Defining The Future Of Freddie Mac

The Federal Home Loan Mortgage Corp. has helped millions of Americans buy and build homes over the past 40 years but on September 7, 2008, it took on what may be its biggest and most important construction project—re-creating a portfolio devastated by the mortgage crisis and, in the process, rebuilding its tattered reputation.

Managing through the turmoil that engulfed the corporate world in 2008 and navigating the rapidly changing governance environment was—and remains—a complicated task. The first priority of the company’s new owners—the U.S. government—was finding leadership. It turned first to John Koskinen, a corporate reorganization specialist who had turned around several companies in his career, making him chairman of the board. CEO Charles “Ed” Haldeman joined the mortgage giant the following year. Together, the pair has identified a path from government life support to recovery.

Haldeman’s approach focuses heavily on people, understanding that a talented and ethical workforce is vital in achieving governance and performance goals. Since taking the helm, Haldeman has seen Freddie Mac bring home a slew of diversity and workplace awards, a fact he believes is a significant factor in the company’s recent success.

Political turmoil and uncertainty continue to exacerbate management’s task, but the board remains focused on fulfilling its obligation to U.S. taxpayers. Managing through the uncertainty while improving governance standards and boosting profitability is made more complicated by having the government as the majority shareholder. The board and management not only must work together, but they must answer to the company’s conservator and primary regulator—the Federal Housing Finance Agency— plus Congress, the U.S. Treasury Department and the Department of Housing and Urban Development.

In an interview with NACD Directorship’s Brendan Sheehan, Haldeman and Koskinen shared their experiences on working in this unique environment, improving governance and managing in crisis.

Can you talk a little about managing through the economic crisis and the emerging recovery? What’s been your strategy for managing the board and the company during this period?
John Koskinen: The government took over on a weekend in September 2008, and I was asked to then put the board together. Our challenge was to find intelligent and capable people who would sign up for the board of a company in an interesting situation. Our goal was to get people who were knowledgeable about various aspects of Freddie Mac’s business—mortgages, housing, urban development— and people who understood the unique challenge and opportunity the company faced.

Freddie Mac and Fannie Mae were effectively the first companies to be impacted in that short crisis period, followed by Merrill Lynch being bought by Bank of America, Lehman Brothers folding, AIG getting government assistance—all of which happened in about 10 days.

It was a volatile period. What was the main concern of the regulator when it first stepped in?
Koskinen: I think the most significant challenge the regulator, the FHFA, was concerned about that weekend, in the middle of chaos and crisis, was how to create as stable a working environment for people as possible and to let people know that even with everything swirling around them there was a future. In the meantime, the important thing was to pay attention to the critical mission of the company to support the nation’s housing market. This continued to be the primary concern, I believe, for the two and a half years since then.

How well did that message resonate with the employees at the time, and did you have any challenges retaining and attracting talent?
Koskinen: We were concerned then— and continue to be—about employee retention. It was a problem during the crisis to some extent, although the economy was collapsing, so there weren’t as many options and alternatives for people then as we knew there would be as the economy recovered.

Throughout it all the goal has been to give people a sense of perspective about where the company fits vis-à-vis the major problems in the economy.

Did this also apply to the CEO position?
Koskinen: We faced unique challenges and had a new CEO who decided after six months that all of the government involvement and oversight and the complicated relationships were not what he had signed on for, and he departed. So I became the interim CEO for six months while we searched for a replacement.

We understood that the new CEO would have to see the situation and the government involvement as an interesting and exciting challenge rather than a burden. We were delighted and fortunate to find Ed, and it didn’t take too much convincing to have him join us. It was important to demonstrate that we could find an extremely qualified, experienced executive who was excited about coming here.

Ed, what was your initial focus when joining the company in 2009?
Haldeman: To John’s point about government involvement, this would not be the right place for a CEO who is an old-school autocratic person who makes a decision and then wants to get right on and implement it. The situation calls for a CEO who is accustomed to the notion of building consensus and realises there is a gauntlet of approvals that one has to go through. I came in with my eyes open and accustomed to working with a board in a partnership way and knowing that my job is to suggest a course of action, but then the board has to agree to it and then we have to go to our regulator and get them to agree with it, and sometimes we even have to go to Treasury and get them to agree too.

