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Fannie and Freddie Fire Their Own Inspector General

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There is no independent auditor overseeing the federal agency responsible for some $6 trillion in home mortgages, because the Department of Justice's Office of Legal Counsel ruled that the agency's inspector general didn't have authority to operate, according to internal memos obtained by the Huffington Post.

The ruling came in response to a request from the Federal Housing Finance Agency itself -- which means that a federal agency essentially succeeded in getting rid of its own inspector general.

The FHFA is home to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, which are jointly responsible for purchasing or guaranteeing more than 80 percent of new mortgages issued since the middle of 2008, according to FHFA numbers.

In September, the Department of Justice ruled that FHFA Inspector General Ed Kelley did not have authority to investigate wrongdoing or other abuses related to the agency, according to an internal DOJ Office of Legal Counsel memo signed by Deputy Assistant Attorney General Daniel Koffsky.

The ruling was made on complicated technical grounds. The current agency was created by a 2008 act that abolished the Federal Housing Finance Board and replaced it with the FHFA. FHFB employees automatically became FHFA employees and retained their "same status, tenure, grade, and pay."

The IG for the new agency, according to the law, needed to be appointed by the president and confirmed by the Senate, but Kelley argued that the purpose of keeping the employees in the same positions was to make sure the agency could continue to operate and that therefore the law applied to him, too.

Kelley still works for the FHFA, but in a non-independent "internal auditor" position in which he must report to the agency head. A message left with FHFA wasn't returned.

On Monday, HuffPost called the main number listed on the FHFA website for people who want to report "a violation of any law, rule or regulation, gross mismanagement, a gross waste of funds, an abuse of authority, or substantial and specific danger to public safety or complaints regarding the programs and operations of the agency."

The phone rang.

"Ed Kelley," said the voice on the other end of the line.

Kelley now heads the Office of Internal Audit and he said he has two employees: an office administrator and a person who oversees the contractors who review financial records. He estimated his budget for contractors was between $100,000 and $150,000.

As IG, he ran into trouble the way most independent investigators do -- by investigating things people didn't want investigated.

Kelley's office had been working with SIGTARP Neil Barofsky, the Special Inspector General overseeing the bank bailout -- the Temporary Asset Relief Program -- when the agency head challenged his authority to operate and asked the FHFA General Counsel's office to look into it.

"I hate to use the word challenge, because the question they raised was whether the statute was clearly established at the Office of the Inspector General," said Kelley.

He declined to get into the specifics of investigations that were cut short. "I don't really want to get into some of these, but obviously there are some programs out here. There's the TARP IGs that are heavily involved in looking at criminal activity surrounding the Make Home Affordable program and different other aspects in the programs they've rolled out [to address] foreclosures and so forth," said Kelley.

"Many of those are projects that would be worth jointly investigating between the TARP office and the IG's office here at FHFA." Kelley's office was starting to do just that when "the question of whether or not we were legally the IG's office came up, and we had to withdraw," he said.

In late February, Barofsky warned that the mortgage modification plan was vulnerable to already existing fraudulent foreclosure rescue schemes. On April 6, he announced that progress was being made as part of a multiagency crackdown.

A month later -- less than four months after Obama's inauguration -- the FHFA started questioning Kelley's legal status. An internal memo -- which HuffPost did not get from Kelley, originally dated May 12, 2009 and updated on June 23, provided the FHFA's opinion that Kelley had no authority to conduct such investigations.

"It's a serious gap in oversight," Barofsky told HuffPost of Ed Kelley's loss. "It does impact what we do. Ed was a member of our TARP IG council and a partner in our investigative work." Barofsky said he still investigates areas of FHFA, but his mandate only covers "a sliver of what they do."

"Fannie and Freddie are awfully big," Barofsky said. "The idea that the agency responsible for conservatorship of Fannie Mae and Freddie Mac doesn't have an inspector general should be a serious cause of concern."

The agency put the blame on the law as written. "Congress did not intend for FHFA to have an Acting or interim IG pending the confirmation of a [presidentially-appointed] IG," writes Janice Kullman, assistant general counsel, in the memo, which was approved by Isabella Sammons, deputy general counsel, and forwarded to General Counsel Alfred M. Pollard.

It's been 16 months since the law took effect.

Obama has yet to nominate a new IG. Kelley said he'd heard that a few candidates were being vetted and wouldn't comment on whether he was one. He guessed there might be a nomination within the next month.

"Given the uncertainty at FHFA, it did not become clear until mid-September that the Inspector General's office required a new nominee," said a White House spokesman. "We are currently working actively to nominate an individual to the position as soon as possible. The process of announcing nominees does take some time given the rigor of the process to ensure that important positions like this one are filled by the highest quality people."

But if that's the case, the White House has been vetting candidates without consulting Sen. Chris Dodd (D-Conn.), the chairman of the Banking, Housing and Urban Affairs Committee. Dodd told HuffPost Monday night that he was unaware that FHFA had no IG and promised to look into the matter.

In the meantime, Kelley has essentially put a halt to investigations.

"We're in an internal audit office, versus an office of the inspector general, and there's a big difference between the two," he said. "An internal audit office operates at the pleasure of the head of the agency... At the end of the day, no matter how independent I am in conducting myself, we have an organizational independence problem, which anybody who looked at it, if people have problems with what we said, we would probably be viewed as not being independent, and probably not being very reliable."

In practice so far, Kelley said, no one has interfered with him as an internal auditor -- but he knows that could change at any moment. "Now, in terms in actuality of whether I'm independent, I feel like I can do what I need to do. I don't feel the discomfort, but that's until the first time you have a disagreement with the head of the agency. And over the years, I've certainly had my share of those. So at this point, there's nothing at the internal audit office I would want to do, that I feel like I can't do. But there are some things I wouldn't attempt at the internal audit office," he said.

The mortgage industry is one of the most susceptible to fraud, yet one of the areas Kelley said he doesn't get into is criminal investigation.

"We don't have the authority to do criminal investigations," he said. "It's the very reason why they set up IG offices themselves, [as opposed to] internal audit offices."

Fannie and Freddie are burning through cash at a staggering rate. Fannie reported a loss of $18.9 billion in the third quarter of 2009, four billion more than it lost the second quarter.

FHFA requested $15 billion from Treasury to plug the hole.

What's it spending money on?

"The company continued to concentrate on preventing foreclosures and providing liquidity to the mortgage market during the third quarter of 2009, with much of our effort focused on the Making Home Affordable Program," boasts the press release accompanying the announcement of the massive loss. "As of September 30, 2009, approximately 189,000 Fannie Mae loans were in a trial period or a completed modification under the Home Affordable Modification Program."

Those are the precise programs that Kelley was looking into when his own agency shut him down.

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