oversight

FHFA-OIG's Current Assessment of FHFA's Conservatorships of Fannie Mae and Freddie Mac

Published by the Federal Housing Finance Agency, Office of Inspector General on 2012-03-28.

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

      FEDERAL HOUSING FINANCE AGENCY
        OFFICE OF INSPECTOR GENERAL


      White Paper: FHFA-OIG’s Current
     Assessment of FHFA’s Conservatorships
         of Fannie Mae and Freddie Mac




White Paper: WPR-2012-001          Dated: March 28, 2012
                               FHFA-OIG’s Current Assessment of FHFA’s
                             Conservatorships of Fannie Mae and Freddie Mac
Background                                                            Summary
In 2007 and 2008, as the residential housing market experienced        As the Enterprises’ regulator and conservator, FHFA has
a sharp decline, the Federal National Mortgage Association             considerable discretion in defining its role and choosing its
            Evaluation of FHFA’s Oversight of Freddie
(Fannie Mae) and the Federal Home Loan Mortgage Corporation
                                                                                Mac’s Repurchase Settlement
                                                                       actions. FHFA’s role as conservator has evolved over time. At
                                                     with
(Freddie Mac) (collectively, the Enterprises) suffered        Bank
                                                         billions of ofthe
                                                                         America
                                                                            outset of the conservatorships, FHFA forbade the
dollars in losses. In response to these losses and to stabilize the    Enterprises from engaging in certain activities and retained
broader financial markets, the Housing and Economic Recovery           approval authority over others. Soon thereafter, FHFA
Act of 2008 (HERA) was enacted on July 30, 2008. HERA,                 delegated day-to-day operational decision-making to the
among other things, created the Federal Housing Finance Agency Enterprises’ directors and managers. Debate as to the proper
(FHFA or Agency) to assume the role of the Enterprises’ safety,        parameters of the Agency’s role as a conservator arose and
soundness, and housing mission regulator. HERA also provided           continues. FHFA-OIG believes that FHFA needs to assume a
a regime, if needed, to guide the Enterprises through insolvency.      more active role, and, thus, as discussed in Appendix A, FHFA-
This regime includes authority for the U.S. Department of the          OIG’s reports consistently have revealed two trends: (1) the
Treasury (Treasury) to provide financial support to the                Agency, in its role as a conservator, does not independently test
Enterprises.                                                           and validate Enterprise decision-making; and (2) the Agency, in
                                                                       its role as a regulator, is not proactive in its oversight and
Less than six weeks later, on September 6, 2008, Fannie Mae
                                                                       enforcement. In addition, FHFA may not have enough
and Freddie Mac entered conservatorships overseen by the
                                                                       examiners to meet its oversight responsibilities.
Agency, and Treasury began to make substantial purchases of the
Enterprises’ senior preferred stock. As of December 31, 2011,          Additionally, FHFA faces significant challenges in managing the
Treasury has committed over $183 billion to support the                conservatorships of the Enterprises. These challenges include:
Enterprises.                                                           (1) attempting to advance the Enterprises’ business interests
                                                                       while assisting distressed homeowners; and (2) simultaneously
Although they were expected to be temporary, the
                                                                       serving as both the Enterprises’ conservator and regulator.
conservatorships have been in place for over three years, and
there is no end in sight. FHFA estimates that, by the end of           As if these challenges were not daunting enough, the uncertain
2014, between $220 and $311 billion in financial support will          future of the Enterprises overshadows all aspects of FHFA’s
have been drawn from the Treasury, and FHFA’s Acting                   regulatory and conservatorship efforts. Although FHFA
Director has stated that taxpayers are unlikely to be fully repaid     recently published a strategic plan for the next phase of the
for their support.                                                     conservatorships (that focuses on building infrastructure for a
                                                                       private secondary mortgage market), the best method for
Scope
                                                                       resolving the Enterprises is dependent on many variables
In this white paper, the FHFA Office of Inspector General              outside of FHFA’s control. These variables include the health
(FHFA-OIG) provides background on the history of the                   of housing finance markets, and debate about what the nation’s
Enterprises leading up to the creation of the conservatorships and mortgage finance system should look like. These variables are
describes their operations to date. It also includes an appendix       important to the American taxpayer, who has been financially
that discusses pertinent issues raised in FHFA-OIG reports.            supporting – and likely will continue to support – the
                                                                       Enterprises. Meanwhile, the practical issues of how FHFA
                                                                       should best manage the conservatorships need careful attention
                                                                       and oversight.

White Paper: WPR-2012-001                                      2                                     Dated: March 28, 2012
      Table of Contents
      Table of Contents .............................................................................................................................. 3
      Abbreviations .................................................................................................................................... 5
      Preface.............................................................................................................................................. 6
      Background....................................................................................................................................... 7
         A.      Evolving Federal Role in Housing Finance ............................................................................... 7
         B.      The Enterprises’ Three Lines of Business ................................................................................. 8
              Single-Family .......................................................................................................................... 8
              Multifamily .............................................................................................................................. 9
              Investment and Capital Markets .............................................................................................. 9
         C.      Fannie Mae and Freddie Mac: 2000 – 2008 ............................................................................. 9
         D.      The Conservatorships ........................................................................................................... 11
              Conservatorships Established ................................................................................................ 11
              Treasury’s Financial Support................................................................................................. 12
              Emergency Economic Stabilization Act of 2008 .................................................................. 13
              The Fragile U.S. Housing Market ......................................................................................... 14
      Conservatorships in Operation .......................................................................................................... 17
         A. FHFA’s Duties and Responsibilities ......................................................................................... 17
              FHFA’s Duties as Regulator Under HERA ........................................................................... 17
              FHFA’s Discretionary/Permissive Powers as Conservator Under HERA ............................ 18
              FHFA’s Duties Under EESA ................................................................................................. 19
         B. Treasury Agreements .............................................................................................................. 19
         C. FHFA’s Governance Milestones .............................................................................................. 20
              Office of Conservatorship Operations ................................................................................... 20
              Conservatorships Governance Committee ............................................................................ 21
              FHFA’s Conservatorships Rule ............................................................................................. 21
         D. Highlights of FHFA’s Conservatorships ................................................................................... 22
              FHFA’s General Approach to Conservatorships ................................................................... 22
                 Efficiency ............................................................................................................................ 23
                 Concordant Goals ................................................................................................................. 23
White Paper: WPR-2012-001                                                3                                               Dated: March 28, 2012
                Operational Savings .............................................................................................................. 23
            Specific Improvement Efforts ............................................................................................... 24
                Foreclosure Prevention ......................................................................................................... 24
                Other Programs .................................................................................................................... 24
      Challenges Faced by FHFA .............................................................................................................. 26
         A. Unique Nature of the Conservatorships .................................................................................... 26
         B. Mission Tensions .................................................................................................................... 28
         C. Tension Between Roles as Regulator and as Conservator .......................................................... 30
         D. An Uncertain Future ............................................................................................................... 31
      Conclusion ...................................................................................................................................... 33
      Scope and Methodology ................................................................................................................... 34
      Appendix A .................................................................................................................................... 35
      Appendix B ..................................................................................................................................... 41




White Paper: WPR-2012-001                                               4                                              Dated: March 28, 2012
      Abbreviations
      EESA..................................................................... Emergency Economic Stabilization Act of 2008
      Fannie Mae......................................................................... Federal National Mortgage Association
      FCIC ......................................................................................... Farm Credit Insurance Corporation
      FDIC ................................................................................... Federal Deposit Insurance Corporation
      FHA............................................................................................... Federal Housing Administration
      FHFA or Agency.......................................................................... Federal Housing Finance Agency
      FHFA-OIG ..................................... Federal Housing Finance Agency, Office of Inspector General
      FHLBank.................................................................................................. Federal Home Loan Bank
      Freddie Mac .................................................................. Federal Home Loan Mortgage Corporation
      GSE ............................................................................................ Government-Sponsored Enterprise
      HAMP ...............................................................................Home Affordable Modification Program
      HARP ................................................................................... Home Affordable Refinance Program
      HUD ............................................................ U.S. Department of Housing and Urban Development
      HERA.......................................................................Housing and Economic Recovery Act of 2008
      MBS ..................................................................................................... Mortgage-Backed Securities
      NCUA ...................................................................................National Credit Union Administration
      OCO ...................................................................................... Office of Conservatorship Operations
      OFHEO ................................................................. Office of Federal Housing Enterprise Oversight
      PSPAs ....................................................................... Senior Preferred Stock Purchase Agreements
      Treasury ........................................................................................ U.S. Department of the Treasury




White Paper: WPR-2012-001                                        5                                         Dated: March 28, 2012
                                    Federal Housing Finance Agency

                                       Office of Inspector General

                                             Washington, DC

                                                 Preface
      FHFA-OIG was established by HERA,1 which amended the Inspector General Act of 1978.2
      FHFA-OIG is authorized to conduct audits, investigations, and other studies 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 white paper provides an overview of the operations of FHFA’s conservatorships.

      This white paper was written principally by Investigative Counsel Nicole R. Mark and Assistant
      Inspector General David M. Frost. It has been distributed to Congress, the Office of
      Management and Budget, and others and will be posted on FHFA-OIG’s website,
      www.fhfaoig.gov.




      George Grob
      Deputy Inspector General for Evaluations




      1
          Public Law No. 110-289.
      2
          Public Law No. 95-452.


White Paper: WPR-2012-001                        6                             Dated: March 28, 2012
      Background
      Before the Great Depression of the 1930s, housing finance was
      exclusively the province of the private sector and generally consisted                                Thrift
      of short-term renewable loans.3 The features of these loans, which                           A financial institution that
      generally included high down payments (approximately half of the                             focuses on taking deposits
      home’s purchase price), short maturities (10 years or less), and large                          and originating home
                                                                                                     mortgages. Thrift banks
      balloon payments, presented significant challenges to widespread
                                                                                                  often have access to low-cost
      home ownership.                                                                             funding from Federal Home
                                                                                                   Loan Banks, which allows
      Further, these pre-Depression era loans typically were funded locally                        for higher savings account
      by life insurers, commercial banks, and thrifts. In the absence of a                           yields to customers and
                                                                                                      increased liquidity for
      nationwide housing finance market, availability and pricing for
                                                                                                         mortgage loans.
      mortgage loans varied widely across the country.
                                                                                                           Read more:
      A.         Evolving Federal Role in Housing Finance                                     http://www.investopedia.com/terms
                                                                                              /t/thriftbank.asp#ixzz1f8HBXcuEhtt
      In response to the Depression era housing crisis, Fannie Mae was                        p://www.investopedia.com/terms/m/
                                                                                     established   in 1938 as a federal
                                                                                                     mbs.asp#ixzz1eRmaEiSs
      government agency.4 Its mandate was to act as a secondary mortgage market facility that could
      purchase, hold, and sell loans insured by the Federal Housing Administration (FHA). By
      purchasing these FHA-insured loans from private lenders, Fannie Mae provided lenders with
      cash to fund new home loans, thus injecting liquidity into the mortgage market.

