Freddie CEO Feels Strain Of Firm's Twin Missions

By Jeffrey H. Birnbaum and David S. Hilzenrath
Washington Post Staff Writers
Wednesday, August 6, 2008

Freddie Mac chief executive Richard F. Syron, who has presided over an implosion of investor confidence in his company, said yesterday that conflicting demands on the government-chartered mortgage giant have made his job "almost impossible."

On the eve of Freddie Mac's quarterly earnings report, Syron said that the McLean company has been whipsawed by the dual tasks of creating profit for private investors and serving the public by boosting the housing market.

"What this organization is all about is balancing among the different missions," Syron said in an interview. "It makes the job almost impossible."

Syron offered a spirited defense of his investment decisions at Freddie Mac, a company he's headed since 2003. He said he agreed to increase the purchasing of risky mortgages earlier this decade to fulfill his company's mandate to improve the housing market. But he did so, he said, in a way that also addressed his shareholders' desire to continue to make money.

"We thought that was the right judgment to make, given the information we had at that point in time," he said. Criticism of his choices "is just a little irritating," he added. "This is what we were required to do."

He also said he exercised restraint in buying relatively few subprime mortgages, the type of investment that helped lead to the crisis facing the financial markets. "We decided to give up market share rather than to chase it," he said.

Freddie Mac executives have said the company made a conscious decision to loosen lending standards during the housing boom to hold on to market share. Anthony S. "Buddy" Piszel, the chief financial officer, said in a December interview that the company's view was: "When the entire marketplace is seeing things one way, we can't unilaterally say we're going to see things another way."

Company spokeswoman Sharon McHale said yesterday that while the company moved in the direction of the market, it didn't go as far as others.

At the end of 2006, before the housing bubble burst, Freddie Mac held $122.2 billion of securities backed by subprime mortgages and $56.2 billion of securities backed by so-called Alt-A loans, which typically were issued on the basis of relaxed underwriting standards. As recently as last year, a major portion of the loans Freddie Mac bought, $97.8 billion, had another risky characteristic: they were interest-only, meaning monthly minimum payments didn't reduce the principal owed.

Several Wall Street analysts expect both Freddie Mac and its sister mortgage finance giant, Fannie Mae, to report losses for the second quarter when the companies release their earnings this week. Credit Suisse analyst Moshe Orenbuch wrote that he expects Freddie Mac to post a net loss of about 60 cents a share when it reports today and that he expects Fannie Mae to disclose a loss of about 75 cents a share when it reports Friday.

Syron said the companies' fortunes are tied to the housing market, which has been in steep decline. The companies have only one line of business -- housing finance -- and are operating during what Syron called "the worst housing downtown in about 80 years."

Yesterday, the Treasury Department awarded a contract worth up to $95,000 to the investment firm Morgan Stanley to help assess the risks facing Fannie Mae and Freddie Mac. "It's a broad mandate, and we start immediately," said Jeanmarie McFadden, a spokeswoman for Morgan Stanley.

The New York Times reported yesterday that Syron ignored warnings in 2004 from his chief risk officer that the company was taking on too-risky loans. Syron told The Post that he remembered being warned about the loans but added, "Every credit officer I know of, their job is always to raise the issue of credit [risk]."

Sharp declines in the share prices of Fannie Mae and Freddie Mac last month prompted Congress and the Bush administration to make explicit what the financial markets have long assumed: That the government is prepared to prop up the companies if either falters. Legislation recently signed by President Bush allows the Treasury to extend unlimited amounts of money to the companies through loans or investments.

This week's earnings reports could shed light on the odds that the government will have cause to put taxpayer money on the line.

In some respects, Freddie Mac is in weaker condition and has performed significantly worse under Syron than Fannie Mae has fared under chief executive Daniel H. Mudd.

Investors are closely watching the "fair value" of the companies, which shows how much their holdings would be worth if sold at current values. By that measure, Freddie Mac is in a deeper hole.

If Freddie Mac had liquidated its assets and liabilities on March 31, it would have been left with a deficit of $5.2 billion, which represented a $31.7 billion plunge in value from a year earlier. In comparison, Fannie Mae's fair value at the end of March was $12.2 billion.

But those numbers depend heavily on subjective judgment about the value of the companies' holdings -- something that investors have become less willing to accept.

As of March 31, $144.2 billion of Freddie Mac's mortgage-related investments were valued based on what the company called "unobservable inputs" -- meaning there were no clear price quotes from the financial markets to use as a measure. The company shifted $153.8 billion of mortgage-related investments into that category this year as market demand for certain mortgage-backed securities dried up and "inputs that were significant to their valuation became limited or unavailable," Freddie Mac said in a filing with the Securities and Exchange Commission.

A related measure that Wall Street will be tracking in today's report from Freddie Mac involves so-called unrealized losses -- declines in the value of mortgage-related investments that Freddie Mac has not yet counted as actual losses because it says it will hold on to them until they recover their value. As of March 31, Freddie Mac had $32.4 billion of unrealized losses, and 40.7 percent of those investments had been impaired for at least a year. Fannie Mae's unrealized losses as of March 31 totaled $9.3 billion.

Analyst Paul J. Miller of the Arlington investment firm Friedman, Billings, Ramsey said that other investors have reported losses on similar securities. Freddie Mac and Fannie Mae should, too, he said.

Investors are also eager to hear what Syron says today when Freddie Mac hosts its first quarterly conference call for analysts and shareholders since the government adopted the rescue plan.

Like Fannie Mae's Mudd, Syron was brought in to put his company's house in order in the aftermath of an accounting scandal, but Syron took longer to finish the job. He stepped in at the end of 2003, and Freddie Mac did not complete the overhaul of its internal controls and financial reporting systems until this year. A federal regulator, the Office of Federal Housing Enterprise Oversight, said last year that Freddie Mac's efforts had suffered from "ineffective planning and inconsistent execution."

Freddie Mac has yet to fulfill a commitment it made in 2003 to separate the jobs of chairman and chief executive, both of which Syron holds, and OFHEO has said it will not relax a potentially costly regulatory constraint on the company until it does.

Government officials, analysts and others fault both companies for not raising more capital sooner, which would have strengthened their financial base and positioned them to provide more support to the troubled housing market. But Freddie Mac has been a source of greater frustration. In November, its capital briefly fell below the level required by the government.

Freddie Mac, which last month completed its delayed registration with the Securities and Exchange Commission, would soon fulfill a long-standing promise to the government to raise more capital. But a depressed stock price could make it much more expensive for Freddie Mac to do so.

Compounding Freddie Mac's woes, it has spent $1 billion buying back its own shares since March 2007 at an average cost of $62.04 per share only to see the stock price tumble. The stock closed yesterday at $8.04.

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