Freddie Mac scandal

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It is a sad statement on the intertwining of business and government when one of the largest Government Sponsored Enterprises (GSE) - Freddie Mac - is on the front pages as understating their earnings by $5 billion (Glater, NY Times, 11/22/03). Apparently, " Former executives apparently manipulated Freddie Mac's earnings in an effort to meet investors' expectations." Interestingly, Glater offers to explain away all of the corporate accounting scandals by stating:

The details of the accounting at Freddie Mac offer a glimpse into the difficult issues facing executives confronted with complex reporting requirements and pressed to meet goals of smooth earnings growth. The restated financial statements show that the company did not simply understate net income consistently; it fluctuated sharply from quarter to quarter.

Some may be wondering just what the heck GSEs are. According to Investopedia.com (a sub-site of the Wall Street Journal) GSEs are:

Privately held corporations with public purposes created by the U.S. Congress to reduce the cost of capital for certain borrowing sectors of the economy. Members of these sectors include students, farmers, and homeowners.

GSEs carry the implicit backing of the U.S. Government, but they are not direct obligations of the U.S. Government. For this reason, these securities will offer a yield premium over Treasuries. Some consider GSEs to be stealth recipients of corporate welfare.

Examples of GSEs include: Federal Home Loan Bank, Federal Home Loan Mortgage Corporation (Freddie Mac), Federal Farm Credit Bank, Resolution Funding Corporation, and The Student Loan Marketing Association.

The overstatement by Freddie Mac of its earnings is significant because GSEs are assumed to be "the most creditworthy fixed income investments available today. GSEs traditionally offer a yield advantage over Treasuries and CDs, while the association with the U.S. government makes them attractive to investors who value quality." (a href="http://personal.fidelity.com/products/fixedincome/poagency.shtml" target="_blank">Agency/Government Sponsored Enterprises from personal.fidelity.com. They go on to state:

The implied guarantee
• Government Sponsored Enterprises carry an implicit guarantee. This means that the federal government acknowledges an interest in the issuing organization and thus implies an interest in the securities it issues. This differs from the explicit guarantee for U.S. Treasury securities, which states that the securities are backed by the full faith and credit of the U.S. government. While an implied guarantee is not considered as safe as an explicit guarantee, the government historically has taken action if the financial status of a GSE appears threatened.
• The government also grants special privileges to GSEs, designed to help ensure the organizations' financial strength. This includes access to large credit lines from the Treasury, typically between $1.0 billion and $4.0 billion, and important exemptions from tax and securities laws.
• The government has the power to regulate GSEs in various ways, including, in some cases, the power to appoint directors to an organization's board.

Cautious investors look at GSEs as not only safe because such business are overseen by the Frderal GOvernment, but because they are backed by the federal government. To have a GSE involved in the same type of activity as Enron, Global Crossing, and Merill Lynch (to name a few) is beyond startling. Is this symptomatic of the revolving door between government and industry where industry agents are placed in regulatory and leadership positions within government, and when they leave government return to the same industries they regulated? Most likely. Is this symptomatic of big money influence on government legislation and funding? Almost assuredly. Fannie and Freddie are the spawn of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the GSE Act). According to the HUD website

The legislation divided the Federal government's regulatory responsibilities over Fannie Mae and Freddie Mac between the Secretary of HUD and the Director of OFHEO. Under the GSE Act, the Secretary of HUD is charged with general regulatory authority over Fannie Mae and Freddie Mac in all areas other than the GSEs' financial safety and soundness which is the responsibility of the Director of OFHEO.

Specifically, the Secretary's authority includes setting and enforcing three affordable housing goals, monitoring compliance with fair lending principles, collecting loan-level data from the GSEs on their loan purchase activities, creating and distributing a public use data base of non-proprietary GSE purchase data, and providing oversight for new program approval.

The overstatement by Freddie Mac is BIG news as well because Fannie and Freddie have provided the back bone of much of the housing financing over the past decade.

Welcome to privtization (corporatization) of the government.

Posted by rowan at November 22, 2003 08:43 AM | TrackBack | Printable Version | [eMail this article!] |