oversight

Evaluation of Federal Housing Finance Agency's Oversight of Fannie Mae's and Freddie Mac's Executive Compensation Programs

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

         Evaluation of Federal Housing Finance Agency’s
          Oversight of Fannie Mae’s and Freddie Mac’s
               Executive Compensation Programs




EVALUATION REPORT: EVL-2011-002         DATED: MARCH 31, 2011
 EVALUATION REPORT: EVL-2011-002                                                             DATED: MARCH 31, 2011

Why We Did This Evaluation                                                 What We Found
In September 2008, the Federal Housing Finance Agency                      FHFA coordinated with Treasury and outside consultants
(FHFA/Agency) placed the Federal National Mortgage Association             to develop the Enterprises’ compensation programs.
and the Federal Home Loan Mortgage Corporation (collectively, the          FHFA believes that such programs are necessary to recruit
Enterprises), into conservatorships due to their mounting losses.          and retain talented executives. Enterprise executive
Since then, the U.S. Department of the Treasury (Treasury) has             compensation packages include provisions designed to
invested over $153 billion in the Enterprises to stabilize them. As        mitigate abusive compensation practices, such as “golden
conservator, FHFA has taken a range of actions to improve the              parachute” severance payments. However, FHFA has not
Enterprises’ finances and operations, including removing and               considered factors that might have resulted in reduced
replacing senior executives and establishing new executive pay plans.      executive compensation costs, such as the impact that
FHFA oversees the Enterprises’ executive compensation levels and           federal financial support has on the Enterprises’ corporate
monitors their ongoing implementation. In 2009 and 2010, FHFA              and executive perfomance, and the compensation paid to
approved executive compensation packages totaling more than $35            senior officials at federal entities that also play a critical
million in annual base salaries and deferred performance pay for the       role in housing finance.
Enterprises’ top six officers.
                                                                           FHFA lacks key controls necessary to monitor the
Given the concerns about executive compensation levels at                  Enterprises’ ongoing executive compensation decisions
companies that have received federal financial support, the FHFA           under the approved packages. Specifically, FHFA has
Office of Inspector General (FHFA-OIG) initiated this evaluation to        neither developed written procedures to evaluate the
assess: (1) the processes used to develop the Enterprises’                 Enterprises’ recommended compensation levels each
compensation packages; (2) FHFA’s ongoing oversight efforts; and           year, nor required Agency staff to verify and test the
(3) the transparency of the Enterprises’ executive compensation            means by which the Enterprises calculate their
policies and practices.                                                    recommended compensation levels. Although the Agency
                                                                           apparently is enhancing its procedures, which is a positive
What We Recommend                                                          development, the new procedures do not address all of
FHFA should establish an ongoing review and analysis process to            FHFA-OIG’s concerns, such as FHFA’s lack of testing and
include such issues as the level of federal support for the Enterprises,   verification of the Enterprises’ submissions in support of
and the compensation levels for the heads of housing-related federal       executive compensation packages.
entities. Additionally, FHFA should establish written criteria and
                                                                           FHFA also does not provide sufficient transparency to the
procedures for reviewing performance data, and conduct
                                                                           public of the Enterprises’ executive compensation
independent verification and testing of the basis for executive
                                                                           programs. Although the Enterprises report relevant
compensation levels. These factors may warrant lower compensation
                                                                           information in public securities filings, more user-friendly
for Enterprise executives. Also, to improve transparency, FHFA
                                                                           information is generally unavailable. For example, FHFA
should post on its website information about executive
                                                                           does not post the Enterprises’ executive compensation
compensation, and provide links to the Enterprises’ securities filings.
                                                                           data or related trend data on its website.
FHFA agreed with most, but not all, of these recommendations.
 TABLE OF CONTENTS

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

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

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

SCOPE AND METHODOLOGY ..................................................................................................... 6

BACKGROUND ......................................................................................................................... 7

          1. DEVELOPMENT OF EXECUTIVE COMPENSATION PACKAGES…….… …………………………..…….. 8

          2. PERFORMANCE-BASED EXECUTIVE COMPENSATION PACKAGES………...……..…..…………..…….. 9

          3. MITIGATION OF PROBLEMATIC COMPENSATION PRACTICES……… …..……………………..…….. 11

          4. ENTERPRISES' EXECUTIVES RECEIVED SUBSTANTIAL COMPENSATION ….… …………………..…….. 12

FINDINGS............................................................................................................................... 13

          1. HIGH-RISK ENTERPRISE PAY ISSUES……….. …………………… ………………………...…….. 13

          2. KEY CONTROLS NECESSARY TO ENSURE EFFECTIVENESS ………..……………..……. .…….…….. 15

          3. TRANSPARENCY ………………..……….. …………….. ……………………………….…….. 19

RECOMMENDATIONS.............................................................................................................. 21

FHFA COMMENTS AND FHFA-OIG’S RESPONSE............................................................................ 23

APPENDIX A: ENTERPRISES’ TOTAL DIRECT COMPENSATION ....................................................... 25

APPENDIX B: MANAGEMENT COMMENTS TO THE DRAFT REPORT ................................................ 26

APPENDIX C: MAJOR CONTRIBUTORS TO THIS REPORT .............................................................. 30
    ABBREVIATIONS

    CEO ................................................................................................. Chief Executive Officer
    CFO................................................................................................... Chief Financial Officer
    COO ................................................................................................. Chief Operating Officer
    DER ...................................................................................... Division of Enterprise Regulation
    EVP .................................................................................................Executive Vice President
    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
    FREDDIE MAC ................................................................ Federal Home Loan Mortgage Corporation
    GAO ................................................................................... Government Accountability Office
    GINNIE MAE ................................................................. Government National Mortgage Association
    GSE ................................................................................... Government-Sponsored Enterprises
    HERA ..................................................................... Housing and Economic Recovery Act of 2008
    HUD ................................................................. Department of Housing and Urban Development
    MBS ............................................................................................. Mortgage-Backed Securities
    OCO ................................................................................ Office of Conservatorship Operations
    OFHEO ................................................................Office of Federal Housing Enterprise Oversight
    OMB .................................................................................... Office of Management and Budget
    OPAR ............................................................................. Office of Policy Analysis and Research
    SEC............................................................................ U.S. Securities and Exchange Commission
    SPSPA ...................................................................... Senior Preferred Stock Purchase Agreement
    TARP ....................................................................................... Troubled Asset Relief Program
    TREASURY ............................................................................... U.S. Department of the Treasury




1    FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 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 (FHFA-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, effectiveness, and efficiency in the administration of
FHFA’s programs.

This evaluation assesses FHFA’s development and oversight of the executive compensation programs of the
Federal National Mortgage Association (Fannie Mae) and the Federal National Mortgage Corporation
(Freddie Mac) as well as the transparency of their compensation programs. 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 its
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 the report 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-2011-002 | 03/31/2011                 2
    PURPOSE OF EVALUATION

    The purpose of this evaluation was to assess the Federal Housing Finance Agency’s (FHFA/Agency)
    development and oversight of the executive compensation programs of the Federal National Mortgage
    Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).

