The Federal Housing Finance Agency (FHFA) Office of Inspector General (OIG) has published an evaluation report detailing Freddie Mac's involvement in unsecured lending to Lehman Brothers just prior to that firm's bankruptcy.  The last Freddie Mac loan to that firm resulted in a loss of $1.2 billion.

Prior to its filing for bankruptcy Lehman was the fourth largest investment bank in the United States with $639 billion in assets. Lehman traded and underwrote stocks and bonds, traded commodities, was active in the credit derivatives market, and became a major player in both commercial and residential securitization markets. Lehman sold mortgages to Freddie Mac and also served as one of its investment bankers. Lehman underwrote common and preferred stock offerings for Freddie Mac as well as various debt securities offerings.

In 2007 it underwrote more mortgage-backed securities (MBS) than any other firm. Its $85 billion mortgage-backed portfolio was equal to approximately four times its shareholders' equity and this high degree of leverage made it vulnerable to the increasing losses it was incurring in its residential housing and commercial property investments.

On June 9, 2008, Lehman announced a $2.8 billion second quarter loss and on September 10, 2008, it posted a third-quarter loss of $3.9 billion.  Its increasing losses were reflected in the price of its common stock.

Freddie Mac had been lending to Lehman since 2005, typically what are known as "Fed Funds" or overnight loans.  In January 2008 the nature of those loans changed to longer term, typically a month, loans which often were rolled over into new loans.  In August 2008 Freddie Mac made two short-term unsecured loans to Lehman Brothers totaling $1.2 billion which were due on September 15, the day Lehman filed for bankruptcy protection. 

Like other companies, Freddie Mac typically invests its cash in a manner intended to ensure that such funds will be returned to it so it can pay its own obligations as they become due.  Choosing counterparties capable of meeting their obligations is not only a function of its financial condition and credit history but also a function of time. The longer the term for which money is lent, the greater the risk of default.  Such assessments were the responsibility of the Credit Risk Management (CCRM) staff of Freddie Mac's Risk Oversight Division.

During 2008, CCRM's oversight of risk with the Lehman loans focused primarily on whether such loans should be limited to overnight (24 hours) or longer (up to 30 days) terms. Indeed, in 2008, some CCRM staff questioned whether Freddie Mac should be making unsecured loans to Lehman at all. However, those concerns, which would have reduced the extent of the Enterprise's exposure, were overruled at senior levels within Freddie Mac as were repeated recommendations that any loans be limited to shorter terms.

Freddie Mac was historically regulated by the Office of Federal Housing Oversight (OFHEO) which was replaced by the FHFA on July 30, 2008.  No examination had been performed by OFHEO related to capital markets counterparties prior to the Lehman bankruptcy.  Following the default FHFA examiners conducted a series of targeted examinations related to counterparty credit risk management and management of Freddie Mac's liquidity and contingency portfolio and made a number of findings regarding Freddie Mac's operations.  It recommended that certain actions be taken to better manage counterparty risk and particularly to clarify that Fed Funds investments do not carry any implied government guarantee.

FHFA's Examiner-in-Charge at Freddie Mac has indicated that the monitoring of counterparty risk is a priority for the Agency and that "significant resources" will be dedicated toward the examination of such risk in the 2013 Examination Plan.  During the second half of 2012, FHFA conducted several targeted examinations relating to various aspects of counterparty risk and now requires the GSEs  to report on counterparty risk (quantitatively and qualitatively) on a monthly basis.  Freddie Mac has amended its Liquidity and Contingency Policy to reflect that its activities are consistent with FHFA and Treasury guidance and suspends unsecured term lending. Second, the Capital Markets Counterparty Credit Risk Management Policy was revised to clearly define the roles and responsibilities of Freddie Mac staff involved in managing the Enterprise's counterparty credit risk program and defines Fed Funds lending as an unsecured investment.

OIG notes that FHFA and Freddie Mac are making attempts to recover the $1.2 billion lost in the Lehmann bankruptcy.  Freddie Mac filed a proof of claim but it stands behind secured creditor's claims.  FHFA, through the Office of General Counsel, has worked to improve the chances of Freddie Mac's recovery and it is possible that Freddie Mac may ultimately recover $1.2 billion but stands to recover no less than $251 million.

OIG says that while FHFA and Freddie Mac have already taken steps to address the shortcomings in Freddie Mac's risk management and control systems, it recommends that that FHFA should:

1. Continue to monitor Freddie Mac's implementation of its counterparty risk management policies and procedures
   a.  Ensure that the independence and decisions of the GSE's risk management staff are not overridden by business management staff, and
   b.  Direct Freddie Mac Internal Audit to audit the CCRM function annually.
2. Continue to pursue all possible avenues to recover the $1.2 billion in the Lehman bankruptcy proceedings.
3. Continue to develop an examination program and procedures encompassing GSE-wide risk exposure to all of Freddie Mac's counterparties.