To your other point about how we managed through this adversity, the whole focus has been to try to get the employees to focus on the present, as distinct from the past or the future.

Back then, and now, there were a huge amount of distractions. The political environment is such that there’s a lot of interest in the past. Many politicians spend their time trying to figure out the past, what went wrong, and how can we fix it. There could be a tendency for management and employees and maybe the board to spend a lot of time being defensive and trying to explain the past. Similarly, the future is quite interesting. There are a lot of people who want to spend a lot of time thinking about what the best business model is going forward, for Freddie Mac. The Treasury put out a position paper on February 11 that talks about the future. I think our challenge at the company has been to not let those distractions take us away from the focus on the present and the important mission of the present.

Remaining in the present is important, but a board must look to the future. What does the short term hold for Freddie?
Koskinen: From the start, it seemed clear to me that the greater risk to the economy, not just to the company, was that out of swirling debate, finger pointing and an attempt to figure out who to blame for the economic downturn, you got a knee-jerk reaction to “fixing” the government-sponsored entities that would be to the detriment of the housing market, the mortgage market and the economy.

Having spent a lot of time in Washington, it seemed to me that our best strategy, and the best contribution we could make to the public good, would be to never have an answer to the question of “What should the future look like?” This is kind of counterintuitive, because the natural inclination of anybody with an interest in these subjects is to try to figure out what the right answer is, to the business model, to the structure, to the political equation. But the problem with having an answer is your views on any other options are automatically discounted.

What we have of great value here is a tremendous amount of experience and data from the past 40 years on how the housing and mortgage markets work. A minimum threshold of success would be to provide data and information to people so that whatever structure the Congress ultimately choses, the system would actually be able to be managed. It’s a complicated business, and it’s pretty easy to get it wrong.

Will the current political wrangling over the budget have an impact on the way Freddie Mac does business?
Koskinen: So we have spent a lot of time and it’s worked reasonably successfully, at the board level and at the management level, being open, trying to become the honest broker of information and analysis. We have spent a lot of time with the Administration and are beginning to have conversations with people on the Hill analysing the implications of various options.

I think there’s a growing comfort level on the part of decision makers that we don’t have an axe to grind. That if they want to talk about totally privatizing the market, we can tell them what that looks like. If they want to get rid of retained portfolios, if they want to get rid of the government guarantee, for securities, we’ll give you our best judgment based on 40 years of experience as to what the market would look like, what the business would look like, what the housing industry would look like.

So we continue to have a dialogue of our own every once in a while at the board level, “Is it time for us to say, in the middle of the political dialogue, here’s what we really think you ought to do?” But in a lot of ways, as I’ve said to the board, we’re kind of at half time. The game is now being played up on the Hill, but there’s a ways to go. There are a lot of options being bounced around Congress but it’s probably unlikely that any final conclusion will be reached before the Presidential election, which means that over the next year and a half or two, we’re going to have the continued challenge of managing in a time of uncertainty in terms of what the future brings.

It sounds like what you’re talking about is basic risk management. How would you describe your risk management processes at Freddie Mac? Have you created a specific risk committee like many other companies have done?
Koskinen: In the last two and a half years, everyone has become much more sensitive to risk. There is a debate in boardrooms about how best to address risk—at the audit committee, forming a risk committee or as a full-board responsibility. To some extent, the answer depends on the nature of your business and the nature of the risk you face. We’ve decided that it’s a full-board responsibility because risk is inherent across our business. Our setup is that we have a business and risk committee, and we have an audit committee, and the way it’s turned out is all of the board members are on one or the other.

In addition to regular two-day board and committee meetings, we hold a joint meeting of the audit and business and risk committee, which is, in effect, a meeting of the whole board. But we treat it as a joint meeting of audit and business and risk, to continually remind everyone that the risks include things you would normally think of in the audit committee; things you would normally consider in the business and risk area, and they cross over and overlap in a lot of ways. Ed’s made a significant number of changes as to how the company analyses and manages against those risks at the management level.

