oversight

Federal Housing Finance Agency's Exit Strategy and Planning Process for the Enterprises' Structural Reform

Published by the Federal Housing Finance Agency, Office of Inspector General on 2011-03-31.

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

      FEDERAL HOUSING FINANCE AGENCY

          OFFICE OF INSPECTOR GENERAL

         Federal Housing Finance Agency’s Exit Strategy
            and Planning Process for the Enterprises’
                       Structural Reform




EVALUATION REPORT: EVL-2011-001         DATED: MARCH 31, 2011
EVALUATION REPORT: EVL-2011-001                                                  DATED: MARCH 31, 2011

Why We Did This Evaluation                                         What We Found
The housing government-sponsored enterprises, the Federal          The Administration’s February 11, 2011, proposal
National Mortgage Association and the Federal Home Loan            recommends that FHFA implement several steps
Mortgage Corporation (collectively, the Enterprises), suffered     under its regulatory authority in the short- to
billions of dollars in losses in 2007 and 2008. The Enterprises’   medium-term to significantly reduce the
regulator, the Federal Housing Finance Agency (FHFA),              Enterprises’ dominant position in the housing
placed them into conservatorships in September 2008, and the       finance system, which the Administration views as
U.S. Department of Treasury (Treasury) agreed to provide           contributing to excessive risk-taking and exposing
substantial financial support to them. To date, Treasury has       taxpayers to significant losses. These short- to
invested more than $153 billion in the Enterprises, and as of      medium-term regulatory steps, including requiring
the third quarter of 2010 they financed approximately 67           the Enterprises to raise guarantee fees on the
percent of newly-issued mortgage-backed securities.                mortgage-backed securities they issue, are intended
                                                                   to offset their cost advantages over potential
On February 11, 2011, the Administration proposed reforms
                                                                   competition and thereby encourage greater private
to the Enterprises’ fundamental roles and structures. The
                                                                   sector participation and capital in mortgage finance.
FHFA Office of Inspector General (FHFA-OIG) initiated this
                                                                   Over the longer-term, the Administration proposes
evaluation to identify the steps FHFA is expected to take in the
                                                                   that Congress should enact legislation that could
short- to medium-term under the Administration’s proposal
                                                                   further restrict the Enterprises’ role in housing
and the adequacy of its planning efforts to do so.
                                                                   finance or eliminate them altogether.
What We Recommend                                                  FHFA-OIG views FHFA’s potential
The FHFA should take specific steps to help ensure the             implementation of its regulatory authorities under
effective implementation of its responsibilities, including: (1)   the Administration’s proposal in the short- to
establishing timeframes and milestones, descriptions of            medium-term as an area of significant risk because,
methodologies to be used, criteria for evaluating the              if not managed effectively, its actions could have
implementation of the initiatives, and budget and financing        negative consequences such as unnecessarily
information necessary to carry out its responsibilities; and (2)   limiting mortgage credit.
developing an external reporting strategy, which might include
the augmentation of existing reports, to chronicle FHFA’s
progress, including the adequacy of its resources and capacity
to meet multiple responsibilities and mitigate any shortfalls.
FHFA agreed with these recommendations.
 TABLE OF CONTENTS


ABBREVIATIONS ....................................................................................................................... 1

PREFACE ................................................................................................................................. 2

PURPOSE OF EVALUATION ........................................................................................................ 3

INTRODUCTION....................................................................................................................... 3

SCOPE AND METHODOLOGY ..................................................................................................... 5

BACKGROUND ......................................................................................................................... 6

FINDINGS................................................................................................................................. 9

          1. FHFA HAS TAKEN STEPS TO IMPROVE THE ENTERPRISES’ FINANCES AND OPERATIONS
          DURING THEIR CONSERVATORSHIPS…..……… ..........…………………………….…..…….. 9

          2. FHFA HAS A SIGNIFICANT ROLE IN IMPLEMENTING THE ADMINISTRATION’S ENTERPRISE
          REFORM PROPOSAL IN THE SHORT- TO MEDIUM-TERM, AND CAREFUL PLANNING IS
          ESSENTIAL……………………………………........………………………..………..……….... 10

          3. FHFA’S CAPABILITY TO MEET MULTIPLE RESPONSIBILITIES RAISES CONCERNS… .. .…….. 12

CONCLUSIONS ....................................................................................................................... 14

