oversight

FHFA's Conservatorships of Fannie Mae and Freddie Mac: A Long and Complicated Journey

Published by the Federal Housing Finance Agency, Office of Inspector General on 2015-03-25.

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

          Federal Housing Finance Agency
              Office of Inspector General




  FHFA’s Conservatorships of
 Fannie Mae and Freddie Mac:

A Long and Complicated Journey




  White Paper  WPR-2015-002  March 25, 2015
                 Executive Summary
                 The Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie
                 Mac (collectively, the Enterprises) in conservatorship in 2008. Risky business
                 practices combined with catastrophic losses had depleted the Enterprises’
                 capital and threatened their ability to provide liquidity to the secondary
                 mortgage market. Since 2008, the Enterprises have required $187.5 billion in
WPR-2015-002     financial support from the U.S. Department of the Treasury (Treasury) in order
                 to avert insolvency and receivership.
March 25, 2015
                 Over the past six years, FHFA has administered two conservatorships of
                 unprecedented scope and simultaneously served as the regulator for these large,
                 complex companies that dominate the secondary mortgage market and the
                 mortgage securitization sector of the U.S. housing finance industry. Congress
                 granted FHFA sweeping conservatorship authority over the Enterprises. For
                 example, as conservator, FHFA can exercise decision-making authority over the
                 Enterprises’ multi-trillion dollar books of business; it can direct the Enterprises
                 to increase the fees they charge to guarantee mortgage-backed securities; it can
                 mandate changes to the Enterprises’ credit underwriting and servicing standards
                 for single-family and multifamily mortgage products; and it can set policy
                 governing the disposition of the Enterprises’ inventory of approximately
                 121,000 real estate owned properties. Further, the conservator’s actions are
                 not subject to judicial review or intervention.

                 Given the taxpayers’ enormous investment in the Enterprises and the
                 Enterprises’ critical role in the secondary housing finance market, FHFA
                 Office of Inspector General (OIG) views its oversight of FHFA’s
                 administration of the conservatorships as crucial to determining whether FHFA
                 is fulfilling its statutory duties and responsibilities and safeguarding taxpayers.
                 OIG’s reports and evaluations provide enhanced transparency and an objective
                 assessment of FHFA’s conservatorship activities.

                 This is the second white paper that OIG has issued on the conservatorships.
                 The first white paper, published in March 2012 (2012 White Paper), set forth
                 the history of the Enterprises leading up to the creation of the conservatorships
                 in 2008 and described conservatorship operations during their first three years.
                 From 2008 to March 2012, the Enterprises suffered significant losses. During
                 that phase of the conservatorships, the objective of FHFA, under former Acting
                 Director DeMarco, was to stabilize the operations of the Enterprises and ensure
                 that the secondary mortgage market continued to function for the benefit of the
                 country’s housing market and financial system. For the conservatorship period
                 covered by the 2012 White Paper, OIG found that FHFA had delegated day-to-
                 day decision-making to the Enterprises, but retained authority to decide matters
                 involving certain types of significant activities.
                 Since that white paper was issued, the Enterprises’ conditions stabilized
                 and market conditions improved. The Enterprises returned to profitability
                 in 2012 and have paid Treasury more than $228 billion in dividends on
                 its $187.5 billion investment. Under Acting Director DeMarco, FHFA
                 established three goals for the Enterprises:

                       Build a new infrastructure for the secondary mortgage market;
WPR-2015-002
                       Gradually contract the Enterprises’ dominant presence in the
March 25, 2015          marketplace while simplifying and shrinking their operations; and

                       Maintain foreclosure prevention activities and credit availability for
                        new and refinanced mortgages.

                 Acting FHFA Director DeMarco sought to reorganize, rehabilitate, and wind
                 up the affairs of the Enterprises to prepare for fundamental housing reform
                 legislation. Like Acting Director DeMarco, Director Watt has repeatedly
                 asserted that conservatorship “cannot and should not be a permanent state” for
                 the Enterprises. Director Watt has indicated that under his stewardship FHFA
                 will continue the conservatorships and build a bridge to a new housing finance
                 system, whenever that system is put into place by Congress. In this phase of
                 the conservatorships, FHFA seeks to place more decision-making in the hands
                 of the Enterprises. This white paper first summarizes FHFA’s evolving
                 management of the conservatorships. Next, it summarizes findings of prior
                 OIG reports that reviewed conservatorship decisions and practices. Last, it
                 outlines OIG’s planned work in the coming year to assess the conservator’s
                 governance practices, internal controls, decision-making process, and follow-
                 up/compliance activities.

                 This report was led by Alexa Strear, Investigative Counsel, with assistance
                 from Ezra Bronstein, Investigative Counsel, Brian Stief, Investigative Counsel,
                 Shereefat Balogun, Investigative Counsel, and Brian Harris, Investigative
                 Counsel. We appreciate the cooperation of FHFA staff, as well as the
                 assistance of all those who contributed to the preparation of this report.

