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By Marilyn Barnewall

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In July 2003, I wrote an article about Freddie Mac’s problems. At that time, Freddie Mac was under investigation by the U.S. Attorney’s Office, the Securities and Exchange Commission, and the Office of Federal Housing Enterprise Oversight.

Very little media coverage was given to the results of those investigations. If any financial problems occur at either Fannie Mae or Freddy Mac, it could cause serious economic repercussions. Thus, the media’s lack of coverage of these investigations is puzzling.

According to the Washington Post, Alan Greenspan testified as late as last February that he believes the size of the two housing giants, Freddie Mac and Fannie Mae, poses a risk to the well-being of the United States economy.

Freddie Mac holds about $1.3 trillion in home mortgages. They package and sell about half of that amount, and keep the other half in their own portfolio. It is one of the nation’s biggest corporations.

The 2003 investigations came about because Freddie Mac’s new auditing firm, PricewaterhouseCooper, disagreed with the company’s prior auditor, Arthur Andersen (of Enron fame).

It was a wake-up call to investors in Freddie Mac’s mortgage-backed securities when the company announced it had fired its president., David Glenn. He failed to cooperate in the PricewaterhouseCooper requested internal accounting review.

Since many of the largest mutual funds – Oppenheimer, Scudder, etc. — invest in Freddie Mac and Fannie Mae, it made the markets nervous. Within a few days, the stock dropped 21 percent in value. At that time, Standard & Poors cut their stock buy recommendation from “hold” to ‘avoid.” This is S&P’s second worst rating.

The disagreement revolves around the company’s treatment of derivatives ? complex agreements whose value depends on the movements of interest rates, stocks or bonds.

Derivatives are very confusing. I don’t know anyone who can describe them very well – including the people who create and sell them. I have had brokers who specialize in derivatives tell me that very thing. You can define them as financial contracts with some kind of tie to the price of securities. It’s an accurate definition, but in no way explains the complexity of this investment vehicle.

Freddie Mac and Fannie Mae have a high degree of favor bestowed upon them by the federal government. And, looking at all of the problems, there is apparently very little oversight – certainly very little qualified oversight — of how this company functions.

This is not, as many people think, a federal agency. It is a shareholder-owned, private company… as is its counterpart in the mortgage markets, Fannie Mae. Its funds are not guaranteed by the U.S. government, though many investors ignore those words in prospectus offerings and choose to believe they are.

I repeat, the U.S. government does not guarantee Freddie Mac’s (or Fannie Mae’s) debt. However, those experts who are supposed to know such things believe the government would prop up both companies if a financial circumstance required it.

Freddie Mac does not make loans to you personally when you purchase a home. If you go to a local bank, your home loan may be sold to Freddie Mac – or to Fannie Mae. You may never know that your loan has been sold, but that is how these two companies earn their incomes. They repackage loans as securities and make them available to private investors.

Both Freddie Mac and Fannie Mae enjoy access to congressional charters that give them the power to make it easier for people to buy a home. Other mortgage companies do not enjoy such benefits.

Both companies are particularly active in helping minorities and females finance homes for which they might not otherwise qualify.

Both have the ability to borrow up to $2.25 billion from the government. Other mortgage companies do not enjoy this kind of credit leverage.

Both enjoy certain tax and tax disclosure exemptions unavailable to other mortgage companies… e.g., they don’t have to pay state income taxes and don’t have to register their bond issues with the SEC

There is little doubt that there were financial shenanigans going on last year at Freddie Mac. Last December, the company agreed to pay a $125 million civil find to settle one inquiry involving a $5 billion misreporting of its earnings between 2000 and 2002.

According to the Office of Federal Housing Enterprise Oversight (OFHEO), “Freddie Mac disregarded accounting rules, internal controls, disclosure standards, and ultimately, the public trust in the pursuit of steady earnings growth.”

That’s not all. There is more.

Maxine B. Baker, president of the Freddie Mac Foundation (created in 1991), was reprimanded for using foundation employees to do her personal chores. She also referred to one employee as “that white girl.” Baker is of African descent.

Baker is still president of the foundation… for which she is paid $168,327 for 20 hours of work a week. Her penalty for being a bad girl is the loss of half her annual bonus. The investigation of Baker got started when she failed to show up at a mandatory ethics compliance training session — training the woman obviously needs — and had a subordinate sign her name to an attendance list.

As a result of all the above, the OFHEO wants civil fines of $5.8 million levied against former Freddie Mac chief executive Leland C. Brendsel and $2.6 million levied against former chief financial officer, Vaughn A. Clarke. Brendsel shouldn’t have a problem paying such a fine… his severance package was $24.4 million.

The decision to seek civil fines was made mid-December, 2003. I could not find any information on the Internet as to whether or not the fines had been levied or paid.

Here we are, a year after the accounting crisis erupted. During the last week of June 2004, Freddie Mac reported its net income fell to $4.9 billion… a 52 percent drop in earnings.

The strangest thing of all? After all of the above was disclosed, the company’s stock hit a 52-week high in January 2004 of $65.15. After Alan Greenspan’s statement on February 25, the stock fell slightly, to $62.12.

When an organization appears to be dominated by employees with ethics problems and says it will take a long time to remove questionable auditing practices, it is eventually evidenced in a company’s financial performance.

There has been ample warning of danger, if you look for it.

 


Marilyn Barnewall, in 1978, was the first female to be named vice president in charge of a major loan and deposit portfolio at Denver’s largest bank. She started the nation’s first private bank, resigned to start her own firm and consulted for banks of all sizes in America and other countries. In June 1992, Forbes dubbed Barnewall “the dean of American private banking.” Author of several banking texts, she has written extensively for the American Banker, Bank Marketing Magazine, and was U.S. consulting editor for Private Banker International (Lafferty Publications, London/Dublin). Article originally appeared in the Grand Junction Free Press. Marilyn can be reached at marilynmacg@yahoo.com.

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