Haldeman: Our structure right now has a chief risk officer and a chief credit officer, both of whom report directly to me. Actually, it was my predecessor who split them out as direct reports, and I like that model. I’m not sure you have to have that in all financial companies, but I think it highlights that we have this one risk—being credit—that is ever present, and then we have a number of other risks under the chief risk officer that would include market risk and operational risk. We also have a credit oversight team within our risk function, so in a sense we have credit there as well in an oversight capacity. Part of the answer to managing risk is the structure, but it’s also cultural and how much stature the chief risk officer has in the company.

There are some companies where the risk job is kind of a check-the-box job, a necessary evil to go through. We’ve tried hard here for the culture to feel different and to have risk officers be a real part of the team, part of the process. We’ve tried to embed the senior risk people in transactions and processes, so that any concerns can be raised early on and mitigated as we’re going through the process.

With the government—and, by extension, taxpayers—being your major shareholder, what is your approach to investor relations?
Haldeman: I think of the taxpayer as having a stake in the company, and as such they are a constituency to which we owe a fair amount of openness. We have many constituencies to whom we owe some responsibility, but the taxpayer probably takes precedence. That influences us in lots of different ways. A lot of judgments we are making have to do with what we can do to reduce the draw from the Treasury and make sure the taxpayer is getting a good deal.

Koskinen: We’re an interesting hybrid of sorts. We’re in a private-sector business, with the government as a major shareholder. But ultimately, as the regulator continues to remind everyone, including the Congress and us, it’s a conservatorship, so by definition, we’re trying to conserve and protect the assets for the shareholders and the taxpayers.

It is an unusual business model. What is the main focus of the board, and how is the company doing lately?
Koskinen: One challenge with communications is that there is a misunderstanding of the situation, which can make it hard to tell the company story. There’s some concern on occasion on the Hill that we’re doing things that are non-productive or spending taxpayer funds in a way that would be different if they had a say in it. The real measure of our success is how much of a draw do we take from the government, which is really about how profitable we are. In other words, what the net equity in the company is. So when you get done with it all we are focused on making money, within the context of conservatorship and or mission.

What is often ignored when people assess our performance is that, because we were one of the first out of the box in terms of getting government support, we ended up with a 10 per cent dividend against the government’s preferred stock. Most other companies that followed us saw the dividend reduced to five per cent because they realised that 10 per cent makes it very difficult to pay off the obligation.

The government has not dropped our rate to five per cent. However, for the past few quarters the amount of our draw has been less than the amount of our dividend.

If you look forward, barring another major downturn in the next couple of years, it’s possible that with virtually all of the draw we have, we will be able to pay the dividend. There will be some quarters where we make enough money and have enough equity to pay the dividend without any draw at all. We’ve moved from fairly significant draws in 2008, 2009, and the first quarter of 2010, to more modest draws since then, so I think that by the end of this year the discussion on the Hill is going to be more focused on whether the model of the government giving Freddie money [through the draw] just for them to give it back, makes sense.

Haldeman: So, to put numbers on John’s point, in the second half of 2010, we paid a preferred dividend to the federal government of $3.2 billion—that’s half of the $6.4 billion annual payment. In order to do that in the third quarter we had a draw of $100 million, and then in the fourth quarter, $500 million, so that for the two quarters combined, our draw was only $600 million compared to that $3.2 billion check that we wrote for dividends. In the first quarter of 2011 we actually had no draw despite paying another $1.6 billion in preferred dividends to the Treasury.

How do you deal with media relations, especially the reputational risk of things being written about you, at the board level?
Koskinen: Ultimately, managing media relations is a responsibility of the management, but with the working relationship that the board has with management, there have been numerous discussions. We’re constrained by the conservatorship about how much we can do: We certainly are not allowed to do any lobbying or presentations on our behalf with the Congress. But we’re also working with the regulator to make sure we’re within their comfort zones in terms of what outside media relations we’re doing.

