Freddie Mac To Pay $125M To Settle Fraud Charges

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In an effort to close the books on the broad accounting scandal, Freddie Mac agreed last week to pay $125 million to settle charges that it manipulated earnings over the past three years. The Office of Federal Housing Enterprise Oversight, which oversees the two major secondary market players, Freddie Mac and Fannie Mae, said Freddie ignored accounting rules and made transactions solely for the purpose of masking earnings volatility. "Weaknesses existed in every aspect of Freddie Mac's accounting process," said Armando Falcon, director of OFHEO, in announcing the settlement.

Freddie admitted last month that it underreported profits by $5 billion over the past three years. The underreporting of earnings stands in contrast to most of the accounting scandals of the past few years in which corporations were charged with overstating their earnings to boost their stock prices. But regulators said Freddie Mac schemed to understate its earnings during the period in order to "smooth out" its financials to please Wall Street.

As part of the settlement, Freddie Mac agreed to separate the functions of chairman of the board and chief executive, consider setting term limits for board members, and submit a plan to improve corporate governance.

The accounting scandal has had a cathartic effect on Freddie Mac, which has a deep relationship with credit unions by not only buying mortgages from them, but providing an investment outlet for surplus credit union cash. Mortgage-backed securities and corporate debt issued by Freddie and Fannie Mae make up some of the most attractive investments in CU portfolios these days. The company's three top execs, including long-time CEO Leland Brendsel, were forced out in June, and Gregory Parseghian, who was named to replace Brendsel, was subsequently forced out by OFHEO, which said Parseghian participated in the same scheme.

More importantly, the scandal has had a catalyzing impact on congressional critics of the two secondary mortgage market giants. Those critics are gaining support to reform the oversight of Freddie Mac and Fannie Mae, which also admitted to accounting blunders recently. Legislation to move the federal regulator from the Department of Housing and Urban Development (HUD) to the Treasury is widely expected to be approved next year. But more importantly, Bush administration officials have expressed willingness in recent weeks to discuss eliminating the guaranteed line of credit both Freddie and Fannie have with the Treasury. The $2.25- billion line of credit amounts to an implied federal guarantee of debt that gives the two companies borrowing advantages over private sector competitors. Discussion of the line of credit, which has been off limits before, appear to be headed towards the center of the debate when Congress adjourns next year.

Meantime, Freddie last week named Richard Syron, a well-respected former president of the Federal Reserve Bank of Boston and of the American Stock Exchange, as well as the Federal Home Loan Bank of Boston, to succeed Parseghian as its new CEO.

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