Freddie Mac Under Investigation; New Management Promises Accurate Numbers

By Sarah Borchersen-Keto, CCH Washington News Bureau. Contributing author, Catherine Hubbard, M.A., CCH Washington News Bureau.

The fallout from Freddie Mac’s January announcement that it would have to restate earnings for the past three years came to a head June 11 when the company announced that the Securities and Exchange Commission (SEC) had opened a formal investigation into alleged accounting irregularities. At the same time, the U.S. Attorney’s office in the Eastern District of Virginia said it had initiated an investigation but declined to offer further details of the criminal probe. Congress also is gearing up to hold hearings on the matter.

Shaun O’Malley, chairman of Freddie Mac’s Board of Directors, announced the same day that the company has been cooperating fully since January with an informal SEC inquiry. He noted that a review by the counsel of Freddie Mac’s Audit Committee does not indicate to date that any employee, other than former President and Chief Operating Officer David Glenn, had acted inappropriately. Freddie Mac fired Glenn a few days earlier due to “serious questions as to the timeliness and completeness of his cooperation and candor” with the Audit Committee counsel.

GETTING TO THE TRUTH

Meanwhile, House Financial Services Committee Chairman Michael Oxley (R-OH) announced that the Capital Markets Subcommittee, chaired by Rep. Richard Baker (R-LA), would hold one or more hearings to examine accounting issues at Freddie Mac, as well as the regulatory oversight of the housing government sponsored enterprises (GSEs).

“Congress needs to get the true story about what was happening at Freddie Mac and what top management was really doing to resolve questions about the company’s books,” Baker said. He added that Congress should be equally concerned about what regulators knew, or didn’t know, and what they have been doing since January.

“These GSEs are too important and have too great a role in financial markets for Congress not to make sure adequate and effective oversight is in place to protect investors, homebuyers, and taxpayers from missteps like this ever happening again,” Baker said.

The GSEs are privately owned but federally-chartered companies created by Congress to help overcome barriers to the flow of credit into certain segments of the economy, such as housing. GSEs are not backed by the full faith and credit of the federal government. Freddie Mac and Fannie Mae were designed to bolster the nation’s housing market through a secondary mortgage market. They have evolved into large sophisticated financial institutions that purchase mortgages and issue mortgage-backed securities on which they guarantee the timely payment of principal and interest.

The Office of Federal Housing Enterprise Oversight (OFHEO), which has the task of ensuring the capital adequacy and financial safety and soundness of Freddie Mac and its sister organization Fannie Mae, said in a letter dated June 7 that the removal of members of the management team “only goes part of the way toward correcting serious problems – concerns surrounding management practices and controls remain.” OFHEO has set up a special investigative team to review accounting practices and possible employee misconduct.

FREDDIE’S OUTLOOK

In a June 9 conference call to investors, Freddie Mac’s new chief executive officer and president Gregory Parseghian said that the company’s economics, value, and risk management positions have not been affected by the revelations. “I’m very optimistic about Freddie Mac’s ability to fulfill its housing mission,” he said. Parseghian added that job number one for the company at this time is to “have scrupulously accurate numbers.”

Martin Baumann, the newly appointed chief financial officer, said Freddie Mac still expects to release its revised results shortly after the end of the second quarter but added that work could continue into the third quarter. The readjustments in earnings are expected to be upward.

Parseghian also said that he had spoken to several ratings agencies, including Standard & Poors, Moodys and Fitch, and that all were “generally supportive” of how the company was conducting its affairs.

FALLOUT CONCERN

However, Standard & Poors announced June 12 that it was “increasingly concerned about the magnitude of the scandal and its potential political fallout.” The ratings agency added that Freddie Mac’s importance to the mortgage market and the economy “gives them political cover, but that cover is not unlimited.”

Federal Reserve Board Chairman Alan Greenspan told the House Energy and Commerce Committee June 10 that there was no reason to differentiate Freddie Mac and Fannie Mae from the rest of the securities industry when it came to SEC disclosure requirements.

Adding her opinion, Federal Reserve Governor Susan Schmidt Bies stated that the Fed is not ready to make a judgement about the Freddie Mac scandal. “We need to reserve judgement until we find out what exactly happened,” she told reporters after a June 11 speech she gave at an American Bankers Association conference in Washington, D.C. “At the appropriate time, I think we’re all going to learn a lot more.” She added that it is not known yet whether the problems at Freddie Mac were caused by underlying weaknesses in the institution or by a certain person. “It’s not clear whether it was a process breakdown, or a breakdodwn by an individual.”

When asked whether the issue could affect homeowner refinancings, Bies said she is “not too concerned,” and that “mortgage securities are still trading fairly well.” The housing market is strong, and banks as a whole are very liquid, she said. “I haven’t seen any signs that there will be a short-run impact on them.”