oversight

Audit of FHFA's Oversight of the Enterprises' Affordable Housing Set-Asides and Allocations

Published by the Federal Housing Finance Agency, Office of Inspector General on 2018-09-24.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

          Federal Housing Finance Agency
              Office of Inspector General




 Audit of FHFA’s Oversight of the
 Enterprises’ Affordable Housing
   Set-Asides and Allocations




Audit Report • AUD-2018-012 • September 24, 2018
                Executive Summary
                Created by the Housing and Economic Recovery Act of 2008 (HERA), the
                Federal Housing Finance Agency (FHFA or Agency) currently serves as the
                supervisor and conservator of Fannie Mae and Freddie Mac (together, the
                Enterprises). HERA also established (in 12 USC § 4567) two affordable
                housing funds – the Housing Trust Fund within the Department of Housing
AUD-2018-012    and Urban Development (HUD) and the Capital Magnet Fund within the
                Department of the Treasury (Treasury) (together, the Affordable Housing
September 24,   Funds) – both to be funded through annual set-asides by the Enterprises.
    2018        (HERA also provided that a limited amount of the set-asides would go into
                a reserve fund (the HOPE Reserve Fund) managed by Treasury.) HERA
                requires the Enterprises to transmit the annual set-aside amounts to these
                Funds, unless the FHFA Director suspends the transmission, upon a finding
                that one or more of three statutory conditions have been met.

                In November 2008, the then-FHFA Director suspended the Enterprises’
                affordable housing set-asides and transmissions until further notice, upon his
                finding that at least one of the statutory conditions was met. In December
                2014, the current FHFA Director lifted the suspension, effective January
                2015. For 2015, 2016, and 2017, the Enterprises set aside and transmitted a
                total of $1.251 billion to the Housing Trust Fund ($0.678 billion), the Capital
                Magnet Fund ($0.364 billion), and the HOPE Reserve Fund ($0.209 billion,
                for 2015 and 2016 only).

                We conducted this audit to understand the analyses, if any, performed by
                FHFA to determine whether the conditions that led to its 2008 temporary
                suspension of set-asides and transmissions had changed as of January 2015
                and whether the explanation provided by FHFA to lift the temporary
                suspension in December 2014 continued in force through February 2018,
                when FHFA directed the Enterprises to transmit their 2017 set-asides. We
                also assessed the accuracy of the Enterprises’ set-aside computations for 2015
                through 2017, as well as FHFA’s oversight of the Enterprises’ set-asides and
                transmissions to the Affordable Housing Funds.

                We found that FHFA first considered whether to lift its temporary suspension
                of the transmissions to the Affordable Housing Funds in 2013. FHFA’s
                General Counsel, in a memorandum to the then-Acting FHFA Director in
                April 2013, analyzed whether one or more of the statutory conditions that led
                to the 2008 temporary suspension continued in force. The General Counsel
                cautioned that the Enterprises had only reported profitable quarters because
                “of the huge infusion of capital they received from the Treasury and which
                has not been repaid... [I]t must be remembered that the goal of the dividend
                sweep is to preserve the availability of Treasury support should further draws
                be needed—a key element in market place willingness to deal with the
                Enterprises.” He concluded:

                       Continuing suspension of the [Affordable Housing Funds]
                       contributions is justified while the Enterprises remain in
                       conservatorship, especially since the Treasury Department has
                       not recovered the amounts that it contributed... to cover
AUD-2018-012           Enterprise losses, currently over $180 billion.

September 24,   In 2014, the General Counsel was asked by the current FHFA Director to
    2018        analyze whether, under HERA, termination of the 2008 temporary suspension
                was warranted because the Enterprises were “making money” and to set forth
                the basis of the Director’s authority to lift this suspension. In a memorandum
                dated October 30, 2014, the General Counsel answered both questions. As to
                the first question, he reviewed the same statutory conditions that he analyzed
                in his 2013 memorandum but came to a different conclusion. In this
                memorandum, he reasoned:

                       The dollar amount of the set aside and allocation as a percentage
                       of unpaid principal balance of new purchases is anticipated to be
                       small compared to recent income and to dividend payments to
                       the Treasury Department and would be viewed as an expense of
                       the Enterprises—embedded in statute and suspended during a
                       time of unusual stress in the determination of the prior Director
                       and now initiated in line with changed circumstances.

                Nowhere does this October 2014 memorandum state, or suggest, that General
                Counsel had previously concluded, in April 2013, that continuing suspension
                of contributions to the Affordable Housing Funds would be justified while the
                Enterprises remain in conservatorship, or attempt to reconcile the differences
                between the two analyses.

                As to the second question, the October 2014 memorandum advised that “a
                decision to lift the suspension of Fund set asides and allocations is within the
                Director’s discretion.”

                In December 2014, the FHFA Director notified each Enterprise, in writing,
                that he was exercising his discretion to terminate the temporary suspension of
                set-asides for and transmission to the Affordable Housing Funds and directed
                the Enterprises to begin transmitting their set-asides, beginning with the fiscal
                year 2015. Those written notifications also directed:

                       In the event that an Enterprise makes a draw during 2015 or any
                       subsequent year or if transfer of the set-aside would cause the
                       Enterprise to make a draw in any year, that Enterprise will make
                       no transfer of set-asides for that year to the Affordable Housing
                       Funds, as supplemented or modified by specific guidance or
                       directive from FHFA.

                The Enterprises calculated their set-asides for 2015, which they transmitted
                to the Affordable Housing Funds. Our audit found that the Enterprises’
AUD-2018-012    computations for the 2015 set-asides and subsequent transmittals were
                accurate.
September 24,
    2018        Operating under this December 2014 notice, the Enterprises calculated their
                set-asides for 2016, which they transmitted to the Affordable Housing Funds.
                Our audit found that the Enterprises’ computations for the 2016 set-asides and
                subsequent transmittals were accurate.

                Because of changes to the federal corporate tax law in December 2017, it
                became necessary for the Enterprises to re-measure the value of their deferred
                tax assets on their balance sheets. When these assets were re-measured, the
                Enterprises were put into a net worth deficit position as of December 31,
                2017, as their net incomes from operations that quarter were insufficient to
                cover the amounts written-down for the decreased value of their deferred tax
                assets. During the first quarter of 2018, FHFA submitted a request to Treasury
                on behalf of the Enterprises to take additional draws to eliminate their net
                worth deficits.

                While the December 2014 notifications directed that a draw by an Enterprise
                in any subsequent year would cause that Enterprise to suspend transmission
                of its set-asides for that year to the Affordable Housing Funds, the FHFA
                Director, by written notices to the Enterprises dated February 7, 2018,
                instructed each Enterprise to proceed with the transfer of 2017 set-asides to
                the Affordable Housing Funds. The FHFA Director explained that he did
                “not consider this one-time event to relate to any financial instability on the
                part of the Enterprise either now or in the future.” Our audit found that the
                Enterprises’ computations for the 2017 set-asides and subsequent transmittals
                were accurate.

                Our audit also found that FHFA took steps to ensure the accuracy and the
                transmittal of the affordable housing allocations.

                We recognize that 12 USC § 4567(b) vests the FHFA Director with authority
                to suspend the set-aside and transmission of the affordable housing allocations
                of one or both Enterprises, upon a finding that one or more of three statutory
                conditions have been met. One federal district court has held that the decision
                of the FHFA Director whether to impose a temporary suspension is committed
                solely to his or her discretion and the Director, in both his December 2014 and
                February 2018 notices, invoked that authority and determined that transmittal
                of the set-asides did not contribute, and would not contribute to the financial
                instability of the Enterprises. For those reasons, we make no formal
                recommendations in this audit. Because FHFA is both the conservator for and
                supervisor of the Enterprises, in which U.S. taxpayers have invested more
                than $191 billion, prudence counsels that FHFA, in the future, acknowledge
AUD-2018-012    and explain the reasons for changes in its critical determinations.

September 24,   We provided a draft of this report to FHFA and received oral and written
    2018        technical comments, which we considered in finalizing this report. FHFA
                declined to provide a written management response.

                This report was prepared by Tara Lewis, Audit Director; David Cho, Auditor-
                in-Charge; and with assistance from Bob Taylor, Assistant Inspector General
                for Audits. We appreciate the cooperation of FHFA staff, as well as the
                assistance of all those who contributed to the preparation of this report.

