FHFA’s Exercise of Its Conservatorship Powers to Review and Approve the Enterprises’ Annual Operating Budgets Has Not Achieved FHFA’s Stated Purpose Evaluation Report EVL-2015-006 September 30, 2015 Federal Housing Finance Agency Office of Inspector General
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FHFA’s Exercise of Its
Conservatorship Powers to Review
and Approve the Enterprises’
Annual Operating Budgets Has Not
Achieved FHFA’s Stated Purpose
Evaluation Report EVL-2015-006 September 30, 2015
Federal Housing Finance Agency Office of Inspector General
EVL-2015-006
Date XX, 2015
EXPLANATION OF REDACTIONS IN REPORT
Redactions in this report were made at the request of the Federal Housing Finance Agency
(FHFA). According to FHFA, the redactions are intended to protect from disclosure material
that is confidential financial, proprietary business, and/or trade secret information. FHFA
claims further that the redacted information would not ordinarily be publicly disclosed, and, if
disclosed, could disadvantage Freddie Mac and Fannie Mae.
EVL-2015-006
September 30, 2015
Executive Summary
Fannie Mae and Freddie Mac (collectively, the Enterprises) have been under
the conservatorship of the Federal Housing Finance Agency (FHFA) since
September 2008. In our annual Audit and Evaluation Plan, the Federal
Housing Finance Agency Office of Inspector General (OIG) identified the
operation of the conservatorships as a strategic risk and a focus of OIG’s work.
This evaluation is the first of a number of projects in which OIG examines
actions taken by FHFA as conservator for the Enterprises.
In the beginning of the conservatorships, FHFA delegated to the Enterprises
the authority to establish their annual operating budgets. Acting pursuant to
this delegated authority, both Enterprises set their annual operating budgets for
fiscal years 2009-2012. (The fiscal year for each Enterprise runs concurrently
with the calendar year.) In November 2012, FHFA, acting as conservator,
rescinded that delegation and determined to require review and approval of the
Enterprises’ annual operating budgets. FHFA’s stated purpose for that action
was to ensure that the budgets aligned with FHFA’s strategic direction and
safety and soundness priorities.
In 2012, the last year before FHFA required that the Enterprises obtain its
approval for their budgets, the combined spending by both Enterprises totaled
$3.9 billion. FHFA has approved the annual operating budgets for both
Enterprises for fiscal years 2013, 2014, and 2015. For fiscal year 2015, FHFA
approved spending in the combined Enterprise budgets that totaled $5.1
billion—an increase of more than $1.2 billion, or approximately 31%, over
2012 spending.
This evaluation looks at whether the conservator’s budget approval process
has been effective in ensuring that the budgets align with FHFA’s strategic
initiatives and safety and soundness priorities.
We found that FHFA’s budget review and approval process has not achieved
FHFA’s stated purpose for re-asserting its approval authority because of late
timing, cursory-level analysis, and inadequate resources. These shortcomings
prevent FHFA from exercising effective control over Enterprise spending,
both in amount and direction. As a consequence, FHFA’s budget review and
approval process has imposed virtually no budget control on the Enterprises,
and FHFA’s approval of the budgets creates the risk that it has endorsed
Enterprise spending that has not been well understood by FHFA.
After OIG finished its review for this evaluation in June 2015, FHFA
determined in late July 2015 to enhance its budget review and approval
process. OIG cannot assess the sufficiency of the newly approved changes
EVL-2015-006
September 30, 2015
to the budget review process until they are fully implemented. Based on
the deficiencies identified by OIG in this evaluation, we make four
recommendations to strengthen the budget review process. FHFA has agreed
to three recommendations and generally agreed to one recommendation.
This evaluation was led by Brian Stief, Investigative Counsel, who was
assisted by Moira Roberts, Special Counsel. We appreciate the cooperation
of FHFA staff, as well as the assistance of all those who contributed to the
preparation of this report.
This report has been distributed to Congress, the Office of Management and
Budget, and others and will be posted on our website, www.fhfaoig.gov.
1. Direct each Enterprise to submit its proposed operating budget and supporting
materials for the next fiscal year so that FHFA has sufficient time before the fiscal
year begins to adequately analyze the proposals.
2. Revise the existing budget review process and staff the review process with employees
who have the qualifications and experience needed for critical financial assessments of
the proposed Enterprise budgets to permit FHFA to determine whether each
Enterprise’s budget aligns with FHFA’s strategic direction and its safety and
soundness priorities.