    Fannie Mae and Freddie Mac (collectively, the Enterprises) 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 suffered 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 the Treasury (Treasury) began providing substantial financial support.1 As of February
    25, 2011, Treasury had invested more than $153 billion in the Enterprises, and FHFA estimates that the
    total taxpayer commitment to the Enterprises could range from $221 billion to $363 billion through 2013. 2
    Because the housing finance crisis has continued and private-sector financing has plummeted, the federal
    government - through the Enterprises, the Federal Housing Administration (FHA), and the Government
    National Mortgage Association (Ginnie Mae) - now dominates the housing finance market. For instance, 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.3

    As the Enterprises’ conservator, FHFA has taken a range of actions to manage, control, and improve the
    Enterprises’ finances and operations and potentially reduce long-term costs to taxpayers. For example, at
    the inception of the Enterprises’ conservatorships, FHFA terminated certain members of the Enterprises’
    boards of directors and certain senior officers, and replaced them with individuals that FHFA believes to be
    well-qualified and capable of improving business practices and operations. FHFA also reviews and approves
    on an annual basis executive compensation packages for the senior officers at each Enterprise, and monitors
    their performance in meeting established performance targets.

    In late 2009, FHFA approved executive compensation packages for the Enterprises’ Chief Executive
    Officers (CEOs), Chief Operating Officers (COOs),4 Chief Financial Officers (CFOs), Executive Vice
    Presidents (EVPs), and those Senior Vice Presidents in charge of principal business units or functions. The
    packages are retroactive to January 1, 2009, and will remain in effect as long as the Enterprises remain in

    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
     FHFA, Third Quarter 2010 Conservator Report, available at
    http://www.fhfa.gov/webfiles/19585/Conservator's_Report112910.pdf.
    4
     Neither Enterprise use the specific term COO, however, they both employ senior executives who perform COO functions.
    Specifically, the Chief Administrative Officer(s) and General Counsel(s) perform COO functions. For purposes of simplicity,
    FHFA-OIG uses COO as a general term to describe the Chief Administrative Officer and General Counsel positions if they
    perform COO functions.


3       FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
conservatorships, unless FHFA acts to change them. Under the packages, the Enterprises’ two CEOs
received approximately $17 million in combined compensation in 2009 and 2010. During the same period,
the Enterprises’ top six officers (their CEOs, COOs, and CFOs) received total combined compensation of
more than $35 million. Under the FHFA approved compensation packages, the executives’ total
compensation for 2009 was to be paid out as of March 15, 2011, and the entirety of their 2010
compensation is to be paid out no later than March 15, 2012.

The level at which the Enterprises’ senior executives are compensated has long been a subject of
considerable public controversy. Some claim that prior to the conservatorships, the Enterprises’
compensation structures lacked transparency and encouraged executives to inflate the companies’ reported
earnings and manipulate their financial statements. Moreover, such criticism has continued following
FHFA’s adoption of multi-million dollar executive compensation packages for the Enterprises in 2009. For
instance, some have noted that, although the Enterprises have lost billions of dollars and continue to depend
upon federal support to remain in business,5 their senior executives continue to receive multi-million dollar
salaries. Indeed, some have contended that the Enterprises’ executives should be compensated at the same
levels as federal agency employees.6

FHFA officials have justified the salaries paid to the Enterprises’ senior executives on several grounds. They
state that significant compensation is necessary to:

    1. Recruit and retain talented executives who can run large and complex companies;
    2. Provide incentives for the executives to meet performance targets;
    3. Restore the Enterprises’ finances and operations;
    4. Off-set the disincentive created by the pending policy proposals calling for the winding down of the
       Enterprises;7 and
    5. Potentially minimize taxpayer costs associated with the conservatorships.

The Enterprises are not the only companies receiving federal government support for which executive
compensation has been a controversial topic. Since 2008, Treasury has used the Troubled Asset Relief
Program (TARP) to provide hundreds of billions of dollars in support to automobile and financial services
companies. Treasury created a specific office, the Special Master for TARP Executive Compensation, to

5
 House Financial Services Committee Hearing, February 25, 2010, available at
http://financialservices.house.gov/hearings/hearingDetails.aspx?newsid=1103.
6
  See, e.g., Statement of Mark A. Calabria of the Cato Institute before the Subcommittee on Capital Markets and Government
Sponsored Enterprises, House Financial Services Committee, February 9, 2011, available at
http://www.cato.org/pub_display.php?pub_id=12774 (“I recommend that all GSE employees be transitioned to the GS pay
scale as soon as possible.”)
7
  Recently, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act), the
Departments of Treasury and Housing and Urban Development issued a report on reforming the housing finance system, which
included recommendations for the phase-out of the Enterprises. Reforming America’s Housing Finance Market: A Report to Congress
(Feb. 11, 2011), available at
http://www.treasury.gov/initiatives/Documents/Reforming%20America's%20Housing%20Finance%20Market.pdf.


                                            FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011                            4
    review and approve the compensation of senior executives of some TARP recipients. But the TARP
    compensation rules do not apply to the Enterprises because they have not received TARP funds.8

    Given the controversy surrounding the issue of executive compensation, the FHFA Office of Inspector
    General (FHFA-OIG) initiated this evaluation to:

          1. Evaluate the steps FHFA has taken to assess the reasonableness of the Enterprise compensation
             packages subsequent to their approval in 2009;
          2. Assess FHFA’s ongoing oversight of the Enterprises’ executive compensation pursuant to the
             approved packages; and
          3. Examine the transparency of the Enterprises’ compensation policies and practices.




    8
     The Enterprises have received federal government support under a different statute, the Housing and Economic Recovery Act
    of 2008 (HERA).


5       FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
SCOPE AND METHODOLOGY

To gain an understanding of the process by which executive compensation is established at Fannie Mae and
Freddie Mac, and the role that FHFA plays in this process, FHFA-OIG conducted a range of interviews with
senior FHFA officials. In particular, FHFA-OIG interviewed FHFA’s Chief Economist who, as head of the
Office of Policy Analysis and Research (OPAR), has played a key role in the Agency’s ongoing oversight of
executive compensation. FHFA-OIG also interviewed OPAR staff and the Office of Conservatorship
Operations (OCO) personnel. Some individuals were interviewed more than once.

FHFA-OIG also requested that FHFA provide all documentation related to its development of the
Enterprises’ executive compensation packages. FHFA-OIG reviewed all the documentation provided by
FHFA, including briefing slides prepared by a compensation consultant hired by FHFA to help determine
the appropriate levels of compensation. Further, FHFA-OIG examined documents in the public domain,
including materials on FHFA’s website, U.S. Securities and Exchange Commission (SEC) filings, FHFA
media statements, information posted on Fannie Mae’s and Freddie Mac’s websites, and documents
available from the Treasury’s Office of Financial Stability, which administers the TARP programs. In
particular, FHFA-OIG reviewed the reports and determination letters released by the Special Master for
TARP Executive Compensation, and SEC filings made by TARP-assisted companies and other financial
firms.

This FHFA-OIG evaluation was conducted under the authority of the Inspector General Act of 1978, as
amended, and in accordance with the Quality Standards for Inspection and Evaluation (January 2011),
which have been promulgated by the Council of Inspectors General on Integrity and Efficiency. These
standards, which are generally accepted by federal government agencies, require FHFA-OIG to plan and
perform an evaluation so as to obtain evidence sufficient to provide reasonable bases to support findings and
conclusions. FHFA-OIG trusts that the evidence discussed here meets these standards. The performance
period for this evaluation was from January 2011 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 C identifies major FHFA-OIG contributors
to this evaluation.




