Freddie Mac's Duel With Regulator: Does It Report Government's Role in Its Losses?

By Zachary A. Goldfarb
Washington Post Staff Writer
Friday, March 27, 2009

Half a year after the government seized Freddie Mac, confusion about its role is stoking tensions between the company and its regulator, including a dispute this month over how much the mortgage giant should reveal to private investors about its financial troubles.

Federal officials who took over Freddie Mac stopped short of nationalizing the company, leaving it partly in private hands. This means Freddie still has to answer to investors and file financial disclosures.

But when Freddie Mac's executives concluded a few weeks ago that they had to disclose that the government's management of the McLean company was undermining its profitability and would cost it tens of billions of dollars, the firm's regulator urged it not to do so, according to several sources familiar with the matter.

Freddie Mac executives refused to bend. The clash grew so severe that they threatened to go to the Securities and Exchange Commission, which oversees corporate disclosures, to secure a ruling that the regulator's request was out of line. The company's regulator backed down, the sources said.

When the government seized Freddie Mac and its larger sister, District-based Fannie Mae in September, it was responding to a financial meltdown that arose in part because of their unusual, hybrid nature: private companies set up by Congress to promote the public good by supporting homeownership. That extraordinary takeover has only fueled disagreement between federal officials and company executives over the firms' status.

On the one hand, the Federal Housing Finance Agency, led by Bush administration appointee James B. Lockhart III, has full authority to direct the companies' affairs. They have been called on by the Obama administration to carry out its public policy objective of reviving the housing market by restructuring mortgages, cutting prices on home loans and taking steps to avoid foreclosure.

But the government doesn't want to nationalize the companies, which would end their pursuit of profits and the requirement that they make regulatory disclosures for the benefit of private investors.

This ambiguity over Freddie's status has at times also made it difficult for the company to reduce mortgage interest rates and to hire and hold on to top executives. The requirement that Freddie pay dividends to the government also increases its debt load, reducing the chances it can ever reemerge as a profitable company.

Now these unresolved questions about Freddie Mac's status are driving the dispute about what it should disclose as a publicly traded company listed on the New York Stock Exchange.

As Freddie Mac executives were preparing their annual 10-K financial disclosure this month, they reported that carrying out the Obama administration's housing plan would cost $30 billion this year. That sum would have to be covered by the Treasury Department. The federal government has pledged to cover $200 billion each in losses for Freddie Mac and Fannie Mae, of which the pair have asked for about $60 billion.

The housing agency asked that the cost of the program be withheld and that the firm soften language describing how government management was undercutting profitability, according to sources.

People familiar with the dispute offered different views about why the regulator sought to prevent the disclosures. One source said the regulatory officials didn't want to make it seem like government actions were causing big losses at the company and would require more taxpayer dollars. Another person said the officials thought that accounting rules would soon change, making the disclosure unnecessary.

Freddie Mac executives told the regulator that they had to disclose the information under federal securities law. The executives said they were prepared to seek confirmation from the SEC for their position if the regulator continued to insist that the information be withheld. But they also agreed to negotiate with the regulator over precise wording.

When the filing was made March 11, it included the following language: "We have made changes to certain business practices that are designed to provide support for the mortgage market in a manner that serves public policy and other non-financial objectives but that may not contribute to profitability," Freddie Mac's regulatory disclosure said. "Some of these changes have increased our expenses or caused us to forgo revenue opportunities."

The main way that the government is c ausing Freddie to incur losses is by requiring it to play a central role in the Obama administration's Homeowner Affordable and Stability Plan, a $75 billion effort launched this month. The program aims to restructure mortgages that struggling borrowers cannot afford, bolster the sagging housing market and bring down interest rates on home loans.

The Obama plan will require Freddie Mac to modify mortgages, which entails reassessing the value of loans and marking them down to current market price. The company must then record a charge to reflect these decreased values. Based on Dec. 31 figures, Freddie Mac said it would incur "an initial pre-tax charge" of $30 billion. That number could grow as the economy declines and would have to be offset by infusions of government capital.

"These initiatives are likely to have a significant adverse effect on our financial results or condition," Freddie Mac warned in its regulatory disclosure.

Freddie Mac spokeswoman Sharon McHale declined to comment on any discussion about the disclosures but said the company and its regulator "share a mutual commitment to ensuring the company is well-positioned to achieve our housing mission, which is critical to the nation's housing market."

FHFA spokeswoman Stefanie Mullin declined to comment.

Several experts in securities law said that publicly traded companies are required to disclose changes that could affect financial performance.

"As a general matter, the federal securities laws require a company to disclose uncertainties that are likely to have a significant impact on an investor's perception of the company. This includes accounting issues," said Brian Lane, a partner at Gibson, Dunn & Crutcher and a former director of the SEC's corporate finance division.

Because of timing, Fannie Mae did not face the same issue over disclosure. Fannie Mae filed its annual report in February, before the details of the administration's housing plan were announced, so the firm did not need to factor in the costs of carrying out the program, according to a person familiar with the matter.

The disclosure dispute is not the only way that Freddie and Fannie's unresolved status has caused problems.

After the companies were taken over, investors around the world who buy the companies' debt and mortgage investments weren't willing to pay top dollar, reflecting doubts about whether the U.S. government would stand behind the firms if they faltered further. As a result, mortgage rates initially rose, further depressing house prices, contrary to what the government intended when it took over the firms.

Then, earlier this month Freddie Mac lost its chief executive, longtime banker David Moffett, who joined the company at the government's behest in September. He clashed with government regulators who pushed him to take steps that would forgo revenue opportunities. Freddie Mac is now looking for a new chief executive, chief operating officer and chief financial officer -- and having trouble finding them.

Inside Freddie Mac, executives are struggling to determine whether their highest priority should be to fulfill the mandates of the Obama administration or find a way back to profitability.

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