[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]



 
FREDDIE MAC'S ACCOUNTING RESTATEMENT: ARE ACCOUNTING STANDARDS WORKING?
=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                COMMERCE, TRADE, AND CONSUMER PROTECTION

                                 of the

                    COMMITTEE ON ENERGY AND COMMERCE
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                            JANUARY 28, 2004

                               __________

                           Serial No. 108-105

                               __________

      Printed for the use of the Committee on Energy and Commerce


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
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                    COMMITTEE ON ENERGY AND COMMERCE

               W.J. ``BILLY'' TAUZIN, Louisiana, Chairman

RALPH M. HALL, Texas                 JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio**               Ranking Member
MICHAEL BILIRAKIS, Florida           HENRY A. WAXMAN, California
JOE BARTON, Texas                    EDWARD J. MARKEY, Massachusetts
FRED UPTON, Michigan                 RICK BOUCHER, Virginia
CLIFF STEARNS, Florida               EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio                FRANK PALLONE, Jr., New Jersey
JAMES C. GREENWOOD, Pennsylvania     SHERROD BROWN, Ohio
CHRISTOPHER COX, California          BART GORDON, Tennessee
NATHAN DEAL, Georgia                 PETER DEUTSCH, Florida
RICHARD BURR, North Carolina         BOBBY L. RUSH, Illinois
  Vice Chairman                      ANNA G. ESHOO, California
ED WHITFIELD, Kentucky               BART STUPAK, Michigan
CHARLIE NORWOOD, Georgia             ELIOT L. ENGEL, New York
BARBARA CUBIN, Wyoming               ALBERT R. WYNN, Maryland
JOHN SHIMKUS, Illinois               GENE GREEN, Texas
HEATHER WILSON, New Mexico           KAREN McCARTHY, Missouri
JOHN B. SHADEGG, Arizona             TED STRICKLAND, Ohio
CHARLES W. ``CHIP'' PICKERING,       DIANA DeGETTE, Colorado
Mississippi                          LOIS CAPPS, California
VITO FOSSELLA, New York              MICHAEL F. DOYLE, Pennsylvania
ROY BLUNT, Missouri**                CHRISTOPHER JOHN, Louisiana
STEVE BUYER, Indiana                 TOM ALLEN, Maine
GEORGE RADANOVICH, California        JIM DAVIS, Florida
CHARLES F. BASS, New Hampshire       JANICE D. SCHAKOWSKY, Illinois
JOSEPH R. PITTS, Pennsylvania        HILDA L. SOLIS, California
MARY BONO, California                CHARLES A. GONZALEZ, Texas
GREG WALDEN, Oregon
LEE TERRY, Nebraska
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
DARRELL E. ISSA, California
C.L. ``BUTCH'' OTTER, Idaho
SUE WILKINS MYRICK, North 
Carolina**
JOHN SULLIVAN, Oklahoma
  **On Leave of Absence

                   Dan R. Brouillette, Staff Director

                   James D. Barnette, General Counsel

      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

        Subcommittee on Commerce, Trade, and Consumer Protection

                    CLIFF STEARNS, Florida, Chairman

FRED UPTON, Michigan                 JANICE D. SCHAKOWSKY, Illinois
BARBARA CUBIN, Wyoming                 Ranking Member
JOHN SHIMKUS, Illinois               HILDA L. SOLIS, California
JOHN B. SHADEGG, Arizona             EDWARD J. MARKEY, Massachusetts
  Vice Chairman                      EDOLPHUS TOWNS, New York
GEORGE RADANOVICH, California        SHERROD BROWN, Ohio
CHARLES F. BASS, New Hampshire       JIM DAVIS, Florida
JOSEPH R. PITTS, Pennsylvania        PETER DEUTSCH, Florida
MARY BONO, California                BART STUPAK, Michigan
LEE TERRY, Nebraska                  GENE GREEN, Texas
ERNIE FLETCHER, Kentucky             KAREN McCARTHY, Missouri
MIKE FERGUSON, New Jersey            TED STRICKLAND, Ohio
DARRELL E. ISSA, California          DIANA DeGETTE, Colorado
C.L. ``BUTCH'' OTTER, Idaho          JOHN D. DINGELL, Michigan,
W.J. ``BILLY'' TAUZIN, Louisiana       (Ex Officio)
  (Ex Officio)

                                  (ii)
















                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Baumann, Martin F., Chief Financial Officer, Freddie Mac.....    28
    Falcon, Hon. Armando, Jr., Director, Office of Federal 
      Housing Enterprise Oversight...............................     7
Additional material submitted for the record by:
    Stearns, Hon. Cliff, and Hon. Janice D. Schakowsky:
        Letter dated January 28, 2004, to Armando Falcon, Jr., 
          requesting material for the record, and response to 
          same...................................................    46
        Letter dated May 13, 2004, to Armando Falcon, Jr., 
          requesting material for the record, and response to 
          same...................................................    49

                                 (iii)










FREDDIE MAC'S ACCOUNTING RESTATEMENT: ARE ACCOUNTING STANDARDS WORKING?

                              ----------                              


                        MONDAY, JANUARY 28, 2004

               House of Representatives    
              Committee on Energy and Commerce,    
                       Subcommittee on Commerce, Trade,    
                                   and Consumer Protection,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10 a.m., in 
room 2322, Rayburn House Office Building, Hon. Cliff Stearns 
(chairman) presiding.
    Members present: Representatives Stearns, Shimkus, Shadegg, 
Ferguson, Issa, Otter, Schakowsky, Solis, Markey, McCarthy, and 
Strickland.
    Staff present: Brian McCullough, majority counsel; David 
Cavicke, majority counsel; Arturo Silva, deputy communications 
director; William Carty, legislative clerk; and Consuela 
Washington, minority counsel.
    Mr. Stearns. Good morning. The subcommittee will come to 
order.
    My colleagues, this is the third hearing we have held in 
the subcommittee on accounting issues raised by Freddie Mac. 
The hearing today will focus on two reports: the supplemental 
report to the Board of Directors of Freddie Mac known as the 
supplement to the Doty report and submitted to the Board on 
November 18, 2003; and the report of the special examination of 
Freddie Mac by the Office of Federal Housing Enterprise 
Oversight, OFHEO, completed in December 2003.
    We have two witnesses here today and I'd like to thank them 
for appearing before the committee to help us better understand 
what happened at Freddie Mac.
    I would like to thank Armando Falcon, Director of OFHEO, 
Freddie's regulator for OFHEO's work on parsing through the 
problems at Freddie that led to Freddie Mac's disregard of 
financial accounting standards.
    I would also like to thank Martin Baumann, CFO of Freddie 
Mac for being here today.
    At the last hearing, we held on the accounting standards 
issued raised by the Doty report, I complimented Mr. Doty on 
his thoroughness and objectivity with regard to the internal 
investigation and the report. Although Mr. Doty is not 
appearing as witness here today, I wish to acknowledge the 
supplemental report was produced with the same rigor as the 
initial report. It also will be a useful tool as guiding our 
review of accounting standards.
    We'll focus on three things today. First, the supplement to 
the Doty report; second, the OFHEO report; and finally, on the 
implications of the contents of these reports for fair 
disclosure under U.S. GAAP.
    The supplement to the Doty report addresses issues that 
were known to require further inquiry at the time of release 
for the initial report. As with the transactions scrutinized in 
the final report, hiding income was a primary factor, if not 
the sole motivation for several transactions investigated for 
the follow-up report.
    The supplement reveals further evidence of earnings 
management at Freddie Mac. The OFHEO report provides an 
overview of the culture at Freddie Mac that facilitated 
earnings management over 11 quarters. The report indicates that 
Freddie disregarded accounting rules, internal controls, and 
disclosure standards to maintain a reputation for steady 
earnings.
    So I look forward to hearing from Mr. Baumann about what 
controls Freddie is putting into place to guard against 
improper accounting.
    The third issue we need to look at today is what this 
information means for accounting standards. Although Freddie 
Mac may have made accounting misstatements, it is possible that 
if some of the transactions were structured more carefully they 
would have been GAAP compliant. It is possible Freddie could 
have hidden billions of dollars of income in a way that 
complied with GAAP.
    I suggest this is not the result we want from our United 
States accounting standards. So called ``mixed attribute'' 
accounting allows companies to decide whether financial assets 
are carried at current market price or at historic costs. Let 
me repeat. Allows companies to decide whether financial assets 
are carried at current market price or at historic costs. 
Freddie Mac shifted assets between categories to manipulate 
earnings without any change in the underlying economics of its 
performance.
    Now taxpayers do not have the option of changing the 
characterization of assets to change the tax treatment. I think 
GAAP should not allow this either. U.S. GAAP was once hailed as 
a premiere accounting system. I believe GAAP is still a strong 
accounting system and I applaud FASB for all their efforts to 
shore up the system over the last 2 years.
    While I do not believe Congress is the appropriate body to 
set detailed accounting standards, I believe we as a committee 
of oversight over accounting standards setting have a 
responsibility to ensure standards produce financial statements 
that are transparent and comprehensible.
    I encourage my colleagues to join me to produce legislation 
to reform GAAP.
    I look forward to a dialog here today that will further 
these efforts and I thank you.
    I ask the distinguished Ranking Member for her opening 
statement.
    Ms. Schakowsky. Thank you, Chairman Stearns, for convening 
this important hearing to follow up on the accounting scandal 
at Freddie Mac. I appreciate, Mr. Falcon, and accompanied by 
Ms. DeLeo this morning and Mr. Baumann's attendance today so 
that we can go over the Office of Federal Housing Enterprise 
oversight examination of just what went wrong at Freddie Mac 
and Freddie Mac's actual restatement of earnings.
    According to OFHEO's report, Freddie Mac used a variety of 
accounting tricks to move gains and losses around to smooth out 
and meet earning expectations. Through their manipulations, 
steady Freddie seemed to live up to its name. However, as its 
restatement shows, and we all know, the cumulative effect of 
their attempts was the hiding of $5 billion of volatility.
    Some have been lulled into a sort of complacence with the 
accounting scandal at Freddie Mac because they under reported 
their earnings. It seemed that while their true earnings 
revealed some unsteadiness, what they were hiding was not so 
bad. They hid profits. But this reporting has been misleading 
as well. In 2001, Freddie's restatement reveals that they over 
reported their earnings by $989 million. Earnings for 2001 
actually were about $1 billion less than they reported. Again, 
that $5 billion was accumulative effect of their restatement.
    My concerns today are not just with Freddie Mac but also 
with the agency put in charge of their oversight. OFHEO's 
oversight was created in 1992 to ensure the safe and sound 
operations of Freddie Mac and Fannie Mae. However, as OFHEO's 
report reveals, a lot was happening at Freddie Mac under their 
oversight.
    Today, we'll focus on the accounting issues that were 
raised by Freddie Mac. Our subcommittee has the responsibility 
to ensure that all companies provide clear and accurate 
financial information to the public. The scandal at Freddie Mac 
is a clear example of what can happen when corporate officers 
do not abide by the rules of clear and accurate accounting.
    All publicly traded companies need to have clear and 
accurate books. This is especially true for Freddie Mac. What 
happens at Freddie Mac has a major impact on the housing 
markets. Freddie purchased almost $600 billion in mortgages in 
2002. It also has helped finance homes for nearly 2.5 million 
low and moderate income families and families living in under 
served areas. It was able to do so at least in part because of 
the benefits and freedoms enjoyed in an established mission as 
a government-sponsored enterprise.
    As we all know, with freedoms come responsibilities. While 
Freddie was trying to live up to their reputation, they were 
not living up to their responsibilities. As a GSE and as one of 
the largest players in the housing market, playing accounting 
games puts more than the corporation's financial standing at 
risk. It puts taxpayers and people's homes in jeopardy.
    As I said before, Freddie Mac is not just another company. 
Therefore, we need to make sure that Freddie Mac is as 
transparent as possible and while I applaud the work that OFHEO 
has done since the scandal has come to light, and appreciate 
Freddie's restatement of earnings, willingness to take steps 
toward remediation, we still have a long way to go.
    Freddie Mac needs to be registered with the SEC and 
voluntary registration is taking too long and does not have the 
same power as mandated. And that is why I support my 
colleagues' efforts, Congressmen Shays and Markey, to require 
Freddie Mac to abide by the same rules of transparency 
available. Because of who you are and place you have in making 
money available for home ownership, it is vital that Freddie 
Mac is held to at least the same standards as other publicly 
traded companies, if not higher.
    I thank you, Mr. Chairman.
    Mr. Stearns. I thank my colleague. Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. It's an important 
hearing and it's good to be back and addressing these concerns. 
I will be brief.
    In the committee summary, obviously we're here to review 
Freddie Mac's announced restated financial cumulative net 
income increase by $5 billion regulatory per capita increase by 
$5.2 billion; stockholders equity increased by $6.7 billion. 
These are obviously restated numbers.
    In OFHEO's report under the executive summary, it talks 
about the corporate culture fostered by the tone at the top 
resulting in intense and sometimes improper efforts by the 
enterprise to manage its reported earnings. And in another 
article in The New York Times dated 30 November, the headline 
``Hiding Profits is Just Deceitful.''
    We're even more involved because this is a government-
sponsored enterprise. There is connection to us because of that 
privilege and I think the public is just getting tired of 
whether it's a for profit entity or a government-sponsored 
entity of leadership at the top rigging the books for purposes 
that are as The New York Times says is deceitful. And so you're 
here to help us sort through really the blow by blow of where 
we're at. Then we do need to look with my colleagues in how 
bills should be written and drafted, laws should be passed to 
bring some more accountability. The public is just tired and we 
should not claim and go after one sector of the corporate world 
while another one goes unscathed for what we would define as 
improper activity.
    So Mr. Chairman, I think it's an important hearing. Thanks 
for calling it and I yield back the balance of my time.
    [The prepared statement of Hon. John Shimkus follows:]
 Prepared Statement of Hon. John Shimkus, a Representative in Congress 
                       from the State of Illinois
    Good Morning. Mr. Chairman, thank you for holding this hearing to 
provide a forum for Freddie Mac to restate their financial reports.
    This hearing marks the third time in the last 7 months that this 
Subcommittee has investigated the accounting practices of Freddie Mac. 
I should hope that this hearing will finally produce an answer to what 
we have been looking for--the accurate depiction of Freddie Mac's 
suspicious transactions. The fact that Freddie Mac, a government 
sponsored enterprise, had to make major revisions to the past three 
years accounting records only adds fuel to the flame in this era of 
corporate distrust. And even these records may not be correct, as 
Freddie Mac will not be issuing its 2002 annual report until June of 
2004--over a year later than normal.
    I am interested to hear from our panel of witnesses and learn more 
about the measures that have taken place to correct the improper 
reporting by this enterprise. I'm also anxious to hear how Freddie Mac 
plans to avoid this type of situation in the future and comply with the 
basic accounting standards they have discarded in the past.
    Thank you Mr. Chairman, and I yield back the remainder of my time.