      In 1954, Fannie Mae was transformed from a government agency to a public-private, mixed
      ownership corporation.5 Later, in 1968, Fannie Mae was reorganized into a publicly-traded, for-
      profit, shareholder-owned company.6 As part of the reorganization, Fannie Mae was subjected to
      regulation by the U.S. Department of Housing and Urban Development (HUD).

      In 1970, the secondary mortgage market was expanded with the establishment of Freddie Mac,
      which was intended to help thrifts manage challenges associated with interest rate risk.7

      3
       A more detailed description of the history of housing finance in the United States is available at:
      http://www.fhfaoig.gov/Content/Files/History%20of%20the%20Government%20Sponsored%20Enterprises.pdf. In
      addition, a diagram showing the evolving federal housing role is included as Appendix B to this white paper.
      4
          See The National Housing Act Amendments of 1938, Title II, 52 Stat. 8 (Feb. 3, 1938).
      5
          See Public Law No. 83-560.
      6
          See Public Law No. 90-448.
      7
          See Public Law No. 91-351.


White Paper: WPR-2012-001                                  7                                      Dated: March 28, 2012
      Specifically, Freddie Mac purchased long-term mortgages from thrifts, increasing their capacity
      to fund additional mortgages and reducing their interest rate risk. The legislation that established
      Freddie Mac also authorized the Enterprises to buy and sell mortgages that were not insured or
      guaranteed by the government. Later in 1989, Freddie Mac was reorganized into a publicly-
      traded, for-profit corporation owned by private shareholders.8

      Federal regulation of the Enterprises changed in 1992 with the creation of the Office of Federal
      Housing Enterprise Oversight (OFHEO), which was an independent regulator within HUD.9
      OFHEO had the authority to conduct routine safety and soundness examinations of Fannie Mae
      and Freddie Mac and to take enforcement actions. The 1992 legislation that created OFHEO
      also amended Fannie Mae’s and Freddie Mac’s charters, requiring them to meet an “affirmative
      obligation to facilitate the financing of affordable housing for low-income and moderate-income
      families.” HUD was designated as the Enterprises’ affordable housing mission regulator.

      B.         The Enterprises’ Three Lines of Business

      The Enterprises have three primary business lines: single-family; multifamily; and investment
      and capital markets.

                          Single-Family

      In their single-family business line, the Enterprises buy single-family mortgages from mortgage
      companies, commercial banks, credit unions, and other financial institutions.10 They hold these
      mortgages in their investment portfolio or securitize them. Regarding securitization, the
      Enterprises bundle loans into mortgage-backed securities (MBS) that they, in turn, sell to
      investors.11 When homeowners make their payments of mortgage principal and interest each
      month, these payments are ultimately transferred (passed-through) to securities investors.

      Typically, the Enterprises receive a “guarantee fee” that is ultimately funded by investors. In
      exchange for this fee, the Enterprises guarantee the payment of principal and interest on their
      MBS. In the event that a homeowner stops making mortgage payments, the Enterprise that
      originated and guaranteed the subject MBS steps in and makes the payments to securities


      8
          Public Law No. 101-73.
      9
          Public Law No. 102-550.
      10
        Some lenders sell single-family mortgages outright to the Enterprises for cash, others exchange them for
      mortgage-backed securities. The cash price paid by an Enterprise depends on the required yield of the loan, which
      includes an implicit guarantee fee. Larger lenders primarily swap loans for mortgage-backed securities. Smaller
      lenders often choose to sell whole loans for cash because they lack the volume and capacity to utilize effectively the
      Enterprises’ swap programs. See Fannie Mae and Freddie Mac G Fee Report Final.pdf, pp 4 and 10.
      11
           Freddie Mac issued the first conventional MBS in 1971.


White Paper: WPR-2012-001                                  8                                     Dated: March 28, 2012
      investors. The Enterprises set the guarantee fees to cover projected credit losses from borrower
      defaults over the life of the loans, administrative costs, and a return on capital.

      In 2010, the Enterprises significantly increased their purchases of delinquent loans from single-
      family MBS trusts. This allowed the Enterprises to use their own lower cost debt to remove non-
      performing, high-interest loans from MBS that they had guaranteed. The Enterprises re-pay the
      investors for the balances of those non-performing loans and then place them in their own
      portfolios, thus realizing substantial cost savings. In 2011, Fannie Mae’s average single-family
      guarantee book of business was approximately $2.9 trillion, and Freddie Mac’s was
      approximately $1.8 trillion.

                         Multifamily

      In their multifamily business line, the Enterprises work with a network of lenders to finance
      apartment buildings across the country. Similar to their single-family business line, the
      Enterprises purchase loans from private lenders and either hold them in their investment
      portfolios or securitize and sell them.

      Multifamily lending has played an important role in how the Enterprises have fulfilled past
      affordable housing mandates. However, the Enterprises do not dominate the multifamily market
      as they do the single-family market. In 2011, Fannie Mae’s average multifamily guaranty book
      of business was approximately $192 billion, and Freddie Mac’s was approximately $174 billion.

                         Investment and Capital Markets

      The Enterprises third line of business involves management of their sizable portfolios of
      mortgages, mortgage-related securities, and other investments. In 2011, Fannie Mae had an
      average total capital markets investment portfolio of $708 billion, and Freddie Mac had a $653
      billion portfolio.

      C.         Fannie Mae and Freddie Mac: 2000 – 2008

      From 2001 until reaching its peak in 2006, the U.S. housing market experienced a rapid increase
      in the valuation of real property.12 This swift escalation is often referred to as the “housing
      bubble.” During this time, Fannie Mae’s and Freddie Mac’s growth generally mimicked real
      property values. Fannie Mae’s assets and guaranteed mortgages increased from $1.3 trillion in
      2000 to $3.1 trillion in 2008, or 11% annually. Likewise, Freddie Mac’s assets and guaranteed
      mortgages increased from $1 trillion in 2000 to $2.2 trillion in 2008, or 10% annually.


      12
           Between 1997 and 2006, home values increased 124%.


White Paper: WPR-2012-001                               9                        Dated: March 28, 2012
      The Enterprises average annual growth of 10% or more was
      stimulated, in part, by aggressive strategies to purchase mortgages
      and mortgage assets originated under questionable underwriting                           Alt-A Mortgage
      standards. For example, the Enterprises purchased large volumes
                                                                                          There is no uniform definition
      of Alt-A mortgages, which typically lacked full documentation of                       of Alt-A mortgages, but a
      borrowers’ incomes and had higher than usual loan-to-value or                        useful working definition is:
      debt-to-income ratios. Additionally, starting in 2001 for Freddie                   A classification of mortgages
                                                                                          in which the risk profile falls
      Mac and 2002 for Fannie Mae, the Enterprises began purchasing                       between prime and subprime.
      private-label MBS collateralized by subprime mortgages, in                            The borrowers involved in
      order to supplement their investment returns and achieve housing-                     these mortgages generally
      related goals.                                                                        have clean credit histories,
                                                                                            but the mortgage itself has
                                                                                           some issues that increase its
      In 2007, housing prices plummeted and loan delinquencies and                           risk profile. These issues
      defaults significantly increased. Fannie Mae and Freddie Mac lost                    include higher loan-to-value
      billions of dollars on their multi-trillion dollar MBS guarantee                    and debt-to-income ratios or
      obligations and investment portfolios. The Enterprises’ single-                     inadequate documentation of
                                                                                              the borrower’s income.
      family business line incurred the greatest losses by far. This line
      suffered $208 billion in capital losses from the end of 2007                          Subprime Mortgage
      through the third quarter of 2011.13 As shown in Figure 1 below,
                                                                                          There is no uniform definition
      from the end of 2007 through the third quarter of 2011, the
                                                                                          of subprime mortgages, but a
      Enterprises had combined losses of $261 billion, and single-family                   useful working definition is:
      losses represented $208 billion of this total.                                        A type of mortgage that is
                                                                                          normally made to borrowers
                                                                                           with lower credit ratings. As
                                                                                             a result of the borrower’s
                                                                                               lower credit rating, a
                                                                                          conventional mortgage is not
                                                                                            offered because the lender
                                                                                          views the borrower as having
                                                                                          a larger-than-average risk of
                                                                                              defaulting on the loan.
                                                                                             Lending institutions often
                                                                                           charge interest on subprime
                                                                                            mortgages at a higher rate
                                                                                                than a conventional
                                                                                               mortgage, in order to
                                                                                            compensate themselves for
                                                                                                carrying more risk.



      13
        A disproportionate share of these credit losses is from nontraditional and higher-risk mortgages (e.g., Alt-A and
      subprime mortgages) and is concentrated in loans originated during the housing bubble. However, housing price
      declines and prolonged economic malaise have also taken a toll on the credit performance of traditional mortgages.


White Paper: WPR-2012-001                                 10                                    Dated: March 28, 2012
      Figure 1: Enterprises Losses from the End of 2007 Through the Third Quarter of 201114


                                                             Investments and Capital
                                           Single Family     Markets and Multifamily   Senior Preferred Dividends
                                 $0


                                -$50
        Losses in $ Billions




                               -$100


                               -$150


                               -$200


                               -$250

      Source: Conservator’s Report on the Enterprises’ Financial Performance, Third Quarter 2011, available at:
      http://www.fhfa.gov/webfiles/19585/Conservator's_Report112910.pdf, pg. 9.

      Additionally, as foreclosures and losses increased, investor confidence in the Enterprises
      deteriorated. This led to a sharp increase in the Enterprises’ borrowing costs and drastic declines
      in shareholder equity, triggering concerns about their potential failures and the broader
      implications of the same.

      On July 30, 2008, in response to the Enterprises’ feeble financial condition and concerns about
      the stability of the financial markets as a whole, HERA was enacted. HERA established FHFA
      as the safety, soundness, and housing mission regulator of the Enterprises. Additionally, section
      1145 of HERA authorized FHFA to appoint conservators for the Enterprises for a variety of
      reasons including inability to meet obligations or undercapitalization. This set the stage for the
      ensuing FHFA conservatorships of the Enterprises.