                This report has been distributed to Congress, the Office of Management and
                Budget, and others and will be posted on our website, www.fhfaoig.gov.

                Marla A. Freedman, Deputy Inspector General for Audits /s/
TABLE OF CONTENTS ................................................................
EXECUTIVE SUMMARY .............................................................................................................2

ABBREVIATIONS .........................................................................................................................8

BACKGROUND .............................................................................................................................9
      Affordable Housing Funds and the HOPE Reserve Fund ........................................................9
      Set-Asides and Transmissions to the Affordable Housing Funds and the HOPE
      Reserve Fund ..........................................................................................................................10
             Requirement to Transmit 25% of the Enterprises’ Set-Asides to the HOPE
             Reserve Fund ..................................................................................................................11
      From September 2008 Through December 2014, FHFA Suspended Enterprise
      Set-Asides and Transmissions to the Affordable Housing Funds ..........................................12

FACTS AND ANALYSIS.............................................................................................................13
      FHFA Performed an Analysis in 2013 and Determined that the Conditions
      Warranting the 2008 Temporary Suspension Remained in Effect .........................................13
      FHFA Performed an Analysis in 2014 to Determine Whether to Lift the Temporary
      Suspension of the Enterprises’ Set-Asides; the FHFA Director Lifted the Temporary
      Suspension for 2015; and the Amounts of the Transmitted Set-Asides for 2015 Were
      Calculated Properly ................................................................................................................15
             Written Analysis Whether to Lift the Suspension for 2015 Contributions.....................15
             Written Notification by the FHFA Director to Terminate the Temporary
             Suspension ......................................................................................................................19
             Directions to Transmit the 2015 Set-Asides; the Amounts of the Transmitted
             Set-Asides for 2015 Were Calculated Properly ..............................................................22
      FHFA Performed a Written Analysis in 2017 to Determine Whether to Direct the
      Enterprises to Transmit the 2016 Set-Asides to the Affordable Housing Funds and
      the HOPE Reserve Fund; the Amounts of the Transmitted 2016 Set-Asides Were
      Calculated Properly ................................................................................................................22
             Written Analysis Whether to Instruct the Enterprises to Transmit the 2016 Set-
             Asides ..............................................................................................................................22
             Directions to Transmit the 2016 Set-Aside; Amounts of the Transmitted Set-
             Asides for 2016 Were Calculated Properly ....................................................................23



                                        OIG • AUD-2018-012 • September 24, 2018                                                                  6
      FHFA’s General Counsel Did Not Prepare a Written Analysis in 2018 to Determine
      Whether the Enterprises’ Draws from Treasury Triggered the Financial Instability
      Condition in HERA and Provided Grounds for a Temporary Suspension of the 2017
      Set-Asides; the Amounts of the Transmitted Set-Asides for 2017 Were Calculated
      Properly...................................................................................................................................24
             No General Counsel Written Analysis as to Whether the Enterprises’ Draws
             from Treasury Triggered the Financial Instability Condition in HERA and
             Provided Grounds for a Temporary Suspension of the 2017 Set-Asides .......................25
             FHFA Director’s Instructions to Transmit the 2017 Set-Asides and His Basis for
             the Determination to Proceed with the Transmissions; the Amounts of the
             Transmitted Set-Asides for 2017 Were Calculated Properly ..........................................26
      FHFA’s Oversight of the Enterprises’ Compliance with FHFA’s Guidance for the
      2015, 2016, and 2017 Set-Asides and Transmissions ............................................................28
             FHFA Required the Enterprises to Certify that Charges and Fees to Originators
             of Mortgages Were Not Increased to Cover the Allocations to the Affordable
             Housing Funds; an FHFA Economist Performed Annual Reviews of Each
             Enterprise’s Financial Information to Validate the Enterprises’ Certifications..............28
             FHFA’s Measures to Ensure the Accuracy and Transmittal of the Affordable
             Housing Allocations........................................................................................................29

CONCLUSION ..............................................................................................................................29

OBJECTIVE, SCOPE, AND METHODOLOGY .........................................................................31

ADDITIONAL INFORMATION AND COPIES .........................................................................32




                                        OIG • AUD-2018-012 • September 24, 2018                                                                 7
ABBREVIATIONS .......................................................................

Affordable Housing Funds     the Housing Trust Fund within HUD and the Capital Magnet Fund
                             within Treasury

Enterprises                  Fannie Mae and Freddie Mac

FHA                          Federal Housing Administration

FHFA                         Federal Housing Finance Agency

HERA                         Housing and Economic Recovery Act of 2008

HUD                          Department of Housing and Urban Development

President’s Budget           Budget of the United States Government

PSPA                         Senior Preferred Stock Purchase Agreement

U.S.C.                       United States Code




                           OIG • AUD-2018-012 • September 24, 2018                       8
BACKGROUND ..........................................................................

Created by HERA, FHFA currently serves as the supervisor and conservator of the
Enterprises.

Affordable Housing Funds and the HOPE Reserve Fund

HERA established the Affordable Housing Funds—the Housing Trust Fund within HUD and
the Capital Magnet Fund within Treasury—to be funded through set-asides by, and
transmissions from, the Enterprises. 1 As discussed more fully below, HERA requires the
Enterprises to transmit the annual set-aside amounts to these funds, unless the FHFA Director
suspends the transmission upon a finding that one or more statutory conditions have been met.

HERA defines the purpose of each fund. The purpose of the Housing Trust Fund is to provide
grants to States “to increase and preserve the supply of rental housing for extremely low- and
very low-income families, including homeless families and to increase homeownership for
extremely low- and very low-income families.” 2 The purpose of the Capital Magnet Fund is
to fund a competitive grant program to attract private capital for, and increase investment in,
“the development, preservation, rehabilitation, or purchase of affordable housing for primarily
extremely low-, very low-, and low-income families” and “economic development activities
or community service facilities such as day care centers, workforce development centers, and
health care clinics, which in conjunction with affordable housing activities implement a
concerted strategy to stabilize or revitalize a low-income area or underserved rural area.” 3

HERA directs FHFA to enforce the Enterprises’ compliance with the requirements for the set-
asides, and transmission of these amounts to HUD (for the Housing Trust Fund) and Treasury
(for the Capital Magnet Fund). 4 While the Enterprises are the funding sources for the Housing




1
  HERA also provides that both the Housing Trust Fund and the Capital Magnet Fund may be funded with
other amounts that are or may be appropriated, transferred, or credited under other law. For example, the
Consolidated Appropriations Act, 2010 (Public Law 111-117) provided an appropriation of $80 million to the
Capital Magnet Fund.
2
    12 USC § 4568. Housing Trust Fund.
3
    12 USC § 4569. Capital Magnet Fund.
4
 For purposes of this report, we use the term “transmitted” as a substitute for the statutory term “allocated” in
HERA.




                                 OIG • AUD-2018-012 • September 24, 2018                                            9
Trust Fund and the Capital Magnet Fund, FHFA is not responsible for administering either
fund under HERA. 5

Additionally, HERA created the HOPE for Homeowners Program 6 administered by the
Federal Housing Administration (FHA), 7 and the HOPE Reserve Fund, managed by Treasury,
and funded through the Enterprises’ set-asides. The HOPE Reserve Fund provides a source of
support for obligations of the HOPE for Homeowners Program.