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




                 Kyle D. Roberts
                 Acting Deputy Inspector General for Evaluations
TABLE OF CONTENTS ................................................................
EXECUTIVE SUMMARY .............................................................................................................2

ABBREVIATIONS .........................................................................................................................5

HISTORY OF THE CONSERVATORSHIPS ................................................................................6
      Unprecedented Length of the Conservatorships .......................................................................6
      FHFA’s Extensive Powers and Discretion as Conservator ......................................................6

FHFA’S CONSERVATORSHIPS IN PRACTICE .........................................................................8
      Strategic Plan for the Conservatorships: Setting the Conservator’s Strategic Goals
      and Priorities .............................................................................................................................9
             Annual Scorecards: Setting Expectations for Short-Term Enterprise
             Performance and Achievement of Strategic Goals .........................................................11
      Conservatorship Governance and Operations ........................................................................11
             Delegated and Undelegated Authorities: Letters of Instruction .....................................12
             Governance Practices ......................................................................................................13

OIG’S PAST OBSERVATIONS ON THE CONSERVATORSHIPS ..........................................15

OIG’S INTENDED OVERSIGHT OF FHFA’S CONSERVATORSHIP ACTIVITIES .............16

CONCLUSION ..............................................................................................................................17

OBJECTIVE, SCOPE, AND METHODOLOGY .........................................................................18

ADDITIONAL INFORMATION AND COPIES .........................................................................19




                                           OIG  WPR-2015-002  March 25, 2015                                                                  4
ABBREVIATIONS .......................................................................
CSP                       Common Securitization Platform

DOC                       Division of Conservatorship

Enterprises               Fannie Mae and Freddie Mac, collectively

Fannie Mae                Federal National Mortgage Association

FDIC                      Federal Deposit Insurance Corporation

FHFA or conservator       Federal Housing Finance Agency

Freddie Mac               Federal Home Loan Mortgage Corporation

HERA                      Housing and Economic Recovery Act of 2008

LOIs                      Letters of Instruction

MSR                       Mortgage Servicing Right

OCO                       Office of Conservatorship Operations

OIG                       Federal Housing Finance Agency Office of Inspector General

PSPAs                     Senior Preferred Stock Purchase Agreements

Treasury                  U.S. Department of the Treasury




                         OIG  WPR-2015-002  March 25, 2015                           5
HISTORY OF THE CONSERVATORSHIPS .....................................

Unprecedented Length of the Conservatorships

FHFA’s conservatorship powers substantially parallel those granted to the Federal Deposit
Insurance Corporation (FDIC) by the Federal Deposit Insurance Act.1 Essentially, those
powers enable the conservator to maintain a troubled institution as an ongoing concern and
protect its assets until either the institution (1) stabilizes or (2) is closed and a receiver
appointed. As OIG explained in the 2012 White Paper, however, a comparison between
FHFA’s conservatorships of the Enterprises and the FDIC’s conservatorships of depositary
institutions is not useful because of the significant differences in the nature and scope of the
entities subject to conservatorships, the different sources of funding, and the duration of the
conservatorships.2

As described by FHFA Director Watt, FHFA’s current strategy is to keep the Enterprises in
conservatorship until Congress passes housing reform legislation. Absent congressional
action or a change in FHFA’s strategy, the conservatorships will continue.

FHFA’s Extensive Powers and Discretion as Conservator

Congress vested FHFA with sweeping powers as conservator.3 These powers position FHFA
to potentially control every aspect of the Enterprises. Director Watt recently testified that
FHFA is involved in “virtually every decision” that Fannie Mae and Freddie Mac make.4 As
conservator, FHFA possesses all rights and powers of any stockholder, officer, or director of



1
 See Congressional Research Service, Financial Institution Insolvency: Federal Authority over Fannie Mae,
Freddie Mac, and Depository Institutions, at 1, 6 (Sept. 10, 2008).
2
  See OIG, FHFA-OIG’s Current Assessment of FHFA’s Conservatorships of Fannie Mae and Freddie Mac,
at 26-28 (Mar. 28, 2012) (WPR-2012-001) (online at www.fhfaoig.gov/Content/Files/WPR-2012-001.pdf)
[hereinafter 2012 White Paper].
3
 The Housing and Economic Recovery Act of 2008 (HERA), Pub. L. No. 110-289, created FHFA and
provides FHFA with its conservatorship powers. OIG published a white paper in 2012 that provides additional
detail on the conservatorships and powers provided by HERA. See OIG, 2012 White Paper, supra note 2, at
18-19. HERA extensively amended the Federal Housing Enterprises Financial Safety and Soundness Act of
1992, Pub. L. No. 102-550, 12 U.S.C. § 4501 et seq.
4
  See House Committee on Financial Services, Testimony of FHFA Director Melvin L. Watt, Hearing on
Sustainable Housing Finance: An Update from the Director of the Federal Housing Finance Agency, 114th Cong.
(Jan. 27, 2015). However, as discussed infra pp. 15-16, OIG has published a number of reports that question
FHFA’s oversight as conservator. In future work, OIG plans to review FHFA’s level of involvement in the
conservatorships.