       D.                        The Conservatorships

                                       Conservatorships Established

      A conservatorship is the legal process in which a person or entity is appointed to establish
      control and conduct oversight of a company, in order to return it to a sound and solvent

      14
        The Enterprises had available capital of $78 billion, so the actual capital deficit through third quarter of 2011 is
      $183 billion. This figure matches Treasury’s commitments to the Enterprises to date.


White Paper: WPR-2012-001                                        11                                 Dated: March 28, 2012
      condition. In a conservatorship, the powers of the company’s directors, officers, and
      shareholders are transferred to the conservator. On September 6, 2008, the then-FHFA Director
      appointed FHFA as the conservator for Fannie Mae and Freddie Mac. At the time, FHFA stated:

                 The purpose of appointing the Conservator is to preserve and conserve the [Enterprises’]
                 assets and property and to put the [Enterprises] in a sound and solvent condition. The
                 goals of the conservatorship are to help restore confidence in [Fannie Mae and Freddie
                 Mac], enhance [their] capacity to fulfill [their] mission, and mitigate the systemic risk
                 that has contributed directly to the instability in the current market.15

      In September 2008, when the conservatorships were created, they were regarded as temporary
      mechanisms. The then-FHFA Director stated that he hoped that the “[c]onservatorship will give
      the Enterprises the time to restore the balances between safety and soundness and provide
      affordable housing and stability and liquidity to the mortgage markets.”16 Moreover, the then-
      Treasury Secretary described the conservatorships as a “time-out” to allow policymakers to
      further consider the future role of the federal government and the Enterprises in the housing
      finance system.17

      As the Enterprises’ conservator, FHFA appointed new Chief Executive Officers for Fannie Mae
      and Freddie Mac and immediately instructed each Enterprise to examine its underwriting
      standards and pricing.18 However, although FHFA initially took control of the Enterprises, it has
      re-delegated to them many of their essential functions. For example, FHFA has generally
      delegated:

                         To the boards of directors, authority to oversee the Enterprises; and

                         To management, authority to conduct the Enterprises’ day-to-day operations.

                          Treasury’s Financial Support

      Simultaneous with the commencement of the conservatorships, Treasury exercised its authority
      under HERA “to purchase any obligations and other securities” issued by the Enterprises19 and

      15
       See FHFA, Questions and Answers on Conservatorship, available at:
      www.fhfa.gov/webfiles/35/FHFACONSERVQA.pdf.
      16
           FHFA Statement by Lockhart 9708 final.pdf, at 10.
      17
        Statement by Secretary Henry M. Paulson, Jr. on Treasury and Federal Housing Finance Agency Action to Protect
      Financial Markets and Taxpayers, September 7, 2008, available at http://www.treasury.gov/press-center/press-
      releases/Pages/hp1129.aspx.
      18
           FHFA_StrategicPlan_2009-2014n, p.30; see also 092308 FHFA Hearing Stmt corrected 092608, pg 6.
      19
           Public Law No. 110-289 § 1117.


White Paper: WPR-2012-001                                  12                               Dated: March 28, 2012
      began to purchase preferred stock pursuant to the Senior Preferred Stock Purchase Agreements
      (PSPAs). As of December 31, 2011, Treasury has provided $183 billion in support to the
      Enterprises under the PSPAs. FHFA predicts that by the end of 2014, Treasury will have
      invested between $220 billion and $311 billion in the Enterprises.

      Under the terms of the PSPAs, the Enterprises must make quarterly dividend payments to
      Treasury at an annual rate equal to 10% of Treasury’s outstanding investment. To date, Treasury
      generally has had to increase its investment in the Enterprises to finance their dividend
      payments.

                         Emergency Economic Stabilization Act of 2008

      Soon after the Enterprises were placed into conservatorships, and as the financial crisis
      continued, the Emergency Economic Stabilization Act of 2008 (EESA) was enacted. EESA
      requires FHFA to:

                        Implement a plan to maximize assistance to homeowners;

                        Use its authority to encourage the servicers of Fannie Mae and Freddie Mac
                         mortgages, considering net present value, to take advantage of federal programs
                         to minimize foreclosures;

                        Coordinate within the federal government concerning homeowner assistance
                         plans; and

                        Submit monthly reports to Congress detailing the progress of its efforts. 20

                         The Evolving Nature of FHFA’s Conservatorships

      FHFA’s conservatorships of the Enterprises have evolved over time. As reflected above, FHFA
      initially viewed the conservatorships as short-term undertakings designed to maintain the
      Enterprises’ business operations. It was – and remains – FHFA’s position that it lacks the
      authority to impose a long-term solution to the Enterprises’ situations and that any such solution
      must be legislative in nature. Thus, early in the conservatorships, FHFA’s primary concern was
      to keep the Enterprises functioning, persuade employees to remain notwithstanding an uncertain
      future, and ensure the smooth transition of executive management teams.

      As time went on and no long-term solution appeared to be imminent, FHFA began to lay the
      foundations for improving critical aspects of the nation’s ailing housing finance system while
      maintaining the Enterprises’ operations over an extended period of time. Starting in early 2010,
      20
           Public Law No. 110-343 § 110 (Oct. 3, 2008).


White Paper: WPR-2012-001                                 13                           Dated: March 28, 2012
      FHFA focused on conserving assets, minimizing corporate losses, and ensuring the Enterprises
      continue to serve their missions. Specific details about these and other programs are discussed in
      greater detail in Section D, Highlights of FHFA’s Conservatorships, under the “Conservatorships
      in Operation” heading.

      More recently, FHFA has issued a strategic plan for the next phase of the conservatorships. The
      plan focuses on building a new secondary mortgage market infrastructure.21

                        The Fragile U.S. Housing Market

      Presently, Fannie Mae, Freddie Mac, and FHA dominate mortgage lending. Combined, they
      guarantee or insure over 90% of mortgage originations. However, the contemporary housing
      market pales in comparison to its size during the housing bubble. Since their peak in early 2006,
      home prices have declined substantially as illustrated by the Fannie Mae Home Price Index and
      the S&P/Case-Shiller Index, as depicted in Figure 2, below.22




      21
         FHFA, Strategic Plan for Enterprise Conservatorships: The Next Chapter in a Story that Needs an Ending,
      (February 21, 2012) pg 4, available at:
      http://www.fhfa.gov/webfiles/23344/StrategicPlanConservatorshipsFINAL.pdf
      22
         The S&P/Case-Shiller index is a group of indexes that tracks changes in home prices throughout the United
      States. The indexes are based on a constant level of data on properties that have undergone at least two arm’s length
      transactions. See http://www.investopedia.com/terms/s/sandp_case_shiller_index.asp#ixzz1oGtKuGM7.


White Paper: WPR-2012-001                                 14                                     Dated: March 28, 2012
      Figure 2: Home Price Growth/Decline Rates in the U.S.
        20%

        15%

        10%

         5%

         0%

         -5%

        -10%

        -15%

        -20%

        -25%
                2000    2001    2002    2003    2004    2005     2006    2007       2008   2009   2010   2011

                                 Fannie Mae Home Price Index            S&P/Case-Shiller Index

      Source: Fannie Mae 2011 Credit Supplement, February 29, 2012, available at:
      www.fanniemae.com/ir/pdf/sec/2011/q1credit_summary.pdf, pg 3.



      Moreover, as the Federal Reserve recently observed, the housing market remains fragile due to
      massive numbers of “underwater” or “negative equity” mortgages (i.e., instances in which
      homeowners owe more on their mortgages than their homes are worth). Due to declines in home
      prices not seen since the Great Depression, about 12 million homeowners – more than 1 out of 5
      homeowners with a mortgage – are underwater, as shown in Figure 3, below.




White Paper: WPR-2012-001                              15                                    Dated: March 28, 2012
      Figure 3: Mortgages with Negative Equity




      Source: Federal Reserve white paper, The U.S. Housing Market: Current Conditions and Policy Considerations,
      available at http://www.federalreserve.gov/publications /other-reports/files/housing-white-paper-20120104.pdf (Jan.
      4, 2012), Fig. 3.

      Further, when housing prices started falling and equity started turning negative, many borrowers
      lost the ability to refinance their mortgages or sell their homes. The 12 million underwater
      homeowners now have an aggregate negative equity of $700 billion.




White Paper: WPR-2012-001                                16                                    Dated: March 28, 2012
      Conservatorships in Operation
      A. FHFA’s Duties and Responsibilities

      FHFA has a panoply of powers that it may use as a regulator and as a conservator. It also has a
      number of responsibilities attendant to its dual roles. As regulator, the Agency’s mission is to
      ensure that the Enterprises operate in a safe and sound manner. As conservator, the Agency
      seeks to conserve and preserve Enterprise assets. As discussed in greater detail below, senior
      FHFA staff view these roles as often aligning. FHFA also has responsibility under EESA.
      Figure 4, below, compares and contrasts FHFA’s duties and authorities as a regulator under
      HERA, as a conservator under HERA, and as federal property manager under EESA.

      Figure 4: FHFA’s Duties and Authorities

      Regulator                        Conservator                       Property Manager

      Duties Under HERA:               Discretionary/Permissive          Duties Under EESA:
                                       Powers Under HERA
      - Oversee the prudential         (includes any and all powers      - Implement a plan to
      operation of each regulated      of the Enterprises’ boards,       maximize assistance to
      entity                           executives, and shareholders      homeowners
      - Ensure that each regulated     including the powers to):         - Encourage the servicers of
      entity operates in a safe and                                      Fannie Mae and Freddie Mac
      sound manner                     - Put the Enterprises in sound    mortgages, considering net
      - Ensure that the Enterprises’   and solvent condition             present value, to take
      activities foster liquid,        - Preserve and conserve the       advantage of federal programs
      efficient, competitive, and      Enterprises’ assets               to minimize foreclosures
      resilient national housing       - Control and operate as many     - Encourage and facilitate
      finance markets                  or as few aspects of the          mortgage modifications in
                                       Enterprises’ operations, as       cases in which the Enterprises
                                       desired                           hold an interest in the
                                                                         obligation or pool of
                                                                         obligations

                      FHFA’s Duties as Regulator Under HERA

      The principal duties of the director of FHFA as a regulator are to oversee the prudential
      operations of each regulated entity and to ensure that:

                     Each regulated entity operates in a safe and sound manner, and maintains
                      adequate capital and internal controls;

White Paper: WPR-2012-001                         17                               Dated: March 28, 2012
                         The operations and activities of each regulated entity foster liquid, efficient,
                          competitive, and resilient national housing finance markets. These include
                          activities relating to mortgages on housing for low- and moderate-income
                          families;

                         Each regulated entity complies with the rules, regulations, guidelines, and orders
                          issued under law;

                         Each regulated entity carries out its statutory mission only through activities that
                          are authorized under law and consistent with the law; and

                         The activities and procedures of each regulated entity are consistent with the
                          public interest.23

      HERA also requires that the Enterprises obtain Agency approval before offering new products;
      prohibits the Enterprises from providing unreasonable executive compensation; requires FHFA
      to establish prudential management and operational standards for the regulated entities; and
      forbids high ranking FHFA officials from receiving compensation from the Enterprises within
      two years of their departure from FHFA.

