Another report, the third in a week, has been issued by the Federal Housing Finance Agency's (FHFA) Office of Inspector General (OIG).  The latest report is an assessment of FHFA's oversight of Fannie Mae's and Freddie Mac's (the GSEs) compliance with their contractual agreements with counterparties.   

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

In September 2012, FHFA introduced a new representation and warranty framework aimed at clarifying lenders' repurchase exposure and liability on future deliveries of noncompliant loan.  FHFA and the GSEs provided guidance regarding this framework which relieved lenders of certain repurchase obligations related to loans with acceptable payment histories but explicitly excluded lenders from such relief if they violated federal or state laws or regulations.   For example, Freddie Mac's guidance states: "[t]he [m]ortgage must comply 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, reinforces the importance of contractual provisions related to compliance with laws and regulations, and the GSEs' ability to pursue seller repurchase of loans originated in violation of consumer protection laws.

OIG points out that multiple federal consumer protection laws apply to residential mortgages including the Fair Housing Act, the Equal Credit Opportunity Act, and the Truth-In-Lending Act. Historically, federal banking regulators such as the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation enforced these laws. Recently, however, the new Consumer Financial Protection Bureau (CFPB) has taken on much of this responsibility.  As a result, federal regulators have begun to collaborate to protect consumers by entering into agreements with CFPB to coordinate key aspects of supervision, such as sharing information and avoiding contradictory directives.

According to its officials, FHFA is considering how to coordinate with other regulators 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.

In spite of their counterparties' commitments, the GSEs do not review the loans they buy at the time of purchase to assess whether consumers are being treated according to applicable law. Instead they generally rely on the counterparties' representations and warranties of compliance with consumer protection laws.  Because the GSEs can require their counterparties to repurchase loans if they discover violations, they concern themselves with compliance issues only when they may be liable as a purchaser for noncompliance. Further, the GSEs have indicated that it is not their duty to monitor and enforce compliance with federal consumer protection laws because there are federal regulatory agencies with these responsibilities.

For its part, FHFA has not performed any reviews specific to how the GSEs monitor counterparty compliance in this area.  It notes that its new supervisory examination guidance that is under development does not explain how such reviews should be conducted. Further, although FHFA's new representations and warranty framework directs the GSEs to conduct reviews of compliance with their seller/servicer guides earlier in the process and to evaluate loan files on a more comprehensive basis, more specific instruction to identify loans  with legal compliance issues is not included. Moreover, like the GSEs, FHFA officials asserted that they rely upon the efforts of other regulators.

FHFA and the GSEs recognized their shared responsibility for protecting the public interest when they explicitly excluded violations of federal and state laws and regulations from the universe of representation and warranty violations that may be forgiven after 36 months of on-time mortgage payments. Yet neither GSE has implemented procedures to identify and refer for repurchase mortgages that were originated in violation of federal and/or state laws or regulations, and FHFA has not instructed them to develop such procedures.

In addition, purchasing and owning mortgages that were originated in violation of federal and/or state laws or regulations may subject the GSEs to increased economic risk. For example, if they buy mortgages and determine that the sellers have inaccurately represented and warranted their compliance with the GSEs, then they may require the sellers to repurchase the mortgages. Accordingly, under the new representation and warranty framework, compliance violations can be the sole basis to demand a seller repurchase a mortgage. The GSEs' failure to pursue seller repurchase demands related to mortgages in default with no material underwriting deficiencies-but that were originated in violation of consumer protection laws- may result in losses to the GSEs that could be avoided or mitigated.

FHFA has begun to put together a plan addressing its role in overseeing the GSEs' oversight of counterparty compliance and has begun to work with federal regulators responsible for supervising and regulating counterparties that sell mortgages to the GSEs. For example, the agency has developed an information-sharing agreement with regulators in the consumer financial market, such as the Federal Reserve Board and the Office of the Comptroller of the Currency and has met with specific regulators, such as the Federal Deposit Insurance Corporation. FHFA is determining how best to coordinate with these agencies to further its mission, but has not specifically addressed its role in monitoring the GSEs' oversight of their counterparties' compliance with contractual provisions requiring adherence to consumer protection laws.

Although OIG agrees that other federal agencies have regulatory and enforcement authority over the GSEs' counterparties with respect to consumer protection laws, FHFA has a statutory responsibility-under the Housing and Economic Recovery Act of 2008 (HERA)-to protect the public interest, which in this instance is at least partially defined by federal and state consumer protection laws. FHFA and the GSEs, in connection with their recent changes to representation and warranty relief procedures, demonstrated their awareness that they cannot condone the purchase and ownership of loans originated in violation of federal and/or state law, but they have not implemented adequate procedures to identify and refer for repurchase such loans.

Going forward, interagency coordination may be helpful in formulating a risk-based plan to assess how the GSEs monitor their counterparties' contractual compliance with federal and state laws generally and with consumer protection laws in particular.

At the conclusion of the assessment OIG recommends that FHFA develop a risk-based plan to monitor the GSEs' oversight of their counterparties' compliance with contractual representations and warranties, including those related to federal consumer protection laws.