3. Set a date certain during the first quarter of 2016 by which FHFA will take final action
on each proposed annual operating budget for 2016 and approve the budget by that
date.
4. Set a date certain, prior to January 31 of each subsequent fiscal year, by which FHFA
will take final action on each proposed annual operating budget and approve the
budget by that date.
OIG provided FHFA an opportunity to respond to a draft report of this evaluation. In its
comments, which are reprinted in their entirety in Appendix A, FHFA agreed with
recommendations 1, 2, and 3, and “generally agreed” to recommendation 4. FHFA also
provided technical comments on the draft report, which were incorporated as appropriate.
OIG EVL-2015-006 September 30, 2015 21
OBJECTIVE, SCOPE, AND METHODOLOGY .................................
The objective of this report was to assess FHFA’s process for review and approval of Fannie
Mae’s and Freddie Mac’s annual operating budgets, as required under the Revised Letters of
Instruction, against the stated purpose for the budget approval: ensuring budget alignment
with FHFA’s strategic direction and safety and soundness priorities.
To achieve this objective, we interviewed FHFA personnel involved with the creation and
execution of the budget review and approval process. Those interviewed included the Deputy
Director of DOC and the DOC staff who conducted the 2014 and 2015 annual budget
reviews. We also reviewed publicly available documents, internal DOC documents, and non-
public information provided by FHFA. Additionally, we reviewed relevant FHFA
communications within FHFA and with the Enterprises. We drew all financial information
from either FHFA internal documents or publicly available Enterprise financial statements.
Our work was conducted under the authority of the Inspector General Act and in accordance
with the Council of the Inspectors General on Integrity and Efficiency’s Quality Standards for
Inspection and Evaluation (January 2012). These standards require us to plan and perform an
evaluation based upon evidence sufficient to provide reasonable bases to support its findings
and recommendations. We believe that the findings and recommendations discussed in this
report meet these standards.
The fieldwork for this report was completed between February and June 2015. The
performance period for this evaluation was between February and August 2015.
APPENDIX A
FHFA's Comments on OIG's Findings and Recommendations
Federal Housing Finance Agency
MEMORANDUM
TO:
FROM:
Kyle D. Roberts, Deputy Inspector General for Evaluations
Bob Ryan, Acting Deputy Director, Division of Conservatorship
SUBJECT: Evaluation Report: FHFA’s Exercise o f Its Conservatorship Powers to Reviewand Approve the Enterprises’ Annual Operating Budgets Has Not Achieved FHFA’s Stated Purpose
DATE: September 24, 2015
This memorandum transmits the Federal Housing Finance Agency’s (FHFA) management response to the recommendations in the draft report prepared by FHFA OIG, FHFA’s Exercise o f Its Conservatorship Powers to Review and Approve the Enterprises’ Annual Operating Budgets Has Not Achieved FHFA's Stated Purpose (Report).
FHFA has reviewed the Report and, as discussed below, concurs with the Report’s recommendations. While we concur with the recommendations and have been taking steps to implement changes, we take issue with the following aspects o f the Report for the reasons explained:
• The Report understates the level o f involvement by FHFA in the decisions leading to the formulation of the Enterprises’ budgets. As the 2012 Letter of Instructions provides, the management of both Enterprises must “consult with and obtain the written approval of the conservator before taking” action on their budgets. However, the Report’s focus solely on the steps undertaken by the Division o f Conservatorship (DOC) in the budget process does not take into account the substantial roles played by other Divisions within FHFA in meetings, discussions, analyses, consultations and decisions about the underlying work manifested in the budgets o f the Enterprises. The Report’s focus on one Division within FHFA may, therefore, lead some readers o f the Report to conclude that FHFA and the Enterprises are not meeting their strategic and safety and soundness obligations, a conclusion that FHFA believes would be clearly erroneous.
• The Report’s assertion that, because o f their conservatorship status, “the corporate governance incentives that animate directors’ conduct in most public companies are largely absent in board governance of the Enterprises” is unwarranted. While FHFA reviews and approves the Enterprises’ budgets because of its ultimate responsibility as conservator, the boards of the Enterprises, in fact, continue to have strong corporate
governance incentives. These incentives include, among others, the obligation to comply with all laws and FHFA’s regulations that require the Enterprises to have corporate governance practices that are consistent with safe and sound operations (of which prudent management of budget and expenses is a core component), indirect accountability to the taxpayers, and exposure to substantial public scrutiny.
