Risk at Freddie Mac

At year-end 2003, Freddie Mac's total mortgage portfolio reached a total principal of $1.4 trillion. The U.S. government did not explicitly back Freddie Mac, a stockholder-owned organization, but investors were said to perceive some degree of implicit government backing. After its success in the 1990s, Freddie Mac made maintaining steady earnings growth in the mid-teens an explicit goal through interest rate risk management. To smooth earnings in a changing interest rate environment, Freddie Mac prided itself on modeling, measuring, and managing credit and interest rate risk. Significant resources were devoted to developing sophisticated, quantitative risk modeling and solutions. Interest rate risk was reduced largely through the use of interest rate swaps and swaptions. The motivation to smooth earnings was inherent in Freddie Mac's culture and caused business problems: The operations (e.g., accounting, audit, etc.) of the organization were not well supported, executive compensation was tied to meeting earnings estimates, and employees involved in developing creative accounting solutions to manage earnings were thought of as "first-class citizens." On January 22, 2003, Freddie Mac announced it would restate earnings for 2002, 2001, and possibly 2000. The following June, the Office of Federal Housing Enterprise Oversight (OFHEO), Freddie Mac's regulator, began an examination of Freddie Mac's culture and the events leading up to the restatement. OFHEO determined that Freddie Mac had neglected operations risk management when managing interest rate risk and earnings, leaving room for accounting and disclosure issues. How should investors view the events leading up to the $5 billion restatement and Freddie Mac's management of interest rate risk and operations risk?

• Loans
• Business and government relations
• Fixed income securities
• Risk management
• Interest rates
• Earnings forecasting