Fannie Mae recklessness risks future financial crises and taxpayer losses, watchdog warns

Nearly seven years after it was bailed out from the housing market crash, mortgage giant Fannie Mae is still engaging in behavior that could precipitate future financial crises and taxpayer losses, a government watchdog warns in a report to be released Wednesday.

The Federal Housing Finance Agency inspector general said its latest concerns involve Fannie Mae’s “haphazard” decision to fill a critical auditor position with an employee who lacked proper qualifications and suffered from a conflict of interest.

Unless Fannie Mae’s leaders and the audit committee that allowed the hiring do their jobs better, there is a “substantial risk” the mortgage company “will operate in an unsafe and unsound manner, suffer losses and expose U.S. taxpayers to further financial risks,” the inspector general said.

The watchdog also had harsh words for the FHFA, the federal agency that oversees Fannie Mae, saying its own leadership failed to act on concerns about the hiring of the auditor position, choosing instead to stay silent.

Fannie Mae and Freddie Mac are two federally insured mortgage giants that were taken over by the U.S. government in fall 2008 during the height of the U.S. financial crisis, which was caused in part by risky subprime mortgages.

Taxpayers bailed out the two entities in one of the most dramatic government interventions in U.S. market history. FHFA was created as a federal agency to provide better oversight to the two mortgage giants.

The current controversy centers on the Chief Audit Executive (CAE), a critical role at Fannie Mae “tasked with providing independent, objective assurance of the enterprise’s governance, risk management and control processes,” the inspector general reported.

But despite the CAE’s role in determining the financial safety of Fannie Mae’s actions, including what loans to hand out, the company internally hired a manager who didn’t have enough experience to meet the role, falling below the “preferable” level of qualifications for the job.

Though looking for at least 15 years’ experience as an auditor, the manager hired had only seven years’ experience and hadn’t worked as an auditor since 1992, the report said.

Furthermore, before becoming the CAE, the manager had served as the chief credit officer for Fannie Mae’s largest business unit. That presented a major conflict of interest, investigators said, since he was strongly invested in the financial success of the company, which could have clouded his judgment on whether a loan was sound.

The report did not name the manager.

Spokespeople for Fannie Mae did not return reporters’ requests for comment Tuesday.

Peter Morici, an economist and professor at the R.H. Smith School of Business at the University of Maryland, said it was “absolutely ridiculous” for Fannie Mae to be hiring its own managers as auditors “when there’s such a large pool [of] talent out there available for this.”

It is “good old-fashioned Latin American corruption,” said Mr. Morici, who also is a frequent columnist for The Washington Times and other publications. “They’re going to inspect their own work, their friends and supervisors. It’s just not what you do. It’s like having the students write and grade their own exams.”

In their report, investigators described the hiring process as “haphazard” and “far from diligent.”

Fannie Mae who were “ready now” to become the CAE.

But the Audit Committee that assembled to hire a new CAE ignored the senior management’s conclusions and decided to only consider internal candidates. The audit committee members then hastily assembled a list of potential choices, producing nine names within six days.

Of those nine names, members of the Audit Committee only interviewed three before selecting their hire. The decision seems to have been a largely arbitrary one, as investigators noted “no corporate record that the Audit Committee formally met, either in person or by phone, to discuss the qualifications of the different candidates and to make its selection.”

Federal investigators slammed the Audit Committee, stating there were “significant lapses in corporate governance” and questioning whether the committee “appreciates its governance obligations in this environment.”

The FHFA said it agreed with the inspector general’s report and would ensure that the Audit Committee records and documents all meetings and decisions.

The federal agency also said they would direct Fannie Mae to hire an independent third party to conduct an evaluation of the Audit Committee itself and its effectiveness.

Fannie Mae has been under strict federal control ever since the financial collapse of 2008. The Treasury Department committed an estimated $200 billion to try to fix Fannie Mae — and fellow mortgage company Freddie Mac — under the Troubled Asset Relief Program, or TARP.

In addition to buying up toxic loans and assets handed out by the companies, the FHFA was charged with righting the ship and trying to get the company back on its feet while ensuring it doesn’t engage in risky loan behavior again.

FHFA officials have been slowly trying to wean both companies off government control by gradually restoring to them greater independence.

But Wednesday’s audit represents a sharp rebuke from federal investigators, who questioned whether some of Fannie Mae’s managers are taking their jobs seriously, and whether FHFA was providing adequate oversight in the face of concerns.

“FHFA’s oversight of Fannie Mae’s appointment of a new CAE was ineffective,” the inspector general concluded. “Several senior FHFA officials questioned the robustness of the hiring process among themselves but elected not to discuss those deficiencies with the Audit Committee after being informed of its selection or with the Fannie Mae Board before it approved the selection.”

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