    Mr. Stearns. I thank my colleague. The gentleman from 
Massachusetts.
    Mr. Markey. Thank you, Mr. Chairman, and thank you so much 
for having this hearing. It is very timely, very important 
because Congress did establish Freddie and its sister company, 
Fannie Mae, to link Wall Street financing to the goal of 
promoting home ownership throughout Main Street America. In 
order to advance this objective, Congress has allowed these two 
companies many regulatory benefits, such as exemption from 
State taxes, a line of credit at the United States Treasury, an 
exemption from the registration, financial reporting 
requirements of the Federal securities laws.
    But while Freddie and Fannie might be ``government-
sponsored enterprises,'' they are also private investor-owned 
corporations. As such, they have responsibilities to their 
shareholders, including the responsibility to provide full and 
complete disclosures regarding their financial and operating 
condition and to obtain audited financial statements that 
comply with generally accepted accounting principles.
    In other words, both of these institutions do a wonderful 
job in creating more housing in the United States. No one is 
going to debate that. But many of those very same families then 
invest their own money into the shares of those companies 
thinking that it must be a very good company. The government 
sponsors it. But it isn't required to provide all the same 
information that other corporations in America are. The 
transparency is not there, so that investors can make the right 
decision. And that's why Christopher Shays and I introduced 
legislation to provide that accurate disclosure and accounting 
practices at these companies.
    Today, we're going to hear from Freddie Mac's principal 
regulator, the Office of Federal Housing Enterprise Oversight 
about the results of its investigation into accounting 
irregularities at Freddie Mac. OFHEO's December 2003 report on 
its special examination of Freddie Mac raises a number of very 
disturbing issues that I look forward to hearing about today.
    The OFHEO report describes a corporate culture that ``casts 
aside accounting rules, internal controls, disclosure standards 
and the public trust in the pursuit of steady earnings 
growth.''
    It details instances in which Freddie Mac ``knowingly 
circumvented prevailing public disclosure standards in order to 
obfuscate particular policies and specific capital market and 
accounting transactions'' and it finds ``a disdain for 
appropriate disclosure standards'' that misled investors, 
ordinary Americans, putting their money into these companies 
and undermined market awareness of the true financial condition 
of the enterprise.
    In my view, these findings only serve to underscore the 
failure of voluntary disclosure to serve the needs of American 
investors and of our financial markets. In the aftermath of 
this accounting scandal, it is time for Freddie Mac's new 
leadership to change course and embrace legislation through 
repeal of its special exemption from the Securities and 
Exchange Commission registration and reporting requirements.
    There is no single step that Freddie Mac could take that 
would do more to signal to investors that the corporate culture 
at the company has changed. There is no single step that the 
Congress could undertake which would better protect investors 
from a repetition of the type of accounting problems that we 
have seen at Freddie Mac.
    Mr. Chairman, again, I want to thank you so much for having 
this very important hearing.
    Mr. Stearns. I thank my colleague. The gentleman from 
Idaho.
    Mr. Otter. I have nothing.
    Mr. Stearns. Mr. Shadegg, I'm sorry, the gentleman from 
Arizona.
    Mr. Shadegg. Thank you very much, Mr. Chairman, for holding 
this hearing. Since our last hearing on this issue on September 
25, the restatement by Freddie Mac of its 2002 financial 
information, coupled with the release of the reports by Baker 
Botts and OFHEO weren't another look at the accounting problems 
which beset Freddie Mac.
    I am pleased that we have such knowledgeable witnesses 
present and was interested to read in their testimony not only 
the description of what went wrong, but also the steps that 
Freddie Mac can and in some instances is taking to correct the 
situation which gave rise to the accounting problems.
    I am also encouraged that Freddie Mac has appointed a chief 
compliance officer to ensure that at least one key employee in 
the company has legal and regulatory compliance as his primary 
function. Important as such structural improvements are, 
however, they pale in comparison to the need to instill in all 
employees, managers and board members, the understanding that 
accounting standards are not a performance metric to be 
manipulated or worked around, but rather a gauge which must be 
kept accurate.
    At the hearing last September, I made the point that 
accurate accounting could best be encouraged through the 
establishment of guidelines, rather than overly formulaic rules 
which can be avoided on technicalities. I'm building a home 
right now and there are certain building codes which it must 
comply with. Obviously, it's important to comply with those 
codes, but it's more important that the home actually be well 
constructed and that it will last for decades and so complying 
with the code isn't the issue, building a sound home is, in 
fact, the issue.
    I was interested to see that in the testimony of Mr. 
Falcon, he bolstered my position. He notes that ``to maintain 
Freddie Mac's image as a smooth and steady earning machine, it 
is now clear that management went to extraordinary lengths to 
transact around FAS 133 and at times failed to comply with 
GAAP.'' He also discusses the culture of deception which 
existed among some members of Freddie Mac's management team and 
their willingness to disguise earnings.
    In the next few weeks we will consider legislation to 
institute certain reforms to Freddie Mac and other government-
sponsored enterprises. It is my hope that this legislation will 
be structured to not only ensure greater compliance with 
technical accounting standards, but will result in greater 
attention to the spirit of accurate reporting without which the 
standards themselves are meaningless.
    I thank you, Mr. Chairman, again for this hearing and look 
forward to the testimony of our witnesses.
    Mr. Stearns. I thank the gentleman. Good morning, Ms. 
Solis, you're welcome. You can take your time and we welcome 
your opening statement if you have one?
    Ms. Solis. I'd like to submit my statement for the record, 
thank you.
    Mr. Stearns. By unanimous consent, so ordered.
    [The prepared statement of Hon. Hilda L. Solis follows:
Prepared Statement of Hon. Hilda L. Solis, a Representative in Congress 
                      from the State of California
    Thank you, Mr. Chairman, for calling this hearing today. I'm 
pleased that this Subcommittee is continuing to examine the problems 
uncovered at Freddie Mac last year, as well as the state of accounting 
standards in general.
    I share the concern held by many of my colleagues on this panel 
about the lack of transparency in corporate accounting. I believe it is 
critical that companies provide thorough and accurate information about 
their financial status to the public. We should not leave investors in 
the dark, defenseless against sloppy accounting by corporate managers.
    Holding corporations accountable is especially important for 
government- sponsored entities such as Freddie Mac. We all know that 
Freddie Mac, along with Fannie Mae, is crucial to the housing market. 
This is especially true in districts such as mine in Los Angeles 
County, which is home to many low to moderate income families, the 
majority of whom are Latino and Asian. I hope that as we continue to 
evaluate this issue, we will keep these consumers--and all taxpayers--
in mind.
    It is in the best interest of our constituents to have a viable, 
secondary housing market. Improving transparency and disclosure 
requirements will help accomplish this goal.
    I want to thank the witnesses for joining us today. I look forward 
to their testimony.
    Thank you.

    [Additional statement submitted for the record follows:]
 Prepared Statement of Hon. W.J. ``Billy'' Tauzin, Chairman, Committee 
                         on Energy and Commerce
    This is the third hearing Chairman Stearns has held on accounting 
problems at Freddie Mac. I commend Chairman Stearns for his dogged 
pursuit of the technical issues associated with accounting questions.
    The most important lesson we have leaned from this inquiry is that 
GAAP Accounting Standards as set by FASB leave much to be desired. 
Although Freddie Mac violated GAAP by hiding billions of dollars in 
earnings, had they done their accounting more carefully, some of those 
transactions would have been permissible.
    So called ``mixed-attribute accounting'' allows some financial 
firms to vary the accounting treatment of an asset by characterizing 
the asset as ``available for sale'' or ``held for investment''. By 
manipulating these categories, some financial firms can alter their 
accounting by billions of dollars without any regard to economic 
reality. This anomaly should change. FASB should be encouraged to adopt 
a rule correcting this.
    We know from the corporate scandals that have surfaced in the past 
two years that it is difficult to regulate fraud. However, lost in some 
of the particular cases is why no one discovered the truth earlier. Are 
accounting standards so complex that virtually anything can be hidden 
or are they so complex that no one is smart enough to understand the 
financial statements? Simply stating that accounting standards should 
be simpler sounds great, but will it benefit anyone if the information 
is meaningless?
    I commend Chairman Stearns for his attention to these questions and 
hope that the Subcommittee will continue this inquiry in this Congress.

    Mr. Stearns. Mr. Falcon, I think we're taken care of all 
our opening statements, so we welcome you this morning, for 
your opening statement.

