Finding Answers to Explain
Issues Freddie Mac Faces
By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL
For three decades, Freddie Mac has been a pillar holding up the nation's key housing market, along with its larger sibling, Fannie Mae. The company, created by the government but now owned by shareholders, buys home mortgages from banks and mortgage lenders, enabling the institutions to make more loans to consumers. Freddie Mac keeps the mortgages itself or packages them together as collateral for bonds sold to investors.
Seen as a beacon of stability on Wall Street, Freddie Mac has found investors eager to buy its shares and bonds, allowing the company to grow. In turn, the company's mortgage buying, and efforts to standardize the lending process, have kept mortgage costs down for homeowners. It has all helped make the U.S. mortgage market the envy of the world, where it is easier and cheaper for consumers to obtain mortgages than in most other nations.
But on the heels of this week's departure of the company's three top executives, amid allegations of document tampering by the company's president and chief financial officer, David Glenn, the Freddie Mac house is showing signs of some cracks. The company's accounting is being challenged by securities regulators, and the Justice Department and the Securities and Exchange Commission have launched investigations into the matter. Freddie Mac's stock has held steady after an initial 16% decline on Monday, but it fell 3% more Wednesday amid worries by some investors that there might be more problems lurking. Any substantive troubles at Freddie Mac could undermine the strength of the $6.6 trillion U.S. mortgage market, which has held up an otherwise shaky economy for the past three years.
Here are some key questions and answers about the evolving Freddie Mac predicament and its impact:
Q: What happened at Freddie ?
A: In January, after a new accounting firm began examining the company's books, Freddie Mac disclosed that it would have to restate earnings for the past three years. The reason: Complex financial instruments, used to protect the company's vast portfolio of mortgages, weren't properly valued. The company's government regulator, the Office of Federal Housing Enterprise Oversight, or OFHEO, also looked at Freddie . Investors were assuaged when the company said earnings likely will be revised higher. But on Monday the executives were eased out amid disclosures by the company that Mr. Glenn wasn't fully cooperating with investigators by altering diaries he had compiled during recent meetings.
Q: Why should I care?
A: Freddie Mac is the second-largest owner of mortgages in the country. Along with Fannie Mae, the companies own or guarantee nearly half of all home mortgages, and about 75% of those less than $322,700. If these companies stumble, the housing market, which represents about 11% of the nation's gross domestic product, could have problems if lenders become more wary of making mortgage loans.
Q: What are these quasigovernment agencies with the odd names?
A: Freddie Mac was established by the government in 1971 as the Federal Home Loan Mortgage Corp. to buy "conventional" mortgages, today defined as those valued at less than $322,700, to bolster the mortgage market. Fannie Mae does the same thing but is larger. Freddie went public a decade ago, though Fannie became a public company in 1968. Other cousins include Ginnie Mae, an agency of the Department of Housing and Urban Development, which guarantees mortgages for other lenders; Sallie Mae, a privatized company that buys student loans; and Farmer Mac, which guarantees pools of agricultural loans. Home Loan Banks, regional banks around the country, lend money to thrifts also to help the housing market.
Q: What is a government-sponsored entity?
A: Like Fannie Mae, Freddie Mac operates under a government charter, meaning it is a quasigovernment entity, or government sponsored. They are exempt from some taxes and don't have the stringent reporting requirements of other private companies. And they have a line of credit with the Treasury Department if they ever need it. They also have to answer to a government regulator, OFHEO. But their assets aren't guaranteed by the government, and they otherwise operate like any other publicly traded company.
Q: How does Freddie make money?
A: Freddie usually sells bonds at low rates because many investors see them as a safe institution and presume that they would be bailed out by the government if big trouble ever hit. Freddie takes that money and buys home mortgages that it puts into its investment portfolio. It makes money on the "spread," or the often-substantial difference between the rates on the bonds it sells and the higher interest rates it receives on the bonds it buys. Freddie Mac also packages mortgages that it has purchased, placing a guarantee on them that homeowners will make their interest payments, and selling them to investors in the booming mortgage-backed securities market.
Q: What has been the impact of Freddie's problems?
A: Freddie's shares, traded on the New York Stock Exchange, are down about 17% since the upheaval began. More important, the company is now forced to pay about 0.12 of a percentage point more to borrow money compared with other bonds. That's not much to most investors, but to a company like Freddie , which just this year has sold more than $34 billion of bonds, according to Thomson Financial, it can add up.
Q: What does it all mean for my mortgage?
A: For now, not much. Freddie and Fannie continue to operate normally, buying up mortgages and keeping the market running. There has been little indication that lenders or investors are refraining from working with the company.
Q: So how nervous should I be?
A: The problem so far seems to be an issue of how Freddie Mac accounted for its earnings. Unlike companies such as Enron Corp. or WorldCom Inc., Freddie doesn't appear to have inflated its earnings; if anything, they held them down. The question is whether this was designed to make earnings higher down the road. "We are acknowledging that in some instances we weren't in compliance" with generally accepted accounting principles, said a Freddie Mac spokesman. "Going forward we intend to fix it and get it right." If the problems ultimately are found to have stemmed from inappropriate accounting, the company likely will continue keep providing the lubrication to keep the mortgage market running smoothly. But if it turns out the company isn't as profitable or safe as it has portrayed itself, investors will be less likely to buy Freddie Mac's debt, hurting the company's ability to buy more mortgages. That could make it harder for lenders to find a good price when they want to sell their mortgage loans, putting upward pressure on rates and perhaps sparking doubts in the white-hot housing market. |
