Next up on the block - Freddie Mac

No comments today on the speculation opportunities in the GSE mortgage companies. However I will discuss some recent developments at Freddie Mac and you can decide for yourself whether this is a good "value" play. I see it more as the short-sale of a lifetime.

Timeline:

Background: Freddie Mac has not filed formal financial reports with the SEC in several years. Apparently they were exempt from filing requirements until 2002 when some regulation subjected them to the same filing requirements as other public companies - re: 10-Q and 10-K (quarterly and annual reports filings.) Since then its been a race to the bottom to get the accounting straightened out and the financials filed and the comedy of errors rolls on. Below are the most recent/scary updates.

March 10, 2006 - Article Link - Relevant Quote from CFO Martin Baumann - "We've made enormous strides in fixing our financial infrastructure but, as we have previously disclosed, the effort is not yet complete," said Martin F. Baumann, Freddie Mac's chief financial officer. "When we found this error, we corrected it immediately. We are continuing to move forward to complete the job of producing timely, accurate financial reports early in 2006. We've also made great progress this year in our business – increasing our market share, building on our already strong capital position and maintaining excellence in risk management."

Relevant follow up comment: "The company also expects to release fourth quarter and full-year 2005 results and to begin filing timely, GAAP-compliant monthly capital reports with its regulator, the Office of Federal Housing Enterprise Oversight, no later than the end of March 2006."

March 22, 2006 - Article Link (its on WSJ sorry) - Relevant quotes - "Freddie Mac said it will replace its chief financial officer, Martin F. Baumann, just three months after offering him a $2 million retention bonus."

"The move follows two embarrassing snags that have delayed the U.S. mortgage-finance company's effort to return to regular, timely reporting of results in the wake of a 2003 accounting scandal. In light of those snags, Mr. Baumann said in an interview, he and the company's top officers -- Chief Executive Richard Syron and Chief Operating Officer Eugene McQuade -- agreed that Freddie needed a finance chief with more expertise in upgrading the computer systems used to generate financial results."

The way that I see it we are headed for tough times ahead with both Fannie Made and Freddie Mac. Talk about moral hazards in lending. I agree that home ownership is a great thing for anyone and a worthy goal for all Americans - I will even go so far to say that it is truly part of the American way of life - and I respect that.

What I don't respect is a system where the commercial banks no longer retain any of the lending risk and instead turn over their loans as fast as possible so that they can then sell them off to the GSEs to retain. I have a feeling we are going to find out that the retention, servicing, etc. of the loans at least the way it is currently being done- is much less profitable than previously anticipated. Guess who is going to foot the bill when this is widely accepted and understood? Joe Q Taxpayer - on two levels:

1) In his taxes
2) In his pension or retirement portfolio where his company most likely is holding a decent amount of securitized mortgage backed securities.

Best regards,

BG