10-Q 1 f65508e10vq.htm 10-Q e10vq
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q
 
 
x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
For the quarterly period ended September 30, 2008
 
or
 
o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
For the transition period from                to
 
Commission File Number: 000-53330
 
 
Federal Home Loan Mortgage Corporation
(Exact name of registrant as specified in its charter)
 
Freddie Mac
     
Federally chartered corporation   52-0904874
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
8200 Jones Branch Drive, McLean, Virginia   22102-3110
(Address of principal executive offices)   (Zip Code)
 
(703) 903-2000
 
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     x Yes  o No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o Accelerated filer o
 
Non-accelerated filer (Do not check if a smaller reporting company) x Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes   x No
 
As of November 10, 2008, there were 647,158,633 shares of the registrant’s common stock outstanding.
 


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FINANCIAL STATEMENTS
 
         
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PART I — FINANCIAL INFORMATION
 
This Quarterly Report on Form 10-Q includes forward-looking statements, which may include expectations and objectives related to our operating results, financial condition, business, capital management, remediation of significant deficiencies in internal controls, credit losses, market share and trends, the conservatorship and its effects on our business and other matters. You should not rely unduly on our forward-looking statements. Actual results might differ significantly from those described in or implied by such forward-looking statements due to various factors and uncertainties, including those described in (i) “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,” or MD&A, “FORWARD-LOOKING STATEMENTS” and “RISK FACTORS” in this Form 10-Q and in the comparably captioned sections of our Form 10-Q for the quarter ended June 30, 2008 and our Form 10 Registration Statement filed and declared effective by the SEC on July 18, 2008, or Registration Statement, and (ii) the “BUSINESS” section of our Registration Statement. These forward-looking statements are made as of the date of this Form 10-Q and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date of this Form 10-Q, or to reflect the occurrence of unanticipated events.
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
EXECUTIVE SUMMARY
 
Conservatorship
 
Entry Into Conservatorship and Treasury Agreements
 
On September 7, 2008, Henry M. Paulson, Jr., Secretary of the U.S. Department of the Treasury, or Treasury, and James B. Lockhart III, Director of the Federal Housing Finance Agency, or FHFA, announced several actions taken by Treasury and FHFA regarding Freddie Mac and Fannie Mae. Director Lockhart stated that they took these actions “to help restore confidence in Fannie Mae and Freddie Mac, enhance their capacity to fulfill their mission, and mitigate the systemic risk that has contributed directly to the instability in the current market.” These actions included the following:
 
  •  placing us and Fannie Mae in conservatorship;
 
  •  the execution of a senior preferred stock purchase agreement by our Conservator, on our behalf, and Treasury, pursuant to which we issued to Treasury both senior preferred stock and a warrant to purchase common stock; and
 
  •  the agreement to establish a temporary secured lending credit facility that is available to us.
 
Entry into Conservatorship
 
On September 6, 2008, at the request of the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve and the Director of FHFA, our Board of Directors adopted a resolution consenting to putting the company into conservatorship. After obtaining this consent, the Director of FHFA appointed FHFA as our Conservator on September 6, 2008, in accordance with the Federal Housing Finance Regulatory Reform Act of 2008, or Reform Act, and the Federal Housing Enterprises Financial Safety and Soundness Act of 1992.
 
Upon its appointment, the Conservator immediately succeeded to all rights, titles, powers and privileges of Freddie Mac, and of any stockholder, officer or director of Freddie Mac with respect to Freddie Mac and its assets, and succeeded to the title to all books, records and assets of Freddie Mac held by any other legal custodian or third party. The Conservator has the power to take over our assets and operate our business with all the powers of our stockholders, directors and officers, and to conduct all business of the company. The Conservator announced at that time that it would eliminate the payment of dividends on common and preferred stock during the conservatorship.
 
On September 7, 2008, the Director of FHFA issued a statement that he had determined that we could not continue to operate safely and soundly and fulfill our critical public mission without significant action to address FHFA’s concerns, which were principally: safety and soundness concerns as they existed at that time, including our capitalization; market conditions; our financial performance and condition; our inability to obtain funding according to normal practices and prices; and our critical importance in supporting the U.S. residential mortgage market. We describe the terms of the conservatorship and the powers of our Conservator in detail below under “Legislative and Regulatory Matters — Conservatorship and Treasury Agreements.”
 
Overview of Treasury Agreements
 
Senior Preferred Stock Purchase Agreement
 
The Conservator, acting on our behalf, entered into a senior preferred stock purchase agreement, or Purchase Agreement, with Treasury on September 7, 2008. Under the Purchase Agreement, Treasury provided us with its commitment to provide up to $100 billion in funding under specified conditions. The Purchase Agreement requires Treasury, upon the request of the Conservator, to provide funds to us after any quarter in which we have a negative net worth (that is, our total liabilities exceed our total assets, as reflected on our GAAP balance sheet). In addition, the Purchase Agreement requires
 
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Treasury, upon the request of the Conservator, to provide funds to us if the Conservator determines, at any time, that it will be mandated by law to appoint a receiver for us unless we receive funds from Treasury under the Commitment. In exchange for Treasury’s funding commitment, we issued to Treasury, as an initial commitment fee: (1) one million shares of Variable Liquidation Preference Senior Preferred Stock (with an initial liquidation preference of $1 billion), which we refer to as the senior preferred stock; and (2) a warrant to purchase, for a nominal price, shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis at the time the warrant is exercised, which we refer to as the warrant. We received no other consideration from Treasury as a result of issuing the senior preferred stock or the warrant.
 
Under the terms of the agreement, Treasury is entitled to a quarterly dividend of 10% per year (which increases to 12% per year if not paid timely and in cash) on the aggregate liquidation preference of the senior preferred stock. To the extent we are required to draw on Treasury’s funding commitment the liquidation preference of the senior preferred stock will be increased by the amount of any funds we receive. The amounts payable for this dividend could be substantial and have an adverse impact on our financial position and net worth. The senior preferred stock is senior in liquidation preference to our common stock and all other series of preferred stock. In addition, beginning on March 31, 2010, we are required to pay a quarterly commitment fee to Treasury, which will accrue from January 1, 2010. We are required to pay this fee each quarter for as long as the Purchase Agreement is in effect. The amount of this fee has not yet been determined.
 
The Purchase Agreement includes significant restrictions on our ability to manage our business, including limiting the amount of indebtedness we can incur to 110% of our aggregate indebtedness as of June 30, 2008 and capping the size of our retained portfolio at $850 billion as of December 31, 2009. See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Retained Portfolio” and “OUR PORTFOLIOS” for a description and composition of our portfolios. In addition, beginning in 2010, we must decrease the size of our retained portfolio at the rate of 10% per year until it reaches $250 billion. Depending on the pace of future mortgage liquidations, we may need to reduce or eliminate our purchases of mortgage assets or sell mortgage assets to achieve this reduction. We currently do not have plans to sell our mortgage assets at a loss. In addition, while the senior preferred stock is outstanding, we are prohibited from paying dividends (other than on the senior preferred stock) or issuing equity securities without Treasury’s consent. The terms of the Purchase Agreement and warrant make it unlikely that we will be able to obtain equity from private sources.
 
The Purchase Agreement has an indefinite term and can terminate only in very limited circumstances, which do not include the end of the conservatorship. The agreement therefore could continue after the conservatorship ends. Treasury has the right to exercise the warrant, in whole or in part, at any time on or before September 7, 2028. We provide more detail about the provisions of the Purchase Agreement, the senior preferred stock and the warrant, the limited circumstances under which those agreements terminate, and the limitations they place on our ability to manage our business under “Legislative and Regulatory Matters — Conservatorship and Treasury Agreements” below. See “ITEM 1A. RISK FACTORS” for a discussion of how the restrictions under the Purchase Agreement may have a material adverse effect on our business.
 
Expected Draw Under the Purchase Agreement
 
At September 30, 2008, our liabilities exceeded our assets under GAAP by $(13.7) billion while our stockholders’ equity (deficit) totaled $(13.8) billion. The Director of FHFA has submitted a request under the Purchase Agreement in the amount of $13.8 billion to Treasury. We expect to receive such funds by November 29, 2008. If the Director of FHFA were to determine in writing that our assets are, and have been for a period of 60 days, less than our obligations to creditors and others, FHFA would be required to place us into receivership. As a result of this draw, the aggregate liquidation preference of the senior preferred stock will increase to $14.8 billion, and our annual aggregate dividend payment to Treasury, at the 10% dividend rate, would increase to $1.5 billion. If we are unable to pay such dividend in cash in any quarter, the unpaid amount will be added to the aggregate liquidation preference of the senior preferred stock and the dividend rate on the unpaid liquidation preference will increase to 12% per year.
 
Treasury Credit Facility
 
On September 18, 2008, we entered into a lending agreement with Treasury, or Lending Agreement, pursuant to which Treasury established a new secured lending credit facility that is available to us until December 31, 2009 as a liquidity back-stop. In order to borrow pursuant to the Lending Agreement, we are required to post collateral in the form of Freddie Mac or Fannie Mae mortgage-backed securities to secure all borrowings under the facility. The terms of any borrowings under the Lending Agreement, including the interest rate payable on the loan and the amount of collateral we will need to provide as security for the loan, will be determined by Treasury. Treasury is not obligated under the Lending Agreement to make any loan to us. Treasury does not have authority to extend the term of this credit facility beyond December 31, 2009, which is when Treasury’s temporary authority to purchase our obligations and other securities, granted by the Reform Act, expires. After December 31, 2009, Treasury may purchase up to $2.25 billion of our obligations under its permanent authority, as set forth in our charter.
 
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As of November 14, 2008, we have not borrowed any amounts under the Lending Agreement. The terms of the Lending Agreement are described in more detail in “Legislative and Regulatory Matters — Conservatorship and Treasury Agreements.”
 
Changes in Company Management and our Board of Directors
 
Since our entry into conservatorship on September 6, 2008, eight members of our Board of Directors have resigned, including Richard F. Syron, our former Chairman and Chief Executive Officer. On September 16, 2008, the Conservator appointed John A. Koskinen as the new non-executive Chairman of our Board of Directors. We currently have four members of our Board of Directors and nine vacancies.
 
As noted above, as our Conservator, FHFA has assumed the powers of our Board of Directors. Accordingly, the current Board of Directors acts with neither the power nor the duty to manage, direct or oversee our business and affairs. The Conservator has indicated that it intends to appoint a full Board of Directors to which it will delegate specified roles and responsibilities.
 
On September 7, 2008, the Conservator appointed David M. Moffett as our Chief Executive Officer, effective immediately. Since September 7, 2008, we have announced the departures of our former Chief Financial Officer and our former Chief Business Officer.
 
Supervision of our Business under the Reform Act and During Conservatorship
 
During the third quarter of 2008, the company experienced a number of significant changes in our regulatory supervisory environment. First, on July 30, 2008, President Bush signed into law the Reform Act, which placed us under the regulation of a new regulator, FHFA. That legislation strengthened the existing safety and soundness oversight of the government sponsored enterprises, or GSEs, and provided FHFA with new safety and soundness authority that is comparable to, and in some respects, broader than that of the federal bank agencies. That legislation gave FHFA enhanced powers that, even if we were not placed into conservatorship, gave them the authority to raise capital levels above statutory minimum levels, regulate the size and content of our portfolio, and to approve new mortgage products. That legislation also gave FHFA the authority to place the GSEs into conservatorship or receivership under conditions set forth in the statute. Refer to “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — EXECUTIVE SUMMARY — Legislative and Regulatory Matters” in our Form 10-Q for the period ended June 30, 2008 for additional detail regarding the provisions of the Reform Act. See “ITEM 1A. RISK FACTORS,” for additional risks and information regarding this legislation, including the receivership provisions.
 
Second, we experienced a change in control when we were placed into conservatorship on September 6, 2008. Under conservatorship, we have additional heightened supervision and direction from our regulator, FHFA, who is also acting as our Conservator.
 
Below is a summary comparison of various features of our business before and after we were placed into conservatorship and entered into the Purchase Agreement. Following this summary, we provide additional information about a number of aspects of our business now that we are in conservatorship under “Managing Our Business During Conservatorship — Our Objectives.” In addition, we describe the impacts of the Treasury agreements on our business above under “Overview of Treasury Agreements” and below under “Legislative and Regulatory Matters — Conservatorship and Treasury Agreements.”
 
 
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Topic     Before Conservatorship     During Conservatorship
             
Authority of Board of Directors, Management and Stockholders    
•   Board of Directors with right to determine the general policies governing the operations of the corporation and exercise all power and authority of the company except as vested in stockholders or as the Board chooses to delegate to management

•   Board of Directors delegated significant authority to management

•   Stockholders with specified voting rights
   
•   FHFA, as Conservator, has all of the power and authority of the Board of Directors, management and the shareholders

•   The Conservator has delegated authority to management to conduct day-to-day operations so that the company can continue to operate in the ordinary course of business. The Conservator retains overall management authority, including the authority to withdraw its delegations to us at any time.

•   Stockholders have no voting rights
             
Regulatory Supervision    
•   Regulated by FHFA, our new regulator created by the Reform Act

•   Reform Act gave regulator significant additional safety and soundness supervisory powers
   
•   Regulated by FHFA, with powers as provided by Reform Act

•   Additional management authority by FHFA, which is serving as our Conservator
             
Structure of Board of Directors    
•   13 directors: 11 independent, plus Chairman and Chief Executive Officer, and one vacancy; independent, non-management lead director

•   Five separate Board committees, including Audit Committee in which one of the five independent members was an “audit committee financial expert”
   
•   Currently, four directors, consisting of a non-management Chairman of the Board and three independent directors (who were also directors of Freddie Mac immediately prior to conservatorship), with neither the power nor the duty to manage, direct or oversee our business and affairs

•   No Board committees have members or authority to act

•   Conservator has indicated its intent to appoint a full Board of Directors to which it will delegate specified roles and responsibilities
             
Management    
•   Richard F. Syron served as Chairman and Chief Executive Officer from December 2003 to September 6, 2008
   
•   David M. Moffett began serving as Chief Executive Officer on September 7, 2008
             
Capital    
•   Statutory and regulatory capital requirements

•   Capital classifications as to adequacy of capital provided by FHFA on quarterly basis
   
•   Capital requirements not binding

•   Quarterly capital classifications by FHFA suspended
             
Net Worth(1)    
•   Receivership mandatory if we have negative net worth for 60 days
   
•   Conservator has directed management to focus on maintaining positive stockholders’ equity in order to avoid both the need to request funds under the Purchase Agreement and our mandatory receivership

•   Receivership mandatory if we have negative net worth for 60 days(2)
             
Managing for the Benefit of Shareholders    
•   Maximize shareholder value over the long term

•   Fulfill our mission of providing liquidity, stability and affordability to the mortgage market
   
•   No longer managed with a strategy to maximize common shareholder returns

•   Maintain positive net worth and fulfill our mission of providing liquidity, stability and affordability to the mortgage market

•   Focus on returning to long-term profitability if it does not adversely affect our ability to maintain net worth or fulfill our mission
             
(1)  Our net worth refers to our assets less our liabilities, as reflected on our GAAP balance sheet. If we have a negative net worth (which means that our liabilities exceed our assets, as reflected on our GAAP balance sheet), then, if requested by the Conservator (or by our Chief Financial Officer, if we are not under conservatorship), Treasury is required to provide funds to us pursuant to the Purchase Agreement. Net worth is substantially the same as stockholders’ equity (deficit); however, net worth also includes the minority interests that third parties own in our consolidated subsidiaries (which was $95 million as of September 30, 2008). At September 30, 2008, we had a negative net worth of $13.7 billion. In addition, if the Director of FHFA were to determine in writing that our assets are, and would have been for a period of 60 days, less than our obligations to creditors and others, FHFA would be required to place us into receivership.
(2)  Treasury’s funding commitment under the Purchase Agreement is expected to enable us to maintain a positive net worth as long as Treasury has not invested the full $100 billion provided for in that agreement.
 
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The conservatorship has no specified termination date. There can be no assurance as to when or how the conservatorship will be terminated, whether we will continue to exist following conservatorship, or what our business structure will be during or following our conservatorship. In a statement issued on September 7, 2008, the Secretary of the Treasury indicated that 2008 and 2009 should be viewed as a “time out” where we and Fannie Mae are stabilized while policymakers decide our future role and structure. He also stated that there is a consensus that we and Fannie Mae pose a systemic risk and that we cannot continue in our current form. For more information on the risks to our business relating to the conservatorship and uncertainties regarding the future of our business, see “ITEM 1A. RISK FACTORS.”
 
Managing Our Business During Conservatorship
 
Our Management
 
FHFA, in its role as Conservator, has overall management authority over our business. During the conservatorship, the Conservator has delegated authority to management to conduct day-to-day operations so that the company can continue to operate in the ordinary course of business. We can, and have continued to, enter into and enforce contracts with third parties. The Conservator retains the authority to withdraw its delegations to us at any time. The Conservator is working actively with management to address and determine the strategic direction for the enterprise, and in general has retained final decision-making authority in areas regarding: significant impacts on operational, market, reputational or credit risk; major accounting determinations, including policy changes; the creation of subsidiaries or affiliates and transacting with them; significant litigation; setting executive compensation; retention of external auditors; significant mergers and acquisitions; and any other matters the Conservator believes are strategic or critical to the enterprise in order for the Conservator to fulfill its obligations during conservatorship. See “Conservatorship and Treasury Agreements — Conservatorship — General Powers of the Conservator Under the Regulatory Reform Act” for more information.
 
Our Objectives
 
Based on the Federal Home Loan Mortgage Corporation Act, which we refer to as our charter, public statements from Treasury officials and guidance from our Conservator, we have a variety of different, and potentially conflicting, objectives, including:
 
  •  providing liquidity, stability and affordability in the mortgage market;
 
  •  immediately providing additional assistance to the struggling housing and mortgage markets;
 
  •  reducing the need to draw funds from Treasury pursuant to the Purchase Agreement;
 
  •  returning to long-term profitability; and
 
  •  protecting the interests of the taxpayers.
 
These objectives create conflicts in strategic and day-to-day decision making that will likely lead to less than optimal outcomes for one or more, or possibly all, of these objectives. For example, maintaining a positive net worth could require us to constrain some of our business activities, including activities that provide liquidity, stability and affordability to the mortgage market. Conversely, to the extent we increase activities to assist the mortgage market, our financial results are likely to suffer, and we may be less able to maintain a positive net worth. We regularly consult with and get direction from our Conservator on how to balance these objectives. To the extent that we are unable to maintain a positive net worth following our expected draw of funds from Treasury after the filing of this Form 10-Q, we will be required to request additional funding from Treasury under the Purchase Agreement, which will further increase our ongoing dividend obligations and, therefore, extend the period of time until we might be able to return to profitability. These objectives also create risks that we discuss in “ITEM 1A. RISK FACTORS.”
 
Changes in Strategies to Meet New Objectives
 
Since September 6, 2008, we have made a number of changes in the strategies we use to manage our business in support of our new objectives outlined above. These include the changes we describe below.
 
Eliminating Planned Increase in Adverse Market Delivery Charge
 
As part of our efforts to increase liquidity in the mortgage market and make mortgage loans more affordable, we announced on October 3, 2008 that we were eliminating our previously announced 25 basis point increase in our adverse market delivery charge that was scheduled to take effect on November 7, 2008. The elimination of this charge will reduce our future net income.
 
Temporarily Increasing the Size of Our Mortgage Portfolio
 
Consistent with our ability under the senior preferred stock purchase agreement to increase the size of our on-balance sheet mortgage portfolio through the end of 2009, FHFA has directed us to acquire and hold increased amounts of mortgage loans and mortgage-related securities in our mortgage portfolio to provide additional liquidity to the mortgage market. Our extremely limited ability to issue callable or long-term debt at this time makes it difficult to increase the size of our mortgage portfolio. In addition, we are also subject to the covenant in the senior preferred stock purchase agreement
 
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prohibiting us from issuing debt in excess of 110% of our aggregate indebtedness as of June 30, 2008. For a discussion of the limitations we are currently experiencing on our ability to issue debt securities, see “LIQUIDITY AND CAPITAL RESOURCES” and “RISK FACTORS.”
 
Current Conditions in the Housing and Mortgage Market
 
Deterioration in Market Conditions and Impact on Third Quarter Results
 
Market conditions affecting the company deteriorated dramatically during the third quarter. This had a materially adverse impact on our quarterly results of operations in the third quarter of 2008 compared to the second quarter of 2008.
 
Home prices nationwide resumed the rate of decline experienced earlier in the year after briefly leveling off during the second quarter of 2008. The percentage decline in home prices was particularly large in California, Florida, Arizona and Nevada, where Freddie Mac has significant concentrations of mortgage loans.
 
Unemployment rates also worsened significantly. California, Arizona and Nevada saw increases of between 14 and 27% in unemployment from the second quarter to the third quarter of 2008, on a seasonally-adjusted basis, while the national rate exceeded 6%. Unemployment rates increased again in October to a national rate of 6.5%. An upward spike in food and other goods prices during the third quarter of 2008 further eroded household financial conditions, and real consumer spending declined significantly. Both consumer and business credit tightened considerably during the third quarter of 2008 as financial institutions curtailed their lending activities. This contributed to significant increases in credit spreads for both mortgage and corporate loans.
 
These macro-economic conditions and other factors contributed to a substantial increase in the number of delinquent loans in our single-family mortgage portfolio during the third quarter of 2008. The rate of transition of these loans from delinquency through foreclosure also increased. We observed a significant increase in market-reported delinquency rates for mortgages serviced by financial institutions not only for subprime and Alt-A loans but also for prime loans. This delinquency data suggests that continuing home price declines and growing unemployment are now affecting behavior by a broader segment of mortgage borrowers, increasing numbers of whom are “underwater,” or owing more on their mortgage loans than their homes are currently worth. Our loan loss severities, or the average amount of recognized losses per loan, also increased in the third quarter of 2008, especially in California, Florida and Arizona, where home price declines have been more severe and where we have significant concentrations of mortgage loans with higher average loan balances than in other states.
 
We were not the only financial institution that was adversely affected by the worsening market conditions during the third quarter of 2008. IndyMac Bank, FSB and Washington Mutual Bank were placed into receivership, and Lehman Brothers Holdings, Inc., or Lehman, filed for bankruptcy. American International Group, Inc. received a substantial infusion of cash from the U.S. government, and both Merrill Lynch & Co, Inc. and Wachovia Corporation were acquired by other institutions. In an attempt to stabilize the markets and restore liquidity, the U.S. government introduced several unprecedented programs to provide various forms of financial support to market participants. One of these proposed programs involves guarantees by the Federal Deposit Insurance Corporation, or FDIC, of the debt obligations issued by banks. This proposal and other existing programs have created uncertainty in the market resulting in limited access to long-term and callable funding. Uncertainty has also contributed to increased borrowing costs relative to the U.S. Treasury market and the London Interbank Offered Rate, or LIBOR. See “LIQUIDITY AND CAPITAL RESOURCES” for further information.
 
These market developments have been the principal drivers of our substantially increased loss for the third quarter of 2008. Our provision for credit losses increased from $2.5 billion in the second quarter of 2008 to $5.7 billion in the third quarter of 2008, principally due to increased estimates of incurred losses caused by the deteriorating economic conditions and evidenced by our increased rates of delinquency and foreclosure; increased mortgage loan loss severities; and, to a much lesser extent, heightened concerns that certain of our seller/servicer counterparties may fail to perform their recourse or repurchase obligations to us.
 
Our security impairments on available for sale securities increased from $1.0 billion in the second quarter of 2008 to $9.1 billion in the third quarter of 2008. The deteriorating market conditions during the third quarter also led to a considerably more pessimistic outlook for the performance of the non-agency mortgage-related securities in our retained portfolio. The loans backing these securities exhibited much worse delinquency behavior than that mentioned above with respect to loans in our guarantee portfolio. Rising unemployment, accelerating house price declines, tight credit conditions, volatility in interest rates, and weakening consumer confidence not only contributed to poor performance during the third quarter but significantly impacted our expectations regarding future performance, both of which are critical in assessing security impairments. Furthermore, the mortgage-related securities backed by subprime and Alt-A and other loans, including Moving Treasury Average, or MTA, loans, have significantly greater concentrations in the states that are undergoing the greatest stress, including California, Florida, Arizona and Nevada. MTA adjustable-rate mortgages (also referred to as option ARMs) have adjustable interest rates and optional payment terms, including options that result in negative amortization, for an initial period of years that allow for deferral of principal repayments. MTA loans generally have a date when the
 
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mortgage is recast to require principal payments under new terms, which can result in substantial increases in monthly payments to the borrower. Additionally, during the third quarter of 2008 there were significant negative ratings actions and unprecedented and sustained categorical asset price declines most notably in the mortgage-related securities backed by Alt-A loans, including MTA loans, in our portfolio. The combination of all of these factors not only had a material, negative impact on our view of expected performance in the third quarter, but also significantly reduced the likelihood of more favorable outcomes, resulting in a substantial increase in other-than-temporary impairments in the third quarter of 2008.
 
Our aggregate losses on trading securities, our guarantee asset and derivatives, net of the unrealized gains on foreign-currency denominated debt, increased from $481 million in the second quarter of 2008 to $4.2 billion in the third quarter of 2008, as the turmoil in the markets contributed to dislocations in the normal correlations between different instruments. In our capacity as securities administrator for our issued securities, we also incurred a $1.1 billion loss in the third quarter of 2008 related to investments in short-term unsecured loans as a result of Lehman’s bankruptcy.
 