                                  OIG  WPR-2015-002  March 25, 2015                                         6
the Enterprises.5 FHFA may operate the Enterprises and conduct all of the Enterprises’
business activities.6 FHFA also may take actions necessary to put the Enterprises in a sound
and solvent condition, and FHFA may take such action as may be appropriate to carry on
the Enterprises’ business and preserve and conserve the Enterprises’ assets and property.7
Congress also granted FHFA incidental powers necessary to carry out the conservator’s
express powers.8

In addition to these expansive powers, Congress provided FHFA with protections against
interference in the exercise of its powers. Generally, HERA prohibits courts from taking any
action to restrain or affect FHFA’s exercise of its powers as conservator or from reviewing
FHFA’s actions as conservator.9 HERA prohibits any other Federal agency or any state from
directing or supervising FHFA in the exercise of its conservator powers.10

At this time, the only meaningful constraint on the conservator’s exercise of statutory
authority is contained in the terms of the Senior Preferred Stock Purchase Agreements,
as amended (PSPAs), which the conservator executed (on behalf of the Enterprises) with
Treasury when FHFA placed the Enterprises in conservatorship.11 Under the terms of the
PSPAs, Treasury committed to provide support to the Enterprises as necessary, up to a
specific cap.12 As of December 31, 2014, Treasury has invested $187.5 billion in the
Enterprises.13 Under the PSPAs, FHFA agreed, as conservator, not to terminate the

5
    12 U.S.C. § 4617(b)(2)(A)(i).
6
    12 U.S.C. § 4617(b)(2)(B)(i).
7
    12 U.S.C. § 4617(b)(2)(D)(i)-(ii).
8
    12 U.S.C. § 4617(b)(2)(J)(i)-(ii).
9
  12 U.S.C. § 4617(f). See, e.g., Babylon v. FHFA, 699 F.3d 221, 228 (2d Cir. 2012) (“A conclusion that
the challenged acts were directed to an institution in conservatorship and within the powers given to the
conservator ends the [Court’s] inquiry.”). Cf. Sonoma v. FHFA, 710 F.3d 987, 992 (9th Cir. 2013) (“[T]he
anti-judicial review provision is inapplicable when FHFA acts beyond the scope of its conservator power.”);
Leon Cnty. v. FHFA, 700 F.3d 1273, 1278 (11th Cir. 2012) (“The FHFA cannot evade judicial scrutiny by
merely labeling its actions with a conservator stamp.”).
10
     12 U.S.C. § 4617(a)(7).
11
  The PSPAs were subsequently amended and restated on September 26, 2008, and have been amended three
additional times: on May 6, 2009, December 24, 2009, and August 17, 2012.
12
  As of the date of this white paper, the maximum amount of remaining funding under the PSPAs is $117.6 billion
and $140.5 billion for Fannie Mae and Freddie Mac, respectively.
13
   See FHFA, Treasury and Federal Reserve Purchase Programs for GSE and Mortgage-Related Securities,
Data as of December 31, 2014, at 2 (Dec. 31, 2014) (online at
www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/TsyFedPP_Dec31_2014R.pdf). Treasury holds
senior preferred stock with a liquidation preference of $189.5 billion for the two Enterprises combined. Upon
initiation of the PSPAs, Treasury received senior preferred stock from each Enterprise with a combined



                                         OIG  WPR-2015-002  March 25, 2015                                    7
conservatorships without Treasury’s prior written approval.14 FHFA further agreed to direct
the Enterprises to:

        Reduce the size of their retained investment portfolios, which historically had been the
         Enterprises’ most significant source of earnings, to $250 billion by December 31,
         2018; and

        Pay to Treasury each quarter a dividend equal to the excess of their net worth over an
         applicable capital reserve amount.15


FHFA’S CONSERVATORSHIPS IN PRACTICE ................................
As a long-term conservator, FHFA is in a very unusual and challenging position.16 The
Enterprises are in conservatorships of unknown duration and, as necessary, rely on Treasury
for financial support.17 Although the Enterprises have been profitable since 2012, their ability
to sustain profitability in the future is not knowable for a number of reasons: the winding
down of their investment portfolios and loss of interest income; the level of guarantee fees


liquidation preference of $2 billion. The liquidation preference has increased to $189.5 billion as a result of
$187.5 billion in Enterprise draws.
14
   The PSPAs also prohibit the Enterprises, without the consent of Treasury, from making any changes to their
capital structures, issuing capital stock, increasing their debt significantly, paying any dividends (other than
those to Treasury), engaging in certain transactions with affiliates, or disposing of any assets unless they are for
“fair market value” in “the ordinary course of business.”
15
  The applicable capital reserve amount will be reduced by $600 million each calendar year until it reaches zero on
January 1, 2018.
16
   According to FHFA Director Watt, the “significant challenges” involved in managing the conservatorships
include: serious delinquencies that have declined but remain historically high compared to pre-crisis levels;
counterparty exposures; and shrinking revenues from the Enterprises’ mortgage-related investment portfolios.
See Senate Committee on Banking, Housing, and Urban Affairs, Hearing on the Federal Housing Finance
Agency: Balancing Stability, Growth, and Affordability in the Mortgage Market, Statement of FHFA Director
Melvin L. Watt, at 3-4 (Nov. 19, 2014) (online at
www.banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=5dc60283-09ab-437f-8484-
b209c4df46a7).
17
   In consideration of the PSPAs, FHFA has taken the position that “it is prudent and in the best interests of the
market to suspend capital classifications of Fannie Mae and Freddie Mac during the conservatorship. FHFA
will continue to closely monitor capital levels, but the existing statutory and FHFA-directed regulatory capital
requirements will not be binding during the conservatorship.” FHFA, Capital Requirements (online at
www.fhfa.gov/SupervisionRegulation/FannieMaeandFreddieMac/Pages/Capital-Requirements.aspx)
(accessed Feb. 9, 2015). See also FHFA, FHFA Announces Suspension of Capital Classifications During
Conservatorship (Oct. 9, 2008) (online at www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Announces-
Suspension-of-Capital-Classifications-During-Conservatorship-and-Discloses-Minimum-and-RiskBased-
Cap.aspx).