                          FHFA’s Discretionary/Permissive Powers as Conservator Under HERA

      As a conservator, FHFA has discretionary or permissive powers, not specific mandates. FHFA
      is authorized to:

                         Succeed to all rights, titles, powers, and privileges of the Enterprises, and any
                          shareholders, officers, or directors of such Enterprises;

                         Operate the Enterprises; and

                         Take such action as may be:

                          o Necessary to put the Enterprises in sound and solvent conditions; and

                          o Appropriate to carry on the business of the Enterprises and preserve and
                            conserve their assets and property. 24


      23
           See 12 U.S.C. § 4513 et seq. for more information on FHFA’s statutory duties as a regulator.
      24
        Public Law No. 110-289 § 1145. For example, under HERA, FHFA can: (1) promulgate regulations regarding the
      conduct of the conservatorship; (2) take title to all books, records, or assets of the Enterprises; (3) take over the
      assets of the Enterprises; (4) collect all obligations and money due to the Enterprises; (5) act in the name of the
      Enterprises; and (6) create contracts to aid in its role.


White Paper: WPR-2012-001                                   18                                    Dated: March 28, 2012
      In addition to those powers enumerated by HERA, FHFA has “such incidental powers as shall be
      necessary to carry out” its enumerated powers.25 In 2009, FHFA interpreted its authorization to
      conserve and preserve the Enterprises’ assets as its “top goal” for its conservatorships,26 and
      often cites this goal.27

                         FHFA’s Duties Under EESA

      EESA requires that FHFA:

                        Implement a plan to maximize assistance to homeowners;

                        Use its authority to encourage the servicers of Fannie Mae and Freddie Mac
                         mortgages, considering net present value, to take advantage of federal programs
                         to minimize foreclosures;

                        Coordinate within the federal government concerning homeowner assistance
                         plans; and

                        Submit monthly reports to Congress detailing the progress of its efforts. 28

      B. Treasury Agreements

      Under the PSPAs, the Enterprises agreed to consult with Treasury and obtain its approval for a
      variety of significant business activities including capital stock issuances and dividend payments;
      ending the conservatorships; transferring assets; and awarding executive compensation. The
      PSPAs also outline certain activities that require approval from both FHFA and Treasury. These
      activities include:

                        Certain executive compensation decisions;

                        Transferring or disposing of any asset, except for fair market value and in the
                         ordinary course of business;

                        Declaring or paying dividends;

      25
           Id.
      26
           FHFA July 30, 2009, Speech, p 12.
      27
        See Statement of Edward DeMarco Before the House Financial Services Committee, Subcommittee on Oversight
      and Investigations (December 1, 2011) pg 3; see also A Strategic Plan for Enterprise Conservatorships: The Next
      Chapter in a Story that Needs and Ending (February 21, 2012) pg 10 (“FHFA has reported on numerous occasions
      that, with taxpayers providing the capital supporting Enterprise operations, this “preserve and conserve” mandate
      directs FHFA to minimize losses on behalf of taxpayers”).
      28
           Public Law No. 110-343 § 110.


White Paper: WPR-2012-001                                19                                   Dated: March 28, 2012
                      Making any distribution of the Enterprises’ equity interests;

                      Purchasing (directly or indirectly), retiring, or acquiring equity interests in the
                       Enterprises;

                      Issuing or selling the capital stock of the Enterprises or any subsidiary;

                      Assuming certain debt;

                      Merging or consolidating with other entities;

                      Reorganizing or recapitalizing the company or any subsidiary involving the
                       Enterprises’ common stock;

                      Reclassifying common stock of the Enterprises or any subsidiary; and

                      Purchasing, leasing, or otherwise acquiring all or substantially all of the assets of
                       another person or entity.

      C. FHFA’s Governance Milestones

                       Office of Conservatorship Operations

      At the inception of the conservatorships, FHFA created a new organizational unit to handle
      conservatorship issues: the Office of Conservatorship Operations (OCO), which serves as a
      principal point of contact between the Agency and the Enterprises. OCO primarily acts as a
      liaison between the Acting Director of FHFA and the Enterprises to preserve and conserve the
      Enterprises’ assets and property, ensure that the Enterprises appropriately focus on their
      missions, and facilitate their emergence from conservatorship.29 In 2009, OCO began tracking
      Enterprise requests for review by the conservator. In October 2010, OCO established a formal
      system to better manage its communications and track pending issues. FHFA has received


      29
        A high ranking FHFA employee stated that FHFA has designed affordable housing goals for the Enterprises that
      the Enterprises can meet without changing their operations from that of a common market player. This realignment
      minimizes any tensions between the business goals of the Enterprises and their housing mission. Despite this
      realignment, FHFA’s Acting Director has stated that:

              Given that the housing goal structure was not designed to address the extended period of time that the
              Enterprises have been operating in conservatorship, eliminating the goals could be consistent with the
              current state of the Enterprises. Similarly, the Enterprises’ duty to serve requirements that were put in
              place under HERA, were designed to stimulate the Enterprises to innovate and undertake other activities to
              address particular markets. Similar to the housing goals, eliminating the duty to serve requirements could
              be consistent with the realities associated with the Enterprises operating in conservatorship.
      See DeMarco Testimony 3-31-11, pg. 14.


White Paper: WPR-2012-001                                20                                    Dated: March 28, 2012
      approximately 600 requests to date and resolved approximately 525 of them. The requests have
      included: informational items, items requiring conservatorship approval pursuant to the
      delegation letters, approval of new products, and other items for which the Enterprises seek
      approval or non-objection.

      The Senior Associate Director of OCO attends most of the Enterprises’ board meetings and
      executive management meetings. Currently, OCO is comprised of six FHFA employees.
      However, a broader group of Agency personnel support OCO’s oversight, on an as needed basis.

                          Conservatorships Governance Committee

      In July 2009, FHFA created the Conservatorships Governance Committee which meets on a
      weekly basis to coordinate issues that affect the Enterprises’ decision-making authorities and
      ongoing business. The Conservatorships Governance Committee is a committee of senior FHFA
      executives whose goal is to ensure coordination on regulatory or supervisory matters that may
      warrant the attention of the conservator. Usually, the Enterprises alert the Conservatorships
      Governance Committee about upcoming issues through a variety of channels.

                          FHFA’s Conservatorships Rule

      On June 20, 2011, FHFA issued a final rule that clarifies the Agency’s conservatorship and
      receivership authorities.30 Pursuant to the rule, as either conservator or receiver, FHFA may take
      a variety of actions related to running the Enterprises, maintaining their assets, and continuing
      their missions.31 The rule also establishes procedures for determining the priority of claims
      against the Enterprises, including claims arising out of shareholder lawsuits.32




      30
           See 12 C.F.R. Part 1237.
      31
        Specifically, as outlined in the rule, as a receiver or a conservator, FHFA may: (1) take over the assets of and
      operate the Enterprises with all the powers of the shareholders (including the authority to vote shares of any and all
      classes of voting stock), the directors, and the officers of the regulated entity and conduct all business of the
      regulated entity; (2) continue the missions of the Enterprises; (3) ensure that the operations and activities of the
      Enterprises foster liquid, efficient, competitive, and resilient national housing finance markets; (4) ensure that the
      Enterprises operate in safe and sound manners; (5) collect all obligations and money due the Enterprises; (6)
      perform all functions of the Enterprises; (7) preserve and conserve the assets and property of the Enterprises; and (8)
      contract for assistance in fulfilling any function, activity, action, or duty of the Agency as conservator or receiver.
      32
           See 12 C.F.R. §§ 1237.7 – 1237.9.


White Paper: WPR-2012-001                                  21                                     Dated: March 28, 2012
      D. Highlights of FHFA’s Conservatorships

                       FHFA’s General Approach to Conservatorships

      A conservator may choose from many approaches to conservatorship, including:

                      Actively managing every aspect of an entity’s operations;

                      Monitoring the conserved entities’ decision-making and stepping in when it feels
                       it is appropriate; or

                      Deferring to the conserved entity on most decisions and stepping in only in cases
                       of greater significance.

      FHFA has implemented a style of conservatorship more akin to the latter approach. Specifically,
      FHFA has delegated day-to-day decision-making to the Enterprises, and they are directed to
      present other matters to FHFA for review or approval.33 In addition, high ranking FHFA
      executives from the Office of the Director, OCO, the Division of Enterprise Regulation, the
      Division of Examination and Programs Support, the Office of Housing and Regulatory Policy,
      and the Office of Policy Analysis meet weekly to share issues they are aware of regarding the
      conservatorships.

      As described above, FHFA has structured its conservatorships by assigning a small cadre of six
      employees to monitor conservatorship issues on a full-time basis. The Agency has stated that
      this characterization understates the resources focused on the conservatorships because a broader

      33
        A November 24, 2008, FHFA directive delegates management of day-to-day operations to the Enterprises, with
      the reservation that the Enterprises need to consult with and obtain FHFA’s consent or non-objection before:
              (1) taking actions involving capital stock, dividends, the PSPAs between Treasury and Fannie Mae and
              Freddie Mac, increases in risk limits, material changes in accounting policy, and reasonably foreseeable
              material increases in operational risk;
              (2) creating any subsidiary or affiliate or any substantial non-ordinary course transactions with any
              subsidiary or affiliate;
              (3) acting on matters that relate to conservatorship including but not limited to actions in connection with
              significant litigation addressing the actions or authority of the conservator, repudiation of contracts,
              qualified financial contracts in dispute due to conservatorship status, and counterparties attempting to
              nullify or amend contracts due to conservatorship status;
              (4) taking actions involving hiring, compensation and termination of benefits of directors and officers at the
              executive vice president level and above and other specified executives;
              (5) taking actions involving retention and termination of external auditors and law firms serving as
              consultants to the Board;
              (6) settling litigation, claims, regulatory proceedings or tax-related matters in excess of a specified
              threshold;
              (7) effecting any merger with or acquisition of a business for consideration in excess of $50 million; and
              (8) taking any action that in the reasonable business judgment of the board at the time that the action is
              taken is likely to cause significant reputational risk.


