The financial world was rocked yesterday when the top three execs of mortgage giant Freddie Mac were ousted from their jobs.
Shares of the nation’s second-largest buyer of mortgages plunged $9.61 to $50.26 – a full 16 percent – shaving $6.6 billion worth of value from the company.
Freddie Mac also said its president had altered documents related to a restatement of financial results from the past three years.
“This is an extremely troubling development, particularly because of the important public policy role [Freddie Mac and its sister company, Fannie Mae] play in our economy,” said Rep. Richard Baker (R-La.), a leading critic of both companies, which are so-called government sponsored enterprises.
Freddie Mac fired President and COO David Glenn this weekend for failing to cooperate with a re-audit of the firm’s financial records, and announced that the audit would not be ready until later in the third quarter.
CEO Leland Brendsel and CFO Vaughn Clarke resigned at the same time.
Freddie Mac is restating its financial performance for the past three years, following a request by its new auditor, PriceWaterhouseCoopers, that it use a new way to account for its use of complex financial derivatives.
The restatement is expected to lead to higher past earnings and diminished future financials.
“The removal of members of the management team only goes a part of the way toward correcting serious problems,” said Armando Falcon Jr., director of the Office of Federal Housing Enterprise Oversight, which regulates both Freddie Mac and Fannie Mae.
“Concerns surrounding management practices and controls remain.”
The two agencies have been under attack since 2000, because their government-sponsored status makes them exempt from federal securities rules that would require they register with the SEC.
Their backing by the U.S. government enables them to take additional risk.
The regulatory body OFHEO has also come under attack as inadequate.
“Today’s news demonstrates OFHEO’s failure and the need to get this company to immediately register with the SEC and comply with our nation’s securities laws,” said Christopher Shays (R-Conn.).
Freddie Mac’s board informed OFHEO of Glenn’s lack of cooperation with the audit process.
Shays and Rep. Edward Markey (D-Mass.) introduced legislation last year that would have required them to comply with SEC registration and disclosure policies.
The bill had little support, but both Fannie Mae and Freddie Mac agreed to register their common stock with the SEC, bringing them in line with federal securities acts.
Under the agreement, Treasury and the SEC did not require that Freddie Mac register its debt and mortgage-backed securities.
“It’s a pretty big shock to the market, because Freddie Mac has a reputation for being very conservative and honest,” said Kate Scheeler, financial services analyst at Schwab Washington Research Group.
“Between a restatement and a firing for a failure to cooperate, it calls that integrity into question in investors’ minds.”
Fannie Mae and Freddie Mac together own or guarantee $3.1 trillion in mortgages, or close to 50 percent of residential debt outstanding in the United States.
The agencies were created by Congress in 1968 and 1970, respectively, buying mortgage loans from lenders such as banks, and giving the lenders additional capital to make more loans.
Former executive vice president Gregory Parseghian was named CEO in yesterday’s shakeup; Shaun O’Malley, former chairman of Price Waterhouse LLP will be chairman and Martin Baumann is CFO.
Parseghian told investors on a conference call Glenn’s altered “diaries” had not led them to suspect any financial fraud.
LOAN ARRANGER
Freddie Mac doesn’t lend directly to home buyers; instead, it guarantees bank loans and buys existing mortgages and mortgage-backed securities. Amid a boom in home buying and refinancing, Freddie Mac bought $384 billion in single-family mortgages in 2001.
How it makes money:
* Banks pay a fee to have Freddie Mac guarantee their loans.
* On the loans it buys, Freddie Mac pays out a lower interest rate and receives higher interest payments.
* Government sponsorship means it has lower taxes and lower operating costs.
Sources: Congressional Budget Office, Freddie Mac