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Financial scandal at mortgage giant

By Nicole Colson | June 20, 2003 | Page 2

THE MORTGAGE giant Freddie Mac is under criminal investigation by the Securities and Exchange Commission (SEC) after its Enron-style accounting scams came to light. The company fired its chief operating officer, David Glenn, over an accounting review, and the CEO and chief financial officer were forced to resign as well. In January, the company admitted that it was "redoing" three years' worth of financial reports.

A good part of Freddie Mac's problems stem from the company's trading in derivatives--complicated investments that amount to little more than gambling on the price of stocks or bonds, or even the direction of different financial markets. Company officials say that the financial restatement wasn't a big deal, simply the result of two accounting firms disagreeing about how to apply obscure rules governing derivatives. But the stock market took a dive last week when Freddie Mac's troubles hit the news--because Wall Street insiders realize the catastrophe in the making if the house of cards built up by derivatives trading during the 1990s boom ever comes tumbling down.

Freddie Mac was created--along with its sister company Fannie Mae--30 years ago by the Congress in order to pump money into the home mortgage market. As a result, even though they are privately owned by shareholders, "Freddie and Fannie" get special perks from the government--like the ability to borrow money directly from the U.S. Treasury, which makes their interest rates on mortgages lower than most other companies.

This has allowed Freddie Mac, in particular, to snap up a huge portion of the massive U.S. mortgage market--by buying up large numbers of home loans from banks and selling them as securities on Wall Street. In 2002, the two companies together owned or guaranteed a whopping 44 percent of the total $6.7 trillion in U.S. mortgage debt. A scandal that takes down Freddie Mac would have a disastrous impact--just as economists believe the bubble in inflated housing prices seems to be going down.

Because of their special status, neither company is required to file financial reports with the SEC. And since Freddie and Fannie make huge contributions to both the Democrats and Republicans, Congress essentially looked the other way when questions about their business practices began to come to light.

Freddie Mac is so large that the federal government would have to step in to prevent a complete collapse into bankruptcy, as happened to Enron. That means taxpayers would be forced to foot the bill for the company's dirty deals.

Now that there's a scandal, the White House is rushing to clean house at the agency that is supposed to regulate Freddie Mac and Fannie Mae--the Office of Federal Housing Enterprise Oversight. But the person that the Bush administration wants to put in charge is Mark Brickell, a longtime champion of--you guessed it--derivatives trading. As the Washington Post commented, "The last thing we need right now is a regulator who's an advocate for the very transactions that caused this mess."

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