                                      FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011                6
    BACKGROUND

    To fulfill their charter and legislative obligations to provide liquidity and support to the residential mortgage
    finance system, the Enterprises have participated
    in the creation and development of the                     Secondary Mortgage Market is a market in which
    secondary mortgage market. In this market,                 mortgages or mortgage-backed securities are bought and
    which is only open to companies that originate             sold. It allows banks to sell mortgages, giving them new
    mortgages such as banks and thrifts, the                   funds to offer more mortgages to new borrowers. See
    Enterprises purchase residential mortgages from            http://useconomy.about.com/od/glossary/g/secondary
    mortgage originators that meet their underwriting          _marke.htm
    standards. The originators can use the proceeds
    of the sales of mortgages to the Enterprises to
    issue new residential mortgages. The Enterprises           Mortgage-Backed Securities are created when a
    hold some of the mortgages they purchase in their          sponsor buys up mortgages from lenders, pools them, and
    retained investment portfolios, and package the            packages them for sale to the public, a process known as
                                                               securitization. See http://financial-
    rest into mortgage-backed securities (MBS),9
                                                               dictionary.thefreedictionary.com/Mortgage-
    which they sell to investors on the secondary              Backed+Security
    market. As part of the process, the Enterprises
    also, in exchange for a fee, guarantee the timely
    payment of interest and principal on MBS that they issue.

    When the housing market began to collapse in 2007 and 2008, the Enterprises lost billions of dollars on
    investments and MBS guarantees. On September 6, 2008, as the Enterprises’ losses mounted, FHFA placed
    them into conservatorships, and Treasury committed to provide billions of dollars in support to the
    Enterprises in the form of preferred stock purchases. Under the terms of the senior preferred stock
    purchase agreements (SPSPAs) with each Enterprise, Treasury purchased preferred shares in the
    Enterprises, thereby enabling them to meet existing financial obligations and remain solvent. Through the
    fourth quarter of 2010, Treasury had purchased more than $153 billion in preferred shares of the
    Enterprises.

    As the Enterprises’ conservator and primary regulator, FHFA has broad powers to control and direct the
    Enterprises’ business activities. For instance, FHFA has replaced some members of their boards of directors
    and senior officers. FHFA also reviews and authorizes the terms and amounts of compensation paid to the
    Enterprises’ executives. Treasury, under the terms of the SPSPAs, also exercises a degree of authority over
    the Enterprises’ executive compensation. Under the SPSPAs, Treasury must be consulted regarding the
    Enterprises’ executive compensation arrangements with senior officers.




    9
        A more detailed discussion of MBS can be found at http://www.sec.gov/answers/mortgagesecurities.htm.


7       FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
FHA and Ginnie Mae are also relevant to this evaluation. Congress established FHA, now an agency within
HUD, in 1934 to broaden homeownership, protect and sustain lending institutions, and stimulate
employment in the building industry. FHA insures a variety of mortgages for initial home purchases,
construction and rehabilitation, and refinancing on mortgages that meet FHA criteria. FHA has played a
particularly large role among minority, lower-income, and first-time homebuyers.

Ginnie Mae, also a unit of HUD, acts like the Enterprises, as a guarantor of timely payment of interest and
principal for certain MBS. Specifically, Ginnie Mae guarantees apply to MBS collateralized by FHA-insured
and other government-guaranteed mortgages. Unlike the Enterprises, Ginnie Mae does not buy and hold
mortgages in investment portfolios nor does it issue MBS. Instead, lenders or securitizers issue the MBS on
which Ginnie Mae provides guarantees.

Other areas that are important for a broader understanding of the issues raised herein follow.

1. FHFA Developed the Enterprises’ Executive Compensation Packages in Coordination with the
   Treasury Special Master for TARP Executive Compensation and Outside Consultants

In late 2008 and 2009, FHFA and Treasury developed the Enterprises’ executive compensation packages in
consultation with the TARP Special Master, a compensation consulting firm retained by the Agency, and
compensation firms retained by the Enterprises. In Congressional testimony, FHFA’s Acting Director
stated that the principal goal of the executive compensation plan development process was to create a
system that provides the Enterprises’ executives with compensation packages that are sufficient to achieve
the goals of the conservatorship, align executive decision-making with the long-term financial prospects of
the Enterprises, and minimize costs to the taxpayers.10 Another critical FHFA concern is to ensure that the
Enterprises can recruit and retain talented executives and professionals. This concern has been heightened
by the Administration’s recent proposal, which recommends that the Enterprises in their current form be
phased-out.

In developing the Enterprises’ executive compensation packages, FHFA considered the compensation
approaches that Treasury’s Special Master developed for companies that received financial assistance under
the TARP. However, an FHFA official advised that the Enterprises’ plans vary from those of the TARP
companies with respect to stock-based compensation because, post-conservatorship, the value of the
Enterprises’ stock has remained near zero. As a result, the Enterprises’ executives receive entirely cash-
based compensation packages (by contrast some TARP recipients’ executives receive substantial
compensation in the form of company stock). In arriving at their executive compensation plans, FHFA also
considered information and analysis provided by a compensation consulting firm it hired, as well as outside
compensation consultants hired by the Enterprises.11 Those consultants assisted the Enterprises in


10
  House Financial Services Committee Hearing, February 25, 2010, available at
http://financialservices.house.gov/hearings/hearingDetails.aspx?newsid=1103.
11
 FHFA paid the outside compensation consultant it hired $403,000 in 2010. During the same period, Fannie Mae and Freddie
Mac paid their outside compensation consultants $655,000 and $560,000, respectively.


                                          FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011                       8
    identifying comparable firms, such as large banks and insurance companies, to provide a basis for assessing
    whether the Enterprises were in line with what similar organizations paid their executives.12

    2. Enterprise Executive Compensation Is Largely Tied to Corporate Performance

    FHFA officials have stated that the Enterprises’ executive compensation levels are largely based on whether
    the Enterprises meet pre-established financial and performance targets. Table 1, below, shows examples of
    each Enterprise’s 2010 financial and performance goals and measures that are tied to executive
    compensation levels. As depicted, Fannie Mae set a goal of maintaining its single-family credit related
    expenses, such as foreclosure expenses, at no more than $45.5 billion. Fannie Mae officials have reported
    that the goal was met, as credit-related expenses were $26 billion in 2010. Similarly, Freddie Mac set a
    target of maintaining its retained mortgage portfolio at $810 billon or less, and it met that goal.

    Although FHFA appears to have ensured that the Enterprises’ executive compensation levels are closely
    linked to objective performance measures, the overall success of FHFA’s oversight is largely dependent
    upon the quality of the metrics that are used. FHFA-OIG did not review these performance measures as
    part of this evaluation. However, as discussed at Finding 2.A, below, FHFA-OIG found that there is room
    for FHFA to improve its procedures. Specifically, FHFA should adopt written criteria and other controls
    for evaluating the Enterprises’ performance measures. Furthermore, federal support for the Enterprises
    under conservatorship may affect the validity of certain performance metrics, namely, by causing executive
    and corporate performance to be overstated (see Finding 1, below, at recommendation (B)), and, by
    extension, providing executives with compensation that is not warranted.