RECOMMENDATIONS.............................................................................................................. 14

FHFA COMMENTS AND FHFA-OIG’S RESPONSE............................................................................ 15

APPENDIX A: MANAGEMENT COMMENTS TO THE DRAFT REPORT ................................................ 16

APPENDIX B: MAJOR CONTRIBUTORS TO THIS REPORT ............................................................... 18
    ABBREVIATIONS

    DODD FRANK ................................................. Dodd-Frank Wall Street Reform and Consumer Protection Act
    FANNIE MAE ................................................................................. Federal National Mortgage Association
    FHA .................................................................................................. Federal Housing Administration
    FHFA ................................................................................................ Federal Housing Finance Agency
    FHFA-OIG ...................................................... Federal Housing Finance Agency, Office of Inspector General
    FHFB .................................................................................................. Federal Housing Finance Board
    FHLBANKS .................................................................................................. Federal Home Loan Banks
    FREDDIE MAC ......................................................................... Federal Home Loan Mortgage Corporation
    GAO.............................................................................................. Government Accountability Office
    GINNIE MAE .......................................................................... Government National Mortgage Association
    GPRA ...................................................... Government Performance and Results Modernization Act of 2010
    GSE .............................................................................................. Government-Sponsored Enterprises
    HERA ............................................................................... Housing and Economic Recovery Act of 2008
    HUD............................................................................. Department of Housing and Urban Development
    MBS........................................................................................................ Mortgage-Backed Securities
    OFHEO ........................................................................... Office of Federal Housing Enterprise Oversight
    OMB .............................................................................................. Office of Management and Budget
    TREASURY ......................................................................................... U.S. Department of the Treasury




1    FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011
                                  FOR OFFICIAL USE ONLY


                                   Office of Inspector General
                               Federal Housing Finance Agency
                                        Washington, DC




                                            PREFACE

The Federal Housing Finance Agency (FHFA/Agency) Office of Inspector General (OIG) was established
by the Housing and Economic Recovery Act of 2008 (HERA) (Public Law No. 110-289), which amended
the Inspector General Act of 1978 (Public Law No. 95-452), to conduct audits, investigations, and other
activities of the programs and operations of FHFA, to recommend policies that promote economy and
efficiency in the administration of such programs and operations, and to prevent and detect fraud and abuse
in them. This is one of a series of audits, evaluations, and special reports published as part of FHFA-OIG’s
oversight responsibilities to promote economy and efficiency in the administration of FHFA’s programs.

This evaluation assesses the adequacy of the FHFA plans to effectively implement the short- to medium-
term elements of the Administration’s proposal to reduce the roles of the Federal National Mortgage
Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) in the U.S.
housing finance system. The evaluation is based on interviews with FHFA employees and officials, direct
observations, and a review of applicable documents.

The recommendations herein have been developed with the best knowledge available to FHFA-OIG and
have been discussed in draft with those responsible for implementation. FHFA-OIG trusts that this
evaluation will result in more effective, efficient, and economical operations. FHFA-OIG expresses our
appreciation to all those who contributed to the preparation of this evaluation.

This evaluation has been distributed to Congress, FHFA, the Office of Management and Budget, and others,
and will be posted on FHFA-OIG’s website, http://www.fhfaoig.gov/.



Richard Parker
Acting Deputy Inspector General for Evaluation



                                     FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011                2
    PURPOSE OF EVALUATION

    The purpose of this evaluation was to assess the adequacy of the Federal Housing Finance Agency’s
    (FHFA/Agency) plans to implement effectively the short- to medium-term elements of the
    Administration’s proposal to reduce the roles of the Federal National Mortgage Association (Fannie Mae)
    and the Federal Home Loan Mortgage Corporation (Freddie Mac) in the U.S. housing finance system.




