By Wyatt Kash. Freddie Mac's stunning decision last month to dismiss its president, and accept the resignations of its CEO and CFO over accounting concerns, was something of an incendiary bombshell. Without question, Freddie Mac is no ordinary corporation. Nor is there any question that a crucial public trust has been shattered and that new oversight measures deserve to be put in place.
But it was also hard to ignore how political forces turbocharged surrounding events. As if on cue, the announcement unleashed immediate calls for SEC, congressional, and even criminal investigations. The general press weighed in just as quickly, fanning the flames of concern over what might happen to credit markets were Freddie to falter.
Freddie and sibling rival, Fannie Mae, have long drawn disdain for having what private finance companies complain are unfair advantages. As builders already know, congressional charters allow Freddie and Fannie to borrow at lower costs and with fewer tax obligations than private sector banks. The intent was to provide financial liquidity to support homeownership, especially among lower-income families. That's a good thing. And they do the job well. But what Congress has unleashed has grown into financial behemoths; Freddie and Fannie own or guarantee roughly 40 percent of the nation's $7 trillion in home mortgages.
Of greater concern to critics is the massive position each company takes in derivatives contracts to hedge against interest rate fluctuations. The combined value of those contracts has reportedly grown from $72 billion in 1993 to $1.6 trillion in 2001. Yet neither publicly traded firm is subject to the same SEC financial scrutiny and disclosure rules required of publicly held companies, nor are they held to the same standards as banks.
To blunt the criticism, both firms took voluntary steps during the past year to adhere to SEC disclosure guidelines. Fannie Mae, in fact, filed its first 10-K and 10-Q reports with the SEC this spring. Freddie Mac was preparing to do the same when outside accountants recognized -- to use a phrase that has sadly become part of everyday vocabulary -- accounting irregularities.
Unlike other accounting scandals where executives hid expenses or inflated earnings, Freddie Mac appears guilty of understating profits. The reason was to make quarterly results appear less volatile.
Doing so allowed it to pay steadier, and thus lower, rates on its mortgages, which helped buoy its stock price. Freddie announced earlier this year plans to restate three years' worth of earnings after the practice came to light.
Freddie Mac's board deserves credit for dismissing president and COO David Glenn when it became clear he was standing in the way of the truth; and for promoting Gregory Parseghian to take his place. While Parseghian is not well known inside Washington political circles, his skills in hedging financial risks are legendary and trusted. Fortunately, the financial markets showed relatively strong support for Freddie Mac's decision and its overall financial health.
Photo: Katherine Lambert
It seems some of the changes being called for make sense: First, hold both organizations to the same financial disclosure laws that public companies must abide by. The argument has always been that that would result in higher mortgage rates and less money to lend. That's questionable, given today's competitive mortgage market. The impact on monthly mortgage payments would be negligible compared to the added stability it would bring to financial markets. It's also a move endorsed by Federal Reserve chairman Alan Greenspan, who has a deep appreciation for how changes in the home mortgages market can ripple through the economy. Second, it's clear OFHEO, the HUD Office of Federal Housing Enterprise Oversight that regulates Freddie and Fannie, is no longer up to the task of overseeing these financial powerhouses. A better choice would be banking sector watchdogs within the Treasury Department or alternatively, the Federal Reserve Board, with the proper funding to do the job right.
Thirdly, require greater capital reserves. And finally, fix the Byzantine accounting rules so there is less ambiguity concerning derivatives and other hedging instruments. While most observers contend Freddie and Fannie have too many friends in Congress to expect major regulatory changes, the time has come to do what's right and responsible for the nation's financial and mortgage lending systems.