Freddie Mac 2009 Annual Report Download - page 194

We recorded a gain of $4.4 billion, primarily in AOCI, on these transferred assets during 2009, which were included in our
Level 3 reconciliation. We believe that the cumulative unrealized losses on non-agency CMBS at December 31, 2009 were
principally a result of decreased liquidity and larger risk premiums in the non-agency mortgage market. We concluded that
the unrealized losses on such securities were temporary, as we do not intend to sell these securities, it is not more likely than
not that we will be required to sell such securities before recovery of the unrealized losses and we expect to receive cash
flows sufficient to recover the entire amortized cost basis of the securities. See “NOTE 6: INVESTMENTS IN
SECURITIES — Evaluation of Other-Than-Temporary Impairments” to our consolidated financial statements for further
information about our evaluation of unrealized losses on our available-for-sale portfolio for other-than-temporary
impairments.
During 2008, our Level 3 assets increased significantly because the market for non-agency mortgage-related securities
backed by subprime, Alt-A and option ARM mortgage loans continued to experience a significant reduction in liquidity and
wider spreads, as investor demand for these assets decreased. As a result, we have observed more variability in the quotes
received from dealers and third-party pricing services. Consequently, we transferred $156.2 billion of Level 2 assets to
Level 3 during 2008. These transfers were primarily within non-agency mortgage-related securities backed by subprime,
Alt-A and option ARM mortgage loans where inputs that are significant to their valuation became limited or unavailable. We
concluded that the prices on these securities received from pricing services and dealers were reflective of significant
unobservable inputs as the markets have become significantly less active, requiring higher degrees of judgment to extrapolate
fair values from limited market benchmarks. We recorded $30.1 billion of additional losses on available-for-sale securities,
within earnings and AOCI, on these transferred assets during 2008, which were included in our Level 3 reconciliation.
See “NOTE 18: FAIR VALUE DISCLOSURES — Table 18.2 — Fair Value Measurements of Assets and Liabilities
Using Significant Unobservable Inputs” to our consolidated financial statements for the Level 3 reconciliation. For discussion
of types and characteristics of mortgage loans underlying our mortgage-related securities, see “RISK MANAGEMENT —
Credit Risks” and “CONSOLIDATED BALANCE SHEETS ANALYSIS — Table 28 — Characteristics of Mortgage-Related
Securities.”
Controls over Fair Value Measurement
To ensure that fair value measurements are appropriate and reliable, we employ control processes to validate the
techniques and models we use. These control processes include review and approval of new transaction types, price
verification and review of valuation judgments, methods, models, process controls and results. Groups independent of our
trading and investing function, including Enterprise Valuation & Risk Control and the Valuation Committee, participate in
the review and validation process. The Valuation Committee includes senior representation from business areas, our
Enterprise Risk Oversight division and our Finance division.
Our Enterprise Valuation & Risk Control group performs monthly independent verification of fair value measurements
by comparing the methodology driven price to other market source data (to the extent available), and uses independent
analytics to determine if assigned fair values are reasonable. Enterprise Valuation & Risk Control’s review targets coverage
across all products with increased attention to higher risk/impact valuations. Validation processes are intended to ensure that
the individual prices we receive from third parties are consistent with our observations of the marketplace and prices that are
provided to us by other dealers or pricing services. Where applicable, prices are back-tested by comparing the settlement
prices to where fair values were measured. Analytical procedures include automated checks of prices for reasonableness
based on variations from prices in previous periods, comparisons of prices to internally calculated expected prices, based on
market moves, and relative value comparisons based on specific characteristics of securities. To the extent that we determine
that a price is outside of established parameters, we will further examine the price, including follow up discussions with the
specific pricing service or dealer and ultimately not use that price if we are not able to determine the price is valid. The
prices provided to us consider the existence of credit enhancements, including monoline insurance coverage and the current
lack of liquidity in the marketplace. These processes are executed prior to the use of the prices in the financial statements.
Where models are employed to assist in the measurement of fair value, material changes made to those models during
the periods presented are put through the corporate model change governance process. Inputs used by those models are
regularly updated for changes in the underlying data, assumptions, valuation inputs, or market conditions.
The Fair Value Option for Financial Assets and Financial Liabilities
We adopted the fair value option for certain eligible financial instruments at January 1, 2008. This statement permits
entities to choose to measure many financial instruments and certain other items at fair value that are not currently required
to be measured at fair value in order to improve financial reporting by providing entities with the opportunity to mitigate
volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex
hedge accounting provisions. The effect of the first measurement to fair value is reported as a cumulative-effect adjustment
to the beginning balance of retained earnings (accumulated deficit). We elected the fair value option for certain available-for-
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