  STATEMENT OF HON. ARMANDO FALCON, JR., DIRECTOR, OFFICE OF 
              FEDERAL HOUSING ENTERPRISE OVERSIGHT

    Mr. Falcon. Thank you, Mr. Chairman, Ranking Member 
Schakowsky, I apologize for the error in my written testimony 
about the misnomer, and members of the subcommittee. Let me 
introduce to my left, Ms. Wanda DeLeo, who is the Chief 
Accountant at OFHEO. I asked her to join me up here to assist 
me in answering any detailed questions about accounting matters 
at Freddie Mac.
    I appreciate the opportunity to discuss with you OFHEO's 
report of the special examination of Freddie Mac. My written 
testimony discusses the key findings and conclusions of the 
report, focusing largely on accounting and earnings management 
issues. I request that the committee include it, as well as the 
full text of the report in the record.
    Mr. Stearns. By unanimous consent, so ordered.
    Mr. Falcon. Thank you. A year ago, Freddie Mac announced 
that completion of its 2002 financial audit would be delayed 
and that earlier periods would be re-audited and restated. They 
switched external auditors from Arthur Anderson to 
PriceWaterhouseCoopers. That triggered an assessment of Freddie 
Mac's accounting policies and practices.
    On June 7, as this re-audit was underway, Freddie Mac 
announced the abrupt departure of three of its principal 
officers. At the same time, I ordered a special examination of 
the circumstances that led to the restatement and management 
changes.
    Although some aspects of the special examination are not 
yet complete, the bulk of the work was finished this past fall. 
OFHEO issued a report of the examination containing the 
findings and conclusions along with appropriate recommendations 
in December.
    Let me now turn to the major findings of the special 
examination. The report of the special examination of Freddie 
Mac reveals how Freddie Mac manipulated its reported earnings 
and disclosed other financial information in a misleading way 
in 1999 through 2002. The report provides a chronology of 
relevant events, reviews the strategies that Freddie Mac 
employed to manipulate earnings and indicates that the Board 
was made aware of transactions whose sole purpose was to shift 
income.
    The report also shows how the executive compensation 
program of Freddie Mac, particularly the compensation tied to 
earnings per share, influenced accounting and management 
practices during that period.
    On January 1, 2001, Freddie Mac, along with other financial 
institutions, was required to implement FAS 133, ``Accounting 
for Derivative Instruments and Hedging Activities.'' In 
addition to their many operational challenges, FAS 133 was 
problematic to Freddie Mac with respect to its goal of steady 
earnings growth. Specifically, FAS 133 required management to 
record a transition adjustment based upon any embedded gain or 
loss in its derivatives portfolio upon adoption of the 
standard.
    Freddie Mac's derivatives portfolio, in particular, its 
portfolio of interest-rate swaptions, had substantial gains 
that had to be recognized on the transition date. Management 
sought to minimize this transition adjustment, in part to 
minimize the appearance of volatility on its balance sheet, as 
well as to shift derivative gains into future periods and 
recognize them gradually into income.
    To maintain Freddie Mac's image as a smooth and steady 
earnings machine, never perturbed by changes in interest rates, 
mortgage volumes, or other economic factors, it is now clear 
that management went to extraordinary lengths to transact 
around FAS 133, and at times failed to comply with GAAP. One 
example of this was the ``Coupon Trade-Up Giant'' transaction, 
referred to in our report as a ``CTUG.''
    The purpose of the CTUG transaction was to move securities 
with embedded losses from the held-to-maturity portfolio to the 
trading portfolio and then into the available for sale 
portfolio. Management wanted the benefit of having its 
securities in a trading account but only for enough time to 
realize a loss and offset its derivative gains.
    The CTUG transaction was a transaction with little or no 
economic substance that Freddie Mac manufactured in order to 
obtain a particular accounting result. Indeed, the economic 
aspects of the deal were negative when one considers the 
operational hazards created by the transaction which compounded 
Freddie Mac's accounting and control weaknesses.
    The report of special examination also detailed the use of 
a dubious method by Freddie Mac to value its swaptions 
portfolio in a way that minimized its derivatives gain. The 
report describes how the head of Freddie Mac's Market Risk 
Oversight unit worked with Freddie Mac's derivatives desk to 
reverse-engineer a lower value for its swaptions portfolio. The 
revised swaption valuation method contributed to a $730 million 
misstatement of the 2001 financial results of Freddie Mac.
    This is illustrative of the culture at Freddie Mac at that 
time and highlights the willingness of all levels of management 
to disguise earnings.
    The FAS 133 transition was not the only episode of improper 
earnings management activities. In January 2001, the shape of 
the yield curve began to change dramatically in favor of 
Freddie Mac which resulted in the windfall of net interest 
income for the enterprise. In order to shift some of this 
windfall from 2001 into the future, management executed the 
first of several interest rate swap transactions that were 
referred to in the report as linked swaps. Each pair of swaps 
substantially offset each other and was virtually riskless for 
Freddie Mac and their counterparts. The link swaps moved 
approximately $450 million in operating earnings from 2001 into 
future years.
    The compensation of senior executives of Freddie Mac, 
particularly compensation tied to earnings per share also 
contributed to the improper accounting and management practices 
of the enterprise. The size of the bonus pool for senior 
executives was linked, in part, to meeting or exceeding annual 
specified earnings per share targets. While not tied directly 
to smoothing earnings growth, actions shifting earnings from 
one quarter to future periods helped ensure that earnings per 
share goals and consequently the bonuses based upon them would 
be achieved in the future.
    In some instances, Freddie Mac knowingly circumvented 
prevailing public disclosure standards in order to conceal 
particular policies and specific capital market and accounting 
transactions. A disdain for appropriate disclosure standards, 
despite oft-stated management assertions to the contrary, 
misled investors and undermined market awareness of the true 
financial condition of the enterprise.
    Within Freddie Mac, no one took responsibility for public 
disclosures. Failure to assign responsibility and 
accountability for disclosure to an internal division 
contributed directly to inaccurate corporate and financial 
reporting. Such a lack of assigned responsibility reflected the 
low regard executive management held for that function.
    For the most part, the same long-tenured shareholder-
elected directors oversaw the same CEO, COO, and General 
Counsel of Freddie Mac from 1990 to 2003. The non-executive 
directors became complacent and allowed past performance of 
those officers to color their oversight. The oversight 
exercised by the Board might have been more vigorous if there 
had been a regular turnover of shareholder-elected directors or 
if directors had not expected to continue to serve on the board 
until the mandatory retirement age or beyond.
    The management of a corporation is responsible for 
maintaining a control environment that will, among other 
things, accurately record transactions to provide for published 
financial statements that are consistent with the true 
financial condition of the firm. In that regard, the obsession 
of Freddie Mac with steady, stable growth in earnings was at 
the expense of proper accounting policies and strong accounting 
controls. Weaknesses in the staffing, skills and resources in 
the Corporate Accounting Department of the enterprise led to 
weak or nonexistent accounting policies, an over reliance on 
the external auditor, weak accounting controls and an over 
reliance on manual systems.
    A thorough review and update of accounting policies had not 
occurred in over 12 years. Freddie Mac's accounting errors 
during this time period were pervasive and persistent occurring 
in more than 30 different accounting issue groups. The 
weaknesses in accounting policies created an environment that 
allowed for and even encouraged transacting around GAAP. These 
weaknesses also encouraged an over reliance on Arthur Andersen, 
the external auditor. Arthur Andersen was soon in a position of 
auditing its own work.
    Freddie Mac, as part of the restatement process has 
reviewed over 150 accounting policies. Senior management and 
the board did not establish and retain a strong internal 
control system. Therefore, they could not provide reasonable 
assurance that transactions were recorded as necessary to 
permit preparation of the financial statements in accordance 
with GAAP. As a direct result of management and the board not 
addressing these weaknesses in a timely fashion, Freddie Mac 
went 10 months without audited financial statements for 2002; 
was forced to re-audit and restate both 2000 and 2001 financial 
statements and will not be able to provide investors with 
quarterly information until at least mid-2004.
    An internal audit report dated December 1996 reported that 
controls over the derivatives execution, administration, and 
accounting processes require improvement and that further 
deterioration in controls could affect the reliability of 
financial reporting. Neither management, internal audit or the 
external auditor addressed these weaknesses during the next 7 
years.
    It should be noted that inadequate documentation and 
controls surrounding the accounting for derivatives were 
identified as one of the six major restatement issues and 
constitute the largest dollar impact of the restatement. Many 
of the weaknesses discussed to date were identified by the 
internal audit, but remained outstanding for a number of years.
    In evaluating the role of the internal audit department, 
the investigation revealed that internal audit did not fully 
comply with industry standards or best practices in the areas 
of competency and communication with the board and management. 
By not following up quickly enough or failing to report the 
failure of management to remedy major control weaknesses during 
that period of the restatement, the internal audit function 
increased the exposure of Freddie Mac to risk.
    Based upon these findings, the examination report 
recommended that OFHEO and Freddie Mac take a broad range of 
actions. As a general matter, the report concluded that OFHEO 
must ensure that Freddie Mac establish an adequate remediation 
plan and is allocating the necessary resources to establish a 
new corporate culture that rewards integrity and the acceptance 
of responsibility, and that penalizes the failure to meet 
appropriate standards of conduct.
    There is a full discussion of these specific 
recommendations in my written testimony. OFHEO's report 
contains 16 recommendations that I have adopted and am moving 
forward to implement. I am pleased to inform the subcommittee 
that the majority of these actions have been put in place.
    Of the 14 recommendations relating directly to Freddie Mac, 
a consent order has applied 11 of these recommendations. I am 
now moving within OFHEO on the remaining three. The consent 
order entered into on December 9th with Freddie Mac expands on 
the recommendations of the report.
    The Board of Directors is reviewing the company's bylaws, 
codes of conduct and employee training to ensure that changes 
are made to avoid problems that were discovered in the course 
of the investigation. The Board will review and recommend 
changes to its committee structure to meet its oversight 
obligations including risk and internal controls that were 
issues in the accounting area.
    The Board and senior management must be briefed not less 
than annually under legal and regulatory responsibilities, 
including a meeting with OFHEO personnel.
    Freddie Mac is developing with OFHEO oversight, a program 
to revise its management culture to give equal weight to 
compliance and operational stability alongside other corporate 
goals. This includes executive compensation that contributed to 
the accounting failures.
    The enterprise will have a consultant review its accounting 
and financial reporting changes and communicate to OFHEO on 
this and improvements to internal controls. The enterprise must 
act to improve its internal audit function and internal 
accounting.
    As to specific unique transactions that did not have a 
business purpose, the enterprise will assure that a valid 
business purpose exists for transactions and that they are 
documented under GAAP.
    Finally, the Board must report quarterly on progress in 
meeting the requirements of the consent order and our staff and 
Freddie Mac's management, I can assure, are meeting on a much 
more frequent basis than that.
    Overall, I believe that Freddie Mac has been subject to a 
rigorous corrective plan by OFHEO and one that establishes 
accounting as a central point of concern. Freddie Mac has 
engaged with OFHEO actively and has been operating in a manner 
that is satisfactory to OFHEO in working through these remedial 
steps.
    Mr. Chairman, that concludes my prepared remarks and I am 
pleased to answer any questions that you or other members of 
the subcommittee may have.
    [The prepared statement of Hon. Armando Falcon, Jr. 
follows:]
    Prepared Statement of Hon. Armando Falcon, Jr., Director, OFHEO
    Mr. Chairman, Ranking Member Schakowsky, and Members of the 
Subcommittee, I appreciate the opportunity to discuss with you OFHEO's 
Report of the Special Examination of Freddie Mac. My prepared testimony 
will summarize the key findings and conclusions of the report, focusing 
largely on the accounting issues, and I request that the Committee 
include it as well as the full text of the report in the record. My 
testimony expresses my own views and not necessarily those of the 
President or the Secretary of Housing and Urban Development.
    Mr. Chairman, OFHEO is an independent agency, chartered by Congress 
in 1992 and funded by assessments on the government sponsored 
enterprises it supervises, Fannie Mae and Freddie Mac. OFHEO's mission 
is to ensure the safe and sound operation of the Enterprises. As do 
other safety and soundness regulators, OFHEO employs a full range of 
supervisory and enforcement tools including examinations, capital 
standards, and prompt corrective action procedures.
    A year ago, Freddie Mac announced that completion of its 2002 
financial audit would be delayed and that earlier periods would be 
reaudited. A switch in external auditors--from Arthur Andersen to 
PricewaterhouseCoopers--had triggered a reevaluation of Freddie Mac's 
accounting policies, especially those relating to hedge accounting 
treatments for derivatives occasioned by implementation of FAS 133. 
However, the reaudit and restatement process itself raised questions 
beyond merely the choice of accounting policies.
    On June 7, as Freddie Mac prepared to announce the abrupt departure 
of three of its principal officers, I ordered a special examination of 
the conditions and activities that led to the accounting failures and 
management changes.
    Although some aspects of the special examination are not yet 
complete, the bulk of the work was finished this past fall. OFHEO 
issued a report of the examination containing the findings and 
conclusions, along with appropriate recommendations, in December.
    Since the early 1990s Freddie Mac promoted itself to investors as 
``Steady Freddie,'' a company of strong and steady growth in profits, 
and developed a corporate culture that placed a very high priority on 
achieving such results. The special examination showed that, to do so, 
Freddie Mac used means that failed to meet its obligations to 
investors, regulators and the public. The company employed a variety of 
techniques ranging from improper reserve accounts to complex derivative 
transactions to push earnings into future periods and meet earnings 
expectations. Freddie Mac cast aside accounting rules, internal 
controls, disclosure standards, and the public trust in the pursuit of 
steady earnings growth. The conduct and intentions of the Enterprise 
were hidden and were revealed only by a chain of events that began when 
Freddie Mac changed auditors in 2002.
                    improper management of earnings
    The Report of the Special Examination of Freddie Mac reveals how 
Freddie Mac manipulated its reported earnings and disclosed other 
financial information in a misleading way in 1999 through 2002. The 
Report provides a chronology of relevant events, reviews the strategies 
that Freddie Mac employed to manipulate earnings, and indicates that 
the Board was made aware of transactions whose sole purpose was to 
shift income. The Report also shows how the executive compensation 
program of Freddie Mac, particularly compensation tied to earnings per 
share, influenced accounting and management practices during that 
period.
    In the period covered by the special examination, senior management 
at Freddie Mac placed an inordinate emphasis on achieving steady, 
stable growth in earnings per share.
    Freddie Mac adopted the goal of steady earnings growth in the early 
1990s after some investors told management that the Enterprise needed 
to communicate clear and simple messages that the public could easily 
understand. Fifteen to sixteen percent earnings growth, or ``mid-teens 
earnings growth,'' was the simple message that management began to 
communicate. That goal was fairly easy when Freddie Mac was primarily a 
securitizer of mortgages. However, as the retained mortgage portfolio 
of the Enterprise grew and its earnings became more sensitive to 
interest rates, steady mid-teens growth became a more challenging goal.
    On January 1, 2001, Freddie Mac, along with other financial 
institutions, was required to implement FAS 133, Accounting for 
Derivative Instruments and Hedging Activities. Given the large size of 
Freddie Mac's derivatives portfolio, FAS 133 presented management with 
many operational challenges relating to systems, documentation, and 
accounting infrastructure. However, in addition to the operational 
challenges, FAS 133 was problematic to Freddie Mac with respect to 
steady earnings. Specifically, FAS 133 required management to record a 
transition adjustment based upon any embedded gain or loss in its 
derivatives portfolio upon adoption of the standard. Freddie Mac's 
derivatives portfolio, in particular its portfolio of interest-rate 
swaptions, had substantial gains that had to be recognized on the 
transition date. Management sought to minimize this transition 
adjustment, in part to minimize the appearance of volatility on its 
balance sheet, as well as to shift derivative gains into future periods 
and recognize them gradually into income.
    To maintain Freddie Mac's image as a smooth and steady earnings 
machine, never perturbed by changes in interest rates, mortgage 
volumes, or other economic factors, it is now clear that management 
went to extraordinary lengths to transact around FAS 133, and at times 
failed to comply with GAAP. One example of this was the ``Coupon Trade-
Up Giant'' transaction, referred to in the Report as ``CTUG.'' The 
purpose of the CTUG transaction was to move securities with embedded 
losses from the held-to-maturity portfolio (where losses are 
unrecognized) to the trading portfolio (where losses would be 
immediately recognized in net income and would offset derivative 
gains), and then into available-for-sale portfolio (where securities 
gains and losses only hit ``other comprehensive income,'' not ``net 
income''). The last step was accomplished with the help of Salomon 
Smith Barney Holdings, which is now part of Citigroup, and involved 
combining $30 billion in mortgage-backed securities into four ``Giant'' 
securities. Management wanted the benefit of having its securities in a 
trading account but only for enough time to realize a loss and offset 
its derivative gains.
    However, the transfer to the available-for-sale portfolio was 
unwound during Freddie Mac's re-audit in 2003. In addition to numerous 
operational problems caused by trying to move $30 billion in mortgage-
backed securities in a short period of time, and the fact that Salomon 
Smith Barney only took possession of the securities for a few hours 
before shipping them back to Freddie Mac, a reaudit ultimately 
concluded that the classification from Trading to Available-for-Sale 
should not have been permitted. Transfers into or from the trading 
category should be rare, and ``rare'' is generally interpreted to mean 
``never'' both in practice and by the SEC. The first transfer to 
trading was permissible under FAS 133 transition values, but not the 
second transfer. That transfer would have required substantive trades. 
However, Freddie Mac did not obtain a legal true sale opinion on these 
transactions. CTUG was a transaction with little or no economic 
substance that Freddie Mac manufactured to obtain a particular 
accounting result. Indeed, the economic aspects of the deal were 
negative when one considers the operational hazards created by the 
transaction, which compounded Freddie Mac's accounting and control 
weaknesses.
    The Report of Special Examination also detailed the use of a 
dubious method used by Freddie Mac to value its swaption portfolio in 
order to minimize its derivatives gain at the time of the FAS 133 
transition. The Report describes how the head of Freddie Mac Market 
Risk Oversight unit worked with Freddie Mac's derivatives desk to 
reverse-engineer a justification for a lower value for the swaptions 
portfolio. The revised swaption valuation method contributed to a $730 
million misstatement of the 2001 financial results of Freddie Mac. The 
fact that the head of Market Risk Oversight worked hand-in-glove with a 
unit he was responsible for overseeing to craft a dubious valuation 
methodology is illustrative of the culture at Freddie Mac at that time 
and highlights the willingness at all levels of management to disguise 
earnings.
    The FAS 133 transition was not the only episode of improper 
earnings management activities. For example, in January 2001, the shape 
of the yield curve began to change dramatically in favor of Freddie 
Mac, as the Federal Reserve began to lower its target for the Fed funds 
rate, which resulted in a much steeper yield curve and a windfall of 
net interest income for the Enterprise. This windfall was made larger 
by derivative positions put in place at the end of 2000 that benefited 
from the steeper yield curve. In order to shift some of this windfall 
from 2001 into the future, management executed the first of several 
interest-rate swap transactions that are referred to in the Report as 
the ``linked swaps.'' The terms of each pair of swaps substantially 
offset each other and were virtually riskless for Freddie Mac and their 
counterparties. The swaps also had little effect on GAAP income but the 
negative cash flow from the first swaps in each pair was reflected in 
operating earnings, a non-GAAP metric that Freddie Mac highlighted for 
the investing public. The linked swaps, in aggregate, moved 
approximately $450 million in operating earnings from 2001 into later 
years. Handwritten notes from Freddie Mac's Board meeting in September 
