-->Freddie Mac's Impending Fiasco

Richard Lehmann, Forbes/Lehmann Income Securities Investor, 07.06.04, 10:10 AM ET

The long-awaited financial update for Freddie Mac was held June 30 and proved to be less than expected. As you may recall, Freddie stopped financial reporting in the second half of last year and fired its top management, supposedly because of earnings manipulation. This explanation was suspect from the outset, given that no one has ever lost his job because he understated earnings. Nevertheless, financial markets accepted this and waited for the earnings restatement. We were then advised in late 2003 that the accounting was so screwed up that no financial reporting would be made for 2003 until June 2004. Now, after spending more than $150 million dollars on an army of accountants, lawyers and consultants, what does management have to say about Freddie's financial performance?

The revised numbers show that Freddie (nyse: FRE - news - people ) broke even for the second half of 2003, after a profitable first half. Losses from its derivatives trading--the source of the accounting problems and of some $4.3 billion in losses in the second half of 2003--were the cause of the poor second-half showing. To refresh your memory, interest rates fell in the first half of 2003, and they rose in the second half. Perhaps you need not be reminded where they've gone since April of this year.

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As I have said in previous columns, the concern has always been that rising rates could cause Freddie to implode, much like the Long Term Capital Management hedge fund or the Orange County investment fund. Only, this time, the fallout could cause a systemwide financial panic.

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