We determined it was necessary to establish a partial valuation allowance against our deferred tax assets due to the rapid deterioration of market conditions discussed above, the uncertainty of future market conditions on our results of operations and the uncertainty surrounding our future business model as a result of our placement into conservatorship by FHFA on September 6, 2008. These and other factors led us to record a non-cash charge of $14.3 billion in the third quarter of 2008 in order to establish a partial valuation allowance against our deferred tax asset. As a result, at September 30, 2008, we had a net deferred tax asset of $11.9 billion representing the tax effect of unrealized losses on our available-for-sale securities portfolio.
 
Each of these drivers of our third quarter results is discussed in more detail below within “GAAP Results” and our “CONSOLIDATED RESULTS OF OPERATIONS”.
 
Credit Overview
 
The factors affecting all residential mortgage market participants during 2008 have continued to adversely impact our single-family mortgage portfolio during the third quarter of 2008. The following statistics illustrate the credit deterioration of loans in our single-family mortgage portfolio, which consists of single-family mortgage loans in our retained portfolio and those backing our guaranteed PCs and Structured Securities.
 
Table 1 — Credit Statistics, Single-Family Mortgage Portfolio(1)
 
                                         
    As of
    09/30/2008   06/30/2008   03/31/2008   12/31/2007   09/30/2007
 
Delinquency rate (in basis points, or bps)(2)
    122       93       77       65       51  
Non-performing assets (in millions)(3)
  $ 35,497     $ 27,480     $ 22,379     $ 18,121     $ 13,118  
REO inventory (in units)
    28,089       22,029       18,419       14,394       11,916  
                                         
                                         
    For the Three Months Ended
    09/30/2008   06/30/2008   03/31/2008   12/31/2007   09/30/2007
        (in units, unless noted)    
 
Loan modifications(4)
    8,316       4,827       4,246       2,272       1,752  
REO acquisitions
    15,880       12,410       9,939       7,284       5,905  
REO disposition severity ratio(5)
    29.3 %     25.2 %     21.4 %     18.1 %     14.1 %
Single-family credit losses (in millions)(6)
  $ 1,270     $ 810     $ 528     $ 236     $ 122  
(1)  Consists of single-family mortgage loans for which we actively manage credit risk, which are those loans held in our retained portfolio as well as those loans underlying our PCs and Structured Securities, excluding Structured Transactions and that portion of our Structured Securities that are backed by Government National Mortgage Association, or Ginnie Mae, Certificates.
(2)  We report single-family delinquency rate information based on the number of loans that are 90 days or more past due and those in the process of foreclosure. Mortgage loans whose contractual terms have been modified under agreement with the borrower are not included if the borrower is less than 90 days delinquent under the modified terms. See “CREDIT RISKS — Credit Performance — Delinquencies” for further information.
(3)  Includes those loans in our single-family mortgage portfolio, based on unpaid principal balances, that are past due for 90 days or more or where contractual terms have been modified as a troubled debt restructuring. Also includes single-family real estate owned, or REO, which are acquired principally through foreclosure on loans within our single-family mortgage portfolio.
(4)  Consist of modifications under agreement with the borrower. Excludes forbearance agreements, which are made in certain circumstances and under which reduced or no payments are required during a defined period as well as repayment plans, which are separate agreements with the borrower to repay past due amounts and return to compliance with the original terms.
(5)  Calculated as the aggregate amount of our losses recorded on disposition of REO properties during the respective quarterly period divided by the aggregate unpaid principal balances of the related loans with the borrowers. The amount of losses recognized on disposition of the properties is equal to the amount by which the unpaid principal balance of loans exceeds the amount of gross sales proceeds from disposition of the properties. Excludes other related credit losses, such as property maintenance and selling expenses, as well as related recoveries from credit enhancements, such as mortgage insurance.
(6)  Consists of REO operations expense plus charge-offs, net of recoveries from third-party insurance and other credit enhancements. See “CREDIT RISKS — Credit Performance — Credit Loss Performance” for further information.
 
As the table above illustrates, we experienced continued deterioration in the performance of our single-family mortgage portfolio. Certain loan groups of the single-family mortgage portfolio, such as Alt-A and interest-only loans, as well as 2006 and 2007 vintage loans, are the main contributors to our worsening credit statistics. These loan groups have been affected by certain macro-economic factors, such as recent declines in home prices, which have resulted in erosion in the borrower’s equity. These loan groups are also concentrated in the West region. The West region comprised 26% of the unpaid principal balances of our single-family mortgage portfolio as of September 30, 2008, but accounted for 48% and 43% of our REO
 
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acquisitions in the third and second quarters of 2008, respectively. Alt-A loans, which represented 10% of our single-family mortgage portfolio as of September 30, 2008, accounted for approximately 50% of our credit losses for the nine months ended September 30, 2008. In addition, stressed markets in the West region (especially California, Arizona and Nevada) and Florida tend to have higher average loan balances than the rest of the U.S. and were most affected by the steep home price declines. As we continue to experience home price declines in these and other regions, the severity of our single-family credit losses will continue to increase, as evidenced by our REO disposition severity ratio.
 
As of September 30, 2008, single-family mortgage loans in the state of Florida comprise 7% of our single-family mortgage portfolio; however the loans in this state make up more than 20% of the total delinquent loans in our single-family mortgage portfolio, based on unpaid principal balances. Consequently, Florida remains our leading state for serious delinquencies, although these have not yet evidenced themselves in REO acquisitions or our credit losses due to the duration of Florida’s foreclosure process. California and Arizona were the states with the highest credit losses in the third quarter of 2008 with 44% of our single-family credit losses on a combined basis. These and other factors caused us to significantly increase our estimate for loan loss reserves during the third quarter of 2008.
 
In an effort to mitigate our losses and the continued growth of non-performing assets, we continue to expand our efforts to increase our foreclosure alternatives. Due to the overall deterioration in the mortgage credit environment, our loss mitigation activity has increased, as exemplified by our increased volumes of loan modifications in 2008. We are continuing to implement and develop strategies designed to mitigate the increase in our credit losses, including a recently announced program by our Conservator to expedite the modification process for certain troubled borrowers.
 
Our non-agency securities in our retained portfolio, which are primarily backed by subprime, Alt-A and MTA mortgage loans, also continue to be affected by the deteriorating credit conditions during 2008. The table below illustrates the changes in delinquencies that are 60 days or more past due within our non-agency mortgage-related securities portfolio backed by subprime, Alt-A, and MTA loans in our retained portfolio. Increases in delinquencies that are 60 days or more past due do not fully reflect the recent poor performance of these securities as cumulative losses are also growing considerably more rapidly. Given the recent unprecedented deterioration in the economic outlook and the renewed acceleration of housing price declines, future performance of the loans backing these securities could continue to deteriorate.
 
Table 2 — Credit Statistics, Non-Agency Mortgage-Related Securities Backed by Subprime, Alt-A and MTA Loans
 
                                         
    As of
    09/30/2008   06/30/2008   03/31/2008   12/31/2007   09/30/2007
 
Delinquency rates:
                                       
Non-agency mortgage-related securities backed by:
                                       
Subprime 1st Lien
    35 %     31 %     27 %     21 %     16 %
Alt-A(1)
    14 %     12 %     10 %     8 %     5 %
MTA
    24 %     18 %     12 %     7 %     4 %
Cumulative loss:
                                       
Non-agency mortgage-related securities backed by:
                                       
Subprime 1st Lien
    4 %     2 %     1 %     1 %     1 %
Alt-A(1)
    1 %     0 %     0 %     0 %     0 %
MTA
    1 %     0 %     0 %     0 %     0 %
Gross unrealized losses, pre-tax (in millions)
  $ 22,411     $ 25,858     $ 28,065     $ 11,127     $ 2,993  
Impairment loss for the three months ended (in millions)
  $ 8,856     $ 826     $     $     $  
(1)  Exclude non-agency mortgage-related securities backed by other loans primarily comprised of securities backed by home equity lines of credit.
 
We held unpaid principal balances of $125.7 billion of non-agency mortgage-related securities backed by subprime and Alt-A and other loans in our retained portfolio as of September 30, 2008 compared to $152.6 billion as of December 31, 2007. We recognized impairment losses on these securities of $8.9 billion for the three months ended September 30, 2008. We had gross unrealized losses, net of tax, on these securities totaling $14.6 billion and $7.2 billion at September 30, 2008 and December 31, 2007, respectively. The increase in unrealized losses, despite the decline in unpaid principal balance, is due to the significant declines in non-agency mortgage asset prices which occurred during 2008 and which accelerated significantly for Alt-A and other loans, including MTA loans, during the third quarter of 2008. We believe the majority of the declines in the fair value of these securities are attributable to decreased liquidity and larger risk premiums in the mortgage market. See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Retained Portfolio” for further information.
 
GAAP Results
 
Summary of Financial Results for the Three Months Ended September 30, 2008
 
Net loss was $25.3 billion and $1.2 billion for the three months ended September 30, 2008 and 2007, respectively. Net loss increased in the three months ended September 30, 2008 compared to the same period of 2007, principally due to the establishment of a partial valuation allowance on our deferred tax asset, increased losses on investment activities, increased derivative losses, increased losses on our guarantee asset as well as increased credit-related expenses, which consist of the provision for credit losses and REO operations expense. In the third quarter of 2008, we recorded a non-cash charge of
 
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$14.3 billion related to the establishment of a partial valuation allowance against our deferred tax asset. The valuation allowance excludes the portion of the deferred tax asset representing the tax effect of unrealized losses on available-for-sale securities recorded in accumulated other comprehensive income, or AOCI, which management has the intent and ability to hold until recovery of the unrealized loss amounts. See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Deferred Tax Asset” for further information. These loss and expense items for the three months ended September 30, 2008 were partially offset by: (a) higher net interest income and income on guarantee obligation; (b) unrealized gains on foreign-currency denominated debt recorded at fair value; (c) lower losses on certain credit guarantees; and (d) lower losses on loans purchased due principally to changes in our operational practice of purchasing delinquent loans out of PC securitization pools in December 2007. As a result of the net loss, at September 30, 2008, our liabilities exceeded our assets under GAAP by $(13.7) billion while our stockholders’ equity (deficit) totaled $(13.8) billion. The Director of FHFA has submitted a request under the Purchase Agreement in the amount of $13.8 billion to Treasury. We expect to receive such funds by November 29, 2008.
 
Net interest income was $1.8 billion for the three months ended September 30, 2008, compared to $761 million for the three months ended September 30, 2007. We held higher amounts of fixed-rate agency mortgage-related securities in our retained portfolio at significantly wider spreads relative to our funding costs during the three months ended September 30, 2008. The increase in net interest income and yield is also due to significantly lower short-term interest rates on our short-term borrowings and lower long-term interest rates on our long-term borrowings for the three months ended September 30, 2008. The combination of a higher proportion of short-term debt, together with a higher proportion of fixed-rate securities within our retained portfolio during a steep yield curve environment, contributed to the improvement in net interest income and net interest yield during the three months ended September 30, 2008.
 
Non-interest income (loss) was $(11.3) billion for the three months ended September 30, 2008, compared to non-interest income of $117 million for the three months ended September 30, 2007. The decrease in non-interest income in the third quarter of 2008 was primarily due to higher losses on investment activity, increased derivative losses, net of related foreign-currency gains and higher losses on our guarantee asset, partially offset by increased income on our guarantee obligation and higher management and guarantee income. Increased losses on investment activity during the third quarter of 2008 were principally attributed to $9.1 billion of security impairments primarily recognized on available-for-sale non-agency mortgage-related securities backed by subprime and Alt-A and other loans during the third quarter of 2008. See “CONSOLIDATED BALANCE SHEET ANALYSIS — Retained Portfolio” for additional information. Income on our guarantee obligation was $783 million and $473 million for the three months ended September 30, 2008 and 2007, respectively. The amortization of income on our guarantee obligation was accelerated in the third quarter of 2008 as compared to the third quarter of 2007 in order to match our economic release from risk on the pools of mortgage loans we guarantee. Management and guarantee income increased 16%, to $832 million for the three months ended September 30, 2008 from $718 million for the three months ended September 30, 2007. This reflects increases in the average balance of our PCs and Structured Securities of 11% on an annualized basis for the three months ended September 30, 2008, as compared to the average balance during the third quarter of 2007. This increase in management and guarantee income also reflects higher average fee rates for the three months ended September 30, 2008 compared to the third quarter of 2007.
 
Non-interest expense for the three months ended September 30, 2008 and 2007 totaled $7.9 billion and $3.1 billion, respectively. This includes normal credit-related expenses of $6.0 billion and $1.4 billion for the three months ended September 30, 2008 and 2007, respectively. For the three months ended September 30, 2008, our provision for credit losses significantly increased due to continued credit deterioration in our single-family credit guarantee portfolio, primarily due to further increases in delinquency rates and higher severity of losses on a per-property basis. Credit deterioration has been largely driven by declines in home prices and regional economic conditions as well as the effect of a greater composition of interest-only and Alt-A mortgage products in the mortgage origination market that we have purchased or guaranteed. REO operations expense increased primarily as a result of an increase in market-based write-downs of REO property due to the decline in home prices, coupled with higher volumes in REO inventory, particularly in the states of California, Florida, Arizona, Michigan and Nevada.
 
Non-interest expense, excluding normal credit-related expenses, for the three months ended September 30, 2008 totaled $1.9 billion compared to $1.7 billion for the three months ended September 30, 2007. The increase in non-interest expense, excluding normal credit-related expenses, was primarily due to a loss of $1.1 billion during the third quarter of 2008, related to the investments in short-term, unsecured loans we made to Lehman in our role as securities administrator for certain trust-related assets offset by decreases in losses on certain credit guarantees and losses on loans purchased. We refer to these transactions with Lehman as the Lehman short-term lending transactions. For more information on the Lehman short-term lending transactions, see “CONSOLIDATED RESULTS OF OPERATIONS — Securities Administrator Loss on Investment Activity.” Losses on certain credit guarantees decreased to $2 million for the three months ended September 30, 2008, compared to $392 million for the three months ended September 30, 2007, due to the change in our method for determining the fair value of our newly-issued guarantee obligation upon adoption of Statement of Accounting Standards, or SFAS,
 
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No. 157, “Fair Value Measurements,” or SFAS 157, effective January 1, 2008. Losses on loans purchased decreased to $252 million for the three months ended September 30, 2008, compared to $649 million for the three months ended September 30, 2007, due to changes in our operational practice of purchasing delinquent loans out of PC pools. See “CONSOLIDATED RESULTS OF OPERATIONS — Non-Interest Expense — Losses on Certain Credit Guarantees and — Losses on Loans Purchased,” for additional information on this change in our operational practice. Administrative expenses totaled $308 million for the three months ended September 30, 2008, down from $428 million for the three months ended September 30, 2007 primarily due to a reduction in our short-term performance compensation during the third quarter of 2008 as well as a decrease in our use of consultants throughout 2008. As a percentage of our average total mortgage portfolio, administrative expenses declined to 5.6 basis points for the three months ended September 30, 2008, from 8.7 basis points for the three months ended September 30, 2007.
 
For the three months ended September 30, 2008 and 2007, we recognized effective tax rates of (46)% and 44%, respectively. See “NOTE 12: INCOME TAXES” to our consolidated financial statements for additional information about how our effective tax rate is determined.
 
Summary of Financial Results for the Nine Months Ended September 30, 2008
 
Effective January 1, 2008, we adopted SFAS 157 which defines fair value, establishes a framework for measuring fair value in financial statements and expands required disclosures about fair value measurements. In connection with the adoption of SFAS 157, we changed our method for determining the fair value of our newly-issued guarantee obligations. Under SFAS 157, the initial fair value of our guarantee obligation equals the fair value of compensation received, consisting of management and guarantee fees and other upfront compensation, in the related securitization transaction, which is a practical expedient for determining fair value. As a result, prospectively from January 1, 2008, we no longer record estimates of deferred gains or immediate, “day one” losses on most guarantees. Our adoption of SFAS 157 did not result in an immediate recognition of gain or loss, but the prospective change had a positive impact on our financial results for the three and nine months ended September 30, 2008.
 
Also effective January 1, 2008, we adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115,” or SFAS 159 or the fair value option, which permits companies to choose to measure certain eligible financial instruments at fair value that are not currently required to be measured at fair value in order to mitigate volatility in reported earnings caused by measuring assets and liabilities differently. We initially elected the fair value option for certain available-for-sale mortgage-related securities and our foreign-currency denominated debt. Upon adoption of SFAS 159, we recognized a $1.0 billion after-tax increase to our retained earnings at January 1, 2008. We may continue to elect the fair value option for certain securities to mitigate interest-rate aspects of our guarantee asset and certain non-hedge designated pay-fixed swaps.
 
Net loss was $26.3 billion and $642 million for the nine months ended September 30, 2008 and 2007, respectively. Net loss increased during the nine months ended September 30, 2008 compared to the same periods of 2007, principally due to the establishment of a partial valuation allowance against our deferred tax asset, increased losses on investment activity primarily related to impairment losses on certain non-agency mortgage-related securities, increased derivative losses, increased losses on guarantee asset as well as an increase in normal credit-related expenses, which consist of our provision for credit losses and REO operations expense. In the third quarter of 2008, we recorded a $14.3 billion non-cash charge related to the establishment of a partial valuation allowance against our deferred tax asset. The valuation allowance excludes the portion of the deferred tax asset representing the tax effect of unrealized losses on available-for-sale securities recorded in AOCI, which management has the intent and ability to hold until recovery of the unrealized loss amounts. These loss and expense items for the nine months ended September 30, 2008 were partially offset by higher net interest income and income on our guarantee obligation as well as lower losses on certain credit guarantees due to our use of the practical expedient for determining fair value under SFAS 157 and lower losses on loans purchased due to changes in our operational practice of purchasing delinquent loans out of PC securitization pools.
 
Net interest income was $4.2 billion for the nine months ended September 30, 2008, compared to $2.3 billion for the nine months ended September 30, 2007. The 2% annualized limitation on the growth of our retained portfolio established by FHFA expired during March of 2008 as we became a timely filer of our financial statements. As a result, we were able to hold higher amounts of fixed-rate agency mortgage-related securities at significantly wider spreads relative to our funding costs during the nine months ended September 30, 2008. Non-interest income (loss) was $(10.4) billion and $1.6 billion for the nine months ended September 30, 2008 and 2007, respectively. The decrease in non-interest income in the 2008 period was primarily due to higher losses on investment activity, higher derivative losses excluding foreign-currency related effects, and higher losses on our guarantee asset. These losses were partially offset by increased income on our guarantee obligation and higher management and guarantee income in the 2008 period. Non-interest expense for the nine months ended September 30, 2008 and 2007 totaled $13.5 billion and $5.8 billion, respectively, and included normal credit-related expenses of $10.3 billion and $2.1 billion, respectively. Non-interest expense, excluding normal credit-related expenses, for the nine
 
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months ended September 30, 2008 and 2007 totaled $3.2 billion and $3.7 billion, respectively. The decline in non-interest expense, excluding normal credit-related expenses, was primarily due to the reductions in losses on certain credit guarantees and losses on loans purchased and was partially offset by the $1.1 billion loss on the Lehman short-term lending transactions. Administrative expenses totaled $1.1 billion for the nine months ended September 30, 2008, down from $1.3 billion for the nine months ended September 30, 2007. As a percentage of our average total mortgage portfolio, administrative expenses declined to 6.8 basis points for the nine months ended September 30, 2008, from 8.8 basis points for the nine months ended September 30, 2007.
 
For the nine months ended September 30, 2008 and 2007, we recognized effective tax rates of (33)% and 66%, respectively. See “NOTE 12: INCOME TAXES” to our consolidated financial statements for additional information about how our effective tax rate is determined.
 
Segments
 
We manage our business through three reportable segments subject to the conduct of our business under the direction of the Conservator, as discussed above under “Managing Our Business During Conservatorship — Our Objectives.”:
 
  •  Investments;
 
  •  Single-family Guarantee; and
 
  •  Multifamily.
 
Certain activities that are not part of a segment are included in the All Other category. We manage and evaluate the performance of the segments and All Other using a Segment Earnings approach. Segment Earnings differs significantly from, and should not be used as a substitute for, net income (loss) as determined in accordance with GAAP. There are important limitations to using Segment Earnings as a measure of our financial performance. Among them, our regulatory capital measures are based on our GAAP results, as is the need to obtain funding under the Purchase Agreement. Segment Earnings adjusts for the effects of certain gains and losses and mark-to-fair-value items, which depending on market circumstances, can significantly affect, positively or negatively, our GAAP results and have in recent periods caused us to record significant GAAP net losses. GAAP net losses will adversely impact our GAAP stockholders’ equity (deficit), as well as our need for funding under the Purchase Agreement, regardless of results reflected in Segment Earnings. For a summary and description of our financial performance on a segment basis, see “CONSOLIDATED RESULTS OF OPERATIONS — Segment Earnings” and “NOTE 16: SEGMENT REPORTING” to our consolidated financial statements.
 
In managing our business, we present the operating performance of our segments using Segment Earnings. Segment Earnings present our results on an accrual basis as the cash flows from our segments are earned over time. The objective of Segment Earnings is to present our results in a manner more consistent with our business models. The business model for our investment activity is one where we generally buy and hold our investments in mortgage-related assets for the long term, fund our investments with debt and use derivatives to minimize interest rate risk, thus generating net interest income in line with our return on equity objectives. We believe it is meaningful to measure the performance of our investment business using long-term returns, not short-term value. The business model for our credit guarantee activity is one where we are a long-term guarantor in the conforming mortgage markets, manage credit risk and generate guarantee and credit fees, net of incurred credit losses. As a result of these business models, we believe that this accrual-based metric is a meaningful way to present our results as actual cash flows are realized, net of credit losses and impairments. We believe Segment Earnings provides us with a view of our financial results that is more consistent with our business objectives and helps us better evaluate the performance of our business, both from period-to-period and over the longer term.
 
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Table 3 presents Segment Earnings (loss) by segment and the All Other category and includes a reconciliation of Segment Earnings (loss) to net income (loss) prepared in accordance with GAAP.
 
Table 3 — Reconciliation of Segment Earnings (Loss) to GAAP Net Income (Loss)
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2008     2007     2008     2007  
    (in millions)  
 
Segment Earnings (loss) after taxes:
                               
Investments
  $ (1,119 )   $ 503     $ (213 )   $ 1,588  
Single-family Guarantee
    (3,501 )     (483 )     (5,347 )     (130 )
Multifamily
    135       83       351       292  
All Other
    (6 )     (45 )     134       (104 )
                                 
Total Segment Earnings (loss), net of taxes
    (4,491 )     58       (5,075 )     1,646  
                                 
Reconciliation to GAAP net loss:
                               
Derivative- and foreign-currency denominated debt-related adjustments
    (1,292 )     (1,725 )     (1,959 )     (3,278 )
Credit guarantee-related adjustments
    (1,076 )     (925 )     568       (596 )
Investment sales, debt retirements and fair value-related adjustments
    (7,717 )     659       (9,288 )     349  
Fully taxable-equivalent adjustments
    (103 )     (98 )     (318 )     (288 )
                                 
Total pre-tax adjustments
    (10,188 )     (2,089 )     (10,997 )     (3,813 )
Tax-related adjustments(1)
    (10,616 )     793       (10,195 )     1,525  
                                 
Total reconciling items, net of taxes
    (20,804 )     (1,296 )     (21,192 )     (2,288 )
                                 
GAAP net loss
  $ (25,295 )   $ (1,238 )   $ (26,267 )   $ (642 )
                                 
(1)  Includes a non-cash charge related to the establishment of a partial valuation allowance against our deferred tax assets of $14.3 billion that is not included in Segment Earnings.
 
Investments Segment
 
Our Investments segment is responsible for our investment activity in mortgages and mortgage-related securities, other investments, debt financing and managing our interest-rate risk, liquidity and capital positions. We invest principally in mortgage-related securities and single-family mortgage loans through our mortgage-related investment portfolio.
 
We seek to manage our mortgage-related investments portfolio to generate positive returns while maintaining a disciplined approach to interest-rate risk and capital management. We seek to accomplish this objective through opportunistic purchases, sales and restructurings of mortgage assets and repurchases of liabilities. Although we are primarily a buy-and-hold investor in mortgage assets, we may sell assets that are no longer expected to produce desired results, to reduce risk, to respond to capital constraints, to provide liquidity or to structure certain transactions in order to improve our returns. We currently do not plan to sell assets at a loss. We estimate our expected investment returns using an option-adjusted spread, or OAS, approach. Our Investments segment activities may also include the purchase of mortgages and mortgage-related securities with less attractive investment returns and with incremental risk in order to achieve our mission. Additionally, we maintain a cash and non-mortgage-related securities investment portfolio in this segment to help manage our liquidity needs.
 
Investments segment performance highlights for the three and nine months ended September 30, 2008:
 
  •  Segment Earnings (loss) decreased to $(1.1) billion in the third quarter of 2008 compared to Segment Earnings of $503 million in the third quarter of 2007. For the nine months ended September 30, 2008, Segment Earnings (loss) decreased to $(213) million compared to Segment Earnings of $1.6 billion during the nine months ended September 30, 2007.
 
  •  Segment Earnings net interest yield was 72 basis points in the third quarter of 2008, an increase of 19 basis points as compared to the third quarter of 2007 due to both the purchase of fixed-rate assets at wider spreads relative to our funding costs and the replacement of higher cost short- and long-term debt with lower cost debt issuances, which was partially offset by lower returns on floating rate securities. Segment Earnings net interest yield increased 5 basis points in the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007 to 58 basis points, due to wider spreads as a result of lower funding costs in the second and third quarters of 2008 and the replacement of higher cost short- and long-term debt with lower cost debt issuances. Also contributing to the increase was the amortization of gains on certain futures positions that matured in March 2008.
 