                                    OIG  WPR-2015-002  March 25, 2015                                                8
they will be able to charge; the future performance of their business segments; the elimination
of a capital cushion to buffer against losses; and the significant uncertainties involving key
market drivers, such as mortgage rates, homes prices, credit standards, and short and long-
term interest rates.18 In the face of these challenges, FHFA must ensure that the Enterprises
continue to fulfill their statutory mission to provide liquidity and stability to the housing
finance market.

FHFA administers the conservatorships through: a combination of communications with the
Enterprises’ respective boards of directors and management, a multi-year strategic plan for the
conservatorships that defines general goals and initiatives, annual conservatorship scorecards
that focus the Enterprises on short-term objectives to further the conservator’s strategic goals,
and governance practices and organizational infrastructure that support these activities.
According to FHFA, the Director meets regularly with the Enterprises’ respective CEOs to
discuss business activities and emerging issues, and meets with the boards of directors to
review the state of the conservatorships and key business matters. FHFA staff also attend
board meetings, weekly management committee meetings, and meet at least weekly with
senior Enterprise staff.19 The following sections provide pertinent details on FHFA’s
conservatorship-related practices.

Strategic Plan for the Conservatorships: Setting the Conservator’s Strategic Goals and
Priorities

The conservator has the authority to establish the Enterprises’ strategic goals, major business
initiatives, priorities, and general performance measures. Not surprisingly, the strategic goals
and priorities set by FHFA have evolved over time, in response to changing market conditions
and the different priorities of each incumbent FHFA Director. Beginning in 2012, FHFA has
developed and published two formal strategic plans that establish strategic goals for the
Enterprises.20




18
   OIG recently issued a white paper that discusses the challenges to the Enterprises’ continued profitability in
the future.
19
  See FHFA Response – OIG Audit 2011-018, FHFA’s Conservator Approval Process for Fannie Mae and
Freddie Mac Business Decisions, at 32 (Sept. 27, 2012) (AUD-2012-008) (online at
www.fhfaoig.gov/Content/Files/AUD-2012-008_2.pdf).
20
  In 2010, the Acting FHFA Director submitted a letter to Congress that described conservatorship operations
and how FHFA would accomplish conservatorship goals. See Letter from Edward DeMarco, Acting Director,
FHFA, to Congress (Feb. 2, 2010) (online at
www.fhfa.gov/Media/PublicAffairs/Documents/Letter_to_Dodd_Frank_Shelby_Bachus-02-02-
2010_n508.pdf).




                                    OIG  WPR-2015-002  March 25, 2015                                             9
In February 2012, FHFA issued a strategic plan for the conservatorships and presented
that plan to Congress (2012 Strategic Plan).21 The 2012 Strategic Plan introduced a
“Build/Contract/Maintain” theme for the conservatorships and identified three strategic goals:
(1) build a new infrastructure for the secondary mortgage market; (2) 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.22 The “build” goal of the 2012 Strategic Plan gave rise to the Common
Securitization Platform (CSP). FHFA envisioned the CSP as a means to replace some parts of
the Enterprises’ back office systems and to create an infrastructure for mortgage securitization
that could be used to develop a future mortgage market without the Enterprises.23 The
“contract” goal led to increased guarantee fees, risk-sharing arrangements, and reductions in
the multifamily businesses. The “maintain” goal continued loss mitigation efforts, including
improvements to the Home Affordable Refinance Program and exploring foreclosure
alternatives, such as short sales and deeds in lieu of foreclosure.

Two years later, FHFA issued a revised strategic plan (2014 Strategic Plan) that
reformulated the strategic goals of the 2012 Plan.24 The 2014 Strategic Plan adopts a
“Maintain/Reduce/Build” theme that is similar to the 2012 Strategic Plan; however, it shifts
away from the emphasis on contracting the Enterprises’ dominant presence in the marketplace
and places greater importance on maintaining accessibility to mortgage credit. The
“maintain” goal of the 2014 Strategic Plan emphasizes, among other things, increasing access
to mortgage credit for underserved, creditworthy borrowers and working with small lenders,
rural lenders, and housing finance agencies at the state level. As part of the “maintain” goal,
the Enterprises revised their underwriting guidelines to permit mortgages with 97 percent
loan-to-value for certain borrowers.25 The “reduce” goal focuses on expanding the number
of credit risk-sharing transactions in the single-family guarantee business and continuing
multifamily transfers to share credit risk with private investors. The “build” goal shifts the