                            Table 1: Select Fannie Mae and Freddie Mac Financial Performance
                                                      Goals and Measures, 2010
                             ENTERPRISE                   GOALS                    EXAMPLES OF MEASURES

                                                 Provide liquidity,
                                                 stability and
                                                                         Single-family credit related expenses
                            FANNIE MAE           affordability to the US
                                                                         of $45.5 billion or lower
                                                 housing and
                                                 mortgage markets

                                                                           Retained mortgage portfolio balance
                            FREDDIE MAC          Financial Execution       below $810 billion (per Treasury's
                                                                           SPSPA)
                        Source: Fannie Mae and Freddie Mac 2010 SEC 10-K Filings, available at
                        http://www.sec.gov/edgar/searchedgar/companysearch.html


    The key provisions of the Enterprises’ executive compensation packages consist of three elements: Base
    Salary, Deferred Base Salary, and Long-Term Incentive Awards (LTIs). The elements, described in more
    detail below, are generally intended to guarantee executives a base annual salary with potentially significant

    12
         Fannie Mae used Freddie Mac in its comparable group, and Freddie Mac used Fannie Mae in its comparable group.


9        FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
increases in compensation on a deferred basis provided the pre-established corporate financial and
operational performance targets are met.

Base Salary: Base salary is tied to the responsibility level of the senior executive, and is intended to
provide the senior executive with a fixed level of compensation commensurate with his or her
responsibilities. Base salary cannot exceed $500,000 per year, except for each Enterprise’s CEO, COO,
and CFO, whose salaries have ranged from about $600,000 to $900,000 in 2009 and 2010. All other
senior executives who were employed at the Enterprises immediately prior to the adoption of their new
executive compensation plans had their salaries adjusted down to the $500,000 limit, effective January 1,
2010.

Deferred Base Salary: Deferred base salary is a separate salary component. It consists of two elements:
a fixed portion and a performance-based portion. Payments of such salary are deferred for up to 15 months
from the end of the calendar year upon which the executive’s performance is being rated (e.g., for calendar
year 2009, the deferred payments were to be made by March 15, 2011), and executives forfeit the deferred
compensation if they leave the Enterprises prior to payment. FHFA officials have stated that deferring
payments for one year is designed to aid in executive retention, which is a major objective of the
Enterprises’ executive compensation plans.

Long-Term Incentive Awards (LTIs): LTIs are designed to provide the Enterprises’ senior executives
with incentives to meet specific corporate and individual performance measures over the long-term, as well
as to remain with the Enterprises for extended periods. LTI payments must be approved by each
Enterprise’s compensation committee and by FHFA. As with deferred base salary, LTI payments are to be
made no later than March 15 of the year following the year to which the annual performance measures are
applicable.

The three salary elements above are combined to form what is known as each executive’s “total direct
compensation.” An Enterprise executive’s total direct compensation is calculated, in simplified form, as
shown in Figure 1.

                          Figure 1: Process by Which Enterprises’ Executives
                              Total Compensation Levels are Calculated

               FIXED                            PERFORMANCE-                       TOTAL DIRECT
               COMPENSATION                     BASED                              COMPENSATION
                                                COMPENSATION
                   •BASE SALARY +                    • PERFORMANCE-
                    FIXED PORTION OF                   BASED ELEMENT
                    DEFERRED BASE                      OF DEFERRED
                    SALARY                             BASE SALARY + LTI


                            Source: FHFA testimony and Fannie Mae and Freddie Mac 10-Ks




                                       FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011             10
     3. The Enterprises’ Executive Performance Plans Are Structured to Mitigate Some Potentially
        Problematic Compensation Practices

     FHFA officials have stated that the Enterprises’ executive compensation packages include provisions
     intended to address some of the problematic issues historically associated with corporate executive
     compensation programs. According to a
     federal panel that recently looked at the issue,    Golden parachute is the term used for special
     corporate executive compensation programs           compensation arrangements, such as, cash, a special bonus,
     frequently provided incentives for financial        stock options or vesting of previously awarded
     services company executives to undertake            compensation, between a company and its senior executives
     excessively risky business strategies, to the       in case the company is acquired or if an individual is fired
                                              13
     ultimate detriment of their companies.              or involuntarily separated. See generally
     Similarly, FHFA’s predecessor found that the        http://lexicon.ft.com/Term?term=golden-parachute
     Enterprises’ historical executive compensation
     plans encouraged their executives to
     undertake business strategies that allegedly manipulated the Enterprises’ financial statements.14 In addition
     to rewarding executives on the upside for high-risk behaviors, some executive compensation packages also
     had significant downside protections, e.g., “golden parachute” severance packages. Such packages were
     awarded to departing executives even in situations when their activities led to the insolvency of their
     companies.

     FHFA officials have stated that the Enterprises’ executive compensation packages address such concerns by:

               Being entirely cash-based. FHFA officials have acknowledged that the packages are cash-based
                because the value of their common stock is essentially zero;
               Requiring FHFA approval of the use of severance or “golden parachute” provisions, thereby
                mitigating the possibility that Enterprise executives could leave with large payouts even if the
                companies’ financial conditions deteriorate; and
               Containing “clawback” provisions under which executives’ salary and deferred compensation can be
                recovered in the event of gross misconduct, gross negligence, conviction of a felony, or erroneous
                performance metrics.

     FHFA officials also have cited other beneficial aspects of the Enterprises’ executive compensation packages,
     such as limits on retirement formula calculations and expense reimbursements.




     13
      “The Financial Crisis Inquiry Report,” Final Report of the National Commission on the Causes of the Financial and Economic
     Crisis in the United States, January 27, 2011, available at http://www.fcic.gov/report.
     14
       Office of Federal Housing Enterprise Oversight (OFHEO), Report of the Special Examination of Freddie Mac, December
     2003, available at http://www.fhfa.gov/webfiles/749/specialreport122003.pdf; and OFHEO, Report of Special Examination
     of Fannie Mae, May 2006, available at http://www.fanniemae.com/media/pdf/newsreleases/FNMSPECIALEXAM.pdf.


