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Testimony of Martin F. Baumario
Subcommittee on Capital Markets, Insurance

and Government Sponsored Enterprises
January 21, 2004
Page 4 of 7

working closely with OFHEO to make sure that we take the remediation steps required by the Consent Order on a timely basis. Actions must be completed within various timeframes, and the Board of Directors and senior management have emphasized to Freddie Mac employees the importance of timely compliance.

Our commitment to implementing the requirements of the Consent Order and the remediation program is unwavering. The remediation program underway at Freddie Mac is moving the company forward.

The activities we have already undertaken as part of the remediation, and our continuing plans, including fulfilling the requirements of the Consent Order, demonstrate our commitment to create a corporate culture in which the type of problems that led to the restatement will never happen again.

Key Remediation Steps

In implementing the Consent Order, Freddie Mac will be building upon its very significant efforts to improve the quality and depth of internal accounting personnel, the strength of the accounting function, and management oversight of that function. This has been, and continues to be, a key priority of the company in the wake of the restatement.

The goals of Freddie Mac's remediation program are to ensure that we have the highest level of accounting expertise, compliance with generally accepted accounting principles and regulatory reporting, and fully accurate, timely, and transparent financial reporting.

Keeping in mind our unwavering commitment to meeting the terms and the spirit of the Consent Order, today I would like to highlight some of the important steps Freddie Mac has already taken.

Freddie Mac has made significant progress in strengthening resources and personnel dedicated to accounting, control and reporting issues. The company has added over 100 professionals in the accounting, reporting and control areas, including a significant number of new officers and senior managers.

Freddie Mac has also retained leading experts in the areas of public disclosures and corporate governance to assist the company in designing and implementing processes and practices in these areas. In October 2003, we hired a Senior Vice President Chief Compliance Officer who is responsible for overseeing Freddie Mac's compliance with policies, procedures and practices, including compliance with laws and regulations. Additionally, in October 2003, we created the position of Chief Enterprise Risk Officer. This executive has oversight responsibility for credit and market risk.

Testimony of Martin F. Baumann
Subcommittee on Capital Markets, Insurance

and Government Sponsored Enterprises
January 21, 2004
Page 5 of 7

We are also working to create and implement new infrastructure and systems to ensure the quality, integrity, transparency, and timeliness of our financial reporting. These enhancements will create durable, automated systems that will keep up with the sophistication of our risk management and business activities.

In addition, we have taken steps to ensure that Freddie Mac's corporate culture promotes integrity, high ethical standards, and the importance of compliance. Virtually all of our employees have completed a corporate-wide training program on the company's Code of Conduct and the provisions of the Sarbanes-Oxley Act.

Looking Ahead

Through the extraordinary efforts of Freddie Mac's Board of Directors, current management team, and employees, we have met the challenges of the past year, and we are looking forward to continuing to improve our reporting, governance, and financial controls.

Together with Freddie Mac's new Chairman and CEO as well as our senior management team, I will ensure that we set the right "tone at the top.” Throughout this difficult and challenging period, Freddie Mac has focused on ensuring that we will emerge a stronger, more disciplined company. And, we have done so while remaining fully committed to fulfilling our mission.

While the restatement represented an important milestone, now that it has been completed, Freddie Mac is focused on bringing our financials completely up-to-date. The company expects to provide an annual report for 2002 and to hold the related annual stockholders' meeting in the first quarter of 2004. Our objective is to release quarterly and full-year 2003 results by June 30, 2004 and to provide the 2003 annual report and hold the related stockholders' meeting as soon as possible thereafter.

Freddie Mac remains irrevocably committed to completing the process of voluntarily registering its common stock with the Securities and Exchange Commission under the Securities Exchange Act of 1934, with the objective of completing the process as soon as possible after the company's return to timely reporting. Freddie Mac reaffirmed this commitment in a letter to Treasury Secretary John Snow on July 14, 2003, in our restatement announcement and in other public statements.

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In 2004, we look forward to working with Chairman Baker, Congressman Kanjorski and the Members of this Subcommittee as you consider regulatory oversight proposals. Freddie Mac has long supported a strong regulator as critical to the achievement of our mission.

Testimony of Martin F. Baumann
Subcommittee on Capital Markets, Insurance

and Government Sponsored Enterprises
January 21, 2004
Page 6 of 7

Conclusion

As I have outlined today, Freddie Mac is bringing our financial statements current and building for the future. We have taken significant steps toward achieving our goal of exemplary financial reporting and controls. The work that we have done, and continue to do as part of our remediation program, together with our commitment to fulfilling the requirements of the Consent Order, will enable us to reach that goal. While we complete this work, we are continuing to fulfill our important public mission, maintain our safety and soundness, and meet our business objectives.

