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SPECIAL EXAMINATION OF FREDDIE MAC

Wednesday, January 21, 2004

U.S. HOUSE OF REPRESENTATIVES,
SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE
AND GOVERNMENT SPONSORED ENTERPRISES,
COMMITTEE ON FINANCIAL SERVICES,

Washington, D.C. The subcommittee met, pursuant to call, at 10:05 a.m., in Room 2128, Rayburn House Office Building, Hon. Richard H. Baker (chairman of the subcommittee) presiding.

Present: Representatives Baker, Ose, Shays, Bachus, Oxley, Kelly, Ney, Shadegg, Ryun, Biggert, Kennedy, Harris, Renzi, Kanjorski, Inslee, Hinojosa, Lucas of Kentucky, Clay, McCarthy and Scott.

Chairman BAKER. I would like to call this meeting of the Capital Market Subcommittee to order and welcome back Members to start off a new year.

This morning we are meeting to formally receive the report of OFHEO with regard to their special examination of the business operations of Freddie Mac. This is indeed an important study and analysis, which I believe will assist the committee in making important policy determinations as we go forward. But we are also pleased to have a representative of Freddie Mac to appear later in the hearing this morning to give their analysis and comment with regard to the findings and recommendations of the Agency.

I believe it should be clearly understood by now that the current regulatory staff has done its best work in attempting to supervise and oversee the two most complex financial organizations in the world, but they have been historically underfunded and, I believe, lacking appropriate regulatory tools to be responsive to the complexities of these ever-changing enterprises.

The effort to create an enhanced regulatory system, however, should be viewed in its proper light, and that is we are attempting to provide stability for the secondary mortgage market into the next decade. We have been extremely fortunate. If any other public operating company had reported multi-billion-dollar restatements over a multiyear period, market reaction to that announcement would have been severe.

To date, we have seen no market dislocation, interest rates continue to remain low, pursuit of home ownership opportunities remains high, and we have been blessed with these unique circumstances in a time of significant corporate governance dislocation.

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We cannot let this window of opportunity pass us by, however. We must act on the findings of the regulator. We must take advice from all interested stakeholders and ensure in the years ahead that the oversight and supervision is more than just adequate; that it is world class in nature, and that we can be hopefully preemptive in setting aside events which might bring adverse consequences to innocent home purchasers.

I view this as an extremely important effort, and I am appreciative of the willingness of the participants in the hearing today to give us their perspectives.

Chairman BAKER. Mr. Kanjorski.

Mr. KANJORSKI. Mr. Chairman, we meet for the first time this year for the purposes of reviewing the special examination report issued and the consent agreement reached in December by the Office of Federal Housing Enterprise Oversight regarding Freddie Mac's financial restatement of more than $5 billion. The report makes serious revelations about how insufficient accounting, audit and internal controls and a troubling culture nurtured by top managers resulted in an environment that led to significant earnings management at Freddie Mac. The constant decree also—the consent decree also requires Freddie Mac to adopt numerous remedial reforms to prevent a similar situation in the future.

One year ago Freddie Mac first revealed that it would delay the release of the 2002 accounting reports pending the completion of a restatement of its financial records for earlier years. This announcement raised considerable concerns for those who monitor GSEs. It also began a period of intense scrutiny of the company by its regulators, lawmakers and the press.

Six months later, Freddie Mac's Board announced an unexpected management shakeup. This change in corporate leadership produced even greater concerns among those with knowledge of GSEs. For example, I observed that government-sponsored enterprises with public responsibilities and private capital have a special obligation to operate fairly, safely, and soundly. I believe and I continue to believe that today. The management of these entities must ensure that they produce accounting statements that reflect their real financial conditions.

At the time I also said that Freddie Mac must maintain sufficient capital reserves, adopt prudent management reforms, expedite completion of its earnings restatements, and employ appropriate accounting techniques to prevent similar problems in the future. I suspect that, before we complete today's hearing, we will discuss each of these issues in great depth. We have a responsibility to study these matters and ensure that the company follows its statutory mandate to operate in a safe and sound manner.

Additionally, the financial reporting problems by Freddie Mac renewed efforts by some to modify GSE regulation. As I said at our very first hearing on oversight of government-sponsored enterprises in March of 2000, we need to have strong independent regulators that have the resources they need to get the job done. I continue to support strong GSE regulation. A strong regulator will protect the continued validity of our capital markets and promote confidence in Freddie Mac and Fannie Mae. It will also ensure tax

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