CNBC EXCLUSIVE: CNBC TRANSCRIPT: CNBC'S TYLER MATHISEN SITS DOWN WITH FRANKLIN RAINES, FORMER FANNIE MAE CHAIRMAN & CEO, TODAY ON CNBC'S "POWER LUNCH" AT 12:20PM ET

WHEN: TODAY, TUESDAY, MAY 4TH AT 12:20PM ET

WHERE: CNBC'S "POWER LUNCH"

Following is the unofficial transcript of a CNBC EXCLUSIVE interview with Franklin Raines, Former Fannie Mae Chairman & CEO, today on CNBC's "Power Lunch" at 12:20PM ET.

All references must be sourced to CNBC.

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MATHISEN: AND ON THIS DAY WHERE THERE IS AN AWFUL LOT OF ATTENTION BEING PAID TO THE PRICE REACTIONON WALL STREET, ALSO A LOT OF ATTENTION BEING PAID HERE AT THE BUSINESS COUNCIL MEETING HERE INWASHINGTON WHERE THE PRESIDENT SPOKE ABOUT AN HOUR AGO COVERING EVERYTHING FOR THE NEED OF FINANCIAL REFORM TO THE NEED TO CONTROL THE DEFICIT. JOINING ME FROM THE MEETING IS AMAN WHO KNOWS A LITTLE BIT ABOUTHOW TO CONTROL DEFICITS. IN FACT, HE WAS THE LAST GUY RUNNING OMB WHEN IT THERE WAS BALANCE IN THE BUDGET AND HE KNOWS ABOUT HOUSING. FRANKLIN RAINES FORMER CHAIRMAN AND CEO AT FANNIE MAE HE IS NOW AT REVOLUTION HEALTH.MR. RAINES, GOOD IT HAVE YOU WITH US.

RAINES: THANK YOU.

MATHISEN: APPRECIATE YOU BEING HERE. I WANT TO GET A SENSE OF WHAT THE ROOM WAS LIKE. I WAS WATCHING THE SPEECH HERE. AFTER THE SPEECH, THE PRESIDENT SPENT SOME TIME TALKING TO SEVERAL EXECUTIVES INCLUDING LLOYD BLANKFEIN WITH WHOM HE PASSED SOME COMMENTS EVIDENTLY, IT WAS NOT EXACTLY A STATE OF THE UNION ADDRESS INTERRUPTED MULTIPLE TIMES BY APPLAUSE.

RAINES: THAT'S TRUE. THE PRESIDENT GAVE A VERY SERIOUS TALK AND I THINK HE WASN'T EXPECTING TO GET A BIG REACTION. HE WAS TRYING TO MAKE HIS CASE FOR WHY HIS POLICIES MADE SENSE TO AN AUDIENCE THAT HAD MULTIPLE EXPERIENCES AND THEY HAVE BEEN BEAT UP A LITTLE BIT AND SUPPORT THINGS THAT THE ADMINISTRATION DOES. I THINK THE ADMINISTRATION IS STILL WORKING OUT ITS ARRANGEMENTS WITH THE BUSINESS COMMUNITY.

MATHISEN: DOES BUSINESS FEEL PICKED ON BY THE BUSINESS ADMINISTRATION?

RAINES: I THINK MANY PEOPLE IN THAT ROOM I THINK THE ANSWER WOULD BE YES THAT THE ADMINISTRATION SCORED POLITICAL POINTS AT THEIR EXPENSE. OF COURSE, A LOT OF THE POLITICAL POINTS WERE EARNED AND THE PRESIDENT IS NOT AS THOUGH HE IS MAKING THIS UP ABOUT THE PROBLEMS IN THE BUSINESS COMMUNITY, BUT I THINK THE TWO SIDES ARE STILL TRYING TO WORK OUT A WAY TO DEAL WITH EACH OTHER.