Thank you for the opportunity to appear today. I look forward to working with Chairman Baker, Ranking Member Kanjorski and the Members of this Subcommittee. I would be happy to answer any questions the Subcommittee might have.

Statement of the Honorable Armando Falcon, Jr., Director of OFHEO,

before the House Financial Services Subcommittee on Capital Markets, Insurance and

Government Sponsored Enterprises Hearing

on

The Office of Federal Housing Enterprise Oversight's December Report of the

Special Examination of Freddie Mac

January 21, 2004

Mr. Chairman, Ranking Member Kanjorski, and Members of the Subcommittee, I appreciate the opportunity to discuss with you OFHEO's Report of the Special Examination of Freddie Mac. My prepared testimony will summarize the key findings and conclusions, and I request that the Subcommittee include the full text of the report in the record. My testimony expresses my own views and not necessarily those of the President or the Secretary of Housing and Urban Development.

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A year ago tomorrow, Freddie Mac announced that completion of its 2002 financial audit would be delayed and that earlier periods would be reaudited. A switch in external auditors – from Arthur Andersen to PricewaterhouseCoopers – had triggered a reevaluation of Freddie Mac's accounting policies, especially those relating to hedge accounting treatments for derivatives occasioned by implementation of FAS 133. Ultimately, a much broader range of accounting policies was reconsidered. Many were changed, resulting in one of the largest corporate financial restatements ever, including a cumulative net increase in retained earnings of $5 billion.

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The reaudit and restatement process raised questions beyond the selection of accounting policies. On June 7, as Freddie Mac prepared to announce the abrupt departure of three of its principal officers, I ordered a special examination of the conditions and activities that led to the accounting failures and management changes. This examination was to expand and supplement an ongoing OFHEO examination of the financial condition of the Enterprise and its reaudit and restatement process.

Our previous examination work had engendered increasing concern about weaknesses in controls and personnel in accounting areas. I believed that the removal of three members of the management team only went part of the way toward correcting serious problems with management practices and controls. We created a special examination unit that ultimately comprised 24 staff members taken from several OFHEO departments on a full or part-time basis. The group was tasked with reviewing the events leading to the restatement and deficiencies in accounting practices and controls. I further asked that the report of the special examination make recommendations for any additional steps that needed to be taken to help ensure the continuing safe and sound operations of the Enterprise.

I instructed the Board of Directors of Freddie Mac to provide its full cooperation with the special examination and to make available to the special examination all

communications to the Board and management regarding deficiencies in accounting practices or its investigation of employee misconduct. I also instructed the Board to provide an explanation of its rationale for the compensation packages the Enterprise proposed for the three individuals in light of the circumstances surrounding their departures.

I also informed the Board of Directors that, in the case of personnel terminated for misconduct, OFHEO would object to any re-employment of these individuals, and that OFHEO could hold them liable for indemnification to Freddie Mac for losses that may have resulted from their conduct.

Finally, I instructed the Board to provide to OFHEO, for review and approval, plans to address reform of the supervision of accounting practices by management; personnel and systems changes; plans for implementing accounting services quality controls; and a program for routine communications by the Board with OFHEO on the progress of the plan of remediation.

The special examination unit reviewed documents generated by the operations of Freddie Mac or obtained by OFHEO over ten years in the course of its regular examination process. Documents, including emails and audio tapes, were produced by the Enterprise pursuant to OFHEO subpoena. OFHEO also obtained, pursuant to subpoena, testimony under oath from numerous employees and members of the Board of Directors of Freddie Mac. In developing this information, OFHEO has cooperated with the Securities and Exchange Commission and the Office of the United States Attorney for the Eastern District of Virginia.

Although some aspects of the special examination are not complete, the bulk of the work was finished this past fall, and I asked for a report of the examination containing the findings and conclusions reached thus far, along with appropriate recommendations, which you received in December.

REPORT SUMMARY

In the early 1990s, Freddie Mac promoted itself to investors as "Steady Freddie," a company of strong and steady growth in profits, and the company developed a corporate culture that placed a very high priority on achieving such results. The examination showed that, to do so, Freddie Mac used means that failed to meet its obligations to investors, regulators and the public. The company employed a variety of techniques ranging from improper reserve accounts to complex derivative transactions to push earnings into future periods and meet eamings expectations. Freddie Mac cast aside accounting rules, internal controls, disclosure standards, and the public trust in the pursuit of steady earnings growth. The conduct and intentions of the Enterprise were hidden and were revealed only by a chain of events that began when Freddie Mac changed auditors in 2002.

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