GAAP Faulted for Freddie Mac Woes

Complying with the current accounting principles didn't suffice, says a congressman.
Stephen TaubFebruary 9, 2004

During recent hearings into the restatements and accounting practices at mortgage-finance company Freddie Mac, Rep. Cliff Stearns (R-Fla.) laid part of the blame on U.S. generally accepted accounting principles.

“It is possible Freddie could have hidden billions of dollars on income in a way that complied with GAAP,” said Stearns, chairman of the House Subcommittee on Commerce, Trade, and Consumer Protection. “I suggest this is not the result we want from U.S. accounting standards.

Stearns acknowledged that U.S. GAAP was once hailed as the premier accounting system, and he said he still believes GAAP is strong. “I applaud FASB for all their efforts to shore up the system over the last two years,” he added.

He added, however, that “we, as the committee of oversight over accounting standard setting, have a responsibility to ensure standards produce financial statements that are transparent and comprehensible,” Stearns explained. “I encourage my colleagues to join me to produce legislation to reform GAAP.”

Stearns specifically criticized Freddie Mac’s use of so called “mixed-attribute accounting,” which the legislator said allows companies to decide whether financial assets are carried at current market price or at historic cost. “Freddie shifted assets between categories to manipulate earrings, without any change in the underlying economics of its performance,” he explained. “Taxpayers do not have the option of changing the characterization of assets to change the tax treatment; I think GAAP should not allow this either.”

Stearns also asked Armando Falcon, director of the Office of Federal Housing Enterprise Oversight, which oversees Freddie Mac and the larger Fannie Mae, to look into whether compensation of the two agency’s 20 top officials contributed to accounting problems, according to “Through our past hearings we learned that Freddie Mac disregarded accounting rules, internal controls, and disclosure standards to maintain a reputation for steady earnings,” Stearns reportedly said. “I appreciate hearing from Freddie Mac about the new controls it is instituting to guard against improper accounting. Given that Freddie Mac hid billions of dollars in income in a way that complied with GAAP, this subcommittee has a responsibility to look at improving these accounting standards.”

Martin Baumann, chief financial officer of Freddie Mac, responded that he is “committed to developing an exemplary finance function that produces accurate, timely, well-controlled and transparent financial reports” and “fully supportive of [Stearns’s] efforts to move GAAP toward a principles-based framework.” Added Bauman, “I believe that a principles-based accounting framework holds the potential to improve the representational faithfulness of financial reporting under U.S. GAAP. A principles-based approach could ensure that all reporting companies meet the substance, and not simply the form, of accounting rules.”