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Risk-control systems were introduced only in , after years of delay and after Fannie and Freddie had lobbied effectively to gut tough proposals.

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The pair are subject to far weaker disclosure standards than other banks in similar lines of business. Why have the mortgage companies had such an easy regulatory ride? One reason is that their sheer importance in the debt markets has made even big Wall Street firms, whose regulators are somewhat more demanding than the OFHEO , wary of crossing them. Another is that Fannie Mae and Freddie Mac have given investment banks every reason not to complain. No other company comes close. Fannie Mae and Freddie Mac are also huge buyers of securities and derivatives, meaning still more commissions.

Nor have congressmen had much cause to grumble. Fannie Mae in particular is reputed to be brilliant at defusing political risk. Both companies have large charitable foundations. Much of the money went to groups dear to congressmen's hearts. America's long litany of corporate scandals has changed all this. More companies are coming under scrutiny, especially if they have large debts, are exposed to the capital markets and have perplexing accounts—like Freddie Mac and Fannie Mae.

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Unease has been growing since last year, when the sharp drop in interest rates, and the consequent rush to refinance mortgages taken out at higher rates, left Fannie Mae with a mismatch between its debt obligations and its revenues from mortgage bonds. The worrying intensified when the three Freddie Mac executives departed earlier this month in connection with an internal audit that is still going on.


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In the past week or so, Grant's Interest Rate Observer , a newsletter, has argued convincingly that figures in Fannie Mae's own accounts brought its reported earnings into question. Mr Baker's colleagues in Congress have begun asking him what could be done. Theoretically, the two companies should not be a source of concern. Their core business consists of buying mortgages from banks and pooling them into bonds to be sold or held.

Freddie Mac

Both companies guarantee the creditworthiness of these bonds, but not the interest-rate risk. They hedge their own exposure to interest-rate risk through derivative contracts. Both firms are helped by their ability to finance their acquisition of mortgages by issuing debt that financial markets believe to be backed by the federal government. As a result, they can raise money more cheaply than genuinely private financial institutions.

The costs and benefits of this implied guarantee are much debated. Alan Greenspan, chairman of the Federal Reserve, believes that it distorts investment and removes the market's ability to control the mortgage companies.

The Scandal in Home Mortgage Financing | Corporate Research Project

Peter Wallison of the American Enterprise Institute, a think-tank, believes that the companies' privileges could also skew mortgage costs in different regions across America. But a growing number of critics say this is more than a typical corporate scandal: It is a government-policy scandal for which taxpayers could be left holding the bag.

And many are wondering if the controversy over accounting issues at Freddie Mac will spill over to its big sister, Fannie Mae. Fannie Mae and Freddie Mac are "government-sponsored enterprises" GSEs created by Congress with special advantages that include exemptions from certain laws and taxes. Even though no evidence yet has surfaced of similar alleged malfeasance by executives at Fannie Mae which carries almost twice the debt of Freddie Mac critics worry openly about it. Watts R-Okla. Watts tells Insight, "It makes no difference whether [Freddie Mac's] announcement is the complete story or the tip of the iceberg, taxpayers and policymakers need to know more than Freddie and Fannie have had to reveal, and the existing regulatory framework for the GSEs is deeply flawed.

I think this has to be changed to protect taxpayers, investors and the marketplace from more surprises.


  1. Site Information Navigation.
  2. Freddie Mac Discloses Possible Earnings Errors - WSJ.
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  4. Freddie Mac Admits It Understated Earnings by $5 Billion.
  5. Peter Wallison, Treasury Department general counsel in the Reagan administration who now is a resident fellow at the American Enterprise Institute, tells Insight, "Right now, I don't think the risk is very high" for the companies to fail. The majority of home loans in the US are at fixed interest rates over a year period.

    But interest rates fluctuate, changing the value of the home mortgage portfolios held by Freddie Mac and Fannie May.

    Therefore in order to reduce risk and smooth out fluctuations caused by interest rate movements, both organisations use derivatives, mainly financial arrangements based on interest rate swaps. It is in the accounting for these derivatives that the problems have arisen at Freddie Mac. According to a report published by the Dow Jones Newswire, Arthur Andersen had a different interpretation of the income from derivatives than that held by PwC.

    Freddie Mac Scandal

    Some derivatives previously classified as hedges will be classified as assets. The change affects the profit figure because the income from a hedge is recognised as part of company income gradually, over its full life, whereas if it is classified as an asset the income or loss has to be recognised in the same period that the asset was purchased.

    Under the changes sought by PwC, Freddie Mac would increase its earnings for the years , and , but would suffer lower earnings in the future as a result.

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    The company has issued reassuring statements that it will not be seriously impacted by the turmoil. The obvious question which arises is that if all that is involved are technical differences in the treatment of derivatives then why have three top officials gone? And why did the company president find it necessary to alter his notebook?