Tag Archives: OIG

What If . . . Fannie and Freddie Imploded?

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photo by US HUD

So, I was spending some quality time with the Federal Housing Finance Agency Office of the Inspector General’s most recent Semiannual Report to the Congress. The Federal Housing Finance Agency (FHFA) is the regulator of Fannie and Freddie as well as their conservator. Essentially, the FHFA calls all of the shots for the two companies.

It got me to wondering, does the Office of the Inspector General really have a handle on whether Fannie and Freddie are in good shape or not? The report opens with a Snapshot of OIG Accomplishments. The Snapshot contains the following categories:

  • OIG Investigations Monetary Results
  • Judicial Actions
  • Hotline Contacts
  • Audit and Evaluation Reports Issued
  • White Papers Issued
  • Office of Compliance and Special Projects Reports Issued
  • Nonmonetary Recommendations Made
  • Regulations Reviewed
  • Responses to Requests Under the Freedom of Information Act

As I read through the report, I had the distinct feeling that I had got lost among the trees of bureaucratic oversight and had lost sight of the contours of the Frannie forest.

I want to know one thing — are the two companies solvent and will they be solvent for the foreseeable future? The OIG’s Snapshot is pretty backward facing and focuses on a lot of pretty minor issues, like counting hotline contacts, instead of focusing on the fundamentals.

I know, I know — if we can measure something, then we want to share it with the world, but the Snapshot actually decreases my faith that OIG and FHFA are taking care of the entire forest and not just a few of the trees they were able to measure.

That being said, the report does get  to some of the important issues later on. It acknowledges that

Since September 2008, FHFA has administered two conservatorships of unprecedented scope and undeterminable duration. Under HERA,the Agency’s actions as conservator are not subject to judicial review or intervention, nor are they subject to procedural safeguards that are ordinarily applicable to regulatory activities such as rulemaking. As conservator of the Enterprises, FHFA exercises control over trillions of dollars in assets and billions of dollars in revenue, and makes business and policy decisions that influence and impact the entire mortgage finance industry. For reasons of efficiency, concordant goals with the Enterprises, and operational savings, FHFA has determined to delegate revocable authority for general corporate governance and day-to-day matters to the Enterprises’ boards of directors and executive management. (10)

The OIG clearly understands what is at stake in the conservatorships. But as I read the remainder of the report, I did not see sufficient emphasis on the range of risks that Fannie and Freddie face, such as hedging risk and operational risk. Hopefully, someone at the FHFA is paying sufficient attention to the range of risks the two companies face. If not, we can expect a new type of crisis down the pike.

Another Fannie/Freddie Bailout?

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The Federal Housing Finance Agency Office of the Inspector General has issued a White Paper Report, The Continued Profitability of Fannie Mae and Freddie Mac Is Not Assured. The Executive Summary opens,

Fannie Mae and Freddie Mac (collectively, the Enterprises) returned to profitability in 2012 after successive years of losses. Their improved financial performance is encouraging; however, their continued profitability is not assured. The mortgage industry is complex, cyclical, and sensitive to changes in economic conditions, mortgage rates, house prices, and other factors. The Enterprises have acknowledged in their public disclosures that adverse market and other changes could lead to additional losses and that their financial results are subject to significant variability from period to period.

Notwithstanding the Enterprises’ recent positive financial results, they face many challenges. For example:

  The Enterprises must reduce the size of their retained investment portfolios over the next few years pursuant to the terms of agreements with the U.S. Department of Treasury (Treasury) and additional limits from FHFA. Declines in the size of these portfolios will reduce portfolio earnings over the long term. These portfolios have been the Enterprises’ largest source of earnings in the past.

  Core earnings from the Enterprises’ business segments—single-family guarantee, multifamily, and investments—comprised only 40% of net income in 2013. Sixty percent of the Enterprises’ net income came from non-recurring tax-related items and large settlements of legal actions and business disputes, which are not sustainable sources of revenue. Core earnings comprised 55% of net income in 2014.

  The Enterprises are unable to accumulate a financial cushion to absorb future losses. Pursuant to the terms of agreements with Treasury, the Enterprises are required to pay Treasury each quarter a dividend equal to the excess of their net worth over an applicable capital reserve amount. The applicable capital reserve amount decreases to zero by January 1, 2018.

  Stress test results released by the Federal Housing Finance Agency (FHFA) in April 2014 indicate that the Enterprises, under the worst scenario—a scenario generally akin to the recent financial crisis— would require additional Treasury draws of either $84.4 billion or $190 billion, depending on the treatment of deferred tax assets, through the end of the stress test period, which is the fourth quarter of 2015.

  Absent Congressional action, or a change in FHFA’s current strategy, the conservatorships will go on indefinitely. The Enterprises’ future status is beyond their control. At present, it appears that Congressional action will be needed to define what role, if any, the Enterprises play in the housing finance system. (1-2)

While I am overall sympathetic to the underlying message of this white paper — Reform Fannie and Freddie Now! — I think it is somewhat misleading. Fannie and Freddie have been sending billions of dollars to the Treasury that exceed the amount of support that they received during the financial crisis. Before we could talk about a second taxpayer bailout, I think we would have to credit them with those excess payments.

That being said, the Obama Administration and Congress have left Fannie and Freddie to linger for far too long in conservatorship limbo. I have no doubt that this state of affairs will contribute to some kind of crisis for the two companies, so we should support some kind of exit strategy that gets implemented sooner rather than later. Inaction is the greatest threat to Fannie and Freddie, and to the housing finance system itself.

Are the FHA’s Losses Heartbreaking?

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The Inspector General of the Department of of Housing and Urban Development issued an audit of FHA’s Loss Mitigation Program (2014-KC-0004).  The Office of the Inspector General (the OIG) did the audit because of its “concern that FHA might have incurred costs while allowing lenders to make large amounts of money by modifying defaulted FHA-insured loans. Our audit objective was to determine the extent to which loans modified under the FHA program generated gains for the lenders.” (1)

The OIG found that

Lenders generated an estimated $428 million in gains from the sale of Government National Mortgage Association securities when modifying defaulted FHA loans in fiscal year 2013. These loan modifications were completed as part of FHA’s loss mitigation program. None of these lender generated gains were used to offset FHA’s insurance fund costs. As a result, FHA missed opportunities to strengthen its insurance fund. (1)

Given that the FHA had to be bailed out for the first time in its 80 year history, the findings of this audit are a bit heartbreaking, at least for a housing finance nerd like me.  $428 million would cover more than a quarter of the amount that Treasury had to advance to the FHA, no small potatoes.

The OIG found that the FHA “may have missed opportunities to strengthen its insurance fund. Lenders could be required to offset gains they obtained from the sale of securities for incentive fees and claims for modified loans that redefault.” (5)

The Auditee Comments and the OIG’s Evaluation of Auditee Comments make it clear that the extent of the gains had by lenders is very contested because the OIG did not “know the costs of the lenders.” (17) This seems like a pretty important missing piece of the story. Nonetheless, I hope that HUD, as the parent of both the FHA and Ginnie Mae, takes questions raised by this audit seriously to ensure that public monies are being put to their best use.