Freddie Mac 2009 Annual Report Download - page 191

The three levels of the fair value hierarchy under the accounting standards for fair value measurements and disclosures
are described below:
Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical
assets or liabilities;
Level 2: Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar
assets and liabilities in markets that are not active; inputs other than quoted market prices that are
observable for the asset or liability; and inputs that are derived principally from or corroborated by
observable market data for substantially the full term of the assets or liabilities; and
Level 3: Unobservable inputs for the asset or liability that are supported by little or no market activity and that are
significant to the fair values.
We categorize assets and liabilities measured and reported at fair value in our consolidated balance sheets within the
fair value hierarchy based on the valuation process used to derive their fair values and our judgment regarding the
observability of the related inputs. Those judgments are based on our knowledge and observations of the markets relevant to
the individual assets and liabilities and may vary based on current market conditions. In applying our judgments, we review
ranges of third party prices and transaction volumes, and hold discussions with dealers and pricing service vendors to
understand and assess the extent of market benchmarks available and the judgments or modeling required in their processes.
Based on these factors, we determine whether the inputs are observable in active markets or whether the markets are
inactive.
Our Level 1 financial instruments consist of exchange-traded derivatives and Treasury bills, where quoted prices exist
for the exact instrument in an active market.
Our Level 2 instruments generally consist of high credit quality agency mortgage-related securities, non-mortgage-
related asset-backed securities, interest-rate swaps, option-based derivatives and foreign-currency denominated debt. These
instruments are generally valued through one of the following methods: (a) dealer or pricing service inputs with the value
derived by comparison to recent transactions of similar securities and adjusting for differences in prepayment or liquidity
characteristics; or (b) modeled through an industry standard modeling technique that relies upon observable inputs such as
discount rates and prepayment assumptions.
Our Level 3 assets primarily consist of non-agency residential mortgage-related securities, CMBS, our guarantee asset,
and mortgage loans held-for-sale. While the non-agency mortgage-related securities market remained weak during 2009 with
low transaction volumes, wide credit spreads and limited transparency, we value our non-agency mortgage-related securities
based primarily on prices received from pricing services and dealers. The techniques used by these pricing services and
dealers to develop the prices generally are either (a) a comparison to transactions of instruments with similar collateral and
risk profiles; or (b) industry standard modeling such as the discounted cash flow model. For a large majority of the securities
we value using dealers and pricing services, we obtain at least three independent prices, which are non-binding to us or our
counterparties. When multiple prices are received, we use the median of the prices. The models and related assumptions
used by the dealers and pricing services are owned and managed by them. However, we have an understanding of their
processes used to develop the prices provided to us based on our ongoing due diligence. We generally have discussions with
our dealers and pricing service vendors on a quarterly basis to maintain a current understanding of the processes and inputs
they use to develop prices. We make no adjustments to the individual prices we receive from third party pricing services or
dealers for non-agency mortgage-related securities beyond calculating median prices and discarding certain prices that are
not valid based on our validation processes. See “Controls over Fair Value Measurement” for information on our validation
processes.
We consider credit risk in the valuation of our assets and liabilities with the credit risk of the counterparty considered in
asset valuations and our own institutional credit risk considered in liability valuations. For foreign-currency denominated
debt with the fair value option elected, we considered our own credit risk as a component of the fair value determination.
The total fair value change was a net gain (loss) of $(0.4) billion and $0.4 billion during 2009 and 2008, respectively. Of
these amounts, $(0.2) billion and $0.3 billion was attributable to changes in the instrument-specific credit risk during 2009
and 2008, respectively. The changes in fair value attributable to changes in instrument-specific credit risk were determined
by comparing the total change in fair value of the debt to the total change in fair value of the interest rate and foreign
currency derivatives used to hedge the debt. Any difference in the fair value change of the debt compared to the fair value
change in the derivatives is attributed to instrument-specific credit risk.
For multifamily held-for-sale loans with the fair value option elected, we consider the ability of the underlying property
to generate sufficient cash flow to service the debt. We recorded $(81) million and $(14) million from the change in fair
value in gains (losses) on investment activity in our consolidated statements of operations during 2009 and 2008,
respectively. Of these amounts, $24 million and ($69) million were attributable to changes in the instrument-specific credit
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