The regulator of Fannie Mae and Freddie Mac should require that banks and mortgage lenders obtain independent, third-party tests to ensure compliance with guidelines, according to a government watchdog report.
Neither Fannie nor Freddie "have routine, independent verification of counterparty compliance," the Federal Housing Finance Agency Office of Inspector General said in a report to be released Friday.
As a result, the government-sponsored enterprises are exposed to greater risk of fraud and the misrepresentation of facts about properties, borrowers or loans, the report said.
The report is the second in the past two weeks that has been highly critical of the FHFA, which oversees Fannie and Freddie while they are in conservatorship. The watchdog recently lambasted the FHFA for failing to analyze the costs to taxpayers of a new plan to reduce buybacks for banks and mortgage lenders.
This latest report continues that criticism of the FHFA's "representation and warranty framework," announced in May, alleging the plan could further shift risks from lenders and servicers to the GSEs themselves.
Since the plan gives lenders relief from buying back nonperforming loans after just three years, the GSEs are increasingly relying on lenders' underwriting processes for assurances of loan quality, the report said.
Other federal agencies involved in the mortgage market do require some type of independent testing of counterparty compliance, the report said. Ginnie Mae, the Securities and Exchange Commission, the Department of Housing and Urban Development and private investors in mortgage-backed securities commonly require third-party attestation of compliance, the report said.
Yet, neither Fannie nor Freddie "has established requirements for those sellers to have their loan production processes independently tested by a third-party as part of either annual financial statement audits or separate engagements," the report said. "The testing can serve as an important component of a governance structure to manage the risk assumed by the (GSEs)."
The inspector general found that fewer than 15% of loans were selected for quality control review at the end of March. Those results of a small sampling of loans indicated "a number of underwriting defects," which required that lenders repurchase the loans.
"With the shift in emphasis to upfront quality control on performing loans, additional attention to counterparty underwriting practices could be critical in protecting the (GSEs') interests through the use of its repurchase ability, which is now limited to three years," the report said.
Fannie has 1,400 mortgage servicer counterparties servicing loans with balances totaling $3.1 trillion. Freddie has 1,200 servicer counterparties with loans worth $1.7 trillion, the report said.
Though the inspector general recommended that FHFA direct Fannie and Freddie to assess having lenders and servicers obtain third-party attestations of compliance, the FHFA disagreed.
Nina Nichols, the FHFA's acting deputy director of regulation, responded by saying FHFA has recently made "significant changes and enhancements" to its counterparty risk management programs. In a memo last week to Russell Rau, the deputy inspector general for audits, Nichols wrote that independent third-party attestations "have limitations as a risk management tool."
The inspector general responded by stating that the GSEs "are only able to conduct detailed reviews of a limited number of counterparties." The agency also noted that past failures to monitor counterparties allowed the fraud scheme by officers and employees at Taylor, Bean & Whitaker to continue over many years.