We featured Fannie Mae in Good to Great due to its extraordinary performance leap in the early 1980s under David Maxwell. Under Maxwell’s leadership, Fannie Mae transformed itself from a bureaucratic, government-chartered entity into a high-powered capital markets enterprise, generating cumulative stock returns substantially above the general stock market. The thirty-year cumulative stock-return pattern used as the basis for selecting Fannie Mae for Good to Great ran from 1969 to 1999, and our research regarding Fannie Mae focused on those years.
Unfortunately, Fannie Mae of the 2000s exemplified just the opposite: great to good to nearly gone. As I mentioned earlier in the text, we didn’t include Fannie Mae in the full analysis for How the Mighty Fall for the simple reason that when we selected our study set of fallen companies in 2005, Fannie Mae (and other financial institutions in our database) hadn’t yet fallen, so they didn’t qualify for this study. Instead of throwing Fannie Mae into the research project at the last minute because it happened to be in the news, I’ve decided to include a brief commentary about it in this appendix.
In reviewing the demise of Fannie Mae and other financial institutions in 2008, I kept thinking about a scene from the movie Titanic. In that scene, J. Bruce Ismay of the White Star Line, which owned the Titanic, turns incredulous when confronted with the impending doom of the giant ship: “But this ship can’t sink.”
“She’s made of iron, sir,” replies ship designer Thomas Andrews. “I assure you, she can.”
As the housing bubble burst, financial executives at major institutions turned incredulous, seemingly unable to believe the terrifying reality of their situation. In examining the materials we assembled on the demise of Fannie Mae, we found little evidence that the company’s executives seriously considered the possibility of failure. Yet in September 2008, Fannie Mae found itself under government conservatorship, a legal status similar to bankruptcy.172 On October 31, Fannie Mae’s stock price, which had stood at $57 a year earlier, had essentially evaporated, falling 98 percent to 93 cents.173
According to an article in the New York Times, Fannie Mae’s CEO later defended the company, pointing out that “almost no one expected what was coming. It’s not fair to blame us for not predicting the unthinkable.”174 And indeed, nearly every major financial institution got mauled in the housing-bubble, subprime-mortgage mess of 2008, including Fannie Mae’s fraternal twin, Freddie Mac, along with institutions like Citigroup. When Vikram Pandit, CEO of Citigroup, appeared on the Charlie Rose show in late November 2008, he made the same argument. “How many times have you seen AAA bonds go to zero?” he asked rhetorically, adding that risk-management models simply didn’t account for the scenarios that had actually unfolded. He later added, “I’m not so sure anybody . . . anybody . . . ran a stress test of the kind of environment that we’re living through today.”175
So, perhaps Fannie Mae just got hammered down by an industry catastrophe; maybe its failure had nothing to do with its self-management. That said, we did find evidence of the first three stages of decline (Stage 1: Hubris Born of Success; Stage 2: Undisciplined Pursuit of More; and Stage 3: Denial of Risk and Peril) at Fannie Mae in the 2000s, leading up to the 2008 crisis.
Maxwell had cultivated an ethic of willful humility while leading Fannie Mae during the 1980s. However, by the early 2000s, Fannie Mae had acquired a reputation for arrogance, enabled by both its extraordinary success and its sense of missionary righteousness vis-à-vis its special role in advancing the American Dream of home ownership.176 Fannie Mae had long prided itself on being a disciplined organization, especially in managing risk, but it also experienced substantial pressures for growth—from within and from Wall Street—compounded by political pressures to help more low-income families become homeowners.177 Its 2001 annual report stated that Fannie Mae was on track to double operating earnings per share in the five years ending in 2003, which implied a 15 percent annual growth rate (compared to the 7 to 10 percent growth rate of the overall residential mortgage market at the time).178 Fannie Mae achieved its goal, appearing headed toward further growth and success, and then became ensnared in an accounting storm.179
In September 2004, the Office of Federal Housing Enterprise Oversight (OFHEO) issued a report accusing Fannie Mae of misapplying Generally Accepted Accounting Principles in an effort to minimize earnings volatility.180 Fannie Mae eventually resolved the crisis, but at a cost. In the words of its 2006 annual report:
“We entered into comprehensive settlements that resolved open matters with the OFHEO special examination, as well as with the SEC’s [Security and Exchange Commission’s] related investigation. As part of the OFHEO settlement, we agreed to OFHEO’s issuance of a consent order. In entering into this settlement, we neither admitted nor denied any wrongdoing or any asserted or implied finding or other basis for the consent order. We also agreed to pay a $400 million civil penalty, with $50 million payable to the U.S. Treasury and $350 million payable to the SEC for distribution to certain shareholders pursuant to the Fair Funds for Investors provision of the Sarbanes-Oxley Act of 2002.”181
More costly than the financial penalties, Fannie Mae had lost much of its momentum while embroiled in the investigation.
The wounded mortgage giant emerged from the accounting settlement to find a growing housing bubble and aggressive competition from companies like Countrywide, Lehman Brothers, Bear Stearns, and others.182 Fannie Mae increased its activity in subprime mortgages, although not to the extent of some other companies.183 As a Fannie Mae executive said to the New York Times, “Everybody understood that we were now buying loans that we would have previously rejected, and that the models were telling us that we were charging way too little. But our mandate was to stay relevant and to serve low-income borrowers. So that’s what we did.”184 As the housing bubble ruptured, Fannie Mae posted losses of $2.2 billion in the first quarter of 2008 and $2.3 billion in the second quarter. To help stave off a collapse of the entire U.S. financial system, the U.S. government put Fannie Mae and Freddie Mac into conservatorship, with the aim of restructuring them by 2010.185
Here are a few observations and lessons:
• Financial institutions have a peculiar relationship relative to Stages 3, 4, and 5. Because of the high levels of leverage that financial enterprises often use, a relatively small set of losses can create a potentially catastrophic loss. Financial institutions caught in a risk-gone-bad downward spiral can crash downward from Stage 3 right into Stage 5, sinking so fast that there remains little time to grasp for salvation.
• Companies already in the stages of decline are extremely vulnerable to turbulence. If the financial storm of 2008 had never happened, or if it hadn’t become so severe, perhaps Fannie Mae would have had an opportunity to reverse its own decline and return to greatness by its own efforts. It lost that opportunity in the calamity of September 2008.
• I’m struck by how the stages of decline—Hubris Born of Success, Undisciplined Pursuit of More, Denial of Risk and Peril, Grasping for Salvation (Government, save us!), and finally, Capitulation to Irrelevance or Death—map fairly well not just to individual companies, but perhaps even to an entire industry, such as financial services or the American auto industry. Even so, it is worth pointing out that companies need not be imprisoned by their industries. Not every financial company toppled during the 2008 crisis, and some seized the opportunity to take advantage of weaker competitors in the midst of the tumult.
• Finally, there’s a provocative lesson: beware the hubris that can arise in conjunction with missionary zeal. In the Built to Last study, Jerry Porras and I found that enduring great companies passionately adhere to a set of timeless core values and pursue a core purpose beyond just making money. But there is also a risk to manage: having an almost righteous sense of one’s values and purpose (“We’re the good guys”) can perhaps make a company more vulnerable to Stages 1 to 3. Fannie Mae’s missionary zeal for expanding the American Dream of home ownership to as many Americans as possible contributed, in part, to its arrogance, its pursuit of growth, and even its increased risk profile. Whenever people begin to confuse the nobility of their cause with the goodness and wisdom of their actions—“We’re good people in pursuit of a noble cause, and therefore our decisions are good and wise”—they can perhaps more easily lead themselves astray. Bad decisions made with good intentions are still bad decisions.