Freddie Mac, WTF? Also Israeli settlements

Freddie Mac, formally called the Federal Home Loan Mortgage Corp., was chartered by Congress in 1970. On its website, it says it has "a public mission to stabilize the nation's residential mortgage markets and expand opportunities for homeownership." - NPR




http://www.npr.org/2012/01/30/145995636/freddie-mac-betting-against-struggling-homeowners



This is just unbelievable, even for mortgage finance standards. Maybe you've noticed the rush to re-fi due to the record-low interest rates now. My wife and I just closed ours, and we cut 100 basis points off our APR, which may save ~$36K in interest (2012 dollars) over the life of our loan. It was an excruciating process though, and my household has near-perfect credit (if you can believe it haha). The bank demanded everything short of a urine sample to make sure we were "qualified borrowers". I can understand if private banks are making it hard to re-fi now, since they are very risk-averse and hesitant to lose out on interest income. But FNME and Freddie Mac are "gov't sponsored enterprises" (and now nationalized as part of their $160B-plus bailout package). They want to make money for their employees and investors, but also function to promote the public good through increased home ownership (the merits of that mission, and the concept of GSE's in general, are debatable of course). Obama has chastised the banks to do more to renegotiate bad mortgages to keep more Americans in their homes and more money in their pockets (since almost everyone loses from a foreclosure). Some banks have been sued recently over improper foreclosure procedures that hastily removed good people from their homes before exhausting all other options.



Fannie and Freddie effectively act as re-fi gatekeepers, because they underwrite most new mortgages. They've made the lending standards so strict that far fewer people can quality than before. I know that lax lending standards got us into the real estate mess, but loan modifications like re-fi's entail less risk on banks (assuming property values are not underwater). If John Smith is affording his $2K/month mortgage now, then he should be able to handle a re-fi down to $1,700, right? That is extra money in Smith's pocket that he will likely inject into the consumer economy, which will help our recovery. And since banks charge re-fi fees and many homeowners don't stay in their homes over the full life of the mortgage, banks don't lose much on a re-fi if at all (or they wouldn't do it in the first place).



But here's the problem, Freddie is also an "investment house" with portfolios of mortgage-backed securities and other vehicles that it uses to generate profit to fund new loans. That sounds fine on the surface, but Freddie has sold the safest tranches of MBS's to Wall Street already, leaving them with the riskiest, most default-prone tranches that sane investors shunned. Those "equity tranches" often contain mortgages from sub-prime borrowers with very high interest rates though (hence the default risk). But they can still generate income if the homeowners keep paying. So Freddie is hoping that those borrowers won't re-fi. In addition, Freddie holds "inverse floater" tranches, where mortgage principal payments are sold to investors, and they retain the interest cash flows. So they have a financial conflict-of-interest to prevent or restrict loan re-fi's.



But you might think, isn't it good that Freddie earns a healthy return to pay off the taxpayer loans faster and loosen up credit for new home buyers? Well yes in the short-term, but no in general. By making it harder to re-fi, Freddie is depressing consumer purchasing power and increasing systemic foreclosure risk, which has economic and social consequences on America for reasons we've already discussed. Those consequences don't affect Freddie of course, which seems more interested in the bottom line than its public mission.



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http://www.npr.org/2012/01/28/146024083/israeli-outpost-pits-courts-vs-government



Also, pretty upsetting news out of the West Bank. Israeli peace activists sued their government over some illegal settlements, and the Supreme Court rules in their favor. By strict international law, all Israeli settlements in the occupied West Bank are considered illegal, but the Israeli gov't has "legalized" some settlement areas in an annexation effort based on Biblical borders. But in the case of the Migron settlement, even Tel Aviv ruled that it must be dismantled because it was built on private land seized from Palestinians (that is still illegal in Israeli law). So on one hand, the courts rule that these places must be torn down, but on the other hand, the gov't rarely acts, or pretends to act, allowing the illegal settlements to continue and even grow. But the Migron case has gotten such publicity that it will be hard to ignore. Though after hearing the news, the Zionist settlers vandalized local Palestinian property and torched their mosque in retaliation.



Is that the conduct of civilized persons? You have beef with your gov't, so then you engage in hate crimes on innocents who had nothing to do with the court ruling, and whose land you stole in the past anyway?

