Freddie Mac Didn’t Set Out to Profit from Homeowners Trapped in High-Rate Mortgages

Freddie Mac Didn’t Set Out to Profit from Homeowners Trapped in High-Rate Mortgages

by Cora Currier ProPublica

Mortgage giant Freddie Mac did not keep homeowners trapped in high-interest loans in order to boost profits on billions of dollars’ worth of complex financial bets it had made. That’s the conclusion reached in a report released today by the inspector general that oversees the agency in charge of Freddie Mac.

Last January, ProPublica and NPR reported that Freddie had dramatically expanded its holdings of mortgage-backed securities that would profit if homeowners stayed in their existing high-interest-rate loans. At the same time, the company had taken steps that made it harder for homeowners to refinance at lower interest rates. Our report stated that there was no evidence of a coordinated attempt to bet against homeowners’ ability to refinance. The inspector general’s report concludes that there was none.

But the inspector general left a key stone unturned: It did not independently evaluate the firewall within Freddie Mac designed to keep Freddie’s investment arm from profiting from insider information about the mortgage giant’s plans to tighten or loosen homeowners’ access to credit. Instead, the inspector general relied on the word of employees it interviewed and conducted no further investigation. It also reported that the agency that oversees Freddie has not tested the firewall’s integrity.

Freddie Mac and its sister company Fannie Mae were bailed out by taxpayers after the financial crisis and are now controlled by the Federal Housing Finance Agency. Freddie and Fannie guarantee most of the mortgages in the U.S., and they have a mission to make home loans more affordable. But Freddie also has a massive investment portfolio and has to protect against losses. Sometimes, those two goals can conflict.

Beginning in 2010, Freddie Mac expanded its portfolio of a particular kind of mortgage-backed security known as an “inverse floater.” The company offered investors a relatively safe bond with a floating interest rate. It then kept on its books what is called an “inverse floater,” which pays out the highest returns if borrowers stay in their mortgages. When interest rates dropped (as they did during that period), Freddie Mac stood to profit on its inverse floaters, because the rates being paid by the pool of borrowers were higher than the prevailing market rates. Inverse floaters lose that advantage the more that homeowners in the pool refinance at the lower rates.

The report says that Freddie’s investment wing increased its holdings in inverse floaters merely because investors were demanding the floating rate bonds linked to them — not because of any strategy to exploit homeowners trapped in high-interest-rate mortgages.

Freddie Mac has an “information wall” designed to separate the employees running Freddie Mac’s investment strategy from those designing and carrying out its policies that impact the mortgage market, such as programs aimed at helping people refinance or making it more difficult for them to do so. The inspector general’s report says that it found “no evidence” that the wall had been breached.

Yet, the inspector general noted that FHFA has not conducted any independent testing of Freddie’s information wall. And the inspector general limited its own investigation of the wall to interviewing Freddie executives and FHFA officials and reviewing policy documents. The inspector general “did not independently evaluate the efficacy of Freddie Mac’s information wall policy,” the report states.

The report emphasizes that there are indeed “tensions between policies aimed at homeowners refinancing and Freddie Mac’s retained investments.” But it says that such tensions are not unique to inverse floaters but are “inherent throughout [Freddie and Fannie’s] various business lines.”

At the end of 2011, Freddie held about $5 billion worth of inverse floaters, according to the report, or less than one percent of its $653 billion investment portfolio.

The report also notes that the company hedges to balance its interest-rate risk, meaning that it places many different bets so that no matter whether interest rates rise or fall, its investments will be close to “net flat” — stay roughly the same, recording neither large profits nor large losses. Freddie does not try to balance the risk of each individual investment, but rather hedges “on its portfolio as a whole.” The report explains:

In the context of inverse floaters, although Freddie Mac may on the one hand benefit from a trend of low interest rates and reduced prepayments by homeowners, on the other hand, Freddie Mac’s other investments may equally suffer from such a trend. Thus, the end result, if perfectly hedged on interest rates, is that Freddie Mac’s overall position will remain the same regardless of prepayments.

The inspector general did not independently evaluate Freddie’s hedging strategies. When ProPublica and NPR first reported on these deals, it was unclear what kind of hedging, if any, Freddie Mac had performed.

The company is also supposed to be reducing its investment portfolio as part of the terms of its government bailout. In a footnote, the inspector general’s report mentions that Freddie Mac told the Securities and Exchange Commission that selling the floating rate securities was a way to reduce its balance sheet. But most Freddie and FHFA officials interviewed by the inspector general said that reducing its balance sheet was not the motivation for Freddie to create inverse floaters, even if that was the result.

Separately, the way Freddie structured the inverse floaters leaves Freddie with nearly all of the risk of the assets that no longer show up on its balance sheet. The reason: As the guarantor of the mortgages that back the securities, Freddie is already on the hook if the homeowner defaults. With inverse floaters, it also retains the risks that homeowners might refinance and that overall interest rates might rise. Indeed, independent analysts told ProPublica and NPR in January that Freddie may actually have increased its risk, because inverse floaters are illiquid and hard to sell.

