Freddie Mac’s charter calls forrnit to make home loans more accessible, both to purchase and refinance theirrnhomes but the ProPublica story, written by JessernEisinger (ProPublica) and Chris Arnold (NPR) charged that the CMO trades “give Freddie a powerful incentive to dornthe opposite, highlighting a conflict of interest at the heart of the company.rnIn addition to being an instrument of government policy dedicated to makingrnhome loans more accessible, Freddie also has giant investment portfolios andrncould lose substantial amounts of money if too many borrowers refinance.”</p

Here,rnin a nutshell, is what the story (we are quoting from an “updated” version)rnsays Freddie has been doing.   </p

Freddierncreates a security (MBS) backed by mortgages it guarantees which was dividedrninto two parts.  The larger portion, backedrnby principal, was fairly low risk, paid a low return and was sold to investors.  The smaller portion, backed by interestrnpayments on the mortgages, was riskier, and paid a higher return determined byrnthe interest rates on the underlying loans. rnThis portion, called an inverse floater, was retained by Freddie Mac.</p

Inrn2010 and 2011 Freddie Mac’s purchase (retention) of these inverse floaters roserndramatically, from a total of 12 purchased in 2008 and 2009 to 29.  Most of the mortgages backing these floaters hadrninterest rates of 6.5 to 7 percent.</p

Inrnstructuring these transactions, Freddie Mac sells off most of the value of thernMBS but does not reduce its risk because it still guarantees the underlyingrnmortgages and must pay the entire value in the case of default.  The floaters, stripped of the real value ofrnthe underlying principal, are also now harder and possibly more expensive tornsell, and as Freddie gets paid the difference between the interest rates on thernloans and the current interest rate, if rates rise, the value of the floatersrnfalls.  </p

WhilernFreddie, under its agreement with the Treasury Department, has reduced the sizernof its portfolio by 6 percent between 2010 and 2011, “that $43 billion drop inrnthe portfolio overstates the risk reduction because the company retained riskrnthrough the inverse floaters.”</p

Sincernthe real value of the floater is the high rate of interest being paid by thernmortgagee, if large numbers pay off their loans the floater loses value.  Thus, the article charges, Freddie has triedrnto deter prospective refinancers by tightening its underwriting guidelines andrnraising prices.  It cites, as its solernexample of tightened standards that in October 2010 the company changed a rulernthat had prohibited financing for persons who had engaged in some short salesrnto prohibiting financing for persons who had engaged in any short sale, but itrnalso quotes critics who charge that the Home Affordable Refinance Programrn(HARP) could be reaching “millions more people if Fannie (Mae) and Freddiernimplemented the program more effectively.”</p

Itrnhas discouraged refinancing by raising fees. rnDuring Thanksgiving week in 2010, the article contends, Freddie quietlyrnannounced it was raising post-settlement delivery fees.  In November 2011, FHFA announced that thernGSEs were eliminating or reducing some fees but the Federal Reserve said that “morernmight be done.”</p

IfrnFreddie Mac has limited refinancing, the article says, it also affected the wholerneconomy which might benefit from billions of dollars of discretionary income generatedrnthrough lower mortgage payments.  Refinancingrnmight also reduce foreclosures and limit the losses the GSEs suffer through defaultsrnof their guaranteed loans. </p

Thernauthors say there is no evidence that decisions about trades and decisionsrnabout refinancing were coordinated.  “Therncompany is a key gatekeeper for home loans but says its traders are “walledrnoff” from the officials who have restricted homeowners from taking advantage ofrnhistorically low interest rates by imposing higher fees and new rules.”</p

ProPublica/NPR says that thernfloater trades “raise questions about the FHFA’s oversight of Fannie andrnFreddie” as a regulator but, as conservator it also acts as the board ofrndirectors and shareholders and has emphasized that its main goal is to limitrntaxpayer losses.  This has frustrated thernadministration because FHFA has made preserving the companies’ assets arnpriority over helping homeowners.  ThernPresident tried to replace acting director Edward J. DeMarco, but Congressrnrefused to confirm his nominee.  </p

Thernauthors conclude by saying that FHFA knew about the inverse floater tradesrnbefore they were approached about the story but officials declined to comment on whether thernFHFA knew about them as Freddie was conducting them or whether the FHFA hadrnexplicitly approved them.” </p

The<bFHFA statement said that Freddie Mac has historically used CMOs as a tool tornmanage its retained portfolio and to address issues associated with securityrnperformance.  The inverse floaters werernused to finance mortgages sold to Freddie through its cash window and to sellrnmortgages out of its portfolio “in response to market demand and to shrink itsrnown portfolio.”  The inverse floaterrnessentially leaves Freddie with a portion of the risk exposure it would havernhad if it had kept the entire mortgage on its balance sheet and also results inrna more complex financing structure that requires specialized risk managementrnprocesses.  (Full FHFA Statement)</p

Thernagency said that for several reasons Freddie’s retention of inverse floaters ended inrn2011 and only $5 billion is held in the company’s $650 billion retainedrnportfolio.  Later that year FHFA staffrnidentified concerns about the floaters and the company agreed that theserntransactions would not resume pending completing of the agency examination.</p

Theserninvestments FHFA said did not have any impact on the recent changes tornHARP.  In evaluating changes, FHFArnspecifically directed both Freddie and Fannie not to consider changes in theirrnown investment income in the HARP evaluation process and now that the HARPrnchanges are in place the refinance process is between borrowers and loanrnoriginators and servicers, not Freddie Mac.

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