MATHISENl THE PRESIDENT SPOKE FORTHRIGHTLY ABOUT THE NEED FOR FINANCIAL REGULATORY REFORM BUT I DON'T BELIEVE I EVER HEARD HIM MENTION THE WORDS FANNIE MAE OR FREDDIE. CAN YOU REALLY REFORM FINANCE IN THIS COUNTRY WITHOUT REFORMING FANNIE AND FREDDIE.

RAINES: WELL FINANCIAL REGULATION REFORM IN THE CURRENT VERSION PRIMARILY FOCUSED ON PROTECTING CONSUMERS AND FANNIE AND FREDDIE THROUGH ITS HISTORY WERE THE BULL WORKS IN PROTECTING CONSUMERS IN THE MORTGAGE AREA. THERE IS A LOT TO BE ACTUALLY LEARNED THERE. IN TERMS OF REFORM DEALING WITH TOO BIG TO FAIL AND THOSE ISSUES, I THINK THAT ULTIMATELY YOU CAN'T HAVE A COMPLETELY REFORM SYSTEM WITHOUT FIGURING OUT WHAT YOU'RE GOING TO DO WITH THESE TWO VERY LARGE COMPANIES THAT ARE PROVIDING THE BULK OF MORTGAGE FINANCE.

MATHISEN: AND AREN'T THEY THE ULTIMATE SORT OF LIVING, BREATHING MODELS FOR TOO BIG TO FAIL. THE TAXPAYERS HAVE PUT IN SOMETHING LIKE $120 BILLION INTO PROPPING UP THOSE TWO INSTITUTIONS. HOW DO YOU FIX THEM?OR DO WE NEED TO DO AWAY WITH THEM? THERE'S LOTS OF COUNTRIES LIKE CANADA AND MANY IN EUROPE WHO DON'T HAVE ANY CORLETS TO FANNIEAND FREDDIE AND HAVE COMPORABLE OR EVEN HIGHER RATES OF HOME OWNERSHIP.

RAINES: BUT THEY ALSO HAVE PASSED ON THE RISK TO THE HOMEOWNER OF INTEREST RATE MOVES.IN THIS COUNTRY THE AVERAGE PERSON CAN GET A 30-YEAR FIXED RATE MORTGAGE.THAT'S NOT TRUE AROUND THE WORLD. I THINK THAT'S THE BIG DIFFERENT IT'S HOW MUCH RISK DO YOU WANT TO PUT ON TO CONSUMERS AND HOW MUCH FINANCIAL INSTITUTIONS AND OTHERS SHOULD BE BEARING. BUT I THINK FANNIE AND FREDDIE, THERE HAS TO BE A WAY FOUND GOING FORWARD. TODAY THEY AND THE FHA ARE 100% OF THE MORTGAGE MARKETS AND WE HAVE SEEN IN THIS LAST CRISIS THAT ORDINARY FINANCIAL INSTITUTIONS WILL WITHDRAW FROM THAT MARKET AT THE SLIGHTEST INDICATION OF PROBLEMS AND YOU SIMPLY CAN'T HAVE A COUNTRY LIKE OURS WITH A LARGE MIDDLE CLASS THAT DOESN'T HAVE A FUNCTIONING MORTGAGE MARKET ALL THE TIME.

MATHISENl BUT CANADA DOES. CANADA HAS A MORTGAGE MARKET AND PEOPLE GET IT AND THEY DON'T HAVE THE DEDUCTIBILITY OF MORTGAGE INTEREST AND YET THEY HAVE 68% HOME OWNERSHIP. WHY NOT WIND DOWN FANNIE AND FREDDIE AND DO YOU THINK REALLY IN YOUR MIND'S EYE THEY WILL BE HERE ANYTHING LIKE THE ROLE THEY HAVE COME TO HAVE TEN YEARS FROM NOW?