White Paper: WPR-2012-001                                 22                                     Dated: March 28, 2012
      group of Agency personnel assist OCO staff. Yet, as discussed in detail in Appendix A, FHFA-
      OIG’s reports to date have found a drawback to this approach has been that FHFA has often
      relied on the Enterprises’ determinations without independently testing and validating them.

      FHFA has provided three explanations for its style of conservatorship: efficiency, concordant
      goals, and operational savings.34

                               Efficiency

      The Acting Director has explained that the Agency’s conservatorship style is the most efficient
      structure for FHFA to use. Specifically, he stated:

              [T]he Enterprises would continue to be responsible for normal business activities and
              day-to-day operations . . . . FHFA reconstituted the boards of directors at each Enterprise
              and charged the boards with ensuring normal corporate governance practices and
              procedures are in place. The new boards are responsible for carrying out normal board
              functions, but they remain subject to review and approval on critical matters by FHFA as
              conservator. The Enterprises are large, complex companies, and this division of
              responsibilities represents the most efficient structure for carrying out FHFA’s
              responsibilities as conservator.

                               Concordant Goals

      The Acting Director has also explained that Enterprises’ goals as private corporations are the
      same as the government’s goals for the conservatorships. Specifically, he stated:

              Like FHFA, the Enterprises’ boards [of directors] are focused on conserving assets,
              minimizing corporate losses, ensuring the Enterprises continue to serve their mission,
              overseeing remediation of identified weaknesses in corporate operations and risk
              management, and ensuring that sound corporate governance principles are followed.

                               Operational Savings

      FHFA also believes the Agency’s conservatorship style is the least costly approach in light of the
      Enterprises’ unknown future. The Acting Director has explained that taking a more active role
      would:



      34
        FHFA Conservatorship Letter from DeMarco to Senators Dodd, Bachus, and Shelby, February 2, 2010 at pp 3-4,
      and DeMarco SBC Testimony November 15, 2011.



White Paper: WPR-2012-001                              23                                  Dated: March 28, 2012
             [I]nvolve a costly build-up of staff at FHFA with an uncertain long-term future for this
             work if Congress legislates away the conservatorships. It would also result in greater
             taxpayer draws to fund this build-up through assessments on Fannie Mae and Freddie
             Mac. It also raises questions as to the purpose of Enterprise management and boards if
             FHFA reviews and repeats so much of their work. As I noted earlier in my statement,
             conservatorship has been predicated on a delegated authority for the Enterprises to run
             their day-to-day business. This approach is aimed at achieving operational savings and
             reducing operational risks. I believe changes to this approach would need to demonstrate
             benefits that outweigh the costs.

                     Specific Improvement Efforts

      During the three-year pendency of the conservatorships, FHFA has implemented a number of
      initiatives to improve the Enterprises. Several of these initiatives are highlighted below:

                            Foreclosure Prevention

      The Enterprises participate in three foreclosure mitigation efforts: the Home Affordable
      Modification Program (HAMP); the Home Affordable Refinance Program (HARP); and their
      own foreclosure mitigation programs. From the start of the conservatorships through December
      2011, the Enterprises have completed 2.1 million foreclosure prevention transactions including
      permanent loan modifications and other forms of assistance. Approximately 1.8 million of these
      actions – including nearly 1.1 million permanent loan modifications – have allowed borrowers to
      retain homeownership. About half of all borrowers who received loan modifications in the
      fourth quarter of 2011 had their monthly payments reduced by over 30%.

      On October 24, 2011, FHFA announced changes to its HARP program that included relaxing the
      limit on the maximum loan-to-value ratio for borrower eligibility, waiving certain
      representations and warranties, and eliminating the need for certain property appraisals.

                            Other Programs

      FHFA has established limits on executive compensation, halted all lobbying by the Enterprises,
      and restricted the Enterprises’ ability to offer new products or enter into new lines of business.
      Additionally, FHFA reports that since the conservatorships commenced “several [guarantee fee]
      price increases have been initiated to better align pricing with risk, and [the Agency] will
      continue to gradually increase guarantee fee pricing to better reflect that which would be
      anticipated in a private, competitive market.”

      In May 2010, FHFA directed the Enterprises to develop uniform standards for data reporting on
      mortgage loans and appraisals. This directive, which is called the Uniform Mortgage Data
      Program, is designed to improve the consistency, quality, and uniformity of data that are
White Paper: WPR-2012-001                         24                               Dated: March 28, 2012
      collected at the beginning of the mortgage process. FHFA intends that this directive will allow
      mortgage originators to identify potential defects at the onset of the mortgage process and will
      improve the quality of mortgage purchases, which may, in turn, reduce repurchase risk for
      originators. In December 2011, the Enterprises began phasing in these uniform standards and
      plan to continue implementation throughout 2012.

      In April 2011, FHFA began a Servicing Alignment Initiative (SAI) to respond to concerns raised
      about how delinquent mortgages were being serviced. Beginning October 1, 2011, the
      Enterprises implemented a single, consistent set of procedures for servicing their delinquent and
      defaulted mortgages. SAI prioritizes early borrower outreach, streamlines documentation
      requirements, simplifies mortgage modification terms and requirements, and establishes a
      schedule of performance-based incentive payments and penalties aimed at ensuring that servicers
      review foreclosure alternatives in a timely manner.




White Paper: WPR-2012-001                         25                              Dated: March 28, 2012
      Challenges Faced by FHFA
      FHFA faces significant challenges such as the unique nature of the conservatorships; inherent
      tensions between the Enterprises’ affordable housing goals and their profitability; and inherent
      tensions between the Enterprises’ concurrent roles as conservator and regulator. Additionally,
      FHFA’s extensive and complex operations may further complicate the latter challenge by
      limiting its ability to separate its dual roles as conservator and regulator. Finally, the length of
      the conservatorships and the uncertain future of the Enterprises are significant concerns that
      overshadow all aspects of FHFA’s activities.

      A. Unique Nature of the Conservatorships

      Black’s Law Dictionary defines a conservator as a “guardian, protector, or preserver.”35 At least
      since the 1930s, courts have recognized that the broad purpose of a conservator is to maintain a
      troubled institution as an ongoing concern.36 But, there are very few guideposts illuminating the
      proper framework of institutional conservatorships. In an effort to garner lessons learned from
      other institutional conservatorships, FHFA-OIG examined three other agencies that have
      operated or could operate an institutional conservatorship: the Federal Deposit Insurance
      Corporation (FDIC), the National Credit Union Administration (NCUA), and the Farm Credit
      Insurance Corporation (FCIC). Although these agencies’ experiences presented useful
      information, as discussed further below, none of their experiences are directly comparable
      because the Enterprises are unique institutions.

      HERA’s conservatorship/receivership provisions were modeled after the FDIC’s
      conservatorships, so a comparison between FHFA’s conservatorships of the Enterprises and the
      FDIC’s conservatorships of depositary institutions would appear to be helpful.37 However,
      practical differences between the Enterprises and depository institutions limit the validity of such
      comparisons and the value of making them. Indeed, FHFA describes its conservatorships of the
      Enterprises as the “largest, most complex conservatorship in history.”38 Figure 5 below
      summarizes these differences.


      35
           Black’s Law Dictionary - conservator.
      36
        Resolution Trust Corp. v. Cedar Minn Building, 956 F.2d 1446, 1454 (8th Cir.1992); In re Fannie Mae 2008
      Securities Litigation, 742 F.Supp.2d 382, at *413 (S.D.N.Y. 2010).
      37
           In re Federal Home Loan Mortg. Corp. Derivative Litigation, 643 F.Supp.2d 790, 795 (E.D.Va. 2009).
      38
           See http://www.fhfa.gov/webfiles/23344/StrategicPlanConservatorshipsFINAL.pdf


White Paper: WPR-2012-001                                 26                                   Dated: March 28, 2012
      Figure 5: Comparison of Institutional Conservatorships to Date
                       FHFA                 FDIC              NCUA                                        FCIC39
      Market Position of      Vast majority of          Individual               Individual               Never
      Conserved Assets        secondary mortgage        institutions,            institutions,            implemented
                              market                    generally one at a       generally one at a       but would be
                                                        time40                   time                     Farm Credit
                                                                                                          System
                                                                                                          institution
      Primary Funding         Taxpayer money            Insurance payments       Insurance payments       Insurance
      Source for Assets       through Treasury          by FDIC members          by NCUA members          payments by
      Infused into            PSPAs                                                                       Farm Credit
      Conserved                                                                                           System
      Institutions                                                                                        members
                                                                                 Federal credit
                              Fannie Mae,               Federal and state        unions and               Farm Credit
      Financial               Freddie Mac               depository               federally insured        System
      Institutions                                      institutions             state-chartered          member banks
      Conserved                                                                  credit unions or         and
                                                                                 corporate credit         associations
                                                                                 unions
      Housing Mission         Yes                       No                       No41                     No

      FHFA’s conservatorships of the Enterprises differ substantially – in both theory and practice –
      from the conservatorships utilized by the FDIC42 and NCUA. First, the primary difference
      between FHFA’s conservatorships and those of the FDIC and NCUA is the nature and scope of
      the entities subject to conservatorships. Typically, an individual depositary institution is one of
      many such institutions. To the extent that account-holders are made whole, the damage to the
      broader economy attendant to the dissolution of such an institution is relatively minor.
      Conversely, the Enterprises are currently responsible for the vast majority of the secondary
      mortgage market. They cannot be abolished without Congressional approval, and their
      importance to the secondary mortgage market makes it unlikely that they can be dissolved in
      very short order without potentially causing catastrophic repercussions throughout the housing
      finance system.
      39
        No conservatorship has been implemented under the FCIC model. The Farm Credit System is a government
      sponsored enterprise.
      40
        At a cost of around $10.7 billion, IndyMac is the most expensive bank closing, to date, in the FDIC’s history.
      This is small compared to the $183 billion Treasury had provided the Enterprises as of the end of the third quarter of
      2011.
      41
        Similar to FHFA’s housing mission, the NCUA has a public mission of making credit available in underserved
      areas. See http://www.ncua.gov/about/History/Pages/History.aspx.
      42
        In theory, if the FDIC were to conserve a very large bank, the conservatorship may be similar to that of the
      Enterprises.