21
  See FHFA, A Strategic Plan for Enterprise Conservatorships: The Next Chapter in a Story that Needs an
Ending (Feb. 21, 2012) (online at
www.fhfa.gov/Media/PublicAffairs/PublicAffairsDocuments/2012letterStrategicPlanConservatorshipsFINAL.
pdf).
22
     See id. at 1-2.
23
     See id. at 2-3, 13-14.
24
  See FHFA, The 2014 Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac (May 13,
2014) (online at www.fhfa.gov/AboutUs/Reports/ReportDocuments/2014StrategicPlan05132014Final.pdf).
25
   The details of these guidelines were released in December 2014. See FHFA, Statement of FHFA Director
Melvin L. Watt on Release of Guidelines for Purchase of Low Down Payment Mortgages (Dec. 8, 2014)
(online at www.fhfa.gov/Media/PublicAffairs/Pages/Statement-of-FHFA-Director-Melvin-L-Watt-on-Release-
of-Guidelines-for-Purchase-of-Low-Down-Payment-Mortgages.aspx).




                                OIG  WPR-2015-002  March 25, 2015                                       10
focus of the CSP to the Enterprises’ existing securitization operations, rather than on the
needs of future market participants.

           Annual Scorecards: Setting Expectations for Short-Term Enterprise Performance
           and Achievement of Strategic Goals

FHFA issues annual conservatorship scorecards to set specific expectations for each strategic
plan goal, which enable FHFA and the Enterprises to track progress toward achieving the
goals.26 Each annual scorecard maps to the strategic plan in place at the time the scorecard is
issued and describes the activities that further each strategic goal. For example, the 2015
Scorecard maps to the 2014 Strategic Plan and identifies 15 activities under the “maintain”
goal, such as enhancing servicer eligibility standards for Enterprise counterparties and
assessing the feasibility of alternate credit score models.

The annual scorecard assigns a weight to each strategic goal and thereby establishes the
importance of each goal relative to the other goals. As with the strategic plan, the weightings
reflect the views and priorities of the incumbent FHFA Director. For example, the 2015
Scorecard assigns a 40 percent weight to the “maintain” goal, which includes increased access
to mortgage credit,27 whereas the 2013 Scorecard (issued under the 2012 Strategic Plan)
assigned a much lower weight, 20 percent, to the same goal.28

Conservatorship Governance and Operations

As conservator, FHFA is vested with express authority to operate the Enterprises. However,
for reasons of efficiency, concordant goals with the Enterprises, and operational savings,29
FHFA has determined to (1) delegate authority for general corporate governance and day-to-
day matters to the Enterprises’ boards of directors and executive management, and (2) retain



26
  A portion of annual compensation for certain senior executives of each Enterprise is tied to the Enterprise’s
performance against the scorecard.
27
   The 2014 Scorecard was the first to reflect the change in the conservator’s goals and priorities outlined
in the 2014 Strategic Plan. Although underlying activities of the 2014 and 2015 Scorecards changed, the
weightings for each strategic goal remained the same. See FHFA, 2014 Scorecard for Fannie Mae, Freddie
Mac and Common Securitization Solutions (May 13, 2014) (online at
www.fhfa.gov/AboutUs/Reports/ReportDocuments/2014Scorecard051314FINAL.pdf); FHFA, 2015
Scorecard for Fannie Mae, Freddie Mac and Common Securitization Solutions (Jan. 14, 2015) (online at
www.fhfa.gov/AboutUs/Reports/ReportDocuments/2015-Scorecard.pdf).
28
 See FHFA, Conservatorship Strategic Plan: Performance Goals for 2013 (Mar. 4, 2013) (online at
www.fhfa.gov/Media/PublicAffairs/PublicAffairsDocuments/2013EnterpriseScorecard3413_N508.pdf).
29
     See OIG, 2012 White Paper, supra note 2, at 23.




                                    OIG  WPR-2015-002  March 25, 2015                                           11
authority for certain significant decisions.30 In practice, these are not bright lines; the
conservator can intervene in any issue or matter at the Director’s discretion. The Director
is supported on conservatorship matters by FHFA’s Division of Conservatorship (DOC).
Generally, DOC manages conservatorship operations; coordinates with the Enterprises on
FHFA’s strategic goals, conservatorship scorecards, and performance assessments; and takes
the lead on matters involving undelegated authorities that require the conservator’s approval
or that require Treasury approval under the PSPAs.