  •  During the third quarter of 2008, we recognized security impairments in Segment Earnings of $1.9 billion that reflect expected credit principal losses. In contrast, non-credit related security impairments of $7.2 billion are not included in Segment Earnings during the third quarter of 2008.
 
  •  Segment Earnings non-interest expense for the third quarter of 2008 includes a loss of $1.1 billion on investment transactions related to the Lehman short-term lending transactions. For more information on the Lehman short-term lending transactions, see “CONSOLIDATED RESULTS OF OPERATIONS — Securities Administrator Loss on Investment Activity.”
 
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  •  The unpaid principal balance of our mortgage-related investment portfolio increased 0.8% to $669 billion at September 30, 2008 compared to $663 billion at December 31, 2007. Agency securities comprised approximately 65% of the unpaid principal balance of the mortgage-related investment portfolio at September 30, 2008 versus 61% at December 31, 2007.
 
  •  Over the course of the past year, worldwide financial markets have experienced unprecedented levels of volatility. This has been particularly true over the latter half of the third quarter of 2008 as market participants struggled to digest the new government initiatives, including our conservatorship. In this environment where demand for debt instruments weakened considerably, the debt funding markets are sometimes frozen, and our ability to access both the term and callable debt markets has been limited. As a result, toward the latter part of the third quarter and continuing into the fourth quarter, we have relied increasingly on the issuance of shorter-term debt at higher-interest rates. While we use interest rate derivatives to economically hedge a significant portion of our interest rate exposure, we are exposed to risks relating to both our ability to issue new debt when our outstanding debt matures and to the variability in interest costs on our new issuances of debt, which directly impacts our Investments Segment earnings.
 
  •  The objectives set forth for us under our charter and conservatorship may negatively impact our Investments segment results. For example, the planned reduction in our retained portfolio balance to $250 billion, through successive annual 10% declines commencing in 2010, will result in an impact on our net interest income. This may cause our Investments segment results to decline.
 
Single-family Guarantee Segment
 
In our Single-family Guarantee segment, we securitize substantially all of the newly or recently originated single-family mortgages we have purchased and issue mortgage-related securities called PCs that can be sold to investors or held by us in our Investments segment. We guarantee the payment of principal and interest on our single-family PCs, including those held in our retained portfolio, in exchange for management and guarantee fees, which are paid on a monthly basis as a percentage of the underlying unpaid principal balance of the loans, and initial upfront cash payments referred to as credit or delivery fees. Earnings for this segment consist of management and guarantee fee revenues, including amortization of upfront payments, and trust management fees, less the related credit costs (i.e., provision for credit losses) and operating expenses. Also included is the interest earned on assets held in the Investments segment related to single-family guarantee activities, net of allocated funding costs.
 
Single-family Guarantee segment performance highlights for the three and nine months ended September 30, 2008 and 2007:
 
  •  Segment Earnings (loss) decreased to $(3.5) billion for the three months ended September 30, 2008 compared to earnings (loss) of $(483) million for the three months ended September 30, 2007. Segment Earnings (loss) decreased to $(5.3) billion for the nine months ended September 30, 2008 compared to $(130) million for the nine months ended September 30, 2007.
 
  •  Segment Earnings provision for credit losses for the Single-family Guarantee segment increased to $5.9 billion for the three months ended September 30, 2008 from $1.4 billion for the three months ended September 30, 2007. Segment Earnings provision for credit losses for the Single-family Guarantee segment increased to $9.9 billion for the nine months ended September 30, 2008 from $2.2 billion for the nine months ended September 30, 2007.
 
  •  Realized single-family credit losses were 27.9 basis points of the average single-family credit guarantee portfolio for the three months ended September 30, 2008, compared to 3.0 basis points for the three months ended September 30, 2007. Realized single-family credit losses for the nine months ended September 30, 2008 were 19.4 basis points compared to 2.2 basis points for the nine months ended September 30, 2007.
 
  •  We implemented several delivery fee increases that were effective at varying dates between March and June 2008, or as our customers’ contracts permitted. These increases included a 25 basis point fee assessed on all loans issued through flow-business channels, as well as higher or new delivery fees for certain mortgage products and for mortgages deemed to be higher-risk based primarily on property type, loan purpose, loan-to-value, or LTV ratio and/or borrower credit scores. Certain of our planned increases in delivery fees that were to be implemented in November 2008 have been cancelled. Our efforts to provide increased support to the mortgage market will likely affect our future guarantee pricing decisions.
 
  •  The single-family credit guarantee portfolio increased by 2% and 18% on an annualized basis for the three months ended September 30, 2008 and 2007, respectively.
 
  •  Average rates of Segment Earnings management and guarantee fee income for the Single-family Guarantee segment increased to 19.4 basis points for the three months ended September 30, 2008 compared to 18.1 basis points for the three months ended September 30, 2007. Average rates of Segment Earnings management and guarantee fee income
 
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  for the Single-family Guarantee segment increased to 19.5 basis points for the nine months ended September 30, 2008 compared to 18.0 basis points for the nine months ended September 30, 2007.
 
  •  The objectives set forth for us under our charter and conservatorship may negatively impact our Single-family Guarantee segment results. For example our objective of assisting the mortgage market may cause us to change our pricing strategy in our core mortgage loan purchase or guarantee business, which may cause our Single-Family guarantee segment results to suffer.
 
Multifamily Segment
 
Our Multifamily segment activities include purchases of multifamily mortgages for our retained portfolio and guarantees of payments of principal and interest on multifamily mortgage-related securities and mortgages underlying multifamily housing revenue bonds. The assets of the Multifamily segment include mortgages that finance multifamily rental apartments. Our Multifamily segment also includes certain equity investments in various limited partnerships that sponsor low- and moderate-income multifamily rental apartments, which benefit from low-income housing tax credits, or LIHTC. These activities support our mission to supply financing for affordable rental housing. Also included is the interest earned on assets held in our Investments segment related to multifamily guarantee activities, net of allocated funding costs.
 
Multifamily segment performance highlights for the three and nine months ended September 30, 2008 and 2007:
 
  •  Segment Earnings increased 63% to $135 million for the three months ended September 30, 2008 versus $83 million for the three months ended September 30, 2007. Segment Earnings increased 20% to $351 million for the nine months ended September 30, 2008 versus $292 million for the nine months ended September 30, 2007.
 
  •  Segment Earnings net interest income was $120 million for the three months ended September 30, 2008, an increase of $32 million versus the three months ended September 30, 2007 as a result of an increase in interest income on mortgage loans due to higher average balances, partially offset by a decrease in prepayment fees, or yield maintenance income. Segment Earnings net interest income was $293 million for the nine months ended September 30, 2008, a decline of $12 million versus the nine months ended September 30, 2007.
 
  •  Mortgage purchases into our multifamily loan portfolio increased approximately 56% for the three months ended September 30, 2008 to $5.2 billion from $3.3 billion for the three months ended September 30, 2007. Mortgage purchases into our multifamily loan portfolio increased approximately 52% for the nine months ended September 30, 2008 to $13.4 billion from $8.8 billion for the nine months ended September 30, 2007.
 
  •  Unpaid principal balance of our multifamily loan portfolio increased to $68.3 billion at September 30, 2008 from $57.6 billion at December 31, 2007 as market fundamentals continued to provide opportunities to purchase loans to be held in our portfolio.
 
  •  Segment Earnings provision for credit losses for the Multifamily segment totaled $14 million and $30 million for the three and nine months ended September 30, 2008, respectively. Segment Earnings provision for credit losses for the Multifamily segment totaled $16 million and $20 million for the three and nine months ended September 30, 2007, respectively.
 
  •  The objectives set forth for us under our charter and conservatorship may negatively impact our Multifamily segment results. For example, our objective of assisting the mortgage market may cause us to change our pricing strategy in our core mortgage loan purchase or guarantee business, which may cause our Multifamily segment results to suffer.
 
Capital Management
 
The conservatorship resulted in changes to the assessment of our capital adequacy and our management of capital. On October 9, 2008, FHFA announced that it was suspending capital classification of us during conservatorship in light of the Purchase Agreement. Concurrent with this announcement, FHFA classified us as undercapitalized as of June 30, 2008 based on discretionary authority provided by statute. FHFA noted that although our capital calculations as of June 30, 2008 reflected that we met the statutory and FHFA-directed requirements for capital, the continued market downturn in July and August of 2008 raised significant questions about the sufficiency of our capital. Factors cited by FHFA leading to the downgrade in our capital classification and the need for conservatorship included (a) our accelerated safety and soundness weaknesses, especially with regard to our credit risk, earnings outlook and capitalization, (b) continued and substantial deterioration in equity, debt and mortgage-related securities market conditions, (c) our current and projected financial performance, (d) our inability to raise capital or issue debt according to normal practices and prices, (e) our critical importance in supporting the U.S. residential mortgage markets and (f) concerns over the proportion of intangible assets as part of our core capital.
 
FHFA will continue to closely monitor our capital levels, but the existing statutory and FHFA-directed regulatory capital requirements will not be binding during conservatorship. We will continue to provide our regular submissions to FHFA on both minimum and risk-based capital. FHFA will publish relevant capital figures (minimum capital requirement, core capital, and GAAP net worth) but does not intend to publish our critical capital, risk-based capital or subordinated debt levels during
 
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conservatorship. Additionally, FHFA announced it will engage in rule-making to revise our minimum capital and risk-based capital requirements. See “NOTE 9: REGULATORY CAPITAL” to our consolidated financial statements for our minimum capital requirement, core capital and GAAP net worth results as of September 30, 2008.
 
FHFA has directed us to focus our risk and capital management on maintaining a positive balance of GAAP stockholders’ equity while returning to long-term profitability. FHFA is directing us to manage to a positive stockholders’ equity position in order to reduce the likelihood that we will need to make a draw on the Purchase Agreement with Treasury. The Purchase Agreement provides that, if FHFA determines as of quarter end that our liabilities have exceeded our assets under GAAP, Treasury will contribute funds to us in an amount equal to the difference between such liabilities and assets; a higher amount may be drawn if Treasury and Freddie Mac mutually agree that the draw should be increased beyond the level by which liabilities exceed assets under GAAP. The maximum aggregate amount that may be funded under the Purchase Agreement is $100 billion. At September 30, 2008, our liabilities exceeded our assets under GAAP by $(13.7) billion while our stockholders’ equity (deficit) totaled $(13.8) billion. The Director of FHFA has submitted a request under the Purchase Agreement in the amount of $13.8 billion to Treasury. Under the Reform Act, FHFA must place us into receivership if our assets are less than our obligations for a period of 60 days. If this were to occur, we would be required to obtain funding from Treasury pursuant to its commitment under the Purchase Agreement in order to avoid a mandatory trigger of receivership under the Reform Act.
 
The Purchase Agreement places several restrictions on our business activities, which, in turn, affect our management of capital. For instance, our retained portfolio may not exceed $850 billion as of December 31, 2009 and must then decline by 10% per year until it reaches $250 billion. We are also unable to issue capital stock of any kind without Treasury’s prior approval, other than in connection with the common stock warrant issued to Treasury under the Purchase Agreement or binding agreements in effect on the date of the Purchase Agreement. In addition, on September 7, 2008, the Director of FHFA announced the elimination of dividends on our common and preferred stock, excluding the senior preferred stock, which will accrue quarterly cumulative dividends at a rate of 10% per year or 12% in any quarter in which dividends are not paid in cash until all dividend accruals have been paid in cash. See “Legislative and Regulatory Matters” for additional information regarding covenants under the Purchase Agreement.
 
A variety of factors could materially affect the level and volatility of our GAAP stockholders’ equity (deficit) in future periods, requiring us to make additional draws under the Purchase Agreement. Key factors include continued deterioration in the housing market, which could increase credit expenses; adverse changes in interest rates, the yield curve, implied volatility or mortgage OAS, which could increase realized and unrealized mark-to-market losses recorded in earnings or AOCI; dividend obligations under the Purchase Agreement; establishment of a valuation allowance for our remaining deferred tax assets; changes in accounting practices or standards; or changes in business practices resulting from legislative and regulatory developments or mission fulfillment activities or as directed by the Conservator. At September 30, 2008, our remaining deferred tax assets, which could be subject to a valuation allowance in future periods, totaled $11.9 billion. In addition, during October 2008 mortgage spreads widened significantly, resulting in additional mark-to-market losses included in stockholders’ equity (deficit). As a result of the factors described above, it is difficult for us to manage our stockholders’ equity (deficit). Thus, it may be difficult for us to meet the objective of managing to a positive stockholders’ equity (deficit).
 
If we need additional draws under the Purchase Agreement, this would result in a considerably higher dividend obligation for us. Higher dividends combined with potentially substantial commitment fees payable to Treasury starting in 2010 and limited flexibility to pay down capital draws will have a significant adverse impact on our future financial position and net worth. For additional information concerning the potential impact of the Purchase Agreement, including taking additional large draws, see “RISK FACTORS.”
 
Liquidity
 
Since early July 2008, we have experienced significant deterioration in our access to the unsecured medium- and long-term debt markets and in the yields on our debt as compared to relevant market benchmarks. Consistent demand for our debt securities has decreased for our term debt and callable debt, and the spreads we must pay on our new issuances of short-term debt securities increased.
 
There are many factors contributing to the reduced demand for our debt securities, including continued severe market disruptions, market concerns about our capital position and the future of our business (including its future profitability, future structure, regulatory actions and agency status) and the extent of U.S. government support for our debt securities. In addition, the various U.S. government programs are still being digested by market participants creating uncertainty as to whether competing obligations of other companies are more attractive investments than our debt securities.
 
As noted above, due to our limited ability to issue long-term debt, we have relied increasingly on short-term debt to fund our purchases of mortgage assets and to refinance maturing debt. As a result, we are required to refinance our debt on a more frequent basis, exposing us to an increased risk of insufficient demand, increasing interest rates and adverse credit market conditions. It is unclear when these market conditions will reverse allowing us access to the longer term debt
 
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markets. See “LIQUIDITY AND CAPITAL RESOURCES — Liquidity” for more information on our debt funding activities and risks posed by our current market challenges and “Part II — Item 1A — Risk Factors” for a discussion of the risks to our business posed by our reliance on the issuance of debt to fund our operations.
 
Fair Value Results
 
Our consolidated fair value measurements are a component of our risk management processes, as we use daily estimates of the changes in fair value to calculate our Portfolio Market Value Sensitivity, or PMVS, and duration gap measures.
 
During the three months ended September 30, 2008, the fair value of net assets, before capital transactions, decreased by $36.7 billion compared to a $8.4 billion decrease during the three months ended September 30, 2007. Included in the reduction of the fair value of net assets is $19.4 billion related to our partial valuation allowance for our deferred tax asset for the three months ended September 30, 2008.
 
Our attribution of changes in the fair value of net assets relies on models, assumptions and other measurement techniques that evolve over time. The following attribution of changes in fair value reflects our current estimate of the items presented (on a pre-tax basis) and excludes the effect of returns on capital and administrative expenses.
 
During the three months ended September 30, 2008, our investment activities decreased fair value by approximately $12.2 billion. This estimate includes declines in fair value of approximately $5.3 billion attributable to the net widening of mortgage-to-debt OAS. Of this amount, approximately $7.9 billion was related to the impact of the net mortgage-to-debt OAS widening on our portfolio of non-agency mortgage-related securities with a limited, but increasing amount attributable to the risk of future losses, as well as an $11.1 billion decrease in negative fair value from our preferred stock. The reduction in fair value was partially offset by our higher core spread income. Core spread income on our retained portfolio is a fair value estimate of the net current period accrual of income from the spread between mortgage-related investments and debt, calculated on an option-adjusted basis.
 
During the three months ended September 30, 2007, our investment activities decreased fair value by approximately $6.2 billion. This estimate includes declines in fair value of approximately $8.0 billion attributable to the net widening of mortgage-to-debt OAS. Of this amount, approximately $3.5 billion was related to the impact of the net mortgage-to-debt OAS widening on our portfolio of non-agency mortgage-related securities.
 
The impact of mortgage-to-debt OAS widening during the three months ended September 30, 2008 decreased the current fair value of our investment activities. Due to the relatively wide OAS levels for purchases during the period, there is a likelihood that, in future periods, we will be able to recognize core-spread income from our investment activities at a higher spread level than historically. We estimate that for the three months ended September 30, 2008, we will recognize core spread income at a net mortgage-to-debt OAS level of approximately 190 to 210 basis points in the long run, as compared to approximately 60 to 70 basis points estimated for the three months ended September 30, 2007. As market conditions change, our estimate of expected fair value gains from OAS may also change, leading to significantly different fair value results.
 
During the three months ended September 30, 2008, our credit guarantee activities, including our single-family whole loan credit exposure, decreased fair value by an estimated $8.1 billion. This estimate includes an increase in the single-family guarantee obligation of approximately $6.3 billion, primarily attributable to an increase in expected default costs.
 
During the three months ended September 30, 2007, our credit guarantee activities decreased fair value by an estimated $6.4 billion. This estimate includes an increase in the single-family guarantee obligation of approximately $7.6 billion, primarily attributable to the market’s pricing of mortgage credit. This increase in the single-family guarantee obligation was partially offset by a fair value increase in the single-family guarantee asset of approximately $0.5 billion and cash receipts primarily related to management and guarantee fees and other up-front fees related to new business.
 
See “CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS” for additional information regarding attribution of changes in the fair value of net assets for the nine months ended September 30, 2008.
 
Legislative and Regulatory Matters
 
Conservatorship and Treasury Agreements
 
Conservatorship
 
On September 6, 2008, FHFA, our safety, soundness and mission regulator, was appointed as our Conservator when the Director of FHFA placed us into conservatorship. The conservatorship is a statutory process designed to preserve and conserve our assets and property, and put the company in a sound and solvent condition. As Conservator, FHFA has assumed the powers of our Board of Directors and management, as well as the powers of our stockholders. The powers of the Conservator under the Reform Act are summarized below.
 
The conservatorship has no specified termination date. In a Fact Sheet issued by FHFA on September 7, 2008, FHFA indicated that the Director of FHFA will issue an order terminating the conservatorship upon the Director’s determination that the Conservator’s plan to restore the company to a safe and solvent condition has been completed successfully. The FHFA’s
 
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September 7, 2008 Fact Sheet also indicated that, at present, there is no time frame that can be given as to when the conservatorship may end.
 
General Powers of the Conservator Pursuant to the Reform Act
 
Upon its appointment, the Conservator immediately succeeded to all rights, titles, powers and privileges of Freddie Mac, and of any stockholder, officer or director of Freddie Mac with respect to Freddie Mac and its assets, and succeeded to the title to all books, records and assets of Freddie Mac held by any other legal custodian or third party. The Conservator has the power to take over our assets and operate our business with all the powers of our stockholders, directors and officers, and to conduct all business of the company.
 
The Conservator may take any actions it determines are necessary and appropriate to carry on our business and preserve and conserve our assets and property. The Conservator’s powers include the ability to transfer or sell any of our assets or liabilities (subject to limitations and post-transfer notice provisions for transfers of qualified financial contracts, as defined below under “Special Powers of the Conservator — Security Interests Protected; Exercise of Rights Under Qualified Financial Contracts”) without any approval, assignment of rights or consent. The Reform Act, however, provides that mortgage loans and mortgage-related assets that have been transferred to a Freddie Mac securitization trust must be held for the beneficial owners of the trust and cannot be used to satisfy our general creditors.
 
In connection with any sale or disposition of our assets, the Conservator must conduct its operations to maximize the net present value return from the sale or disposition, to minimize the amount of any loss realized, and to ensure adequate competition and fair and consistent treatment of offerors. The Conservator is required to pay all of our valid obligations that were due and payable on September 6, 2008 (the date we were placed into conservatorship), but only to the extent that the proceeds realized from the performance of contracts or sale of our assets are sufficient to satisfy those obligations. In addition, the Conservator is required to maintain a full accounting of the conservatorship and make its reports available upon request to stockholders and members of the public.
 
We remain liable for all of our obligations relating to our outstanding debt and mortgage-related securities. In a Fact Sheet dated September 7, 2008, FHFA indicated that our obligations will be paid in the normal course of business during the conservatorship.
 
Special Powers of the Conservator Under the Reform Act
 
     Disaffirmance and Repudiation of Contracts
 
The Conservator may disaffirm or repudiate contracts (subject to certain limitations for qualified financial contracts) that we entered into prior to its appointment as Conservator if it determines, in its sole discretion, that performance of the contract is burdensome and that disaffirmation or repudiation of the contract promotes the orderly administration of our affairs. The Reform Act requires FHFA to exercise its right to disaffirm or repudiate most contracts within a reasonable period of time after its appointment as Conservator. As of November 14, 2008, the Conservator had not determined whether or not such reasonable period of time had passed for purposes of the applicable provisions of the Reform Act.
 
As of November 14, 2008, the Conservator has advised us that it has not disaffirmed or repudiated any contracts we entered into prior to its appointment as Conservator. We can, and have continued to, enter into and enforce contracts with third parties.
 
The Conservator has advised us that it has no intention of repudiating any guarantee obligation relating to Freddie Mac’s mortgage-related securities because it views repudiation as incompatible with the goals of the conservatorship. In addition, as noted above, the Conservator cannot use mortgage loans or mortgage-related assets that have been transferred to a securitization trust to satisfy the general creditors of the company. The Conservator must hold these assets for the beneficial owners of the related Freddie Mac mortgage-related securities.
 
In general, the liability of the Conservator for the disaffirmance or repudiation of any contract is limited to actual direct compensatory damages determined as of September 6, 2008, which is the date we were placed into conservatorship. The liability of the Conservator for the disaffirmance or repudiation of a qualified financial contract is limited to actual direct compensatory damages determined as of the date of the disaffirmance or repudiation. If the Conservator disaffirms or repudiates any lease to or from us, or any contract for the sale of real property, the Reform Act specifies the liability of the Conservator.
 
     Limitations on Enforcement of Contractual Rights by Counterparties
 
The Reform Act provides that the Conservator may enforce most contracts entered into by us, notwithstanding any provision of the contract that provides for termination, default, acceleration, or exercise of rights upon the appointment of, or the exercise of rights or powers by, a conservator.
 
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     Security Interests Protected; Exercise of Rights Under Qualified Financial Contracts
 
Notwithstanding the Conservator’s powers described above, the Conservator must recognize legally enforceable or perfected security interests, except where such an interest is taken in contemplation of our insolvency or with the intent to hinder, delay or defraud us or our creditors. In addition, the Reform Act provides that no person will be stayed or prohibited from exercising specified rights in connection with qualified financial contracts, including termination or acceleration (other than solely by reason of, or incidental to, the appointment of the Conservator), rights of offset, and rights under any security agreement or arrangement or other credit enhancement relating to such contract. The term qualified financial contract means any securities contract, commodity contract, forward contract, repurchase agreement, swap agreement and any similar agreement, as determined by FHFA.
 
     Avoidance of Fraudulent Transfers
 
The Conservator may avoid, or refuse to recognize, a transfer of any property interest of Freddie Mac or of any of our debtors, and also may avoid any obligation incurred by Freddie Mac or by any debtor of Freddie Mac, if the transfer or obligation was made: (1) within five years of September 6, 2008; and (2) with the intent to hinder, delay, or defraud Freddie Mac, FHFA, the Conservator or, in the case of a transfer in connection with a qualified financial contract, our creditors. To the extent a transfer is avoided, the Conservator may recover, for our benefit, the property or, by court order, the value of that property from the initial or subsequent transferee, unless the transfer was made for value and in good faith. These rights are superior to any rights of a trust or any other party, other than a federal agency, under the U.S. bankruptcy code.
 
     Modification of Statutes of Limitations
 
Under the Reform Act, notwithstanding any provision of any contract, the statute of limitations with regard to any action brought by the Conservator is: (1) for claims relating to a contract, the longer of six years or the applicable period under state law; and (2) for tort claims, the longer of three years or the applicable period under state law, in each case, from the later of September 6, 2008 or the date on which the cause of action accrues. In addition, notwithstanding the state law statute of limitation for tort claims, the Conservator may bring an action for any tort claim that arises from fraud, intentional misconduct resulting in unjust enrichment, or intentional misconduct resulting in substantial loss to us, if the state’s statute of limitations expired not more than five years before September 6, 2008.
 
     Suspension of Legal Actions
 
In any judicial action or proceeding to which we are or become a party, the Conservator may request, and the applicable court must grant, a stay for a period not to exceed 45 days.
 
     Treatment of Breach of Contract Claims
 
Any final and unappealable judgment for monetary damages against the Conservator for breach of an agreement executed or approved in writing by the Conservator will be paid as an administrative expense of the Conservator.
 
     Attachment of Assets and Other Injunctive Relief
 
The Conservator may seek to attach assets or obtain other injunctive relief without being required to show that any injury, loss or damage is irreparable and immediate.
 
     Subpoena Power
 
The Reform Act provides the Conservator, with the approval of the Director of FHFA, with subpoena power for purposes of carrying out any power, authority or duty with respect to Freddie Mac.
 
     Current Management of the Company Under Conservatorship
 
As noted above, as our Conservator, FHFA has assumed the powers of our Board of Directors. Accordingly, the current Board of Directors acts with neither the power nor the duty to manage, direct or oversee our business and affairs. The Conservator has indicated that it intends to appoint a full Board of Directors to which it will delegate specified roles and responsibilities. Until FHFA has made these delegations, our Board of Directors has no power to determine the general policies that govern our operations, to create committees and elect the members of those committees, to select our officers, to manage, direct or oversee our business and affairs, or to exercise any of the other powers of the Board of Directors that are set forth in our charter and bylaws.
 