White Paper: WPR-2012-001                                  27                                     Dated: March 28, 2012
      The Enterprises’ large sizes and the costs of maintaining them also distinguish them from other
      conserved institutional entities. For example, from 2007 to 2011, the total value of all of the
      losses suffered by the NCUA’s 7,400 credit unions was between $5 billion and $10 billion. The
      total charges against credit for the Enterprises during the same period were around $261 billion.
      Likewise, when IndyMac collapsed in 2008 and FDIC placed it into conservatorship, it was the
      largest bank collapse in almost 20 years; yet, the failure cost the FDIC around $10.7 billion – a
      fraction of the Enterprises’ losses since 2007. Further, as stated above, FHFA estimates that the
      Enterprises will require between $220 billion and $311 billion in taxpayer dollars by the end of
      2014.

      Second, the sources of funding are different. The FDIC, NCUA, and FCIC primarily fund their
      conservatorship activities by making assessments on the entities subject to their regulation.
      Thus, whereas premiums paid by healthy depositary institutions and credit unions fund, or at
      least defray, the conservatorship operations of the FDIC and NCUA, FHFA’s conservatorships
      of the Enterprises are supported entirely by money derived from Treasury. This funding may
      result in FHFA’s conservatorships being tasked with responsibilities outside the normal goals of
      returning the conserved entities to safe and sound conditions.43

      Third, there are significant practical differences among the kinds of institutions conserved by the
      FDIC, NCUA, and FHFA to date. The NCUA and FDIC conservatorships are of individual
      institutions, generally one at a time. In these cases, the conserved entity is a small enough player
      in the market that it can be largely abolished through receivership; and placed under new
      management or returned to solvency through being acquired by a financially sound buyer (or
      some combination of the two). Under these circumstances, a conservatorship often acts as a
      temporary stop on the way to a return to solvency. By contrast, the Enterprises have trillions of
      dollars of assets and obligations; and, thus, their size alone limits the practicality of a
      manageable resolution/acquisition.44

      In sum, the Enterprises are so markedly different from other conserved entities that using the
      FDIC or NCUA models as guideposts may not be feasible.

      B. Mission Tensions

      FHFA faces considerable outside pressure regarding its responsibilities. The Acting Director
      described the difficulties this places on the Agency:

      43
        For example, FHFA faces tensions between the Enterprises’ affordable housing mission and profitability as
      discussed later in this paper.
      44
        As FHFA has stated: “Unlike the banking industry, there are not thousands of potential firms ready to step into the
      business of mortgage securitization.” See www.fhfa.gov/webfiles/23344/StrategicPlanConservatorshipsFINAL.pdf.


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               Conflicting opinions abound about what our responsibilities should be.
               Some think FHFA should be doing more to help housing recover, others
               think that FHFA should be winding down the Enterprises’ operations more quickly. . . .45

      Policies that have emerged since the conservatorships – such as stricter underwriting standards
      and the “Making Homes Affordable” programs – have revealed a possible tension between the
      Enterprises’ business mission and the preservation and conservation of their assets and the
      provision of assistance to struggling homeowners.46 For example, stricter underwriting
      standards, which promote the Enterprises’ “bottom line” interests, may also make mortgages
      harder to obtain. Home affordability programs, in essence, do the opposite. Although they
      promote homeowner assistance, they may add costs and financial risk to the Enterprises and
      taxpayers.

      For instance, an Enterprise’s business mission will benefit from the stream of payments received
      from a high-interest mortgage. Should that mortgage be refinanced at a lower rate, the stream of
      payments it produces would be lower. This, in turn, would reduce the value of the Enterprises’
      business investment. However, facilitating the refinance of a high-interest mortgage may also
      serve to prevent a default. Thus, it could be argued that the choice between advancing business
      interests and advancing the mission to assist struggling homeowners is, in fact, a false dichotomy
      – both missions could be advanced by a sound refinancing program.

      On the other hand, the vast majority of homeowners with mortgages that exceed the value of
      their homes are current on their payments. Thus, it could also be argued that an Enterprise that
      facilitates stream-lined refinancing of mortgages on “underwater” homes may well harm its
      business mission by granting lower payment rates to homeowners who were not likely to default.
      Then again, to the extent that an Enterprise facilitates the refinancing only of mortgages that it
      deems likely to default, or that are already in default, it may be disfavoring unfairly those
      struggling homeowners who have honored their mortgage obligations. Accordingly, such a
      policy may have the inadvertent effect of promoting “strategic defaults” by homeowners who
      would otherwise have continued to make their payments.

      FHFA faces challenges in weighing these risks associated with its disparate missions, fulfilling
      its statutory responsibilities, and choosing appropriate courses of action during the ongoing
      conservatorships.

      45
        DeMarco Testimony Before the Senate Banking Committee, 2/28/12, pg 6, available at
      http://www.fhfa.gov/Default.aspx?Page=30.
      46
        The Enterprises are also required to provide stability in the secondary mortgage market for low-income, rural, and
      underserved markets. This responsibility arises from the Enterprises’ charters and the Federal Housing Enterprises
      Financial Safety and Soundness Act of 1992, as amended by section 1125 of HERA.


White Paper: WPR-2012-001                                 29                                    Dated: March 28, 2012
      C. Tension Between Roles as Regulator and as Conservator

      Senior FHFA employees have stated that FHFA’s roles as the Enterprises’ conservator and
      safety and soundness regulator are generally aligned. Specifically, FHFA believes that as a
      conservator, its mission is to preserve the assets of Fannie Mae and Freddie Mac. Whereas, as
      the Enterprises’ regulator, FHFA has stated that its mission is to ensure the Enterprises provide
      liquidity, stability, and affordability to the mortgage market in a safe and sound manner. Both as
      a conservator and as a safety and soundness regulator, FHFA has an interest in ensuring that the
      Enterprises conduct their businesses and operations in a manner that limits risk-taking.

      Similarly, FHFA’s actions since the initiation of the conservatorships reflect a general alignment
      between conservator and regulator objectives. In particular, FHFA has taken steps to reduce the
      risk associated with business practices that generated billions of dollars of credit losses. Among
      these steps, FHFA has caused the Enterprises to increase guarantee fees on their MBS.

      Although its roles may be generally aligned, FHFA faces challenges in ensuring its independence
      as a safety and soundness regulator. To the extent that FHFA, as conservator, directs the
      Enterprises’ business activities and operations, its capacity to independently review and critique
      the outcome of those directives – in its role as a safety and soundness regulator – could become
      compromised. For example, FHFA could potentially be faced with criticizing its own actions or
      those of its senior officials. A high ranking FHFA official explained that early in the
      conservatorships, OCO tapped staff from the examinations team to help with conservatorship
      issues. In late 2010 and early 2011, FHFA implemented a reorganization to better separate its
      responsibilities as a conservator from those as a regulator. This included returning examination
      staff to more traditional supervisory functions.

      FHFA, thus far, has avoided this inherent conflict by delegating most of the management of the
      Enterprises to their boards of directors and managers. But if FHFA were to become a more
      active conservator, that could increase the potential for tension between its dual roles. Although
      FHFA’s delegated conservator approach in concept may be justified, its implementation has its
      costs. As discussed in Appendix A, FHFA-OIG has found that in some critical matters, FHFA
      has unduly relied on determinations of the Enterprises without independently testing and
      validating the decisions.

      The ability of FHFA to manage effectively the conservatorships through a delegated approach
      may ultimately depend on other factors, such as strong regulatory oversight and enforcement,
      and robust internal controls at the Enterprises. As discussed in Appendix A, this is an area of
      concern for FHFA-OIG because in multiple reports, FHFA-OIG identified instances in which
      FHFA was not active in oversight and enforcement, and Enterprise internal controls were
      lacking.


White Paper: WPR-2012-001                         30                               Dated: March 28, 2012
      Likewise, Appendix A indicates that in several other reports, FHFA-OIG found that FHFA has
      left some areas bereft of strong regulatory oversight and enforcement and allowed the
      Enterprises to have inadequate internal controls.

      D. An Uncertain Future

      The Fannie Mae and Freddie Mac conservatorships were intended to be temporary solutions to a
      larger problem. Indeed, FHFA has emphasized that the conservatorships “cannot be a permanent
      state for the Enterprises.”47 The lack of guidance about the outcome of the conservatorships has
      been difficult for the Agency and becomes harder with each passing day. As reflected above, the
      Agency has found it increasingly difficult to make investments in organizational infrastructure
      and to make human resources decisions without knowledge as to when – or, indeed, if – the
      conservatorships can be concluded.

      According to the Agency, a conservator’s goal “is to continue the operations of a regulated
      entity, rehabilitate it and return it to a safe, sound and solvent condition.” Once this has been
      accomplished, “the Director will issue an order terminating the conservatorship.”48 HERA does
      not limit the duration of the conservatorships, but the statute indicates that Congress intended the
      conservatorships to be finite. Specifically, the statues states:

                 The Agency may, at the discretion of the Director, be appointed conservator or receiver
                 for the purpose of reorganizing, rehabilitating, or winding up the affairs of a regulated
                 entity.49

      As a practical matter, however, the Enterprises’ future solvency – and, thus, emergence from the
      conservatorships – is unlikely without legislative action. FHFA officials have stated that the
      PSPAs have made it virtually impossible for the Enterprises to emerge from the
      conservatorships. For example, the Enterprises currently owe Treasury $183 billion, and are
      required to pay 10% dividends on Treasury’s outstanding investment. Merely paying the 10%
      annual dividend (i.e., $18.3 billion, presently) would not reduce Treasury’s outstanding
      investment. Moreover, the Enterprises have had to borrow from Treasury at least part of their
      dividend payments to Treasury, thus increasing the value of their outstanding debt. As a result, it
      would appear highly unlikely – if not mathematically impossible – for the Enterprises to buy
      themselves out of the conservatorships. FHFA’s Acting Director has stated that:




      47
           Federal Housing Finance Agency 2008 Report to Congress, p. 3.
      48
           FHFA, Questions and Answers on Conservatorship, p. 2.
      49
           12 U.S.C. § 4617(a)(2).


White Paper: WPR-2012-001                                 31                          Dated: March 28, 2012
                [T]he Enterprises will not be able to earn their way back to a condition that allows them
                to emerge from conservatorship. In any event, the model on which they were built is
                broken beyond repair. Conservatorship allows the Enterprises to continue serving their
                public purpose while lawmakers determine the ultimate resolution of the conservatorships
                and the future legal structure for housing finance50

      Despite the uncertain future, and pending a long-term congressional resolution, FHFA has
      created a three-part strategic plan for the conservatorships. FHFA’s goals are to: (1) build a new
      infrastructure for the secondary mortgage market; (2) gradually contract the Enterprises’
      dominant presence in the marketplace while simplifying and shrinking their operations; and (3)
      maintain foreclosure prevention activities and credit availability for new and refinanced
      mortgages. FHFA believes that this plan “leav[es] open all options for Congress and the
      Administration regarding the resolution of the conservatorships.”51




      50
           DeMarco NC Speech 9 19 11, p5.
      51
        FHFA, Strategic Plan for Enterprise Conservatorships: The Next Chapter in a Story that Needs an Ending,
      (February 21, 2012) pg 4, available at:
      http://www.fhfa.gov/webfiles/23344/StrategicPlanConservatorshipsFINAL.pdf.