2001 show that management informed the Board that derivatives were 
being used to shift income.
    Other earnings management techniques involved keeping the level of 
loan loss reserves higher than allowed by GAAP, and maintaining a 
reserve account to cushion fluctuations in premiums and discounts 
resulting from mortgage prepayments. That reserve, known at Freddie Mac 
as the FAS 91 reserve, was not allowed by GAAP, but Freddie Mac's 
outside auditor, Arthur Andersen, chose to look past it. When Arthur 
Andersen began receiving negative publicity in late 2001 and early 2002 
for its work with Enron, the Chief Operating Officer of Freddie Mac 
resisted pressure from the Board to change auditors, since he was aware 
that hiring new auditors could result in increased ``restatement 
risk.'' Ultimately, the Board insisted on hiring new auditors, and his 
fears of restatement were realized.
                         executive compensation
    The compensation of senior executives of Freddie Mac, particularly 
compensation tied to earnings per share, also contributed to the 
improper accounting and management practices of the Enterprise. The 
size of the bonus pool for senior executives was tied, in part, to 
meeting or exceeding annual specified earnings per share targets. While 
not tied directly to smoothing earnings growth, actions shifting 
earnings from one quarter to future periods helped ensure that earnings 
per share goals, and consequently the bonuses based upon them, would be 
achieved in the future.
                               disclosure
    In some instances, Freddie Mac knowingly circumvented prevailing 
public disclosure standards in order to obfuscate particular policies 
and specific capital market and accounting transactions. A disdain for 
appropriate disclosure standards, despite oft-stated management 
assertions to the contrary, misled investors and undermined market 
awareness of the true financial condition of the Enterprise.
    Within Freddie Mac, no one took responsibility for public 
disclosures. Failure to assign responsibility and accountability for 
disclosure to an internal division contributed directly to inaccurate 
corporate and financial reporting. Such a lack of assigned 
responsibility reflected the low regard executive management had for 
that function.
                           board of directors
    For the most part, the same long-tenured shareholder-elected 
Directors oversaw the same CEO, COO, and General Counsel of Freddie Mac 
from 1990 to 2003. The non-executive Directors allowed the past 
performance of those officers to color their oversight. Directors 
should have asked more questions, pressed harder for resolution of 
issues, and not automatically accepted the rationale of management for 
the length of time needed to address identified weaknesses and 
problems. The oversight exercised by the Board might have been more 
vigorous if there had been a regular turnover of shareholder-elected 
Directors or if Directors had not expected to continue to serve on the 
Board until the mandatory retirement age or beyond. Conversely, the 
service periods of the presidentially appointed Directors are far too 
short, averaging just over 14 months, for them to play a meaningful 
role on the Board.
            weak accounting, auditing and internal controls
    The management of a corporation is responsible for maintaining a 
control environment that will, among other things, accurately record 
transactions to provide for published financial statements that are 
consistent with the true financial condition of the firm. In that 
regard, the obsession of Freddie Mac with steady, stable growth in 
earnings was at the expense of proper accounting policies and strong 
accounting controls. Weaknesses in the staffing, skills, and resources 
in the Corporate Accounting Department of the Enterprise led to weak or 
nonexistent accounting policies, an over reliance on the external 
auditor, weak accounting controls, and an over reliance on manual 
systems. Given the size of the company and its role in the housing 
finance and capital markets, those weaknesses effectively increased the 
systemic risk posed by the Enterprise.
                   accounting personnel and expertise
    The staffing levels and experience in the financial accounting 
reporting functions were insufficient throughout the restatement 
periods. The key finance functions over this period were unbalanced 
with major gaps either left unfilled or filled with interim personnel 
with inadequate skills. This shortage of staff and experience caused 
key person dependencies in crucial control areas. The need for skill 
and experience is heightened when the process is complex, as is the 
derivatives and securitization accounting process at Freddie Mac. Many 
of the strategies and transactions during this period were not GAAP 
compliant; therefore, Freddie Mac was faced with one of the largest 
restatements in corporate history.
    The primary responsibility for an entity's financial statements 
rests with management. Part of that responsibility is to assure that 
staffing levels in financial accounting are sufficient to support a 
control environment within the financial reporting process to ensure 
that significant errors are either prevented or detected at an early 
stage. Senior management and the Board failed to provide adequate 
resources to the corporate accounting function even though they were 
being continuously told about the weaknesses.
    Senior management simply ignored warning signs about problems in 
Corporate Accounting and/or did not consider the problems important 
enough to provide adequate supervision, funding and or insist on a 
timely resolution. The lack of attention to staffing, skill set and 
resources led to weak or non-existent accounting policies, weak 
accounting controls, over reliance on manual systems and over reliance 
on the external auditor. Each of these areas will be discussed in turn.
                          accounting policies
    A thorough review and update of accounting policies had not 
occurred at Freddie Mac in over twelve years. Accounting policies 
should be researched and documented regularly to assure proper 
accounting treatment of existing and new business transactions. They 
should be used as a mechanism to keep employees informed of how to 
account for new and recurring transactions. Many of the transactions 
and policies that have been investigated at Freddie Mac did not have 
established accounting policy guidance and/or the policies in place 
were outdated, insufficient or incorrect, leading to misapplication of 
GAAP and, ultimately, to the need to reaudit and restate its financial 
statements.
    Freddie Mac's accounting errors during this time period had been 
pervasive and persistent; occurring in more than 30 different 
accounting issue groups. The weaknesses in accounting policies created 
an environment that allowed for and even encouraged transacting around 
GAAP. These weaknesses also encouraged an over reliance on Arthur 
Andersen, the external auditor, a situation which led to questions as 
to auditor independence.
    Management used the weak accounting policy group and the non-
existent process surrounding the setting of accounting policies to 
justify accounting practices after transactions had taken place rather 
than allowing the group to set ``best practice''. Freddie Mac, as part 
of the restatement process, has rewritten and/or reviewed 150 
accounting policies.
                    over reliance on arthur andersen
    Freddie Mac's shortage of accounting staff, inadequate expertise 
and weak or non-existent accounting policies led to an environment that 
encouraged reliance on the external auditors for basic accounting 
functions and decisions. This dependency led to the external auditor 
acting in a first-line management capacity, taking part in day-to-day 
operations, and, to an extent, and auditing its own work.
    In 2001, Arthur Andersen received $1 million for its audit work and 
$3.7 million for its consulting fees, of which $1.5 million related to 
FAS 133 consulting. OFHEO believes that Arthur Andersen's independence 
as an auditor may have been compromised by the size of the consulting 
fees compared to the fees charged for the audit work.
    SEC requirements for independence of auditors are clear that in 
day-to-day operations of the business, external auditors may not 
function as management or as an employee of its audit client. Arthur 
Andersen appears to have disregarded this principle by counseling the 
company on issues ranging from FAS 133 implementation to accounting 
affects of new products. The many organizational changes in the 
accounting department heads, especially at the controller position, led 
to the accounting staff heavily relying on Arthur Andersen.
    In this regard, evidence supports the conclusion that Arthur 
Andersen was participating in day-to-day decisions and often acting as 
an employee or in a management capacity. They also performed extensive 
consulting work that may have led them to use extreme and sometimes 
unsupportable assumptions to support specific transactions. Couple this 
with an environment where management often negotiated accounting 
decisions and in some cases went as far as suggesting a change in 
auditors if desired results were not achieved, and the result is an 
environment which can compromise the auditor's independence.
    There are also indicators that the Board was comfortable relying 
completely on the external auditor for accounting expertise. This 
contradicts current accounting literature, which holds management 
accountable for the accuracy of their financial statements.
                          accounting controls
    Senior management and the Board did not establish and maintain a 
strong internal control system. Therefore, they could not provide 
reasonable assurance that transactions were recorded as necessary to 
permit preparation of financial statements in accordance with GAAP. As 
a direct result of management and the Board not addressing these 
weaknesses in a timely fashion, Freddie Mac went ten months without 
audited financial statements for 2002, was forced to reaudit and 
restate both 2000 and 2001 financial statements, and will not be able 
to provide investors with current quarterly information during 2004.
    As noted previously, staffing levels and expertise in the financial 
accounting area have been insufficient since at least 1998. It has also 
been demonstrated that the enterprise operated from 1991 to 2003 with 
non-existent or outdated accounting policies and manuals. Add to this 
insufficient controls over the financial reporting process such as 
system and data integrity issues in debt and derivatives accounting, 
account reconciliation issues, an ineffective process to react promptly 
to new transactions, and a labor intensive close-out process and you 
have an environment that will not only allow errors but will most 
likely result in material misstatements in the financial reporting 
process. Discussed below are some of the weaknesses in controls that 
existed during the restatement period.
                              derivatives
    In an internal audit report dated December 1996, the General 
Auditor reported that controls over the derivatives execution, 
administration, and accounting processes require improvement and that 
further deterioration in controls could prevent objectives relating to 
the effectiveness and efficiency of operations and the reliability of 
financial reporting from being achieved.
    Management through their internal self-assessment process also 
identified these same weaknesses. Weaknesses within the derivative area 
continued to be identified, but not addressed by management, internal 
audit, or the external auditor during the next seven years. The latest 
internal audit report stated that inadequate documentation of hedge 
effectiveness and other required information could disqualify the use 
of favorable FAS 133 accounting treatment. The report also stated that 
procedures for derivatives accounting processes, including 
documentation, effectiveness testing, quality control, analysis, and 
management review, need improvement to ensure compliance with hedge 
accounting standards. Significant functional limitations in the 
derivatives accounting systems create an elevated risk of material 
operational error. It should be noted that inadequate documentation and 
controls surrounding the accounting for derivatives were identified as 
one of the six major restatement issues and constitute the largest 
dollar impact of the restatement.
                            reconciliations
    General ledger account reconciliations are a key internal control 
necessary/used to provide reasonable assurance that the corporation's 
financial statements fairly present its financial position and results 
of operations. Not reconciling general ledger accounts dramatically 
increases the risk that financial reports will not be accurate. The 
issue regarding reconciliation was brought to management's attention as 
early as 1995. At that time Internal Audit reported that corporate 
accounting was not effectively monitoring account reconciliations 
performed by the decentralized account unit.
    Internal Audit again identified reconciliation weaknesses in their 
1998 audit. And in 1998 and 1999 Arthur Andersen addressed the issues 
regarding reconciliation and data integrity in its management letters. 
In fact, in 1998 Arthur Andersen said that guidance should be provided 
for the timely and consistent reconciliation of data to the general 
ledger and other approved sources of data. Reconciliation issues were 
still outstanding in 2002.
                        internal audit function
    Many of the weaknesses discussed to date were identified by 
Internal Audit but remained outstanding for a number of years. In 
evaluating the role of the Internal Audit Department the investigation 
revealed that Internal Audit did not fully comply with industry 
standards or best practices in the areas of competency and 
communication with the Board and Management.
    Best practices do not require internal auditors to conduct 
financial audits, but the Internal Audit Department of Freddie Mac 
should have policies and procedures in place to address its obligation 
to evaluate risk exposure relative to the reliability and integrity of 
the financial information of the Enterprise. Given the volume and wide 
range of accounting errors made by Freddie Mac, the conclusion of the 
Internal Audit Department that financial accounting and reporting 
controls were marginal was a substantial overstatement of their 
quality.
    Internal auditors should review operations and programs to 
ascertain the extent to which results are consistent with established 
goals and objectives to determine whether operations and programs are 
being implemented or performed as intended. A review of relevant 
internal audit reports noted several instances where major control 
weaknesses identified as early as 1998 remain unresolved five years 
later. In many of these instances, internal audit identified major 
control weakness and set agreed upon actions as well as target 
completion dates. However, the completion dates of the corrective 
actions were repeatedly extended. As a result, each of the issues 
remained outstanding.
    By not following up quickly enough or failing to report the failure 
of management to remedy major control weakness during the period of the 
restatement, the internal audit function increased the exposure of 
Freddie Mac to risk.
    The Internal Audit Department of Freddie Mac did not accept 
responsibility for the reliability and integrity of the financial 
information of the Enterprise, did not follow-up effectively on 
identified deficiencies, and did not communicate effectively with 
management and the Board. In combination, the weaknesses in Corporate 
Accounting, the Internal Audit Department, and questionable 
independence of the external auditor meant that there were weak points 
at each major control juncture at Freddie Mac.
                               conclusion
    Weaknesses in the Corporate Accounting area with respect to 
staffing, skill set, and resources led to weak or non existent 
accounting policies, an over reliance on the external auditors, weak 
accounting controls and an over reliance on manual systems. Couple this 
with a weak internal audit department that did not accept 
responsibility for the reliability and integrity of financial 
information, did not maintain effective controls over the review and 
follow-up of audit findings and you have an environment with weak 
points at each major control juncture.
    This weak control environment provided the opportunity for 
management to promote an attitude that GAAP was something to be 
transacted around. In this regard, the attention of management on 
meeting analyst's expectations at the expense of proper accounting 
policies and strong accounting controls lead to aggressive accounting 
and concurrently resulted in the restatement and reaudit. Management 
and the Board continually ignored their responsibility for adopting 
sound accounting policies, establishing and maintaining a strong 
internal control system to assure that financial statements were 
prepared in accordance with GAAP. The Board appeared to be operating 
under the misconception that as long as the external accounting firm 
signed off on a policy or transaction that management's responsibility 
was fulfilled.
    Management and the Board must accept full responsibility for the 
Company's financial statements. The auditor's responsibility is to 
express an opinion on the financial statements. It is management's 
responsibility to adopt sound accounting policies and to establish and 
maintain an internal control environment that among other things will 
ensure the effectiveness of the accounting and financial reporting 
processes. Freddie Mac's Senior Management and Board did not live up to 
these responsibilities during this timeframe.
                            recommendations
    The examination report recommended that OFHEO and Freddie Mac take 
a broad range of actions. I agree with the recommendations and we are 
moving to implement them. As a general matter, the report concluded 
that OFHEO must ensure that Freddie Mac has established an adequate 
remediation plan and is allocating the necessary resources to establish 
a new corporate culture that rewards integrity and the acceptance of 
responsibility, and that penalizes failure to meet appropriate 
standards of conduct.
    The report also detailed a number of specific actions. To improve 
the effectiveness of the Board of Directors, Freddie Mac should 
separate the functions of the Chief Executive Officer and the Chairman 
of the Board, impose strict term limits on Directors, and require that 
the Board meet more frequently.
    To address Freddie Mac's general neglect of operations risks and 
compliance issues, the report recommends that Freddie Mac establish a 
formal compliance provision and a position of Chief Risk Officer, 
reporting directly to the CEO, with explicit responsibility for 
operations risk, as well as credit and market risk. In addition, 
Freddie Mac's Internal Audit Department needs to be strengthened so 
that it can play a more effective role.
    To address accounting weaknesses, Freddie Mac will review all 
accounting and financial reporting changes and communicate this to 
OFHEO. The enterprise must also act to improve its internal audit and 
accounting functions. The report also recommends that OFHEO consider 
requiring a periodic change of external audit firms. Freddie Mac needs 
to establish and maintain superior accounting controls and prevent 
undue reliance on its external auditor. It must also document the 
legitimate business purpose of every significant business transaction.
    To address inappropriate managerial incentives, the report 
recommended that Freddie Mac refocus its compensation program more on 
long-term goals, not on short-term earnings.
    Until remediation efforts have taken full effect, Freddie Mac 
remains exposed to substantial management and operations risk. The 
report recommends that OFHEO consider addressing this concern by 
requiring Freddie Mac to hold significant regulatory capital surpluses, 
at least until it can produce timely and GAAP--consistent financial 
reports.
    Finally, the report recommends that OFHEO take three additional 
steps to reduce the possibility of future Enterprise difficulties. 
First, OFHEO should implement regulations that provide for mandatory 
disclosure, similar to that required of SEC-registered companies, if 
Congress does not repeal the exemptions of the Enterprises from 
securities law. Second, OFHEO should expand its capacity to detect and 
investigate misconduct by including more substantive tests of the 
internal control frameworks at the Enterprises, including procedures to 
identify pressures to commit fraud and opportunities to carry it out. 
Third, OFHEO should conduct a special examination of the accounting 
practices of Fannie Mae.
                             ofheo actions
    Mr. Chairman, I am pleased to inform the subcommittee that the 
majority of these actions have been put in place. Of the 14 
recommendations relating directly to Freddie Mac, a consent order has 
applied 11 of these recommendations, while I am moving now within OFHEO 
on the remaining three.
    The consent order entered into on December 9th with Freddie Mac 
expands on the recommendations of the report and Freddie Mac has 
initiated a compliance program with the consent order that OFHEO is not 
only monitoring but working with the management to see that it moves 
along promptly.
    Key provisions for accounting matters and related matters are as 
follows:
    The Board of Directors is reviewing the company's bylaws, code of 
conduct and employee training to assure that changes are made that will 
support an environment to avoid problems that were discovered in the 
course of the investigation. The Board will review and recommend 
changes to its committee structure to meet its oversight obligations 
including operations risk and internal controls that were issues in the 
accounting area. The Board and senior management must be briefed not 
less than annually on their legal and regulatory responsibilities; this 
includes no less than annually a meeting with OFHEO personnel.
    Freddie Mac is developing, with OFHEO oversight, a program to 
revise its management culture to give equal weight to compliance and 
operational stability along side other corporate goals; this includes 
executive compensation that contributed to the accounting failures.
    The Enterprise will have a consultant review its accounting and 
financial reporting changes and communicate to OFHEO on this and 
improvements to internal controls. The Enterprise must act to improve 
its internal audit function and internal accounting.
    As to specific unique transactions that did not have a business 
purpose, the Enterprise will assure that a valid business purpose 
exists for transactions and that they are documented under GAAP.
    Finally, the Board must report quarterly on progress in meeting the 
requirements of the consent order and our staff and Freddie's 
management, I can assure you, are meeting on a much more frequent basis 
than that.
    Overall, I believe that Freddie Mac has been subject to a rigorous 
corrective plan by OFHEO and one that establishes accounting as a 
central point of concern. Freddie has engaged with OFHEO actively and 
has been operating in a manner that is satisfactory to OFHEO in working 
through these remedial steps.
    That concludes my prepared remarks. I am pleased to answer any 
questions that you and Members of the Committee may have.

