US taxpayers may pay legal bills of mortgage executives

WASHINGTON:When the US government took over mortgage giants Fannie Mae and Freddie Mac,taxpayers inherited more than bad debts. They also potentially are responsiblefor tens of millions of dollars in legal fees for the executives at the centerof the housing market's collapse.

With the Justice Departmentinvestigating companies involved in the mortgage and financial meltdown,executives around the country are hiring high-powered defence lawyers. Like manylarge companies, Fannie and Freddie had contracts promising to cover legal billsfor their executives.

When the US government delivered a $200 billionbailout to Fannie and Freddie, that representation obligation passed to thefederal government, which may find itself paying for the lawyers defending theexecutives against the government's own prosecutors.
"Who'd have thought wemight be on the hook for paying the defense costs when we're also paying theprosecution costs?" said Doug Heller, executive director of Consumer Watchdog, agroup that has been critical of the financial bailout packages. "To defend theeconomy from the havoc that's been created, we're going to defend the havoccreators?"

The Bush administration is working to avoid it. TheFederal Housing Finance Agency, an oversight organization, said in regulatoryfilings it soon will try to prohibit Fannie and Freddie from paying legal feesto its executives. Such a prohibition almost certainly would lead to a costlycourt fight over who is responsible for the bills when the Justice Departmentcomes knocking.

Fannie and Freddie's contracts also cover legal feesfrom shareholder lawsuits. Taxpayers could be forced to pay those legal bills,too. If the shareholders should win, which they could do by proving thecompanies were mismanaged, the government could be liable for millions ofdollars to make up for the executives' failures.

It would not be thefirst time federal money intended to prop up the financial industry was used forunintended purposes. Days after it received an $85 billion federal bailout loan,American International Group Inc. spent $440,000 on an executive retreat withspa treatments, banquets and golf outings.

Both Fannie Mae andFreddie Mac have been subpoenaed as part of the wide-ranging Justice Departmentinvestigation. The two companies are key to the US mortgage industry. Afterbanks make loans to home buyers, Fannie and Freddie buy the mortgages from thebanks so bankers can have cash on hand to make more loans and keep the economyhumming. Fannie and Freddie then bundle those loans and sell them asmortgage-backed securities. The proceeds of those sales help buy moremortgages.

In recent years, however, the companies have bought morerisky, subprime mortgages. When the housing bubble burst and the subprimeindustry imploded, investors feared the risk of buying Fannie and Freddie'smortgage-backed securities, making it harder for the companies to raisemoney.

Combined, Fannie and Freddie own or guarantee almost half themortgages in the United States. The Treasury Department stepped in to keep thecompanies from collapsing and taking the mortgage industry down withthem.

Neither Fannie nor Freddie has said whether they already haveadvanced any legal fees to former executives. The companies are required to makegeneral disclosures about such payments, but only on quarterly corporatefilings.

Whenthe US government took over, Fannie Mae chief executive Daniel H Mudd, FreddieMac chief executive Richard F Syron and the rest of the leaders at the twoagencies were fired. All those executives would be entitled to have their legalfees covered.

The obligations easily could stretch into millions ofdollars. Both companies have promised to pay legal fees for all current andformer board members, executives and employees charged or investigated inconnection with their employment.

Legal fees can add up quickly.After Freddie Mac restated its earnings in 2003, it became embroiled in severalinvestigations and lawsuits. By the middle of 2005, the company had paid $16.8million in legal fees for its executives and employees.

Executiveswho are convicted of wrongdoing are required to give the money back. Those whoare acquitted, who are merely witnesses or who are investigated but nevercharged do not need to reimburse the company.

It is impossible todetermine how much money might be at stake. In taking over the two mortgagegiants, the federal government pledged to spend up to $200 billion to keep bothcompanies afloat. The amount the government actually will spend depends on howwell the companies perform in a changing mortgage industry.

With somuch money at stake, defense attorneys are watching closely to see how broadlyhousing regulators restrict any future legal payments. The Fannie and Freddiecontracts give the executives the right to sue to force the companies to paytheir legal fees. If the executives should win, the cost of those lawsuits getspassed to Fannie and Freddie, with taxpayers standing ready to foot that bill,too.


AP-TK-06-11-08 0315GMT<