Freddie Mac: Past Profits Up, But ...

Beleaguered mortgage-market giant Freddie Mac said Wednesday it expects to restate earnings for the past three years higher by $1.5 billion to $4.5 billion, a shift that will likely crimp future profits.

The government-sponsored company, which ousted three top executives earlier this month and is under investigation by federal prosecutors and securities regulators over its accounting, acknowledged that the correction is expected to reduce its income by an equivalent amount during the next few years and make its financial results more turbulent.

The "cumulative increases related to these adjustments will have offsetting effects in future periods," the company said in a news release. "These accounting policy changes will cause greater volatility in Freddie Mac's financial statements for prior periods. Freddie Mac believes there also will be significant volatility in its results in future periods."

The company said the errors were mainly due to its accounting for gains from derivatives, complex financial instruments it uses to hedge against swings in interest rates and from mortgage securities.

Billionaire investor Warren Buffett recently called derivatives "financial weapons of mass destruction," saying they posed a threat to the nation's financial system. Derivatives played a role in the stunning collapse of Enron in late 2001.

Congress created Freddie Mac and Fannie Mae to buy home loans from banks and other lenders to supply ready cash to the home mortgage market. The companies buy mortgages from lenders to keep in their portfolios and package others into securities for sale on Wall Street.

The two are major forces on the housing market — one of the few bright spots in the slowed economy. As of the end of 2002, Freddie Mac has $583 billion in mortgages in its portfolio and had $742 billion in mortgage-backed securities. Fannie Mae reported $1.029 trillion in securities outstanding and $797 billion in its portfolio.

The disclosure came as House lawmakers proposed a measure prescribing tighter regulation and a change in the supervisory system for the two big companies, which are congressionally chartered yet also publicly traded.

"The information we are disclosing today reflects poorly on Freddie Mac's past accounting, control and disclosure practices," said Gregory Parseghian, the company's new chief executive officer and president. "Management is aggressively addressing these issues. At the same time, we remain focused on our business and mission."

Freddie Mac said it has strengthened its accounting processes and added new staff to address the problems.

Officials expect to complete the audit next month and said the actual restatement could differ from the range given Wednesday.

McLean, Va.-based Freddie Mac, one of the biggest U.S. corporations with nearly $40 billion in revenue, stunned markets when it announced that it had fired its president, David Glenn, for what it called his failure to fully cooperate in an internal accounting review. The company's chairman and chief executive, Leland Brendsel, resigned along with the chief financial officer, Vaughn Clarke.

Brendsel left with a $24 million compensation package. Glenn forfeited his departure salary and bonus, and some $11 million in company stock options to which he had not yet taken title, but keeps options worth $5.3 million. The federal agency that supervises Freddie Mac and Fannie Mae is reviewing the compensation deals.

Freddie Mac fired Arthur Andersen LLP as its auditing firm in March 2002, replacing it with PricewaterhouseCoopers — which is conducting the ongoing accounting review.

Under the new legislative proposal, a Treasury Department agency would be empowered to define and limit the scope of Freddie Mac and Fannie Mae's activities, restrict growth of their assets, and even put them into receivership and possible liquidation if it should determine that their capital was seriously inadequate.

It also would be able to remove officers, directors and others from the companies and impose civil fines of up to $2 million a day on the companies or their executives for violations of law or regulations.