RAINES: MY GUESS IS THEY WILL BE HERE. MY GUESS IS THERE MAY BE SOME TINKERING AROUND THE OWNERSHIP THEY MAY NOT BE PUBLIC COMPANIES GOING FORWARD OR THEY COULD BECOME COOPERATIVES. BUT I THINK THE AMERICAN SYSTEM AND ITS FOCUS ON 30-YEAR FIXED RATE MORTGAGES IS A VERY POWERFUL, VERY POWERFUL THING. CANADA IS A COUNTRY OF 20, 25 MILLION PEOPLE WITH ADJUSTABLE RATE MORTGAGES, FOUR BANKS, NOT A VERY CONSUMER FRIENDLY ENVIRONMENT. ALTHOUGH, IF YOU PUT THE BURDEN ON THE CONSUMERS, IT'S TRUE.YOU WON'T HAVE AS MANY CRISES AMONG YOUR LARGE FINANCIAL INSTITUTIONS.

MATHISEN: I WANT TO GET TO FISCAL POLICY, BUT I DON'T WANT TO LEAVE FANNIE AND FREDDIE AND THE HOUSING BUBBLE TOO QUICKLY. I WANT TO READ SOMETHING WRITTEN TODAY'S WALL STREET JOURNAL BY ROBERT WILMERS OF M&T BANK ABOUT REFORMING FANNIE AND FREDDIE AND HE SAYS WE CANNOT REFORM THESE GOVERNMENT-SPONSORED ENTERPRISES UNLESS WE FULLY CONFRONT THE EXTENT TO WHICH THEIR OUTRAGEOUS BEHAVIOR AND RECKLESS BUSINESS PRACTICES HAVE AFFECTEDTHE ENTIRE COMMERCIAL BANKING SECTOR AND THE U.S. ECONOMY AS A WHOLE. HOW RESPONSIBLE WAS FANNIE FOR THE HOUSING BUBBLE AND WHAT ENSUED AND WHAT LEVEL OF ACCOUNTABILITY DO YOU PERSONALLY TAKE FOR THE DECISIONS YOU MADE AS THE CEO THAT MAY HAVE CONTRIBUTED TO THE COLLAPSE OF THE HOUSING MARKET AND THE MORTGAGE FINANCE SYSTEM IN THIS COUNTRY.

RAINES: WELL BOB WILMERS IS AN OLD FRIEND AND A LONG-TIME CUSTOMER OF FANNIE MAE, SO I HAVE A LOT OF RESPECT FOR HIM. YOU KNOW, WHEN I WAS AT FANNIE MAE, WE HAD A VERY TOUGH RISK MANAGEMENT STRUCTURE. BUT THAT WAS FIVE, THAT WAS ALMOST SIX YEARS AGO AND INSTEAD OF STAYING THE COURSE, AS LATER MANAGEMENT SAID, THEY CHANGED THAT STRUCTURE IN ORDER TO BECOME A BIGGER PLAYER IN THE MARKET. THEY WERE LOSING MARKET SHARE BY MAINTAINING THEIR TOUGH STANDARDS. THEY WANTED TO BE A PLAYERS, THEYJUMPED IN AND THEY BOUGHT A LOT OF THINGS THEY SHOULDN'T HAVE BOUGHT. THEY TESTIFIED TO THIS THEMSELVES, SO I'M NOT REALLY SPEAKING OUT OF TURN HERE. AND THAT REALLY LED TO THE COMPANY'S FAILING FINANCIALLY BECAUSE THEY TOOK ON MORE RISK THAN THEY SHOULD HAVE.

MATHISEN: WERE YOU FOLLOWING WHAT YOU THOUGHT TO BE CONGRESSIONAL MANDATES TO EXPAND THE KIND OF MORTGAGES THAT FANNIE MAE WOULD GO IN AND BUY?