         Delegated and Undelegated Authorities: Letters of Instruction

Delegations of authority from the conservator to the Enterprises’ boards of directors and
executive management are a defining feature of the conservatorships. However, FHFA
emphasizes that it relies on frequent engagement with the Enterprises to consult, formally or
informally, on a wide range of business activities whether delegated or not.31 FHFA has
issued “letters of instruction” (LOIs) to the Enterprises’ respective boards of directors that
define and outline the scope of delegated and undelegated authorities. FHFA issued the
current version of the LOIs in 2012.32 FHFA views the LOIs as necessary guideposts, but
has cautioned that the Letters could not be written in a manner that covers all possible issues
involving the Enterprises. The LOIs should be viewed as one means of communication,
supplemented by engagement with Enterprise officials. That said, the LOIs require the
Enterprises to consult with, and obtain approval from, the conservator on critical matters.
Examples of these matters include:

        Actions involving the PSPAs;

        Executive compensation;

        Legal settlements over $50 million;



30
  For general background on FHFA’s delegations of authority to the Enterprises, see OIG, FHFA’s
Conservator Approval Process for Fannie Mae and Freddie Mac Business Decisions, at 5-6 (Sept. 27, 2012)
(AUD-2012-008) (online at www.fhfaoig.gov/Content/Files/AUD-2012-008_2.pdf).
31
  See FHFA Response – OIG Audit 2012-018, FHFA’s Conservator Approval Process for Fannie Mae and
Freddie Mac Business Decisions, at 31-32 (Sept. 27, 2012) (AUD-2012-008) (online at
www.fhfaoig.gov/Content/Files/AUD-2012-008_2.pdf).
32
   FHFA issued Order No. 2008-006 in November 2008 to the Enterprises’ boards of directors, which
delegated general corporate governance responsibilities to the newly constituted boards. The first LOIs
were issued in 2008 in conjunction with the Order and revised in November 2012; the revisions expanded the
matters for which the Enterprises are required to obtain the conservator’s approval. OIG’s 2012 White Paper
did not address the revised LOIs because FHFA’s revisions occurred after publication. FHFA has advised OIG
that it is again in the process of reviewing the LOIs and expects to make a number of modifications to the LOIs
in 2015.



                                   OIG  WPR-2015-002  March 25, 2015                                            12
          Annual operating budgets;

          Material changes to contractual agreements with the top five single-family sellers and
           servicers; and

          Enterprise actions likely to cause significant reputational risk or result in substantial
           negative publicity.

The LOIs also require the Enterprises to promptly notify the conservator of significant
changes to the Enterprises’ single-family and multifamily policies and loss mitigation
strategies. FHFA reserves the right to manage any aspect of the Enterprises it deems
necessary, including directing them to undertake conservator-led strategic initiatives (e.g., the
CSP or the Servicing Alignment Initiative). FHFA also reserves the right to modify the LOIs
at any time. For example, although the LOIs did not specifically require it, FHFA directed the
Enterprises to submit certain transactions involving mortgage servicing right (MSR) sales and
transfers to the conservator for approval prior to proceeding. FHFA also issues guidance
related to the LOIs. For example, FHFA provided guidance to the Enterprises regarding
business-related expenses and standards for communicating with external audiences. Further,
the conservator requires the Enterprises to submit regular reports on significant business
activities, such as quarterly business-related expense reports.

FHFA tracks actions that fall under the auspices of the conservatorships.33 In 2014, for
example, FHFA completed over 750 conservatorship actions. These actions include
conservator directives to the Enterprises to undertake actions related to strategic goals
and scorecard objectives, conservator approvals and denials of non-delegated activities,
conservator acknowledgements of Enterprise reports submitted in accordance with
conservator requirements, and conservator responses to policy changes proposed by the
Enterprises.

           Governance Practices

OIG described FHFA’s general conservatorship governance practices and the conservator
approval process for Enterprise business decisions in its 2012 White Paper.34 Although
FHFA has made changes to its organizational structure since that time, its internal governance
practices have not substantially changed. For example, the FHFA Director meets weekly
with FHFA executives to discuss key issues. He also chairs a committee that focuses on
conservatorship issues, which affords FHFA executives the opportunity to review and discuss


33
  For purposes of this white paper, the term “actions” refers to finalized decisions on matters in which the
conservator is involved.
34
     See OIG, 2012 White Paper, supra note 2, at 20-24.



                                    OIG  WPR-2015-002  March 25, 2015                                        13
conservatorship-related matters. Additionally, a division of FHFA employees coordinates
with the Enterprises to achieve strategic goals and provides support for conservatorship
operations. The following discussion highlights noteworthy changes in FHFA’s
conservatorship governance that have occurred since 2012.

DOC replaced the Office of Conservatorship Operations (OCO) in 2013 as the lead group
responsible for maintaining the governance structure and processes necessary to manage the
conservatorships.35 According to FHFA, DOC “facilitates communications between the
Enterprises and the conservator to ensure the prompt identification of emerging issues and
their timely resolution. The division also works with the Enterprises’ boards and senior
management to establish priorities and milestones for accomplishing the goals of the
conservatorship.”36 DOC has 25 authorized positions (seven are vacant at this time), whereas
OCO had six employees at the time OIG issued the 2012 White Paper.

The Conservatorship Committee replaced the Conservatorship Governance Committee
described in OIG’s 2012 reports; however, the Conservatorship Committee serves the same
basic purpose: to provide an executive level review of issues related to FHFA’s role as
conservator.37 The Committee is chaired by the FHFA Director, and its members are senior
FHFA executives, such as the Director’s Special Advisors; the FHFA General Counsel; and
the Deputy Directors of DOC, the Division of Housing and Mission Goals, and the Division
of Enterprise Regulation. The Conservatorship Committee provides a forum to discuss
conservatorship-related issues and to provide advice to the Director on pending Enterprise
requests. Notably, the Director has not delegated his decision-making authority to the
Committee on matters that require conservator approval.