White Paper: WPR-2012-001                               32                                   Dated: March 28, 2012
      Conclusion
      The Enterprises play a large and critical role providing liquidity to the housing finance system
      through the secondary mortgage market. Today, the housing finance system is still fragile.
      Owners of the vast majority of residential mortgages, Fannie Mae and Freddie Mac, are perhaps
      the largest victim of this fragility, and, thus, they continue to be dependent on federal support
      (now totaling $183 billion) to prevent their insolvency.

      Additionally, Fannie Mae’s and Freddie Mac’s place in the future housing financing system
      remains highly uncertain. Members of Congress have introduced and continue to introduce
      legislative proposals defining the future role of the federal government in the secondary
      mortgage market. Yet, Congress, the Administration, and other policymakers have not agreed
      upon a definitive path. With dim prospects for a quick recovery of the housing finance system,
      and ultimate resolution of the Enterprises uncertain, FHFA faces significant challenges
      continuing to manage effectively Fannie Mae and Freddie Mac.




White Paper: WPR-2012-001                         33                              Dated: March 28, 2012
      Scope and Methodology
      This white paper is one in a series of audits, evaluations, and special reports reflecting FHFA-
      OIG’s ongoing oversight and analysis of FHFA’s conservatorships of the Enterprises.

      To gain an understanding of the issues discussed herein, FHFA-OIG interviewed: the Senior
      Associate Director of OCO; the Chief Financial Officer; and the Deputy Chief Financial Officer
      of FHFA. FHFA-OIG also interviewed industry officials with experience in institutional
      conservatorships. Finally, FHFA-OIG utilized a variety of public resources.

      FHFA-OIG notes that a potential limitation of this white paper is that it did not interview all
      Agency officials involved with the conservatorship, but instead relied primarily on publicly
      available documents. FHFA-OIG also did not submit formal document requests. FHFA-OIG
      believes this methodological limitation is mitigated by the fact that there have been numerous
      public statements by then Director James B. Lockhart and Acting Director Edward DeMarco
      regarding the issues developed herein.

      This white paper 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 were promulgated by the Council of Inspectors General on Integrity and
      Efficiency. These standards require FHFA-OIG to plan and perform evaluations that obtain
      evidence sufficient to provide reasonable bases for its findings and recommendations. FHFA-
      OIG trusts that the findings and recommendation contained in this report meet these standards.

      The performance period for this special report was from August 2011 to March 2012.

      FHFA-OIG appreciates the efforts of FHFA and its staff in providing information and access to
      necessary documents to accomplish this evaluation.




White Paper: WPR-2012-001                         34                               Dated: March 28, 2012
      Appendix A
                               Trends Identified by FHFA-OIG Reports
      FHFA-OIG reports have identified a variety of deficiencies in FHFA’s operations, and these
      deficiencies appear to reflect two significant and related themes. First, with respect to the
      conservatorships, FHFA often relied on determinations of the Enterprises without independently
      testing and validating them, thereby giving undue deference to Enterprise decision-making.
      Second, regarding its regulatory responsibilities, FHFA was not proactive in its oversight and
      enforcement efforts. As detailed below, both themes have emerged in multiple reports. In
      addition, FHFA may not have enough examiners to meet its regulatory and conservatorship
      oversight responsibilities.

      A. FHFA’s Lack of Independent Testing and Validation of Enterprise Decision-Making

      Six FHFA-OIG reports reflect that a side-effect of FHFA’s approach as conservator to delegate
      most business decisions to the Enterprises is that the Agency’s oversight is not proactive and
      often relies upon the Enterprises’ review and corporate governance processes. However, FHFA-
      OIG believes that some matters are sufficiently important to warrant greater involvement and
      scrutiny by the Agency.

              Deferral to Freddie Mac’s Analysis of Repurchase Claim Exposure

      At the end of 2010, FHFA approved a $1.35 billion settlement of mortgage repurchase claims
      that Freddie Mac asserted against Bank of America. In approving the settlement, FHFA relied
      on Freddie Mac’s analysis of the settlement without testing the assumptions underlying the
      Enterprise’s existing loan review process. An FHFA-OIG report found that FHFA did not act
      timely or test concerns raised by an FHFA senior examiner months prior to the settlement about
      limitations in Freddie Mac’s existing loan review process for mortgage repurchase claims.52 The
      senior examiner was concerned that the loan review process Freddie Mac used for repurchase
      claims failed to account adequately for changes in foreclosure patterns among loans originated
      during the housing boom. According to the senior examiner, this could potentially cost the
      Enterprise a considerable amount of money. Freddie Mac’s internal auditors independently
      identified concerns about the process and, in June 2011, recommended that the issue be studied
      further. Following initiation of FHFA-OIG’s report, FHFA suspended future Enterprise
      mortgage repurchase settlements premised on the Freddie Mac loan review process and set in
      motion activities to test the assumptions underlying the loan review process.

      52
        For FHFA-OIG’s Evaluation of the Federal Housing Finance Agency’s Oversight of Freddie Mac’s Repurchase
      Settlement with Bank of America, please see http://www.fhfaoig.gov/Content/Files/EVL-2011-006.pdf.

White Paper: WPR-2012-001                             35                                 Dated: March 28, 2012
              Limited Oversight of the Enterprises’ Administration of the Home Affordable
              Modification Program

      A key initiative of Treasury’s Making Home Affordable program is HAMP, which involves
      servicers agreeing to modify mortgages for borrowers facing default or foreclosure. In early
      2009, the Enterprises began participating in HAMP. The Enterprises entered into five-year
      agreements with Treasury to manage the program and oversee participants’ compliance with
      program requirements. An FHFA-OIG report found that FHFA largely removed itself from
      overseeing the negotiations of the agreements and did not engage in any substantive review to
      evaluate the agreements’ feasibility, risks, or the suitability of the Enterprises to serve as
      Treasury’s financial agents. This lack of engagement may have contributed to the agreements’
      omission of significant details concerning payments to the Enterprises, the scope of their
      responsibilities, and processes to resolve differences. As a consequence of the omissions,
      significant problems developed in these areas almost from the beginning, requiring FHFA and
      the Enterprises to devote substantial time and resources to resolve ambiguities.53

              Incomplete Analysis of Executive Compensation at Fannie Mae and Freddie Mac

      For 2009 and 2010, the Enterprises awarded their top six officers over $35 million in
      compensation. FHFA reviewed and approved these compensation awards based on the
      Enterprises’ determinations and recommendations. However, an FHFA-OIG report found that
      FHFA did not test or validate the means by which the Enterprises calculated their recommended
      compensation levels and did not consider factors that might have resulted in reduced executive
      compensation costs.54

              Insufficient Transaction Testing

      Transaction testing is the method employed by financial institution examiners to arrive at
      independent impressions about the financial and operational conditions of an institution (e.g.,
      mortgage company, bank, etc.) as well as its compliance with applicable laws and regulations.
      An example of transaction testing would be reviewing a regulated entity’s loan files to test the
      veracity of statements concerning loan underwriting and performance. During an evaluation of
      FHFA’s capacity to examine the government-sponsored enterprises (GSEs), a senior FHFA
      manager acknowledged to FHFA-OIG that examiners too often accept assertions made by

      53
        For FHFA-OIG’s Evaluation of the Federal Housing Finance Agency’s Role in Negotiating Fannie Mae’s and
      Freddie Mac’s Responsibilities in Treasury’s Making Home Affordable Program, please see
      http://www.fhfaoig.gov/Content/Files/EVL-2011-003.pdf.
      54
        For FHFA-OIG’s Evaluation of the Federal Housing Finance Agency’s Oversight of Fannie Mae’s and Freddie
      Mac’s Executive Compensation Programs, please see
      http://www.fhfaoig.gov/Content/Files/Exec%20Comp%20DrRpt%2003302011%20final,%20signed.pdf.


White Paper: WPR-2012-001                             36                                  Dated: March 28, 2012
      Enterprise managers rather than validate such assertions through appropriate transaction
      testing.55 This may be related to FHFA having too few examiners to ensure the efficiency and
      effectiveness of its examination program. As illustrated below, this is also indicative of the
      second emerging trend: that the Agency was not proactive in its oversight and enforcement
      efforts.

              Limited Oversight of Legal Expenditures

      Between 2004 and October 31, 2011, Fannie Mae paid out $99.4 million in legal expenses for
      the defense of lawsuits, investigations, and administrative actions against three former senior
      executives; the Enterprise paid considerable addition sums for other executives. Additionally,
      Freddie Mac has paid $10.2 million in legal defense costs for former senior executives since its
      conservatorship began. To their credit, Fannie Mae and Freddie Mac have taken steps to manage
      costs associated with lawsuits against their indemnification-eligible directors and officers.
      However, an FHFA-OIG report found that – despite the Enterprises’ large outlays for legal
      expenses – the Agency has never independently validated the Enterprises’ processes for
      determining the reasonableness or the validity of the legal services provided on behalf of their
      executives or the bills presented for such services.56

              Insufficient Allocation of Resources to Processing Consumer Complaints

      In 2011, FHFA-OIG conducted an audit of the Agency’s consumer complaints process and
      concluded that FHFA’s oversight of the receipt, processing, and disposition of consumer
      complaints of fraud, waste, and abuse (including foreclosure abuses) was inadequate.57 The
      Agency had failed to prioritize consumer complaints, and this had consequences. For example,
      FHFA did not identify complaints requiring resolution in advance of time-sensitive events like
      foreclosure or other legal proceedings. Consequently, borrowers might not have received help in
      time. The lack of prioritization and process also cost FHFA the opportunity to perform routine
      substantive analysis to identify trends and potential risk areas. Such information could have
      served as an “early warning system” for emerging problems, such as the foreclosure document
      controversy. Finally, the failure to focus on consumer complaints missed important fraud
      allegations. For example, in June 2008, serious allegations of fraud involving Taylor, Bean &
      Whitaker Mortgage Corp. were reported to OFHEO; yet, OFHEO and subsequently FHFA did

      55
        For FHFA-OIG’s Evaluation of Whether FHFA has Sufficient Capacity to Examine the GSEs, please see
      http://www.fhfaoig.gov/Content/Files/EVL-2011-005.pdf.
      56
        For FHFA-OIG’s Evaluation of FHFA’s Management of Legal Fees for Indemnified Executives, please see
      http://www.fhfaoig.gov/Content/Files/EVL-2012-002.pdf.
      57
        For FHFA-OIG’s Audit of the Federal Housing Finance Agency’s Consumer Complaints Process, please see
      http://www.fhfaoig.gov/Content/Files/AUD-2011-001.pdf.