    Mr. Stearns. Mr. Falcon, thank you very much. Does your 
associate, Ms. DeLeo, do you have anything that you would like 
to say?
    Ms. DeLeo. I have no prepared statement.
    Mr. Stearns. No prepared statement, okay. I'll start with 
the opening questions.
    In your statement, as well as in members' here, words like 
manipulated, misled, scandal, scheme, deception, disguised 
earnings, circumvented, undermanned, undermined, market 
awareness, pervasive, these are the terms that have been used.
    Freddie Mac's problems were discovered by the board of 
directors, as I understand. Is that correct?
    Mr. Falcon. This all was uncovered initially as a result in 
a change in external auditors by the company.
    Mr. Stearns. Mr. Falcon, since your job is oversight, why 
didn't your office detect it first, since you had a fiduciary 
responsibility, as the oversight for the government, why 
wouldn't your office detect it, identify this problem in your 
normal accounting and oversight?
    Mr. Falcon. That's a fair question, Mr. Chairman. We were 
aware of these transactions, but we weren't aware of the 
accounting for these transactions. These transactions, 
generally, did not pose additional risk to the company from a 
safety and soundness perspective. We would have prevented them 
from entering into them had we understood the purpose of these 
transactions.
    So we're familiar with them from a risk management 
standpoint, but the accounting for these transactions is really 
what's at issue here.
    Mr. Stearns. Do you think your office has enough people, 
enough expertise to identify these problems?
    If you were going to say to someone today, by golly, this 
is what I want, so this won't happen again, what would you say?
    Mr. Falcon. I think what's required on the part of OFHEO, 
Mr. Chairman, is additional resources and expertise, not just 
across the board, but more specifically in the accounting area. 
Safety and soundness regulators generally do not secondarily 
certify that the financial statements----
    Mr. Stearns. Only the accountant?
    Mr. Falcon. Right, only the external auditor does that.
    Mr. Stearns. So really your office could never detect this 
kind of mismanagement, misled, schemes, scandals, all these 
things. Your office could never have detected this?
    Mr. Falcon. We weren't equipped to----
    Mr. Stearns. You weren't equipped to detect this.
    Mr. Falcon. [continuing] this kind of accounting 
misconduct.
    Mr. Stearns. Okay.
    Mr. Falcon. May I add, we are working to bring this 
expertise on board in the agency beginning with the creation of 
an office of chief accountants which Ms. DeLeo----
    Mr. Stearns. I'm just trying to understand how it occurred 
and I'm trying--my next question goes to what our jurisdiction 
is which is FASB.
    Do you think FASB has to change its ``mixed attribute'' 
accounting rule? Because as a taxpayer, all of Americans cannot 
take their income and segment it. Say I'll report half of this 
$50,000 this year and the other $30,000 at a later year, when I 
have a low income, so then I don't have to pay taxes on $80,000 
or $60,000 or $50,000. I'll just show a very small percentage 
of this income this year and then I'll show it next year or 2 
years. I'm not sure when, so that I don't have to pay the 
taxes. That could put you in jail as a taxpayer.
    Yet, our corporations, and I understand what's being done 
by Freddie Mac is pretty much done throughout all of the 
corporations. Is that your understanding that most other 
corporations do the same thing that Freddie Mac--so Freddie Mac 
is not alone on this?
    It's difficult for you to answer that.
    Mr. Falcon. Right.
    Mr. Stearns. But I'm just saying what I hear. But let's 
forget that for the moment, but should the rules at FASB be 
changed to prevent corporations, Freddie Mac, from segmenting 
and mixing their assets so that they don't have to pay and show 
in a timely fashion these revenues?
    Mr. Falcon. I certainly think with respect to Freddie Mac, 
the accounting standards were clear to the company, but what we 
saw was a disregard for the accounting standards and the 
entering of transactions to shift earnings. Now with respect to 
the general issue about the accounting standards which you 
mentioned, I'm not prepared to answer that question, but I 
think Ms. DeLeo can elaborate on that for you.
    Mr. Stearns. Sure. I need somebody who is familiar with 
this to say FASB's accounting standards are not working. Is 
that true?
    Ms. DeLeo. I think we would probably all agree that there 
are flaws in the current accounting standards that are out 
there.
    Mr. Stearns. So the accounting standards from FASB are 
flawed in this area?
    Ms. DeLeo. Let me preface that. In that regard they are 
moving with their financial instrument, their fair value 
financial instrument in that area and I think that will 
certainly help.
    Mr. Stearns. Not solved, but help.
    Ms. DeLeo. But help, exactly. But the root causes of what 
we saw at Freddie Mac were not the existing accounting 
standards. It was the inability to implement and apply those 
standards correctly that created these problems.
    Mr. Stearns. The Doty report indicated that one of the main 
activities of the head of the financial engineering was to find 
and exploit anomalies, irregularities in GAAP. Now how do we 
stop that? I mean tell me what is Freddie Mac's department of 
financial engineering? I understand what the finance department 
is. What's financial engineering in your estimation?
    Ms. DeLeo. May I address the first part of your question?
    Mr. Stearns. Sure, absolutely, yes.
    Ms. DeLeo. I think what we normally would have seen in a 
corporation is three areas, a strong internal accounting group, 
a strong internal audit staff and external auditors. What we 
found at Freddie was weaknesses in all of those areas, so when 
that existed you're going to have a situation where you're 
going to have misapplications of GAAP.
    Mr. Stearns. Okay, is financial engineering a department, 
generally, that's okay? It sounds like a financial engineering 
department is one to exploit and--find and exploit anomalies in 
GAAP.
    Ms. DeLeo. Well, that particular department was, I guess 
that name is a misnomer, but had you had a strong accounting--
--
    Mr. Stearns. You wouldn't need a financial engineer.
    Ms. DeLeo. And they would have prevented or turned down 
anything that that group was working on that would have 
misapplied GAAP.
    Mr. Stearns. Fannie Mae is also under your jurisdiction, 
Mr. Falcon.
    Mr. Falcon. Yes.
    Mr. Stearns. And are you saying here today that there's no 
problems in the GAAP accounting compliance in that corporation 
too today?
    Mr. Falcon. I'm not prepared to say that at this moment. We 
do not, as I said, secondarily, review accounting statements 
for compliance for GAAP and so we are about to undertake an 
extensive review of Fannie Mae to determine and make sure that 
there aren't any problems at Fannie Mae.
    Mr. Stearns. My time has expired.
    Ms. Schakowsky. Thank you, Mr. Chairman. I appreciate your 
good questions, too. I was going to start really the same way. 
This is a scathing statement that you made. Some of the 
language is pretty harsh in here, rightfully so, I think, but 
obfuscate particular policies, disdain for appropriate 
disclosure standards, misled investors, low regard for 
disclosure, obsession with steady stable growth and earnings at 
the expense of proper accounting policies and strong accounting 
controls, weak or nonexistent accounting policies and on and 
on.
    It really led me to think really the same question. Since, 
as I understand OFHEO, you employ ``a full range of supervisory 
and enforcement tools including examination, capital standards 
and prompt corrective action procedures.'' Is it simply just 
the lack of expertise or is it that in the past you have not 
been looking for the thing, since safety and soundness wasn't a 
concern that you weren't looking at all for the things that we 
have subsequently have been discovered?
    Mr. Falcon. This accounting misconduct is not something 
that we would--you have to review their financial transactions 
and how they applied GAAP to those transactions to be able to 
protect against this type of conduct. And this conduct by its 
very nature isn't obvious or made plain to the public, 
investors or regulators. You have to go in and try to find this 
type of misconduct. And with that and an accounting review by 
our agency on a regular basis, we can't do that which is why 
we're changing this part of our oversight program over these 
two enterprises. We will begin with use of our Office of 
Compliance as well as an Office of Chief Accounting to begin to 
spot check and review the implementing of the accounting 
standards.
    Ms. Schakowsky. Now if they were forced to register with 
the SEC, the SEC would do that kind of work, is that correct? 
And let me just ask, and do you support legislation that would 
require, since they've been so lackadaisical and to date have 
not registered with the SEC.
    Mr. Falcon. I think it became very clear to us, 
Congresswoman, in the course of this investigation that a 
system of voluntary disclosure standards is not adequate and so 
I do support the repeal of the company's 1933 and 1934 
exemptions.
    Ms. Schakowsky. Freddie Mac has been fined $125 million. I 
want to ask you, and I don't know the answer to this, is this 
sufficient? I think what Americans are feeling right now is 
that some of these scandals go largely unpunished that while 
there is a little burst of energy at first and isn't this 
terrible and a lot of finger pointing and wagging that in the 
end it's maybe a slap on the wrist and that's about it.
    We have a particular responsibility here. It's one thing to 
talk about Enron or some private, totally private company and 
isn't this awful and there should be more consequences, but 
still we, because it's a GSE, have particular responsibility. 
Is this sufficient so far in the way of a fine?
    Mr. Falcon. You mentioned the adjectives that were in the 
report and the testimony about the type of conduct they 
discovered. I'm not pleased about that kind of conduct at all, 
any more than you are.
    As you pointed out, these are government-sponsored 
enterprises. They live off of a public trust to fulfill their 
mission.
    Ms. Schakowsky. Exactly.
    Mr. Falcon. And if that public trust is violated, then our 
housing finance system is at risk which is why we are taking as 
strong an action as possible. I think the fine of $125 million 
was a very substantial fine, one of the largest ever imposed by 
a safety and soundness regulator for misconduct. Top management 
has been replaced. You'll see over the course of the next year 
a turnover on the board and we are implementing a very strong 
remedial plan for the company. This week, we'll decide whether 
or not the company shouldn't hold additional capital pending 
its compliance with the remediation plan.
    Ms. Schakowsky. I thank you and thank you, Mr. Chairman.
    Mr. Stearns. I thank my colleague. I would just say to her 
question that I think Freddie Mac had $900 billion income and 
probably had a profit of $10 billion, so $125 million is a 
very, very small fee of fine and the gentleman from Arizona.
    Mr. Shadegg. Thank you, Mr. Chairman. I appreciate the 
questioning of my colleagues. I think you've done an excellent 
job of bringing out the points. I guess I'm intrigued by Ms. 
DeLeo, a comment you just made, that I think is almost 
pervasive here and if I'm misreading what you intended, correct 
me.
    You said that it was the result of an inability to apply 
the standards and I jotted down the words very quickly. I guess 
I think that's a mischaracterization, because I don't think it 
was an inability. I think it was a chosen intent not to apply 
the standards. I don't think it was because they couldn't apply 
the appropriate standards. I think they read the standards 
carefully. I think they understood what the standards required. 
I think they figured out how to deceive, how to get around the 
standards through deception to achieve the end they wanted and 
that's the course they pursued, which means the fundamental 
issue for me is not are the standards appropriate and we 
already concede there are some problems with the standards, but 
rather, at least as I perceive it, it's not a question of 
whether the standards are appropriate. Indeed, they may be 
flawed to some degree.
    There may be technical loopholes that shouldn't be there, 
but it seems to me the issue really is what's the culture? If 
the culture is you're going to set down a series of standards 
for us, and we're going to look carefully at the letter of 
those standards and we're going to manipulate them whatever way 
we can to report what we'd like to report and still comply with 
the letter of the law; if they claim they can do that, but 
we'll be able to get away with doing what we wanted to do, then 
I don't think the biggest problem is fixing the standards, I 
think the biggest problem is changing the culture. And your 
word ``inability to apply the standards'' troubles me.
    Am I misperceiving? Do we see this issue differently?
    Ms. DeLeo. It's where the inability is used. My comment was 
in reference to the expertise in the accounting area. Freddie 
did not have the proper expertise to be able to interpret and 
apply those standards. That allowed individuals outside 
accounting to be able to manipulate and work around that.
    I do agree with your comment.
    Mr. Falcon. The point is, Congressman, that the lack of a 
strong internal audit function, internal accounting office in 
the company, allowed those outside that office to work around 
the accounting rules without there being someone internal to 
police their conduct and additionally with the external 
auditor, not objecting to this conduct, in fact, Arthur 
Andersen was involved in day to day accounting decisions in the 
company, so in essence, they were auditing their own work. The 
lack of this expertise internal to the company allowed those in 
the financial transactions area to just disregard accounting 
standards.
    Mr. Shadegg. I agree very strongly with the comments of the 
Ranking Member with regard to the fact that this is unlike the 
Enron scandal or other public or other private entity scandals. 
This one is at our doorstep and I am deeply concerned that 
absent some draconian steps, we're not going to be able to 
regain the credibility of the public. And I guess you have 
already said that you think the exemption from the 1933 and 
1934 acts should be repealed? What other steps do you think are 
necessary to regain credibility?
    Mr. Falcon. I think we've recommended some very good 
corporate governance reforms for the companies in our report, 
Congressman. We will soon promulgate the corporate governance 
rule which will implement these.
    We found that there was a conflict between one individual 
serving as both the Chairman of the Board and CEO of the 
company. The role of the Board is to oversee the management of 
the company and when you have a strong Chairman of the Board, 
what we found with Freddie Mac is that that is not a best 
practice and it allows that individual to sort of weaken the 
Board's oversight function.
    We are also going to require that the Board become more 
active and meet more frequently. This company is still meeting 
just four times a year and a company as sophisticated as this I 
think needs a more active Board. So we are moving to implement 
more corporate governance reforms.
    Mr. Shadegg. Some believe that if there had not been a 
change in the auditor, there wouldn't have been a restatement 
and none of this would have been caught and Freddie Mac would 
still be engaged in what it was doing. Do you share that view?
    Mr. Falcon. That may be. Absent, our lack of resources and 
expertise in this accounting area and our lack of a mission in 
looking at how they applied GAAP in their financial statements, 
that could be which is why we have to move in that direction, 
begin to take on that responsibility.
    Mr. Shadegg. So to those who say your criticism of the 
entity isn't very credible because you guys didn't catch this, 
your response is we didn't have the duty and we didn't have the 
resources?
    Mr. Falcon. Right. I'm reluctant to say something which 
sounds like it wasn't our job, but in essence, the safety and 
soundness of a company requires the cooperation of not just the 
regulator. Management of the company has to run the company 
soundly. The Board of Directors has to fulfill its obligations 
and the external auditor has to do its job properly. The role 
of the regulator is to try to oversee that all of those 
functions are done right. Without the resources and expertise 
related to the accounting area, we could not properly oversee 
the work of the external auditor.
    I don't think we're looking to implement a system where we 
secondarily certify the financial statements. More importantly, 
we need to make sure that when new accounting standards are 
brought on line, like this one involving FAS 133, that we have 
the capacity to make sure that the implementation of this 
accounting standard is done properly and that on an on-going 
basis the company is not using transactions to do anything like 
shifting earnings.
    Mr. Shadegg. I'm compelled to conclude by just noting, I 
think it's Paul Harvey who sometimes self-government without 
self-discipline won't work. It looks to me like the situation 
here and the situation with the Enron problems is people who 
are entrusted with responsibility, there simply isn't a big 
enough army of overseers to watch them all. If their basic 
motivation is deceit, then it's going to be tough.
    Mr. Falcon. Right.
    Mr. Shadegg. We're going to have problems with them and 
it's really unfortunate because vastly expanding the regulatory 
structure just means you need smarter people to get around it 
and I'm not certain that's a very good answer. We need a 
culture of people who say I'm not looking at the letter of the 
law. I'm looking at my obligation to the people for whom the 
law was intended to protect.
    Mr. Chairman, I yield back the balance of my time.
    Mr. Stearns. I thank the gentleman. The gentleman from 
Ohio.
    Mr. Strickland. No questions.
    Mr. Stearns. No questions. The gentlelady from California.
    Ms. Solis. Actually, just more of a comment. I too am 
overwhelmed to hear all these statements being made and I would 
just ask the reforms that you are proposing, do you really 
believe that that's going to require a change in behavior?
    Mr. Falcon. I think part of the problem has generated from, 
as we said in the report, a tone at the top. And aside from all 
of the additional corporate governance requirements and 
statutory changes that we're requesting to strengthen 
oversight, we also fundamentally need to make sure that there 
is a new corporate culture that's brought about, where the tone 
at the top is one of strict integrity and compliance with rules 
and regulations. That's something that we are looking at very 
closely and tracking very closely and so far, we're encouraged 
by the new tone we're seeing by the new CEO and Chairman that 
was brought into the company and the activities that the 
company has taken by way of remedial reforms.
    So we have to make sure that there's a new corporate 
culture. Along the lines of what Mr. Shadegg said, everyone has 
to fulfill their own responsibilities.
    Ms. Solis. I would just add that obviously these 
institutions, Fannie Mae and Freddie Mac, play an essential 
role in communities like mine where we are in a phase where 
we're not able to secure enough capital to provide sufficient 
housing for low income and middle income families and the 
integrity of these programs, obviously, are very reflective of 
what we as Members of Congress support. We have different 
activities, in fact, with some of these organizations in our 
Districts, so that doesn't sit well for us when we have to go 
home and our constituents are reading about all this 
mismanagement and somewhat collusion--I hate to use that word, 
but that's what it sounds like to me from reading your 
testimony, that there's collusion on the part of the accounting 
firms with these organizations.
    We're not satisfied with that and I know there's 
legislation being proposed and we're certainly going to be 
monitoring that and hopefully, we're going to see that there is 
more transparency made available to the public.
    Mr. Falcon. I fully support that, Congresswoman.
    Mr. Stearns. I thank my colleague. I was just going to ask 
a couple of questions before you leave, Mr. Falcon and if 
anyone else would like to ask a few additional follow-up 
questions.
    You issued a fine of $125 million and I think you also were 
trying to get some of their stock options or some of their 
compensation back. How successful have you been on that?
    Mr. Falcon. We're taking an action that's pending right now 
that I can't discuss too much because it's the subject of 
litigation. We are moving to require that the former Chairman 
of the Board and CEO, as well as the Chief Financial Officer of 
the company, be terminated for cause which could result in 
their losing approximately $25 million or more, in addition to 
some recovery of past bonuses and other benefits they received.
    Mr. Stearns. How much would that add up to? What would be 
the whole package that you're asking that they return? $25 
million plus bonuses, plus stock options?
    Mr. Falcon. For these two individuals, I think the total 
might approach possibly $32 million.
    Mr. Stearns. $32 million you're asking for a return of?
    Mr. Falcon. Right. In the case of another individual, the 
former Vice Chairman of the company, he was terminated for 
cause which resulted in his loss of substantial severance 
benefits. What we're trying to do, Mr. Chairman, is set a clear 
standard that if top management of a company engages in 
misconduct, those individuals should be terminated for cause 
and not just allowed to resign and walk away with the financial 
windfall.
    We're being challenged on it, but it's a principle that 
we're going to continue to fight for.
    Mr. Stearns. The other point I wanted to make is you gave a 
fine to Freddie Mac, but the question I have, shouldn't the 
people who are involved with the accounting, the engineering--
financial engineering, shouldn't some of thee people who are 
not the CFO and the president and so forth, chairman of the 
board, shouldn't these people also be fired in your opinion and 
why haven't--have you recommended that because the people that 
are at the highest level of management can set the culture, but 
the people who execute the things that have led to the scandal, 
shouldn't they also be terminated?
    Mr. Falcon. And some of them have, Mr. Chairman, some of 
them have.
    Mr. Stearns. Have you recommended and identified who those 
folks were?
    Mr. Falcon. Yes. We've been working with the company, now 
the former head of their investment at finance division which 
structured many of these transactions, became the CEO of the 
company. At the direction of myself, that individual has been 
replaced.
    Mr. Stearns. Ms. DeLeo, do you also feel that the people 
who are in the sort of second tier of management should also be 
eliminated and fired?
    Don't you think there's culpability there as well as the 
top people?
    Ms. DeLeo. I think that's a decision that we have to look 
at and that Freddie has to look at.
    Mr. Stearns. Are you looking at that now and have you 
identified those people and know what they did wrong?
    Ms. DeLeo. Yes, we have been.
    Mr. Stearns. Because the Doty report would indicate that 
these folks were exploiting these anomalies and I think if 
they're exploiting them that that's wrong and they should be 
implicated too and I'm just wondering, we don't hear about the 
termination of those people. Had there been many terminations 
by those folks?
    Mr. Falcon. There have been at least two dozen individuals, 
I believe, who have faced the range of sanctions from 
reprimands to loss of bonuses to termination for the company, 
depending on the level of conduct that they engaged in.
    Mr. Stearns. Okay. Anyone else? Yes.
    Ms. Schakowsky. Thank you, Mr. Chairman. Mr. Falcon, in 
your statement, you talk about executive compensation and I was 
wondering--I was hoping in asking if we could get a copy of the 
OFHEO study of executive compensation of Freddie and Fannie 
which has been presented to the Financial Services Committee.
    I understand that Fannie Mae has retained the services of 
former Clinton prosecutor Ken Starr who is reportedly trying to 
keep the Financial Services Committee from releasing that 
report and so I am asking you if we can get a copy of that 
report for the record.
    [The report is retained in subcommittee files.)
    Mr. Falcon. I'd be happy to provide it to you, to the 
Committee, Congresswoman. The information was information on 
the salary and total benefits of the senior most individuals of 
the two companies. We provided it to the House Financial 
Services Committee with the understanding that it is 
confidential information and I believe we can provide it to you 
as well.
    Ms. Schakowsky. To the extent that you say that 
compensation of senior executives contributed to the improper 
accounting and management practices of the enterprise, I would 
think that at the very least it should be provided to us, but 
also, I would think that the public has a right to see that as 
well.
    Mr. Falcon. What that is referencing to is their bonus was 
structured in a way that I think 40 to 60 percent of the 
bonuses were dependent upon achieving these earnings targets. 
That's what that is in reference to. But we'll certainly work 
to fulfill your request, Congresswoman.
    Ms. Schakowsky. And what is the rationale for it being 
confidential?
    Mr. Falcon. Only the information related to the top five 
individuals at the company is subject to the public disclosure 
standards. It's the same as for every corporation. This list 
went beyond the top five individuals and included compensation 
for individuals that are covered by our excessive compensation 
regulation. It's a list of approximately 20 or so individuals 
for each company.
    Ms. Schakowsky. Well, I think it is worth having a 
discussion about what portions at the very least of that should 
be made public. The issue is one, I think, that should be open 
to scrutiny by more than just members of the Committee, but I 
thank you for your willingness to make it available to us.
    Mr. Issa. Would the gentlelady yield?
    Ms. Schakowsky. Yes.
    Mr. Issa. If you struck the names of those 20 individuals 
and released the information as to their programs and incentive 
without personal information, would that eliminate the concern 
of privacy and allow for more broad evaluation?
    Mr. Falcon. Possibly, Congressman. May I ask that our 
counsels work with the Committee on this issue?
    Mr. Issa. Would the gentlelady consider that acceptable as 
a starting point?
    Ms. Schakowsky. Well, as a starting point, but I still 
think that full disclosure is in order.
    And let me ask you this, have the executive compensation 
practices changed at Freddie Mac since your report and since 
all of these problems have been revealed?
    Mr. Falcon. Yes, they have, Congresswoman. The emphasis on 
short-term earnings is no longer part of that compensation, the 
bonus of that structure. They have worked to correct that 
problem.
    Ms. Schakowsky. Thank you. I look forward to seeing it.
    Mr. Stearns. Thank you. The gentleman from California 
declines. Okay. I think there's no one else, so Mr. Falcon and 
Ms. DeLeo, we appreciate both of you being here and we'll go to 
the next panel.
    Thank you.
    Mr. Martin Baumann, Chief Financial Officer, Freddie Mac. 
We welcome you to the table and we appreciate your 
participation and look forward to your opening statement.
    [Off mic conversation.]
    Mr. Stearns. Maybe I'll ask counsel if there's any legal 
restraining order, but we'll take that when we get to report. 
We'll move forward.
    Mr. Baumann, let me welcome you and we appreciate your 
opening statement.