In its written response to the inspector general’s report, the FHFA did not address Freddie Mac’s statements to the SEC. When contacted by ProPublica, an FHFA spokesperson declined to comment.

The report said that FHFA issued misleading statements to the public on when it ordered Freddie to stop creating inverse floaters. According to the report, in the spring of 2011, the FHFA began a review of Freddie Mac’s mortgage securities operation, in large part to determine whether the company held too many complex and risky mortgage products, including inverse floaters.

But an executive at Freddie didn’t suspend inverse floaters and certain other complex securities deals until January 6, and FHFA didn’t explicitly order Freddie Mac to stop selling inverse floaters until January 30, 2012, after ProPublica’s story was published. In fact, according to the report, that day marked “the first time that FHFA’s senior leadership met to discuss the Agency’s position with respect to inverse floaters.”

By then, however, Freddie had long since stopped selling floating rate securities — not because of any order from FHFA but because the market for them dried up in spring 2011 when Federal Reserve chairman Ben Bernanke indicated that interest rates would remain low for at least another year.

That’s not how FHFA described what happened after our story broke. In a statement released in response to ProPublica and NPR’s reports, the agency said that staff met with Freddie in December 2011 and came to an agreement then to suspend inverse floater trades. The inspector general’s report concludes that statement was misleading: “prior to January 2012, neither Freddie Mac nor FHFA made a decision to halt Freddie Mac’s creation and investment in inverse floaters; the market for reciprocal floating rate bonds simply disappeared. Had the market reappeared and Freddie Mac found the economics were again profitable, [Freddie] would have been free to structure floating-rate and inverse floating-rate investments.”

In a response to the report, the FHFA disputed the inspector general’s reading of the public statement, saying that it did not claim “that there was a specific, well-articulated FHFA policy and agreement” in December. The agency also emphasized that it did not take a position on inverse floaters only in reaction to media reports. While acknowledging that “the key stakeholders” had met together for the first time on January 30th, the day ProPublica and NPR released their original stories, the FHFA emphasizes that it had been in communication with Freddie on inverse floaters over the previous year.

The inspector general’s report was requested by Senator Robert Menendez, D-NJ, last January, after our story brought the issue to light.

Copy of the report below…

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4closureFraud.org

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Oversight of Freddie Mac’s Investment in Inverse Floaters

Comments
4 Responses to “Freddie Mac Didn’t Set Out to Profit from Homeowners Trapped in High-Rate Mortgages”
  1. Ken Hansen says:

    Golden West Financial Corporation, remember them? Those were the guys who started ProPublica. They were one of largest mortgage lenders and savings and loans in the country at one time. Now, that doesn’t mean anything by itself, other than an interesting point of note.
    However, this “investigative” reporting by ProPublica and NPR discredits both organizations since they reported the opposite of what’s “corrected” above. The press has a very big role in Bank propaganda, Paul Kiel in particular is a writer who grabs hold of a story, makes it appear he is objectively in support of victimized consumers. But like most writers, he completely ignores the level of tragedy, repackages criminogenics as if they were just mistakes or incompetence, and by doing so, he clearly reveals the editorial goal – which is to obscure tragedy as some kind of innocent bureacratic failure that doesn’t require public outrage, massive law enforcement or further inquiry.

  2. bobbi swann says:

    @ Sarah – I don’t believe that Freddie Mac underwrote those liar loans. They were a product that was released by Wall Street to generate huge amounts of income on the ‘back side’, and more importantly even more income when they defaulted. As in the case of Countrywide, who was the largest producer, along with World Savings, to bring on the liar loans they were ultimately changed through a system within those entitites to be sold to Freddie and when recognized after the bubble burst Freddie made them buy back the loans. You remember who ultimately made BofA purchse Countrywide, don’t you? Do you think maybe it was a tactic to ‘hide’ the obvious fraud that was being committed to Freddie and yet Freddie/Fannie were owned by the taxpayers. Just think about the manipulation of this whole scheme and yet as of today, not one executive has been held accountable for such actions! You can thank your current presidential ‘executive in charge’ for that!

  3. Sarah says:

    Didn’t Freddie Mac underwrite liars loans? That’s the real question. ProPublica doesn’t want to go there though. Liars loans aren’t being discussed by the press, but it remains one of the most important aspects of the whole housing crisis. It’s a criminal conspiracy, the press appears to want the American people to either be confused or forget about that, much the way they won’t talk about the real nature of war or any other topic that puts the status quo in an unfavorable light. This is a war, no gun shots are being fired, but people are being destroyed.

  4. keepon says:

    “Freddie Mac Didn’t Set Out to Profit from Homeowners Trapped in High-Rate Mortgages.”

    …and so, on the day that it realized that it WAS profiting from TRAPPED HOMEWOWNERS- to WHAT Law Enforcement Agency did they report this MISHAP? TO WHOM did they WRITE THE CHECK RETURNING their discovered ILL GOTTEN GAINS? …and WHERE did THEY LEAVE the TRAPPED HOMEOWNERS?

    Homeowners are quite lucky to have had this particular agency created to PROTECT HOMEOWNERS! Can you imagine what might have otherwise happened? What is WORSE THAN TRAPPED?

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