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I am not sure of the nature of Freddie's holdings, but from what the article describes, that is the nature of the business - it is not "betting against homeowners" as NPR suggests (playing the populism card). However, what is/would be problematic is the extent to which holding these positions created incentives (on which they acted) to increase the red tape associated with refinancing. This is why Freddie insists that  ``...its employees who make investment decisions are "walled off" from those who decide the rules for homeowners."

I do not know exactly how Freddie addresses these issues and if it compensates its employees in a way that avoids this conflict of interest. But it sounds as though they are at least thinking about it.

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I'm as appalled as anyone about the actions of big banks and Fannie/Freddie in the housing market.  But I'm not convinced this is a real story.

These inverse floaters may be part of a legitimate hedging strategy.  As part of its core business Freddie has a huge exposure to mortgage interest rates.  If mortgage interest rates go up, the mark-to-market value of those mortgages will drop.  That's the scenario when hedging is the right thing to do: when as part of your core business you have an exposure to market forces outside your control, the responsible action is to hedge against that risk.  It's like airlines buying oil futures to hedge against future changes in oil prices, because they buy a huge amount of the stuff as part of their core business.

We don't know Freddie's overall exposures here.  $3.4B sounds like a lot of money, but compared to Freddie's overall portfolio, and their overall exposure to the mortgage interest rate, that may be tiny.  That is, we know they've got $3.4B betting this direction, but if they've got $50B betting the opposite direction (because that's their core business, buying mortgages), it'd be obvious that their net position is actually the opposite direction.

Only knowing one piece of their portfolio doesn't give us enough information to conclude the direction of their overall financial interest.

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I agree that we don't know enough to make an informed evaluation. However, NPR did reach out to Freddie execs and their PR to give them a chance to respond, and they mostly declined. If the their portfolio positions are truly as you said, don't you think they would want to explain that to the public in order to diffuse the "betting against the homeowner" allegation? Especially now that they are a ward of the state, under a "pro-homeowner" administration, you would think there would be a better effort at disclosure and explanation. Also, PIMCO's Simon came down pretty hard on Freddie over this - he should know more about Freddie's positions, and what incentive would he have to exaggerate?

Of course we don't want Freddie and Fannie to make stupid mortgage bets (on top of the stupid bets already on their balance sheets), and they are entitled to hedge their risk. I think the Obama admin. is offering additional incentives to get them to relax re-fi rules, but can't they just force their hand through the FHFA? Maybe Congress can rewrite their protocols, but that process would be slow I suppose.

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Naked Capitalism does a long-form argument against the NPR/ProPublica piece here: http://www.nakedcapitalism.com/2012/01/propublicas-off-base-charges-about-freddie-macs-mortgage-bets.html  She argues they've just misunderstood how this trade works, that it's a hedging issue primarily, and that even if their net position is what ProPublica argues, the causality runs the opposite way (they don't set policy based on their trading book, they set the trading book based on the policy).  There's also a long explanation of inverse floaters with the technical details, which is pretty interesting (or maybe just incredibly dry, depending on your perspective!).  And towards the end there's some speculation about why PIMCO would offer the quotes they did.

Freddie does have a conflict of interest here, but it's not because of this trading position.  It's because their objectives of supporting homeowners and taxpayers are to some extent at odds with one another.  There's plenty going wrong in mortgage-land, but this trading position isn't a smoking gun, it's a distraction.  You know they're planning to wrap up the "state AG mortgage settlement" whitewash this week, by Friday?  They've done no investigation, they're just selling the banks a waiver of liability for pennies on the dollar, and the result will be to close off a whole range of serious legal abuses from any criminal charges.  If it goes through, expect bank stocks to jump up.

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Thanks for the link and I think that's pretty convincing - sorry to send everyone that trash piece (well on the bright side it was a quick refresher course in MBS's and GSE's). I would have expected better from NPR and ProPublica. If PIMCO's Simon was trying to use his comments to stir things up, you would think he would employ media with larger audiences though. Or maybe if he expressed his "shock" to the business press, they would have ridiculed him?

As you said, it's a shame that we haven't really engaged in serious investigation and punishment over mortgage and securities fraud. A few people were made examples of (and they were so foolish and egregious that Elle Woods could have gotten them convicted), but many worse offenders are still at large. There isn't the political will in DC, and after the Citizens United ruling, I think big money interests will be able to lean on and silence regulators even more.