   STATEMENT OF MARTIN F. BAUMANN, CHIEF FINANCIAL OFFICER, 
                          FREDDIE MAC

    Mr. Baumann. Thank you, Chairman Stearns, Ranking Member 
Schakowsky and members of the subcommittee. It's a pleasure to 
be here this morning.
    My name is Martin F. Baumann. I am the Executive Vice 
President and Chief Financial Officer of Freddie Mac. I joined 
Freddie Mac in April 2003. I was hired to build a strong 
finance function within Freddie Mac and to restore confidence 
in the company's financial reporting. I am committed to 
developing an exemplary finance function that produces 
accurate, timely, well-controlled and transparent financial 
reports.
    Prior to joining Freddie Mac, I worked at PriceWater-
houseCoopers for more than 30 years as a partner, as deputy 
chairman of the World Financial Services Practice, and as the 
Global Banking Leader.
    I welcome the opportunity to be here today to provide 
Freddie Mac's views on the use of fair value-based measures, to 
discuss the accounting errors addressed by our restatement and 
to discuss Freddie Mac's on-going corporate-wide remediation 
program.
    Freddie Mac has been working hard to regain the confidence 
of all of our stakeholders. Last year we completed the 
restatement and began implementing a corporate-wide remediation 
program to ensure that the accounting and financial control 
issues that led to the need for the restatement will never 
happen again.
    Today, Freddie Mac is focused on bringing our financials 
current. We believe our accounting policies for the restatement 
periods are fully compliant with GAAP and we are completely 
committed to using GAAP as the primary underpinning for our on-
going communications with our shareholders and other interested 
parties.
    Freddie Mac's mission is to ensure a stable supply of low 
cost mortgages for America's families, whenever and wherever 
they need them. Despite our difficulties last year, we 
maintained our focus on fulfilling our special responsibilities 
to home buyers, the public, Congress and investors.
    Freddie Mac has the right leadership to attain our goals in 
our new Chairman and CEO, Dick Syron. Dick has extensive 
expertise and is committed to our important public mission and 
to regaining the full confidence of the public and our 
stakeholders.
    Before I comment on the accounting errors addressed by 
Freddie Mac's restatement of prior years' results, I would like 
to offer some views on principle-based accounting, fair value 
and GAAP.
    Mr. Chairman, as I stated during my appearance before this 
subcommittee last summer, I am fully supportive of your efforts 
to move GAAP to a principles-based framework. I believe that a 
principles-based approach could ensure that all reporting 
companies meet the substance and not simply the form of 
accounting rules.
    The move to greater use of fair values is another important 
step in accounting. Over the years, the FASB has made 
significant progress toward increasing the use within GAAP of 
fair value-based measures for financial instruments. Freddie 
Mac is committed to providing investors with the information 
they need to understand how we view and manage our business.
    To that end, we are preparing to become one of the first 
financial institutions to provide investors with a full, fair 
value balance sheet on a quarterly basis which will show mark-
to-market gains and losses on our business and provide 
investors with an additional measurement tool, along with our 
GAAP financial statements.
    The restatement was a significant step in Freddie Mac's 
progress toward achieving accurate and timely financial 
reporting. We're now completing our annual report for 2002 and 
the latest stockholders' meeting will be held on March 31, 
2004. We completed the restatement while maintaining our 
business fundamentals and delivering on our congressional 
mandate to make mortgage credit more available for America's 
families.
    We remain fully committed to our mission of helping make 
housing more affordable for more Americans and maintaining 
liquidity in the housing market which, for the past several 
years, has bolstered the U.S. economy.
    The restatement did not affect the fundamental strength of 
Freddie Mac's business. Freddie Mac's business operations 
remain strong and interest rate risk and credit risk remain 
low. Our risk profile remains conservative with an average 
duration gap of zero for December 2003, unchanged since 
October.
    For anyone not familiar with the concept of a duration gap, 
a zero duration gap means that, in general, changes in the 
value of assets due to changes in interest rates are expected 
to be equally offset by changes in the value of liabilities and 
derivative contracts.
    Now I'd like to comment on the accounting corrections made 
in connection with the restatement of Freddie Mac's financial 
statements. The accounting errors addressed by the restatement 
fall into five categories: securities classifications, 
accounting for derivative instruments, asset transfers and 
securitizations, valuation of financial instruments, and other 
corrections. Detailed information on these accounting errors is 
provided in our restatement press release.
    Freddie Mac has accepted the conclusions of the report of 
the Board's independent investigative counsel, Baker Botts. 
That report found that the principal factors contributing to 
the restatement were lack of sufficient accounting expertise 
and internal control and management weaknesses as a consequence 
of which Freddie Mac personnel made numerous errors in applying 
GAAP.
    In addition, certain capital market transactions were 
executed and certain accounting policies were implemented with 
a view to their effect on earnings in the context of Freddie 
Mac's goal of achieving steady earnings growth. Also, certain 
reserve accounts and other adjustments which were known 
departures from GAAP, but were not considered to be material at 
the time, were also made with a view to their effect on 
earnings.
    In addition to completing the restatement of prior year 
financial results, Freddie Mac is currently engaged in an 
active remediation program that began in the spring of 2003 
when the governance committee of the Board of Directors asked 
me to develop a remediation program to ensure that the factors 
contributing to the need for the restatement would not recur. 
Our program combines the steps required by the December 9, 2003 
consent order between Freddie Mac and OFHEO, Freddie Mac's 
safety and soundness regulator, with the actions that were 
underway in our pre-existing remediation program.
    The remediation program demonstrates our commitment to 
create a corporate culture in which the type of problems that 
led to the restatement will never happen again.
    We are building upon our very significant efforts to 
improve the quality and depth of internal accounting personnel, 
the strength of the accounting function and management 
oversight of that function. This has been and continues to be a 
key priority of the company in the wake of the restatement.
    We are also working to create and implement new 
infrastructure and systems to ensure the quality, integrity, 
transparency and timeliness of our financial reporting. 
Together with Freddie Mac's new chairman and CEO, as well as 
our senior management team, I will ensure that we set the right 
tone at the top, one that promotes integrity, high ethical 
standards and the importance of compliance.
    Freddie Mac's Board of Directors, current management team 
and employees are continuing to improve our reporting, 
governance and financial controls. Now that the restatement is 
complete, we are focused on bringing our financials up to date. 
Our objective is to release quarterly and full year 203 results 
by June 30, 2004 and to provide the 2003 annual report and hold 
the related stockholders meeting as soon as possible 
thereafter.
    Freddie Mac remains irrevocably committed to completing the 
process of voluntarily registering its common stock with the 
Securities and Exchange Commission under the Securities 
Exchange Act of 1934, with the objective of completing the 
process, as soon as possible, after the company's return to 
timely reporting.
    Freddie Mac recognizes the importance of transparent 
accounting and reporting standards and we're committed to 
providing investors with the information they need who 
understand how we view and manage our business. We have already 
taken significant steps toward achieving our goal of exemplary 
financial reporting and controls. The work that we have done 
and continue to do as a part of the remediation program will 
enable us to reach that goal.
    As we complete this work, we are continuing to fulfill our 
important public mission, maintain our safety and soundness and 
meet our business objectives.
    Thank you for the opportunity to appear today. I look 
forward to working with you and the members of this 
subcommittee, Chairman Stearns, and Congresswoman Schakowsky, 
as you focus on financial accounting standards. I will be happy 
to answer any questions the subcommittee might have.
    [The prepared statement of Martin F. Baumann follows:]
   Prepared Statement of Martin F. Baumann, Chief Financial Officer, 
                              Freddie Mac
    Thank you, Chairman Stearns and Members of the Subcommittee. It is 
a pleasure to be here this morning.
    My name is Martin F. Baumann. I am the Executive Vice President and 
Chief Financial Officer of Freddie Mac. I joined Freddie Mac in April 
2003. I was hired to build a strong finance function within Freddie Mac 
and to restore confidence in the company's financial reporting. I am 
committed to developing an exemplary finance function that produces 
accurate, timely, well-controlled and transparent financial reports.
    Prior to joining Freddie Mac, I worked at PricewaterhouseCoopers 
for more than 30 years as a partner, as deputy chairman of the World 
Financial Services Practice, and as the Global Banking Leader. At 
PricewaterhouseCoopers, I was responsible for certifying the financial 
statements of some of the largest United States and international 
banking, insurance and other financial services companies.
    I welcome the opportunity to be here today to provide Freddie Mac's 
views on the use of fair value-based measures within generally accepted 
accounting principles (GAAP), to discuss the accounting errors and 
related corrections addressed by our restatement, and to discuss 
Freddie Mac's ongoing corporate-wide remediation program.
    Last year was a challenging year for Freddie Mac. In January, we 
announced a restatement of prior-year earnings and in June, our Board 
of Directors made changes in the company's senior management.
    Freddie Mac has been working hard to regain the confidence of all 
of our stakeholders. We have completed the restatement of prior-year 
financial results and we are implementing a corporate-wide remediation 
program to ensure that the accounting and financial control issues that 
led to the need for the restatement will never happen again.
    Freddie Mac's mission is to ensure a stable supply of low cost 
mortgages for America's families--whenever and wherever they need them. 
We recognize our special responsibility to homebuyers, the public, the 
Congress and investors. Despite our difficulties last year, we 
maintained our focus on fulfilling these important responsibilities.
    Today, Freddie Mac is focused on bringing our financials current. 
We are building an environment that will allow us to provide 
comprehensive and understandable information about our company, 
incorporating the highest level of financial transparency, accounting 
controls, compliance, and professional standards.
    GAAP is the foundation for all financial reporting. We believe 
Freddie Mac's accounting policies for the restatement periods are fully 
compliant with GAAP, and we are completely committed to using GAAP as 
the primary underpinning for our on-going communications with our 
shareholders and other interested parties.
    Freddie Mac has the right leadership to attain our goals in our new 
Chairman and Chief Executive Officer, Richard F. Syron. Dick has 
extensive industry expertise, and corporate leadership and financial 
experience, having led a Fortune 500 firm, served as chairman and chief 
executive officer of the American Stock Exchange, and served as the 
president of the Federal Reserve Bank of Boston and as president of the 
Federal Home Loan Bank of Boston. He is committed to our important 
public mission and to regaining the full confidence of the public and 
our stakeholders.
    Before I provide an overview of the accounting errors and related 
corrections addressed by Freddie Mac's restatement of prior-year 
results, I would like to offer some views on principles-based 
accounting, and fair value and GAAP.
                      principles-based accounting
    The Securities and Exchange Commission and the Financial Accounting 
Standards Board (FASB), among others, have been studying the potential 
efficacy of adopting a U.S. financial reporting system based on 
principles-based standards.
    Mr. Chairman, as I stated during my appearance before this 
Subcommittee last summer, I am fully supportive of your efforts to move 
GAAP toward a principles-based framework. I believe that a principles-
based accounting framework holds the potential to improve the 
representational faithfulness of financial reporting under U.S. GAAP. A 
principles-based approach could ensure that all reporting companies 
meet the substance, and not simply the form, of accounting rules.
    I look forward to working with you, Mr. Chairman, and with the 
Members of this Subcommittee as you work toward this new accounting 
framework.
                          fair value and gaap
    Fair value measurement is having an increasingly important role for 
purposes of GAAP financial reporting and disclosure. Over the years, 
the FASB has made significant progress toward increasing the use within 
GAAP of fair value-based measures for financial instruments.
    Capital markets participants have expressed support for fair value 
measurement concepts. And, fair value measures are of increasing 
interest and importance to our investors. Freddie Mac is committed to 
providing investors with the information they need to understand how we 
view and manage our business, so that investors can value our business 
fairly and accurately. To that end, Freddie Mac is preparing to become 
one of the first financial institutions to provide investors with a 
full fair value balance sheet on a quarterly basis, which will show 
mark-to-market gains and losses on our business and provide investors 
with an additional measurement tool, along with our GAAP financial 
statements.
     completing our restatement and fulfilling our mission in 2003
    On November 21, 2003, the Freddie Mac Board of Directors and our 
management team announced the release of the company's restated and 
revised financial results for the years 2000 through 2002. The 
restatement was a significant step in Freddie Mac's progress toward 
achieving accurate and timely financial reporting.
    Freddie Mac completed this restatement while maintaining our 
business fundamentals and delivering on our congressional mandate to 
make mortgage credit more available for America's families. For more 
than 30 years, Freddie Mac has helped meet the home financing needs of 
families at all income levels, in all communities, and in all parts of 
the country. Meeting the annual affordable housing goals is a key 
aspect of meeting our mission. In fact, Freddie Mac has successfully 
met all of the permanent affordable housing goals since they were 
established by the Department of Housing and Urban 
Development.1
---------------------------------------------------------------------------
    \1\ Final calculations for the 2003 goals have not yet been 
completed.
---------------------------------------------------------------------------
    We remain fully committed to our mission of helping make housing 
more affordable for more Americans and maintaining liquidity in the 
housing market, which, for the past several years, has bolstered the US 
economy.2 In fulfilling our mission, Freddie Mac plays an 
important role in maintaining the strength of the housing sector, a 
sector that directly accounts for approximately 15 percent of the Gross 
Domestic Product (GDP) and has accounted for 36 percent of the growth 
in GDP over the last two years.3 Furthermore, we have 
contributed to growth in the economy by helping homeowners refinance 
into lower rate mortgages and redeploy some of their housing 
equity.4 These benefits are directly attributable to the 
long-term, prepayable fixed rate mortgage, which our activities make 
widely available.
---------------------------------------------------------------------------
    \2\ According to the National Association of Realtors' announcement 
this past Monday, January 26, 2004, sales of previously owned homes set 
a record high in 2003, totaling 6.1 million--a 9.6 percent increase 
from the previous record set in 2002. In addition, U.S. census data 
through November 2003 show that new home sales continued to increase 
over 2002 and 2001 sales.
    \3\ These percentages are based on data published by the Bureau of 
Economic Analysis, U.S. Department of Commerce for 1996 through 2003 
and data for the same years available upon request from Freddie Mac.
    \4\ See Remarks by Federal Reserve Chairman Alan Greenspan before 
the Annual Convention of the Independent Community Bankers of America, 
Orlando, Florida, March 4, 2003, available online at 
www.federalreserve.gov.
---------------------------------------------------------------------------
    The restatement did not affect the fundamental strength of Freddie 
Mac's business.
    Freddie Mac's business operations remain strong and interest-rate 
risk and credit risk remain low. Our risk profile remains conservative, 
with an average duration gap of zero for December 2003, unchanged since 
October. In fact, we maintained a low duration gap throughout 2003.
    Now, I would like to provide an overview of the accounting 
corrections made in connection with the restatement and revision of 
Freddie Mac's financial statements.
                         accounting corrections
    Freddie Mac has classified the accounting errors and related 
corrections addressed by the restatement into five categories. These 
five categories involve subjective judgments by Freddie Mac regarding 
classification of amounts and particular aspects of these errors may 
fall within one or more of these categories. While these 
classifications are not required under GAAP, Freddie Mac believes these 
classifications may assist investors in understanding the nature and 
impact of the corrections made in completing the restatement.
    These errors and accounting changes are described in detail in 
Freddie Mac's press release announcing the restatement, and in 
particular, in Appendix II, ``Detailed Discussion of Accounting Errors 
and Other Changes'' and Appendix III, ``Fair Value and Interest-Rate 
Risk Measures.'' A copy of our press release and the accompanying 
appendices is available online at www.freddiemac.com.
                        Security Classification
    Freddie Mac is required to classify its investments in one of three 
categories--held-to-maturity, available-for-sale, or trading--primarily 
based on management's investment intention at the time the company 
acquires a security. During the restatement period, Freddie Mac engaged 
in transactions involving securities in the held-to-maturity category 
that management accounted for as financings, but should have accounted 
for as sales. Accordingly, GAAP requires management to reclassify all 
securities previously classified as held-to-maturity into the 
available-for-sale category and to discontinue use of the held-to-
maturity accounting classification for all securities until at least 
2004, approximately two years after the last transaction giving rise to 
this error.
    During the restatement period, management also transferred 
mortgage-related securities that it had designated for accounting 
purposes as trading into both the held-to-maturity and available-for-
sale classifications when it should have retained the trading 
classification for these securities. Management has reversed this 
misclassification and recorded unrealized gains and losses on the 
securities in earnings for the appropriate period.
Accounting for Derivative Instruments
    Freddie Mac applies risk-management strategies with strict 
discipline. We use derivatives to manage interest-rate risk associated 
with financial assets and liabilities. We believe the accounting issues 
associated with derivatives identified in the restatement have not 
affected the performance of the company's derivatives from a risk 
management perspective. As part of the restatement, management has 
corrected several errors in the company's accounting for derivatives. 
These corrections consisted of removing from earnings previously 
reported gains and losses related to hedged items for a portion of the 
company's fair value hedges and recording in earnings previously 
deferred gains and losses for a portion of the company's cash flow 
hedges.
Asset Transfers and Securitizations
    Whenever Freddie Mac sells Mortgage Participation Certificates 
(PCs), GAAP requires the guarantee fee stream to be recorded as a 
retained interest (the guarantee asset) and the associated obligation, 
including the guarantee of payments of principal and interest to 
security holders, as a liability (the guarantee obligation). Freddie 
Mac failed to do this. To correct this error, management has recorded 
the guarantee asset and guarantee obligation for PCs and other mortgage 
securities sold by the company during the restatement period and 
included these amounts in the determination of gain or loss on sale. 
Subsequent to the sale, Freddie Mac has reported the guarantee asset 
and obligation at fair value with changes included in earnings.
Valuation of Financial Instruments
    During the restatement period, Freddie Mac made numerous errors in 
estimating the fair value of the company's derivatives and securities. 
Management has corrected these errors in estimating fair value as well 
as other errors identified after extensive review of valuation 
methodologies and results. In addition to the corrections affecting the 
financial statements, management has incorporated the results of this 
re-valuation in Freddie Mac's Fair Value Balance Sheets as of December 
31, 2002 and 2001.
Other Corrections
    During the restatement process, management identified numerous 
other accounting policies and practices requiring correction, and has 
taken corrective action. These other corrections are discussed in the 
restatement press release available online at www.freddiemac.com.
                          remediation program
    In addition to completing the restatement of prior-year financial 
results, Freddie Mac is currently engaged in an active remediation 
program. This program combines the steps required by the December 9, 
2003 Consent Order between Freddie Mac and OFHEO, Freddie Mac's safety 
and soundness regulator, with the actions that were underway in our 
preexisting remediation program.
    Our remediation program began in the spring of 2003 when the 
Governance Committee of the Board of Directors asked me to develop a 
remediation program to ensure that the factors contributing to the need 
for the restatement would not recur. Thereafter, the Board of Directors 
approved a comprehensive remediation program that has been--and is--
effecting far-reaching changes in the company's financial reporting, 
control and management functions.
    The Consent Order added further key items to our existing 
remediation program resulting in an enhanced comprehensive remediation 
program designed to ensure the integrity of Freddie Mac's financial 
reporting, controls and governance, and also to prevent a recurrence of 
the problems that led to the need for the restatement.
    The activities we have already undertaken as part of the 
remediation, and our continuing plans, including fulfilling the 
requirements of the Consent Order, demonstrate our commitment to create 
a corporate culture in which the type of problems that led to the 
restatement will never happen again.
                         key remediation steps
    Freddie Mac is building upon its very significant efforts to 
improve the quality and depth of internal accounting personnel, the 
strength of the accounting function, and management oversight of that 
function. This has been, and continues to be, a key priority of the 
company in the wake of the restatement.
    The company has added over 100 professionals in the accounting, 
reporting and control areas, including a significant number of new 
officers and senior managers.
    We have also retained leading experts in the areas of public 
disclosures and corporate governance to assist the company in designing 
and implementing processes and practices in these areas. In October 
2003, we hired a Senior Vice President--Chief Compliance Officer who is 
responsible for overseeing Freddie Mac's compliance with policies, 
procedures and practices, including compliance with laws and 
regulations.
    Additionally, in October 2003, we created the position of Chief 
Enterprise Risk Officer.
    We are also working to create and implement new infrastructure and 
systems to ensure the quality, integrity, transparency, and timeliness 
of our financial reporting.
    Finally, we have taken steps to ensure that Freddie Mac's corporate 
culture promotes integrity, high ethical standards, and the importance 
of compliance. Virtually all of our employees have completed a 
corporate-wide training program on the company's Code of Conduct and 
the provisions of the Sarbanes-Oxley Act.
                             looking ahead
    Through the extraordinary efforts of Freddie Mac's Board of 
Directors, current management team, and employees, we have met the 
challenges of the past year, and we are looking forward to continuing 
to improve our reporting, governance, and financial controls.
    Throughout this difficult and challenging period, Freddie Mac has 
focused on ensuring that we will emerge a stronger, more disciplined 
company. And, we have done so while remaining fully committed to 
fulfilling our mission.
    We are bringing our financial statements current and building for 
the future. The company expects to provide an annual report for 2002 
and has announced the related annual stockholders' meeting to be held 
on March 31, 2004. Our objective is to release quarterly and full-year 
2003 results by June 30, 2004 and to provide the 2003 annual report and 
hold the related stockholders' meeting as soon as possible thereafter.
    Freddie Mac remains irrevocably committed to completing the process 
of voluntarily registering its common stock with the Securities and 
Exchange Commission under the Securities Exchange Act of 1934, with the 
objective of completing the process as soon as possible after the 
company's return to timely reporting. Freddie Mac reaffirmed this 
commitment in a letter to Treasury Secretary John Snow on July 14, 
2003, in our restatement announcement and in other public statements.
                               conclusion
    Freddie Mac recognizes the importance of transparent accounting and 
reporting standards and we are committed to providing investors with 
the information they need to understand how we view and manage our 
business. We fully support the Subcommittee's efforts to move toward a 
principles-based accounting framework.
    While the restatement represented an important milestone, now that 
it has been completed, Freddie Mac is focused on bringing our 
financials up-to-date. We have already taken very significant steps 
toward achieving our goal of exemplary financial reporting and 
controls. The work that we have done, and continue to do, as part of 
our remediation program will enable us to reach that goal. As we 
complete this work, we will continue to fulfill our important public 
mission, maintain our safety and soundness, and meet our business 
objectives.
    Thank you for the opportunity to appear today. I look forward to 
working with Chairman Stearns and the Members of this Subcommittee as 
you focus on financial accounting standards. I would be happy to answer 
any questions the Subcommittee might have.

