OIG Finds GSEs, FHFA Lax in Oversight of Counterparty Compliance

Another report, the third in a week, has been issued by the FederalrnHousing Finance Agency’s (FHFA) Office of Inspector General (OIG).  The latest report is an assessment of FHFA’srnoversight of Fannie Mae’s and Freddie Mac’s (the GSEs) compliance with their contractualrnagreements with counterparties.   rn</p

Counterparties include entities that sell mortgage loans to the GSEs orrnwho service loans for them.  Both GSEsrnhave written selling and servicing guides that their counterparties representrnand warrant to follow including agreeing to comply with all federal and state laws and regulations- including consumer protection statutes-applicable to originating, selling, and servicingrnmortgage loans. If the GSEs discover that counterparty has not complied, then they can require the original lender to repurchase noncompliantrnloans.</p

In September 2012, FHFArnintroduced a newrnrepresentation and warranty framework aimed at clarifying lenders’ repurchase exposure and liability on future deliveries of noncompliantrnloan.  FHFA and the GSEs provided guidance regardingrnthis framework which relieved lenders of certain repurchase obligations related to loans with acceptablernpayment histories but explicitly excluded lenders from such relief if they violated federal or state laws orrnregulations.   For example,rnFreddie Mac’s guidance states: “[t]he [m]ortgage mustrncomply with all applicable federal, tate and local laws, ordinances, regulations and orders, including without limitation, tate anti-predatory lending laws and regulations.” The new framework, thus, reinforcesrnthe importance of contractual provisions related to compliance with laws and regulations, and thernGSEs’ ability to pursue seller repurchase of loans originated in violationrnof consumer protection laws.</p

OIG pointsrnout that multiple federal consumer protection laws apply to residential mortgages including the Fair Housing Act, the Equal Credit Opportunity Act,rnandrnthe Truth-In-Lending Act. Historically, federal banking regulators such as the Office of the Comptroller of the Currencyrnandrnthe Federal DepositrnInsurance Corporation enforced these laws. Recently, however, the newrnConsumer Financial Protection Bureau (CFPB) has taken on much of this responsibility.  As a result, federal regulatorsrnhave begun to collaborate to protect consumers byrnentering into agreements with CFPB to coordinate key aspects of supervision, such as sharing information and avoiding contradictory directives.</p

According to its officials, FHFA is considering how to coordinate with otherrnregulators in light of its responsibility to make sure the GSEs work is consistent with the public interest, but has not actively supervised the GSEs oversight of counterparties’ contractual compliance with federal consumer protection laws.</p

In spite ofrntheir counterparties’ commitments,rnthe GSEs do not review the loansrntheyrnbuy at the time of purchase to assess whether consumers are being treated according to applicable law. Insteadrnthey generally rely on the counterparties’ representations andrnwarrantiesrnof compliance withrnconsumer protectionrnlaws.  Because the GSEsrncan require their counterparties to repurchase loans if they discover violations, they concern themselves with compliance issues only when they may bernliable as a purchaser for noncompliance. Further, the GSEs have indicated that it is notrntheir duty to monitor and enforce compliance with federal consumer protection laws because there are federal regulatory agencies with these responsibilities.</p

For its part, FHFA has not performed any reviews specific to how the GSEsrnmonitor counterparty compliancernin this area.  It notes that its new supervisory examinationrnguidance that is under development does not explain how such reviews should be conducted. Further, although FHFA’s new representationsrnand warranty framework directsrnthe GSEs to conduct reviews of compliance with their seller/servicer guides earlier in the process and to evaluaternloan files on a more comprehensive basis, more specific instruction to identify loans  with legal compliance issues is not included.rnMoreover, like the GSEs, FHFA officials asserted that they rely upon the efforts of other regulators.</p

FHFA and the GSEs recognized their shared responsibility for protecting the publicrninterest when they explicitly excluded violations of federal and staternlaws and regulations from the universe ofrnrepresentation and warranty violationsrnthat may be forgiven after 36 months of on-time mortgagernpayments. Yet neitherrnGSE has implemented procedures to identify and refer for repurchase mortgages that were originated in violation of federal and/orrnstate laws or regulations,rnandrnFHFA has not instructed them to develop such procedures.</p

In addition,rnpurchasing and owning mortgages that were originated in violationrnof federal and/or state laws or regulations may subject the GSEs tornincreased economic risk. For example, if they buy mortgages and determine that the sellers have inaccurately represented and warranted their compliance withrnthe GSEs, then they may require thernsellers to repurchasernthe mortgages. Accordingly, under the new representation and warranty framework, compliancernviolations can be the sole basis to demand a seller repurchase a mortgage. The GSEs’ failure to pursuernseller repurchase demands related to mortgages in default with no materialrnunderwriting deficiencies-but that were originated in violation of consumer protection laws-rnmayrnresult in lossesrnto the GSEs that could be avoided or mitigated.</p

FHFA hasrnbegunrnto put togetherrna plan addressing its role</bin overseeing the GSEs' oversight of counterpartyrncompliance and hasrnbegun to work with federal regulators responsible for supervising and regulating counterparties that sell mortgages to the GSEs.rnFor example, the agency has developed an information-sharing agreement with regulators in the consumer financial market, such as thernFederal Reserve Board and the Office of the Comptroller of the Currency andrnhas met with specific regulators, such as the Federal DepositrnInsurance Corporation. FHFA is determining how best to coordinate with these agencies to further its mission,rnbut has not specifically addressed its role in monitoring the GSEs'rnoversight of theirrncounterparties' compliance with contractual provisions requiring adherence to consumer protection laws.</p