The discussion at the board level has been, almost from the start, how to appropriately communicate information that will give people the correct picture of what’s actually happening here. And so we have some discussion and debate back and forth among various members of the board.

The board has, over the past couple years, seen us get to the point where the facts begin to explain themselves, and we could, in our disclosures and conversations, focus on what we are really achieving. That story is that, recently, we are not drawing as much money and the company is starting to do better. The board does not define media policy, but it does consider the question: “How do we get the message out?”

So what is your feeling about the portrayal of Freddie Mac in the media, and how do you think the public views the company?
Haldeman: I would say our board has been equally as frustrated as management on our seeming inability to get an accurate portrayal of the company in the public’s mind. We would both like to be more aggressive in getting the message out but sometimes are constrained by our regulator with regard to not advocating, not lobbying, not advertising. You know, we wish the story we just told you about our draw over the past nine months could get out there, but the way journalists write that is, “Freddie has another draw, Freddie goes to the Treasury again,” right? That is simply not a realistic reflection of what is actually happening.

On the compensation front, the journalists are right that I get paid a lot of money. There’s no denying that $5 or $6 million is a lot of money. The context one would put around that, I think, would be that if we take a look at our top-15 highest-paid executives here, compensation is down about 35 or 40 per cent from peak levels, and at the same level almost precisely, that it was 10-12 years ago. I think another contextual point we would make is that last year, that is, 2010, we reduced our overall G&A [general and administrative expenses] spending by about $88 million, so we took five per cent of the cost out in one year. We further reduced G&A spending by another 10 per cent in the first quarter of 2011. This indicates that we do focus a lot on doing the right thing for the taxpayer and trying to keep our expenses down.

Speaking of the regulator, how much influence does it have on setting compensation, and for that matter, on board-level decisions?
Koskinen: When I started, one of the questions was what would be the delegation of authority to the board from the regulator, who as conservator basically had total authority. We had a very good but somewhat lengthy discussion for a couple of months, and ultimately, with a handful of exceptions, compensation being one of them, the board was delegated authority and therefore the management had authority over the normal, run-of-the-mill issues. A significant percentage of what we do, 80 or 90 per cent of it, is run as if it were a normal corporation.

The compensation committee and the board approved our compensation program, and the regulators had the final say. So all of these figures, all of these programs, short-term and long-term compensation, were approved by the regulator and by the Treasury and by Ken Feinberg, special master for executive compensation under the Troubled Asset Relief Program, when he was there.

What is the day-to-day level of interaction between the regulator and yourselves? Do you talk to them on a weekly basis, daily basis?
Haldeman: I visit with the director [of FHFA] weekly and he’s totally available by phone if we need to talk something over. But I think you should have a sense that the regulator is very connected throughout all levels of the company, and there are many, many people from the regulator here today and every day. I would suspect that there could be 20 to 50 people from the regulator here today in various functional areas of the company. There are some finance people, accounting people and lawyers who supervise us closely.

If you work to develop a cooperative relationship, it turns out that that can work. It can take a little longer sometimes to get decisions made, but I think the board meets with the FHFA director twice a year, once in his capacity as regulator and once in his capacity as conservator. I think the board feels that there is a workable relationship; I don’t think that we have anybody that thinks that it’s dysfunctional or a major problem.

What does the future hold for Freddie Mac?
Koskinen: I think one of the ways to conclude the discussion is that when we started out, it was a very positive signal for the members of the management team and the employees that there was going to be a board, because they wanted the company to continue to function as much as it could, even under conservatorship, as if it were a corporation, not a government agency. The board was seen as a real board, with real authority: We wouldn’t have been able to sign up the people we have if it didn’t have that authority.

The employees derive great comfort and satisfaction from the fact that, on a day-in and day-out basis, the company really runs like a normal corporation— there’s a board, there’s a chairman, there’s a CEO. The other side of that coin, to Ed’s point, is that it’s clear that we haven’t been turned into a government agency. The company still is really being run as a competitive private-sector enterprise. It’s just that the major shareholder happens to be the federal government and the American public.

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