    Mr. Stearns. Mr. Baumann, thank you very much and thank you 
for appearing and I think we're all encouraged now that you're 
the new CFO, that a lot of the changes will be made and that 
you'll stay on top of it.
    Were you one of the auditors, not working for the company, 
but an outside auditor when this occurred?
    In other words, what was your role, before you were CFO you 
said your experience was as an auditor.
    Mr. Baumann. Yes.
    Mr. Stearns. Had you been involved with Freddie Mac in any 
way?
    Mr. Baumann. I was a partner at PriceWaterhouseCoopers, 
with PriceWaterhouseCoopers for 33 years.
    Mr. Stearns. And PriceWaterhouseCoopers was their auditors?
    Mr. Baumann. PriceWaterhouseCoopers became Freddie Mac's 
auditors in 2002, replacing Arthur Andersen. That's correct.
    Mr. Stearns. Okay, and when you talked to your colleagues 
back at PriceWaterhouse in your new position, did they ever 
tell you some things that they feel should still be done?
    Mr. Baumann. PriceWaterhouseCoopers issues a variety of 
many recommendations to management, to the board about things 
that we need to do to improve the internal controls and 
accounting expertise at Freddie Mac. I've been meeting with the 
Price
WaterhouseCoopers team that's on the ground, doing the work on 
a regular basis, listening to their recommendations and 
findings and trying to implement as many of those 
recommendations as we can, as quickly as we can to improve the 
accounting expertise and internal controls of the company.
    Mr. Stearns. Does Freddie Mac still have a financial 
engineering department?
    Mr. Baumann. I don't know that Freddie Mac ever had a 
department that was----
    Mr. Stearns. Or just financial engineering----
    Mr. Baumann. But we do not have any financial engineering 
department today. Our transactions are recorded completely in 
accordance with GAAP.
    Mr. Stearns. What happened to the head of the financial 
engineering that I talked to Mr. Falcon about earlier? Is he 
still there?
    Mr. Baumann. As I said, I don't know about a financial 
engineering department, but let me say this, as part of the 
program to change prior management, the former CEO, the former 
Chief Operating Officer, the former Chief Financial Officer, 
the former Comptroller, former Chief Investment Officer, the 
former General Counsel and many other people in the company 
have been let go from the company.
    Mr. Stearns. But Mr. Falcon indicated there was a financial 
engineering department. He described what they did. It was 
confirmed by Ms. DeLeo, so my question is do you think that 
department still exists in maybe some kind of form? Is it still 
using its skill to influence earnings?
    Mr. Baumann. There is no financial engineering component in 
the company today. I am responsible for all financial reporting 
of the company and I ensure that financial reporting is fully 
in accordance with GAAP and I have no responsibility for bottom 
line earnings. My job is to make sure that our financial 
results are reported in an unbiased, accurate, reliable and 
transparent way.
    Mr. Stearns. In your opening statement, I believe you said 
this, certain transactions were entered into with a review to 
influence toward influencing earnings. Is that true?
    Mr. Baumann. I said certain transactions were entered into 
with the view to their effect on earnings, yes.
    Mr. Stearns. I'm not a security lawyer, but I would 
indicate that's code for securities fraud. If you're actually 
entering into a review toward influencing earnings, in your 
estimation are you still doing that?
    Mr. Baumann. We are not entering into any transactions 
today with a view to their effect on earnings in terms of 
trying to influence what the accounting results will be.
    Mr. Stearns. But your statement has indicated that in the 
past that's what they were doing?
    Mr. Baumann. The Baker Botts report that was done, the 
investigative report determined that certain capital markets 
transactions and certain reserve accounts were maintained with 
the view to their----
    Mr. Stearns. Influencing earnings. Now your 30 years with 
PriceWaterhouse wouldn't you interpret, if you met some people 
in a corporation doing that, you're an outside auditor coming 
in and they were using transactions and entering them primarily 
to influence earnings, wouldn't you consider that fraudulent 
today?
    Mr. Baumann. Well, that was not my job at 
PriceWaterhouseCoopers. My job was to report on the financial 
statements and report matters if they were inappropriate to 
Securities and Exchange Commission and other regulatory 
authorities who would have the responsibility for making those 
determinations.
    At Freddie Mac, there have been two investigations so far; 
one by the Baker Botts firm, one by OFHEO, who has issued a 
comprehensive report. There's an on-going investigation by the 
Securities and Exchange Commission, the U.S. Attorney's Office 
and there are more than 12 civil suits all looking at what the 
causes of the restatement were.
    We focus every day on----
    Mr. Stearns. I understand. I'm just trying to look at this 
as an outsider because if I hear an accountant is trying to be 
competent and something occurs because he's incompetent, that's 
one thing. But if a person strictly is sitting there trying to 
influence earnings by manipulating transaction, I would think 
that's a securities fraud. But that's just based upon what you 
said in the past.
    Let me ask you this, OFHEO's report states that no one at 
Freddie Mac took responsibility for public disclosures and this 
led to inaccurate financial reporting. I guess what has Freddie 
Mac done to remedy this management deficiency?
    Mr. Baumann. I have absolute responsibility for financial 
disclosures and all disclosures at Freddie Mac and my job is to 
ensure that all disclosures are complete, accurate, 
transparent, honest and reliable. As I said before, I have no 
responsibility to run the businesses and I have no 
responsibility for what the earnings are of the company. My job 
is to ensure that all of our disclosures are complete and 
unbiased and accurate.
    Mr. Stearns. In your opinion of 30 years with 
PriceWaterhouse and your job now as the CFO, should we 
encourage FASB to reform the use of mixed attribute accounting 
so that abuses like these described in the Doty report do not 
occur in the future? And if so, what would your recommendation 
be?
    Mr. Baumann. A couple of comments to that. First of all, I 
agree with the comments that were made earlier that it isn't 
the accounting rules that caused the restatement, it was the 
fact that the company lacked expertise in implementing those 
rules. That was the real problem. Having said that I do agree 
with the initiatives, Congressman Stearns, that you are 
embarking upon to improve principles-based accounting, such 
that reports cannot be filed, but simply comply with rules, but 
at the same time, may not tell the whole story. Principles-
based accounting and disclosures, in my mind, today even, 
disclosures in my mind, require companies to ensure that the 
entire story is told even if rules are complied with.
    So further efforts on principles-based accounting to ensure 
that, I agree with.
    In addition to that, movement toward fair value accounting 
so that there isn't a mixed model of some assets of fair value, 
some at cost, some liabilities at cost could create greater 
understanding of financial statements.
    Mr. Stearns. So you would not be using mixed attribute 
accounting in the future?
    Mr. Baumann. Freddie Mac has to comply with GAAP and we 
will comply with GAAP and today's GAAP does have certain mixed 
attribute accounting requirements.
    Mr. Stearns. So you'll still use it?
    Mr. Baumann. We have to use what the accounting rules are 
and fully disclose information. In addition to that, we've said 
we are supplementing that with further disclosures quarterly 
around fair values.
    Mr. Stearns. Will you also provide fair value accounts?
    Mr. Baumann. We have said, first of all, GAAP requires that 
certain fair value information be provided annually. We have 
said that it is our intention, in addition, to provide fair 
value information and full fair value balance sheet on a 
quarterly basis going forward.
    Mr. Stearns. My time has expired.
    Ms. Schakowsky. Thank you, Mr. Baumann, I appreciate the 
tough talk and I'm serious about that, that an acknowledgement 
of the problems that were and a commitment to make the changes. 
The one thing I noticed when you talked about what your 
responsibilities were for disclosure, you didn't mention 
timely.
    And I'm concerned in your testimony when you said the 
objective of completing the process, that is voluntarily 
registering common stock with the SEC ASAP, as soon as 
possible, as opposed to exactly when? Now we know that--and you 
referred to--you affirmed the commitment that you had made, 
that had been made in July--you had made, yes, in July of 2003 
in the restatement announcement and other public statements.
    So when is this exactly going to happen? Fannie Mae, even 
with their accounting problems, already did it last March. I 
understand that it will be close to 2005 before you register.
    Mr. Baumann. Congresswoman, if I omitted timely in my 
response to questions to Chairman Stearns, it was an error. My 
oral statement did say that I'm committed to developing an 
exemplary finance function that produces accurate, timely, well 
controlled and transparent financial reports.
    First thing Freddie Mac had to do was to complete the 
restatement of prior years and as indicated in our restatement 
press release, the company made many accounting errors in the 
past. Correcting those errors means also correcting some 
financial infrastructure in the company to build accounting 
systems that are based on the right rules, not the wrong rules. 
We're doing that right now as quickly as possible. I've engaged 
all the major, really all the major consulting firms, are 
working with us in many ways to build that infrastructure as 
quickly as possible and as accurately and reliably as possible 
so we can get our financial statements, current, timely and 
continue with the 1934 Act registration process.
    I've met with the Securities and Exchange Commission 
already and they have agreed that as soon as we get our 2002 
annual report issued----
    Ms. Schakowsky. Which is when?
    Mr. Baumann. February, which will be in February, our 2002 
annual report, that the SEC is willing to re-engage with us in 
discussing the registration process so we can begin a draft of 
the filing such that as soon as we become current in our 
financial reports, that we could be registered with the SEC as 
promptly as possible.
    Ms. Schakowsky. And when is 2003 going to be done?
    Mr. Baumann. We've stated that our objective is to release 
our 2003 results by June 30, 2004. And as I indicated, that's 
the function of building the accounting infrastructure that we 
need to ultimately get timely in the long term as well as 
getting the results out the door.
    Ms. Schakowsky. Timely being 6 weeks after the quarter?
    Mr. Baumann. Approximately and that's with the SEC 
guidelines, that's correct. That's approximately the timeframe.
    Ms. Schakowsky. Well, if you were registered with the SEC, 
it would be approximately. That would be what it is.
    Mr. Baumann. It's 45 days, the rules, and they are coming 
down to 35 days over the next year, that's correct.
    Ms. Schakowsky. The legislation that would remove the 
exemption, does Freddie Mac have a position on that 
legislation?
    Mr. Baumann. The 1933 Act legislation on the registration 
of securities is really designed to help consumers, more so 
than to help Freddie Mac. It's very important that consumers 
getting mortgages are able to look in an interest rate on their 
house. They're able to do that because of the way the mortgage 
market operates. Mortgage brokers are able to lock in interest 
rates for consumers because of the to be announced mortgage 
market that they can lock in the mortgage rates----
    Ms. Schakowsky. So you support the legislation?
    Mr. Baumann. It would not be good for consumers. It would 
increase the cost of mortgages to homeowners. So we do not 
support that.
    Ms. Schakowsky. I would recommend that you rethink that 
position. I think that there are a lot of people out there that 
would feel a great deal more confidence if Freddie had to abide 
by the same rules as other corporations that already feel that 
how come there hasn't been this full disclosure, while it's 
voluntary. And I think that it would ultimately be in your 
interest to rethink your position on that legislation.
    Let me just ask you--I'm out of time. Thank you, Mr. 
Chairman.
    Mr. Stearns. Thank you. The gentleman from New Jersey is 
recognized, Mr. Ferguson.
    Mr. Ferguson. Thank you, Mr. Chairman. I appreciate Mr. 
Baumann for being here today and certainly appreciate all the 
work that the new management team is going through. Obviously, 
there was a lot of bad thing going on at Freddie and I 
appreciate the tough talk. We appreciate the work that the new 
management team has been putting into place, obviously, very, 
very disconcerting the things that have come out, the things 
that we have learned and the things now that you're sharing 
with us and previous panel was sharing with us this morning.
    I'm actually just interested, I have a couple of questions 
about the restatement and how it's affected the current status 
of the company and some of the financial aspects of the 
company. First, what is the effect that the restatement has on 
your current capital position at the company?
    Mr. Baumann. The restatement increased the company's 
regulatory capital by $5.2 billion, so the fact that the 
earnings were restated upwards strengthened the capital 
position in the company. The company is fully in compliance 
with our capital guidelines and has a very large and healthy 
capital surplus.
    Mr. Ferguson. So in addition to the fact that people should 
have more confidence in the management team because of what's 
been uncovered and the new commitments and the verbal 
commitments and other protections that you put in place with 
the new management team, in addition to perhaps confidence that 
people should have in the new management team, there's also 
perhaps reason to have confidence in the new financial position 
of the company.
    Mr. Baumann. Freddie Mac's financial position has been 
strong throughout this, before the restatement and after the 
restatement, Freddie Mac's financial condition is very strong, 
a strong capital position, as I stated in my testimony. The 
risks that we measure and monitor in our business, interest 
rate risk which is inherent in mortgages and credit risk that 
we guarantee is part of our business, are those risks that we 
maintain control of those risks. Our risk measures are low. Our 
business fundamentals are very sound.
    Mr. Ferguson. So things are actually going very, very well. 
The deceptions and what not of the prior management team, it 
wasn't as if you were doing really poorly and these--the 
misleading facts and reports and accounting practices and what 
not made the company look a little bit better. In fact, the 
company was doing quite well and things were made to look a 
little bit worse than they were because with the restatement 
you're position obviously is much stronger. Would you agree 