Set-Asides and Transmissions to the Affordable Housing Funds and the HOPE Reserve
Fund

HERA establishes the formulas to calculate the annual set-asides by the Enterprises and
transmissions to the Affordable Housing Funds. HERA directs that the annual contribution
from each Enterprise shall be an amount equal to 4.2 basis points for each dollar of the unpaid
principal balance of its total new business purchases. 8 HERA instructs that each Enterprise



5
  That FHFA has no role in administration of these two Funds was underscored by Director Watt in a January
2015 congressional hearing. In response to a Member’s question about the impact of the Funds on affordable
housing, the Director stated in part that: “[W]e don’t have any control over at FHFA over the use of these
funds. Those decisions are actually made at Treasury and HUD.” (Hearing before the Committee on Financial
Services, U.S. House of Representatives, Sustainable Housing Finance: An Update from the Director of the
Federal Housing Finance Agency, at 13 (Jan. 27, 2015) (Serial No. 114 1) (online at
www.gpo.gov/fdsys/browse/collection.action?collectionCode=CHRG&browsePath=114%2FHOUSE%2FCom
mittee+on+Financial+Services&isCollapsed=false&leafLevelBrowse=false&isDocumentResults=true&ycord=
164).
6
  According to HERA, the purpose of the HOPE for Homeowners Program is: (1) to create an FHA program,
participation in which is voluntary on the part of homeowners and existing loan holders, to insure refinanced
loans for distressed borrowers to support long-term, sustainable homeownership; (2) to allow homeowners to
avoid foreclosure by reducing the principal balance outstanding, and interest rate charged, on their mortgages;
(3) to help stabilize and provide confidence in mortgage markets by bringing transparency to the value of
assets based on mortgage assets; (4) to target mortgage assistance under this section to homeowners for their
principal residence; (5) to enhance the administrative capacity of the FHA to carry out its expanded role under
the HOPE for Homeowners Program; (6) to ensure the HOPE for Homeowners Program remains in effect only
for as long as is necessary to provide stability to the housing market; and (7) to provide servicers of delinquent
mortgages with additional methods and approaches to avoid foreclosure.
7
 Part of HUD, FHA is a mortgage insurer and operates as a self-funded entity, typically obtaining capital to
operate its programs from the mortgage insurance premiums it receives from lenders that participate in the
programs.
8
  For purposes of this statutory provision, FHFA determined and, through a supervisory communication dated
March 19, 2015, informed the Enterprises that “new business purchases” includes acquisitions of single-family
and multi-family mortgage loans that an Enterprise holds in portfolio or that support a guaranteed Enterprise
trust, but does not include Long Term Standby Commitments or other commitments to buy mortgages at a later
date or time, acquisitions of delinquent loans from guaranteed Enterprise trusts, post-mortgage loan purchase
credit enhancements, or securitizations of previously purchased mortgages.




                                 OIG • AUD-2018-012 • September 24, 2018                                             10
shall transmit 65% of its annual set-aside amount to HUD for the Housing Trust Fund and
35% of its annual set-aside amount to Treasury for the Capital Magnet Fund.

HERA also required the FHFA Director to issue a regulation prohibiting each Enterprise from
passing on, to the originators of mortgages purchased or securitized by the Enterprise, the
costs of any required allocation to the Affordable Housing Funds through increased charges or
fees, or decreased premiums, or in any other manner. On December 16, 2014, FHFA issued
an interim final rule 9 and on March 26, 2015, a final rule 10 implementing this requirement.

      Requirement to Transmit 25% of the Enterprises’ Set-Asides to the HOPE Reserve Fund

HERA established the HOPE Reserve Fund to be managed by Treasury, with allocations to
the HOPE Reserve Fund to come from a portion of the Affordable Housing Funds set-asides
and allocations by the Enterprises. According to FHFA’s General Counsel, the Enterprises’
obligations to make deposits to the HOPE Reserve Fund is governed by the Appendix to the
Budget of the United States Government (the President’s Budget) for a given fiscal year. For
the years when this HERA provision was applicable, 25% of the aggregate amount set-aside
and transmitted by the Enterprises for the Affordable Housing Funds was to be deposited into
the HOPE Reserve Fund and the remaining amount was to be transmitted to the Housing
Trust Fund (65%) and to the Capital Magnet Fund (35%). 11 Since HERA was enacted, such
assessments were included only in the President’s Budgets for fiscal years 2016 and 2017. 12

Regardless of whether the Enterprises set aside an amount for the HOPE Reserve Fund, the
total amount of the set-aside to the Affordable Housing Funds remains the same (4.2 basis
points of new business purchases).




9
    79 Fed. Reg. 74595 (Dec. 16, 2014).
10
     80 Fed. Reg. 15885 (Mar. 26, 2015).
11
   The HOPE Reserve Fund assessments are reported in the Department of the Treasury section of the
Appendix to the President’s Budget (for fiscal year 2016, Identification code 020-5582-0-2-371, page 1025; for
fiscal year 2017, Identification code 020-5581-0-2-371, page 1040). Budget documents for federal fiscal years
1996 through 2019 are online at www.gpo.gov/fdsys/browse/collectionGPO.action?collectionCode=BUDGET.
12
   The HOPE Reserve Fund was established to pay, if necessary, the subsidy costs associated with the
refinanced loans under the HOPE for Homeowners program. The HOPE for Homeowners program was
available to qualified homeowners between October 1, 2008, and September 30, 2011. Based on our review of
HUD budget documents, there was very little activity in the HOPE for Homeowners program; only about $125
million in loan guarantees were refinanced under this program, compared with the amount authorized in HERA
of up to $300 billion.



                                 OIG • AUD-2018-012 • September 24, 2018                                         11
From September 2008 Through December 2014, FHFA Suspended Enterprise
Set-Asides and Transmissions to the Affordable Housing Funds

HERA directs that the FHFA Director “shall” temporarily suspend the transmission of the
Enterprises’ annual set-asides upon a finding that one or more conditions have been met.
These conditions in 12 USC § 4567(b) are:

       (1) that the transmissions are contributing, or would contribute, to the financial
       instability of the Enterprise;

       (2) that the transmissions are causing, or would cause, the Enterprise to be classified
       as undercapitalized; or

       (3) that the transmissions are preventing, or would prevent, the Enterprise from
       successfully completing a capital restoration plan under section 4622 of this title.

HERA does not define the term “financial instability.”

Pursuant to that authority, the then-FHFA Director found that at least one of these conditions
was met and in a letter to each Enterprise dated November 13, 2008, served notice that FHFA
was suspending the Enterprises’ set-asides and transmissions until further notice. He
explained in those letters that this temporary suspension was triggered by FHFA’s findings
that the transmissions would (1) further contribute to the financial instability of each
Enterprise and (2) cause the Enterprises, which were facing negative net worth, to increase the
size of their draws from Treasury.

FHFA’s suspension of set-asides and allocations continued through 2014. In December 2014,
the current FHFA Director lifted the suspension, effective January 2015.

The total amount of the Enterprises’ allocations to the Housing Trust Fund, Capital Magnet
Fund, and HOPE Reserve Fund for set-asides made during 2015, 2016, and 2017 was $1.251
billion, consisting of $724 million allocated by Fannie Mae and $527 million allocated by
Freddie Mac. See Figure 1 following:




                           OIG • AUD-2018-012 • September 24, 2018                                12
                          FIGURE 1. ENTERPRISES’ SET-ASIDES AND ALLOCATIONS
                      TO THE AFFORDABLE HOUSING FUNDS AND HOPE RESERVE FUND
                               2015 THROUGH 2017 (DOLLARS IN MILLIONS)
                                        Affordable Housing Funds              HOPE Reserve
      Enterprise           Year      Housing Trust   Capital Magnet              Fund                Total
  Fannie Mae               2015           $106                $57                   $54                $217
                           2016            131                 70                    67                 268
                           2017            155                 84                    —*                 239
  Total – Fannie Mae                      $392               $211                  $121                $724
  Freddie Mac              2015             $81                      $43               $41             $165
                           2016              91                       49                47              187
                           2017             114                       61               —*               175
  Total – Freddie Mac                      $286                     $153               $88              $527
  Total Enterprises                        $678                     $364              $209            $1,251
 *An assessment on the Enterprises for the HOPE Reserve Fund was not included in the President’s Budget for
 fiscal year 2018. FHFA confirmed with Treasury that no deposit to the HOPE Reserve Fund (from the 2017
 set-asides) was required in 2018.
 Source: Fannie Mae’s and Freddie Mac’s public financial reports.



FACTS AND ANALYSIS ...............................................................

FHFA Performed an Analysis in 2013 and Determined that the Conditions Warranting
the 2008 Temporary Suspension Remained in Effect

We found that FHFA first considered whether to lift the temporary suspension of the
transmissions to the Affordable Housing Funds in 2013. FHFA’s General Counsel, in a
memorandum to the then-Acting FHFA Director in April 2013, analyzed whether the one or
more of the statutory conditions that led to the 2008 temporary suspension continued in force.

As of the end of the first quarter 2013, both Enterprises reported a positive net worth. Fannie
Mae projected a positive net worth of $62.4 billion at March 31, 2013, and anticipated that
its aggregate dividend payments to Treasury by June 30, 2013, would be $95.0 billion, and
Treasury’s investment in it remained at $117.1 billion at March 31, 2013 (as dividend
payments do not offset prior Treasury draws). Freddie Mac projected a positive net worth
of $10.0 billion at March 31, 2013, and anticipated that its aggregate dividend payment to
Treasury by June 30, 2013, would be $29.6 billion and Treasury’s investment in it remained
at $72.3 billion at March 31, 2013.