RAINES: WELL, WE DID HAVE MANDATES FOR BUYING AFFORDABLE LOANS, BUT WHEN I WAS THERE, WE MANAGED THE COMPANY ACCORDING TO RISK. I WANTED TO DO NOTHING THAT PUT THE FUTURE OF THE COMPANY AT RISK AND WE DIDN'T. IN FACT, IF YOU LOOK AT WHAT HAPPENED SINCE THEN, ALMOST ALL THE LOSSES THAT FANNIE MAE HAS EXPERIENCED CAME FROM MORTGAGES THAT WERE BOUGHT TWO YEARS AFTER I LEFT.

MATHISEN: YOU LEFT IN 2004, LET THE RECORD SHOW.

RAINES: THAT'S CORRECT.

MATHISEN: I WONDER WHETHER AS YOU WATCHED OR REACTED TO THE GELDMAN SACHS HEARINGS LAST WEEK THERE WASN'T A MOMENT WHEN YOU THOUGHT, WOW, THEY GOT THE WRONG COMPANY UP HERE. THEY'RE LOOKING AT A COMPANY WHOSE ROLE WAS NO WHERE NEAR AS CENTRAL TO THE HOUSING MARKET COLLAPSE AS THE COMPANY FANNIE AND FREDDIE WERE.

RAINES: WELL, I DON'T THINK THAT'S TRUE.THEY MAY HAVE HAD THE WRONG COMPANY AMONGST THE INVESTMENT BANKS BECAUSE GOLDMANWAS NOT AS BIG A PLAYER IN SOME OF THE MORTGAGES AS SOME OF THE OTHERS LIKE LEHMAN BROTHERS, BUT IN FACT MOST OF THE EROSION AND CREDIT STANDARDS HAPPENED ON WALL STREET. IT DIDN'T HAPPEN AMONG THE GSEs. WALL STREET LED WITH THE SUBSECURITIZATION OF SUBPRIME LOANS AND THEY LED WITH THE SECURTIZATION OF NONCONFORMING LOANS THAT DIDN'T FIT THE FANNIE AND FREDDIE STANDARDS.THEY REALLY WERE THE ENGINE. GOLDMAN WAS NOT NECESSARILY THE LEADER OF THAT.SO, IN SOME WAYS, IT'S UNFAIR TO PICK ON THEM. BUT AS JOHN MACK HAS SAID, THE ENTIRE INDUSTRY LET DOWN ITS STANDARDS AND WITH ALONG WITH THE RATING AGENCIES FLOODED THE MARKET WITH SECURITIES THAT PROBABLY SHOULD NEVER HAD BEEN ISSUED.

MATHISEN: THEY'RE TELLING ME WE HAVE TO GO, BUT I HAVE TO ASK YOU ABOUT THE DEFICIT, WHICH IS SO HUGE. HOW YOU WERE THE LAST GUY IN OFFICE RUNNING OMB A TIME THE DEFICIT WENT AWAY AND WE WERE IN SURPLUS AT THAT TIME. GIVE ME THE THREE THINGS THAT YOU THINK WE NEED TO DO TO GET THE BUDGET BACK IN BALANCE, APART FROM GROW THE ECONOMY, WHICH IS PROBABLY THE SINGLE BEST WAY TO DO IT. BUT CAN YOU DO THAT AND RAISE TAXES AT THE SAME TIME?

RAINES: THE EASIEST WAY TO THINK ABOUT THIS IS WHEN WE BALANCED THE BUDGET WE BALANCED IT AT 19% GDP. TODAY REVENUE IS ONLY 15% AND SPENDING IS 25%. SO, WE'VE GOT THIS HUGE DEFICIT. SO, TO ME , IT'S PRETTY SIMPLE. YOU HAVE TO RAISE REVENUE AND YOU HAVE TO CUT SPENDING BACK TO MORE HISTORIC LEVELS THAT WE HAVE BEEN ABLE TO SUPPORT IN THIS COUNTRY.

MATHISEN: THANK YOU VERY MUCH, APPRECIATE IT.

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