11        FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
4. The Enterprises’ Total Executive Compensation in 2009 and 2010 Was Substantial

According to FHFA’s Acting Director, the Enterprises’ executive compensation packages for 2009 and
2010 set annual total compensation targets of $6 million for the Enterprises’ CEOs, $3.5 million for the
CFOs, and less than $3 million for Executive Vice Presidents and below. These annual targeted
compensation amounts will remain in place indefinitely, unless they are modified by FHFA. Figure 2 shows
that the approved compensation for the top six executives at Fannie Mae and Freddie Mac for 2009 and
2010 totaled more than $35.4 million. (Appendix A shows a more detailed breakdown of that amount.)
The Enterprises’ two CEOs received approximately half ($17 million) of the $35.4 million. However, had
the CEOs met their targeted total compensation levels, which they did not, they would have received an
additional $7 million. In other words, they could have been paid as much as $24 million over two years, an
extraordinary sum.15

                      Figure 2: Total Compensation of Top Six Senior Officers at Enterprises in 2009 and 2010

                                                                                                         $35,453,092
                  Total
                                                                      $18,460,914
               Compensation
                                                                  $16,992,178

                                                                  $17,147,274
               CEO/President                     $9,305,223
                                           $7,842,051

                                             $8,602,732
                         CFO        $4,635,250
                                $3,967,482

                                                  $9,703,086
                     CAO/GC         $4,520,441
                                    $5,182,645


                               $-                       $10,000,000             $20,000,000       $30,000,000          $40,000,000

                                Total Compensation               Fannie Mae         Freddie Mac

                Source: Fannie Mae and Freddie Mac 2009 and 2010 10-Ks




FHFA’s Acting Director has acknowledged that executive compensation levels under the compensation
packages are significant, but noted that they are substantially lower than they were before the
conservatorships began. According to the Acting Director, the Enterprises’ overall executive compensation
matches their pre-2000 levels, and are 40 percent below the levels at which they were paid shortly before
the conservatorships were established in September 2008.

The Acting Director regards the executives’ compensation levels as reasonable given the progress that the
Enterprises have made while in conservatorships. For example, in February 2010, the Acting Director
testified that both Enterprises made progress in 2009 in terms of their loss mitigation efforts and
achievement of reductions in credit losses.

15
  The annual targeted compensation for each CEO is $6 million annually or $12 million per year. Thus, the total targeted
compensation for both CEOs for 2009 and 2010 was $24 million.

                                                        FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011                   12
     FINDINGS

      In conducting this evaluation, FHFA-OIG found that FHFA: (1) has not reviewed issues necessary to
     determine whether the approved compensation packages for the Enterprises’ executives in 2009 are
     reasonable and whether compensation is sufficient to recruit and retain key professionals; (2) lacks key
     controls necessary to monitor the Enterprises’ ongoing compensation decisions under their approved
     packages; and (3) does not provide sufficient transparency to the public of the Enterprises’ executive
     compensation programs.




     1. FHFA Has Addressed Some High-Risk Enterprise Pay Issues, but Has Not Reviewed Key Issues
            to Determine Whether Compensation Levels Are Reasonable and Meet Enterprise Requirements


     Although FHFA has considered a number of factors in developing the Enterprises’ compensation packages,
     compensation remains a key management and risk area. The more than $35 million in total compensation
     awarded to the Enterprises’ top six officers in 2009 and 2010, as well as the prospects of continuing such
     compensation levels going forward, is likely to raise concerns from members of Congress and the public,
     especially given the level of taxpayer support for the Enterprises. Further, compensation is subject to
     frequent changes based upon evolving economic and policy issues that affect the housing markets and the
     operation of the Enterprises. Accordingly, FHFA-OIG recommends that the Enterprises’ executive
     compensation levels should be subject to ongoing Agency review and analysis.

     In this regard, the FHFA-OIG has identified the following matters as meriting FHFA’s review of the
     Enterprises’ current executive compensation levels:16 the disparity with compensation at federal housing
     entities, the impact of federal assistance, and recruitment and retention challenges.

     A. The Disparity in Compensation Between the Enterprises’ Executives and Senior Executives at Federal
        Entities that Are Providing Critical Support to the Housing Finance System, i.e., FHFA, Ginnie Mae
        and FHA

     Although the executives at the Enterprises have far more generous compensation packages than the
     executives at FHFA, Ginnie Mae, and FHA, FHFA has not conducted a comparability analysis that takes
     these differences into account.17 While such comparability analyses are a common means of establishing

     16
       On the basis of documents provided by FHFA, and FHFA-OIG staff discussions with Agency officials, the FHFA-OIG
     concludes that these issues were not fully considered in 2008 and 2009, during the development of the Enterprises’ executive
     compensation packages.
     17
       As discussed earlier, the Enterprises’ consultants did assist them in identifying comparable groups in developing their
     compensation plans. These comparable groups included large banks and insurance companies, as well as the Enterprises’
     themselves, but not FHA, FHFA, or Ginnie Mae.


13        FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
compensation levels, an FHFA official stated that the Agency never seriously considered comparing the
Enterprises’ compensation to compensation at FHFA, FHA, and Ginnie Mae. The official also stated that
there are key differences between the organizations, including their relative sizes and the complexity of
their operations. He noted that, for example, Ginnie Mae is a “pass-through” organization that simply
guarantees MBS issued by lenders and securitizers and is not responsible for credit risk management, which
is the job of FHA. In contrast, he stated that the Enterprises issue MBS and are responsible for credit risk
management.

Although there may be key differences between the Enterprises and FHA, FHFA, and Ginnie Mae, it is also
the case that FHA, FHFA, and Ginnie Mae play key roles in the mortgage finance system, and that their
senior officials make far less in compensation than the Enterprises’ executives. For example, Ginnie Mae
financed 29 percent of all newly-issued MBS in the third quarter of 2010, which is approximately the same
amount as Freddie Mac. Yet, HUD reports the President of Ginnie Mae’s compensation is less than
$200,000 annually. FHFA-OIG does not take a position as to whether compensation levels should be
comparable among the Enterprises’ executives and those of FHFA, FHA, and Ginnie Mae, but believes that
FHFA should formally review the current situation to account for the disparate levels of compensation and
render this issue transparent to Congress and members of the public.

B. The Extent to Which Federal Support of the Enterprises May Facilitate Their Capacity to Meet
   Performance Targets and, By Extension, the Ability of Their Executives to Achieve Higher Levels of
   Compensation That May Not Be Warranted

Since the Enterprises have been in conservatorships, Treasury has invested more than $153 billion to
maintain their stability and solvency. Further, in November 2008, the Federal Reserve announced that it
would purchase up to $1.25 trillion in the Enterprises’ MBS. Under this program, the Federal Reserve
purchased essentially all of the Enterprises’ net MBS issuances in 2009.

In 2009, executive compensation at
Fannie Mae was based on, among other        The annual report on Form 10-K provides a comprehensive
things, whether Fannie Mae was able to      overview of the company's business and financial condition and
issue at least 37.5 percent of all new      includes audited financial statements. Although similarly
MBS issues. Fannie Mae’s 2009 Form          named, the annual report on Form 10-K is distinct from the
10-K stated that it had exceeded its        “annual report to shareholders,” which a company must send to
annual corporate performance goal of        its shareholders when it holds an annual meeting to elect
issuing 37.5 percent of all new MBS         directors. See http://www.sec.gov/answers/form10k.htm
issuances by issuing 47 percent. It seems
unlikely that Fannie Mae could have
commanded such a large share of the market without the Federal Reserve’s purchases of its MBS.

Given the massive federal support, FHFA-OIG believes that FHFA should assess such instances and
determine whether discounts to the executives’ compensation should be applied as appropriate to
compensate for executive performance data that may be overstated because of federal assistance.