    INTRODUCTION

    The financial conditions of Fannie Mae and Freddie Mac (collectively, the Enterprises) were dramatically
    weakened by the housing finance crisis, but since the onset of the crisis their share of the U.S. housing
    finance market has grown. Fannie Mae and Freddie Mac are housing government-sponsored enterprises
    (GSEs) that were established, among other reasons, to help provide liquidity to the housing finance system,
    including during periods of economic stress. In 2007 and 2008, the U.S. housing finance system began to
    suffer its worst downturn since the Great Depression, and Fannie Mae and Freddie Mac lost billions of
    dollars. In September 2008, as the Enterprises’ losses mounted, FHFA placed them into conservatorships,
    and the U.S. Department of Treasury (Treasury) began providing substantial financial support that
    purportedly has stabilized their financial conditions.1 The conservatorships were viewed as a temporary
    measure to stabilize the Enterprises’ financial conditions; they were not intended to be permanent.
    Further, as of February 25, 2011, Treasury has invested more than $153 billion in the Enterprises. FHFA
    estimates that the total taxpayer investment could range from $221 billion to $363 billion through 2013.2
    As the housing finance crisis continued and private sector financing plummeted, the federal government -
    through the Enterprises, the Federal Housing Administration (FHA), and the Government National
    Mortgage Association (Ginnie Mae) - assumed a dominant position in mortgage finance.3 Specifically, as of
    the third quarter of 2010, the Enterprises financed approximately 67 percent of all newly originated
    mortgage securities, and Ginnie Mae financed about 29 percent.4 Meanwhile, FHFA, other federal financial

    1
     Additionally, in November 2008, the Federal Reserve announced a program to purchase up to $1.25 trillion of the Enterprises’
    mortgage-backed securities.
    2
        FHFA press release, October 21, 2010, available at http://www.fhfa.gov/webfiles/19409/Projections_102110.pdf.
    3
     FHA is an agency within the Department of Housing and Urban Development (HUD) that provides insurance on certain
    mortgages and compensates lenders for borrower defaults and foreclosures on these mortgages. Ginnie Mae is a government
    corporation that guarantees investors will receive the timely payment of principal and interest on mortgage securities
    collateralized by FHA-insured and other government-guaranteed mortgages.
    4
     FHFA, Third Quarter 2010 Conservator Report, available at
    http://www.fhfa.gov/webfiles/19585/Conservator's_Report112910.pdf.


3       FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011
regulators and agencies, financial observers, trade groups, and academics have observed that Congress and
the Administration need to reach agreement on fundamental, permanent reforms to the housing finance
system, including the nature and scope of the Enterprises. Moreover, the Dodd-Frank Wall Street Reform
and Consumer Protection Act of 2010 (Dodd-Frank), required Treasury to submit a plan to Congress to
reform key components of the housing finance system.
On February 11, 2011, the Administration submitted its plan, which recommends the wind down of the
Enterprises, and that FHFA institute a serie-s of initiatives under its regulatory authority in the short- to
medium-term. Such initiatives include: increasing guarantee fees and down-payment requirements that are
intended to reduce gradually the Enterprises’ dominant role in the housing finance system; encouraging
greater private sector participation and capital in mortgage finance; and minimizing risks and potential
taxpayer losses. The Administration’s proposal thus seeks to reduce the federal role in housing finance by
leveling the playing field and encouraging the private sector.
On the day that the Administration’s proposal was released, FHFA’s Acting Director stated that he was
pleased the Administration had put forward a framework to strengthen the Nation’s housing finance system,
restore the critical role of private capital, and identify options for the long-term structure of housing
finance.5 Further, the Acting Director said he will consider and discuss with the Administration the details
of the framework, consistent with its responsibilities as both conservator and regulator, and looks forward
to working with the Administration and Congress to restore the functioning of private markets and preserve
the stability and liquidity of the secondary mortgage market.
Given the significant impact that FHFA’s actions under the Administration’s proposal will likely have upon
the Enterprises and the housing finance system, FHFA-OIG commenced a review of the Agency’s planning
processes to implement the Administration’s short- to medium-term initiatives. Specifically, our objectives
were to:
    1. Identify FHFA’s efforts to prepare and plan for the Enterprises’ eventual exits from their
       conservatorships prior to the announcement of the Administration’s proposal on February 11,
       2011;
    2. Identify FHFA’s specific roles and responsibilities under the Administration’s proposal, and assess
       whether the Agency has an effective planning process for implementation; and
    3. Provide early insights into FHFA’s resources and capacity to implement effectively the
       Administration’s short- to medium-term plans to limit the Enterprises’ role in the housing finance
       system, as well as meet its responsibilities as both conservator and regulator.




5
 Statement of FHFA Acting Director Edward DeMarco on February 11, 2011, available at
http://www.fhfa.gov/webfiles/19696/Statement_021111.pdf.

