The lack of fiscal control at Freddie Mac (NYSE: FRE ) is not reassuring. The company disclosed this morning that its understatement of profits, earlier pegged to be no higher than $4.5 billion, came in at just over $5 billion for the years 2000-2002. The big surprise, though, is that it actually overstated its earnings in 2001 by $989 million. Overall, however, the company's results were understated .
Many investors are unclear as to why any company would understate its earnings. It's quite simple, really, and firms as diverse as Microsoft (Nasdaq: MSFT ) and General Electric (NYSE: GE ) have been criticized for using various legal, but distasteful "cookie jar" methods to save earnings for a rainy day. Stocks are generally awarded higher multiples if their earnings are thought to be steady and recurrent. By delaying or understating earnings in a period that has gone exceedingly well, the company smooths out its results, and can retain some of those unclaimed earnings at a later date should they need to generate slightly higher results than they achieve organically.
So for a company nicknamed "Steady Freddie," the steadiness is part of the game -- it's part of what makes Freddie Mac an attractive investment. Wall Street demands it and Freddie supplies it using shady accounting, doctored diaries, and fancy swaps, asset "parking," and other tools devised by ... yup, Wall Street. I think I'm going to be sick.
A report that was released in conjunction with the restatements shows how several Wall Street banks, including CSFB (NYSE: CSR ) and Goldman Sachs (NYSE: GS ) , assisted with Freddie's convoluted derivative transactions to help the company groom its earnings.
The report by Baker & Botts law firm showed how Goldman, for example, partnered with Freddie Mac in some linked swap transactions to move more than $400 million of earnings from 2001 into later years. These swaps were approved by David Parseghian at Freddie, who briefly assumed the CEO's mantle at the company until regulators figured out that he was in the deception up to his eyeballs and demanded his ouster.
Freddie Mac says that it will be able to provide its 2003 restated financials by June. Problems solved, right? I'm unconvinced. Recently Freddie and Fannie Mae (NYSE: FNM ) were able to avoid greater oversight by federal regulators into their activities. Critics have charged in recent years that the two companies have taken on substantially more risk in order to continue their rates of growth as the housing markets have matured. Given that all of the above -- all of it -- was done for the sake of keeping Freddie Mac's stock price as high as possible and generating big bonuses for corporate executives, I'd suggest that the circumstances that made such financial malfeasance both possible and attractive need to be addressed, and badly.
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