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Freddie Pressured Over Accounting Disclosure
Regulator Worried Information Could Raise Bailout's Cost

By Zachary A. Goldfarb
Washington Post Staff Writer
Wednesday, May 6, 2009

When Freddie Mac privately suggested to regulators last month how it planned to account for its mounting losses, the mortgage giant set off a firestorm.

Freddie Mac's regulator pressed the company to withhold information related to the proposal from a federal filing, concerned that this seemingly arcane discussion of accounting practices could add billions of dollars to the government's cost of bailing out financial firms, two people familiar with the matter said.

But the company's executives refused, the sources said. They worried that removing the information from the report to the Securities and Exchange Commission could expose them to accusations they'd hid required details from regulators.

The dispute between the mortgage giant and the Federal Housing Finance Agency was the latest since the federal government took over McLean-based Freddie Mac and its larger sister, District-based Fannie Mae, in September, enlisting the companies in the campaign to revive the housing market and pledging to cover their losses. The transition has proven awkward for companies that are still, in part, privately owned by investors.

In the middle of this debate was David B. Kellermann, Freddie Mac's acting chief financial officer who died in an apparent suicide on April 22. Kellermann, who had spent years reworking Freddie Mac's accounting after a scandal earlier this decade, "felt pressured" to withhold information that he felt he had a duty to provide, said a person knowledgeable of his tenure at the company.

While several people familiar with Kellermann's final days said he took the clash with regulators personally, investigators have offered no indication that this contributed to his death. He left no note, law enforcement sources said, and no motivation has been disclosed.

Freddie Mac and Fannie Mae were seized last year after the Treasury Department determined that increasing losses at the firms posed a risk to the wider financial system. Together, the two companies have received nearly $60 billion from the government to shore up their health.

In March, Freddie Mac executives, including Kellermann, had tussled with FHFA over whether to disclose to investors that government management was undermining profitability and may cost the company about $30 billion, sources familiar with the dispute said. The regulator had urged Freddie not to do so, three sources said. The company threatened to appeal to the SEC and ultimately disclosed the possible cost. An FHFA official has said that it did not try to prevent the disclosure.

This potential expense was related to the Obama administration's housing recovery program, for which Freddie Mac playing a part in modifying the mortgages of homeowners facing foreclosure. Many of these loans had been bundled into securities. So to modify the mortgages, Freddie Mac has to pluck them out of the securities, which entails reassessing the value of the loans and marking them down to their current market price. The company might then have to record a charge to reflect these decreased values.

Based on Dec. 31 figures, Freddie Mac said it might have to incur "an initial pre-tax charge" of $30 billion. That loss would be covered by taxpayer dollars.

But whether to disclose this potential cost wasn't the company's only recent battle with its regulator.

Freddie Mac later concluded that it would not have to take the loss after all, two sources said. But the company wanted confirmation from the SEC that this accounting approach was correct.

The sources for this article spoke on condition of anonymity to protect their jobs. Spokesmen for the two mortgage finance companies and FHFA declined to comment.

Kellermann prepared a memo to the SEC known as a "pre-filing," sources recounted. In this document, Freddie Mac would discuss its interpretation of accounting regulations, explain why the firm wouldn't need to take the charge and review other possible accounting interpretations.

FHFA, which reviews the firm's contacts with the SEC, became concerned, source said. That's because one of the alternate accounting methods that Freddie Mac planned to review was the one currently used at Fannie Mae. Freddie Mac was preparing to argue it could not use this accounting method.

According to sources, officials at FHFA and Fannie Mae worried that such a claim could lead the SEC to question whether Fannie Mae was doing its accounting properly. Fannie Mae was also involved in carrying out the administration's housing efforts and, using separate reasoning, had also concluded it would not have to take a charge. If Fannie Mae after all did have to report the loss, the tab to the taxpayers would run into the billions of dollars.

FHFA asked Freddie Mac to submit a "pre-filing" to the SEC that did not discuss other alternate accounting methods, but only its own, sources said. Kellermann and Freddie Mac's accounting team refused, afraid that sending such a memo could open up the company and its employees to allegations of impropriety.

Asked to comment on whether companies are required to review alternative methods in such filings, the SEC referred a reporter to the agency Web site. It says: "Staff is able to provide the clearest guidance when companies provide a written submission outlining the factual details, accounting considerations, financial statement impact, as well as the disclosures expected to accompany the accounting." Among those details is an "outline of the possible alternative answers considered and rejected."

Lynn Turner, a former SEC chief accountant, said withholding that information "certainly exposes them to the SEC coming back and saying, 'Hey, you didn't give us all the facts. Therefore, if we had known all the facts, we might have come to another conclusion.' " He added, "If they withheld that information from the SEC, I would say it would be very misleading."

Freddie Mac, Fannie Mae and FHFA negotiated for several weeks about the contents of the filing before reaching an agreement, according to sources. Freddie Mac would say that its own approach was the right one. But Freddie Mac would also say that its interpretation should not invalidate Fannie Mae's continuing use of its own approach.

The SEC got back in touch on April 21. It agreed. Freddie Mac wouldn't have to take the charge, nor would Fannie Mae.

Most of the accounting team at Freddie Mac was gratified with the result, sources recalled. But Kellermann didn't seem allayed, a person who saw him said.

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