                                       FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011              14
     C. The Potential Challenges in Recruiting and Retaining Key Technical Expertise

     FHFA’s Acting Director has stated that recruitment and retention are key concerns given the Enterprises’
     uncertain future, especially given the Administration's recent proposal calling for the wind down of the
     Enterprises. Under the circumstances, the potential exists that key Enterprise professionals, such as
     specialists in MBS issuances or credit risk management, information technology, and accounting could be
     difficult to recruit and retain. FHFA officials have stated that the Enterprises are actively considering
     recruitment and retention issues, including whether their existing compensation packages are sufficient to
     attract and keep key technical personnel. FHFA anticipates that the Enterprises will complete these reviews
     over the next several months.

     FHFA should consider developing objective metrics with which to analyze the data produced by the
     Enterprises, and thereby gain a better understanding of their recruitment and retention issues. This would
     put the Agency in a position to provide more meaningful oversight of the Enterprises’ decision-making
     processes, as well as their implementation of any compensation-based strategies designed to address their
     recruitment and retention issues.



      2. FHFA Lacks a Number of Key Controls Necessary to Ensure the Effectiveness of Its Ongoing
                             Enterprise Executive Compensation Oversight Processes


     FHFA established the Enterprises’ overall compensation packages in 2009, and it has an ongoing oversight
     responsibility to ensure that annual compensation decisions made pursuant to the packages are appropriate.
     The Enterprises’ executives’ actual total direct compensation each year depends largely upon their
     performance in meeting pre-established financial and performance targets. Absent a rigorous and credible
     corporate performance measurement process, FHFA would not be well-positioned to provide assurance
     that the compensation being paid to executives at the Enterprises each year is justified. In that regard,
     FHFA-OIG determined that the Agency’s oversight processes lack a number of key controls necessary to
     help ensure their effectiveness, such as:

            Written evaluation criteria;
            Testing and verification procedures; and
            Documentation standards.

     FHFA officials have reported that the Agency plans to establish new oversight procedures for executive
     compensation, which is a positive development. However, these procedures, as described to FHFA-OIG,
     do not address all the limitations FHFA-OIG has identified.




15    FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
A. FHFA Has Not Adopted Standard Evaluation Criteria Under Which to Review the Enterprises’
   Proposed Corporate Performance Goals, or Their Performance Against Those Goals

The total compensation that the Enterprises’ executives are to receive each year is based largely upon their
performance in meeting pre-established financial and performance targets, such as reducing credit-related
losses. As such, it is critical that FHFA develop a credible process for monitoring the Enterprises’
development of various performance goals, as well as measuring their performance against those same
goals.

Figure 3, below, summarizes FHFA’s processes for reviewing and approving corporate performance, as
well as determining executive compensation levels.

    1) In advance of each calendar year, the Enterprises submit to FHFA for its review and approval the
       Enterprises’ proposed corporate performance goals and measures. Several offices within FHFA,
       including the OCO, the OPAR, and the Division of Enterprise Regulation (DER), review the
       proposed performance goals and measures. These offices examine the performance goals and
       measures only at the Enterprise level; they do not review them at the senior executive level. In
       other words, FHFA determines what will be the overall performance goals and total compensation
       pools of the Enterprises, and then delegates to the Enterprises decision-making authority regarding
       which executives are responsible for achieving such goals and what the total compensation for each
       such executive will be, subject to statutory limitations.


          Figure 3: FHFA’s Process for Reviewing and Approving the Enterprises’ Proposed Performance
          Goals and Measures, Self-Assessment Performance Data, and Executive Compensation Levels


           Beginning of Each                                        End of Each
            Calendar Year              FHFA: Reviews               Calendar Year           FHFA: Reviews
         •Enterprises: Submit          and Approves            •Enterprises: Submit        and Approves
          Proposed Corporate                                    Self Assessments
          Performance Goals       •Enterprises:                 and Results of        •Enterprises: Submit
          and Measures             Resubmit Modified            Measurements           Compensation
                                   Goals and Measures                                  Recommendations
                                   for Consensus                                       for Executives Based
             FHFA: Reviews                                           FHFA: Reviews     on Performance
             and Comments                                            and Approves

                                      Basis for Assessing Corporate & Executive
                                           Performance in the Coming Year




        FHFA lacks agency-wide or uniform documented procedures for the OCO, the OPAR, and the
        DER to review and approve the proposed corporate performance goals and measures. Owing to
        the dearth of records documenting the individual offices’ reviews, FHFA-OIG cannot opine



                                      FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011               16
                concerning: (i) precisely what review processes the individual FHFA offices employed; (ii) whether
                these offices employed consistent processes; or (iii) whether the processes employed are effective.

                Once these FHFA offices approve the goals and measures, the Enterprises’ board of directors must
                also approve them, and they become the basis for assessing corporate and executive performance
                for the coming year.

            2) At the end of the calendar year, the Enterprises submit self-assessments to FHFA in which they
               provide data concerning how they performed against the corporate goals established for the year.
               Similar to the practices employed when the OCO, the OPAR, and the DER review and approve
               performance goals and measures, these offices analyze successful achievement of the established
               goals at the Enterprise level only. Additionally, these offices have no agency-wide or uniform
               documented procedures for analyzing achievement of the goals. Accordingly, like with FHFA’s
               process for setting performance goals and measures, FHFA-OIG was unable to assess the efficacy of
               FHFA’s analysis of goal achievement.

                Once FHFA approves the performance data, the Enterprises’ boards of directors also must
                approve.

     FHFA has established various procedures to review the Enterprises’ corporate performance on an annual
     basis. However, as described above, certain management and internal controls necessary to help ensure the
     integrity of these processes are lacking. According to the Government Accountability Office (GAO) and
     the Office of Management and Budget (OMB), establishing and documenting management procedures is a
     key means by which to ensure that responsibilities are being carried-out and objectives attained.18 FHFA,
     however, has not developed substantive, written criteria for either evaluating the Enterprises’ proposed
     corporate performance goals (at the start of each calendar year) or their self-assessments of their success in
     achieving these goals (at year-end).

     Moreover, given that FHFA’s internal practices are not documented, FHFA-OIG is unable to gauge
     whether sufficient internal controls exist. For example, FHFA has not established content requirements for
     the Enterprises’ annual submissions. This could result in, among other things, variances in the contents of
     the Enterprises’ submissions.

     The lack of standardized evaluation criteria, documentation of management procedures, and internal
     controls therefore renders FHFA unable to demonstrate that its oversight of Enterprise executive
     compensation is effective, consistent, and reliable.


     18
       See GAO, Standards for Internal Control in the Federal Government, GAO/AIMD-00.21.3.1 (Washington, D.C., November
     1999) and Office of Management and Budget, Management’s Responsibility for Internal Control, OMB Circular No. A-123
     Revised, Appendix A, “Internal Control Over Financial Reporting” (Washington, D.C., December 2004). See also United States
     Government Accountability Office, Securities and Exchange Commission: Additional Actions Needed to Ensure Planned Improvements and
     Address Limitations in Enforcement Division Operations, GAO-07-830 (August 2007), http://www.gao.gov/new.items/d07830.pdf.