FHFA, in its role as Conservator, has overall management authority over our business. During the conservatorship, the Conservator has delegated authority to management to conduct day-to-day operations so that the company can continue to operate in the ordinary course of business. The Conservator retains the authority to withdraw its delegations to management at any time. The Conservator is working actively with management to address and determine the strategic direction for the enterprise, and in general has retained final decision-making authority in areas regarding: significant impacts on operational, market, reputational or credit risk; major accounting determinations, including policy changes; the creation of subsidiaries or affiliates and transacting with them; significant litigation; setting executive compensation; retention of external auditors;
 
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significant mergers and acquisitions; and any other matters the Conservator believes are strategic or critical to the enterprise in order for the Conservator to fulfill its obligations during conservatorship.
 
Treasury Agreements
 
The Reform Act granted Treasury temporary authority (through December 31, 2009) to purchase any obligations and other securities issued by Freddie Mac on such terms and conditions and in such amounts as Treasury may determine, upon mutual agreement between Treasury and Freddie Mac. As of November 14, 2008, Treasury had used this authority as follows:
 
Agreement and Related Issuance of Senior Preferred Stock and Common Stock Warrant
 
     Purchase Agreement
 
On September 7, 2008, we, through FHFA, in its capacity as Conservator, and Treasury entered into the Purchase Agreement. The Purchase Agreement was subsequently amended and restated on September 26, 2008. Pursuant to the Purchase Agreement, we agreed to issue to Treasury one million shares of senior preferred stock with an initial liquidation preference equal to $1,000 per share (for an aggregate liquidation preference of $1 billion), and a warrant for the purchase of our common stock. The terms of the senior preferred stock and warrant are summarized in separate sections below. We did not receive any cash proceeds from Treasury as a result of issuing the senior preferred stock or the warrant.
 
The senior preferred stock and warrant were sold and issued to Treasury as an initial commitment fee in consideration of the commitment from Treasury to provide up to $100 billion in funds to us under the terms and conditions set forth in the Purchase Agreement. In addition to the issuance of the senior preferred stock and warrant, beginning on March 31, 2010, we are required to pay a quarterly commitment fee to Treasury. This quarterly commitment fee will accrue from January 1, 2010. The fee, in an amount to be mutually agreed upon by us and Treasury and to be determined with reference to the market value of Treasury’s funding commitment as then in effect, will be determined on or before December 31, 2009, and will be reset every five years. Treasury may waive the quarterly commitment fee for up to one year at a time, in its sole discretion, based on adverse conditions in the U.S. mortgage market. We may elect to pay the quarterly commitment fee in cash or add the amount of the fee to the liquidation preference of the senior preferred stock.
 
The Purchase Agreement provides that, on a quarterly basis, we generally may draw funds up to the amount, if any, by which our total liabilities exceed our total assets, as reflected on our GAAP balance sheet for the applicable fiscal quarter (referred to as the deficiency amount), provided that the aggregate amount funded under the Purchase Agreement may not exceed $100 billion. The Purchase Agreement provides that the deficiency amount will be calculated differently if we become subject to receivership or other liquidation process. The deficiency amount may be increased above the otherwise applicable amount upon our mutual written agreement with Treasury. In addition, if the Director of FHFA determines that the Director will be mandated by law to appoint a receiver for us unless our capital is increased by receiving funds under the commitment in an amount up to the deficiency amount (subject to the $100 billion maximum amount that may be funded under the agreement), then FHFA, in its capacity as our Conservator, may request that Treasury provide funds to us in such amount. The Purchase Agreement also provides that, if we have a deficiency amount as of the date of completion of the liquidation of our assets, we may request funds from Treasury in an amount up to the deficiency amount (subject to the $100 billion maximum amount that may be funded under the agreement). Any amounts that we draw under the Purchase Agreement will be added to the liquidation preference of the senior preferred stock. No additional shares of senior preferred stock are required to be issued under the Purchase Agreement.
 
The Purchase Agreement provides that the Treasury’s funding commitment will terminate under any the following circumstances: (1) the completion of our liquidation and fulfillment of Treasury’s obligations under its funding commitment at that time; (2) the payment in full of, or reasonable provision for, all of our liabilities (whether or not contingent, including mortgage guarantee obligations); and (3) the funding by Treasury of $100 billion under the Purchase Agreement. In addition, Treasury may terminate its funding commitment and declare the Purchase Agreement null and void if a court vacates, modifies, amends, conditions, enjoins, stays or otherwise affects the appointment of the Conservator or otherwise curtails the Conservator’s powers. Treasury may not terminate its funding commitment under the agreement solely by reason of our being in conservatorship, receivership or other insolvency proceeding, or due to our financial condition or any adverse change in our financial condition.
 
The Purchase Agreement provides that most provisions of the agreement may be waived or amended by mutual written agreement of the parties; however, no waiver or amendment of the agreement is permitted that would decrease Treasury’s aggregate funding commitment or add conditions to Treasury’s funding commitment if the waiver or amendment would adversely affect in any material respect the holders of our debt securities or Freddie Mac mortgage guarantee obligations.
 
In the event of our default on payments with respect to our debt securities or Freddie Mac mortgage guarantee obligations, if Treasury fails to perform its obligations under its funding commitment and if we and/or the Conservator are not diligently pursuing remedies in respect of that failure, the holders of these debt securities or Freddie Mac mortgage
 
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guarantee obligations may file a claim in the United States Court of Federal Claims for relief requiring Treasury to fund to us the lesser of: (1) the amount necessary to cure the payment defaults on our debt and Freddie Mac mortgage guarantee obligations; and (2) the lesser of: (a) the deficiency amount; and (b) $100 billion less the aggregate amount of funding previously provided under the commitment. Any payment that Treasury makes under those circumstances will be treated for all purposes as a draw under the Purchase Agreement that will increase the liquidation preference of the senior preferred stock.
 
The Purchase Agreement includes several covenants that significantly restrict our business activities, which are described below under “Covenants Under Treasury Agreements — Purchase Agreement Covenants.”
 
The Purchase Agreement is filed as an exhibit to this Form 10-Q.
 
     Issuance of Senior Preferred Stock
 
Pursuant to the Purchase Agreement described above, we issued one million shares of senior preferred stock to Treasury on September 8, 2008. The senior preferred stock was issued to Treasury in partial consideration of Treasury’s commitment to provide up to $100 billion in funds to us under the terms set forth in the Purchase Agreement.
 
Shares of the senior preferred stock have no par value, and have a stated value and initial liquidation preference equal to $1,000 per share. The liquidation preference of the senior preferred stock is subject to adjustment. Dividends that are not paid in cash for any dividend period will accrue and be added to the liquidation preference of the senior preferred stock. In addition, any amounts Treasury pays to us pursuant to its funding commitment under the Purchase Agreement and any quarterly commitment fees that are not paid in cash to Treasury or waived by Treasury will be added to the liquidation preference of the senior preferred stock. As described below, we may make payments to reduce the liquidation preference of the senior preferred stock.
 
Holders of the senior preferred stock are entitled to receive, when, as and if declared by our Board of Directors, cumulative quarterly cash dividends at the annual rate of 10% per year on the then-current liquidation preference of the senior preferred stock. The initial dividend, if declared, will be payable on December 31, 2008 and will be for the period from but not including September 8, 2008 through and including December 31, 2008. If at any time we fail to pay cash dividends in a timely manner, then immediately following such failure and for all dividend periods thereafter until the dividend period following the date on which we have paid in cash full cumulative dividends (including any unpaid dividends added to the liquidation preference), the dividend rate will be 12% per year.
 
The senior preferred stock ranks ahead of our common stock and all other outstanding series of our preferred stock, as well as any capital stock we issue in the future, as to both dividends and rights upon liquidation. The senior preferred stock provides that we may not, at any time, declare or pay dividends on, make distributions with respect to, or redeem, purchase or acquire, or make a liquidation payment with respect to, any common stock or other securities ranking junior to the senior preferred stock unless: (1) full cumulative dividends on the outstanding senior preferred stock (including any unpaid dividends added to the liquidation preference) have been declared and paid in cash; and (2) all amounts required to be paid with the net proceeds of any issuance of capital stock for cash (as described in the following paragraph) have been paid in cash. Shares of the senior preferred stock are not convertible. Shares of the senior preferred stock have no general or special voting rights, other than those set forth in the certificate of designation for the senior preferred stock or otherwise required by law. The consent of holders of at least two-thirds of all outstanding shares of senior preferred stock is generally required to amend the terms of the senior preferred stock or to create any class or series of stock that ranks prior to or on parity with the senior preferred stock.
 
We are not permitted to redeem the senior preferred stock prior to the termination of Treasury’s funding commitment set forth in the Purchase Agreement; however, we are permitted to pay down the liquidation preference of the outstanding shares of senior preferred stock to the extent of (1) accrued and unpaid dividends previously added to the liquidation preference and not previously paid down; and (2) quarterly commitment fees previously added to the liquidation preference and not previously paid down. In addition, if we issue any shares of capital stock for cash while the senior preferred stock is outstanding, the net proceeds of the issuance must be used to pay down the liquidation preference of the senior preferred stock; however, the liquidation preference of each share of senior preferred stock may not be paid down below $1,000 per share prior to the termination of Treasury’s funding commitment. Following the termination of Treasury’s funding commitment, we may pay down the liquidation preference of all outstanding shares of senior preferred stock at any time, in whole or in part. If, after termination of Treasury’s funding commitment, we pay down the liquidation preference of each outstanding share of senior preferred stock in full, the shares will be deemed to have been redeemed as of the payment date.
 
The certificate of designation for the senior preferred stock is incorporated by reference as an exhibit to this Form 10-Q.
 
     Issuance of Common Stock Warrant
 
Pursuant to the Purchase Agreement described above, on September 7, 2008, we, through FHFA, in its capacity as Conservator, issued a warrant to purchase common stock to Treasury. The warrant was issued to Treasury in partial
 
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consideration of Treasury’s commitment to provide up to $100 billion in funds to us under the terms set forth in the Purchase Agreement.
 
The warrant gives Treasury the right to purchase shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis on the date of exercise. The warrant may be exercised in whole or in part at any time on or before September 7, 2028, by delivery to us of: (a) a notice of exercise; (b) payment of the exercise price of $0.00001 per share; and (c) the warrant. If the market price of one share of our common stock is greater than the exercise price, then, instead of paying the exercise price, Treasury may elect to receive shares equal to the value of the warrant (or portion thereof being canceled) pursuant to the formula specified in the warrant. Upon exercise of the warrant, Treasury may assign the right to receive the shares of common stock issuable upon exercise to any other person. The warrant contains several covenants, which are described under “Covenants Under Treasury Agreements — Treasury Warrant Covenants.”
 
As of November 14, 2008, Treasury has not exercised the warrant. The warrant is incorporated by reference as an exhibit to this Form 10-Q.
 
Lending Agreement
 
On September 18, 2008, we entered into the Lending Agreement with Treasury under which we may request loans until December 31, 2009. Loans under the Lending Agreement require approval from Treasury at the time of request. Treasury is not obligated under the Lending Agreement to make, increase, renew or extend any loan to us. The Lending Agreement does not specify a maximum amount that may be borrowed thereunder, but any loans made to us by Treasury pursuant to the Lending Agreement must be collateralized by Freddie Mac or Fannie Mae mortgage-backed securities. Further, unless amended or waived by Treasury, the amount we may borrow under the Lending Agreement is limited by the restriction under the Purchase Agreement on incurring debt in excess of 110% of our aggregate indebtedness as of June 30, 2008.
 
The Lending Agreement does not specify the maturities or interest rate of loans that may be made by Treasury under the credit facility. In a Fact Sheet regarding the credit facility published by Treasury on September 7, 2008, Treasury indicated that loans made pursuant to the credit facility will be for short-term durations and would in general be expected to be for less than one month but no shorter than one week. The Fact Sheet further indicated that the interest rate on loans made pursuant to the credit facility ordinarily will be based on daily LIBOR, fixed for a similar term of the loan plus 50 basis points. Given that the interest rate we are likely to be charged under the credit facility will be significantly higher than the rates we have historically achieved through the sale of unsecured debt, use of the facility in significant amounts could have a material adverse impact on our financial results.
 
As of November 14, 2008, we have not requested any loans or borrowed any amounts under the Lending Agreement.
 
For a description of the covenants contained in the Lending Agreement, refer to “Covenants under Treasury Agreements — Lending Agreement Covenants” below. For additional information on the terms of the Lending Agreement, refer to our Current Report on Form 8-K filed with the SEC on September 23, 2008 and a copy of the Lending Agreement is incorporated by reference as an exhibit to this Form 10-Q.
 
Covenants under Treasury Agreements
 
The Purchase Agreement, warrant and Lending Agreement contain covenants that significantly restrict our business activities. These covenants, which are summarized below, include a prohibition on our issuance of additional equity securities (except in limited instances), a prohibition on the payment of dividends or other distributions on our equity securities (other than the senior preferred stock or warrant), a prohibition on our issuance of subordinated debt and a limitation on the total amount of debt securities we may issue. As a result, we can no longer obtain additional equity financing (other than pursuant to the Purchase Agreement ) and we are limited in the amount and type of debt financing we may obtain.
 
Purchase Agreement Covenants
 
The Purchase Agreement provides that, until the senior preferred stock is repaid or redeemed in full, we may not, without the prior written consent of Treasury:
 
  •  Declare or pay any dividend (preferred or otherwise) or make any other distribution with respect to any Freddie Mac equity securities (other than with respect to the senior preferred stock or warrant);
 
  •  Redeem, purchase, retire or otherwise acquire any Freddie Mac equity securities (other than the senior preferred stock or warrant);
 
  •  Sell or issue any Freddie Mac equity securities (other than the senior preferred stock, the warrant and the common stock issuable upon exercise of the warrant and other than as required by the terms of any binding agreement in effect on the date of the Purchase Agreement);
 
  •  Terminate the conservatorship (other than in connection with a receivership);
 
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  •  Sell, transfer, lease or otherwise dispose of any assets, other than dispositions for fair market value: (a) to a limited life regulated entity (in the context of a receivership); (b) of assets and properties in the ordinary course of business, consistent with past practice; (c) in connection with our liquidation by a receiver; (d) of cash or cash equivalents for cash or cash equivalents; or (e) to the extent necessary to comply with the covenant described below relating to the reduction of our portfolio of retained mortgages and mortgage-backed securities beginning in 2010;
 
  •  Incur indebtedness that would result in our aggregate indebtedness exceeding 110% of our aggregate indebtedness as of June 30, 2008;
 
  •  Issue any subordinated debt;
 
  •  Enter into a corporate reorganization, recapitalization, merger, acquisition or similar event; or
 
  •  Engage in transactions with affiliates unless the transaction is (a) pursuant to the Purchase Agreement, the senior preferred stock or the warrant, (b) upon arm’s length terms or (c) a transaction undertaken in the ordinary course or pursuant to a contractual obligation or customary employment arrangement in existence on the date of the Purchase Agreement.
 
The Purchase Agreement also provides that we may not own mortgage assets in excess of: (a) $850 billion on December 31, 2009; or (b) on December 31 of each year thereafter, 90% of the aggregate amount of our mortgage assets as of December 31 of the immediately preceding calendar year, provided that we are not required to own less than $250 billion in mortgage assets.
 
In addition, the Purchase Agreement provides that we may not enter into any new compensation arrangements or increase amounts or benefits payable under existing compensation arrangements of any named executive officer (as defined by SEC rules) without the consent of the Director of FHFA, in consultation with the Secretary of the Treasury.
 
We are required under the Purchase Agreement to provide annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K to Treasury in accordance with the time periods specified in the SEC’s rules. In addition, our designated representative (which, during the conservatorship, is the Conservator) is required to provide quarterly certifications to Treasury certifying compliance with the covenants contained in the Purchase Agreement and the accuracy of the representations made pursuant to the agreement. We also are obligated to provide prompt notice to Treasury of the occurrence of specified events, such as the filing of a lawsuit that would reasonably be expected to have a material adverse effect. As of November 13, 2008, we believe we were in compliance with the covenants under the Purchase Agreement.
 
For a summary of the terms of the Purchase Agreement, see “Purchase Agreement and Related Issuance of Senior Preferred Stock and Common Stock Warrant — Purchase Agreement” above. For the complete terms of the covenants, see the copy of the Purchase Agreement filed as an exhibit to this Form 10-Q.
 
Warrant Covenants
 
The warrant we issued to Treasury includes, among others, the following covenants: our SEC filings under the Exchange Act will comply in all material respects as to form with the Exchange Act and the rules and regulations thereunder; we may not permit any of our significant subsidiaries to issue capital stock or equity securities, or securities convertible into or exchangeable for such securities, or any stock appreciation rights or other profit participation rights; we may not take any action that will result in an increase in the par value of our common stock; we may not take any action to avoid the observance or performance of the terms of the warrant and we must take all actions necessary or appropriate to protect Treasury’s rights against impairment or dilution; and we must provide Treasury with prior notice of specified actions relating to our common stock, such as setting a record date for a dividend payment, granting subscription or purchase rights, authorizing a recapitalization, reclassification, merger or similar transaction, commencing a liquidation of the company or any other action that would trigger an adjustment in the exercise price or number or amount of shares subject to the warrant.
 
The warrant remains outstanding through September 7, 2028.
 
As of November 13, 2008, we believe we were in compliance with the covenants under the warrant. For a summary of the terms of the warrant, see “Purchase Agreement and Related Issuance of Senior Preferred Stock and Common Stock Warrant — Issuance of Common Stock Warrant” above. For the complete terms of the covenants contained in the warrant, a copy of the warrant is incorporated by reference as an exhibit to this Form 10-Q.
 
Lending Agreement Covenants
 
The Lending Agreement includes covenants requiring us, among other things:
 
  •  to maintain Treasury’s security interest in the collateral, including the priority of the security interest, and take actions to defend against adverse claims;
 
  •  not to sell or otherwise dispose of, pledge or mortgage the collateral (other than Treasury’s security interest);
 
  •  not to act in any way to impair, or to fail to act in a way to prevent the impairment of, Treasury’s rights or interests in the collateral;
 
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  •  promptly to notify Treasury of any failure or impending failure to meet our regulatory capital requirements;
 
  •  to provide for periodic audits of collateral held under borrower-in-custody arrangements, and to comply with certain notice and certification requirements;
 
  •  promptly to notify Treasury of the occurrence or impending occurrence of an event of default under the terms of the lending agreement; and
 
  •  to notify Treasury of any change in applicable law or regulations, or in our charter or bylaws, or certain other events, that may materially affect our ability to perform our obligations under the lending agreement.
 
The Lending Agreement expires on December 31, 2009.
 
As of November 13, 2008, we believe we were in compliance with the covenants under the Lending Agreement. For a summary of the terms of the Lending Agreement, see “Lending Agreement” above. For the complete terms of the covenants contained in the Lending Agreement, a copy of the agreement is incorporated by reference as an exhibit to this Form 10-Q.
 
Effect of Conservatorship and Treasury Agreements on Existing Stockholders
 
The conservatorship and Purchase Agreement have materially limited the rights of our common and preferred stockholders (other than Treasury as holder of the senior preferred stock). The conservatorship has had the following adverse effects on our common and preferred stockholders:
 
  •  the powers of the stockholders are suspended during the conservatorship. Accordingly, our common stockholders do not have the ability to elect directors or to vote on other matters during the conservatorship unless the Conservator delegates this authority to them;
 
  •  the Conservator has eliminated common and preferred stock dividends (other than dividends on the senior preferred stock) during the conservatorship; and
 
  •  according to a statement made by the Secretary of the Treasury on September 7, 2008, because we are in conservatorship, we “will no longer be managed with a strategy to maximize common shareholder returns.”
 
The Purchase Agreement and the senior preferred stock and warrant issued to Treasury pursuant to the agreement have had the following adverse effects on our common and preferred stockholders:
 
  •  the senior preferred stock ranks senior to the common stock and all other series of preferred stock as to both dividends and distributions upon dissolution, liquidation or winding up of the company;
 
  •  the Purchase Agreement prohibits the payment of dividends on common or preferred stock (other than the senior preferred stock) without the prior written consent of Treasury; and
 
  •  the warrant provides Treasury with the right to purchase shares of our common stock equal to up to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis on the date of exercise for a nominal price, thereby substantially diluting the ownership in Freddie Mac of our common stockholders at the time of exercise. Until Treasury exercises its rights under the warrant or its right to exercise the warrant expires on September 7, 2028 without having been exercised, the holders of our common stock continue to have the risk that, as a group, they will own no more than 20.1% of the total voting power of the company. Under our charter, bylaws and applicable law, 20.1% is insufficient to control the outcome of any vote that is presented to the common shareholders. Accordingly, existing common shareholders have no assurance that, as a group, they will be able to control the election of our directors or the outcome of any other vote after the time, if any, that the conservatorship ends.
 
As described above, the conservatorship and Treasury agreements also impact our business in ways that indirectly affect our common and preferred stockholders. By their terms, the Purchase Agreement, senior preferred stock and warrant will continue to exist even if we are released from the conservatorship. For a description of the risks to our business relating to the conservatorship and Treasury agreements, see “ITEM 1A. RISK FACTORS.”
 
Treasury Mortgage-Backed Securities Purchase Program
 
Pursuant to its authority under our charter, as amended by the Reform Act, on September 7, 2008, Treasury announced a program under which Treasury will purchase GSE mortgage-backed securities in the open market. The size and timing of Treasury’s investments in GSE mortgage-backed securities will be subject to the discretion of the Secretary of the Treasury. The scale of the program will be based on developments in the capital markets and housing markets. Treasury’s authority to purchase GSE mortgage-backed securities expires on December 31, 2009.
 
New York Stock Exchange Matters
 
As of November 14, 2008, our common stock continues to trade on the New York Stock Exchange, or NYSE. We have been in discussions with the staff of the NYSE regarding the effect of the conservatorship on our ongoing compliance with the rules of the NYSE and the continued listing of our stock on the NYSE in light of the unique circumstances of the conservatorship. To date, we have not been informed of any non-compliance by the NYSE.
 
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Other Regulatory Matters
 
FHFA is responsible for implementing the various provisions of the Reform Act. In a statement published on September 7, 2008, the Director of FHFA indicated that FHFA will continue to work expeditiously on the many regulations needed to implement the new legislation, and that some of the key regulations will address minimum capital standards, prudential safety and soundness standards and portfolio limits. In general, we remain subject to existing regulations, orders and determinations until new ones are issued or made.
 
Since we entered into conservatorship on September 6, 2008, FHFA has taken the following actions relating to the implementation of provisions of the Reform Act.
 
Adoption by FHFA of Regulation Relating to Golden Parachute Payments
 
FHFA issued interim final regulations pursuant to the Reform Act relating to “golden parachute payments” in September 2008. Under these regulations, FHFA may limit golden parachute payments as defined. On September 14, 2008, the Director of FHFA notified us that severance and other payments contemplated in the employment contract of Richard F. Syron, our former Chairman and Chief Executive Officer, are golden parachute payments within the meaning of the Reform Act and that these payments should not be paid, effective immediately. On September 22, 2008, the Director of FHFA notified us that severance payments contemplated in the employment agreement of Anthony S. Piszel, our former Chief Financial Officer, are golden parachute payments within the meaning of the Reform Act and should not be paid. Patricia L. Cook, our former Chief Business Officer, also will not receive severance payments contemplated under her employment agreement.
 
Suspension of Regulatory Capital Requirements During Conservatorship
 
As described in “Capital Management,” FHFA announced in October 2008 that our existing statutory and FHFA-directed regulatory capital requirements will not be binding during the conservatorship.
 
Subordinated Debt
 
FHFA has directed us to continue to make interest and principal payments on our subordinated debt, even if we fail to maintain required capital levels. As a result, the terms of any of our subordinated debt that provide for us to defer payments of interest under certain circumstances, including our failure to maintain specified capital levels, are no longer applicable. In addition, the requirements in the agreement we entered into with FHFA in September 2005 with respect to issuance, maintenance, and reporting and disclosure of Freddie Mac subordinated debt have been suspended during the term of conservatorship and thereafter until directed otherwise.
 
Emergency Economic Stabilization Act of 2008, or EESA
 
On October 3, 2008, the President signed into law the EESA which among other actions, gave further authority to Treasury to purchase or guarantee financial assets from financial institutions in the public market. The EESA also requires FHFA, as Conservator, to implement a plan for delinquent single family and multifamily mortgage loans (including mortgage-backed securities and asset-backed securities) to maximize assistance for homeowners and encourage servicers to take advantage of the HOPE for Homeowners Program implemented by the U.S. Department of Housing and Urban Development, or HUD, or other available programs to minimize foreclosure. FHFA must develop and begin implementing a plan 60 days after the date of enactment. We cannot predict the content of the plan FHFA may implement or its effect on our business.
 
Mission and Affordable Housing Goals
 
As was the case in 2007, market conditions are making it harder to meet certain affordable housing targets. Nevertheless, we estimate that our affordable mortgage purchases will substantially mirror the levels of goal-qualifying loans being originated in the market today.
 
On September 12, 2008, FHFA issued a statement indicating that support for multifamily housing finance is central to our public purpose and that the conservatorship does not affect existing contracts, our authority to enter into new contracts, or their enforceability. The statement indicated that FHFA, as Conservator, expects us to continue underwriting and financing sound multifamily business.
 
On October 27, 2008, FHFA issued a letter finding that we had officially met or exceeded the affordable housing goals for 2007, except for the two subgoals which HUD had previously determined to be infeasible.
 
