Freddie Mac 2011 Annual Report Download - page 76

We face risks and uncertainties associated with the internal models that we use for financial accounting and reporting
purposes, to make business decisions, and to manage risks. Market conditions have raised these risks and uncertainties.
We make significant use of business and financial models for financial accounting and reporting purposes and to
manage risk. We face risk associated with our use of models. First, there is inherent uncertainty associated with model
results. Second, we could fail to properly implement, operate, or use our models. Either of these situations could
adversely affect our financial statements and our ability to manage risks.
We use market-based information as inputs to our models. However, it can take time for data providers to prepare
information, and thus the most recent information may not be available for the preparation of our financial statements.
When market conditions change quickly and in unforeseen ways, there is an increased risk that the inputs reflected in our
models are not representative of current market conditions.
The severe deterioration of the housing and credit markets beginning several years ago and, more recently, the
extended period of economic weakness and uncertainty has increased the risks associated with our use of models. For
example, certain economic events or the implementation of government policies could create increased model uncertainty
as models may not fully capture these events, which makes it more difficult to assess model performance and requires a
higher degree of management judgment. Our models may not perform as well in situations for which there are few or no
recent historical precedents. We have adjusted our models in response to recent events, but there remains considerable
uncertainty about model results.
Models are inherently imperfect predictors of actual results. Our models rely on various assumptions that may be
incorrect, including that historical experience can be used to predict future results. It has been more difficult to predict the
behaviors of the housing and credit capital markets and market participants over the past several years, due to, among
other factors: (a) the uncertainty concerning trends in home prices; (b) the lack of historical evidence about the behavior
of deeply underwater borrowers, the effect of an extended period of extremely low interest rates on prepayments, and the
impact of widespread loan refinancing and modification programs (such as HARP and HAMP), including the potential for
the extensive use of principal reductions; and (c) the impact of the concerns about deficiencies in foreclosure
documentation practices and related delays in the foreclosure process.
We face the risk that we could fail to implement, operate, or adjust or use our models properly. This risk may be
increasing due to our difficulty in attracting and retaining employees with the necessary experience and skills. For
example, the assumptions underlying a model could be invalid, or we could apply a model to events or products outside
the model’s intended use. We may fail to code a model correctly or we could use incorrect data. The complexity and
interconnectivity of our models create additional risk regarding the accuracy of model output. While we have processes
and controls in place designed to mitigate these risks, there can be no assurances that such processes and controls will be
successful.
Management often needs to exercise judgment to interpret or adjust modeled results to take into account new
information or changes in conditions. The dramatic changes in the housing and credit capital markets in recent years have
required frequent adjustments to our models and the application of greater management judgment in the interpretation and
adjustment of the results produced by our models. This further increases both the uncertainty about model results and the
risk of errors in the implementation, operation, or use of the models.
We face the risk that the valuations, risk metrics, amortization results, loan loss reserve estimations, and security
impairment charges produced by our internal models may be different from actual results, which could adversely affect
our business results, cash flows, fair value of net assets, business prospects, and future financial results. For example, our
models may under-predict the losses we will suffer in various aspects of our business. Changes in, or replacements of, any
of our models or in any of the assumptions, judgments, or estimates used in the models may cause the results generated
by the model to be materially different from those generated by the prior model. The different results could cause a
revision of previously reported financial condition or results of operations, depending on when the change to the model,
assumption, judgment, or estimate is implemented. Any such changes may also cause difficulties in comparisons of the
financial condition or results of operations of prior or future periods.
Due to increased uncertainty about model results, we also face increased risk that we could make poor business
decisions in areas where model results are an important factor, including loan purchases, management and guarantee fee
pricing, asset and liability management, market risk management, and quality-control sampling strategies for loans in our
single-family credit guarantee portfolio. Furthermore, any strategies we employ to attempt to manage the risks associated
with our use of models may not be effective. See “MD&A — CRITICAL ACCOUNTING POLICIES AND
ESTIMATES” and “QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK — Interest-Rate
Risk and Other Market Risks” for more information on our use of models.
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