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Freddie Mac Flap Hurts Industry Reputation

July 30, 2003

WASHINGTON (AP) _ The accounting failure and management shake-up at Freddie Mac have had a ``devastating″ effect on the reputations of the housing finance giant and its larger rival Fannie Mae and have hurt consumers by pushing up mortgage interest rates, Fannie Mae’s chairman said Wednesday.

Franklin Raines, in blunt comments nearly two months after Freddie Mac’s turmoil came to light, also said he believed Fannie Mae had unfairly suffered ``collateral damage″ to its public image and business from the debacle at the other big government-sponsored company.

Unfair, Raines said, ``because unlike Freddie Mac, we didn’t do any of these things.″

In a drive to smooth out volatility in earnings and meet Wall Street’s forecasts, Freddie Mac breached accounting rules and manipulated internal accounts, an internal investigation found. As a result the company underreported its profits by between $1.5 billion and $4.5 billion in 2000-2002, putting it among the biggest corporate accounting failures of recent years.

The internal inquiry also found that Freddie Mac’s new chief executive, Gregory Parseghian, was involved in several of the questionable transactions in his former role as chief investment officer.

The Justice Department and the Securities and Exchange Commission are investigating Freddie Mac, which announced in early June that it had ousted three top executives.

``I think it’s been devastating to the reputation of these firms and I think it has caused material harm to consumers,″ Raines said in a meeting with reporters at Fannie Mae’s headquarters in Washington. ``It was a mistake. It was a management failure.″

The federal agency that supervises the two companies, which has been investigating Freddie Mac’s accounting, also plans a special accounting review of Fannie Mae. Both companies extensively use derivatives, complex financial instruments, to reduce their risk by hedging against swings in interest rates.

Raines drew distinctions between his company’s accounting policies and techniques and those of Freddie Mac, portraying Fannie Mae as a nimble yet responsible corporation with strong internal controls. Fannie Mae recently reported a 25 percent drop in its second-quarter earnings caused by changes in the value of derivatives contracts, even though its business expanded significantly.

The recent surge in mortgage interest rates was caused at least in part by uncertainty stemming from Freddie Mac’s problems and concern over what the government might do in response to them, Raines said.

A spokeswoman for McLean, Va.-based Freddie Mac disputed that notion.

``I think there were a lot of things going on in the market that caused interest rates to rise,″ Sharon McHale said, citing the Federal Reserve’s recent reduction of short-term interest rates and stronger-than-anticipated economic indicators. ``I think the Fed action was the primary driver, certainly not Freddie Mac.″

Rates on benchmark 30-year mortgages last week climbed for the fifth week in a row, rising to the highest level since the mid-January _ a trend that is slowing refinancing by consumers. The average rate was 5.94 percent, up sharply from 5.67 percent a week earlier.

Economists have cited several factors for the rise, including signs that the economy is gaining traction, concern about swelling federal budget deficits and disappointment in financial markets that the Federal Reserve didn’t make a bolder cut to short-term interest rates on June 25.

Fannie Mae and Freddie Mac, two of the nation’s largest companies and both publicly traded, were created by Congress to pump money into the multitrillion-dollar home mortgage market. They have grown explosively in recent years as they’ve bought home loans from banks and bundled them into securities for sale to investors around the globe.

To resolve its accounting errors, Freddie Mac plans to restate past results adding back the billions of dollars in profits that it underreported. An equivalent amount would be deducted from earnings during the next few years.

The SEC generally frowns on companies deliberately bending accounting rules to smooth out volatility in earnings.


On the Net:

Fannie Mae: http://www.fanniemae.com

Freddie Mac: http://www.freddiemac.com

Securities and Exchange Commission: http://www.sec.gov

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