Conforming Loan Limits
 
On November 7, 2008, FHFA announced that the conforming loan limit will remain $417,000 for 2009, with higher limits in certain cities and counties.
 
Pursuant to the Reform Act, FHFA has set loan limits for certain “high-cost” areas in 2009. These limits are set equal to 115% of area median house prices and cannot exceed 150% of the base limit, or $625,500 for a one-unit property. The new limits affect loans purchased in 2009.
 
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SELECTED FINANCIAL DATA AND OTHER OPERATING MEASURES(1)
 
                                                         
    At or for the Nine
       
    Months Ended September 30,     At or for the Year Ended December 31,  
    2008     2007     2007     2006     2005     2004     2003  
    (dollars in millions, except share-related amounts)  
 
Income Statement Data
                                                       
Net interest income
  $ 4,171     $ 2,325     $ 3,099     $ 3,412     $ 4,627     $ 8,313     $ 8,598  
Non-interest income (loss)
    (10,387 )     1,589       194       2,086       1,003       (2,723 )     532  
Non-interest expense
    (13,534 )     (5,813 )     (9,270 )     (3,216 )     (3,100 )     (2,378 )     (2,123 )
Net income (loss) before cumulative effect of change in accounting principle
    (26,267 )     (642 )     (3,094 )     2,327       2,172       2,603       4,809  
Cumulative effect of change in accounting principle, net of taxes
                            (59 )            
Net income (loss)
    (26,267 )     (642 )     (3,094 )     2,327       2,113       2,603       4,809  
Net income (loss) available to common stockholders
    (26,777 )     (938 )     (3,503 )     2,051       1,890       2,392       4,593  
Earnings (loss) per common share before cumulative effect of change in accounting principle:
                                                       
Basic
    (30.90 )     (1.43 )     (5.37 )     3.01       2.82       3.47       6.68  
Diluted
    (30.90 )     (1.43 )     (5.37 )     3.00       2.81       3.46       6.67  
Earnings (loss) per common share after cumulative effect of change in accounting principle:
                                                       
Basic
    (30.90 )     (1.43 )     (5.37 )     3.01       2.73       3.47       6.68  
Diluted
    (30.90 )     (1.43 )     (5.37 )     3.00       2.73       3.46       6.67  
Dividends per common share
    0.50       1.50       1.75       1.91       1.52       1.20       1.04  
Weighted average common shares outstanding (in thousands)(2):
                                                       
Basic
    866,472       653,825       651,881       680,856       691,582       689,282       687,094  
Diluted
    866,472       653,825       651,881       682,664       693,511       691,521       688,675  
Balance Sheet Data
                                                       
Total assets
  $ 804,390     $ 786,871     $ 794,368     $ 804,910     $ 798,609     $ 779,572     $ 787,962  
Short-term debt
    319,641       252,776       295,921       285,264       279,764       266,024       279,180  
Long-term senior debt
    459,808       468,903       438,147       452,677       454,627       443,772       438,738  
Long-term subordinated debt
    4,501       5,232       4,489       6,400       5,633       5,622       5,613  
All other liabilities
    34,140       34,196       28,911       33,139       31,945       32,720       32,094  
Minority interests in consolidated subsidiaries
    95       281       176       516       949       1,509       1,929  
Stockholders’ equity (deficit)
    (13,795 )     25,483       26,724       26,914       25,691       29,925       30,408  
Portfolio Balances(3)
                                                       
Retained portfolio(4)
  $ 736,876     $ 713,164     $ 720,813     $ 703,959     $ 710,346     $ 653,261     $ 645,767  
Total PCs and Structured Securities issued(5)
    1,834,408       1,664,776       1,738,833       1,477,023       1,335,524       1,208,968       1,162,068  
Total mortgage portfolio
    2,196,338       2,021,935       2,102,676       1,826,720       1,684,546       1,505,531       1,414,700  
Ratios
                                                       
Return on average assets(6)
    (4.4 )%     (0.1 )%     (0.4 )%     0.3 %     0.3 %     0.3 %     0.6 %
Return on common equity(7)
    N/A       (6.6 )     (21.0 )     9.8       8.1       9.4       17.7  
Return on total equity(8)
    N/A       (3.3 )     (11.5 )     8.8       7.6       8.6       15.8  
Dividend payout ratio on common stock(9)
    N/A       N/A       N/A       63.9       56.9       34.9       15.6  
Equity to assets ratio(10)
    0.8       3.3       3.4       3.3       3.5       3.8       4.0  
Preferred stock to core capital ratio(11)
    130.2       23.4       37.3       17.3       13.2       13.5       14.2  
  (1)  See “ITEM 2. FINANCIAL INFORMATION — SELECTED FINANCIAL DATA AND OTHER OPERATING MEASURES” in our Registration Statement for information regarding accounting changes impacting periods prior to January 1, 2008.
  (2)  Includes the weighted average number of shares during the 2008 periods that are associated with the warrant for our common stock issued to Treasury as part of the Purchase Agreement. This warrant is included in basic EPS, since it is unconditionally exercisable by the holder at a minimal cost of $.00001 per share.
  (3)  Represent the unpaid principal balance and exclude mortgage loans and mortgage-related securities traded, but not yet settled. Effective in December 2007, we established a trust for the administration of cash remittances received related to the underlying assets of our PCs and Structured Securities issued. As a result, for December 2007 and each period in 2008, we report the balance of our mortgage portfolios to reflect the publicly-available security balances of our PCs and Structured Securities. For periods prior to December 2007, we report these balances based on the unpaid principal balance of the underlying mortgage loans. We reflected this change as an increase in the unpaid principal balance of our retained portfolio by $2.8 billion at December 31, 2007.
  (4)  The retained portfolio presented on our consolidated balance sheets differs from the retained portfolio in this table because the consolidated balance sheet caption includes valuation adjustments and deferred balances. See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Table 17 — Characteristics of Mortgage Loans and Mortgage-Related Securities in our Retained Portfolio” for more information.
  (5)  Includes PCs and Structured Securities that are held in our retained portfolio. See “OUR PORTFOLIOS — Table 53 — Freddie Mac’s Total Mortgage Portfolio and Segment Portfolio Composition” for the composition of our total mortgage portfolio. Excludes Structured Securities for which we have resecuritized our PCs and Structured Securities. These resecuritized securities do not increase our credit-related exposure and consist of single-class Structured Securities backed by PCs, Real Estate Mortgage Investment Conduits, or REMICs, and principal-only strips. The notional balances of interest-only strips are excluded because this line item is based on unpaid principal balance. Includes other guarantees issued that are not in the form of a PC, such as long-term standby commitments and credit enhancements for multifamily housing revenue bonds.
  (6)  Ratio computed as annualized net income (loss) divided by the simple average of the beginning and ending balances of total assets.
  (7)  Ratio computed as annualized net income (loss) available to common stockholders divided by the simple average of the beginning and ending balances of stockholders’ equity, net of preferred stock (at redemption value). Ratio is not computed for periods in which stockholders’ equity is less than zero.
  (8)  Ratio computed as annualized net income (loss) divided by the simple average of the beginning and ending balances of stockholders’ equity. Ratio is not computed for periods in which stockholders’ equity is less than zero.
  (9)  Ratio computed as common stock dividends declared divided by net income available to common stockholders. Ratio is not computed for periods in which net income (loss) available to common stockholders was a loss.
(10)  Ratio computed as the simple average of the beginning and ending balances of stockholders’ equity divided by the simple average of the beginning and ending balances of total assets.
(11)  Ratio computed as preferred stock (excluding senior preferred), at redemption value divided by core capital. Senior preferred stock does not meet the statutory definition of core capital. See “NOTE 9: REGULATORY CAPITAL” to our consolidated financial statements for more information regarding core capital.
 
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CONSOLIDATED RESULTS OF OPERATIONS
 
The following discussion of our consolidated results of operations should be read in conjunction with our consolidated financial statements including the accompanying notes. Also see “CRITICAL ACCOUNTING POLICIES AND ESTIMATES” for more information concerning our more significant accounting policies and estimates applied in determining our reported financial position and results of operations.
 
Table 4 — Summary Consolidated Statements of Income — GAAP Results
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2008     2007     2008     2007  
    (in millions)  
 
Net interest income
  $ 1,844     $ 761     $ 4,171     $ 2,325  
Non-interest income (loss):
                               
Management and guarantee income
    832       718       2,378       1,937  
Gains (losses) on guarantee asset
    (1,722 )     (465 )     (2,002 )     (168 )
Income on guarantee obligation
    783       473       2,721       1,377  
Derivative gains (losses)(1)
    (3,080 )     (188 )     (3,210 )     (394 )
Gains (losses) on investment activity
    (9,747 )     478       (11,855 )     (44 )
Unrealized gains (losses) on foreign-currency denominated debt recorded at fair value
    1,500             684        
Gains (losses) on debt retirement
    36       91       312       187  
Recoveries on loans impaired upon purchase
    91       125       438       232  
Foreign-currency gains (losses), net
          (1,162 )           (1,692 )
Other income
    25       47       147       154  
                                 
Non-interest income (loss)
    (11,282 )     117       (10,387 )     1,589  
                                 
Non-interest expense
    (7,886 )     (3,070 )     (13,534 )     (5,813 )
                                 
Loss before income tax (expense) benefit
    (17,324 )     (2,192 )     (19,750 )     (1,899 )
Income tax (expense) benefit
    (7,971 )     954       (6,517 )     1,257  
                                 
Net loss
  $ (25,295 )   $ (1,238 )   $ (26,267 )   $ (642 )
                                 
(1)  Includes derivative gains (losses) on foreign-currency swaps of $(1,578) million and $1,155 million for the three months ended September 30, 2008 and 2007, respectively, and $(389) million and $1,685 million for the nine months ended September 30, 2008 and 2007, respectively. Also includes derivative gains (losses) of $228 million and $(69) million on foreign-currency denominated receive-fixed swaps for the three and nine months ended September 30, 2008, respectively.
 
Net Interest Income
 
Table 5 presents an analysis of net interest income, including average balances and related yields earned on assets and incurred on liabilities.
 
Table 5 — Net Interest Income/Yield and Average Balance Analysis
 
                                                 
    Three Months Ended September 30,  
    2008     2007  
          Interest
                Interest
       
    Average
    Income
    Average
    Average
    Income
    Average
 
    Balance(1)(2)     (Expense)(1)     Rate     Balance(1)(2)     (Expense)(1)     Rate  
    (dollars in millions)  
 
Interest-earning assets:
                                               
Mortgage loans(3)
  $ 95,174     $ 1,361       5.72 %   $ 71,163     $ 1,103       6.20 %
Mortgage-related securities
    676,197       8,590       5.08       655,215       8,943       5.46  
                                                 
Total retained portfolio
    771,371       9,951       5.16       726,378       10,046       5.53  
Investments(4)
    47,393       356       2.94       44,135       592       5.25  
Securities purchased under agreements to resell and federal funds sold
    29,379       162       2.20       27,046       367       5.42  
                                                 
Total interest-earning assets
    848,143       10,469       4.93       797,559       11,005       5.51  
                                                 
Interest-bearing liabilities:
                                               
Short-term debt
    241,150       (1,468 )     (2.38 )     175,407       (2,292 )     (5.12 )
Long-term debt(5)
    589,377       (6,795 )     (4.60 )     588,936       (7,521 )     (5.10 )
                                                 
Total debt securities
    830,527       (8,263 )     (3.96 )     764,343       (9,813 )     (5.10 )
Due to PC investors
                      7,401       (98 )     (5.31 )
                                                 
Total interest-bearing liabilities
    830,527       (8,263 )     (3.96 )     771,744       (9,911 )     (5.10 )
Expense related to derivatives
          (362 )     (0.18 )           (333 )     (0.17 )
Impact of net non-interest-bearing funding
    17,616             0.09       25,815             0.17  
                                                 
Total funding of interest-earning assets
  $ 848,143       (8,625 )     (4.05 )   $ 797,559       (10,244 )     (5.10 )
                                                 
Net interest income/yield
            1,844       0.88               761       0.41  
Fully taxable-equivalent adjustments(6)
            98       0.05               98       0.05  
                                                 
Net interest income/yield (fully taxable-equivalent basis)
          $ 1,942       0.93             $ 859       0.46  
                                                 
 
 
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    Nine Months Ended September 30,  
    2008     2007  
          Interest
                Interest
       
    Average
    Income
    Average
    Average
    Income
    Average
 
    Balance(1)(2)     (Expense)(1)     Rate     Balance(1)(2)     (Expense)(1)     Rate  
    (dollars in millions)  
 
Interest-earning assets:
                                               
Mortgage loans(3)
  $ 89,760     $ 3,924       5.83 %   $ 68,580     $ 3,244       6.31 %
Mortgage-related securities
    656,548       25,103       5.10       649,030       26,278       5.40  
                                                 
Total retained portfolio
    746,308       29,027       5.19       717,610       29,522       5.49  
Investments(4)
    46,970       1,155       3.23       47,328       1,849       5.15  
Securities purchased under agreements to resell and federal funds sold
    21,491       403       2.49       26,138       1,048       5.34  
                                                 
Total interest-earning assets
    814,769       30,585       5.00       791,076       32,419       5.46  
                                                 
Interest-bearing liabilities:
                                               
Short-term debt
    228,640       (5,149 )     (2.96 )     173,083       (6,749 )     (5.14 )
Long-term debt(5)
    565,705       (20,231 )     (4.76 )     583,521       (22,028 )     (5.03 )
                                                 
Total debt securities
    794,345       (25,380 )     (4.24 )     756,604       (28,777 )     (5.05 )
Due to PC investors
                      8,043       (322 )     (5.33 )
                                                 
Total interest-bearing liabilities
    794,345       (25,380 )     (4.24 )     764,647       (29,099 )     (5.06 )
Expense related to derivatives
          (1,034 )     (0.17 )           (995 )     (0.17 )
Impact of net non-interest-bearing funding
    20,424             0.11       26,429             0.17  
                                                 
Total funding of interest-earning assets
  $ 814,769       (26,414 )     (4.30 )   $ 791,076       (30,094 )     (5.06 )
                                                 
Net interest income/yield
            4,171       0.70               2,325       0.40  
Fully taxable-equivalent adjustments(6)
            310       0.05               292       0.05  
                                                 
Net interest income/yield (fully taxable-equivalent basis)
          $ 4,481       0.75             $ 2,617       0.45  
                                                 
(1)  Excludes mortgage loans and mortgage-related securities traded, but not yet settled.
(2)  For securities in our retained portfolio and cash and investment portfolios, we calculated average balances based on their unpaid principal balance plus their associated deferred fees and costs (e.g., premiums and discounts), but excluded the effect of mark-to-fair-value changes.
(3)  Non-performing loans, where interest income is recognized when collected, are included in average balances.
(4)  Consist of cash and cash equivalents and non-mortgage-related securities.
(5)  Includes current portion of long-term debt.
(6)  The determination of net interest income/yield (fully taxable-equivalent basis), which reflects fully taxable-equivalent adjustments to interest income, involves the conversion of tax-exempt sources of interest income to the equivalent amounts of interest income that would be necessary to derive the same net return if the investments had been subject to income taxes using our federal statutory tax rate of 35%.
 
Net interest income and net interest yield on a fully taxable-equivalent basis increased during the three and nine months ended September 30, 2008 compared to the three and nine months ended September 30, 2007. During the latter half of the first quarter of 2008 and continuing into the second quarter of 2008, liquidity concerns in the market resulted in more favorable investment opportunities for agency mortgage-related securities at wider spreads. In response, we increased our purchase activities resulting in an increase in the average balance of our interest-earning assets. The increases in net interest income and net interest yield on a fully taxable-equivalent basis are primarily attributable to both the purchases of fixed-rate assets at wider spreads relative to our funding costs and the replacement of higher cost short- and long-term debt with lower cost debt issuances. Interest income for the third quarter of 2008 includes $80 million of income related to the accretion of other-than-temporary impairments of investments in available-for-sale securities recorded in the second quarter of 2008. Net interest income and net interest yield for the three and nine months ended September 30, 2008 also benefited from funding fixed-rate assets with a higher proportion of short-term debt in a steep yield curve environment as well as replacing higher cost long-term debt with lower cost issuances. However, our use of short-term debt funding has also been driven by the unprecedented levels of volatility in the worldwide financial markets, which has limited our ability to obtain long-term and callable debt funding. During the first nine months of 2008, our short-term funding balances increased significantly when compared to the first nine months of 2007. We seek to manage interest rate risk by attempting to substantially match the duration characteristics of our assets and liabilities. To accomplish this, we use a strategy that involves asset and liability portfolio management, including the use of derivatives for purposes of rebalancing the portfolio and maintaining low PMVS and duration gap. While we use interest rate derivatives to economically hedge a significant portion of our interest rate exposure, due to the market turmoil we are exposed to risks relating to both our ability to issue new debt when our outstanding debt matures and to the variability in interest costs on our new issuances of debt which directly impacts our net interest income and net interest yield. The increases in net interest income and net interest yield on a fully tax-equivalent basis during the nine months ended September 30, 2008 were partially offset by the impact of declining interest rates because our floating rate assets reset faster than our short-term debt during the first quarter of 2008. As a result of the creation of the securitization trusts in December of 2007, interest due to PC investors is now recorded in trust management fees within other income on our consolidated statements of income. See “Non-Interest Income — Other Income” for additional information about due to PC investors interest expense.
 
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Non-Interest Income
 
Management and Guarantee Income
 
Table 6 provides summary information about management and guarantee income. Management and guarantee income consists of contractual amounts due to us (reflecting buy-ups and buy-downs to base management and guarantee fees) as well as amortization of certain pre-2003 deferred credit and buy-down fees received by us that were recorded as deferred income as a component of other liabilities. Post-2002 credit and buy-down fees are reflected as increased income on guarantee obligation as the guarantee obligation is amortized.
 
Table 6 — Management and Guarantee Income(1)
 
                                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
    Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate  
    (dollars in millions, rates in basis points)  
 
Contractual management and guarantee fees
  $ 796       17.6     $ 657       16.2     $ 2,331       17.5     $ 1,884       16.1  
Amortization of credit and buy-down fees included in other liabilities
    36       0.8       61       1.5       47       0.4       53       0.5  
                                                                 
Total management and guarantee income
  $ 832       18.4     $ 718       17.7     $ 2,378       17.9     $ 1,937       16.6  
                                                                 
Unamortized balance of credit and buy-down fees included in other liabilities, at period end
  $ 371             $ 390             $ 371             $ 390          
(1)  Consists of management and guarantee fees related to all issued and outstanding guarantees, including those issued prior to adoption of Financial Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34,” or FIN 45, in January 2003, which did not require the establishment of a guarantee asset.
 
The primary drivers affecting management and guarantee income are the average balance of our PCs and Structured Securities and changes in management and guarantee fee rates. Contractual management and guarantee fees include adjustments to the contractual rates for buy-ups and buy-downs, whereby the contractual management and guarantee fee rate is adjusted for up-front cash payments we make (buy-up) or receive (buy-down) at guarantee issuance. Our average rates of management and guarantee income are also affected by the mix of products we issue, competition in market pricing and customer preference for buy-up and buy-down fees. The majority of our guarantees are issued under customer “flow” channel contracts, which have pricing schedules for our management and guarantee fees that are fixed for periods of up to one year. The remainder of our purchase and guarantee securitization of mortgage loans occurs through “bulk” purchasing with management and guarantee fees negotiated on an individual transaction basis. The appointment of FHFA as Conservator and the Conservator’s subsequent directive that we provide increased support to the mortgage market will likely affect our future guarantee pricing decisions.
 
Management and guarantee income increased for the three and nine months ended September 30, 2008 compared to the three and nine months ended September 30, 2007, primarily reflecting an increase in the average PCs and Structured Securities balances of 11% and 14%, respectively, on an annualized basis. The average contractual management and guarantee fee rate for the three and nine months ended September 30, 2008 was higher than the three and nine months ended September 30, 2007, primarily due to an increase in buy-up activity. To a lesser extent, increased purchases of 30-year fixed-rate product during 2008, which has higher guarantee fee rates relative to adjustable-rate mortgages, or ARMs, and 15-year fixed-rate product, have also contributed to the increase in guarantee fee rates.
 
Gains (Losses) on Guarantee Asset
 
Upon issuance of a guarantee of securitized assets, we record a guarantee asset on our consolidated balance sheets representing the fair value of the management and guarantee fees we expect to receive over the life of our PCs or Structured Securities. Guarantee assets are recognized in connection with transfers of PCs and Structured Securities that are accounted for as sales under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, a replacement of Financial Accounting Standards Board, or FASB, Statement No. 125.” Additionally, we recognize guarantee assets for PCs issued through our guarantor swap program and for certain Structured Transactions that we issue to third parties in exchange for non-agency mortgage-related securities. Subsequent changes in the fair value of the future cash flows of our guarantee asset are reported in the current period income as gains (losses) on guarantee asset.
 
The change in fair value of our guarantee asset reflects:
 
  •  reductions related to the management and guarantee fees received that are considered a return of our recorded investment in our guarantee asset; and
 
  •  changes in the fair value of management and guarantee fees we expect to receive over the life of the related PC or Structured Security.
 
The fair value of future management and guarantee fees is driven primarily by expected changes in interest rates that affect the estimated life of mortgages underlying our PCs and Structured Securities and related discount rates used to determine the net present value of the cash flows. For example, an increase in interest rates generally slows the rate of
 
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prepayments and extends the life of our guarantee asset and increases the fair value of future management and guarantee fees. Our valuation methodology for our guarantee asset uses market-based information, including market values of interest-only securities, to determine the fair value of future cash flows associated with our guarantee asset.
 
Table 7 — Attribution of Change — Gains (Losses) on Guarantee Asset
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2008     2007     2008     2007  
    (in millions)  
 
Contractual management and guarantee fees
  $ (730 )   $ (585 )   $ (2,139 )   $ (1,661 )
Portion related to imputed interest income
    299       138       757       395  
                                 
Return of investment on guarantee asset
    (431 )     (447 )     (1,382 )     (1,266 )
Change in fair value of management and guarantee fees
    (1,291 )     (18 )     (620 )     1,098  
                                 
Gains (losses) on guarantee asset
  $ (1,722 )   $ (465 )   $ (2,002 )   $ (168 )
                                 
 
Losses on our guarantee asset increased by $1.3 billion for the three months ended September 30, 2008 compared to the three months ended September 30, 2007, primarily due to greater declines in market valuations for interest-only mortgage securities, which are used to value our guarantee asset, during the third quarter of 2008 compared to the third quarter of 2007. Contractual management and guarantee fees represent cash received in the current period related to our PCs and Structured Securities with an established guarantee asset and have increased proportionately with the average balance of outstanding guarantees. Losses on our guarantee asset increased by $1.8 billion for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007, primarily due to the decreases in fair value of management and guarantee fees resulting from lower market valuations for interest-only mortgage securities. Declines in market values for interest-only mortgage securities during 2008 were attributed to decreases in interest rates during the three and nine months ended September 30, 2008 combined with the effects of a decline in investor demand for mortgage-related securities.
 
Income on Guarantee Obligation
 
Upon issuance of our guarantee, we record a guarantee obligation on our consolidated balance sheets representing the fair value of our obligation to perform under the terms of the guarantee. Our guarantee obligation primarily represents our performance and other related costs, which consist of estimated credit costs, including estimated unrecoverable principal and interest that will be incurred over the expected life of the underlying mortgages backing PCs, estimated foreclosure-related costs, and estimated administrative and other costs related to our guarantee. Our guarantee obligation is amortized into income using a static effective yield determined at inception of the guarantee based on forecasted repayments of the principal balances. The static effective yield is periodically evaluated and adjusted when significant changes in economic events cause a shift in the pattern of our economic release from risk. For example, certain market environments may lead to sharp and sustained changes in home prices, which results in the need for an adjustment in the static effective yield for specific mortgage pools underlying the guarantee. When this type of change is required, a cumulative catch-up adjustment, which could be significant in a given period, will be recognized and a new static effective yield will be used to determine our guarantee obligation amortization.
 
Effective January 1, 2008, we began estimating the fair value of our newly-issued guarantee obligations at their inception using the practical expedient provided by FIN 45, as amended by SFAS 157. Using this approach, the initial guarantee obligation is recorded at an amount equal to the fair value of the compensation received in the related guarantee transactions, including upfront delivery and other fees. As a result, we no longer record estimates of deferred gains or immediate “day one” losses on most guarantees. All unamortized amounts recorded prior to January 1, 2008 will continue to be deferred and amortized using existing amortization methods.
 
Table 8 provides information about the components of income on guarantee obligation.
 
Table 8 — Income on Guarantee Obligation
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2008     2007     2008     2007  
          (in millions)        
 
Amortization income related to:
                               
Static effective yield
  $ 679     $ 432     $ 1,940     $ 1,223  
Cumulative catch-up
    104       41       781       154  
                                 
Total income on guarantee obligation
  $ 783     $ 473     $ 2,721     $ 1,377  
                                 
 
Amortization income increased for the three and nine months ended September 30, 2008, compared to the three and nine months ended September 30, 2007. This increase is due to (1) higher guarantee obligation balances in 2007, which included significant market risk premiums, including those that resulted in significant day one losses (i.e., where the fair value of the guarantee obligation at issuance exceeded the fair value of the guarantee and credit enhancement-related assets), (2) higher cumulative catch-up adjustments for the three and nine months ended September 30, 2008, and (3) higher average
 
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balances of our PCs and Structured Securities. The cumulative catch-up adjustments recognized during the nine months ended September 30, 2008 were principally due to significant declines in home prices and, to a lesser extent, increases in mortgage prepayment speeds related to pools of mortgage loans issued during 2006 and 2007. These cumulative catch-up adjustments are recorded to provide a pattern of revenue recognition that is more consistent with our economic release from risk and the timing of the recognition of losses on the pools of mortgage loans we guarantee.
 
