Still haven’t learned: Freddie, Fannie taking new mortgage risks with questionable appraisals

Audit finds they bought loans despite red flags on appraisals

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In a fresh sign that lessons from the financial crisis six years ago haven’t been fully heeded, the government-backed mortgage giants Fannie Mae and Freddie Mac bought billions of dollars of mortgages last year despite red flags suggesting something could be wrong with their appraisals, investigators disclosed Thursday.

The report from the Federal Housing Finance Agency’s inspector general found that both mortgage giants, which had to be taken over and bailed out by taxpayers in 2008, were overriding warning messages generated by a new computerized system designed to detect problems with appraisals because, they said, the new screening system was rejecting too many qualifying loans.

Because of the decision to override the warning system, “Fannie Mae spent $13 billion buying over 56,000 loans even though the portal’s analysis of the associated appraisals warned [Fannie Mae officials] that the appraisals were potentially in violation of its underwriting requirements” between January 2013 through June 2013, investigators found.

Between June 2013 through September 2013, Freddie Mac “spent $6.7 billion buying over 29,000 loans despite the portal warning [Freddie Mac officials] that either no property value could be provided or the value of the property was in question,” the report said.

In addition, the survey noted, the two housing finance giants acquired nearly $88 billion in loans where problems with the portal’s screening standards “did not allow them to determine if the appraiser was properly licensed to assess the value of the properties, which served as collateral for the loans.”

The report did not conclude there were potentially massive problems with the purchased loans, but because the warning messages were turned off, at least some questionable loans were approved. The inspector general and the two companies identified 23 loans worth $3.4 million that relied on flawed appraisals provided by two appraisers who had lost their licenses. Those loans violate mortgage regulations and will have to be repurchased by the lenders who sold them to Fannie and Freddie, the report said.

While the amount of flawed loans is small compared to the trillions of dollars in defaulted subprime mortgages underwritten by the mortgage giants during the 2000s housing bubble, the agency watchdog said it shows that, six years after the collapse of the housing market, Fannie and Freddie still have not fully implemented the safeguards needed to ensure loans are sound in the future.

“The [computer] portal is a vital tool to minimizing the risk of loss and should be fully used to improve loan quality,” the IG said. “Assessing the value of collateral securing mortgage loans is one of the pillars in making sound underwriting decisions.”  

The agencies protested that the current computer flagging system is flawed and is sending out false warnings based on inaccurate information. But the IG said that is no excuse when Fannie and Freddie have paid contractors $52 million in the last four years to set up the computer portal.

The mortgage giants and their regulator, the FHFA, whose authority to crack down on bad lending practices was strengthened considerably during the crisis, said they agreed with the IG and will follow its recommendations, but have reasons for automatically ignoring thousands of the computer-generated warnings that could potentially disqualify loans being offered for sale.

They said the computer’s data base is incomplete and not fully reliable. The computer may signal that an appraiser was not properly licensed, for example, when the appraiser had in fact renewed his license but the database had not yet received that information from the National Registry of appraisers, on which it relies to update information.

Moreover, the mortgage agencies said they ignored many of the warnings because the violations were technical in nature and they did not want to overburden mortgage lenders. Mortgage brokers have been complaining loudly about all the new lending burdens and fees imposed by them by Fannie and Freddie and have been pleading for relief from what they view as heavy-handed overregulation.

Based largely on the dictates handed down by Fannie, Freddie and the Federal Housing Administration, lenders have been providing loans only to the most creditworthy borrowers since the housing crisis, making it difficult or impossible for people with average or below-average credit ratings to get home loans.

For those reasons, many analysts say what is wrong with the mortgage market today is not that Fannie and Freddie are not being cautious enough, but that they have overreacted to their losses during the crisis and are tightening up too much on credit, causing a credit crunch. Moreover, few think that appraisals today, which generally reflect prices that are down by as much as 50 percent from peaks seen in 2006, are grossly overinflated like the appraisals that endorsed hyperbolic increases in home prices during the housing bubble.

You can read the full report here.

Patrice Hill contributed to this report.

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