Accounting problems at Freddie Mac were more extensive than many people realized, and attorneys hired by the housing finance company’s board of directors to investigate withheld some information, a federal regulator says.
Armando Falcon, the outgoing director of the Office of Federal Housing Enterprise Oversight, told Congress on Thursday that “lack of candor” prompted him to order an agency investigation last month of Freddie Mac’s accounting.
But a Republican senator pointedly asked Falcon, whose agency supervises Freddie Mac and Fannie Mae the other big government-sponsored mortgage finance company why he didn’t start the inquiry sooner.
Another Republican, Sen. Chuck Hagel of Nebraska, said he and GOP colleagues will soon propose legislation to change the regulatory regime for overseeing Freddie Mac and Fannie Mae, the two biggest companies in the multi-trillion-dollar home mortgage market. A bill proposed by Republican lawmakers in the House would abolish Falcon’s agency, which is part of the Housing and Urban Development Department, and move its authority to the Treasury Department division that supervises savings and loan companies.
Falcon, a President Clinton appointee, was testifying before the Senate Banking Committee, making his first public statements on Freddie Mac’s debacle since the company announced that it had ousted three top executives and the Justice Department confirmed it was conducting a criminal investigation.
Freddie Mac’s new leaders disclosed recently that it underreported earnings by $1.5 billion to $4.5 billion over the past three years. To resolve the errors, the congressionally chartered yet publicly traded company plans to restate past results adding back those profits. An equivalent amount would be deducted from earnings during the next few years.
The disclosure raised the question of whether the company purposely bent its accounting to smooth out volatility in its earnings, a practice generally frowned on by the Securities and Exchange, which also is investigating the company’s accounting.
Falcon outlined to the Senate panel a wide scope of accounting problems, which he said will affect in the restatement process about half of its derivatives contracts and all its mortgage securities. Derivatives are complex financial instruments used by Freddie Mac and Fannie Mae to hedge against swings in interest rates. The two companies buy home loans from banks and other lenders and package them into securities for sale on Wall Street.
Falcon said the lawyers hired by Freddie Mac’s board of directors to investigate “had not been fully forthcoming” with agency regulators in a May 27 meeting.
James Doty, the Washington attorney who led the internal review, later characterized Falcon’s statements as a “misunderstanding” and disputed his assertion that the regulators had asked the lawyers directly about the integrity of senior management.
“I regret if there was a misunderstanding,” Doty said in a telephone interview. “We have tried to be candid and cooperative.”
It wasn’t until June 4 that the attorneys learned that then-president David Glenn had altered his records of meetings concerning the accounting review information that they promptly disclosed to the regulators, said Doty, who was an SEC general counsel in the first Bush administration.
Falcon testified that after the May 27 meeting, his agency “learned of very troubling information regarding the conduct and integrity of management in matters related to the restatement(of earnings), indicating the board’s counsel had not been fully forthcoming. This lack of candor contributed to my decision on June 7th to initiate an investigation.”
Two days later, Freddie Mac announced that it had ousted the three executives including Glenn for what it called his failure to fully cooperate in an internal accounting review.
But Sen. Jim Bunning, R-Ky., asked Falcon why he didn’t begin the agency investigation much earlier, in January, when Freddie Mac disclosed that it would have to restate its earnings for the past three years.
“There is a misperception that we weren’t aware of the accounting problems or weren’t working on it,” Falcon said. “The companies are safe and sound. We have fulfilled our mission.”
Committee chairman Sen. Richard Shelby, R-Ala., said he was concerned by the attorneys’ having reported that “Freddie Mac lacked sufficient accounting expertise and adequate internal controls only a few weeks” after Falcon’s agency had declared the company’s audit processes effective.