Derivative Overview
 
Table 9 presents the effect of derivatives on our consolidated financial statements, including notional or contractual amounts of our derivatives and our hedge accounting classifications.
 
Table 9 — Summary of the Effect of Derivatives on Selected Consolidated Financial Statement Captions
 
                                                 
    Consolidated Balance Sheets  
    September 30, 2008     December 31, 2007  
    Notional or
                Notional or
             
    Contractual
    Fair Value
    AOCI
    Contractual
    Fair Value
    AOCI
 
Description
  Amount(1)     (Pre-Tax)(2)     (Net of Taxes)(3)     Amount(1)     (Pre-Tax)(2)     (Net of Taxes)(3)  
    (in millions)  
 
Cash flow hedges — open
  $     $     $     $     $     $  
No hedge designation
    1,632,226       5,778             1,322,881       4,790        
                                                 
Subtotal
    1,632,226       5,778             1,322,881       4,790        
Balance related to closed cash flow hedges
                (3,554 )                 (4,059 )
                                                 
Subtotal
    1,632,226       5,778       (3,554 )     1,322,881       4,790       (4,059 )
Derivative interest receivable (payable), net
            805                       1,659          
Trade/settle receivable (payable), net
            (6 )                              
Derivative collateral (held) posted, net
            (4,896 )                     (6,204 )        
                                                 
Total
  $ 1,632,226     $ 1,681     $ (3,554 )   $ 1,322,881     $ 245     $ (4,059 )
                                                 
 
                                                                 
    Consolidated Statements of Income  
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
    Derivative
    Hedge
    Derivative
    Hedge
    Derivative
    Hedge
    Derivative
    Hedge
 
    Gains
    Accounting
    Gains
    Accounting
    Gains
    Accounting
    Gains
    Accounting
 
Description
  (Losses)     Gains (Losses)(4)     (Losses)     Gains (Losses)(4)     (Losses)     Gains (Losses)(4)     (Losses)     Gains (Losses)(4)  
    (in millions)  
 
Cash flow hedges — open(5)
  $     $ (20 )   $     $     $     $ (16 )   $     $  
No hedge designation(5)
    (3,080 )           (188 )           (3,210 )           (394 )      
                                                                 
Total
  $ (3,080 )   $ (20 )   $ (188 )   $     $ (3,210 )   $ (16 )   $ (394 )   $  
                                                                 
(1)  Notional or contractual amounts are used to calculate the periodic settlement amounts to be received or paid and generally do not represent actual amounts to be exchanged. Notional or contractual amounts are not recorded as assets or liabilities on our consolidated balance sheets.
(2)  The value of derivatives on our consolidated balance sheets is reported as derivative assets, net and derivative liability, net, and includes derivative interest receivable or (payable), net, trade/settle receivable or (payable), net and derivative cash collateral (held) or posted, net.
(3)  Derivatives that meet specific criteria may be accounted for as cash flow hedges. Changes in the fair value of the effective portion of open qualifying cash flow hedges are recorded in AOCI, net of taxes. Net deferred gains and losses on closed cash flow hedges (i.e., where the derivative is either terminated or redesignated) are also included in AOCI, net of taxes, until the related forecasted transaction affects earnings or is determined to be probable of not occurring.
(4)  Hedge accounting gains (losses) arise when the fair value change of a derivative does not exactly offset the fair value change of the hedged item attributable to the hedged risk, and is a component of other income in our consolidated statements of income. For further information, see “NOTE 10: DERIVATIVES” to our consolidated financial statements.
(5)  For all derivatives in qualifying hedge accounting relationships, the accrual of periodic cash settlements is recorded in net interest income on our consolidated statements of income and those amounts are not included in the table. For derivatives not in qualifying hedge accounting relationships, the accrual of periodic cash settlements is recorded in derivative gains (losses) on our consolidated statements of income.
 
In the first quarter of 2008, we began designating certain derivative positions as cash flow hedges of changes in cash flows associated with our forecasted issuances of debt consistent with our risk management goals. In the periods presented prior to 2008, we only elected cash flow hedge accounting relationships for certain commitments to sell mortgage-related securities. We expanded this hedge accounting strategy in an effort to reduce volatility in our consolidated statements of income. For a derivative accounted for as a cash flow hedge, changes in fair value are reported in AOCI, net of taxes, on our consolidated balance sheets to the extent the hedge was effective. The ineffective portion of changes in fair value is reported as other income on our consolidated statements of income. We record changes in the fair value, including periodic settlements, of derivatives not in hedge accounting relationships as derivative gains (losses) on our consolidated statements of income. However, in conjunction with the conservatorship on September 6, 2008, we determined that we can no longer assert that the associated forecasted issuances of debt are probable of occurring and as a result, we discontinued this hedge accounting strategy. As a result of this discontinued hedge accounting strategy, we transferred $27.6 billion in notional amount and $(488) million in market value from open cash-flow hedges to closed cash-flow hedges on September 6, 2008. See “NOTE 10: DERIVATIVES” to our consolidated financial statements for additional information about our discontinuation of derivatives designated as cash-flow hedges.
 
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Derivative Gains (Losses)
 
Table 10 provides a summary of the notional or contractual amounts and the gains and losses related to derivatives that were not accounted for in hedge accounting relationships. Derivative gains (losses) represents the change in fair value of derivatives not accounted for in hedge accounting relationships because the derivatives did not qualify for, or we did not elect to pursue, hedge accounting, resulting in fair value changes being recorded to earnings. Derivative gains (losses) also includes the accrual of periodic settlements for derivatives that are not in hedge accounting relationships. Although derivatives are an important aspect of our management of interest-rate risk, they will generally increase the volatility of reported net income (loss), particularly when they are not accounted for in hedge accounting relationships.
 
Table 10 — Derivatives Not in Hedge Accounting Relationships
 
                                                 
    Notional or
                         
    Contractual Amount     Derivative Gains (Losses)  
    September 30,     Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007     2008     2007  
    (in millions)  
 
Call swaptions:
                                               
Purchased
  $ 184,022     $ 262,802     $ 1,824     $ 1,657     $ 2,522     $ (64 )
Written
          1,000       (7 )     (16 )     14       34  
Put swaptions:
                                               
Purchased
    36,550       18,325       22       (70 )     (31 )     166  
Written
    6,000       1,000       154       27       64       (119 )
Receive-fixed swaps:
                                               
Foreign-currency denominated
    13,367       22,095       228       157       (69 )     (343 )
U.S. dollar denominated
    316,461       259,975       2,101       3,026       4,400       285  
                                                 
Total receive-fixed swaps
    329,828       282,070       2,329       3,183       4,331       (58 )
Pay-fixed swaps
    452,633       380,370       (5,296 )     (6,513 )     (9,170 )     (2,460 )
Futures
    245,535       109,848       (534 )     105       (41 )     54  
Foreign-currency swaps(1)
    13,688       23,842       (1,578 )     1,155       (389 )     1,685  
Forward purchase and sale commitments
    199,811       61,800       280       185       548       114  
Other(2)
    164,159       62,159       8       (13 )     (64 )     9  
                                                 
Subtotal
    1,632,226       1,203,216       (2,798 )     (300 )     (2,216 )     (639 )
Accrual of periodic settlements:
                                               
Receive-fixed swaps(3)
                    753       (66 )     1,474       (161 )
Pay-fixed swaps
                    (1,128 )     182       (2,723 )     485  
Foreign-currency swaps
                    105       (5 )     263       (82 )
Other
                    (12 )     1       (8 )     3  
                                                 
Total accrual of periodic settlements
                    (282 )     112       (994 )     245  
                                                 
Total
  $ 1,632,226     $ 1,203,216     $ (3,080 )   $ (188 )   $ (3,210 )   $ (394 )
                                                 
(1)  Foreign-currency swaps are defined as swaps in which the net settlement is based on one leg calculated in a foreign-currency and the other leg calculated in U.S. dollars.
(2)  Consists of basis swaps, certain option-based contracts (including written options), interest-rate caps, swap guarantee derivatives and credit derivatives. Includes $27 million loss related to the Lehman bankruptcy for both the three and nine months ended September 30, 2008. For additional information, see “CREDIT RISKS — Institutional Credit Risk — Derivative Counterparty Credit Risk.”
(3)  Includes imputed interest on zero-coupon swaps.
 
We use receive- and pay-fixed swaps to adjust the interest-rate characteristics of our debt funding in order to more closely match changes in the interest-rate characteristics of our mortgage-related assets. During the third quarter of 2008, fair value losses on our pay-fixed swaps of $5.3 billion contributed to an overall loss recorded for derivatives. The losses were partially offset by gains on our receive-fixed swaps of $2.3 billion as longer-term swap interest rates decreased. Additionally, we use swaptions and other option-based derivatives to adjust the characteristics of our debt in response to changes in the expected lives of mortgage-related assets in our retained portfolio. The gains on our purchased call swaptions, which increased during the third quarter of 2008, compared to the third quarter of 2007, were primarily attributable to decreasing swap interest rates and an increase in implied volatility during the third quarter of 2008.
 
During the nine months ended September 30, 2008, we recognized a larger derivative loss as compared to the nine months ended September 30, 2007. On a year-to-date basis for 2008, swap interest rates declined resulting in a loss on our pay-fixed swap positions, partially offset by gains on our receive-fixed swaps. Additionally, the decrease in swap interest rates on a year-to-date basis for 2008, combined with an increase in volatility resulted in a gain related to our purchased call swaptions for the nine months ended September 30, 2008.
 
Effective January 1, 2008, we elected the fair value option for our foreign-currency denominated debt. As a result of this election, foreign-currency translation gains and losses and fair value adjustments related to our foreign-currency denominated debt are recognized on our consolidated statements of income as unrealized gains (losses) on foreign-currency denominated debt recorded at fair value. Prior to January 1, 2008, translation gains and losses on our foreign-currency denominated debt were recorded in foreign-currency gains (losses), net and the non-currency related changes in fair value were not recognized. We use a combination of foreign-currency swaps and foreign-currency denominated receive-fixed swaps to hedge the changes in fair value of our foreign-currency denominated debt related to fluctuations in exchange rates and
 
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interest rates, respectively. Derivative gains (losses) on foreign-currency swaps were $(1.6) billion and $(389) million for the three and nine months ended September 30, 2008, respectively, compared to $1.2 billion and $1.7 billion for the three and nine months ended September 30, 2007, respectively. These amounts were offset by fair value gains (losses) related to translation of $1.7 billion and $539 million for the three and nine months ended September 30, 2008, respectively, and $(1.2) billion and $(1.7) billion for the three and nine months ended September 30, 2007, respectively, on our foreign-currency denominated debt. In addition, the interest-rate component of the derivative gains (losses) of $228 million and $(69) million for the three and nine months ended September 30, 2008, respectively, on foreign-currency denominated receive-fixed swaps largely offset market value adjustments gains (losses) included in unrealized gains (losses) on foreign-currency denominated debt recorded at fair value of $(165) million and $145 million for the three and nine months ended September 30, 2008, respectively. See “Unrealized Gains (Losses) on Foreign-Currency Denominated Debt Recorded at Fair Value” and “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” to our consolidated financial statements for additional information about our election to adopt the fair value option for foreign-currency denominated debt. See “ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA — AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND ACCOMPANYING NOTES — NOTE 11: DERIVATIVES” in our Registration Statement for additional information about our derivatives.
 
Gains (Losses) on Investment Activity
 
Gains (losses) on investment activity includes gains and losses on certain assets where changes in fair value are recognized through earnings, gains and losses related to sales, impairments and other valuation adjustments. Table 11 summarizes the components of gains (losses) on investment activity.
 
Table 11 — Gains (Losses) on Investment Activity
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2008     2007     2008     2007  
    (in millions)  
 
Gains (losses) on trading securities(1)
  $ (932 )   $ 257     $ (2,240 )   $ 302  
Gains (losses) on sale of mortgage loans(2)
    31       19       97       39  
Gains (losses) on sale of available-for-sale securities
    287       228       540       13  
Security impairments on available-for-sale securities
    (9,106 )     (1 )     (10,217 )     (351 )
Lower-of-cost-or-fair-value adjustments
    (20 )     (25 )     (28 )     (47 )
Gains (losses) on mortgage loans elected at fair value
    (7 )           (7 )      
                                 
Total gains (losses) on investment activity
  $ (9,747 )   $ 478     $ (11,855 )   $ (44 )
                                 
(1)  Include mark-to-fair value adjustments recorded in accordance with Emerging Issues Task Force, or EITF, 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets” on securities classified as trading of $(101) million and $(15) million for the three months ended September 30, 2008 and 2007, respectively, and $(427) million and $(18) million for the nine months ended September 30, 2008 and 2007, respectively. Prior period amounts have been revised to conform to the current period presentation.
(2)  Represent gains (losses) on mortgage loans sold in connection with securitization transactions.
 
Gains (Losses) on Trading Securities
 
We recognized net losses on trading securities for the three and nine months ended September 30, 2008, as compared to net gains for the three and nine months ended September 30, 2007. On January 1, 2008, we implemented fair value option accounting and transferred approximately $87 billion in securities, primarily ARMs and fixed-rate PCs, from available-for-sale securities to trading securities significantly increasing our securities classified as trading. The unpaid principal balance of our securities classified as trading was approximately $116 billion at September 30, 2008 compared to approximately $12 billion at December 31, 2007. During the third quarter of 2008, we sold agency securities classified as trading securities with unpaid principal balances of $58 billion, which generated a realized loss of $547 million. The increased balance in our trading portfolio when compared to the third quarter of 2007, combined with wider credit spreads, also contributed to the losses on trading securities for the three and nine months ended September 30, 2008. The gains recognized during the three and nine months ended September 30, 2007 were primarily the result of the effect of declining interest rates on our REMIC securities classified as trading.
 
Gains (Losses) on Sale of Available-For-Sale Securities
 
Net gains on the sale of available-for-sale securities increased for the third quarter of 2008, as compared to the third quarter of 2007. During the third quarter of 2008, primarily prior to conservatorship, we entered into structuring transactions and sales of seasoned securities with unpaid principal balances of $14.8 billion, primarily consisting of agency mortgage-related securities, which generated a net gain of $287 million. During the third quarter of 2007, we entered into structuring transactions and sales of seasoned securities with unpaid principal balances of $32.1 billion generating net gains of $279 million recognized in gains (losses) on investment activity because the securities sold had higher coupon rates than those available in the market at the time of sale. In addition, during the third quarter of 2007, we sold non-mortgage-related
 
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asset-backed securities with an unpaid principal balance of $12 billion generating net losses of $52 million to generate cash for more favorable investment opportunities.
 
Net gains on the sale of available-for-sale securities increased for the nine months ended September 30, 2008, as compared to the nine months ended September 30, 2007. During the nine months ended September 30, 2008, we sold securities with unpaid principal balances of $35 billion, primarily consisting of agency mortgage-related securities, which generated a net gain of $538 million. These sales occurred principally during the earlier months of the first quarter and prior to conservatorship during the third quarter of 2008 when market conditions were favorable and were driven in part by our need to maintain our mandatory target capital surplus. We were not required to sell these securities. However, in an effort to improve our capital position in light of the unanticipated extraordinary market conditions that began in the latter half of 2007, we strategically selected blocks of securities to sell, the majority of which were in a gain position. These sales reduced the assets on our balance sheet, against which we were required to hold capital. In addition, the net gains on these sales increased our retained earnings, further improving our capital position. During the nine months ended September 30, 2007, we sold $63 billion of PCs and Structured Securities, which generated a net gain of $147 million.
 
Security Impairments on Available-For-Sale Securities
 
During the third quarter of 2008 and 2007, we recorded other-than-temporary impairments related to investments in available-for-sale securities of $9.1 billion and $1 million, respectively. Of the impairments recognized during the third quarter of 2008, $8.9 billion related to non-agency securities backed by subprime or Alt-A and other loans, including MTA loans, primarily due to the combination of a more pessimistic view of future performance due to the significant weakness of the economic environment during the third quarter of 2008, significant declines in the valuation of these securities and poor performance of the underlying collateral of these securities. Also contributing to the impairment charge was a determination that there was substantial uncertainty surrounding the ability of two monoline bond insurers to pay all future claims on securities which we previously held in an unrealized loss position. In making this determination, we considered our own analysis as well as additional qualitative factors, such as the ability of each monoline to access capital and to generate new business, pending regulatory actions, ratings agency actions, security prices and credit default swap levels traded on each monoline. We rely on monoline bond insurance, including secondary coverage, to provide credit protection on some of our securities held in our mortgage-related investment portfolio as well as our non-mortgage-related investment portfolio. Monolines are companies that provide credit insurance principally covering securitized assets in both the primary issuance and secondary markets. We also recognized impairment charges of $244 million related to our available-for-sale non-mortgage-related securities with $10.8 billion of unpaid principal balance, as management could no longer assert the positive intent to hold these securities to recovery. The decision to impair these securities is consistent with our consideration of sales of securities from the cash and investments portfolio as a contingent source of liquidity.
 
During the nine months ended September 30, 2008 and 2007, we recorded impairments related to investments in available-for-sale securities of $10.2 billion and $351 million, respectively. Of the impairments recognized during the nine months ended September 30, 2008, $9.7 billion related to non-agency securities backed by subprime or Alt-A and other loans, including MTA loans, as discussed above. Of the remaining $534 million, the majority, $458 million, related to impairments of our available-for-sale non-mortgage-related securities during the nine months ended September 30, 2008 where we did not have the intent to hold to a forecasted recovery. During the nine months ended September 30, 2007, security impairments on available-for-sale securities included $348 million in impairments attributed to agency mortgage-related securities in an unrealized loss position that we did not have the intent to hold to a forecasted recovery.
 
See “CONSOLIDATED BALANCE SHEET ANALYSIS — Other-Than-Temporary Impairments” for additional information.
 
Unrealized Gains (Losses) on Foreign-Currency Denominated Debt Recorded at Fair Value
 
We elected the fair value option for our foreign-currency denominated debt effective January 1, 2008. Accordingly, foreign-currency exposure is now a component of unrealized gains (losses) on foreign-currency denominated debt recorded at fair value. Prior to that date, translation gains and losses on our foreign-currency denominated debt were reported in foreign-currency gains (losses), net in our consolidated statements of income. We manage the foreign-currency exposure associated with our foreign-currency denominated debt through the use of derivatives. For the three and nine months ended September 30, 2008, we recognized fair value gains of $1.5 billion and $684 million, respectively, on our foreign-currency denominated debt primarily due to the U.S. dollar strengthening relative to the Euro. See ‘‘Derivative Gains (Losses)” for additional information about how we mitigate changes in the fair value of our foreign-currency denominated debt by using derivatives. See “Foreign-Currency Gains (Losses), Net” and “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” to our consolidated financial statements for additional information about our adoption of SFAS 159.
 
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Gains (Losses) on Debt Retirement
 
Gains on debt retirement were $36 million and $312 million during the three and nine months ended September 30, 2008, respectively, compared to gains of $91 million and $187 million during the three and nine months ended September 30, 2007, respectively. During the nine months ended September 30, 2008, we recognized gains due to the increased level of call activity, primarily involving our debt with coupon levels that increase at pre-determined intervals, which led to gains upon retirement and write-offs of previously recorded interest expense.
 
Recoveries on Loans Impaired upon Purchase
 
Recoveries on loans impaired upon purchase represent the recapture into income of previously recognized losses on loans purchased and provision for credit losses associated with purchases of delinquent loans from our PCs and Structured Securities in conjunction with our guarantee activities. Recoveries occur when a non-performing loan is repaid in full or when at the time of foreclosure the estimated fair value of the acquired property, less costs to sell, exceeds the carrying value of the loan. For impaired loans where the borrower has made required payments that return the loan to less than 90 days delinquent, the recovery amounts are instead accreted into interest income over time as periodic payments are received.
 
The amount of impaired loans purchased into our retained portfolio increased significantly during 2007. However, since December 2007, when we changed our practice for optional purchases of impaired loans, the rate of increase in the carrying balances of these loans has slowed. See “CREDIT RISKS — Mortgage Credit Risk — Loans Purchased Under Financial Guarantees” for more information. During the three months ended September 30, 2008 and 2007, we recognized recoveries on loans impaired upon purchase of $91 million and $125 million, respectively. During the nine months ended September 30, 2008 and 2007, we recognized recoveries on loans impaired upon purchase of $438 million and $232 million, respectively. Our recoveries on impaired loans decreased during the third quarter of 2008 compared to the third quarter of 2007, due to higher severities during the third quarter of 2008 on those loans that proceeded to foreclosure, which reduced our recoveries. Recoveries on impaired loans increased during the nine months ended September 30, 2008 compared to the same period in 2007 due to the higher average balances of these loans within our retained portfolio and higher volume of these loans that proceeded to foreclosure in 2008.
 
Foreign-Currency Gains (Losses), Net
 
We manage the foreign-currency exposure associated with our foreign-currency denominated debt through the use of derivatives. We elected the fair value option for foreign-currency denominated debt effective January 1, 2008. Prior to this election, gains and losses associated with the foreign-currency exposure of our foreign-currency denominated debt were recorded as foreign-currency gains (losses), net in our consolidated statements of income. With the adoption of SFAS 159, foreign-currency exposure is now a component of unrealized gains (losses) on foreign-currency denominated debt recorded at fair value. Because the fair value option is prospective, prior period amounts have not been reclassified. See “Derivative Gains (Losses)” and “Unrealized Gains (Losses) on Foreign-Currency Denominated Debt Recorded at Fair Value” and “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” to our consolidated financial statements for additional information.
 
For the three and nine months ended September 30, 2007, we recognized net foreign-currency translation losses primarily related to our foreign-currency denominated debt of $1.2 billion and $1.7 billion, respectively, as the U.S. dollar weakened relative to the Euro during the period. During the same period, these losses were offset by an increase of $1.2 billion and $1.7 billion, respectively, in the fair value of foreign-currency-related derivatives recorded in derivative gains (losses).
 
Other Income
 
Other income primarily consists of resecuritization fees, trust management income, fees associated with servicing and technology-related products, including Loan Prospector® , fees related to multifamily loans (including application and other fees) and various other fees received from mortgage originators and servicers. Resecuritization fees are revenues we earn primarily in connection with the issuance of Structured Securities for which we make a REMIC election, where the underlying collateral is provided by third parties. These fees are also generated in connection with the creation of interest-only and principal-only strips as well as other Structured Securities. Trust management fees represent the fees we earn as administrator, issuer and trustee, net of related expenses, which prior to December 2007, were reported as due to PC investors, a component of net interest income.
 
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Non-Interest Expense
 
Table 12 summarizes the components of non-interest expense.
 
Table 12 — Non-Interest Expense
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2008     2007     2008     2007  
          (in millions)        
 
Administrative expenses:
                               
Salaries and employee benefits
  $ 133     $ 216     $ 605     $ 656  
Professional services
    61       103       188       296  
Occupancy expense
    16       16       49       46  
Other administrative expenses
    98       93       267       275  
                                 
Total administrative expenses
    308       428       1,109       1,273  
Provision for credit losses
    5,702       1,372       9,479       2,067  
REO operations expense
    333       51       806       81  
Losses on certain credit guarantees
    2       392       17       719  
Losses on loans purchased
    252       649       423       1,129  
Securities administrator loss on investment activity
    1,082             1,082        
LIHTC partnerships
    121       111       346       354  
Minority interests in earnings of consolidated subsidiaries
          4       8       22  
Other expenses
    86       63       264       168  
                                 
Total non-interest expense
  $ 7,886     $ 3,070     $ 13,534     $ 5,813  
                                 
 
Administrative Expenses
 
Administrative expenses decreased for the three and nine months ended September 30, 2008, compared to the three and nine months ended September 30, 2007, primarily due to a reduction in our short-term performance compensation during the third quarter of 2008 as well as a decrease in our use of consultants throughout 2008. Since it is likely portions of our corporate objectives for 2008 will not be met, we partially reversed short-term performance compensation amounts during the third quarter of 2008 that had been previously accrued. As a percentage of the average total mortgage portfolio, administrative expenses declined to 5.6 basis points and 6.8 basis points for the three and nine months ended September 30, 2008, respectively, from 8.7 basis points and 8.8 basis points for the three and nine months ended September 30, 2007, respectively.
 
Provision for Credit Losses
 
Our credit loss reserves reflect our best estimates of incurred losses. Our reserve estimates for mortgage loan and guarantee losses are based on our projections of the results of strategic loss mitigation initiatives, including a higher rate of loan modifications for troubled borrowers, and projections of recoveries through repurchases by seller/servicers of defaulted loans due to failure to follow contractual underwriting requirements at the time of the loan origination.
 
Our reserve estimates also reflect our best projection of mortgage loan defaults. However, the unprecedented deterioration in the national housing market and the uncertainty in other macroeconomic factors makes forecasting of default rates increasingly imprecise.
 
