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the top" and corporate culture, internal controls, review of existing Board and senior management practices and compensation, and changes to the role of Board Chairman and company CEO and terms for the Board of Directors. Finally, OFHEO is pursuing legal actions requiring the termination for cause of the company's former CEO and CFO.

Our review of Freddie Mac practices continues, as we now will look into counterparty activities and oversee Freddie Mac's implementation of the consent order.

I have undertaken actions at OFHEO as well. Our examination force is being strengthened. A new office of chief accountant will elevate our work in the important field of corporate accounting and reporting and a new office of compliance will expand our capacity to address ongoing Enterprise compliance with OFHEO rules and requirements and be available to investigate more deeply targeted areas of concern.

On this latter point, I would note that we have, within budget constraints, begun our review of accounting and corporate controls at Fannie Mae.

THE CURRENT BUDGET SITUATION

Mr. Chairman, I would like to close my testimony with an urgent appeal to the Committee for assistance in obtaining our 2004 budget. Once again, the appropriations process has placed severe constraints on our operations. The short-term continuing resolutions we are operating under prevent us from hiring the additional examiners, accountants and analysts we need to strengthen our oversight. In addition, we are unable to hire the forensic accounting help we need to assist in the Fannie Mae review.

If a long-term CR is enacted which freezes OFHEO's budget at 2003 levels, we will need to scale back oversight at the very time that greater oversight has never been more urgent. I urge the Committee to help OFHEO get its full resources as soon as possible.

Mr. Chairman, thank you for the opportunity to testify. I will be pleased to answer any questions you and the Subcommittee may have.

Appendix

OFHEO must ensure that the management of Freddie Mac has established an adequate remediation plan and is allocating the necessary resources to ensure that all of the remedial recommendations are promptly implemented. OFHEO should also take steps to ensure that the following recommendations are implemented:

1. Freddie Mac Should Separate the Functions of the CEO and the Chairman

of the Board

2. Freddie Mac Should Develop Financial Incentives for Employees Based

on Long-Term Goals, not Short-Term Earnings 3. OFHEO Should Establish a Regulatory System of Mandatory Disclosures

for the Enterprises or Their Securities Exemptions Should be Repealed 4. OFHEO Should Consider Requiring a Periodic Change of the External

Auditors at the Enterprises, Not Just a Change in Engagement Partner 5. OFHEO Should Require Freddie Mac to Hold a Capital Surplus and

Should consider Limiting the Growth of the Retained Portfolio Until

Freddie Mac Produces Timely and Certified Financial Statements 6. OFHEO Should Establish a “Materiality” Standard for the Provision of

Sufficient Information to the Board of Directors 7. Freddie Mac Should Impose Strict Term Limits on the Members of the

Board of Directors 8. OFHEO Should Ensure that the Board Becomes More Actively Involved

in Oversight of the Enterprise 9. Freddie Mac Should Establish a Formal Compliance Program 10. Freddie Mac Should Establish the Position of Chief Risk Officer 11. Freddie Mac Should Document the Legitimate Business Purpose of Every

Significant Derivative Transaction 12. Freddie Mac Should Establish and Maintain Superior Accounting

Controls

13. Freddie Mac Should Prevent Undue Reliance on the External Auditor

14. Freddie Mac Should Strengthen and Clarify the Role of the Internal Audit

Department 15. OFHEO Should Expand Its Capacity to Detect and Investigate

Misconduct 16. OFHEO Should Conduct a Special Examination of the Accounting

Practices of Fannie Mae

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IV. COUNTERPARTIES...
The Linked Swaps....
Coupon Trade-Up Giants (CTUGs)
The Blaylock Transactions....
Other Counterparties........

74 76 80 81 82

V. ACCOUNTING AND AUDITING........
Weaknesses in Accounting.

Inadequate Accounting Personnel and Expertise..
Out-of-Date or Nonexistent Accounting Policies..
Reliance on External Auditor for Basic Accounting Functions and Decisions...
Lack of Accounting Controls .

Derivatives Execution, Administration, and Accounting..
Guaranteed Mortgage Securities Reconciliation......
Trades with Blaylock & Partners and with Salomon Smith Barney...
Inadequate Implementation of the Financial Reporting Controls

Improvement Plan.....
Weaknesses in the Internal Audit Function...

Lack of Responsibility Regarding Financial Information.....
Inadequate Follow-Up of Identified Deficiencies.....
Internal Audit Control Weakness Timeline...........
Ineffective Communication to the Board and Senior Management...

83 84 84 91 96 102 104 105 107

109 112 113 115 117 118

........

VI. DISCLOSURE........

Disclosures Required by the SEC..
Materiality.....
A Culture of Minimal Disclosure.....
The Failure of the Internal Controls of Freddie Mac..

122 123 124 133 137

VII. THE BOARD OF DIRECTORS........

143

Failure of Non-Executive Directors to Make Adequate Inquiries
Failure of Non-Executive Board Members to Secure Adequate Information..
Limited Time for Board Discussion ....
Complacency of Non-Executive Board Members....
Failure to Ensure the Hiring of Qualified Executives for Key Positions.
Failure to Hold Management Accountable........

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