                              OIG • AUD-2018-012 • September 24, 2018                                         13
In his written analysis, the General Counsel reasoned:

       Statutory Requirement. The plausible rationale for the mandate to make
       contributions to the [Affordable Housing Funds] is that Enterprise status as GSEs
       [government sponsored enterprises]… enabled them to generate profits for private
       investors and that it was fair to require the Enterprises to make contributions to
       affordable housing, contributions that would come out of those private investor
       profits.

       Conservatorship and Market Stability. Both Enterprises continue to be deeply
       insolvent but for the Treasury’s capital infusions… Requiring the Enterprises to
       make contributions to the [Affordable Housing Funds], amounting to millions of
       dollars a year, would aggravate that insolvency. While the Enterprises are not
       currently unstable—in the sense that America’s housing finance markets are
       functioning, market participants continue to rely on the Enterprises to meet their
       obligations, and the economy is slowly recovering—all of this is only because of
       the continuing Treasury support of the Enterprise. The statute must be interpreted
       in light of the conditions in which it was enacted, when the Enterprises were free-
       standing companies not supported by taxpayer contributions. The Enterprises are
       not stable in the absence of that government support; withdrawing or weakening
       such support [would] immediately give rise to massive market instability.

       Treasury Support. Any contributions in conservatorship would be paid by the
       Treasury, and hence by the taxpayers, either because they would be included
       in draws… or because they would reduce dividend payments to the Treasury,
       postponing Treasury’s recovery of the capital that has already been provided. That
       was not what these provisions intended. Indeed, it could be questioned whether
       these [Affordable Housing Funds] provisions have any applicability at all when
       the Enterprises are in conservatorship, similar to the agency having suspended the
       Enterprises’ capital classifications.

The General Counsel cautioned:

       Director Determination. Enterprise reporting of profitable quarters does not alter
       this analysis. The Enterprises can report these profits only because of the huge
       infusion of capital they received from the Treasury and which has not been repaid.
       Further profitability may be questioned, and it must be remembered that the goal
       of the dividend sweep is to preserve the availability of Treasury support should
       further draws be needed—a key element in market place willingness to deal with
       the Enterprises. Therefore, any diversion of funds from the Enterprises threatens
       the availability of a key conservatorship support function… The Director of


                           OIG • AUD-2018-012 • September 24, 2018                           14
       FHFA should take the above considerations in mind in authorizing any
       expenditures or diversion of funds from conservatorship purposes and while
       considering the preservation of assets and the desired market presence of the
       Enterprises.

The General Counsel concluded:

       Continuing suspension of the [Affordable Housing Funds] contributions is
       justified while the Enterprises remain in conservatorship, especially since the
       Treasury Department has not recovered the amounts that it contributed… to cover
       Enterprise losses, currently over $180 billion.

FHFA Performed an Analysis in 2014 to Determine Whether to Lift the Temporary
Suspension of the Enterprises’ Set-Asides; the FHFA Director Lifted the Temporary
Suspension for 2015; and the Amounts of the Transmitted Set-Asides for 2015 Were
Calculated Properly

   Written Analysis Whether to Lift the Suspension for 2015 Contributions

According to the General Counsel, the current FHFA Director asked him at some point in
2014 to analyze whether termination of the suspension of the Enterprises’ set-asides and
transmissions to the Affordable Housing Funds was warranted in light of the fact that the
Enterprises were “making money.” The General Counsel also recalled that the Director asked
him to set forth the basis of the Director’s authority to lift this suspension. In a memorandum
dated October 30, 2014, the General Counsel answered both questions.

As of the end of the third quarter 2014, both Enterprises reported a positive net worth. Fannie
Mae projected a positive net worth of $6.4 billion at September 30, 2014, and anticipated that
its aggregate dividend payments to Treasury by December 2014 would be $134.5 billion in
comparison to the $117.1 billion in Treasury’s investment in it. Freddie Mac projected a
positive net worth of $5.2 billion at September 30, 2014, and anticipated that its aggregate
dividend payment to Treasury by December 2014 would be $88.2 billion and Treasury’s
investment in it remained at $72.3 billion.

In an October 2014 memorandum, the General Counsel first explained that HERA required
the Enterprises to set-aside and transmit monies to the Affordable Housing Funds, unless
the FHFA Director imposed a suspension of those contributions upon a finding that one or
more of three statutory conditions had been met. Next, he addressed whether the statutory
conditions that gave rise to the 2008 suspension had changed. His memorandum explained:




                           OIG • AUD-2018-012 • September 24, 2018                                15
•   Financial Instability. The statute provides for temporary suspension of funding where
    the Director finds that the allocations ‘are contributing, or would contribute, to the
    financial instability of the enterprise...’

    The Director has primary access to information concerning the financial state of the
    Enterprises. Not only their current income, but as well their market performance, asset
    mix, expenses and other information inform his decisions. The Director can look to
    market certainty surrounding the presence of the Enterprises, satisfaction of debt
    holders with Enterprise debt, stability of Enterprise contracting and dealing with
    counterparties, core market improvements and other market factors as well as internal
    management of assets and liabilities to determine that an Enterprise’s current and
    foreseeable future conditions warrant set asides. The Director may decide that
    allocations to the Funds would represent a small percentage of anticipated income and
    would not contribute to financial instability, either in fact or in any adverse market
    reactions.

    The conservatorships themselves provide evidence of market stability by providing
    public assurance of strong government oversight and management of core Enterprise
    activities.

•   Capital. The statute provides for suspension of contributions where allocations ‘are
    causing, or would cause, the enterprise to be classified as undercapitalized...’

    The capital determination that a Director would make is not applicable in
    conservatorship. Capital classifications were suspended and, in effect, replaced with
    [Treasury’s investments] to maintain net worth to each Enterprise. The allocations
    to a Trust or Magnet Fund, therefore, would not affect the capital ‘position’ of an
    Enterprise as there is no such position set forth during the conservatorships. Thus,
    there is no ability for an allocation to move an Enterprise to an undercapitalized
    position. Until some action by Congress altering Enterprise status or some action such
    as moving to receivership with a capital classification imposed, it is not possible to
    make a finding regarding a movement in an Enterprises capital standard. Setting aside
    funds and making allocations would be an expense of the Enterprises, not an alteration
    of capital levels.

•   Capital Plans. The statute provides for suspension of contributions where allocations
    ‘are preventing, or would prevent, the enterprise from successfully completing a
    capital restoration plan under section 4622 of this title.’

    As there are no capital standards in the FHFA conservatorships, there is no ability to
    submit a capital restoration plan. Further, the [Enterprises are not permitted to build]
    capital… Until Congress acts or receiverships are determined to be necessary with

                        OIG • AUD-2018-012 • September 24, 2018                                16
       enunciated capital standards, the absence of capital levels and, therefore, that ability to
       have capital restoration plans prevents a finding that the Enterprises are not meeting
       capital restoration goals. Again, the set asides and allocations would be expenses of
       the Enterprises, not detracting from any restoration plans.

The General Counsel then explained that HERA vested the FHFA Director with discretion to
impose a suspension of the set-asides and transmission of the payments and to lift any prior
suspension. He wrote:

       In current circumstances, it is within the Director’s authority to determine to rescind
       the finding that the statutory set asides and allocations would contribute to continued
       financial instability of an Enterprise and, thereby, to terminate the suspension. In
       exercising his authority, the Director of FHFA may take into account the
       considerations of Enterprise stability, capital position, size of the sets [sic] asides and
       the role of the Treasury Department support. The Director maintains discretion to
       revisit the issue and to make a new finding that subsequent contributions could
       contribute to financial instability and to suspend contributions if circumstances evolve
       in the future.

