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Freddie Mac's Creative Accounting

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Certified Residential Appraiser
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It is not the income cooking that bothers me....it is the inflated values of the mortgages held. You know, the ones were the collateral is oversated by 20%-30%
on a regular basis.



Freddie Mac's creative accounting
Commentary: Up, down or sideways, revenue smoothing is still wrong
Monday, June 09, 2003

Inman News Features




Freddie Mac this morning bid a not-so-fond farewell to its top three executives in the aftermath of what appears to have been an effort to cook the corporate books on a grand scale. Regardless of whatever ill-conceived rationale the company relied upon in juggling in its revenues, it's still wrong.

Freddie Mac President and COO David Glenn was fired because of "serious questions as to the timeliness and completeness of his cooperation and candor" with the lawyers Freddie Mac's board of directors' audit committee brought in to investigate accounting errors discovered during a previously announced restatement of its 2000, 2001 and 2002 financial statements. Chairman and CEO Leland C. Brendsel and EVP and CFO Vaughn Clarke today resigned from those four positions, according to a company statement.

Cooking the books usually involves inflating revenues to make a corporation appear to be more profitable than it actual is. But in Freddie Mac's bizarre variation on that theme, one of the country's largest and most prominent and important corporations admittedly reported less revenue than it actually earned.

Freddie Mac earlier this year announced the coming restatements of its financial results and said the likely cumulative effect would be an increase in reported earnings and a stronger capital position at the end of last year. The restatements are expected to reveal the real volatility in Freddie Mac's quarterly earnings because most of the accounting adjustments involve shifts of revenue from one quarter to another, according to the corporation.

This dicey accounting was produced by the very same corporation that last July said it had "long been at the vanguard of disclosure practices," "already meets or exceeds SEC reporting standards" and "is subject to the same standards as every other public company."

Allowing some revenue to simmer on a back burner initially sounds like a nutty idea. But it netted the corporation some attractive--albeit ill-gotten--benefits.

Reporting less revenue allowed Freddie Mac to lower its quarterly earnings while interest rates were low and mortgage originations were booming in anticipation of future quarters when interest rates might be higher and mortgage originations might be slower. The shift from the sunny skies to the cloudy weather could have resulted in a poor showing on a quarter-to-quarter or year-over-year basis. Those negative comparisons would have represented a fall from truly dizzying heights, but nonetheless could have triggered Wall Street's short-tempered wrath and punished Freddie Mac's stock price at some unknown yet anticipated future time.

Instead the punishment was meted out today. Freddie Mac shares were trading in the $49 range this afternoon, a drop from the $55-plus level in recent months.

The accounting shenanigans also allowed Freddie Mac to lower its income tax liability, a maneuver that hurts taxpayers and bites one of the hands that feeds Freddie Mac's success.

But those anticipated leaner days didn't materialize. The simmering revenues rose to a boil and the cooked books not only caught fire, but also sent up a flame that government regulators spotted. The company now must restate its prior earnings to reflect reality, rather than reporting those stashed-away revenues in a future not-so-rosy quarter.

It doesn't take an accounting genius to know that under-reporting revenues is a no-no. Even a humble humanities major who ducked into one or two accounting classes would know revenues and expenses must be reported in the period when they are incurred.

Quarterly revenue management isn't a new scam. Corporations have been smoothing revenues from one quarter to the next for decades. But that doesn't make it right nor does it mean whoever is responsible for it should be allowed to use the "everybody does it" excuse.

The bigger mysteries are why it took federal regulators so long to take a closer look at Freddie Mac's books and why it will take another three to six months to sort out what really happened in 2000, 2001 and 2002. Investors deserve better, and federal regulators should throw the book at whoever is responsible for these misdeeds.
 
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