The provision for credit losses increased significantly for the three and nine months ended September 30, 2008, compared to the three and nine months ended September 30, 2007, respectively, as continued weakening in the housing market affected our single-family mortgage portfolio. See “Table 1 — Credit Statistics, Single-Family Mortgage Portfolio” for a presentation of the quarterly trend in the deterioration of our credit statistics. For the three and nine months ended September 30, 2008, we recorded additional reserves for credit losses on our single-family mortgage portfolio as a result of:
 
  •  increased estimates of incurred losses on mortgage loans that are expected to experience higher default rates. Our estimates of incurred losses are higher for loans we purchased or guaranteed in certain years, or vintages, particularly those we purchased during 2006, 2007 and to a lesser extent 2005 and 2008. Continued deterioration of macroeconomic factors, such as decreases in home prices and rising rates of unemployment during 2008 have negatively impacted our estimates of incurred loss, especially for those mortgages we purchased during these years. Our estimates of incurred loss have also increased significantly for certain product-types, particularly Alt-A, adjustable-rate and interest-only mortgage products and for loans on properties in certain states, such as California, Florida, Nevada and Arizona;
 
  •  an observed increase in delinquency rates and the percentage of loans that transition from delinquency to foreclosure, with more severe increases concentrated in certain regions of the U.S. as well as loans with second lien, third-party financing. For example, as of September 30, 2008, single-family mortgage loans in the state of Florida comprise 7% of our single-family mortgage portfolio; however the loans in this state make up more than 20% of the total delinquent loans in our single-family mortgage portfolio, based on unpaid principal balances. Similarly, as of September 30, 2008, approximately 14% of loans in our single-family mortgage portfolio have second lien, third-party
 
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  financing; however we estimate that these loans comprise more than 25% of our delinquent loans, based on unpaid principal balances;
 
  •  increases in the estimated severity of losses on a per-property basis, net of recoveries from credit enhancements, driven in part by declines in home sales and home prices. The states with the largest declines in home prices and highest increases in severity of losses include California, Florida, Nevada, Arizona, Virginia, Georgia and Michigan;
 
  •  increases in the average unpaid principal balance of delinquent loans in our single-family mortgage portfolio. During the third quarter of 2008, there was a significant increase in the average size of delinquent loans, primarily attributed to our West region, which comprised approximately 30% of our total delinquent loans in the single-family mortgage portfolio; and
 
  •  to a lesser extent, increases in counterparty exposure related to our estimates of recoveries through repurchases by seller/servicers of defaulted loans due to failure to follow contractual underwriting requirements at origination and under separate recourse agreements. During the third quarter of 2008, several of our seller/servicers were acquired by the FDIC, declared bankruptcy or merged with other institutions. These and other events increase our counterparty exposure, or the likelihood that we may bear the risk of mortgage credit losses without the benefit of recourse to our counterparty.
 
We expect our provisions for credit losses to remain high for the remainder of 2008 and the extent and duration that credit losses remain high in future periods will depend on a number of factors, including changes in property values, regional economic conditions, third-party mortgage insurance coverage and recoveries and the realized rate of seller/servicer repurchases. We expect to further increase our single-family loan loss reserves in future periods as additional losses are incurred, particularly related to mortgages originated in 2006, 2007 and to a lesser extent those originated in 2005 and 2008. Loans originated during 2006 and 2007 represent approximately 35% of the unpaid principal balance of our single-family loans underlying our PCs and Structured Securities and 15% of the unpaid principal balance of single-family loans that we hold in our retained portfolio. Although the credit characteristics of loans underlying our newly-issued guarantees during the nine months ended September 30, 2008 have progressively improved, we have experienced weak credit performance to date from loans purchased in the first and second quarters of 2008.
 
REO Operations Expense
 
The increase in REO operations expense for the three and nine months ended September 30, 2008, as compared to the three and nine months ended September 30, 2007, was due to significant increases in the volume of our single-family property foreclosures combined with declining single-family REO property values during 2008. The decline in home prices, which has been both rapid and dramatic in certain geographical areas, combined with our higher REO inventory balance, resulted in an increase in the market-based writedowns of REO, which totaled $172 million and $404 million for the three and nine months ended September 30, 2008, respectively. REO operations expense also increased due to higher real estate taxes, maintenance costs and net losses on sales experienced during the three and nine months ended September 30, 2008 as compared to the three and nine months ended September 30, 2007. We expect REO operations expense to continue to increase in the remainder of 2008, as single-family REO volume continues to increase and home prices decline.
 
Losses on Certain Credit Guarantees
 
Losses on certain credit guarantees consist of losses recognized upon the issuance of PCs in guarantor swap transactions. Prior to January 1, 2008, our recognition of losses on certain guarantee contracts occurred due to any one or a combination of several factors, including long-term contract pricing for our flow business, the difference in overall transaction pricing versus pool-level accounting measurements and, less significantly, efforts to support our affordable housing mission. Upon adoption of SFAS 157, our losses on certain credit guarantees in subsequent periods, if any, will generally relate to our efforts to meet our affordable housing goals.
 
Effective January 1, 2008, upon the adoption of SFAS 157, which amended FIN 45, we estimate the fair value of our newly-issued guarantee obligations as an amount equal to the fair value of compensation received, inclusive of all rights related to the transaction, in exchange for our guarantee. As a result, we no longer record estimates of deferred gains or immediate “day one” losses on most guarantees. All unamortized amounts recorded prior to January 1, 2008 will continue to be amortized using existing amortization methods. This change had a significant positive impact on our financial results for the three and nine months ended September 30, 2008. Losses on certain credit guarantees totaled $2 million and $17 million for the three and nine month periods ended September 30, 2008, respectively. For the three and nine months ended September 30, 2007, we recognized losses of $392 million and $719 million, respectively, on certain guarantor swap transactions entered into during the period and we deferred gains of $204 million and $854 million, respectively, on newly-issued guarantees entered into during those periods.
 
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Losses on Loans Purchased
 
Losses on non-performing loans purchased from the mortgage pools underlying PCs and Structured Securities occur when the acquisition basis of the purchased loan exceeds the estimated fair value of the loan on the date of purchase. Effective December 2007, we made certain operational changes for purchasing delinquent loans from PC pools, which significantly reduced the volume of our delinquent loan purchases and consequently the amount of our losses on loans purchased for the three and nine months ended September 30, 2008. We made these operational changes in order to better reflect our expectations of future credit losses and in consideration of our capital requirements. As a result of increases in delinquency rates of loans underlying our PCs and Structured Securities and our increasing efforts to reduce foreclosures, the number of loan modifications increased significantly during both the three and nine months ended September 30, 2008, as compared to the same periods in 2007. When a loan is modified, we generally exercise our repurchase option and hold the modified loan in our retained portfolio. See “Recoveries on Loans Impaired upon Purchase” and “CREDIT RISKS — Table 46 — Changes in Loans Purchased Under Financial Guarantees” for additional information about the impacts from non-performing loans on our financial results.
 
During the three and nine months ended September 30, 2008, the market-based valuation of non-performing loans continued to be adversely affected by the expectation of higher default costs and reduced liquidity in the single-family mortgage market. However, our losses on loans purchased decreased 61% to $252 million during the three months ended September 30, 2008 compared to $649 million during the three months ended September 30, 2007 and decreased 63% to $423 million during the nine months ended September 30, 2008 compared to $1.1 billion during the nine months ended September 30, 2007. The decrease in losses on loans purchased during the 2008 periods compared to 2007 is attributed to the declining volume of our optional repurchases of delinquent loans underlying our guarantees.
 
Securities Administrator Loss on Investment Activity
 
In August 2008, acting as the security administrator for a trust which holds mortgage loan pools backing our PCs, we invested in $1.2 billion of short-term, unsecured loans which we made to Lehman on the trust’s behalf. We refer to these transactions as the Lehman short-term lending transactions. These transactions were due to mature on September 15, 2008; however Lehman failed to repay these loans and the accrued interest. On September 15, 2008, Lehman filed a chapter 11 bankruptcy petition in the Bankruptcy Court for the Southern District of New York. To the extent there is a loss related to an eligible investment for the trust, we, as the administrator are responsible for making up that shortfall. During the third quarter of 2008, we recorded a $1.1 billion loss to reduce the carrying amount of this asset to our estimate of the net realizable amount on these transactions. See “Off-Balance Sheet Arrangements” for further discussion.
 
Income Tax (Expense) Benefit
 
For the three months ended September 30, 2008 and 2007, we reported an income tax (expense) benefit of $(8.0) billion and $954 million, respectively. For the nine months ended September 30, 2008 and 2007, we reported an income tax (expense) benefit of $(6.5) billion and $1.3 billion, respectively. Included in income tax (expense) benefit for the three and nine months ended September 30, 2008, is a non-cash charge of $(14.3) billion recorded during the third quarter of 2008 in order to establish a partial valuation allowance against our deferred tax assets. See “NOTE 12: INCOME TAXES” to our consolidated financial statements for additional information.
 
Segment Earnings
 
Our operations consist of three reportable segments, which are based on the type of business activities each performs — Investments, Single-family Guarantee and Multifamily. We manage our business through these segments, subject to the conduct of our business under the direction of the Conservator, as discussed above under “EXECUTIVE SUMMARY — Managing Our Business During Conservatorship — Our Objectives.” The activities of our business segments are described in “EXECUTIVE SUMMARY — Segments.” Certain activities that are not part of a segment are included in the All Other category; this category consists of certain unallocated corporate items, such as remediation and restructuring costs, costs related to the resolution of certain legal matters and certain income tax items. We manage and evaluate performance of the segments and All Other using a Segment Earnings approach. Segment Earnings is calculated for the segments by adjusting net income (loss) for certain investment-related activities and credit guarantee-related activities. Segment Earnings differs significantly from, and should not be used as a substitute for, net income (loss) before cumulative effect of change in accounting principle or net income (loss) as determined in accordance with GAAP. There are important limitations to using Segment Earnings as a measure of our financial performance. Among them, our regulatory capital measures are based on our GAAP results, as is the need to obtain funding under the Purchase Agreement. Segment Earnings adjusts for the effects of certain gains and losses and mark-to-fair-value items, which depending on market circumstances, can significantly affect, positively or negatively, our GAAP results and have in recent periods caused us to record significant GAAP net losses. GAAP net losses will adversely impact our GAAP stockholders’ equity (deficit), as well as our need for funding under the Purchase Agreement, regardless of results reflected in Segment Earnings. Also, our definition of Segment Earnings may differ from similar measures used by other companies. However, we believe that the presentation of Segment Earnings
 
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highlights the results from ongoing operations and the underlying results of the segments in a manner that is useful to the way we manage and evaluate the performance of our business. See “NOTE 16: SEGMENT REPORTING” to our consolidated financial statements for more information regarding our segments and the adjustments used to calculate Segment Earnings.
 
In managing our business, we present the operating performance of our segments using Segment Earnings. Segment Earnings presents our results on an accrual basis as the cash flows from our segments are earned over time. The objective of Segment Earnings is to present our results in a manner more consistent with our business models. The business model for our investment activity is one where we generally buy and hold our investments in mortgage-related assets for the long term, fund our investments with debt and use derivatives to minimize interest rate risk, thus generating net interest income in line with our return on equity objectives. We believe it is meaningful to measure the performance of our investment business using long-term returns, not short-term value. The business model for our credit guarantee activity is one where we are a long-term guarantor in the conforming mortgage markets, manage credit risk and generate guarantee and credit fees, net of incurred credit losses. As a result of these business models, we believe that this accrual-based metric is a meaningful way to present our results as actual cash flows are realized, net of credit losses and impairments. We believe Segment Earnings provides us with a view of our financial results that is more consistent with our business objectives and helps us better evaluate the performance of our business, both from period-to-period and over the longer term.
 
Investments Segment
 
Through our Investments segment, we seek to manage our mortgage-related investment portfolio to generate positive returns while maintaining a disciplined approach to interest-rate risk and capital management. We seek to accomplish this objective through opportunistic purchases, sales and restructurings of mortgage assets and repurchases of liabilities. Although we are primarily a buy-and-hold investor in mortgage assets, we may sell assets that are no longer expected to produce desired returns to reduce risk, respond to capital constraints, provide liquidity or structure certain transactions in order to improve our returns. We currently do not plan to sell assets at a loss. We estimate our expected investment returns using an OAS approach.
 
Table 13 presents the Segment Earnings of our Investments segment.
 
Table 13 — Segment Earnings and Key Metrics — Investments
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2008     2007     2008     2007  
    (dollars in millions)  
 
Segment Earnings:
                               
Net interest income
  $ 1,343     $ 909     $ 3,123     $ 2,801  
Non-interest income (loss)
    (1,871 )     (4 )     (1,981 )     50  
Non-interest expense:
                               
Administrative expenses
    (104 )     (125 )     (365 )     (386 )
Other non-interest expense
    (1,089 )     (7 )     (1,105 )     (22 )
                                 
Total non-interest expense
    (1,193 )     (132 )     (1,470 )     (408 )
                                 
Segment Earnings before income taxes
    (1,721 )     773       (328 )     2,443  
Income tax expense
    602       (270 )     115       (855 )
                                 
Segment Earnings, net of taxes
    (1,119 )     503       (213 )     1,588  
Reconciliation to GAAP net loss:
                               
Derivative- and foreign-currency denominated debt-related adjustments
    (1,282 )     (1,719 )     (1,935 )     (3,264 )
Credit guarantee-related adjustments
          1             2  
Investment sales, debt retirements and fair value-related adjustments
    (7,710 )     659       (9,281 )     349  
Fully taxable-equivalent adjustment
    (103 )     (98 )     (318 )     (288 )
Tax-related adjustments(1)
    3,246       469       4,238       1,311  
                                 
Total reconciling items, net of taxes
    (5,849 )     (688 )     (7,296 )     (1,890 )
                                 
GAAP net loss
  $ (6,968 )   $ (185 )   $ (7,509 )   $ (302 )
                                 
Key metrics — Investments:
                               
Growth:
                               
Purchases of securities — Mortgage-related investment portfolio:(2)(3)
                               
Guaranteed PCs and Structured Securities
  $ 21,938     $ 47,110     $ 134,536     $ 103,423  
Non-Freddie Mac mortgage-related securities:
                               
Agency mortgage-related securities
    12,173       5,599       46,244       10,431  
Non-agency mortgage-related securities
    22       10,187       1,906       62,740  
                                 
Total purchases of securities — Mortgage-related investment portfolio
  $ 34,133     $ 62,896     $ 182,686     $ 176,594  
                                 
Growth rate of mortgage-related investment portfolio (annualized)
    (32.64 )%     (0.61 )%     1.07 %     0.96 %
Return:
                               
Net interest yield — Segment Earnings basis
    0.72 %     0.53 %     0.58 %     0.53 %
(1)  Excludes any allocation of the non-cash charge related to the establishment of the partial valuation allowance against our deferred tax asset.
(2)  Based on unpaid principal balance and excludes mortgage-related securities traded, but not yet settled.
(3)  Exclude single-family mortgage loans.
 
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Segment Earnings for our Investments segment decreased $1.6 billion in the third quarter of 2008 compared to the third quarter of 2007. For our Investments segment, Segment Earnings non-interest income (loss) for the third quarter of 2008 includes the recognition of security impairments of $1.9 billion that reflect expected credit principal losses on our non-agency mortgage-related securities compared to security impairments of $1 million in the third quarter of 2007. Security impairments that reflect expected or realized credit principal losses are realized immediately pursuant to GAAP and in Segment Earnings. In contrast, non-credit related security impairments are not included in Segment Earnings. Segment Earnings non-interest expense for the third quarter of 2008 includes a loss of $1.1 billion related to the Lehman short-term lending transactions. Segment Earnings net interest income increased $434 million and our Segment Earnings net interest yield increased 19 basis points for the third quarter of 2008 compared to the third quarter of 2007. The increases in Segment Earnings net interest income and net interest yield were primarily driven by both fixed-rate assets purchased at wider spreads relative to our funding costs and the replacement of higher cost short- and long-term debt with lower cost debt issuances.
 
Segment Earnings for our Investments segment decreased $1.8 billion in the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007. Segment Earnings for our Investments segment includes the recognition of security impairments during the nine months ended September 30, 2008, of $2.0 billion that reflect expected credit principal losses on our non-agency mortgage-related securities compared to $2 million of security impairments recognized during the nine months ended September 30, 2007. Segment Earnings non-interest expense for the nine months ended September 30, 2008 includes a loss of $1.1 billion related to the Lehman short-term lending transactions. Segment Earnings net interest income increased $322 million and our Segment Earnings net interest yield increased 5 basis points to 58 basis points for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007. These increases were primarily due to purchases of fixed rate assets at wider spreads relative to our funding costs as well as the amortization of gains on certain futures positions that matured in March 2008 and the replacement of higher cost short- and long-term debt with lower cost debt issuances. Partially offsetting these increases in Segment Earnings net interest income were lower returns on floating rate securities.
 
In the three and the nine months ended September 30, 2008, the annualized growth rates of our mortgage-related investment portfolio were (32.64)% and 1.07%, respectively, compared to (0.61%) and 0.96% for the three and nine months ended September 30, 2007. The unpaid principal balance of our mortgage-related investment portfolio increased from $663.2 billion at December 31, 2007 to $668.6 billion at September 30, 2008. The overall increase in the unpaid principal balance of our mortgage-related investment portfolio was primarily due to more favorable investment opportunities for agency securities, due to liquidity concerns in the market, during the latter half of the first quarter and continuing into the second quarter.
 
Over the course of the past year, worldwide financial markets have experienced unprecedented levels of volatility. This has been particularly true over the latter half of the third quarter of 2008 as market participants struggled to digest the new government initiatives, including our conservatorship. In this environment where demand for debt instruments weakened considerably, the debt funding markets are sometimes frozen, and our ability to access both the term and callable debt markets has been limited. As a result, toward the latter part of the third quarter and continuing into the fourth quarter, we have relied increasingly on the issuance of shorter-term debt at higher interest rates. While we use interest rate derivatives to economically hedge a significant portion of our interest rate exposure, we are exposed to risks relating to both our ability to issue new debt when our outstanding debt matures and to the variability in interest costs on our new issuances of debt which directly impacts our Investments Segment earnings.
 
We held $57.1 billion of non-Freddie Mac agency mortgage-related securities and $204.5 billion of non-agency mortgage-related securities as of September 30, 2008 compared to $47.8 billion of non-Freddie Mac agency mortgage-related securities and $233.8 billion of non-agency mortgage-related securities as of December 31, 2007.
 
At September 30, 2008 and December 31, 2007, we held investments of $79.8 billion and $101.3 billion, respectively, of non-agency mortgage-related securities backed by subprime loans. In addition to the contractual interest payments, we receive substantial monthly remittances of principal repayments on these securities, which totaled more than $5.9 billion and $21.6 billion during the three and nine months ended September 30, 2008, respectively, representing a return on our investment in these securities. These securities include significant credit enhancement, particularly through subordination, and 80% and 100% of these securities were investment grade at September 30, 2008 and December 31, 2007, respectively. The unrealized losses, net of tax, on these securities are included in AOCI and totaled $8.8 billion and $5.6 billion at September 30, 2008 and December 31, 2007, respectively. We believe that the declines in fair values for these securities are mainly attributable to poor underlying collateral performance, decreased liquidity and larger risk premiums in the mortgage market.
 
We also invested in non-agency mortgage-related securities backed by Alt-A and other loans in our mortgage-related investment portfolio. We have classified these securities as Alt-A if the securities were labeled as Alt-A when sold to us or if we believe the underlying collateral includes a significant amount of Alt-A loans. We have classified $46 billion and
 
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$51.3 billion of our single-family non-agency mortgage-related securities as Alt-A and other loans at September 30, 2008 and December 31, 2007, respectively. In addition to the contractual interest payments, we receive substantial monthly remittances of principal repayments on these securities, which totaled $1.6 billion and $5.9 billion during the three and nine months ended September 30, 2008, respectively, representing a return on our investment in these securities. We have focused our purchases on credit-enhanced, senior tranches of these securities, which provide additional protection due to subordination. 89% and 100% of these securities were investment grade at September 30, 2008 and December 31, 2007, respectively. The unrealized losses, net of tax, on these securities are included in AOCI and totaled $5.8 billion and $1.7 billion at September 30, 2008 and December 31, 2007, respectively. The declines in fair values for these securities are mainly attributable to poor underlying collateral performance, decreased liquidity and larger risk premiums in the mortgage market. See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Retained Portfolio” for additional information regarding our mortgage-related securities.
 
The objectives set forth for us under our charter and conservatorship may negatively impact our Investments segment results. For example, the planned reduction in our retained portfolio balance to $250 billion, through successive annual 10% declines commencing in 2010, will cause a corresponding reduction in our net interest income. This may cause our Investments segment results to decline.
 
Single-Family Guarantee Segment
 
Through our Single-family Guarantee segment, we seek to issue guarantees that we believe offer attractive long-term returns relative to anticipated credit costs while fulfilling our mission to provide liquidity, stability and affordability in the residential mortgage market. In addition, we seek to improve our share of the total residential mortgage securitization market by enhancing customer service and increasing the volume of business with our customers.
 
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Table 14 presents the Segment Earnings of our Single-family Guarantee segment.
 
Table 14 — Segment Earnings and Key Metrics — Single-Family Guarantee
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2008     2007     2008     2007  
    (in millions)  
 
Segment Earnings:
                               
Net interest income(1)
  $ 52     $ 181     $ 187     $ 528  
Non-interest income:
                               
Management and guarantee income
    883       738       2,618       2,119  
Other non-interest income(1)
    94       27       301       77  
                                 
Total non-interest income
    977       765       2,919       2,196  
Non-interest expense:
                               
Administrative expenses
    (164 )     (203 )     (580 )     (611 )
Provision for credit losses
    (5,899 )     (1,417 )     (9,878 )     (2,175 )
REO operations expense
    (333 )     (50 )     (806 )     (80 )
Other non-interest expense
    (20 )     (18 )     (68 )     (58 )
                                 
Total non-interest expense
    (6,416 )     (1,688 )     (11,332 )     (2,924 )
                                 
Segment Earnings (loss) before income taxes
    (5,387 )     (742 )     (8,226 )     (200 )
Income tax benefit
    1,886       259       2,879       70  
                                 
Segment Earnings (loss), net of taxes
    (3,501 )     (483 )     (5,347 )     (130 )
Reconciliation to GAAP net loss:
                               
Credit guarantee-related adjustments
    (1,074 )     (927 )     574       (597 )
Tax-related adjustments(2)
    375       325       (202 )     208  
                                 
Total reconciling items, net of taxes
    (699 )     (602 )     372       (389 )
                                 
GAAP net loss
  $ (4,200 )   $ (1,085 )   $ (4,975 )   $ (519 )
                                 
Key metrics — Single-family Guarantee:
                               
Balances and Growth (in billions, except rate):
                               
Average securitized balance of single-family credit guarantee portfolio(3)
  $ 1,792     $ 1,612     $ 1,761     $ 1,552  
Issuance — Single-family credit guarantees(3)
  $ 64     $ 125     $ 309     $ 357  
Fixed-rate products — Percentage of issuances(4)
    88.5 %     86.3 %     88.3 %     80.1 %
Liquidation rate — Single-family credit guarantees (annualized rate)(5)
    12.1 %     13.3 %     16.8 %     15.3 %
Credit:
                               
Delinquency rate(6)
    1.22 %     0.51 %                
Delinquency transition rate(7)
    25.4 %     15.1 %                
REO inventory increase, net (number of units)
    6,060       1,664       13,697       3,161  
Single-family credit losses, in basis points (annualized)
    27.9       3.0       19.4       2.2  
Market:
                               
Single-family mortgage debt outstanding (total U.S. market, in billions)(8)
  $ 11,254     $ 11,034     $ 11,254     $ 11,034  
30-year fixed mortgage rate(9)
    6.3 %     6.6 %     6.1 %     6.4 %
(1)  In connection with the use of securitization trusts for the underlying assets of our PCs and Structured Securities in December 2007, we began recording trust management income in non-interest income. Trust management income represents the fees we earn as administrator, issuer and trustee. Previously, the benefit derived from interest earned on principal and interest cash flows between the time they were remitted to us by servicers and the date of distribution to our PCs and Structured Securities holders was recorded to net interest income.
(2)  Excludes any allocation of the non-cash charge related to the establishment of the partial valuation allowance against our deferred tax asset.
(3)  Based on unpaid principal balance.
(4)  Excludes fixed-rate Structured Securities backed by non-Freddie Mac issued mortgage-related securities.
(5)  Includes termination of long-term standby commitments.
(6)  Represents the percentage of single-family loans in our credit guarantee portfolio, based on loan count, which are 90 days or more past due at period end and excluding loans underlying Structured Transactions. See “CREDIT RISKS — Mortgage Credit Risk” for a description of our Structured Transactions.
(7)  Represents the percentage of loans that have been reported as 90 days or more delinquent, which subsequently transitioned to REO within 12 months of the date of delinquency. The rate does not reflect other loss events, such as short-sales and deed-in-lieu transactions.
(8)  U.S. single-family mortgage debt outstanding as of June 30, 2008 for 2008 and September 30, 2007 for 2007. Source: Federal Reserve Flow of Funds Accounts of the United States of America dated September 18, 2008.
(9)  Based on Freddie Mac’s Primary Mortgage Market Survey, or PMMS. Represents the national average mortgage commitment rate to a qualified borrower exclusive of the fees and points required by the lender. This commitment rate applies only to conventional financing on conforming mortgages with LTV ratios of 80% or less.
 