                                         FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011             4
    SCOPE AND METHODOLOGY

    To complete our work, we:

           Reviewed the Administration’s proposal, FHFA documents, and the Government Performance and
            Results Modernization Act of 2010 (GPRA), which establishes federal planning standards;
           Interviewed FHFA officials regarding their participation in the development of the Administration’s
            proposal to reform the Enterprises’ structures, as well as how they plan to implement the
            proposal’s various requirements; and
           Analyzed FHFA materials pertaining to its organizational structure and the number of examiners
            that it has to carry out its existing mission, and discussed these issues with Agency management.

    The scope of our work was largely confined to those portions of the Administration’s proposal that FHFA
    can implement under its existing regulatory authority, such as raising the Enterprises’ guarantee fees or
    down-payment requirements. Based upon the Acting FHFA Director’s statements, we understand that the
    Agency is evaluating the Administration’s short- to medium-term proposals. We do not comment on the
    appropriateness of any particular long-term reform policy option included in the Administration’s proposal,
    which FHFA may not have existing regulatory authority to implement.
    We conducted our evaluation under the authority of the Inspector General Act of 1978, as amended, and
    according to the Quality Standards for Inspection and Evaluation (January 2011) which has been
    promulgated by the Council of Inspectors General on Integrity and Efficiency. These standards, which are
    generally accepted across the federal government, require us to plan and perform our evaluations so as to
    obtain evidence sufficient to provide reasonable bases for our findings and conclusions. We trust that the
    evidence set forth herein meets these standards. We performed our evaluation during the period
    November 2010 to March 2011.
    We provided FHFA staff with briefings and presentations concerning the results of our fieldwork and the
    information summarized in this evaluation.
    We appreciate the efforts of FHFA management and staff in providing the information and access to
    necessary documents to accomplish this evaluation. Appendix B identifies major FHFA-OIG contributors
    to this evaluation.




5    FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011
BACKGROUND

To fulfill their charter and legislative obligations to provide liquidity to and support the mortgage finance
system, the Enterprises helped develop what is commonly
known as the secondary mortgage market. As leaders in the              Mortgage-Backed Securities
secondary mortgage market, they purchase mortgages that                are created when the sponsor
                                       6
meet their underwriting standards. Such mortgages are                  buys up mortgages from lenders,
referred to as conventional, conforming mortgages, and the             pools them, and packages them
Enterprises purchase them from mortgage originators such as            for sale to the public, a process
banks and thrifts. In turn, the originators can use the                known as securitization. See
proceeds of the sales of mortgages to the Enterprises to make          http://financial-
additional mortgages. The Enterprises hold some of the                 dictionary.thefreedictionary.com
mortgages that they purchase in their retained portfolios.             /Mortgage-Backed+Security
Their combined mortgage portfolios stood at about $1.5
trillion at year-end 2010 (see Figure 1). The Enterprises may
also package mortgages that they purchase into Mortgage-Backed Securities (MBS), which are then
sold to other investors in the secondary mortgage market. In exchange for a fee (the “guarantee fee”), the
Enterprises guarantee the timely payment of mortgage interest and principal on MBS that they compile,
package, and sell. As shown in Figure 1, as of year-end 2010, the Enterprises had outstanding guarantees
on approximately $4.9 trillion worth of MBS.7
As their share of the U.S. housing finance market deteriorated in the middle of the last decade, the
Enterprises increasingly supplemented their earnings with
non-traditional investments. From about 2004 through
2007, the Enterprises purchased large volumes of private-          Private-Label MBS are
label MBS, which at the time had investment grade                  securitized mortgages that do not
ratings, but, nonetheless, were backed by subprime                 conform to the criteria set by the
mortgage assets. Further, the Enterprises purchased large          Enterprises and Ginnie Mae. See
volumes of what are known as Alt-A mortgages (mortgages            http://securitization.weekly.com/
that lack documentation of key items such as borrowers’            private-label-mbs.html.
incomes), and packaged them into guaranteed MBS, which
were sold to investors. When the housing finance system suffered a substantial downturn in 2007 and
2008, the Enterprises suffered billions of dollars in losses on these investments and guarantees. As a


6
  These standards include limits on the size of loans the Enterprises may purchase, referred to as the conforming loan limit, which
varies by region and currently has a maximum value of $729,750 for single-family properties in the contiguous U.S. The
Enterprises also have traditionally required 20 percent homeowner equity (i.e., down-payments) in mortgages that they purchase
(loan to value ratio of 80 percent) or required mortgage insurance on mortgages with less than 20 percent equity (i.e., loan to
value ratios that exceed 80 percent).
7
    The Enterprises may also hold their own MBS in their retained mortgage portfolios.