He elaborated on the change in circumstances that could lead the FHFA Director to terminate
the temporary suspension:

       The Director could reasonably exercise his discretion to find that set asides and
       allocations would not contribute to the financial instability of the Enterprises...
       based on circumstances that have changed since the time the suspension was
       initially put in place, such as changes in the Enterprises’ income statements and
       balance sheets, changes in markets for housing and housing finance, changes in
       the legal environment, and changes in the arrangement for Treasury support of the
       Enterprises. Further the Director could consider that neither Fannie Mae nor
       Freddie Mac has made a draw from the Treasury Department... since the [sic]
       2012 during which time the Enterprises have paid multiple billions in ‘dividends’
       to the Treasury Department and the Third Amendment to the [PSPA] helps
       preserve the stability of the funds available to the Enterprises and, thereby, their
       financial stability and market confidence. FHFA continues to monitor the
       financial condition of the Enterprises.

       Finally, a formal and explicit reservation by FHFA of its authority to revise or
       reverse a decision on setting aside and allocating money to the Funds at any
       time... reinforces the prudential nature of a Director’s decision to take such
       actions in line with the statute.




                            OIG • AUD-2018-012 • September 24, 2018                                  17
In conclusion, the General Counsel wrote:

       The Director has the ability to make a determination under 12 USC 4567 to revisit
       the findings underlying a suspension of contributions where circumstances have
       changed. Here a decision to lift the suspension of Fund set asides and allocations
       is within the Director’s discretion. The lifting of the suspension and institution of
       the program, with an embedded plan to suspend set asides, as outlined to the
       Office of General Counsel, meets legal sufficiency for a Director’s determination.

As previously explained, one purpose of this audit is to understand the April 2013 and
October 2014 analyses, not to assess their adequacy. We note that both memoranda review the
same statutory conditions set forth in 12 USC 4567, but analyze those conditions differently,
and the October 2014 memorandum makes no reference to the prior April 2013 analysis or
attempts to reconcile differences between the two. Two examples are illustrative:

   •   Whether continued suspension of the Enterprises’ set-asides and transmissions is
       warranted during conservatorship:

       o April 2013: “Continuing suspension of the [Affordable Housing Funds]
         contributions is justified while the Enterprises remain in conservatorship,
         especially since the Treasury Department has not recovered the amounts that it
         contributed under the PSPAs to cover Enterprise losses, currently over $180
         billion.... Indeed, it could be questioned whether these [Affordable Housing Funds]
         provisions have any applicability at all when the Enterprises are in
         conservatorship, similar to the agency having suspended the Enterprises’ capital
         classifications.”

       o October 2014: “Further the Director could consider that neither Fannie Mae nor
         Freddie Mac has made a draw from the Treasury Department under the [PSPA]
         since the [sic] 2012 during which time the Enterprises have paid multiple billions
         in ‘dividends’ to the Treasury Department and the Third Amendment to the
         [PSPA] helps preserve the stability of the funds available to the Enterprise and,
         thereby, their financial stability and market confidence.”

   •   Whether lifting the suspension during the conservatorship would effectively cause the
       Treasury to pay the contributions:

       o April 2013: “Any contributions in conservatorship would be paid by the Treasury,
         and hence by the taxpayers, either because they would be included in draws under
         the PSPAs or because they would reduce dividend payments to the Treasury,
         postponing Treasury’s recovery of the capital that has already been provided. That
         was not what these provisions intended.”


                           OIG • AUD-2018-012 • September 24, 2018                              18
       o October 2014: While acknowledging “[c]ontributions to the Funds would... reduce
         any payments to the Treasury Department,” the “dollar amount of the set aside and
         allocation… is anticipated to be small compared to recent income and to dividend
         payments to the Treasury Department” and “would be viewed as an expense of the
         Enterprises—embedded in statute and suspended during a time of unusual stress in
         the determination of the prior Director and now initiated in line with changed
         circumstances.”

The General Counsel reported to us that, in addition to this memorandum, he provided the
FHFA Director with supplemental information in response to his question about earnings,
potential set-aside amounts, and FHFA guidance on implementation issues. The supplemental
information included Enterprise public statements on profitability and continued profitability;
estimates of the potential set-aside and allocation amounts based on the Enterprises’ new
business purchases data for 2013 and 2014 (year-to-date at the time of the analysis);
information from the annual and quarterly reports showing that the Enterprises’ total dividend
payments to Treasury have exceeded the total draws from Treasury; and anticipated FHFA
guidance on several related matters, including the scope of total new business purchases,
methods for calculating and reporting set-asides, and procedures for transferring the funds.

   Written Notification by the FHFA Director to Terminate the Temporary Suspension

Subsequently, the FHFA Director notified each Enterprise, on December 11, 2014, that he
was exercising his discretion to terminate the temporary suspension of set-asides for and
transmission to the Affordable Housing Funds and directed the Enterprises to begin
transmitting their set-asides to the Affordable Housing Funds, beginning with fiscal year
2015. The notice explained that “circumstances have changed and the temporary suspension is
no longer justified” because the “financial operations” of each Enterprise have “stabilized to a
sufficient level,” which is evidenced by the fact that neither Enterprise had required a draw
since 2012 and that both Enterprises had paid a total of $163.4 billion in dividends to
Treasury. The notice further explained that the other two conditions set forth in HERA were
not applicable because FHFA had suspended capital classifications for the Enterprises and
neither was attempting to complete a capital restoration plan. Finally, the notice
acknowledged that while the profit levels since 2012 were not expected to be sustainable,
reasonable projections indicated that both Enterprises would remain profitable for the
foreseeable future.

The notice directed each Enterprise to set aside and transmit funds to the Affordable Housing
Funds, pursuant to 12 USC 4567(a), for 2015 and in subsequent years, in accordance with
specific terms and conditions, which could be supplemented or modified by FHFA:




                           OIG • AUD-2018-012 • September 24, 2018                                 19
   •   During each fiscal year, commencing with 2015 and thereafter, each Enterprise will
       set aside an amount equal to 4.2 basis points of each dollar of unpaid principal balance
       of its total new business purchases during such year;

   •   Within 60 days after the end of 2015 and each year thereafter, each Enterprise will
       transmit its set-aside in accordance with 12 USC 4567(a)(2)(B), unless the Enterprise
       has made a draw from Treasury during that year or the transmission of the set-aside
       would cause the Enterprise to have to make a draw from the Treasury; and

   •   In the event that an Enterprise makes a draw during 2015 or any subsequent year or if
       transfer of the set-aside would cause the Enterprise to make a draw in any year, that
       Enterprise will make no transfer of set-asides for that year to the Affordable Housing
       Funds, as supplemented or modified by specific guidance or directive from FHFA.

That notice advised that FHFA would monitor the financial condition of the Enterprises and,
pursuant to HERA, retained the authority to revise or reverse its decision to terminate the
temporary suspension.

During a January 2015 hearing by the House Financial Services Committee, the FHFA
Director was questioned about the basis for his December 2014 decision to lift the temporary
suspension of the Enterprises’ set-asides. He explained that he:

       [S]imply followed the statute. The statute tells us the exact circumstances for the
       criteria to be applied on the suspension of the contributions to the Housing Trust
       Fund. And it tells us the criteria to be applied under normal circumstances for
       funding. And that is whether the contributions to these funds would contribute or
       are contributing to the financial instability of the Enterprises, whether they are
       causing or would cause the enterprises to be classified as undercapitalized, or
       whether they are preventing or would prevent the Enterprises from successfully
       completing a capital restoration plan.

When pressed by a Committee Member to explain why he suspended guarantee fees and
moved away from risk-based pricing but lifted the suspension on contributions to the Housing
Trust Fund, Director Watt explained:

       [A]ll I am doing is following the statutes that were written by Congress and
       passed by Congress. And we are trying to do it as judiciously and prudently as we
       can. I am not even trying to connect those two things. The Housing Trust Fund
       funding was an independent decision that was based on the statute. The g-fee
       decision was a prudence decision just to give us an opportunity to study the issue
       thoroughly. And we are doing that. And we don’t know where we are going to get



                           OIG • AUD-2018-012 • September 24, 2018                                20
        to on that. So I think judging where that might go at this point would be
        premature.

        If the statutory standards are met, the contributions to the trust fund can be
        suspended. They were suspended in 2008 by the acting Director at that time.
        And we applied the same principles under changed circumstances to reinstate
        them. That is all we did. But the Housing Trust Fund was not created by FHFA.
        The Housing Trust Fund was created by Congress. And the decision to fund it or
        not fund it is based on statutory criteria.

