Freddie Mac On The Defensive

Mortgage giant Freddie Mac admitted Friday inflating 2001 earnings by nearly $1 billion, the first acknowledgment in its months-long accounting crisis that it overstated profits.

The company said it may not be able to complete its accounting for 2003 until next June, but that its overall earnings over a three-year period are being restated higher by $5 billion in a long-awaited adjustment. That includes $4.4 billion for 2000-2002, close to what the government-sponsored company had estimated in September, and $600 million for periods before 2000.

Freddie Mac had previously acknowledged understating its earnings over several years - but not overstating them as some other companies have done - to smooth out volatility in profits and uphold its image on Wall Street as a steady performer.

"We've now arrived in Enron territory, and we should all be gravely concerned," said Rep. Richard Baker, R-La., a longtime critic of how Freddie Mac and larger rival Fannie Mae operate. "What other surprises await us?"

McLean, Va.-based Freddie Mac is the second-largest U.S. buyer of home mortgages, a publicly traded corporation with $40 billion revenue a year. It has ousted two chief executives since its accounting troubles came to light in early June and is under criminal investigation by the Justice Department and a civil inquiry by the Securities and Exchange Commission. The accounting debacle rattled Wall Street and the multitrillion-dollar home mortgage market.

Some experts, including Fannie Mae Chairman Franklin Raines, have blamed some of the recent rise in mortgage interest rates on market uncertainty stemming from Freddie Mac's accounting turmoil and concern over what the government might do in response. But economists have cited several other factors, including signs that the economy is gaining traction and concern about swelling federal budget deficits.

Asked Friday why the company didn't disclose the $989 million overstatement earlier, when it went public with estimates of its underreported earnings, Freddie Mac executive Martin Baumann said, "There were many accounting corrections the company had to make."

Baumann, the executive vice president for finance and chief financial officer, told reporters in a conference call that company auditors at PricewaterhouseCoopers had just completed on Thursday the massive financial reckoning - a $100 million project announced in January.

The accounting change is expected to reduce Freddie Mac's income by an equivalent amount during the next few years and make earnings more volatile. The company warned Friday of further volatility ahead and said its restated results show "significantly greater" turbulence than it previously reported.

It said the error in its 2001 earnings - restated to $3.16 billion from $4.15 billion - stemmed from failure to properly account for losses from derivatives, the financial instruments that Freddie Mac and Fannie Mae use to hedge against swings in interest rates.

The head of the federal agency that oversees the two mortgage finance giants, which also is investigating Freddie Mac's finances, noted that the company still had not completed its accounting for this year.

"The necessity of this restatement, and the magnitude of the accounting improprieties and management misconduct reinforce the need for (government) remediation and enforcement actions," Armando Falcon, director of the Office of Federal Housing Enterprise Oversight, said in a statement.

The agency last month levied a $125,000 civil fine, the first monetary sanction in its 10-year history, on ousted Freddie Mac president David Glenn. Glenn is providing information in the agency's investigation.

The company said Friday that its financial condition is sound and its ability to manage risk uncompromised.

"The restatement is a significant step in Freddie Mac's progress toward achieving accurate and timely financial reporting and controls," said Shaun O'Malley, the company's chairman. "Freddie Mac completed this restatement while maintaining our business momentum and delivering on our congressional mandate to lower mortgage costs for America's homeowners."

Freddie Mac and Fannie Mae were created by Congress to pump money into the home mortgage market, by buying home loans from banks and other lenders and bundling them into securities for sale on Wall Street. They have grown explosively in recent years.

The Bush administration earlier this year asked Congress for tighter federal supervision over the two companies.