Criminal investigation into Freddie Mac

Federal prosecutors in Virginia, Maryland, have opened a criminal investigation into the giant mortgage finance company Freddie Mac, which this week purged its top management after the discovery of unspecified accounting irregularities.

The criminal investigation, still at a very early stage, comes as the Securities and Exchange Commission market regulatory agency steps up an informal months-old investigation of its own, and senior Congressional figures announced they would hold hearings into the controversy.

In a curt statement, Paul McNulty, the US attorney for eastern Virginia where the mortgage company is based, confirmed his office had opened an investigation "involving Freddie Mac". He gave no details, but officials said it would focus on possible violations of federal security laws. The simmering problems at Freddie Mac, which manages a mortgage portfolio worth $1.29 trillion (£780bn), burst into the open on Monday when it sacked David Glenn, its president, saying he had failed to co-operate with an internal inquiry into its accounting practices. Freddie Mac's chief executive and chief financial officer were also forced out.

Freddie Mac and its corporate sister Fannie Mae are strange public-private hybrids, quoted on the stock-exchange, yet bolstered by a de facto guarantee of solvency from the federal government. They buy mortgages from banks and other lenders, which they bundle and sell to investors as mortgage backed securities. The two companies then trade on the derivatives market to reduce the risk of fluctuation in the value of its underlying assets, the mortgages themselves. It is here the questionmarks appear to lie.

Mr Glenn is said to have moved and altered pages in a business diary relating to these transactions. The changes were made while Freddie Mac was examining its results for the past three years, after discovering that its previous auditor, Arthur Andersen, had misapplied existing accounting rules. Freddie Mac was quick to assure that the re-audit will probably show an increase in earnings for the years in question. Yet its shares have dropped 15 per cent since Monday. And one analyst added, referring to the perception that the company is government-backed, "If this had been an ordinary public company, the fall would have been 30 per cent."