                                              FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011                              6
    consequence of these and additional losses, the Enterprises were placed into conservatorships in September
    2008.




    The FHLBank System is a housing GSE that consists of 12 regionally-based Federal Home Loan Banks
    (FHLBanks). The FHLBank System’s primary mission is to support housing finance and community and
    economic development. To carry out its mission, the FHLBank System issues debt in capital markets,
    generally at relatively favorable rates due to its GSE status, and each FHLBank makes loans (advances) to
    member financial institutions, such as banks and thrifts, located in its region. Traditionally, member
    institutions have secured advances by pledging single-family mortgages or investment-grade securities as
    collateral to their FHLBank. Like the Enterprises, FHLBanks also generally have investment portfolios that
    hold mortgage-related securities. Several FHLBanks invested in subprime MBS prior to 2008, and have
    subsequently suffered significant losses due to these investments. As of September 30, 2010, the FHLBanks
    had total assets of $903 billion of which advances and investments constituted approximately 90 percent
    (about $830 billion).
    FHFA was established by the Housing and Economic Recovery Act of 2008 (HERA). Prior to the
    enactment of HERA, the Office of Federal Housing Enterprise Oversight (OFHEO), which was an
    independent entity within HUD, was responsible for Fannie Mae’s and Freddie Mac’s safety and soundness
    oversight. HUD, on the other hand, was responsible for overseeing their housing mission achievement.
    Unlike other federal banking regulators, OFHEO lacked authority to set appropriate capital standards for
    the Enterprises. Another agency, the Federal Housing Finance Board (FHFB), was the safety and soundness
    and mission regulator of the FHLBank System. HERA established FHFA as the expert safety and soundness
    and housing mission regulator for all of the housing GSEs and provided the Agency with authorities similar
    to those of bank regulators, such as added flexibility to set capital standards. FHFA is authorized to conduct


7    FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011
examinations, develop regulations, and issue enforcement orders, as deemed appropriate. Like other
federal financial regulators, such as the Federal Deposit Insurance Corporation, FHFA finances its activities
through assessments on its regulated entities, the housing GSEs, as opposed to through the Congressional
appropriations process.




                                      FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011                8
    FINDINGS


       1. FHFA Has Taken Steps to Improve the Enterprises’ Finances and Operations During Their
                                                    Conservatorships


    FHFA officials have advised that, since the establishment of the Enterprises’ conservatorships in September
    2008, the Agency has taken several steps to strengthen the Enterprises’ financial condition and operational
    practices. FHFA officials view these steps as consistent with the overall purposes of a conservatorship to
    preserve and maintain assets, and an eventual exit strategy. In particular, pursuant to its authority under
    HERA, FHFA removed certain members of the Enterprises’ boards of directors and certain senior officers,
    and replaced them with new officials. FHFA officials have mentioned that, since the inception of the
    conservatorships, the Enterprises have adopted much more conservative mortgage purchase, underwriting,
    and investment standards. For example, the Enterprises have increased their standards regarding mortgage
    borrowers’ credit scores and down-payment requirements, and they have raised their MBS guarantee fees
    to help offset potential risks. Further, the Enterprises’ purchases of private-label MBS backed by subprime
    mortgages and of Alt-A mortgages have ceased. FHFA officials also have stated that restoring the
    Enterprises’ financial condition and operational practices will likely facilitate their transition to whichever
    long-term reform option is decided upon.
    Although FHFA has taken steps to improve the Enterprises’ financial condition and operational practices, it
    has not developed an overall Agency planning strategy for the Enterprises to exit the conservatorships.
    According to FHFA officials, their decision not to engage in any such planning was due to several factors.
    Foremost among them is the scope of the effort involved in establishing new missions and structures for the
    Enterprises. In particular, they said that purported flaws in the Enterprises’ corporate structures can only
    be addressed through legislation. FHFA officials and others have often stated that the Enterprises’ status as
    GSEs allowed them to issue debt at relatively favorable rates, operate with limited capital, and engage in
    excessive risk-taking with taxpayers potentially exposed to resulting losses.
    To address the Enterprises’ alleged structural and systemic defects, the Administration has developed and
    evaluated reform strategies for nearly a year. In April 2010, Treasury and HUD issued for public comment
    seven questions regarding the future of the housing finance system. One question related to the future roles
    of Fannie Mae and Freddie Mac. Treasury and HUD received approximately 300 public comments, and
    held a conference in August 2010 regarding the future of the housing finance system and the appropriate
    roles of the Enterprises. Dodd-Frank also required Treasury to submit a plan for the future of the housing
    finance system, including the Enterprises’ roles. The Administration submitted such a plan on February 11,
    2011.
    To assist in the Administration’s planning process, FHFA officials said that the Agency hosted several
    meetings with Treasury and other officials to help explain how the Enterprises operate. They also provided