Director Watt testified that, pursuant to HERA, the FHFA Director shall temporarily suspend
the Enterprises’ set-asides and transmissions to the Affordable Housing Funds upon a finding
that they “are contributing or would contribute to the financial instability of the Enterprises.”
According to Director Watt, “the primary factor you are looking at is whether [the
Enterprises] are making money or not.” In response to a question from a Committee member
to explain the basis for the decision to suspend payments if the Enterprises have to make a
draw from the Treasury, when HERA is silent on the issue, Director Watt responded that he
was “following the conservatorship statute there.” Another Committee Member asked how
FHFA could reach the conclusion that the Enterprises were financially stable when they
were in conservatorship and undercapitalized. Director Watt responded: “We put in place
prudential stops if circumstances go back in the other direction. If we ever have a draw on
the Treasury, that would automatically stop the funding of the Housing Trust Fund.” He
explained that the other two statutory conditions were not applicable to the Enterprises
because they were in conservatorship. 13

In a letter to the Enterprises dated March 19, 2015, regarding implementation of the FHFA
Director’s December 10, 2014, direction, FHFA’s General Counsel underscored the same
terms and conditions. His guidance instructed:

        [I]f an Enterprise makes a draw from the Treasury Department under the terms of
        the Senior Preferred Stock Purchase Agreement, as amended, based on a net
        worth deficit for any quarter of the fiscal year or if a quarterly ‘set aside’ amount
        would cause the Enterprise to make a draw for any quarter of such fiscal year, the
        Enterprise will make no allocation or transfer for that year, and any liabilities



13
   See Hearing before the Committee on Financial Services, U.S. House of Representatives, Sustainable
Housing Finance: An Update from the Director of the Federal Housing Finance Agency, at 9, 14, 25, 26, 34
(Jan. 27, 2015) (Serial No. 114-1) (online at
www.gpo.gov/fdsys/browse/collection.action?collectionCode=CHRG&browsePath=114%2FHOUSE%2FCom
mittee+on+Financial+Services&isCollapsed=false&leafLevelBrowse=false&isDocumentResults=true&ycord=
164).



                              OIG • AUD-2018-012 • September 24, 2018                                      21
       accrued for such allocation or transfer will be appropriately reversed in the
       Enterprise’s financial statements.

   Directions to Transmit the 2015 Set-Asides; the Amounts of the Transmitted Set-
   Asides for 2015 Were Calculated Properly

On February 17, 2016, the FHFA Director instructed the Enterprises to transmit funds set
aside during 2015 for the affordable housing programs, in accordance with remittance
instructions provided by Treasury. The amounts set aside by the Enterprises during 2015 and
subsequently transmitted totaled $382 million ($217 million in total transmitted by Fannie
Mae and $165 million in total transmitted by Freddie Mac).

Applying HERA’s instructions for the amount of the annual set-asides, and FHFA’s definition
of new business purchases, we determined that the Enterprises’ computations for the 2015
set-asides for the affordable housing allocations and the HOPE Reserve Fund and their
subsequent transmittals in 2016 were accurate.

FHFA Performed a Written Analysis in 2017 to Determine Whether to Direct the
Enterprises to Transmit the 2016 Set-Asides to the Affordable Housing Funds and the
HOPE Reserve Fund; the Amounts of the Transmitted 2016 Set-Asides Were Calculated
Properly

   Written Analysis Whether to Instruct the Enterprises to Transmit the 2016 Set-Asides

The Enterprises continued to make set-asides for the Affordable Housing Funds during 2016.
A memorandum to the FHFA Director dated February 16, 2017, “Affordable Housing Funds,”
from FHFA’s General Counsel, reviewed whether any change had occurred in the first
condition that might warrant imposition of a temporary suspension. The General Counsel
reported:

   •   “During 2016 neither Enterprise made a draw on the Treasury Department under
       the PSPAs and FHFA has confirmed by review of each Enterprise’s 2016 year-end
       financials that transfer of funds set aside and allocated in 2016 would not cause either
       Enterprise to make a draw in this quarter.”

   •   “Each Enterprise’s 2016 financial reports contains information on the total amount
       of new business purchases for the quarter and then for the year as the basis for
       calculating the set aside amounts.... In the case of Fannie Mae, that amount totals
       $268 million; in the case of Freddie Mac, it is $187 million.”

   •   “[E]ach Enterprise, for fiscal year 2016, has now provided FHFA with a certification
       by an officer of the Enterprise with knowledge of the statutory requirements and the


                           OIG • AUD-2018-012 • September 24, 2018                                22
       Enterprise’s business practices that, based on information known to that officer, the
       Enterprise has not raised its guarantee fees or imposed other charges or fees on
       originators for the purpose of covering the costs of any allocation required...
       Additionally, each Enterprise provided FHFA information about its process in support
       of its certification.”

   •   “FHFA has reviewed the financial statements and disclosures of the Enterprises.
       FHFA has reviewed other available data, including information about ongoing
       guarantee fees as well as “up-front fees”... through, among other sources, monthly
       guarantee-fee data submissions and quarterly reporting submissions by the
       Enterprises... Thus, in light of the process undertaken by the Enterprise and FHFA
       review of materials as part of its oversight process, that certification has been found
       sufficient.”

The General Counsel concluded:

       In sum, each Enterprise has met applicable statutory, regulatory and supervisory
       conditions for transferring funds set aside and allocated to the affordable housing
       programs and may be directed to make those transfers, in accordance with
       remittance instructions provided to it by the Department of the Treasury.

   Directions to Transmit the 2016 Set-Aside; Amounts of the Transmitted Set-Asides for
   2016 Were Calculated Properly

On February 17, 2017, the FHFA Director instructed the Enterprises to transmit funds set
aside during 2016 for the affordable housing allocations, in accordance with remittance
instructions provided by Treasury. The amounts set aside by the Enterprises during 2016 and
subsequently transmitted totaled $455 million ($268 million in total allocated by Fannie Mae
and $187 million in total allocated by Freddie Mac).

Applying HERA’s instructions for the amount of the annual set-asides and FHFA’s definition
of total new business purchases, we determined that the Enterprises’ computations for the
2016 set-asides for the affordable housing allocations and their subsequent transmittals in
2017 were accurate.




                           OIG • AUD-2018-012 • September 24, 2018                               23
FHFA’s General Counsel Did Not Prepare a Written Analysis in 2018 to Determine
Whether the Enterprises’ Draws from Treasury Triggered the Financial Instability
Condition in HERA and Provided Grounds for a Temporary Suspension of the 2017 Set-
Asides; the Amounts of the Transmitted Set-Asides for 2017 Were Calculated Properly

The Enterprises continued to make set-asides for the affordable housing allocations during
2017.

In an October 2017 hearing before the House Financial Services Committee on Sustainable
Housing Finance, the FHFA Director was asked whether he continued to hold the position
that, in the event that an Enterprise was required to take a draw from the Treasury, that
Enterprise would not transmit its set-side for that year to the Affordable Housing Funds. The
Director provided a more qualified response that “one would presume” in the event that an
Enterprise was required to take a draw from Treasury, that “we would – we may not be
meeting the statutory standards” to contribute or suspend annual payments, if FHFA
determined that payments of set-asides was going to increase that Enterprise’s financial
instability. 14

Because of the changes in the corporate tax law in December 2017, it became necessary for
the Enterprises to re-measure the value of their deferred tax assets on their balance sheets.
Specifically, on December 22, 2017, the Tax Cuts and Jobs Act 15 was enacted into law and
mostly took effect on January 1, 2018. One of its provisions cut the federal corporate income
tax rate from 35% to 21%. The Act’s overall lowering of the corporate tax rate impacted those
companies that recorded deferred tax assets on their balance sheets that could be used to
reduce future tax liabilities or defer them. When the federal corporate tax rate was lowered by
this Act, the deferred tax assets of such companies decreased in value. Generally accepted
accounting principles require companies to re-measure their deferred tax assets at the reduced
rate in the period in which the legislation is enacted. As a result, companies with large
deferred tax assets were required to write down the value of those assets for the fourth quarter
of 2017 to account for the drop in corporate tax rates. 16



14
   Hearing before the Committee on Financial Services, U.S. House of Representatives, Sustainable Housing
Finance: An Update for the Director of the Federal Housing Finance Agency (Oct. 3, 2017). The official
transcript for this hearing was not available on the Government Publishing Office website as of September 17,
2018. The hearing webcast with the Director’s response is available on the Committee’s website at
https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=402338, at 1:51 (1 hour, 51 minutes).
15
     Public Law 115-97.
16
   Market Watch, “Tax bill lowered corporate tax rate, so why are some companies announcing charges?”,
(Jan. 31, 2018) (online at www.marketwatch.com/story/tax-bill-lowered-corporate-tax-rate-so-why-are-some-
companies-announcing-charges-2018-01-18).