with that?
    Mr. Baumann. The reported financial position is $5 billion 
of capital greater than previously before the restatement, so 
the business fundamentals of Freddie Mac were sound before and 
continue to be sound, yes.
    Mr. Ferguson. Following the restatement, what do you owe 
the Federal Government in taxes?
    Mr. Baumann. The additional taxes that were due to the 
Federal Government from the restatement were less than--under 
$30 million. So the restatement had a pretax accounting impact 
of about $7.5 billion, more or less. Then we provided income 
tax from a GAAP accounting perspective of about $2.5 billion, 
but that's deferred taxes that's really not reportable for 
taxes in accordance with tax rules until and unless those 
amounts are realized. It's largely unrealized gains there. So 
the tax liability that additional tax liability that was owed 
was somewhere just slightly less than $30 million.
    Mr. Ferguson. That's all I had for questions, I just wanted 
to wish you well. You've got a long road ahead of you in terms 
of regaining the trust and confidence of people in the 
financial community and the public and certainly taxpayers. It 
seems to be that you're on the right road and obviously the 
company's position is a strong one in terms of financial 
status, but in terms of rebuilding that confidence of your new 
management team, there's obviously a lot of work that still 
needs to be done. You seem to be done on the right track, so we 
certainly wish you well and we're going to continue to monitor, 
of course, your progress, and look forward to working with you 
in the future.
    Thank you, Mr. Chairman.
    Mr. Baumann. Thank you very much.
    Mr. Stearns. And I thank--I echo the encouragement of the 
gentleman from New Jersey.
    Mr. Markey?
    Mr. Markey. Thank you, Mr. Chairman. Mr. Baumann, for 
years, Freddie Mac has opposed the Shays-Markey bill to repeal 
your SEC registration and reporting exemption. In so doing, the 
company has argued that Freddie Mac's current disclosures 
already meet or exceed the SEC's requirements and that Freddie 
Mac was at the vanguard of financial disclosure, accounting 
practices and risk management and that Freddie's disclosure 
``met or exceeded SEC requirements.''
    Based on what you now know about the accounting 
irregularities, disclosure inadequacies and the poor risk 
management at Freddie Mac, wouldn't you agree that those claims 
were simply not true?
    Mr. Baumann. Freddie Mac has acknowledged that the public 
disclosures in the past were less than would have been required 
of an SEC registrant.
    Mr. Markey. Has Freddie Mac reconsidered its previous 
opposition to repeal of your exemption from the full compliance 
with the SEC registration and reporting requirements? Are you 
now willing to support the Shays-Markey bill or some form of 
that that would require full disclosure?
    Mr. Baumann. Congressman, Freddie Mac is committed to 
complete accurate, reliable, transparent, timely disclosures. 
We're going to lead the way in the future about the reliability 
and timeliness of disclosures. We're irrevocably committed to 
registering under the 1934 Act. With respect to the 1933 Act, 
as I commented earlier, we don't believe that's in the best 
interest of consumers. We think the impact of that would be an 
increase in mortgage costs and a lack of availability of locked 
in mortgage rates on 30 year mortgages.
    Mr. Markey. You understand, Mr. Baumann----
    Mr. Baumann. We don't think that's in the best interest----
    Mr. Markey. You understand no one trusts Freddie Mac any 
more, no one trusts the numbers. They don't trust you saying 
that you're voluntarily going to do something. Voluntary 
commitments are like oral commitments. They aren't worth the 
paper that they aren't printed on.
    And we don't trust you. We don't trust your organization. 
We need you to comply with the law, the same law that everyone 
else complies with. You're not going to have the trust of the 
American public, of the investing public, of the Congress, 
unless and until you fully comply with the same disclosure that 
other companies do.
    There's no question that over the years that Freddie has 
been lying about its full compliance, has been lying about the 
fact that it's meeting the same standards as every other 
company in America.
    So you're saying that we can't expect Freddie to have final 
registration statement filed with the SEC and declared 
effective, that you're not going to do that?
    Mr. Baumann. Under the 1934 Act----
    Mr. Markey. No, under the 1933 Act, you're not going to do 
it?
    Mr. Baumann. The SEC has studied this. The Administration 
has studied this issue just last year and determined that it 
was their view that it was not necessary for the agencies to 
register under the 1933 Act and felt that 1934 Act registration 
was appropriate and we are committed to 1934 Act registration.
    Mr. Markey. But you do realize that after that, a scandal 
broke out. They evaluated it. They said it wasn't needed and 
then one of the hugest scandals in financial history broke out 
then at your company. You understand that? You may have made an 
evaluation, but it's obviously the same kind of erroneous 
evaluation that was made about weapons of mass destruction in 
Iran. It turned out that all of the intelligence and analysis 
up until the point at which that scandal occurred was 
inaccurate.
    So I'm asking you again, knowing what you know how, after 
the scandal, do you believe that Freddie should have to comply 
with the 1933 Act requirements?
    Mr. Baumann. Congressman, again, it's our position that 
registering under the 1934 Act will have all of the disclosure 
requirements about our financial condition, the same as any 
other company in America. However, the 1933 Act registration 
would not enhance that at all----
    Mr. Markey. Fine.
    Mr. Baumann. But would be a cost to consumers.
    Mr. Markey. Several months ago, my staff and the 
subcommittee staff asked your staff to provide us with copies 
of the draft registration statement Freddie Mac filed with the 
Commission in November 2002, along with copies of any comments 
provided by the SEC staff on this draft registration statement 
and any related correspondence between Freddie Mac, its legal 
counsel and the SEC staff related to this draft registration 
statement.
    Mr. Baumann, we haven't received any response to this 
request and so I would like to ask you if you are willing to 
commit to providing these documents to the subcommittee?
    Mr. Baumann. As far as we know, we haven't gotten that 
request from the committee. We'd be happy to receive that 
request and do everything we can----
    Mr. Markey. No, you received it. You received that request. 
You received that request.
    Mr. Baumann. I'm told by our lawyers, we didn't receive it 
from the committee, but I'll look into that, Congressman.
    Mr. Markey. So will we receive the information? I'm asking 
you now, will you send it to us? You have now received the 
request. Will you send it to us?
    Mr. Baumann. We'll be happy to our lawyers meet with your 
lawyers to discuss that----
    Mr. Markey. No, I'm asking you, Mr. Baumann. You're in 
charge. Will you give us the information? Not your lawyers 
talking to my lawyers. I'm talking to you. You're the boss.
    Mr. Baumann. Right.
    Mr. Markey. Do you want to give us the information or not? 
Or are you going to continue to play this hide and seek with us 
and the public?
    Mr. Baumann. I will review that and I will get back to you.
    Mr. Markey. Okay. Again, these voluntary commitments are 
like oral agreements. Again, they aren't worth the paper that 
they aren't printed on.
    Freddie has been issuing press releases for years, claiming 
that it meets or exceeds SEC disclosure requirements and that 
Freddie is in the vanguard of corporate disclosure and we now 
know that those claims were simply not true. And investors in 
the financial markets just want you to simply give it up, 
comply with public disclosure requirements that every other 
public company also has to comply with. And let me ask you one 
final question, if I may, and I appreciate your indulgence, Mr. 
Chairman.
    In your response to Ms. Schakowsky, you said you oppose the 
Shays-Markey bill because of concerns over the impact that the 
bill would have on the to be issued market for your mortgage-
backed securities.
    Are you aware that the bill grants the SEC rulemaking 
authority so that it can adopt appropriately tailored rules to 
address this type of situation and in light of that authority, 
would you be wiling to reconsider your opposition and support 
the bill? If that issue could be dealt with, would you then 
support the bill?
    Mr. Baumann. There are many aspects of registration of the 
1933 Act that are problematic, including not just the impact on 
the TBA market, which could impact the interest rate lock that 
consumers get. It could greatly increase our costs because of 
the volume of our security issuances which would have effect, 
therefore, in the long term of impacting the cost to consumers.
    Also, it would have the significant impact on the 
Securities and Exchange Commission's ability to deal with the 
volume of securities that the two agencies issue.
    A lot of these matters have been studied by the 
Administration and by the SEC and as a result of that, studies 
today indicate that that registration is not warranted.
    Mr. Markey. Again, I think it's just a canard, once again, 
and I think it's an excuse not to comply. And I think that your 
maintenance here that the SEC is just stupid or incompetent and 
can't draft a regulation that would deal with your concerns is 
just further evidence that you just don't want to comply with 
the same regulations that every other company does. And your 
message to the investing public, to the millions of people who 
put their money in your company is just caveat emptor, it's 
1898 at Freddie. And I just think again you're running an 
ahistorical company in terms of the transparency that should be 
provided to investors in ensuring that they get the information 
which they deserve.
    Mr. Chairman, I have a UC request as well. I have three 
press releases issued by Freddie Mac, one dated October 19, 
2000; one dated March 16, 2001; and one dated July 12, 2002, 
that all make claims that Freddie Mac is either in the vanguard 
of corporate disclosure and risk management or that Freddie Mac 
meets or exceeds SEC reporting standards and I would like to 
pass----
    Mr. Stearns. By unanimous consent, so ordered. What does 
1898 mean to you?
    Mr. Markey. That's before the Progressive movement began. 
That was before President McKinley passed away and Teddy 
Roosevelt took over.
    Mr. Stearns. Okay.
    Mr. Markey. The Republican Party, by the way.
    Mr. Stearns. Right, that's what I was trying to lead to.
    Mr. Markey. Thank you.
    Mr. Stearns. I was trying to bring out the Republican Party 
as being cited here.
    The gentleman from Ohio.
    Mr. Strickland. Thank you, Mr. Chairman. Mr. Baumann, how 
long have you been CFO?
    Mr. Baumann. I was hired by Freddie Mac as Executive Vice 
President of Finance in April 2003. I received the additional 
title of Chief Financial Officer in June of 2003.
    Mr. Strickland. So would you say you inherited a large 
headache, so to speak when you assumed these positions?
    Mr. Baumann. I came into the company with a lot of work to 
be done in terms of improving the accounting expertise in the 
company, improving internal controls and getting the company 
registered under the 1934 Act. There's a lot of work to be 
done.
    Mr. Strickland. And is it your judgment that you made and 
are making progress?
    Mr. Baumann. Yes. We are making significant progress. I've 
hired--since I've been here, over 100 people into our 
accounting functions to build the accounting expertise needed. 
We've issued, we've completed the restatement of prior years' 
results. We started to build the infrastructure up. We've 
greatly improved internal controls and as evidenced by the 
restatement press release, improved transparency around 
disclosures in terms of a description of those accounting 
errors that took place in the past, so we think we're well on 
our way to meeting the standards that should be expected of 
Freddie Mac which in my view are the highest standards that we 
should comply with.
    Mr. Strickland. I have one question. Over the last 3\1/2\ 
years, some of your biggest detractors, Freddie Mac's biggest 
detractors, I'm talking about GE, AIG, for example, have lost 
billions of dollars of shareholder money. GE has lost, I 
understand, about $260 bill; AIG about $70 billion. That's 
since the fall of 2000. These losses have hit the union pension 
funds particularly hard.
    Even with the accounting problems that have existed at 
Freddie Mac, and the rather tough economic times that we've 
gone through, you haven't lost value over that same period of 
time. To what do you attribute Freddie's financial endurance 
during this period of time, especially when we consider the 
experience of some of your greatest critics?
    Mr. Baumann. Well, first of all, understanding investors 
and the markets is a challenge for anybody to try to say why 
some companies increase in value and others don't increase or 
decrease in value, but that's always a challenge. But certainly 
Freddie Mac, throughout the restatement, the company has had 
very strong business fundamentals.
    The company has fulfilled the mission of putting people in 
homes. The company has maintained very low interest rate risk 
measures. It's maintained very low credit risk measures. It's 
been very prudent in its acquisition of mortgages for the 
retained portfolio, acquiring mortgages as appropriate in terms 
of managing that risk and fulfilling its responsibilities.
    So I suspect investors are looking at the Agency and saying 
that we are fulfilling our responsibilities, doing it in a 
prudent, measured way and the company is safe and sound.
    Mr. Strickland. I thank you for the answer. Thank you, Mr. 
Chairman.
    Mr. Stearns. Thank you. I think we are complete. Mr. 
Baumann, I just want to reiterate what you said in your opening 
statement is your mission is to supply low cost mortgage for 
American families wherever and whenever they need them. You're 
doing that job very well and I think Freddie Mac should be 
proud of that and as any corporation knows occasionally there's 
some people that do things that have to be corrected and we're 
doing that and I encourage you and I want to thank you for 
testifying and I think you provided enhanced credibility for 
your corporation by you being here and your forthright 
presentation and your character and personality I think comes 
through.
    That's why you were hired to be the CFO, so I'm here to 
thank you and also say that I think overall we had a pretty 
good hearing, bringing out some of the problems. It doesn't 
hurt to bring these problems out. If the problems continue, 
that's a problem, but it looks like you're on top of them. 
You're trying to correct them and I think that's good for the 
investors and that's good for America.
    So with that, the subcommittee is adjourned.
    Mr. Baumann. Thank you, Mr. Chairman.
    [Whereupon, at 11:51 a.m., the hearing was concluded.]
    [Additional material submitted for the record follows:]


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