WASHINGTON — The Federal Housing Finance Agency must develop specific rules to determine when it should take an enforcement action against a troubled Federal Home Loan Bank, according to a report released Wednesday by the agency's watchdog.
While the agency has some guidelines, the FHFA lacks concrete "policies, systems and documentation standards," said the report from the FHFA's Office of the Inspector General.
Since 2008, four of the 12 Home Loan banks — Boston, Pittsburgh, Seattle, and Chicago — have faced "significant financial and operational difficulties," due largely to their investments in certain high-risk mortgage securities, the report said.
But the FHFA IG said the agency lacked a formal enforcement policy to guide its oversight of those firms.
"Without vigorous FHFA oversight, the potential exists that the troubled FHLBanks will engage in risky financial strategies that could further endanger their financial safety and soundness and the capacity to serve their housing missions," the report says.
FHFA officials acknowledged that existing guidelines do "not constitute a specific agency policy." Rather, agency officials have broad discretion in deciding under what circumstances to take formal action against a troubled bank.
But the IG's office said such wide discretion made it unclear when the agency will initiate a formal enforcement action.
"In its current form, the guidance has limited to no practical value for examiners in determining whether to classify an FHLBank as having supervisory concerns," the IG report states. "Further, FHFA sends mixed messages to its examiners and the FHLBanks through its seemingly inconsistent interpretation and application of the guidance."
To illustrate, the IG's office said that in its review it had found that there had been significant differences between how the Home Loan Bank of Seattle was treated versus the Boston and Pittsburgh banks. Seattle received a formal enforcement action while the other two institutions did not.
"FHFA-OIG observes that FHFA has not established written criteria defining the exceptions to its guidance generally to initiate formal enforcement actions when FHLBanks are classified as supervisory concerns," the report says. "Nor did FHFA provide documentation for such exceptions."
A lack of consistent policies also contributed to cases where FHFA had not taken proactive steps to hold troubled Home Loan banks and their officers accountable for failing to correct risks identified or for engaging in questionable risk-taking, according to the IG's report.
For example, the FHFA did not enforce a key provision in the Chicago Home Loan Bank's consent order, according to the report. The bank was required to send revised policies and procedures to address its market risk within 90 days, but ended up not submitting them until mid-2010, or nearly three years after the consent order had been established.
While FHFA said it was "unacceptable" for the bank to take that long, it did not take further enforcement action based on its non-compliance, according to the report.
Of utmost concern to the IG is that the lack of transparency in how the FHFA makes decisions to take enforcement action hinders outside reviews of the agency's oversight activities.
"It is especially important that these banks receive strong oversight and early intervention at signs of financial and operational difficulties," said Steve Linick, the Inspector General of the FHFA, in a press release, urging the agency to take corrective action.
The IG's review also found that the agency didn't have an automated system to monitor whether improvements were being made to deficiencies identified in examinations.
Lastly, the agency was not consistently documenting its interaction with the Home Loan banks, especially in regards to instances where FHFA may have implied to bank boards' that certain senior officials should be removed due to their responsibility for the deterioration of a bank.
In one example cited in the report, a senior FHFA official said the agency had advised the chairman of a troubled Home Loan Bank that the agency didn't have confidence in the senior executive officer's ability to carry out their responsibilities. By that evening, the board reached a severance agreement with the executive.
The IG's office said it was not able to confirm any of these personnel actions because no documentation was kept by the agency.
According to the IG's report, FHFA officials said "they had not considered their interactions with FHLBanks regarding the removal of senior officials as necessitating documentation."
The IG's office did identify areas where the FHFA had taken positive steps in overseeing the troubled banks, including encouraging fiscally conservative dividend and investment practices and closely monitoring them through examinations and ongoing communications.
The FHFA agreed to all three of the IG's recommendations, including developing a written enforcement policy for troubled Home Loan banks that would ensure deficiencies are corrected within certain deadlines. It also agreed to create an automated system to report bank examination findings and lastly, to document its interactions with the Home Loan banks.