Freddie Mac’s Bad Bank of America Deal: Who Kept Tabs?

The Federal Housing Finance Agency Office of the Inspector General reports that Freddie Mac made a poor deal when it settled claims about bonds sold to it by Bank of America (NYSE: BAC). The report must make anyone who reads it wonder who was supposed to monitor the reasonableness of such transactions. The answer is that probably no one did, at least not enough to make Freddie Mac management concerned about the transactions.

The inspector’s office wrote, “prior to the Bank of America settlement, an FHFA senior examiner raised serious concerns about limitations in Freddie Mac’s existing loan review process for mortgage repurchase claims, which, according to the senior examiner, could potentially cost Freddie Mac a considerable amount of money.” In other words, the examiner’s concerns went unaddressed. The amount of the settlements was large enough to warrant concern — two agreements that totaled $2.87 billion.

The report’s conclusion would be stunning, were it not for so many similar lapses of judgment by Fannie Mae and Freddie Mac before the credit crisis. Freddie Mac would not have needed to settle with Bank of America if it had done due diligence before those transactions occurred. The excuse of Freddie Mac management is almost certainly that it was duped along with hundreds of other buyers of mortgages and mortgage instruments. If there was stupidity in the original evaluation process, why should there not be stupidity in how the damage was settled?

The government and financial firms in the private sector have used the stupidity excuse on many occasions. The sellers of derivatives did not disclose risks. The settlement of claims are based on a lack of knowledge about what was bought and sold as well. The idea that sophisticated managers at both the buyers and sellers did not understand the transactions means that there was never any skill within the U.S. financial industry at all. A small number of geniuses mislead scores of supposedly well-trained people.

Freddie Mac management probably wanted to settle its transactions with Bank of America as quickly and quietly as possible. What better way to keep the settlement out of the light of day? The inspector general unearthed the weaknesses of the transaction after the fact and made recommendations about how to keep it from happening again. Since the opinions of senior examiners were ignored when the arrangement with the Bank of America was struck, is there any reason to think criticism of it will matter at all?

Douglas A. McIntyre