The Inspector General of the Federal Housing Finance Agency will conduct a wide-scale audit of Fannie Mae and Freddie Mac REO management practices.

"It is intended to determine whether the Agency and the Enterprises manage REO to maximize financial recoveries and minimize the negative effects of foreclosures on affected communities," the watchdog said in a white paper released Thursday.

Fannie and Freddie hold more than 173,000 repossessed homes as of March 31, a 20% reduction from 218,000 held at the same point last year, according to their first quarter financial statements.

The end of 2011 marked the first year the GSEs sold more REO than they acquired. Fannie and Freddie disposed of 353,851 properties and took on roughly 298,000 last year.

But with legislative actions, servicing problems and other delays, the foreclosure timelines lengthened across the country, driving up costs for each REO department. According to the FHFA IG, Fannie and Freddie spent more than $8.5 billion managing their REO inventories since 2007. The height came in 2010, when the GSEs spent more than $2.3 billion that year alone.

Much of the money goes to servicers, asset management firms, and brokers to handle the valuation, upkeep and sales of these homes.

The Inspector General report said the FHFA studied the processes at each firm and found some potential risks. According to findings finalized in March, one GSE did not perform comprehensive background checks of its contractors.

One GSE did not inspect how well vendors did their work, and the other lacked enough oversight to protect against unnecessary maintenance and repairs, according to the findings. The report did not disclose which GSE had specific problems.

The FHFA installed requirements to fix the risks and report progress throughout 2012, according to the inspector general.

The separate inspector general audit will assess FHFA oversight of the contractors and will test sample properties for error rates. The watchdog said it would also monitor the progressing REO-to-rental program.

"A failure in Enterprise efforts to secure and maintain foreclosed properties could drive up Enterprise losses and cause damage in affected communities, e.g., foreclosed properties can lower the value of surrounding properties and increase blight and crime," according to the inspector general white paper.