WASHINGTON Freddie Mac's failure to properly review some defaulted loans could cost taxpayers billions of dollars, according to a report on Tuesday that may give the government extra firepower to wring far more money from Bank of America in legal settlements.
A senior examiner at the Inspector General's office of the Federal Housing Finance Agency, the regulator's independent watchdog, had raised concerns about Freddie Mac's loan review process months before the FHFA reached a $1.3 billion settlement with Bank of America (BAC.N) over poorly underwritten mortgages.
But the regulatory board did not act on the examiner's findings in a timely way, the report said. Neither did it test Freddie Mac's analysis underlying the huge settlement it reached with BofA on defaulted loans, the inspector general said in the report.
Analysts said the findings could help the government recoup additional funds. So far, $65 billion in taxpayer funds have been funneled to Freddie Mac since it was seized by the government in September 2008.
"The report suggests that Freddie Mac did not receive full value," said Peter Swire, a law professor at Ohio State University in Columbus, Ohio.
He said the inspector general's findings in the report provide FHFA with more impetus to push harder for bigger settlements in additional lawsuits against Bank of America.
Bank of America's stock fell 1.82 percent on Tuesday to close at $6.48.
"Our settlement with Freddie Mac was fair and reasonable and based on our extensive, well-defined course of dealing prior to the settlement in addressing and resolving repurchase claims," said Dan Frahm, a Bank of America spokesman. "Like any negotiated settlement, neither party obtained everything it sought."
Freddie Mac FMCC.OB had bought mortgages from the Countrywide unit of Bank of America during the housing boom. These loans defaulted at higher-than-expected rates in the third through fifth years after they were written.
But Freddie Mac aggressively reviewed only mortgages that went into foreclosure or showed payment problems during the first and second years, the FHFA senior examiner found.
Freddie Mac therefore did not review 300,000 loans for possible repurchase claims. This could potentially cost the company "billions of dollars of losses," the examiner said, according to the report.
"By relying on Freddie Mac's analysis of the settlement without testing the assumptions underlying Freddie Mac's existing loan review process, FHFA senior managers may have inaccurately estimated the risk of loss to Freddie Mac," the report said.
A dozen FHFA staffers and managers were alerted to the concerns raised by the senior examiner, yet the regulator "did not timely act on or test the data underlying these concerns prior to the approval of the Bank of America settlement," the report said.
A Freddie Mac spokesman declined to comment on the Inspector General's findings.
The Freddie Mac spokesman, Michael Cosgrove, said at the time of the agreement with Bank of America earlier this year, the company was in discussions with the lender in order to find ways to resolve loan repurchase requests. The agreement was "commercially reasonable based upon our internal evaluation and judgments," he said.
Freddie Mac signed its $1.35 billion settlement with Bank of America Corp. last December, with FHFA's approval. The deal involved pending and future repurchase demands on 787,000 loans previously sold to Freddie Mac by Bank of America and Countrywide.
"The Inspector General's report is very damning," said Representative Brad Miller, a Democrat who is a member of the House Financial Services Committee and has proposed legislation to reform housing finance.
"The officials at Freddie Mac who decided to settle these claims for billions less than taxpayers had coming should obviously lose their jobs immediately," Miller said in a statement.
Earlier this month, FHFA filed a lawsuit against 18 banks seeking unspecified damages for losses on about $200 billion of soured bonds. According to the lawsuits, the securities should have never been sold because the underlying mortgages did not meet investors' criteria.
The FHFA, which has been acting as the independent regulator of Freddie Mac and its sister company, Fannie Mae, for three years, responded to the Inspector General's findings, with a letter dated September 19 saying "there are areas for improvement" at the agency.
"FHFA is developing and will soon issue policies and procedures to its examiners and managers regarding the agency's expectations for how to raise and resolve critical safety and soundness concerns," the letter said.
(Reporting and writing by Margaret Chadbourn; Additional reporting by Julie Haviv; Editing by Dan Grebler)