35
   FHFA created the Division of Conservatorship in late 2013, subsequent to the issuance of the 2012 White
Paper on the conservatorships. DOC succeeded OCO, which was established early in the conservatorships
to coordinate and facilitate communications and decision-making for delegated and non-delegated matters.
DOC’s mandate is slightly broader in scope than OCO’s former mandate; in addition to facilitating
communication between the Enterprises and conservator, DOC oversees the implementation of FHFA’s
strategic plans for Enterprises’ conservatorships.
36
 FHFA, Leadership & Organization: Division of Conservatorship (online at
www.fhfa.gov/AboutUs/Pages/Leadership-Organization.aspx) (accessed on Jan. 22, 2015).
37
   The Conservatorship Committee replaced the Conservatorship Governance Committee in July 2014.
According to FHFA, there are not substantive differences between the two committees. For information on
the Conservatorship Governance Committee, see FHFA’s Conservator Approval Process for Fannie Mae
and Freddie Mac Business Decisions, at 10-11 (Sept. 27, 2012) (AUD-2012-008) (online at
www.fhfaoig.gov/Content/Files/AUD-2012-008_2.pdf); see also OIG, 2012 White Paper, supra note 2, at 21.




                                  OIG  WPR-2015-002  March 25, 2015                                        14
OIG’S PAST OBSERVATIONS ON THE CONSERVATORSHIPS........
OIG has published a number of reports that evaluated certain actions taken by FHFA acting as
conservator. Prior OIG reports have flagged shortcomings in FHFA’s governance practices as
conservator for the Enterprises. These reports highlighted the following:

        FHFA lacked written criteria and procedures for submitting and reviewing the
         Enterprises’ annual performance measures and year-end performance assessment
         data in connection with its oversight of Fannie Mae’s and Freddie Mac’s executive
         compensation programs.38

        FHFA lacked a formal review process for compensatory fee settlements and
         significant MSR transfers.39

Additionally, OIG has reviewed a number of actions taken by the Enterprises in response
to direction from the conservator and found that FHFA lacked the tools to measure the
effectiveness of such actions. These reports highlighted the following:

        FHFA lacked credible performance measures, specifically project schedules,
         timelines, and cost estimates, to track the progress of the development of the CSP.40

        FHFA failed to develop fixed definitions or methods to measure whether guarantee fee
         increases would actually encourage private sector investment.41

OIG reports have also shown that FHFA, as conservator, at times has failed to independently
test the Enterprises’ decision-making and operations, and at times has failed to ensure the
effective implementation of its directives. These reports highlighted the following:




38
  See OIG, Evaluation of Federal Housing Finance Agency’s Oversight of Fannie Mae’s and Freddie Mac’s
Executive Compensation Programs, at 22 (Mar. 31, 2011) (EVL-2011-002) (online at
www.fhfaoig.gov/Content/Files/ExecCompDrRpt03302011finalsigned.pdf).
39
  See OIG, FHFA’s Oversight of Fannie Mae’s 2013 Settlement with Bank of America, at 16-17 (Aug. 22,
2013) (EVL-2013-009) (online at www.fhfaoig.gov/Content/Files/EVL-2013-009.pdf).
40
  See OIG, Status of the Development of the Common Securitization Platform, at 26-29 (May 21, 2014) (EVL-
2014-008) (online at www.fhfaoig.gov/Content/Files/EVL-2014-008.pdf).
41
  See OIG, FHFA’s Initiative to Reduce the Enterprises’ Dominant Position in the Housing Finance System
by Raising Gradually Their Guarantee Fees, at 34 (July 16, 2013) (EVL-2013-005) (online at
www.fhfaoig.gov/Content/Files/EVL-2013-005_4.pdf).




                                 OIG  WPR-2015-002  March 25, 2015                                        15
        The Enterprises suffered an estimated $158 million in financial harm as a result of
         reimbursing their servicers for excessively priced lender-placed insurance coverage.42

        Fannie Mae and Freddie Mac erroneously reimbursed servicers in the amount of
         $89 million and $70 million, respectively.43

        FHFA did not sufficiently verify implementation of the Servicing Alignment Initiative
         or evaluate its effectiveness.44

        Each Enterprise had different understandings of delegated and non-delegated
         authorities under the 2008 LOIs, which led to inconsistent decision-making.45

OIG recently established the Office of Compliance and Special Projects to monitor FHFA’s
efforts to implement controls responsive to recommendations in OIG reports because effective
implementation is critical to the success of the recommended improvements. OIG will issue
reports from the Office of Compliance and include these reports in its semiannual reports to
Congress.