Recommendation 1:
Direct each Enterprise to submit its proposed operating budget and supporting materials for the next fiscal year so that FHFA has sufficient time before the fiscal year begins to adequately analyze the proposals.
Management Response to Recommendation 1:
FHFA agrees with this recommendation. FHFA’s views on the appropriate level of control over the budget as well as a number of other matters have been evolving throughout the period of conservatorship and have been under more intense review throughout 2014 and 2015. This review led to a decision by FHFA in July 2015 to accelerate the timetable for the Enterprises to submit their proposed budgets and supporting materials for review and approval by FHFA. FHFA communicated that decision to the Enterprises in August 2015 and requested that the Enterprises submit information regarding their proposed significant strategic initiatives and baseline expenses for 2016 in October of 2015. While the revised timeline may not allow both Enterprises sufficient time to submit final board-approved 2016 budgets for review and approval by FHFA before the end of 2015, FHFA will require submissions by December for subsequent fiscal years.
Recommendation 2:
Revise the existing budget review process and sta ff the review process with employees who have the qualifications and experience needed fo r critical financial assessments o f the proposed Enterprise budgets to permit FHFA to determine whether each Enterprise's budget aligns with FHFA’s strategic direction and its safety and soundness priorities.
Management Response to Recommendation 2:
FHFA agrees with this recommendation. As outlined in 1 above, FHFA changed its review protocols in 2015. FHFA is in the process of hiring a Financial Analyst within DOC to lead the operating budget review and DOC has assigned two additional staff members with relevant technical qualification and experience to support the budget review process. In addition, DOC will strategically consult with staff from FHFA’s Division of Housing Mission and Goals and Division of Enterprise Regulation with expertise on specific budget
2
items and strategic initiatives and staff from FHFA’s Office of Budget and Financial Management with expertise on baseline expenditures.
Recommendation 3:
Set a date certain during the first quarter o f 2016 by which FHFA will take final action on each proposed annual operating budget for 2016 and approve the budget by that date.
Management Response to Recommendation 3:
FHFA agrees with this recommendation and will advise the OIG when each Enterprise’s budget for 2016 is approved.
Recommendation 4:
Set a date certain, prior to January 31 o f each subsequent fiscal year, by which FHFA will take final action on each proposed annual operating budget and approve the budget by that date.
Management Response to Recommendation 4:
FHFA generally agrees with this recommendation. FHFA has set as an objective taking final action on each Enterprise’s budget by January 31 of each subsequent year and believes that FHFA’s active engagement with the Enterprises throughout the budgeting process will usually enable FHFA to meet that objective. However, FHFA strongly believes that basing budget decisions on the most up to date financial information available and having prior review and approval o f the budgets by the boards of the Enterprises are critically important. Consequently, FHFA approvals with conditions or disapprovals, which may cause FHFA to need additional time to receive supplemental information from the Enterprises and time for additional board approvals, may result in justifiable delays in providing final FHFA approval. FHFA will document the reasons for any such delays and will exercise appropriate conservatorship discretion to approve the budget as soon as practicable when such a delay occurs.
Cc: Larry Stauffer, Acting Chief Operating OfficerJohn Major, Internal Controls and Audit Follow-Up Manager
APPENDIX B
2015 Freddie Mac Budget Summary Table by DOC [REDACTED]
($ in Millions)
Division
Single FamilyM ultifamilyCapital MarketsInformation TechnologyFinanceLegalEnterprise Risk Management Internal Audit ComplianceOffice of Chief Administrator Human Resources and Diversity Office of CEO Make Home Affordable Unallocated Expense ***
Total Administrative Expense by Division
FY 2014 Budget
ActualFY2014
Delta vs. FY2014 Budget
ProposedFY2015Budget
Delta vs.2014
Actuals
*** Represents the CEO's expectation of realized underspend across Divisions.
Freddie Mac 2 014 Budget Performance($ in Millions)
FY 2014 Actual Delta vs.2014
BudgetCategory:Budget FY 2014
Divisional Base Strategic Inititiatives:
CoreCSP / Single Security
Subtotal = Extraordinary Items:
SF Credit, QC and PC Recoveries PLS and Other Litigation
Subtotal =Legacy Pension Expense Other G&A
Total Administrative Expenses
FTE Employee Headcount FTE Contractor Headcount
2015 Fannie Mae Budget Summary Table by DOC [REDACTED]