Freddie Mac, the US’s second largest mortgage finance lender, is delaying its earnings restatement until this month, having previously said it would restate its earnings for 2000-2002 by the end of the third quarter.

The postponement is one of the latest events in an accounting scandal

that centres on the way former Freddie executives “managed” gains on

many derivatives trades, with “steady earnings growth” in mind,

deferring profits to future years, according to a recently released

independent report on the company’s financial statements.

The crisis, which has led to an investigation into Freddie’s accounting

by the US Justice Department and the Securities and Exchange

Commission, has also forced changes in the company’s management. Three senior executives, including chairman and

chief executive Leland Brendsel who was one of the longest serving

corporate heads in the US, were replaced in June. In August, Gregory Parseghian, who had been named to succeed as chief

executive, was also replaced when Freddie’s regulator, the Office of

Federal Housing Enterprises Oversight, became uncomfortable with his

involvement in some of the company’s accounting practices.

Freddie’s executives estimate that the accounting errors were between

$4.5bn and $4.7bn, which is at the high end of the range by which the

company had expected to restate.

The delay in restating has coincided with hearings in Congress that

have put a spotlight on the special status and the regulation of

housing government sponsored enterprises (GSEs), of which the most

important are Freddie and its larger sister mortgage finance provider,

Fannie Mae.

A chief concern, voiced by congressmen as well as US Federal Reserve

officials, is that Freddie and Fannie – which the government

established to finance the mortgage market, promote home ownership and

affordable housing, largely by buying mortgages from banks and using

them to back bonds – have grown too fast and become over-leveraged.

According to Richard Baker, a Republican member of Congress who heads

the House Finance Services sub-committee that oversees Freddie and

Fannie, at the end of 2002 the combined outstanding debt of the two was

$1499bn. Their combined assets at the same date were estimated at

$1600bn, which was about 44% more than those at Citigroup, the biggest

US bank.

Mr Baker told Congress that the two GSEs could become so highly

leveraged because they operated with an implied government guarantee.

This made it cheaper for them to sell their debt securities than for

other mortgage lenders (thereby lowering their borrowing costs) and

easier for them to invest in or guarantee home mortgages.

However, senior Fed officials have warned that the implied government

guarantee, which amounts to markets’ belief that the government, or the

US taxpayer, will rescue Freddie and Fannie in a crisis, could be a

disaster waiting to happen if it proved to be less than rock solid.

This is because mortgages owned or guaranteed by the two companies

comprise 45% of the country’s total residential mortgage market.

As Freddie’s and Fannie’s mortgage portfolios have increased to

$1300bn in the past decade, the budget of their regulator, which is

widely seen to be too lenient and under-equipped, rose to only $32m.

Little wonder that US Treasury Secretary John Snow told the Senate

Banking Committee on October 16 that a consensus was growing for

“strong, world-class” supervision of Freddie and Fannie, as well as for

the 12 federal home loan banks that are also GSEs. And he has proposed

the Treasury Department for the task.

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