                                OIG • AUD-2018-012 • September 24, 2018                                         24
At the time the law was enacted, each Enterprise held billions of dollars of deferred tax assets
on its balance sheet. When these assets were re-measured, the Enterprises were put into a net
worth deficit position as of December 31, 2017, as their net incomes from operations that
quarter were insufficient to cover the amounts written-down for the decreased value of their
deferred tax assets. As FHFA explained in its 2017 Report to Congress:

       [E]ach Enterprise had to re-measure its [deferred tax assets] due to the [Tax Cuts
       and Jobs Act’s] reduction in the statutory corporate tax rate and record a one-time
       federal income tax provision expense in the fourth quarter of 2017. As a result of
       the income tax provision expense, each Enterprise had a net worth deficit as of
       December 31, 2017. Consequently, in the first quarter of 2018, FHFA submitted a
       request to the Treasury Department on behalf of Fannie Mae for $3.7 billion and
       on behalf of Freddie Mac for $0.3 billion to eliminate their net worth deficits.

   No General Counsel Written Analysis as to Whether the Enterprises’ Draws from
   Treasury Triggered the Financial Instability Condition in HERA and Provided Grounds
   for a Temporary Suspension of the 2017 Set-Asides

Unlike the practice for the transmission of the 2015 and 2016 set-asides, the General Counsel
did not prepare a written analysis with respect to the 2017 set-asides. In an interview, the
General Counsel explained to us that he was advised by the FHFA Director that the Director
exercised his discretion and determined that the Enterprises should transmit their 2017
set-asides to the Affordable Housing Funds. After the Director made that decision, he notified
the Enterprises of his decision, on February 4, 2018, and directed them to transmit their 2017
set-asides.

According to the General Counsel, the Director made his determination before the Office
of General Counsel began its analysis, and his determination mooted the need for any such
analysis. The General Counsel reported to us that he undertook a very high-level review of
the new tax law, which he did not reduce to writing, and understood from that review that the
Enterprises’ February 2018 draw from the Treasury was a unique occurrence, caused by the
need to re-measure their deferred tax assets as a result of the Tax Cuts and Jobs Act of 2017,
which he thought would be off-set by the tax savings in 2018. In response to our request for
specifics of his high-level review, the General Counsel provided this explanation in writing:

       My review centered on the issue that the tax law would have an impact on firms
       with deferred tax assets (DTA) and that, as to those assets, it would be a one-time
       event. News stories immediately after the passage of the law and a few before
       indicated that companies would see a benefit from the overall lowering of the
       corporate tax rate, but certain companies with deferred tax assets would face a
       one-time hit to their balance sheets.... This was not unique to the Enterprises,


                            OIG • AUD-2018-012 • September 24, 2018                                25
         according to the news stories, and would be a one-time event. This was important
         to my understanding of what would occur at the Enterprises; the outcome was
         predicted, thus these news stories gave some comfort on the outcomes.

The General Counsel also provided us with illustrative articles he reviewed. He further
advised us that he discussed the results of his high-level review with the Director.

     FHFA Director’s Instructions to Transmit the 2017 Set-Asides and His Basis for the
     Determination to Proceed with the Transmissions; the Amounts of the Transmitted
     Set-Asides for 2017 Were Calculated Properly

The FHFA Director notified the Enterprises on February 7, 2018, to proceed with the transfer
of 2017 set-asides to the Affordable Housing Funds. In his written notification to Fannie Mae,
the Director explained:

         This letter supplements my letter to you of December 11, 2014 about the [set-
         asides and transmission] of funds to the Housing Trust Fund and Capital Magnet
         Fund.

         As I stated in my December 11, 2014 letter, my decision to exercise discretion
         regarding the reinstatement of contributions to the affordable housing funds
         related solely to whether ‘contributions to these Funds would cause financial
         instability and is not a finding for any other purpose.’ While the enactment of
         the Tax Cuts and Jobs Act of 2017, PL 115-97 (2017), requires Fannie Mae to
         re-measure its net deferred tax asset using the new law’s lower corporate tax rate
         which will trigger a one-time charge through the provision for federal income
         taxes and will require a draw… I do not consider this one-time event to relate to
         any financial instability on the part of the Enterprise either now or in the future.
         Indeed, between my December 11, 2014 letter and the enactment of the new tax
         law Fannie Mae has consistently generated profits that enable the Enterprise to
         declare dividends totaling $31.9 billion under the terms of the PSPA, and the
         reduction in the corporate tax rate under the new tax law is expected to increase
         the Enterprise’s net income in the future after the one-time charge is taken. 17

In response to our inquiry as to analyses conducted by the Director or other FHFA personnel
on whether transmission of the 2017 set-asides to the Affordable Housing Funds should be
made, we were advised that the FHFA Director made such an analysis. He explained in
writing that he reached his determination based on the following considerations:


17
  The last sentence in the FHFA Director’s letter to Freddie Mac used a different dividend total of
$21.4 billion.



                                 OIG • AUD-2018-012 • September 24, 2018                              26
     •   Regular consultations and meetings with the Enterprise CEOs at which the financial
         strength, and current and projected financial performance were discussed;

     •   Routine meetings with FHFA staff; and

     •   Quarterly meetings with FHFA financial staff at which the [Securities and Exchange
         Commission] SEC filings and quarterly financial reports were discussed in substantial
         detail in preparation for FHFA approval and Enterprise filing and public disclosure of
         these reports.

According to the FHFA Director, these meetings, consultations, and staff presentations
confirmed that the DTA was a one-time accounting event that did not adversely affect the
financial condition of the Enterprises on an ongoing basis and that the reduction in the
corporate tax rate was expected to increase the Enterprises’ net income and financial strength
going forward, and would not adversely impact the financial stability they had demonstrated
since 2014.

As previously explained, one purpose of this audit is to understand whether the explanation
provided by FHFA to lift the temporary suspension in December 2014 continued in force
through February 2018, when FHFA directed the Enterprises to transmit their 2017 set-asides.
We recognize that 12 USC § 4567(b) vests the FHFA Director with authority to suspend the
set-aside and transmission of the affordable housing allocations of one or both Enterprises,
upon a finding that one or more of three statutory conditions have been met. One federal
district court has held that the decision of the FHFA Director whether to impose a temporary
suspension is committed solely to his or her discretion. 18 The FHFA Director, in both his
December 2014 and February 2018 notices, invoked that authority and determined that
transmittal of the set-asides would not contribute “to the financial instability of the
Enterprises.”

That said, the FHFA Director’s February 2018 letter to each Enterprise, and his response
to our inquiry makes no effort to explain the reasons for his change in position from his
December 11, 2014, notifications and January 2015 testimony. Previously, the FHFA
Director stated that any draw by an Enterprise would cause the suspension of funding by that
Enterprise to the Affordable Housing Funds for that year. In his February 2018 notification,
the FHFA Director determined that a draw by each Enterprise in 2018, caused by the
re-measurement of the deferred tax assets in 2017, would not suspend the Enterprises’
contributions to the Affordable Housing Funds for 2017.


18
   Order Granting Defendant’s Motion to Dismiss the First Amended Complaint, Samuels v. FHFA et al., No.
1:13-cv-22399-MGC (S.D. Fla.) at 12 (online at www.nlihc.org/sites/default/files/Samuels_v_FHFA_9-29-
14.pdf).



                               OIG • AUD-2018-012 • September 24, 2018                                     27
The amounts set aside by the Enterprises during 2017 and subsequently transmitted totaled
$414 million ($239 million in total allocated by Fannie Mae and $175 million in total
allocated by Freddie Mac).

Applying HERA’s instructions for the amount of the annual set-asides and FHFA’s definition
of total new business purchases, we determined that the Enterprises’ computations for the
2017 set-asides for the Affordable Housing Funds and the subsequent transmittals in 2018
were accurate.