White Paper: WPR-2012-001                             37                                 Dated: March 28, 2012
      not provide adequate follow-up on the allegations. Taylor, Bean & Whitaker turned out to be a
      $2.9 billion mortgage fraud case, one of the largest in history, and involved significant losses to
      Freddie Mac. Freddie Mac’s losses might have been less had the 2008 fraud allegation received
      prompt attention.

      B. FHFA Was Not Proactive in Oversight and Enforcement

      As illustrated by multiple reports described below, FHFA-OIG has identified instances in which
      FHFA was not proactive in its oversight and enforcement. Accordingly, within its regulatory
      functions, the Agency faces challenges in its ability to identify new and emerging risks
      potentially impacting the GSEs; establish guidelines and policies governing Enterprise oversight;
      and provide strong, consistent enforcement for violations of policy.

              FHFA Did Not Identify New and Emerging Risks Potentially Impacting the GSEs

      FHFA-OIG’s work has raised concerns with the Agency’s ability to identify and act on early
      indicators of risk.

      For example, there were indicators as early as 2006 that could have led FHFA (and its
      predecessor) to identify the heightened risk posed by foreclosure processing abuses within
      Fannie Mae’s default-related legal services network.58 Indicators such as a significant increase
      in foreclosures accompanying the deterioration of the housing market, consumer complaints
      alleging improper foreclosures, contemporaneous media reports of foreclosure abuses, and public
      court filings in Florida and elsewhere highlighting such abuses should have triggered careful
      assessment and action by FHFA. Notwithstanding these indicators, FHFA did not devote
      attention to this issue until August 2010.

      A recent FHFA-OIG report on mortgage servicing identified another instance in which the
      Agency missed opportunities to identify risks.59 As of June 30, 2011, Freddie Mac had a
      mortgage servicing portfolio containing nearly 12 million mortgages with an unpaid principal
      balance of nearly $1.8 trillion. When Freddie Mac, or either of the Enterprises, purchase
      mortgages they enter into contracts with mortgage servicers to collect mortgage payments, set
      aside taxes and insurance premiums in escrow, forward interest and principal payments to the
      contractually designated party, and respond to payment defaults. As early as 2008, FHFA had
      information indicating that mortgage servicing represented a heightened risk to the Enterprises.
      Specifically, through its off-site monitoring activities FHFA noted a substantial increase in the

      58
        For FHFA-OIG’s Audit of FHFA’s Oversight of Fannie Mae’s Default-Related Legal Services, please see
      http://www.fhfaoig.gov/Content/Files/AUD-2011-004.pdf.
      59
       For FHFA-OIG’s Evaluation of FHFA’s Supervision of Freddie Mac’s Controls over Mortgage Servicing
      Contractors please see http://www.fhfaoig.gov/Content/Files/AUD%202012-001.pdf.


White Paper: WPR-2012-001                             38                                  Dated: March 28, 2012
      number of Enterprise delinquent loans starting in 2008. In early 2009, FHFA became aware of
      servicers’ poor performance and weaknesses in Freddie Mac’s oversight of its servicers. Yet,
      FHFA did not take timely or appropriate action to address these indicators. Even now, FHFA
      has not clearly defined its role regarding servicers or sufficiently coordinated with federal
      banking regulators about risks and supervisory concerns with individual servicers.

              FHFA Has Not Always Managed Risk Well by Establishing Guidelines and Policies
              Governing Enterprise Oversight

      Even when FHFA has identified risks, the Agency has not always managed those risks through
      establishing sufficient regulations or guidance. For example, the recent servicing report found
      that FHFA has not developed sufficient regulations or guidance governing the Enterprises’
      oversight and risk management of servicers. Specifically, FHFA has not established and
      implemented effective Enterprise regulations or guidance controlling the reporting of critical
      servicer information and establishing baseline requirements for mortgage servicing. Instead,
      FHFA relies on the Enterprises to individually monitor counterparty risk as part of their ongoing
      risk management activities.

      Similarly, as described in FHFA-OIG’s recent report on default-related legal services, FHFA has
      not developed sufficient regulations or guidance governing the Enterprises’ oversight and risk
      management of default-related legal services. In its report, FHFA-OIG found that FHFA has
      neither an ongoing risk-based supervisory plan detailing examination and continuous supervision
      of default-related legal services, nor finalized examination guidance and procedures for use in
      performing targeted examinations and monitoring of such services. Moreover, FHFA does not
      have a formal process to address performance problems associated with law firms that have
      relationships – either directly through contract or through its loan servicers – with both of the
      Enterprises.

              FHFA Has Not Consistently Enforced Directives for Violations of Policy

      Even in instances in which FHFA has identified risks and taken steps to manage those risks, the
      Agency has not been consistent in enforcing its directives to ensure that the risks are, in fact,
      adequately addressed. As Fannie Mae’s conservator and regulator, FHFA’s authority over the
      Enterprise is broad and includes the ability to discipline or remove Enterprise personnel to ensure
      compliance with Agency mandates. However, an FHFA-OIG report found that FHFA has not
      exercised this or other authorities to compel Fannie Mae’s compliance with the requirement to
      have an effective operational risk requirement. 60 Fannie Mae’s lack of an acceptable and


      60
        For FHFA-OIG’s Evaluation of the FHFA’s Oversight of Fannie Mae’s Management of Operational Risk, please
      see http://www.fhfaoig.gov/Content/Files/EVL-2011-004.pdf.


White Paper: WPR-2012-001                             39                                 Dated: March 28, 2012
      effective operational risk management program may have resulted in missed opportunities to
      strengthen oversight of law firms with which it contracts to process foreclosures.

      Further, insufficient enforcement by FHFA is not limited to the Enterprises. Since at least 2008,
      four Federal Home Loan Banks (FHLBanks) have faced significant financial and operational
      difficulties, primarily due to their investments in certain high-risk mortgage securities. FHFA
      has oversight responsibility for the FHLBanks and recognizes the need to ensure that they do not
      abuse their GSE status and engage in imprudent activities. Yet, an FHFA-OIG report found that
      FHFA has not established a consistent and transparent written enforcement policy for the
      FHLBanks classified as having the most “supervisory concerns” within the FHLBank system.61
      This has contributed to instances in which FHFA has not acted to proactively hold FHLBanks
      classified as “supervisory concerns” and their officers sufficiently accountable for engaging in
      questionable risk taking.

      C. FHFA May Not Have Enough Examiners to Meet Its Regulatory and Conservatorship
      Oversight Responsibilities

      FHFA has critical regulatory responsibilities with respect to the GSEs and conservator
      responsibilities regarding the Enterprises. To satisfy these responsibilities, Congress provided
      FHFA significant budget and hiring authority. Nonetheless, an FHFA-OIG report noted that the
      Agency has too few examiners to ensure the efficiency and effectiveness of its GSE oversight
      program; due to examiner shortages, FHFA has scaled back planned work during examinations,
      and examinations have often taken much longer than expected to complete.62 Additionally,
      FHFA-OIG has identified shortfalls in the Agency’s examination coverage, particularly in the
      crucial area of Real Estate Owned. These limitations stem from insufficient examination
      capacity and make FHFA’s early identification of possible risks more challenging.




      61
        For FHFA-OIG’s Evaluation of FHFA’s Oversight of Troubled Federal Home Loan Banks, please see
      http://www.fhfaoig.gov/Content/Files/Troubled%20Banks%20EVL-2012-001.pdf .
      62
        For FHFA-OIG’s Evaluation of Whether FHFA has Sufficient Capacity to Examine the GSEs, please see
      http://www.fhfaoig.gov/Content/Files/EVL-2011-005.pdf.

White Paper: WPR-2012-001                             40                                 Dated: March 28, 2012
       Appendix B
                           The Evolving Federal Role in Housing Finance
   The Early Years
                             1934    • Congress creates the Federal Housing Administration (FHA)

                             1938    • Congress creates Federal National Mortgage Association (Fannie Mae)

                                     • Congress amends Fannie Mae’s charter to change it from a government
                             1954
                                       corporation into a “mixed-ownership corporation”

                             1968    • Fannie Mae is reorganized as a publicly-traded company

                             1970    • Congress creates the Federal Home Loan Mortgage Corporation (Freddie Mac)

                             1989    • Freddie Mac becomes a publically-traded, shareholder-owned company

                                     • Congress creates the Office of Federal Housing Enterprise Oversight (OFHEO)
                             1992
                                       to regulate Fannie Mae and Freddie Mac
   Conservatorship
                                     • Congress enacts the Housing and Economic Recovery Act of 2008 (HERA)
                        July 2008
                                      creating FHFA from OFHEO and other agencies

               September 6, 2008     • FHFA places the Enterprises in conservatorship

                                     • The Enterprises and the Department of the Treasury enter into Senior Preferred
               September 7, 2008
                                      Stock Purchase Agreements (PSPAs)

                                     • Enterprises and Treasury amend PSPAs: Treasury agrees to make up to
              September 26, 2008
                                      $100,000,000,000 in funding immediately available for withdrawal

                 October 3, 2008     • Congress enacts the Emergency Economic Stabilization Act of 2008 (EESA)

                                     • FHFA creates the Office of Conservatorship (OCO) to act as a liasion between
                     October 2008
                                      FHFA and the two Enterprises

                                     • FHFA issues the "delegation memo" to the Enterprise that provides them with
              November 24, 2008       issues they need to consult with FHFA on and obtain FHFA’s consent or non-
                                      objection before acting

                                     • Enterprises and Treasury amend PSPAs to change the maximum amount to be
                      May 6, 2009
                                       provided to the Enterprises to $200,000,000,000

                                     • FHFA creates the Conservatorship Governance Committee to ensure
                        July 2009     coordination on regulatory or supervisory matters that may warrant the attention
                                      of the Conservator

                                     • Enterprises and Treasury amend PSPAs to to change the maximum amount to
              December 24, 2009       be provided to the Enterprises to $400,000,000,000 over the amount drawn as of
                                      December 31, 2010

                                     • OCO implements a status report protocol to track issues coming from the
                     October 2010
                                      Enterprises

                     June 20, 2011   • FHFA enacts a Rule which implements authorities under HERA



White Paper: WPR-2012-001                           41                                      Dated: March 28, 2012