9    FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011
technical assistance to Treasury and other officials, upon request. However, FHFA officials stated that they
did not actively participate in the development of the policy options that the Administration forwarded to
Congress on February 11, 2011. These FHFA officials explained that they believe it would not have been
appropriate for the Agency, as the Enterprises’ conservator and independent regulator, to actively
participate in the development of such broad policy options.



     2. FHFA Has a Significant Role in Implementing the Administration’s Enterprise Reform
               Proposal in the Short- To Medium-Term, and Careful Planning Is Essential


According to the Administration’s proposal, gradually decreasing the Enterprises’ role in the housing
finance system is a primary goal of overall reform of the system. The proposal identifies a variety of
problems with the Enterprises’ current structures, which need to be addressed to encourage the private
sector and capital to return to the housing finance system, and to limit future taxpayer losses similar to
those associated with the conservatorships.
Over the long-term, the Administration’s proposal, as it relates to reducing the role of the Enterprises, lays
out three options for Congress to consider. Namely, eliminating the Enterprises:

       In their entirety;
       In their entirety, but establishing an insurer to protect against catastrophic mortgage insurance
        losses; and
       In their current form, but allowing private companies to issue MBS that would be protected by a
        government reinsurance guarantee program.

The proposal also includes an analysis of the various advantages and disadvantages associated with each long-
term option. Further, the proposal states that the FHLBank System’s mission should be to focus its advance
business on small- and medium-sized lenders rather than large lenders. Narrowing the FHLBank System’s
focus would reduce the housing GSEs’ role in mortgage finance. Similar to the approach for reducing the
Enterprises’ role in the housing finance system, the proposal would limit FHA’s role by raising its mortgage
insurance premiums.
In addition to these long-term structural options, the Administration’s proposal recommends that FHFA,
under its existing regulatory authority, take several steps in the short- to medium-term to further its overall
goal of limiting the Enterprises’ existing role in the housing finance system. The Administration also
articulates its support for other actions that FHFA is in a position to influence. These actions are intended
to raise gradually the Enterprises’ cost of doing business or the costs associated with the mortgages that they
finance, and, thereby, encourage private lenders and others to compete with the Enterprises. In particular,
the proposal recommends or supports that, under FHFA oversight, the Enterprises:

       Increase guarantee fees on their MBS;


                                      FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011                  10
            Increase the down-payment requirements for the mortgages that they purchase; and
            Decrease their mortgage investment portfolios.

