A Breakfast Warning That Fannie Mae Was a Fraud Made a Chairman Quit That Night
Todd Combs did not know Steve Friedman chaired the mortgage giant, and his blunt accounting lesson turned into an offer to start a fund.
Joys of Compounding · Todd Combs - Investing, The Last Liberal Art - [Art of Investing, EP.1]Todd Combs, an investor who had bet against the stock of Marsh McLennan, showed up for breakfast thinking he was giving free advice. Steve Friedman, a Wall Street veteran who had been asked to take over Marsh McLennan, a giant insurance broker, wanted to know what he would be walking into.
Combs knew the company well. He had been short Marsh McLennan stock for two years, betting it would fall, and had dug through its business waiting for regulators to act. When New York Attorney General Eliot Spitzer ousted the leadership over alleged collusion, Friedman got the call to run the company. An insurance expert told Friedman to talk to Combs, describing Combs as the investor who had bet most heavily against the stock.
They talked about Marsh for two hours. Combs walked him through what he had found. He was short the insurance giant AIG too. Then, as they were wrapping up, Friedman asked a throwaway question.
Was there anything else Combs felt sure about?
Combs did not know Friedman chaired Fannie Mae, a mortgage finance company, and he told him that Fannie Mae was 10 times worse than Marsh. Combs said Fannie Mae was "a complete accounting fraud," and people were going to go to prison over it.
Friedman turned white and grabbed the table. When Friedman said he was on the board, Combs told him he should get off it by tomorrow. They agreed to meet for breakfast again the next day.
At that second breakfast, Combs walked Friedman through derivatives accounting, the rules for financial contracts tied to other assets, and what he called arcane, Byzantine stuff. Friedman, a lawyer, kept having to excuse himself from the meeting. That evening at five, he resigned from the Fannie Mae board.
The next day, Friedman called back with a different proposition. Friedman told Combs, "we've been looking for somebody for seven or eight years," and said they wanted him to start a fund.
Questions people ask
What exactly is Fannie Mae?
Fannie Mae buys home loans from lenders, bundles them into securities, and guarantees them, with a special federal charter. Because investors believed the government stood behind it, it could borrow cheaply, so doubts about its accounting shook confidence far beyond one company.
Was Combs right about the fraud?
Regulators later found Fannie Mae had manipulated earnings to smooth profits and trigger bonuses, and it paid a $400 million penalty in 2006. In 2008, as mortgage losses mounted, the government seized it and placed it under conservatorship, where it remains.
Who is Steve Friedman?
Friedman rose at Goldman Sachs, where he served as co-chairman, then served in Washington running the National Economic Council from 2002 to 2005. He took over at Marsh McLennan in 2004 after the Spitzer investigation, and later chaired the Federal Reserve Bank of New York from 2008 to 2009.