17        FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
B. FHFA’s Reviews of the Enterprises’ Recommended Compensation Levels for Individual Executives are
   Limited, Lack Written Criteria, and Do Not Include Testing and Verification

After FHFA approves the Enterprises’ performance self-assessments at the end of each calendar year, the
Enterprises submit for review compensation data for individual executives. The OCO, the OPAR, and the
DER then review the compensation data at the senior executive level. According to FHFA officials, the
Agency’s review of the Enterprises’ proposed individual executive compensation levels is limited. In
general, FHFA delegates to the Enterprises, through their compensation committees and boards of
directors, responsibility for determining the appropriate compensation for each executive, and accepts their
proposed recommendations unless there is an observed reason to do otherwise. FHFA officials have stated
that the OCO, the OPAR, and the DER focus their attention on those cases in which a proposed
compensation recommendation is “aberrant” or an “outlier,” i.e., very high or very low as compared to
compensation proposals made in the comparable financial firms listed in the affected Enterprises’ Forms 10-
K. FHFA officials have further stated that they give special attention to compensation proposals that are
inconsistent with the Agency’s experience with a particular executive.

As is the case with FHFA’s annual reviews of the Enterprises’ proposed corporate measures and self-
assessment data, FHFA has not adopted standard criteria by which to evaluate individual executive
compensation proposals. Thus, FHFA cannot, among other things, ensure the consistency of such annual
reviews.

Moreover, FHFA’s practice of accepting the Enterprises’ recommended compensation levels, unless they
are “aberrations” or “outliers,” is inconsistent with commonly accepted examination and auditing
procedures that call for testing and verification of key decisions. Absent such testing and verification, FHFA
lacks an empirical basis for concluding that the Enterprises are accurately and appropriately fixing their
executives’ compensation levels. Specifically, FHFA does not:

       Verify executives’ performance ratings;
       Reconstruct how an Enterprise calculated a recommended compensation level; or
       Determine whether such calculations were made in accordance with established policies and
        procedures.

Further, the lack of testing and verification does not provide a reasonable basis for outside observers, such
as FHFA-OIG, Congress, or taxpayers to be assured that the Enterprises are, in fact, making individual
compensation decisions consistent with policies and procedures.

C. FHFA’s Executive Documentation Policies and Procedures Are Inadequate

FHFA has not established procedures to ensure that key compensation documents are stored on a consistent
basis and readily available to relevant Agency officials and staff. For example, an FHFA official has stated
that, due to constrained personnel resources, many compensation documents remain largely inaccessible in
his office awaiting electronic filing. In another case, FHFA-OIG’s request for documents related to FHFA’s


                                      FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011                 18
     review and approval process was met by an Agency official’s instruction to an OPAR employee to
     download the requested material from the official’s FHFA email account, which is not available to other
     Agency staff on an ongoing basis. Without the means to file key documents in a consistent manner and,
     thereby make them readily accessible to Agency officials, FHFA’s ability to execute its compensation
     oversight functions is significantly decreased.

     D. FHFA’s Planned Policy Revisions May Not Be Sufficient

     Shortly before this evaluation concluded in March 2011, an Agency official stated that new procedures were
     being developed for executive compensation oversight. These procedures would reportedly establish a
     consistent basis for reviewing the Enterprises’ proposed corporate performance goals and self-assessment
     data. FHFA also is in the process of recruiting two professionals to enhance its executive compensation
     oversight processes. Although these initiatives are positive developments, the procedures’ final form
     remains to be seen. Moreover, as described to FHFA-OIG staff, the new procedures would not address at
     least one key limitation in the Agency’s procedures. Specifically, the proposed procedures do not include
     testing and verification of the Enterprises’ recommended executive compensation levels.



           3. FHFA Does Not Provide Sufficient Transparency to the Public of the Enterprises’ Executive
                                                         Compensation Programs


     A key principle associated with reforms to executive compensation is that the terms of such compensation
     must be transparent to shareholders and others. For example, in June 2009, Treasury Secretary Timothy
     Geithner set forth five broad-based principles that are intended to guide corporations in setting the rates at
     which their executives are compensated.19 The fifth principle is the promotion of transparency and
     accountability in the process of setting executive compensation. In discussing this principle, Secretary
     Geithner noted that “many of the compensation practices that encourage excessive risk-taking might have
     been more closely scrutinized if compensation committees had greater independence and shareholders had
     more clarity.” Moreover, Members of Congress have requested that the Enterprises enhance transparency
     in terms of their executive compensation practices and have introduced legislation designed to bring about
     this result.20

     Implementing the recommendations discussed previously in this evaluation would make the Enterprises’
     executive compensation practices more transparent. Specifically, conducting a formal analysis of the
     significant differences in compensation among the Enterprises, FHFA, FHA, and Ginnie Mae and whether
     they are warranted, might assist FHFA in articulating the basis for the Enterprises’ executive compensation
     levels, as well as making any adjustments that may be warranted. Further, strengthening the processes and


     19
          See Http://www.treasury.gov/press-center/press-releases/Pages/tg163.aspx.
     20
          House Financial Services Committee hearing, February 25, 2010.


19        FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
procedures by which it oversees the setting of the Enterprises’ executive compensation packages could
enhance FHFA’s capacity to provide assurances that such compensation is reasonable and justified.

FHFA also could take reasonable steps to enhance the availability of user-friendly information that is
available to the public about the Enterprises’ corporate performance and executive compensation. The
Enterprises’ 10-Ks contain considerable information about Enterprise performance goals, self-assessment
data, and executive compensation, and FHFA officials have claimed that such information is sufficient.
However, FHFA does not direct users of its website to the 10-K filings for performance and compensation
information. Further, the 10-K filings can be detailed and complex and they do not include trend data.

Accordingly, FHFA-OIG believes that FHFA should provide accessible and user-friendly executive
compensation information on its website, including:

       Links that specifically direct users to the Enterprises’ SEC filings for further information regarding
        their performance and executive compensation issues;
       Trend data showing how the Enterprises are performing in meeting key performance measures
        over time;
       Trend data showing executive compensation levels and whether such compensation is in line with
        the Enterprises’ performance; and
       Analyses that demonstrates the reasonableness of the compensation being paid to the Enterprises’
        senior executives.




                                      FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011                 20
     CONCLUSIONS

     In developing the Enterprises’ compensation packages, FHFA, to its credit, has consulted with key experts
     such as the Treasury Special Master for TARP Executive Compensation. FHFA also ensured the packages
     were performance-based and addressed concerns about problematic executive pay practices, such as “golden
     parachute” severance packages. However, given the government’s significant financial commitments to the
     Enterprises and the potential for significant additional taxpayer losses, multi-million dollar compensation
     packages paid to the Enterprises’ executives will likely continue to generate significant controversy.

     Accordingly, FHFA has an ongoing responsibility to review and analyze these packages carefully and
     continuously; and to ensure that they are, in fact, reasonable, intellectually defensible and economically
     appropriate. Further, FHFA has an obligation to develop a credible oversight process to ensure that annual
     compensation decisions made pursuant to the packages are appropriate, and to take reasonable steps to
     enhance transparency about the Enterprises’ performance and executive compensation levels.




     RECOMMENDATIONS

     To provide assurance that the Enterprises’ executive compensation levels are reasonable and appropriate,
     we recommend that FHFA establish an ongoing process of review and analysis that includes the following
     factors:

         1. The disparity in compensation between the Enterprises’ executives and the senior executives at
            federal entities that are providing critical support to the housing finance system, i.e., Ginnie Mae,
            FHFA, and FHA;
         2. The extent to which federal financial support for the Enterprises may facilitate their capacity to
            meet certain performance targets and, by extension, the capacity of their executives to achieve high
            levels of compensation that may not be warranted; and
         3. The potential challenges the Enterprises might face in recruiting and retaining technical expertise,
            which might include the employment of objective metrics to assess these issues and the extent to
            which existing compensation levels may need to be revised.