     In carrying out these responsibilities, the proposal recommends that FHFA serve on a joint working group
     with FHA to consider changes to pricing and other standards. It also recommends that FHFA and FHA seek
     public comment on the appropriate pace of the transition, issue a timeline for tightening standards and
     raising pricing, and provide regular reports to various entities within the executive branch, specifically the
     Financial Housing Finance Oversight Board and the Financial Stability Oversight Council.
     Although the Administration’s short- to medium-term recommendations are new and FHFA is in the
     process of evaluating them, we believe that planning is essential to their efficient and successful
     implementation. For example, the establishment of timelines and benchmarks is critical to assess progress
     in implementing plans, and is consistent with GPRA planning requirements. The Administration’s proposal
     contemplates substantial changes to the housing finance system, and in particular the Enterprises’ dominant
     role in it. The Enterprises’ domination has evolved over many years, and change likely will be challenging.
     Accordingly, it will be critical for market participants and others to understand FHFA’s timelines,
     benchmarks, and methodologies for, among other initiatives, raising guarantee fees and down-payment
     requirements. This way they can judge whether FHFA’s actions are achieving their intended results of
     reducing the Enterprises’ role in the housing finance system. Further, without such information, market
     participants may lack the ability to adjust to the proposed changes, which could potentially affect financial
     market stability and mortgage availability and terms.
     Moreover, to the extent FHFA implements the Administration’s short- to medium-term initiatives, the
     Agency will need to establish robust protocols to apprise the public of its efforts. The Administration’s
     proposal does not recommend that FHFA establish an external communication strategy. It is critical,
     however, that federal agencies are transparent and open when implementing strategies, and that they
     establish methods to provide information to external stakeholders, such as Congress, on an ongoing basis.
     The Administration, Congress, market participants, and others will need ongoing information and analysis
     about the contemplated changes to the Enterprises’ role in the housing finance system. Without such
     information, the potential exists that external stakeholders will not understand FHFA’s planning and
     strategies, or changes thereto, and their impact on the mortgage finance system. Further, the
     Administration and Congress may not be adequately informed about any changes that may be necessary to
     FHFA’s plans and strategies, and, thus, will be unable to make necessary adjustments to help ensure FHFA’s
     success.




11    FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011
               3. FHFA’s Capability to Meet Multiple Responsibilities Raises Concerns


Although FHFA’s resources and capacity to carry out its multiple responsibilities, including those contained
in the Administration’s proposal, have not yet been the subject of a formal FHFA-OIG audit or evaluation,
they raise concerns and are a major priority for our future work. Created in 2008, FHFA is a relatively new
agency that replaced the previously fragmented regulatory structure for the housing GSEs. Prior to 2008,
three agencies, OFHEO, HUD, and FHFB, independently provided oversight of the GSEs. Establishing a
common culture, singular regulatory approach, and consistent policies would have been challenging under
normal circumstances, but in FHFA’s case these challenges were further aggravated by the housing finance
crisis and the weakened financial condition and operational practices of the Enterprises. For example,
within weeks of its establishment, FHFA appointed itself as the Enterprises’ conservator, an unprecedented
action given the Enterprises’ size and substantial roles in the housing finance system. Under the
conservatorships, FHFA staff members have multiple responsibilities not ordinarily required of a federal
financial regulator. These responsibilities include appointing senior officers, approving their performance
and compensation levels, attending boards of directors meetings (and in some cases participating in them),
and reviewing the regulated entities’ required financial statements. It also should be noted that FHFA staff
have had to cope with the fact that several FHLBanks have experienced financial and operational challenges
in recent years, largely due to their investments in subprime mortgage assets.
Under current circumstances, it is unclear whether FHFA has sufficient resources to meet its existing
responsibilities as conservator for the Enterprises as well as impending responsibilities contained in the
Administration’s proposal. Prior to the publication of the Administration’s proposal, FHFA announced a
reorganization and staffing increase. FHFA’s Acting Director announced plans for the Agency to hire
approximately 75 to 80 additional staff, which represents an increase of about 16 percent (FHFA has
approximately 466 positions filled). According to the Acting Director, the strain placed on FHFA by the
conservatorships is a major contributing factor for the reorganization and the plan to hire additional staff.
Regulatory responsibilities under Dodd-Frank are another factor. On the other hand, the Acting Director
did not mention the then unpublished Administration proposal to reform the housing finance system as a
factor in his decision to reorganize and augment staff.
Moreover, it is not clear at this point whether FHFA will be able to attract a sufficient number of skilled
individuals to occupy the new positions. The planned hires cover a range of responsibilities, particularly
bank examiners with experience gained from other federal financial regulatory agencies. However, FHFA’s
Acting Director advised that it may be difficult to hire the desired personnel for a number of reasons,
including:

       An unwillingness to move to the Washington, D.C. area, which is where the Enterprises are
        located; and
       The Administration’s stated intention to wind down the Enterprises over time, which could affect
        FHFA’s long-term viability.




