Freddie Mac Attack
Freddster (noun): Fraudster who profits from conflict of interest at Freddie Mac (the knife).
The idea is that Freddie Went long the interest payments on mortgages and not the principal repayments. This means the harder it is to refinance, the better for Freddie Mac. Freddie Mac also has significant regulatory power to decide how hard it is to refinance Freddie Mac insured loans. The conflict of interest is clear.
via Kevin Drum where commenter
Andrew Sprung wrote
“Could Einsinger and Arnold”s story have been prompted by an administration leak as a prelude to a recess appointment to replace DeMarco at FHFA?”
I hope so, or rather I wish I had any hope that it is so. But at least it is a hint that someone in the White House has decided to put pressure on DeMarco.
I also look forward to testimony by the Freddie Mac CEO Charles Haldeman who I expect will have considerable trouble recalling details (see HR Block)
After the jump I cut and paste a summary of the conflict of interest from Eisenger and Arnold with human interest and Freddie Mac efforts to respond to the accusation deleted.
Those mortgages underpin securities that get divided into two basic categories.
One portion is backed mainly by principal, pays a low return, and was sold to investors who wanted a safe place to park their money. The other part, the inverse floater, is backed mainly by the interest payments on the mortgages … . So this portion of the security can pay a much higher return, and this is what Freddie retained.
In 2010 and ’11, Freddie purchased $3.4 billion worth of inverse floater portions — their value based mostly on interest payments on $19.5 billion in mortgage-backed securities, according to prospectuses for the deals.
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It’s … a big problem if people … refinance their mortgages. That’s because a refi is a new loan; the borrower pays off the first loan early, stopping the interest payments. Since the security Freddie owns is backed mainly by those interest payments, Freddie loses.
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Restricting credit for people who have done short sales isn’t the only way that Freddie Mac and Fannie Mae have tightened their lending criteria in the wake of the financial crisis, making it harder for borrowers to get housing loans.
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just as it was escalating its inverse floater deals, it was also introducing new fees on borrowers, including those wanting to refinance. During Thanksgiving week in 2010, Freddie quietly announced that it was raising charges, called post-settlement delivery fees.
In a recent white paper on remedies for the stalled housing market, the Federal Reserve criticized Fannie and Freddie for the fees they have charged for refinancing. Such fees are “another possible reason for low rates of refinancing” and are “difficult to justify,” the Fed wrote.
A former Freddie employee, who spoke on condition he not be named, was even blunter: “Generally, it makes no sense whatsoever” for Freddie “to restrict refinancing” from expensive loans to ones borrowers can more easily pay, since the company remains on the hook if homeowners default.
You can trade on what you think is likely to happen. You can trade on what you think the best fit is for your portfolio. You can trade with the intention of jiggering the outcome. It’s no use for you or me to engage in that third, jiggering sort of trade, but there is clearly a possibility for Freddie. As the article notes, there is no evidence that Freddie is engaged in jiggery-pokery, but there is clear reason for suspicion.
I am curious about the description of the activity as “trades”. In common financial parlance, “trades” are short-term, “investments” are long-term. It kinda makes a difference here. Freddie also packages mortgages, so instead of purchasing interest-payment flows, could have been the seller of zeros. That, it strikes me, is a very different kettle of fish than going into the market and buying interest-payments. Did Freddie go into the market and buy payment flows, or did it buy mortgages and strip them? If my mandate is to buy mortgages, I need money to do it. Principle payments on mortgages rise over time, and are a source of little cash in the early years of a mortgage. Freddie could have gotten the net present value of future principle payments in a single chunk and then used the cash to buy more mortgages. Interest payments, on the other hand, are larger up front and fall as principle payments rise. If Freddie is looking for cash to run its business, stripping mortgages and selling the zeros makes sense. Was Freddie engaged in trading or in mortgage investment? I can’t tell from what has been reported. I can’t tell if the reporter has thought about the difference.
Ceasar’s wife and all that, so if Freddie was going to do this sort of thing, there should have been controls in place and more transparency.
So, scratch that bit about Freddie selling zeros. Freddie was reportedly buying inverse floaters. A bit less than 1/3 of 1% of Freddie’s portfolio was in inverse floaters. Hard to see how that would overwhelm other parts of the portfolio and leak out into mortgage underwriting rules, but may it’s just me who thinks 1/3 fo 1% is small.
Now, about the reports that Freddie was betting against refis with inverse floaters. The holder of a floater gets the difference between a fixed rate written into the float and the market rate. As market rates go down, the pay-out on the floater goes up – thus “inverse”. Um, doesn’t that mean Freddie wants rates to go down? So either it wasn’t inverse floaters in the standard sense, or Freddie wasn’t betting against refis. In fact, Forbes argues that inverse floaters were a good idea in 2010 and early 2011 (after which Freddie’s risk office told Freddie to stop buying inverse floaters) if you thought concern over rising rates were mistaken. (Or if you had a portfolio that was exposed to rising rates – mortgage portfolios have that ol’ convexity devil to worry about.)
I think ProPublica does good work most of the time. (NPR’s Planet Money does good work on finance, but the rest of NPR is terrible.) I just think there is a lot here that needs to be explained before we conclude that Freddie let its holdings get in the way of its underwriting.
Yves at Naked Capitalisim today posted an entirely different thesis.
If this triple posts please delete the extra two…
Yves at Naked Capitalisim today posted an entirely different thesis.
If this triple posts please delete the extra two…
Yves at Naked Capitalisim today posted an entirely different thesis.
If this triple posts please delete the extra two…
The rest of NPR is terrible in writing about economics and finance – and politics a good bit of the time. Otherwise, I really like ’em.
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