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Does Freddie Mac bet against homeowners?

A conflict of interest is said to be 'at the heart' of the giant, government-owned mortgage company.

By MSN Money Partner Jan 31, 2012 1:53PM

This post comes from Marilyn Lewis at MSN Money.


Freddie Mac, the taxpayer-owned giant mortgage company, stands accused of making multibillion-dollar bets that pay off when homeowners are trapped in expensive mortgages with higher interest rates.


Here's the potentially explosive part of the story: Freddie, at the same time, tightened its rules and raised fees on refinancing, effectively preventing many homeowners from getting new home loans that would let them take advantage of falling market rates. Post continues below.

Some economists believe that easing the rules for refinancing mortgages would significantly help the country resolve the housing crisis. But others disagree that it would help much.


National Public Radio and ProPublica, the independent news service, teamed up to investigate Freddie's investments.


Their stories don't say that Freddie deliberately limited consumers' access to mortgage refinancing in order to further its investment profits. Freddie's investments and its tighter rules appear to have been done independently of each other. Freddie says there's a wall between decision makers in the two areas, according to the stories.


Freddie didn't respond directly to the reports, but the Federal Housing Finance Agency, Freddie's regulator, issued a statement (.pdf file). It notes that while $5 billion of Freddie's $650 billion portfolio had been held in reverse floaters, the investment "ceased" in 2011 after "FHFA supervision staff identified concerns regarding the controls, including risk management, surrounding the inverse floaters."



'Conflict of interest'

The joint investigation uncovers "a conflict of interest at the heart" of Freddie Mac, ProPublica's article says


"Freddie Mac's own financial health improves when homeowners can't refinance," says National Public Radio:

Simply put, "Freddie Mac prevented households from being able to take advantage of today's mortgage rates -- and then bet on it," says Alan Boyce, a former bond trader who has been involved in efforts to push for more refinancing of home loans.

In 2010 and 2011, Freddie Mac added the controversial investments, called "inverse floaters," to its portfolio. These complex mortgage-backed securities earn "more money for Freddie Mac when homeowners in higher-interest-rate loans were unable to qualify for a refinancing," NPR says.


You could argue -- and Forbes Magazine staff writer Daniel Fisher does -- that Freddie was just doing what any well-run business does: hedging its bets. Freddie wasn't betting against homeowners, Fisher says: It was betting against rising interest rates.


Inverse floaters were, Fisher argues:

… Just the thing to buy in late 2010 and early 2011 if you thought widespread fears of higher rates were overblown.
… I find it hard to believe Freddie Mac's relatively small investment in inverse floaters -- $4.3 billion out of a $663 billion portfolio -- led it to adopt policies that made it difficult for homeowners to refinance. Stranger things have happened, I suppose. It would be interesting to hear how those derivatives actually performed between early 2011 and today.

Mixed incentives

But Freddie isn't just any company. Its charter, says ProPublica, "calls for the company to make home loans more accessible." It insures most American mortgages -- $663 billion worth -- so Freddie's rules set many of the mortgage industry's guidelines.


Do Freddie's trading bets work against its public mission, for which it receives billions of taxpayer dollars? ProPublica and NPR seem to say they do.


The trades, while legal, give Freddie "a powerful incentive" to make refinancing difficult for homeowners, says ProPublica.


NPR reports:

"We were actually shocked they did this," says Scott Simon, who heads the mortgage-backed securities team at the giant bond trading and investment firm called PIMCO. "It seemed so out of line with their mission, out of line with what Congress wanted them to do."

While the investigation uncovered no deliberate sabotage, it does illustrate what a contradictory set of masters and missions Freddie serves. Like most companies, Freddie advances its own financial interests, in part through its investments. Yet, unlike most companies, it is supported by vast sums of taxpayer money.


Freddie's story

Freddie started life as an oddball hybrid in 1970: It was a private company created by the federal government to expand the home-loan market.


It makes mortgages accessible by buying the loans from mortgage lenders. That lets the lenders -- banks -- make a profit from fees and sales. They also get their money back by selling their mortgages to Freddie, leaving them free to use the money again to create more mortgages.


Over the last decade, Freddie has been embroiled in controversy:

  • 2008. The government bailed out Freddie Mac and Fannie Mae for their failed mortgage investments. The cost for both through 2014 is expected to run $124 billion -- $52 billion for Freddie alone, says The Wall Street Journal.
  • 2006. Freddie paid a $3.8 million fine to the Federal Election Commission to settle charges that it "improperly used corporate resources to put on 85 fundraising events that raised about $1.7 million for federal candidates," Reuters says
  • 2003. After investigating Freddie and Fannie for more than two years, federal regulators reported (.pdf file) that Freddie had "cast aside accounting rules, internal controls, disclosure standards, and the public trust in the pursuit of steady earnings growth."

The Washington Post says

… Freddie's new audit firm ultimately uncovered billions of dollars of accounting errors and distortions, and an investigation conducted for Freddie's board found that the company had engineered elaborate transactions to get around accounting rules.

The New York Times has an explainer with more background.


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