Not sure if this broke last night or earlier. Damning report from IG. If it was last night, maybe a joint statement from you and ES? Even if it only ends up a few places, it further drives home that you and he are the head of the pack (increasingly needed as so many other AGs jump on board). Stmt could be a short, soft way of basically saying, "We told you so, this is why we're involved,"

Freddie Faulted on Mortgage Reviews

By NICK TIMIRAOS

A federal watchdog said Freddie Mac may have given up opportunities to recover billions of dollars in claims over defaulted mortgages and suggested that a January settlement with Bank of America Corp. to resolve $1.3 billion in bad-loan claims was inadequate.

The report is to be released Tuesday by the inspector general for the Federal Housing Finance Agency, which regulates Freddie Mac and its larger cousin, Fannie Mae.

A senior FHFA examiner warned in September 2010, months before the Bank of America settlement, that Freddie "could be passively absorbing billions of dollars in losses" by not more aggressively reviewing defaulted loans that could be sold back to lenders, the report said. January's settlement resolved many of those "buyback" demands with Bank of America, which saw its shares rally after striking deals with Freddie and Fannie. The FHFA approved the settlement with Bank of America last year.

The inspector general's report suggested Freddie Mac's lax reviews may have cost it billions of dollars.

In its report, the inspector general suggested that Freddie hasn't been aggressive enough in reviewing loans and implied that the company was lax because it wanted to preserve its business relationships with top customers like Bank of America.

The issue underscores the pressures facing the FHFA, which is responsible for conserving the assets of Fannie and Freddie.

The FHFA sued 18 banks seeking unspecified damages on nearly $200 billion in soured bond investments this summer. Fannie and Freddie, which were taken over by the government three years ago, have cost taxpayers $141 billion so far.

A Freddie Mac spokesman declined to comment directly about the report, but referred to a statement earlier this year that called the settlement with Bank of America "commercially reasonable based upon our internal evaluation and judgments."

The goal of the settlement was to "enable both firms to resolve this issue and focus attention on other business matters," said Michael Cosgrove, a Freddie Mac spokesman.

In a written response to the report, the FHFA said it hadn't changed its view that the settlement between Freddie and Bank of America "was appropriate and reasonable." The agency also said it had provided extensive comments and corrections to the inspector general before publication of the report and that it didn't agree with many of the report's inferences.

A Bank of America spokesman said the settlement "was fair and reasonable…. Like any negotiated settlement, neither party obtained everything it sought."

Freddie typically reviews loans that default in their first two years because historically those loans have been the most likely to have flaws. But the FHFA examiner found that a greater share of some mortgages, including certain types of adjustable-rate mortgages, that Freddie bought from 2005 to 2007 were defaulting after two years, the report said.

Because those loans weren't reviewed, Freddie missed the opportunity to inspect about 300,000 loans for repurchase, the report said. Billions in dollars "will be lost if nothing is done," the examiner said in an email to superiors in September 2010.

Fannie and Freddie buy loans from banks and sell them to investors as securities, providing guarantees to make investors whole if loans default. Banks agree that loans meet certain standards when they sell them to the mortgage companies, promising to buy back loans that are later found to run afoul of those guidelines.

As of January, Freddie had asked lenders to buy back about 8% of the one million loans it guaranteed that were in foreclosure. From 2008 until June 30, 2011, lenders have bought back from Freddie nearly $15 billion in defaulted loans.

"FHFA and Freddie Mac must do more to ensure that high-dollar settlements of repurchase claims are accurately estimated and in the best interests of taxpayers," said Steve Linick, the FHFA's inspector general, in a statement.

As a result of the inspector general's review, the FHFA has suspended similar mortgage-repurchase settlements.

Some mortgage-industry executives have said that Fannie and Freddie have been too aggressive in efforts to force banks to buy back mortgages, which has prompted lenders to further tighten already tight lending standards.

Such practices are "hamstringing any easing" in lending, said Tim Rood, a former Fannie Mae executive who is now a partner at the Collingwood Group, a housing-finance consulting firm. Others have said settlements are needed to start putting the repurchase battles to bed.

The settlement with Bank of America applied not only to outstanding claims but also to future ones. It covered nearly 787,000 loans sold by Countrywide Financial Corp., which the Charlotte, N.C., bank bought in 2008. The report said Countrywide's loans had 50% more of the types of violations that result in "buy backs" than average, according to Freddie Mac. For Countrywide alone, Freddie had reviewed 58% of all loans in foreclosure and made repurchase claims on 24% of such loans.

In an internal audit completed in June, Freddie Mac officials also raised questions about the loan-sampling process, according to Tuesday's report. It didn't address the Bank of America settlement.

Write to Nick Timiraos at nick.timiraos@wsj.com

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Alexander Snyder-Mackler
(302) 598-8678