FHFA’s Oversight of the Enterprises’ Compliance with FHFA’s Guidance for the 2015,
2016, and 2017 Set-Asides and Transmissions

Subsequent to FHFA’s decision to lift the temporary suspension of the set asides for the
affordable housing allocations and written notice to the Enterprises in December 2014, FHFA
provided written supplemental guidance on the calculations of the amount of the set-asides
and required the Enterprises to take certain actions to ensure the accuracy of their calculations
and verify that transmittal of the set-asides had occurred.

   FHFA Required the Enterprises to Certify that Charges and Fees to Originators of
   Mortgages Were Not Increased to Cover the Allocations to the Affordable Housing
   Funds; an FHFA Economist Performed Annual Reviews of Each Enterprise’s Financial
   Information to Validate the Enterprises’ Certifications

FHFA’s General Counsel, in a letter to the Enterprises dated March 19, 2015, underscored the
prohibition against redirecting the costs of any affordable housing allocations funds through
increased charges or fees to the originators of mortgages purchased or securitized by an
Enterprise. To ensure that this prohibition was followed, FHFA required each Enterprise to
certify in writing, for each calendar year, that the Enterprise had not raised its guarantee fees
or imposed other charges or fees on originators for the purpose of covering the costs of any
transmitted affordable housing allocations. Additionally, FHFA instructed each Enterprise to
provide information about its process in support of its certification that fees were not raised or
passed along to originators to cover the costs of the allocation to the funds. As directed, the
Enterprises provided FHFA with the certifications and information for the 2015, 2016, and
2017 set-asides and allocations.

As an additional measure to ensure the Enterprises’ compliance with the prohibition, a
supervisory economist in FHFA’s Division of Housing Mission and Goals reviewed various
Enterprise reports containing information about fees and charges for each of the three years
(2015, 2016, and 2017) and prepared a memorandum for each year documenting the results of
his review. In each memorandum, he stated “I have reviewed the various data sources that I



                            OIG • AUD-2018-012 • September 24, 2018                                  28
have available to me and, taken as a whole, the data are inconsistent with the premise that the
Enterprises are engaging in the prohibited pass-through of costs.”

   FHFA’s Measures to Ensure the Accuracy and Transmittal of the Affordable Housing
   Allocations

For the 2015 through 2017 set-asides, FHFA provided guidance to the Enterprises for
transmitting the affordable housing allocations, in accordance with wiring instructions
separately provided by Treasury. This guidance was sent once FHFA was satisfied with the
Enterprises’ calculations of the set-asides, disclosures, and certifications (that the cost of the
allocations was not passed on to originators). Once the allocations were transmitted, the
Enterprises confirmed to FHFA’s Office of General Counsel that the payments for the
affordable housing allocations were made.


CONCLUSION ............................................................................

In November 2008, the then-FHFA Director suspended the Enterprises’ affordable housing
set-asides and transmissions until further notice. In April 2013, the General Counsel advised
the Acting FHFA Director that the conditions that led to the temporary suspension of set-
asides had not changed. In October 2014, the General Counsel reviewed the same statutory
conditions but analyzed them differently, and advised the FHFA Director in writing that he
could exercise his discretion and lift the suspension. His October 2014 memorandum made no
reference to his prior April 2013 analysis or attempted to reconcile differences between the
two. In December 2014, the FHFA Director notified the Enterprises that he was exercising his
discretion to terminate the temporary suspension of set-asides for and transmission to the
Affordable Housing Funds and directed the Enterprises to begin transmitting their set-asides,
beginning with fiscal year 2015. Those written notifications also instructed that, in the event
an Enterprise were to make a draw in 2015 or subsequently, that Enterprise would make no
transfer of set-asides for that year to the Affordable Housing Funds.

The Enterprises calculated their set-asides for 2015, which they transmitted to the Affordable
Housing Funds. Our audit found that the Enterprises’ computations for the 2015 set-asides
and subsequent transmittals were accurate. Operating under this December 2014 notice, the
Enterprises calculated their set-asides for 2016, which they transmitted to the Affordable
Housing Funds. Our audit found that the Enterprises’ computations for the 2016 set-asides
and subsequent transmittals were accurate.

Because of changes to the federal corporate tax law in December 2017, it became necessary
for the Enterprises to re-measure the value of their deferred tax assets on their balance sheets.
When these assets were re-measured, the Enterprises were put into a net worth deficit position

                             OIG • AUD-2018-012 • September 24, 2018                                 29
as of December 31, 2017, as their net incomes from operations that quarter were insufficient
to cover the amounts written-down for the decreased value of their deferred tax assets. During
the first quarter of 2018, FHFA submitted a request to Treasury on behalf of the Enterprises to
take additional draws to eliminate their net worth deficits.

While the December 2014 notifications directed each Enterprise that a draw in any subsequent
year would cause that Enterprise to suspend transmission of its set-asides for that year to the
Affordable Housing Funds, the FHFA Director, by written notices to the Enterprises dated
February 7, 2018, instructed each Enterprise to proceed with the transfer of 2017 set-asides to
the Affordable Housing Funds. The FHFA Director explained that he did “not consider this
one-time event to relate to any financial instability on the part of the Enterprise either now or
in the future.” Our audit found that the Enterprises’ computations for the 2017 set-asides and
subsequent transmittals were accurate.

Our audit also found that FHFA took steps to ensure the accuracy and the transmittal of the
affordable housing allocations.

We recognize that 12 USC § 4567(b) vests the FHFA Director with authority to suspend the
set-aside and transmission of the affordable housing allocations of one or both Enterprises,
upon a finding that one or more of three statutory conditions have been met. One federal
district court has held that the decision of the FHFA Director whether to impose a temporary
suspension is committed solely to his or her discretion, and the Director, in both his December
2014 and February 2018 notices, invoked that authority and determined that transmittal of
the set-asides did not contribute, and would not contribute, to the financial instability of the
Enterprises. For those reasons, we make no formal recommendations in this audit. Because
FHFA is both the conservator for and supervisor of the Enterprises, in which U.S. taxpayers
have invested more than $191 billion, prudence counsels that FHFA, in the future,
acknowledge and explain the reasons for changes in its critical determinations.




                            OIG • AUD-2018-012 • September 24, 2018                                 30
OBJECTIVE, SCOPE, AND METHODOLOGY .................................

The objectives of our audit were to (1) understand the analyses, if any, performed by FHFA
to determine whether the conditions that led to its 2008 temporary suspension of set-asides
and transmissions had changed as of January 2015, and whether the explanation provided
by FHFA to lift the temporary suspension in December 2014 continued in force through
February 2018, when FHFA directed the Enterprises to transmit their 2017 set-asides;
(2) assess the accuracy of the Enterprises’ set-aside computations for 2015 through 2017; and
(3) assess FHFA’s oversight of the Enterprises’ set-asides and transmissions to the Affordable
Housing Funds.

To address our objectives, we:

   •   Researched and identified applicable laws, regulations, and other guidance related to
       FHFA’s oversight of affordable housing allocations;

   •   Obtained and reviewed FHFA and the Enterprises’ documentation and correspondence
       related to FHFA’s oversight of the affordable housing allocations;

   •   Obtained and reviewed documentation regarding FHFA’s analyses and determination
       to lift the suspension of allocations beginning in 2015; and

   •   Interviewed FHFA officials to gain an understanding of the background related to
       lifting the suspension of allocations and the circumstances behind the Director’s
       determination to direct the Enterprises to allocate the 2017 set-asides.

We conducted this performance audit between May 2018 and September 2018 in accordance
with generally accepted government auditing standards. Those standards require that we plan
and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis
for our findings and conclusions based on our audit objective. We believe that the evidence
obtained provides a reasonable basis for our findings and conclusions based on our audit
objective.




                           OIG • AUD-2018-012 • September 24, 2018                               31
ADDITIONAL INFORMATION AND COPIES .................................


For additional copies of this report:

   •   Call: 202-730-0880

   •   Fax: 202-318-0239

   •   Visit: www.fhfaoig.gov



To report potential fraud, waste, abuse, mismanagement, or any other kind of criminal or
noncriminal misconduct relative to FHFA’s programs or operations:

   •   Call: 1-800-793-7724

   •   Fax: 202-318-0358

   •   Visit: www.fhfaoig.gov/ReportFraud

   •   Write:

                FHFA Office of Inspector General
                Attn: Office of Investigations – Hotline
                400 Seventh Street SW
                Washington, DC 20219




                            OIG • AUD-2018-012 • September 24, 2018                        32