OIG’S INTENDED OVERSIGHT OF FHFA’S
CONSERVATORSHIP ACTIVITIES ................................................
FHFA’s actions as conservator are not subject to judicial review or intervention; therefore
strong, independent OIG oversight of FHFA conservatorship actions and processes is critical
to safeguard taxpayer dollars and ensure that FHFA is fulfilling its statutory duties. OIG’s
future work regarding the conservatorships will include:

        Identification of trends in conservator decisions and requests for conservator action;




42
  See OIG, FHFA’s Oversight of the Enterprises’ Lender-Placed Insurance Costs, at 17 (June 25, 2014)
(EVL-2014-009) (online at www.fhfaoig.gov/Content/Files/EVL-2014-009.pdf).
43
   See OIG, Freddie Mac Could Further Reduce Reimbursement Errors by Reviewing More Servicer Claims,
at 15 (Aug. 27, 2014) (EVL-2014-011) (online at www.fhfaoig.gov/Content/Files/EVL_2014_011.pdf); OIG,
Evaluation of Fannie Mae’s Servicer Reimbursement Operations for Delinquency Expenses, at 20-21 (Sept.
18, 2013) (EVL-2013-012) (online at www.fhfaoig.gov/Content/Files/EVL-2013-012.pdf).
44
  See OIG, FHFA’s Oversight of the Servicing Alignment Initiative, at 14 (Feb. 12, 2014) (EVL-2014-003)
(online at www.fhfaoig.gov/Content/Files/EVL-2014-003.pdf).
45
  See OIG, FHFA’s Conservator Approval Process for Fannie Mae and Freddie Mac Business Decisions, at
14-15 (Sept. 27, 2012) (AUD-2012-008) (online at www.fhfaoig.gov/Content/Files/AUD-2012-008_2.pdf).



                                 OIG  WPR-2015-002  March 25, 2015                                      16
        Assessment of the efficiency and effectiveness of FHFA’s governance of conservator
         decisions and the monitoring of compliance with those decisions; and

        Evaluation of the efficiency and effectiveness of FHFA’s process for identifying,
         developing, and implementing conservator-sponsored initiatives, and for monitoring
         the success of those initiatives.

Beyond these areas of concentration, OIG will take a risk-based approach when identifying
additional conservatorship activities to examine.


CONCLUSION ............................................................................
While there appears to be consensus that government-run conservatorships of the Enterprises
are not sustainable in the long-term, there is little consensus in Congress about what the
nation’s mortgage finance system should look like and what role, if any, the Enterprises
should play in it. Until some resolution is achieved, the Enterprises will continue to operate
under FHFA’s conservatorship, which according to FHFA Director Watt, continue to pose
“significant challenges,” including serious delinquencies that have declined but remain
historically high compared to pre-crisis levels; counterparty exposures; and shrinking
revenues from the Enterprises’ mortgage-related investment portfolios.46 The importance
of OIG’s close oversight of FHFA’s conservatorship of the Enterprises, through independent
fact finding, objective analysis, and reporting, is underscored by the sheer size of the
$187.5 billion taxpayer bailout of the Enterprises and their uncertain future.




46
  See Senate Committee on Banking, Housing, and Urban Affairs, Hearing on the Federal Housing Finance
Agency: Balancing Stability, Growth, and Affordability in the Mortgage Market, Statement of FHFA Director
Melvin L. Watt, at 3-4 (Nov. 19, 2014) (online at
www.banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=5dc60283-09ab-437f-8484-
b209c4df46a7).



                                 OIG  WPR-2015-002  March 25, 2015                                        17
OBJECTIVE, SCOPE, AND METHODOLOGY .................................
The objectives of this white paper were to:

      Update stakeholders on the current state of FHFA’s conservatorships;

      Document any changes in FHFA’s conservatorship governance since we published the
       2012 White Paper;

      Summarize findings of prior OIG reports that examined conservatorship decisions and
       practices; and

      Outline areas of interest for future OIG work pertaining to the conservatorships.

To address this report’s objectives, we interviewed key personnel at FHFA, including the Deputy
Director of DOC. We also reviewed publicly available data from the Enterprises’ filings with
the Securities and Exchange Commission, FHFA’s annual reports to Congress, and our
previously published OIG reports. Additionally, we reviewed non-public information provided
by FHFA and the Enterprises. The data used in this report covered the period from 2008 through
the end of 2014, when available. We did not independently test the reliability of FHFA’s or the
Enterprises’ data.

The preparation of this white paper was conducted under the authority of the Inspector
General Act of 1978, and in accordance with The Quality Control Standards for Inspection
and Evaluation (January 2012), which was issued by the Council of the Inspectors General
on Integrity and Efficiency. These standards require OIG to plan and perform evaluations to
obtain evidence sufficient to provide a reasonable basis for its findings and recommendations.
We believe that this white paper meets these standards. The performance period for this
white paper report was from November 2014 to February 2015.

We provided FHFA with the opportunity to respond to a draft of this white paper. We appreciate
the efforts of FHFA, the Enterprises, and their staff in providing information and access to
necessary documents to accomplish this study.




                             OIG  WPR-2015-002  March 25, 2015                                 18
ADDITIONAL INFORMATION AND COPIES


For additional copies of this report:

      Call: 202-730-0880

      Fax: 202-318-0239

      Visit: www.fhfaoig.gov



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

      Call: 1-800-793-7724

      Fax: 202-318-0358

      Visit: www.fhfaoig.gov/ReportFraud

      Write:

                FHFA Office of Inspector General
                Attn: Office of Investigation – Hotline
                400 Seventh Street, S.W.
                Washington, DC 20024




                              OIG  WPR-2015-002  March 25, 2015                          19