                                      FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011                12
     FHFA must compete with, among others, the Federal Deposit Insurance Corporation and the Office of the
     Comptroller of the Currency, as well as state regulatory agencies, for experienced staff, and the other
     agencies have offices throughout the nation and offer perceptibly better job security.
     As discussed previously, the Administration’s proposal calls for FHFA to play a critical role in efforts over
     the short- to medium-term to reduce the Enterprises’ current role in the housing finance system. This
     supplemental responsibility will be challenging and delicate, given that, as of the third quarter of 2010, the
     Enterprises financed about 67 percent of new MBS issuances, market participants are familiar with their
     general business practices, and the housing finance system remains fragile. In the latter regard, for
     example, if FHFA causes the Enterprises to raise guarantee fees too quickly, there could be a negative
     reaction within the housing finance system that could unnecessarily restrict the availability of mortgage
     credit or result in mortgage terms, such as interest rates, that are unaffordable to many potential
     borrowers. This and other new responsibilities associated with FHFA’s implementation of the
     Administration’s proposal could further stress FHFA staff. Therefore, FHFA-OIG is concerned about the
     breadth of FHFA’s responsibilities and its capacity to fulfill them. FHFA-OIG plans to monitor carefully
     these issues over time.




13    FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011
CONCLUSIONS

To the extent that FHFA implements the Administration’s short- to medium-term recommendations to
limit the Enterprises’ dominant positions in the housing finance system, it is essential that the Agency
develop a systematic planning process to do so. As the Enterprises’ regulator and conservator, FHFA is
uniquely positioned to assess such factors as the appropriateness of their guarantee fees and down-payment
requirements and how much higher those standards would need to be to offset the Enterprises’ current cost
advantages over private sector competitors. Further, FHFA is positioned to assess how market participants
and borrowers might react to changes in the Enterprises’ roles and whether any further changes are
necessary to ensure a better transition. Failure on the part of FHFA to adopt critical elements of effective
planning such as timelines, benchmarks, criteria, methodologies, information requirements, and an external
reporting strategy could hinder its success.
Finally, it is critical that FHFA have the capacity to meet both its existing responsibilities as conservator and
regulator of the Enterprises and its new responsibility under the Administration’s proposal to manage a
short- to medium-term effort to limit the Enterprises’ presence in the housing finance system.
Going forward, these issues will require careful monitoring by the FHFA, the FHFA-OIG, the
Administration, Congress, and others.




RECOMMENDATIONS

We recommend that FHFA take the following steps as it implements its regulatory responsibilities in the
short- to medium-term under the Administration’s proposal:
    1. Establish timeframes and milestones, descriptions of methodologies to be used, criteria for
       evaluating the implementation of the initiatives, and budget and financing information necessary to
       carry out its responsibilities; and
    2. Develop an external reporting strategy, which might include the augmentation of existing reports,
       to chronicle its progress, including the adequacy of its resources and capacity to meet multiple
       responsibilities and mitigate any shortfalls.




                                       FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011                   14
     FHFA COMMENTS AND FHFA-OIG’S RESPONSE


     FHFA-OIG provided a draft of this evaluation to FHFA for its review and comment. On March 22, 2011,
     FHFA’s Senior Associate Director for Conservatorship Operations provided the Agency’s written
     comments, which are published verbatim in Appendix A. FHFA agreed with the draft evaluation’s
     recommendations in its written comments.




15    FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011
APPENDIX A: MANAGEMENT COMMENTS TO THE
DRAFT REPORT




              FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011   16
17   FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011
APPENDIX B: MAJOR CONTRIBUTORS TO THIS REPORT


EMILIA DISANTO

MADHURI EDWARDS

JENNIFER FAIN

JAY JACOBSEN

JACOB KENNEDY (REFERENCER)

WESLEY M. PHILLIPS

BRYAN SADDLER

DAVID SEIDE

WILLIAM H. WOLFE




                             FEDERAL HOUSING FINANCE AGENCY | EVL-2011-001 | 03/31/2011   18
     ADDITIONAL INFORMATION AND COPIES



   TO OBTAIN ADDITIONAL COPIES OF THIS REPORT:
         Call the Office of Inspector General (OIG) at: 202-408-2544
                     Fax your request to: 202-445-2075
                 Visit the OIG web site at: www.fhfaoig.gov




                             OIG HOTLINE
To Report Suspected Fraud, Waste, and Abuse in FHFA Programs or Operations:
                              Call: OIG Hotline at 1-800-793-7724
                              Fax: 202-408-2972
                              Visit: www.fhfaoig.gov or
                              Write to us at:
                          Federal Housing Finance Agency
                          Office of Inspector General
                          1625 Eye Street, NW
                          Washington, DC 20006-4001