Realty Times January 6, 2004

Should Freddie Mac Still Get Federal Backing?
by Peter G. Miller

The New Year opens with a growing debate in Washington, the question of how best to deal with Freddie Mac and its muddled finances.

Freddie Mac and Fannie Mae do not make loans directly to consumers. Instead, they buy mortgages that meet their standards from local and national lenders. The money they use to buy such loans comes from investors and portfolio earnings.

The two firms own perhaps 40 to 45 percent of all home mortgages. They, along with other mortgage buyers, form the "secondary" marketplace for loans.

The secondary market has two major attractions. First, the secondary market loans are available nationwide on a uniform basis. There is never a shortage of mortgage funds in one state or region because money moves easily nationwide. Second, mortgage lenders can sell their loans in the secondary market and thus get fresh capital -- capital they can use to make more mortgages.

GSEs

Fannie Mae and Freddie Mac started as government entities but are now "GSEs," or government sponsored enterprises. This means they have both private shareholders and the advantage of special rules unavailable to private competitors.

Under its federal charter, Freddie Mac has a line of credit with Treasury, special exemptions from certain Securities and Exchange Commission filing requirements, and is exempt from payment of state taxes, according to Rep. James A. Leach (R-Iowa), Chairman Emeritus of the House Committee on Financial Services. Leach says these attributes give the appearance to the markets that Freddie Mac has government agency status.

How much credit do they have?

"One of the major government privileges granted to GSEs is a line of credit with the United States Treasury," says Representative Ron Paul (R-TX). "According to some estimates, the line of credit may be worth over $2 billion dollars. This explicit promise by the Treasury to bail out GSEs in times of economic difficulty helps the GSEs attract investors who are willing to settle for lower yields than they would demand in the absence of the subsidy."

The two secondary lenders are now regulated by the Office of Federal Housing Enterprise Oversight, an agency which has more than lived up to its name: The "oversight" in this case involves some $5 billion in profits Freddie Mac didn't originally report and OFHEO didn't notice.

But now Freddie Mac has new leaders and promises of change have been made.

  • "The new management team of Freddie Mac, working closely with our Board of Directors, is determined to set high standards for candor and transparency in our financial reporting. Our investors and the public should expect and demand nothing less," said Gregory J. Parseghian, chief executive officer and president, in a June 25th statement.

  • "The information we are disclosing today," he continued, "reflects poorly on Freddie Mac's past accounting, control and disclosure practices. Management is aggressively addressing these issues. At the same time, we remain focused on our business and mission. Based on our current understanding, we expect the cumulative effect of the restatement to increase retained earnings as of December 31, 2002, by a range of $1.5 billion to $4.5 billion."

    By The Numbers

    In November Freddie Mac said in a restatement it had unreported profits of $4.4 billion in 2000, 2001, and 2002 plus $600 million prior to 2000. That's a "net cumulative increase" of $5 billion, an expression which does not mean profits were generated in each and every accounting period.

    In the first quarter of 2001 Freddie Mac originally reported a net income of $837 million -- a huge amount. But in its November restatement Freddie Mac says it actually lost $111 million during the quarter -- a swing of $948 million ($111 million + $837 million).

    Freddie Mac says it will not have quarterly or annual results for 2003 until sometime later this year: "The company's objective is to release quarterly and full-year 2003 results by June 30, 2004 and to provide its 2003 annual report and hold its related stockholders' meeting as soon as practicable thereafter."

    Not everyone has been satisfied with the Freddie Mac November restatement. J.C. Watts, a former congressman (R-OK) and now chairman of FM Policy Focus, a group which "monitors" Fannie Mae and Freddie Mac, says "Freddie Mac's long-awaited restatement does little to reassure taxpayers, homeowners or Wall Street that all is well. In fact, it raises more questions than it answers."

    Time For Change

    Having a line of credit with the U.S. Treasury implies to many investors that taxpayers will step in if there's trouble with a GSE. That perception is a huge benefit when it comes time to borrow money or price stock.

    But should the government provide such support when the finances associated with Freddie Mac are so unclear?

    It's time to close the door to possible Treasury borrowing by Freddie Mac, at least until all financial records are current and verified. No lender would give you credit without up-to-date records, so why should Freddie Mac get such a pass from U.S. taxpayers?

    At this point there will be screams that without a federal line of credit the ability of Freddie Mac to do business will be impeded and mortgage rates will surely rise. Nonsense. Private companies compete daily in the secondary market with Freddie Mac -- and they do so without special privileges from Uncle Sam.

    For more articles by Peter G. Miller, please press here.


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