Segment Earnings (loss) for our Single-family Guarantee segment declined to a loss of $(3.5) billion for the three months ended September 30, 2008 compared to a loss of $(483) million for the three months ended September 30, 2007. Segment Earnings (loss) for our Single-family Guarantee segment declined to a loss of $(5.3) billion for the nine months ended September 30, 2008 compared to a loss of $(130) million for the nine months ended September 30, 2007. These declines reflect an increase in normal credit-related expenses due to higher delinquency rates, higher volumes of non-performing loans and foreclosures, higher severity of losses on a per-property basis and a decline in home prices and other regional economic conditions. The decline in Segment Earnings for this segment for the three and nine months ended September 30, 2008 was partially offset by an increase in Segment Earnings management and guarantee income as compared to the three and nine months ended September 30, 2007. The increase in Segment Earnings management and guarantee income for this segment for the three and nine months ended September 30, 2008 is primarily due to higher average balances of the single-family credit guarantee portfolio, an increase in the average fee rates shown in the table below and higher delivery and credit fee amortization. Amortization of upfront fees increased as a result of cumulative catch-up adjustments
 
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recognized during the nine months ended September 30, 2008. These cumulative catch-up adjustments result in a pattern of revenue recognition that more is consistent with our economic release from risk and the timing of the recognition of losses on pools of mortgage loans we guarantee.
 
Table 15 below provides summary information about Segment Earnings management and guarantee income for the Single-family Guarantee segment. Segment Earnings management and guarantee income consists of contractual amounts due to us related to our management and guarantee fees as well as amortization of credit fees.
 
Table 15 — Segment Earnings Management and Guarantee Income — Single-Family Guarantee
 
                                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
          Average
          Average
          Average
          Average
 
    Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate  
    (dollars in millions, rates in basis points)  
 
Contractual management and guarantee fees
  $ 727       16.0     $ 639       15.6     $ 2,142       16.0     $ 1,835       15.5  
Amortization of upfront fees included in other liabilities
    156       3.4       99       2.5       476       3.5       284       2.5  
                                                                 
Total Segment Earnings management and guarantee income
    883       19.4       738       18.1       2,618       19.5       2,119       18.0  
                                                                 
Adjustments to reconcile to consolidated GAAP:
                                                               
Reclassification between net interest income and management and guarantee fee(1)
    53               7               147               14          
Credit guarantee-related adjustments(2)
    (124 )             (40 )             (441 )             (240 )        
Multifamily management and guarantee income(3)
    20               13               54               44          
                                                                 
Management and guarantee income, GAAP
  $ 832             $ 718             $ 2,378             $ 1,937          
                                                                 
(1)  Management and guarantee fees earned on mortgage loans held in our retained portfolio are reclassified from net interest income within the Investments segment to management and guarantee fees within the Single-family Guarantee segment. Buy-up and buy-down fees are transferred from the Single-family Guarantee segment to the Investments segment.
(2)  Primarily represent credit fee amortization adjustments.
(3)  Represents management and guarantee income recognized related to our Multifamily segment that is not included in our Single-family Guarantee segment.
 
For the three months ended September 30, 2008 and 2007, the annualized growth rates of our single-family credit guarantee portfolio were 2.2% and 18.3%, respectively. For the nine months ended September 30, 2008 and 2007, the annualized growth rates of our single-family credit guarantee portfolio were 7.1% and 17.1%, respectively. Our mortgage purchase volumes are impacted by several factors, including origination volumes, mortgage product and underwriting trends, competition, customer-specific behavior and contract terms. Single-family mortgage purchase volumes from individual customers can fluctuate significantly. Despite these fluctuations, our share of the overall single-family mortgage origination market was higher in the nine months ended September 30, 2008 as compared to recent years, as mortgage originators have generally tightened their credit standards, causing conforming mortgages to be the predominant product in the market during this period. As a result, we have seen improvements in the credit quality of mortgages delivered to us in 2008. However, our purchase volume and also our market share have significantly declined during the third quarter of 2008.
 
During 2008, we implemented several increases in delivery fees, which are paid at the time of securitization. These increases included a 25 basis point fee assessed on all loans purchased or guaranteed through flow-business channels, as well as higher or new upfront fees for certain mortgages deemed to be higher-risk based on product type, property type, loan purpose, LTV ratio and/or borrower credit scores. Upfront fees are recognized in Segment Earnings management and guarantee fee income rather than as part of income on guarantee obligation under GAAP. Certain of our planned increases in delivery fees that were to be implemented in November 2008, including a 25 basis point increase in flow-business purchases, have been cancelled. On October 3, 2008, we announced several changes to delivery fee schedules that take effect for settlements on and after January 2, 2009, including increasing certain delivery fees based on combinations of LTV ratios, credit scores, product types and other characteristics. These increases in delivery fees will have a positive impact on our results of operations; however, the appointment of FHFA as Conservator and the Conservator’s subsequent directive that we provide increased support to the mortgage market will likely affect future guarantee pricing decisions. The objectives set forth for us under our charter and conservatorship may negatively impact our Single-family Guarantee segment results. For example our objective of assisting the mortgage market may cause us to change our pricing strategy in our core mortgage loan purchase or guarantee business, which may cause our Single-Family guarantee segment results to suffer.
 
We have also made changes to our underwriting guidelines for loans delivered to us for purchase or securitization in order to reduce our credit risk exposure for new business. These changes include reducing purchases of mortgages with LTV ratios over 95%, and limiting combinations of higher-risk characteristics in loans we purchase, including those with reduced documentation. In some cases, binding commitments under existing customer contracts may delay the effective dates of underwriting adjustments for a period of months. There has been a shift in the composition of our new issuances during 2008 to a greater proportion of higher-quality, fixed-rate mortgages and a reduction in our guarantee of interest-only and Alt-A mortgage loans. For example, Alt-A loans made up approximately 18% and 22% of our mortgage purchase volume during 2006 and 2007, respectively. Due to changes in underwriting practices and reduced originations in the market during 2008, Alt-A loan products made up approximately $25.3 billion or 8% of our mortgage purchase volume during the nine months
 
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ended September 30, 2008. In October 2008, we announced that we will no longer purchase mortgages originated in reliance on reduced documentation of income and assets and mortgages to borrowers with credit scores below a specified minimum delivered to us on and after February 1, 2009.
 
Our Segment Earnings provision for credit losses for the Single-family Guarantee segment increased to $5.9 billion for the three months ended September 30, 2008, compared to $1.4 billion for the three months ended September 30, 2007. Our Segment Earnings provision for credit losses for the Single-family Guarantee segment increased to $9.9 billion for the nine months ended September 30, 2008, compared to $2.2 billion for the nine months ended September 30, 2007, due to continued credit deterioration in our single-family credit guarantee portfolio, primarily related to 2006 and 2007 loan purchases. Mortgages in our single-family credit guarantee portfolio purchased by us in 2006 and 2007 have higher delinquency rates, higher transition rates to foreclosure, as well as higher loss severities on a per-property basis than our historical experiences. Our provision for credit losses is based on our estimate of incurred losses inherent in both our credit guarantee portfolio and the mortgage loans in our retained portfolio using recent historical performance, such as trends in delinquency rates, recent charge-off experience, recoveries from credit enhancements and other loss mitigation activities.
 
The delinquency rate on our single-family credit guarantee portfolio increased to 122 basis points as of September 30, 2008 from 65 basis points as of December 31, 2007. Increases in delinquency rates occurred in all product types for the three months ended September 30, 2008, but were most significant for interest-only, Alt-A and ARM mortgages. See “CREDIT RISKS — Table 49 — Single-Family Credit Loss Concentration Analysis” for additional delinquency information. We expect our delinquency rates will continue to rise in the remainder of 2008.
 
The impact of the weak housing market was first evident during 2007 in areas of the country where unemployment rates have been relatively high, such as the North Central region. However, we have also experienced significant increases in delinquency rates and REO activity in the West, Northeast and Southeast regions during the nine months ended September 30, 2008, compared to the nine months ended September 30, 2007, particularly in the states of California, Florida, Nevada and Arizona. The West region represents approximately 30% of our REO property acquisitions during the nine months ended September 30, 2008, based on the number of units. The highest concentration in the West region is in the state of California. At September 30, 2008, our REO inventory in California represented approximately 30% of our total REO property inventory. California has accounted for an increasing amount of our credit losses and it comprised approximately 31% of our total credit losses in the nine months ended September 30, 2008.
 
During the nine months ended September 30, 2008, our single-family credit guarantee portfolio also continued to experience increases in the rate at which loans transitioned from delinquency to foreclosure. The increase in these delinquency transition rates, compared to our historical experience, has been progressively worse for mortgage loans purchased by us during 2006 and 2007. This trend is, in part, due to the increase of non-traditional mortgage loans, such as interest-only and Alt-A mortgages, as well as an increase in estimated current LTV ratios for mortgage loans originated during those years. For the three months ended September 30, 2008, single-family charge-offs, gross, were $1.2 billion compared to $133 million for the three months ended September 30, 2007. Single-family charge-offs, gross, increased to $2.4 billion for the nine months ended September 30, 2008 as compared to $340 million for the nine months ended September 30, 2007, primarily due to the increase in the volume of REO acquisitions as well as continued deterioration in the national real estate market. In addition, there has also been an increase in loss severity, or the average charge-off, on a per property basis, during the three and nine months ended September 30, 2008 compared to the three and nine months ended September 30, 2007.
 
Multifamily Segment
 
Through our Multifamily segment, we seek to manage our investments in multifamily mortgage loans to generate positive returns while fulfilling our mission to provide stability and liquidity for the financing of rental housing nationwide. We also seek to issue guarantees that we believe offer attractive long-term returns relative to anticipated credit costs. Prior to 2008, we have not typically securitized multifamily mortgages, because our multifamily loans are typically large, customized, non-homogenous loans that are not as conducive to securitization as single-family loans and the market for multifamily securitizations is relatively illiquid. Accordingly, we typically hold multifamily loans for investment purposes. Beginning in 2008, we have increased our guarantee portfolio of multifamily mortgages and we expect to further increase our multifamily guarantee activity in the remainder of 2008, as market conditions permit.
 
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Table 16 presents the Segment Earnings of our Multifamily segment.
 
Table 16 — Segment Earnings and Key Metrics — Multifamily
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2008     2007     2008     2007  
          (dollars in millions)        
 
Segment Earnings:
                               
Net interest income
  $ 120     $ 88     $ 293     $ 305  
Non-interest income:
                               
Management and guarantee income
    20       14       54       44  
Other non-interest income
    16       7       31       16  
                                 
Total non-interest income
    36       21       85       60  
Non-interest expense:
                               
Administrative expenses
    (37 )     (48 )     (135 )     (142 )
Provision for credit losses
    (14 )     (16 )     (30 )     (20 )
REO operations expense
          (1 )           (1 )
LIHTC partnerships
    (121 )     (111 )     (346 )     (354 )
Other non-interest expense
    (3 )     (4 )     (12 )     (16 )
                                 
Total non-interest expense
    (175 )     (180 )     (523 )     (533 )
                                 
Segment Earnings (loss) before income taxes
    (19 )     (71 )     (145 )     (168 )
LIHTC partnerships tax benefit
    147       129       445       402  
Income tax benefit
    7       25       51       58  
                                 
Segment Earnings, net of taxes
    135       83       351       292  
Reconciliation to GAAP net income:
                               
Derivative-related adjustments
    (10 )     (6 )     (24 )     (14 )
Credit guarantee-related adjustments
    (2 )     1       (6 )     (1 )
Investment sales, debt retirements and fair value-related adjustments
    (7 )           (7 )      
Tax-related adjustments(1)
    7       1       13       5  
                                 
Total reconciling items, net of taxes
    (12 )     (4 )     (24 )     (10 )
                                 
GAAP net income
  $ 123     $ 79     $ 327     $ 282  
                                 
Key metrics — Multifamily:
                               
Balances and Growth:
                               
Average balance of Multifamily loan portfolio(2)
  $ 66,004     $ 48,663     $ 62,507     $ 47,166  
Average balance of Multifamily guarantee portfolio(2)
    14,087       7,698       12,878       7,838  
Purchases — Multifamily loan portfolio(2)
    5,164       3,311       13,416       8,839  
Purchases — Multifamily guarantee portfolio(2)
    845       194       4,332       320  
Liquidation rate — Multifamily loan portfolio (annualized rate)
    4.1 %     10.7 %     6.1 %     13.0 %
Credit:
                               
Delinquency rate(3)
    0.01 %     0.06 %                
Allowance for loan losses
  $ 87     $ 45                  
(1)  Excludes any allocation of the non-cash charge related to the establishment of the partial valuation allowance against our deferred tax asset.
(2)  Based on unpaid principal balance.
(3)  Based on net carrying value of mortgages 90 days or more delinquent as well as those in the process of foreclosure and excluding Structured Transactions.
 
The multifamily mortgage market differs from the residential single-family market in several respects. The likelihood that a multifamily borrower will make scheduled payments on its mortgage is a function of the ability of the property to generate income sufficient to make those payments, which is affected by rent levels and the percentage of available units that are occupied. Strength in the multifamily market therefore is affected by the balance between the supply of and demand for rental housing (both multifamily and single-family), which in turn is affected by employment, the number of new units added to the rental housing supply, rates of household formation and the relative cost of owner-occupied housing alternatives. Although multifamily demand market fundamentals have been solid in much of the nation, liquidity concerns and wider credit spreads have affected institutions that participate in the multifamily market during 2008. However, we have continued to support the multifamily housing market during 2008 by making investments that we believe have attractive expected returns. The objectives set forth for us under our charter and conservatorship may negatively impact our Multifamily segment results. For example, our objective of assisting the mortgage market may cause us to change our pricing strategy in our core mortgage loan purchase or guarantee business, which may cause our Multifamily segment results to suffer.
 
Segment Earnings for our Multifamily segment increased $52 million, or 63%, for the three months ended September 30, 2008 compared to the three months ended September 30, 2007, primarily due to higher net interest income and higher non-interest income. Net interest income increased $32 million for the three months ended September 30, 2008 compared to the three months ended September 30, 2007, driven by a 36% increase in the average balances of our Multifamily loan portfolio, partially offset by lower yield maintenance fee income on declines in loan refinancing activity. Loan purchases into the Multifamily loan portfolio were $5.2 billion for the three months ended September 30, 2008, a 56% increase compared to the three months ended September 30, 2007 as we continued to provide stability and liquidity for the financing of rental housing nationwide. Non-interest income increased $15 million due to an increase in management and
 
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guarantee income and, to a lesser extent, an increase in bond application fees for the three months ended September 30, 2008 compared to the three months ended September 30, 2007.
 
Segment Earnings for our Multifamily segment increased $59 million, or 20%, for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007, primarily due to higher LIHTC partnership tax benefit, higher non-interest income and lower non-interest expense, partially offset by a decrease in net interest income. LIHTC partnership tax benefit increased $43 million for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007 as we continued to see the benefit from new fund investments entered into during 2007. There have been no new LIHTC investments in 2008. Tax benefits from LIHTC partnerships are recognized in our Multifamily Segment Earnings apart from their use at the corporate level. Non-interest income increased $25 million for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007, due to an increase in management and guarantee income and, to a lesser extent, an increase in bond application fees. Non-interest expense decreased $10 million for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007, primarily due to lower administrative expenses and lower expenses related to LIHTC partnerships, partially offset by an increase in provision for credit losses for our Multifamily segment. Net interest income of our Multifamily segment declined $12 million for the nine months ended September 30, 2008, compared to the nine months ended September 30, 2007 due to significantly lower yield maintenance fee income on declines in loan refinancing activity. Loan purchases into the Multifamily loan portfolio were $13.4 billion for the nine months ended September 30, 2008, a 52% increase when compared to the nine months ended September 30, 2007. As part of the guarantee arrangements pertaining to multifamily housing revenue bonds, we have provided commitments to advance funds, commonly referred to as “liquidity guarantees.” At September 30, 2008, we had outstanding liquidity guarantee advances of $307 million. See “OFF-BALANCE SHEET ARRANGEMENTS” for more information about our liquidity guarantees.
 
CONSOLIDATED BALANCE SHEETS ANALYSIS
 
The following discussion of our consolidated balance sheets should be read in conjunction with our consolidated financial statements, including the accompanying notes. Also see “CRITICAL ACCOUNTING POLICIES AND ESTIMATES” for more information concerning our more significant accounting policies and estimates applied in determining our reported financial position.
 
Cash and Investments Portfolio
 
We maintain a cash and investments portfolio that is important to our financial management and our ability to provide liquidity and stability to the mortgage market. Of the $68.6 billion in this portfolio as of September 30, 2008, $50.2 billion represents investments in cash and cash equivalents. At September 30, 2008, the investments in this portfolio also included $10.4 billion of non-mortgage-related securities that we could sell to provide us with an additional source of liquidity to fund our business operations. We also use this portfolio to help manage recurring cash flows and meet our other cash management needs. In addition, we use the portfolio to hold capital on a temporary basis until we can deploy it into retained portfolio investments or credit guarantee opportunities. We may also sell the securities in this portfolio to meet mortgage-funding needs, provide diverse sources of liquidity or help manage the interest-rate risk inherent in mortgage-related assets.
 
Credit concerns and resulting liquidity issues have greatly affected the financial markets. The reduced liquidity in U.S. financial markets prompted the Federal Reserve to take several significant actions during 2008, including a series of reductions in the discount rate totaling 3.0%. The rate reductions by the Federal Reserve have had an impact on other key market rates affecting our assets and liabilities, including generally reducing the return on our cash and investments portfolio and lowering our cost of short-term debt financing. During the nine months ended September 30, 2008, we increased the balance of our cash and investments portfolio by $18 billion, primarily due to a $42 billion increase in highly liquid shorter-term cash and cash equivalent assets including deposits in financial institutions and commercial paper partially offset by a $25 billion decrease in longer-term non-mortgage-related investments including asset-backed securities. As a result of counterparty credit concerns during the third quarter, these deposits in financial institutions included substantial cash balances in accounts that did not earn a rate of return.
 
We recognized other-than-temporary impairment charges in our cash and investments portfolio of $244 million, during the third quarter of 2008, related to our non-mortgage-related investments with $10.8 billion of unpaid principal balance, as management could no longer assert the positive intent to hold these securities to recovery. Cumulative other-than-temporary impairments taken on these securities during 2008 were $458 million. The decision to impair these securities is consistent with our consideration of sales of securities from the cash and investments portfolio as a contingent source of liquidity. We estimate that the future expected principal and interest shortfall on these securities will be significantly less than the impairment loss required to be recorded under GAAP, as we expect these shortfalls to be less than the recent fair value declines. The portion of the impairment charges associated with these expected recoveries will be accreted back through net interest income in future periods. As a result of the other-than-temporary impairment charges recorded this quarter, there are no remaining net unrealized losses in our non-mortgage-related investments portfolio.
 
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Retained Portfolio
 
We are primarily a buy-and-hold investor in mortgage assets. We invest principally in mortgage loans and mortgage-related securities, which consist of securities issued by us, Fannie Mae, Ginnie Mae and other financial institutions. We refer to these investments that are recorded on our consolidated balance sheet as our retained portfolio.
 
On October 9, 2008, FHFA announced that the Director of FHFA has suspended the capital classifications of Freddie Mac during the conservatorship, in light of the Purchase Agreement, and that existing statutory and FHFA-directed regulatory capital requirements will not be binding during the conservatorship. However, under the Purchase Agreement our retained portfolio may not exceed $850 billion as of December 31, 2009 and then must decline by 10% per year thereafter until it reaches $250 billion.
 
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Table 17 provides detail regarding the mortgage loans and mortgage-related securities in our retained portfolio.
 
Table 17 — Characteristics of Mortgage Loans and Mortgage-Related Securities in our Retained Portfolio
 
                                                 
    September 30, 2008     December 31, 2007  
    Fixed
    Variable
          Fixed
    Variable
       
    Rate     Rate     Total     Rate     Rate     Total  
    (in millions)  
 
Mortgage loans:
                                               
Single-family(1)
                                               
Conventional:(2)
                                               
Amortizing
  $ 28,696     $ 806     $ 29,502     $ 20,461     $ 1,266     $ 21,727  
Interest-only
    412       780       1,192       246       1,434       1,680  
                                                 
Total conventional
    29,108       1,586       30,694       20,707       2,700       23,407  
RHS/FHA/VA
    1,312             1,312       1,182             1,182  
                                                 
Total single-family
    30,420       1,586       32,006       21,889       2,700       24,589  
Multifamily(3)
    63,077       5,229       68,306       53,114       4,455       57,569  
                                                 
Total mortgage loans
    93,497       6,815       100,312       75,003       7,155       82,158  
                                                 
PCs and Structured Securities:(1)(4)
                                               
Single-family
    277,927       94,426       372,353       269,896       84,415       354,311  
Multifamily
    267       2,326       2,593       2,522       137       2,659  
                                                 
Total PCs and Structured Securities
    278,194       96,752       374,946       272,418       84,552       356,970  
                                                 
Non-Freddie Mac mortgage-related securities:(1)
                                               
Agency mortgage-related securities:(5)
                                               
Fannie Mae:
                                               
Single-family
    21,633       34,105       55,738       23,140       23,043       46,183  
Multifamily
    652       124       776       759       163       922  
Ginnie Mae:
                                               
Single-family
    412       157       569       468       181       649  
Multifamily
    25             25       82             82  
                                                 
Total agency mortgage-related securities
    22,722       34,386       57,108       24,449       23,387       47,836  
                                                 
Non-agency mortgage-related securities:
                                               
Single-family:
                                               
Subprime(6)
    451       79,303       79,754       498       100,827       101,325  
Alt-A and other(7)
    3,365       42,627       45,992       3,762       47,551       51,313  
Commercial mortgage-backed securities
    25,155       39,196       64,351       25,709       39,095       64,804  
Obligations of states and political subdivisions(8)
    13,011       45       13,056       14,870       65       14,935  
Manufactured housing(9)
    1,165       192       1,357       1,250       222       1,472  
                                                 
Total non-agency mortgage-related securities(10)
    43,147       161,363       204,510       46,089       187,760       233,849  
                                                 
Total unpaid principal balance of retained portfolio
  $ 437,560     $ 299,316       736,876     $ 417,959     $ 302,854       720,813  
                                                 
Premiums, discounts, deferred fees, impairments of unpaid principal balances and other basis adjustments
                    (8,654 )                     (655 )
Net unrealized losses on mortgage-related securities, pre-tax
                    (33,145 )                     (10,116 )
Allowance for loan losses on mortgage loans held-for-investment(11)
                    (459 )                     (256 )
                                                 
Total retained portfolio per consolidated balance sheets
                  $ 694,618                     $ 709,786  
                                                 
  (1)  Variable-rate single-family mortgage loans and mortgage-related securities include those with a contractual coupon rate that, prior to contractual maturity, is either scheduled to change or is subject to change based on changes in the composition of the underlying collateral. Single-family mortgage loans also include mortgages with balloon/reset provisions.
  (2)  See “CREDIT RISKS — Mortgage Credit Risk” for information on Alt-A and subprime loans, which are a component of our single-family conventional mortgage loans.
  (3)  Variable-rate multifamily mortgage loans include only those loans that, as of the reporting date, have a contractual coupon rate that is subject to change.
  (4)  For our PCs and Structured Securities, we are subject to the credit risk associated with the underlying mortgage loan collateral.
  (5)  Agency mortgage-related securities are generally not separately rated by nationally recognized statistical rating organizations, but are viewed as having a level of credit quality at least equivalent to non-agency mortgage-related securities AAA-rated or equivalent.
  (6)  Single-family non-agency mortgage-related securities backed by subprime residential loans include significant credit enhancements, particularly through subordination. For information about how these securities are rated, see “Table 18 — Investments in Available-for-Sale Non-Agency Mortgage-Related Securities backed by Subprime Loans, Alt-A, MTA and Other Loans in our Retained Portfolio,” “Table 24 — Ratings of Available-For-Sale Non-Agency Mortgage-Related Securities backed by Subprime Loans at September 30, 2008” and “Table 25 — Ratings of Available-For-Sale Non-Agency Mortgage-Related Securities backed by Subprime Loans at September 30, 2008 and November 10, 2008.”
  (7)  Single-family non-agency mortgage-related securities backed by Alt-A and other mortgage loans include significant credit enhancements, particularly through subordination. For information about how these securities are rated, see “Table 18 — Investments in Available-For-Sale Non-Agency Mortgage-Related Securities backed by Subprime Loans, Alt-A, MTA and Other Loans in our Retained Portfolio,” “Table 26 — Ratings of Available-For-Sale Non-Agency Mortgage-Related Securities backed by Alt-A and Other Loans at September 30, 2008” and “Table 27 — Ratings of Available-For-Sale Non-Agency Mortgage-Related Securities backed by Alt-A and Other Loans at September 30, 2008 and November 10, 2008.”
  (8)  Consist of mortgage revenue bonds. Approximately 61% and 67% of these securities held at September 30, 2008 and December 31, 2007, respectively, were AAA-rated as of those dates, based on the lowest rating available.
  (9)  At September 30, 2008 and December 31, 2007, 32% and 34%, respectively, of mortgage-related securities backed by manufactured housing bonds were rated BBB− or above, based on the lowest rating available. For the same dates, 91% and 93% of manufactured housing bonds had credit enhancements, respectively, including primary monoline insurance that covered 23% of the manufactured housing bonds. At September 30, 2008 and December 31, 2007, we had secondary insurance on 60% and 72% of these bonds that were not covered by the primary monoline insurance, respectively. Approximately 3% and 28% of these mortgage-related securities were backed by manufactured housing bonds AAA-rated at September 30, 2008 and December 31, 2007, respectively, based on the lowest rating available.
(10)  Credit ratings for most non-agency mortgage-related securities are designated by no fewer than two nationally recognized statistical rating organizations. Approximately 66% and 96% of total non-agency mortgage-related securities held at September 30, 2008 and December 31, 2007, respectively, were AAA-rated as of those dates, based on the lowest rating available.
(11)  See “CREDIT RISKS — Credit Loss Performance — Loan Loss Reserves” for information about our allowance for loan losses on mortgage loans held-for-investment.