SWEETHEART DEAL FOR BANK OF AMERICA

In its review, Freddie Mac focused on loans that defaulted within two years. But in the Countrywide portfolio, foreclosures tended to peak in the fourth year.*



And so you get this picture, from a 2011 report by Freddie's internal auditor. What you're seeing is that Freddie's review process (the black line) looked hardest at the bucket of loans containing 16% of total foreclosures. It mostly ignored the bucket containing 70% of the foreclosures. By comparison, this is a bit like searching for a lost salt shaker and spending more time looking on the roof than in the kitchen.



We have reason to think Freddie was being willfully ignorant. An examiner at Freddie's regulator, the Federal Housing Finance Agency, warned that the majority of foreclosures were going uncounted in March 2010. Sure enough, in June 2011, regulators told Freddie that their review process was ignoring "over 93% of the year-to-date foreclosures from the 2005 and 2006."



Funky mortgage math designed to appease the big banks should sound familiar. Credit rating agencies gave AAA-ratings to huge tranches of mortgage-backed securities based on surreal models. This enabled them to earn fees from the investment banks sponsoring those offerings. In 2008, these quid pro quo arrangements contributed to the credit crash. You would think by 2010 people would have known better.

Perhaps they did.



WHAT DID FREDDIE KNOW?



This is when the story gets interesting. In June, a senior manager at Freddie Mac told the Federal Housing Finance Agency (FHFA) that he would review a sample of older loans, which showed a greater likelihood to end in foreclosure.



But no one ever did review those loans. One manager claimed his staff was "resource-constrained." Another said that a senior manager was "vehemently against looking at more loans" (p. 21). Freddie's managers seemed to want the issue to go away. One senior manager said he didn't think Freddie Mac "would recover enough from a more expansive loan review process" if they lost the business of Bank of America and other loan sellers.



After Freddie reached a tentative settlement with Bank of America, its internal auditors raised the same issue. Because the bank wanted to reach the settlement by the end of the year, however, there was no time to do a proper analysis, so Freddie produced an estimate based on an unrepresentative loan sample. Most revealingly, a senior management memorandum stated, "management made a deliberate decision not to consider changes to our sampling procedures" (p. 27, emphasis added).

The final twist in this story is that after the Bank of America settlement was signed, sealed, and delivered, Freddie essentially admitted the problem. The same senior manager who prepared the Freddie Mac estimate in 2010 admitted that "Freddie Mac could recover several billion additional dollars by changing its current loan review process" (p. 30).

