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Freddie Mac (NYSE: FRE), the government backed entity whose CFO recently died, presumably by suicide, is under investigation by the FBI, for accounting irregularities, says The Wall Street Journal.
The FBI is said to be focusing on "whether the giant government-backed mortgage company improperly delayed the recognition of billions of dollars of losses, according to people familiar with the matter."
The Journal reported: 'A confidential February 2008 report by the investigative firm Kroll concluded that "inappropriate application" of accounting rules "enabled Freddie to defer billions of dollars of losses incurred from 2001 through 2004" on derivative contracts whose value depends on fluctuations in interest rates, according to people involved in the matter. Those losses, currently pegged at about $3.7 billion, are due to be gradually recognized in quarterly earnings statements over the next several years.'
To be sure, the overall picture of the situation remains unsorted. The investigation has been ongoing for six months. Freddie Mac says that there is nothing wrong with the accounting, citing '"disagreement among the experts" and Freddie's defense of its accounting," as a point of contention. And there seem to be different takes on the situation from others involved. According to The Journal: 'A spokeswoman for Kroll, a New York-based unit of Marsh & MacLennan Cos., declined to comment. The regulator, the Federal Housing Finance Agency, said it had decided early last year "not to take issue with the accounting" despite the findings of Kroll, which had been hired by the regulator to look into the matter, a spokeswoman for the agency said.'
But, what is clear is that the FBI and the SEC are still investigating the matter, and that there seems to be a difference of opinion among different parties that have seen Freddie's books about whether the accounting is straigth forward.
There has been no connection between the death of Freddie CFO David Kellerman and the investigation. Mr. Kellerman was described as being under stress recently before his death, but the reasons have not been reported. The Associated Press reported: "Freddie Mac's acting chief financial officer was apparently told to take time off from work days before he committed suicide." AP added the following: "Kellermann was promoted last September when the government seized the mortgage company and ousted its top two executives. Neighbors said Kellermann had lost a noticeable amount of weight under the strain of the new job. Some neighbors said they suggested to Kellermann should quit to avoid the stress, but Kellermann responded that he wanted to help the company through its problems."
And there is more. According to AP, the relationship between the government regulators and Freddie Mac has been difficult. The wire service reported that "That relationship has been tense and stressful, with Kellermann working long hours, a colleague said. Freddie Mac executives recently battled with federal regulators over whether to disclose potential losses on mortgage securities tied to the Obama administration's housing plan, said a person familiar with the deliberations who was not authorized to discuss the matter publicly."
Mr. Kellerman, according to AP was not a target of any investigation. Yet, his life at Freddie Mac was increasingly difficult.
Investigative reporting by the Associated Press reveals a world of persecution and paranoia created by government "shadows," a term describing "regulators examining his every move."
Central to the conflict faced by Mr. Kellerman and Freddie Mac were divided loyalties, between its obligation to the government, and its fiduciary duty to shareholders. Mr. Kellerman was under immense pressure as he "oversaw a staff of about 500 at Freddie Mac's headquarters in McLean and had been working on the first-quarter financial report, due by the end of May. But he'd also been caught recently in a dispute between Freddie and the Securities and Exchange Commission over its financial reports, according to a law enforcement official who spoke on condition of anonymity because the person was not authorized to discuss the case."
Mr. Kellerman was also under intense pressures at home. According to AP: "Neighbors noticed a security detail showed up at his sprawling suburban home in the upscale Washington suburb of Vienna after executives at Freddie Mac faced intense criticism for deciding to pay retention bonuses. Kellermann was to receive $850,000 paid out in four installments. He had already received $170,000 in December."
According to AP: "Freddie Mac's chief human resources officer asked him to take some time off because he'd been leaving work after 8 p.m. and sometimes working at home for hours, said a person close to the company who spoke on condition of anonymity because the individual wasn't authorized to discuss it publicly. Kellermann agreed to do so, and his work responsibilities would be given to two employees, the individual said. He never came back. On Wednesday, authorities responding to a 911 call found his body in the home he shared with his wife and 5-year-old daughter."
Obama Housing Plan Set To Implode?
The Obama housing plan is wreaking havoc on money managers. According to Bloomberg: "The head of Greenwich Financial Services LLC warned bond investors in Washington last month that government efforts to reverse the housing slump are doing more harm than good by undermining debt contracts."
According to the report: "Bondholders are preparing for a fight over legislation approved last month by the House of Representatives that would shield companies that collect homeowners’ payments from lawsuits over modified mortgages, even if new terms harm investors. The government’s actions may increase borrowing costs because creditors would demand higher returns to compensate for the risk that once-sacrosanct investment terms can be changed, they say."
At the center of this complex issue is the president's plan to cut mortgage payments for homeowners in distress. According to Bloomberg, money managers are concerned that "their clients will be hurt as consumers and banks get assistance," while investors are left holding the bag." This could lead to lawmakers protecting '“predatory lending” and fraud, partly by hindering investor efforts to force repurchases of soured loans.'
And the overall effect is likely to be higher interest rates as confidence in the bond and credit markets plummets.
In other words, the current legislation is attempting to rewrite the rulebook for mortgage debt obligations.
So, how big is the problem? According to Bloomberg: "About 64 percent of the value of America’s home loans is bundled into bonds, a market that is 10 percent bigger than the sum of Treasuries outstanding. Mortgages account for 80 percent of consumer debt, and housing costs represent about 22 percent of the economy, Federal Reserve and Hoover Institution data show."
Conclusion
The CFO of a government backed financial company is found hanging in his home one day after being asked to take some time off to relieve stress. Neighbors and friends concur that he was under significant amounts of stress.
There is a government connection beyond that of ongoing investigations as AP reports a fight between regulators and Freddie Mac about whether to report losses related to mortgage securities tied to the Obama administration.
As Bloomberg reports, there is rising concern among bond managers who own mortgage debt about the White House and Congress rewriting the rules of the game and leaving them holding the bag.
This story is just beginning to develop. For investors, it's a good idea to remain very short term oriented in the stock market, because if and when this thing breaks, it could make what we've already seen look very tame.
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