homebuyers -- Confronting Raines is a well-publicized study by FM Watch, a vocal coalition of Fannie's competitors whose board includes the CEOs of such financial giants as Chase Manhattan, Wells Fargo and GE Capital. The study, based on Department of Housing & Urban Development data, asserts that from 1996 to 2000 Fannie Mae and Freddie Mac lagged banks and other mortgage originators by 30 percent in serving African-Americans, by 11 percent in serving Hispanics and by 24 percent in serving homebuyers earning below-median income.

Raines, throwing up his hands, disputes the study's methodology, pointing out that it includes "loans for the sub-prime market that we don't serve." He indicates that fully 51.6 percent of Fannie's 2001 financing went to low- and moderate-income households, topping HUD's goal of 50 percent. That compares with 25 percent when he initially joined the company in 1991.

Managing criticism from competitors

"Remember who our critics are," he says. "It's significant that criticism of us is not coming from affordable housing groups, governors or mayors.

On Fannie's debt, risk and transparency -- The company's debt-to-equity ratio, five times higher than the average of commercial banks, prompts FM Watch Executive Director Mike House to fume, "If Fannie Mae were to be regulated like a commercial bank, it would face serious risk of closure." The Wall Street Journal lately has been scathing. In a February editorial headlined, "Freddie Mac, Fannie Mae Seem More Volatile as Accounting Rule Highlights Hedging Risks," the newspaper strongly criticized the two companies' use of financial derivatives. The Bush Administration, in its 2003 budget document, warns that many people erroneously believe the federal government backs Fannie and Freddie, and falsely regard investments in the two as risk-free.

Eyebrows also are raised in Congress, where some members fear Fannie's high debt and perceived federal backing could someday lead to a taxpayer bailout. Rep. Richard Baker (R-La.), chairman of the House subcommittee on capital markets, is pushing legislation to toughen oversight of the two firms.

Raines doesn't deny the high debt. "But if we're going to buy mortgages," he says, "we have to buy them with equity and debt. I assure you we have no debt for which there's no offsetting asset. The biggest holders of mortgages in the U.S. are banks. And they finance themselves by issuing debt. I don't understand what [our critics] are saying, except they think that the word debt, like risk, will scare people.

"All Fannie Mae owns is mortgages on American homes. What safer investment is there? Would our critics rather that we own Third World debt or junk bonds?"

Rigorous risk-based capital rules

The rising concern about risk at Fannie and Freddie has prompted HUD's Office of Federal Housing Enterprise Oversight to issue a rule requiring the firms to carry enough capital to remain solvent for 10 years, even in a worst-case scenario. Raines calls it "the most rigorous risk-based capital regime to be imposed on any companies anywhere in the world." But he welcomes it. "We hope it will further solidify the view that we are very well managed," he says.

As for Fannie's venture into sub-prime loans, Raines points to an inherent conflict between calls for his company to increase its support of under-served borrowers and concerns over its added risk. He confirms that the firm has "dramatically increased" its portfolio of loans to homebuyers with low down payments, and says it hopes to do more. "But we won't take on new risk until we understand it," he insists.

To help allay concerns, Fannie has stepped up its transparency, issuing key financial statistics monthly including results of interest rate risk sensitivity analyses.

On Fannie's size and government ties -- Raines believes that Fannie's size and structure have served the nation well. He lets statistics make the point. The company says that it has provided more than 34 million homeowners with more than $2.8 trillion in housing finance since its privatization in 1968 and has saved consumers $20 million by lowering mortgage costs. "The fact is," comments UBS Warburg's Gordon, "Fannie is a very, very efficient way for the government to support housing."

Tech initiatives boost efficiency

Raines rails at suggestions that Fannie is "subsidized" by Washington. "We write the government checks, not vice-versa," he declares. "All the benefits we get are exceeded by benefits to homeowners." He notes that the firm last year paid more than $2 billion in federal taxes and real-estate levies, making it one of the largest taxpayers in the U.S. Its state-and-local income-tax exemption, he explains, reflects Congress' recognition that if individual jurisdictions were allowed to meet revenue needs by taxing Fannie, "it would add a little bit of money to everybody's mortgages all over the country."

So it goes for Raines--responding to charge after charge. But his role in rebuffing criticism has overshadowed his significant management moves. Morgan Stanley Dean Witter analyst Ken Posner praises, for example, Raines' "focused business model" and technology initiatives that have helped the firm "successfully improve efficiency despite the expansion in business volume."

Raines considers his most significant accomplishments to be the launching of the American Dream plan, decentralizing decision-making and tightening earnings goals. Moreover, he cites his strengthening of Fannie's effort to create customized -- rather than one-size-fits-all -- mortgage products. In fact, he says, "developing custom solutions in a market that people think of as a commodity" is his company's biggest long-term challenge. Unfortunately, critics disagree.

OPERATING NET INCOME

1986-2001 IN $BILLIONS

1986   $.10
1987   $.37
1988   $.50
1989   $.80
1990  $1.17
1991  $1.36
1992  $1.62
1993  $1.87
1994  $2.13
1995  $2.14
1996  $2.72
1997  $3.05
1998  $3.41
1999  $3.91
2000  $4.44
2001  $5.36

Note: Table made from bar graph
OPERATING EARNINGS PER SHARE

1986-2001

1986  $0.12
1987  $0.39
1988  $0.53
1989  $0.78
1990  $1.12
1991  $1.25
1992  $1.48
1993  $1.71
1994  $1.94
1995  $2.15
1996  $2.48
1997  $2.83
1998  $3.23
1999  $3.72
2000  $4.29
2001  $5.20

Source: Fannie Mae

Note: Table made from bar graph

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RELATED ARTICLE: African-American Pioneer

WHEN FRANKLIN RAINES TOOK OVER as Fannie Mae's chairman and CEO in January 1999, he became the first African-American to head a top-100 U.S. corporation.

He's rapidly getting company. Last year Kenneth Chenault became chairman and CEO of American Express and Stan O'Neal president and COO at Merrill Lynch. Richard Parsons will lead AOL Time Warner as CEO starting this month.

Raines' success at Fannie is credited with paving the way. But he attributes the rise of minority CEOs to civil rights laws passed in the 1960S and 1970s. "For 30 years, blacks have been allowed to go to the best schools and the best graduate schools," he says. "Now (the nation] is reaping the benefit."