     To strengthen its oversight of the Enterprises’ ongoing executive compensation policies and practices
     pursuant to the compensation packages, FHFA should:




21    FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
    1. Establish written criteria and procedures for reviewing the Enterprises’ annual performance
       measures and year-end performance assessment data, as well as their recommended executive
       compensation levels;
    2. Conduct independent testing and verification, perhaps on a randomized basis, to gain assurance that
       the Enterprises’ bases for developing recommended individual executive compensation levels is
       reasonable and justified; and
    3. Create and implement policies to ensure that all key executive compensation documents are stored
       consistently and remain readily accessible to appropriate Agency officials and staff.

To enhance transparency associated with the Enterprises’ conservatorships and executive compensation,
FHFA should:

    1. Post on its Internet website summarized information about the Enterprises’ executive
       compensation packages, the Enterprises corporate performance goals and performance against
       those goals, executive compensation levels, and related trend data; and
    2. Establish links in these Internet website postings to SEC filings and other relevant information.




                                     FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011              22
     FHFA COMMENTS AND FHFA-OIG’S RESPONSE

     FHFA-OIG provided a draft of this evaluation to FHFA for its review and comment. On March 29, 2011,
     FHFA’s Chief Economist provided the Agency’s written comments, which are published verbatim in
     Appendix B. FHFA agreed to:

             1. Study how federal support for the Enterprises and their conservatorship status may facilitate
             their capacity to meet certain performance goals;
             2. Institute a practice of regularly monitoring and evaluating metrics associated with recruitment
             and retention of employees and considering appropriate compensation levels;
             3. Establish a formal and systematic approach for reviewing the Enterprises’ performance measures
             and self-assessment data;
             4. Strengthen its executive compensation document storage systems; and
             5. Consider options for improving the transparency of the Enterprises’ executive compensation
             programs, including establishing links to their securities filings on FHFA’s website.
     FHFA did not agree, however, with FHFA-OIG’s recommendations to: (1) assess disparities in
     compensation among senior officials of the Enterprises and of FHFA, FHA, and Ginnie Mae; and (2) test
     and verify the Enterprises’ annual salary recommendations for their senior executives.
     In its written comments, FHFA stated that private sector compensation scales are the most useful
     comparables given the size and complexity of the Enterprises’ activities. FHFA added that no government
     agency comes close to being able to manage the Enterprises’ varying activities without relying on private
     contractors (FHFA-OIG questions the validity of this assertion, given that the Enterprises rely heavily on a
     wide spectrum of private sector contractors and consultants), and, therefore, government pay levels are not
     useful benchmarks by which to evaluate the Enterprises’ pay levels.
     FHFA-OIG noted the distinctions between the Enterprises and the three federal agencies in the draft
     evaluation report. FHFA-OIG also has indicated, however, that FHFA’s exclusive reliance upon private
     sector salary comparisons fails to take into account the critical distinction between the Enterprises and other
     companies, e.g., the $153 billion in federal funds and other federal assistance that the Enterprises have
     received to date, and the unique advantage that federal assistance may provide their executives in meeting
     their individual performance goals. Accordingly, FHFA-OIG continues to believe that FHFA should
     conduct a formal comparability analysis between the Enterprises and the three federal agencies involved in
     the mortgage market in order to arrive at appropriate levels of executive compensation. Additionally, such
     an analysis would enhance transparency regarding such compensation.
     Although FHFA stated that testing of the Enterprises’ corporate performance goals is desirable, and
     processes are in place to do so, the Agency also noted that it does not conduct such testing of recommended
     compensation for individual executives. FHFA stated that it relies on the Enterprises’ boards of directors

23    FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
and senior management to establish such compensation levels. FHFA added that it reviews the results for
reasonableness and has requested reconsideration in some instances.
As stated in the report, FHFA’s policy of not testing and verifying recommended individual compensation
levels is not fully consistent with examination and auditing standards, which require a degree of professional
skepticism in evaluating the activities of regulated entities. Absent such testing, FHFA lacks an empirical
basis for concluding that the Enterprises are appropriately setting executive compensation levels. Similarly,
FHFA’s lack of verification does not provide a reasonable basis for outside observers, such as FHFA-OIG,
Congress, and taxpayers to be assured that the Enterprises are, in fact, making compensation decisions
consistent with policies and procedures.




                                      FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011                 24
     APPENDIX A: ENTERPRISES’ TOTAL DIRECT
     COMPENSATION


                                       Total Direct Compensation of Top Six Executives
                                 Fannie Mae and Freddie Mac, Calendar Years 2009 and 2010
                                 Base Salary Rate                Deferred Pay        Long-Term Incentive       Total
                                                                                           Awards          Compensation
                                                                                                               Paid
                                 2009          2010           2009          2010      2009        2010      2009 & 2010
       Fannie Mae
          CEO/President      $   860,523 $ 900,000 $ 2,867,200 $ 2,945,000 $ 832,500 $ 900,000 $ 9,305,223
          CFO                    675,000     425,000   1,700,000     992,750     517,500     325,000    4,635,250
          CAO/GC                 439,346     500,000   1,278,610   1,396,184     421,301     485,000    4,520,441
       Total                 $ 1,974,869 $ 1,825,000 $ 5,845,810 $ 5,333,934 $ 1,771,301 $ 1,710,000 $ 18,460,914
       Freddie Mac
          CEO                $ 1,084,435 $ 900,000 $         1,227,083 $ 2,912,450 $ 395,833 $ 1,322,250 $       7,842,051
          CFO                    259,343     675,000           370,999    1,558,005     428,002     676,133      3,967,482
          GC/Secretary           600,000     500,000         1,260,000    1,277,720     663,750     881,175      5,182,645
       Total                 $ 1,943,778 $ 2,075,000 $       2,858,082 $ 5,748,175 $ 1,487,585 $ 2,879,558 $    16,992,178
       Total - Enterprises   $ 3,918,647 $ 3,900,000 $       8,703,892 $ 11,082,109 $ 3,258,886 $ 4,589,558 $   35,453,092
       Source: Fannie Mae and Freddie Mac 2009 and 2010 SEC 10-K Filings.




25   FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
APPENDIX B: MANAGEMENT COMMENTS TO THE
DRAFT REPORT




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FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011   28
29   FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011
APPENDIX C: MAJOR CONTRIBUTORS TO THIS
REPORT


DAVID BLOCH

MADHURI EDWARDS

ANDREW GEGOR

JAY JACOBSEN

JACOB KENNEDY (REFERENCER)

WESLEY M. PHILLIPS

BRYAN SADDLER

DAVID SEIDE




                             FEDERAL HOUSING FINANCE AGENCY | EVL-2011-002 | 03/31/2011   30
     ADDITIONAL INFORMATION AND COPIES



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                     Fax your request to: 202-445-2075
                 Visit the OIG web site at: www.fhfaoig.gov




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                              Write to us at:
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