Bets against homeowners

Bets against homeowners

February 1st, 2012 in Opinion Times

Freddie Mac is one of two federal mortgage agencies that have been under pressure from the Obama administration to provide mortgage relief for homeowners stuck with high-interest-rate loans and/or underwater mortgages. Yet the giant agency, the backstop owner of millions of mortgages, apparently created and sold around $5 billion in mortgage securities the past two years that profited only if affected homeowners remained tied to their higher-cost mortgages. And it did so even as the regulatory arm of Freddie Mac was tightening rules that made it harder for tens of thousands of mortgage holders to refinance their loans.

The discovery of Freddie Mac's conflict of interest and apparent profiteering in betting against its mortgage holders was the result of an investigation by ProPublica and National Public Radio, which reported its findings Monday. Their report quickly prompted the Treasury Department to initiate its own investigation into Freddie Mac's investment bets against mortgage holders.

ProPublica and NPR pointed out that Freddie Mac officials had emphasized that its regulatory arm was "walled off" from its investments traders, and said there was "no coordination" between the two. The reporters also said "there was no evidence" of a linkage between investment strategies and concomitant rule-making.

Regardless, the conflict should have been apparent to Freddie Mac's top officials and CEO, Charles Haldeman Jr. The agency's charter, after all, directs Freddie Mac to facilitate home loans to bolster homeownership among Americans by underwriting reasonably priced mortgages. Its top officials should have known that its investment market traders were bundling mortgage securities in 2010 and 2011 that were most profitable if the mortgagers stayed in their higher-interest loans, when the post-bubble trend in a harder economy should have been to help them get into lower-rate loans.

That is the heart of what appears to be a needless and mercenary scandal. As the ProPublica/NPR report on the investigation shows, the agency bundled the interest-rate portion only of loans with interest rates of around 7 percent into securities, and sold off the less-risky, and less-profitable, principle portions of the loans. They could sell these "inverse floater" securities at more profitable margins because current inter-bank lending rates were so low, but their profits depended on mortgagers who wouldn't or couldn't refinance to lower-rate loans.

The securities are notable partly because they seem modeled on the sort of risky derivatives and swaps that were at the heart of the disastrous 2007 financial implosion, and partly because Freddie Mac was trading in such securities more than three years later, in 2010 and 2011.

The White House has been pushing Freddie Mac and Fannie Mae for the last three years to ramp up relief for home buyers who were lured into unaffordable mortgages before the housing bubble imploded, and before the Great Recession slashed jobs and family incomes. Relief is warranted: the implosion led to millions of foreclosures and a depressed housing that remains a huge drag on the economy. Providing mortgage holders with more easily accessible refinancing would free up hundreds of dollars a month for households to put into our consumer-driven economy. Betting against some mortgage holders just goes against their needs.

Freddie Mac officials have suggested that the tighter rules on refinancing were reasonably directed to circumstances that reflect other credit or financing issues, i.e., short sales and multiple mortgages. They also say losses resulting from refinancing mortgages in the "inverse floater" securities would mean a loss to American taxpayers.

The ProPublica/NPR report does note that the agency refinanced more than $170 billion in mortgages in the first three quarters of 2001, "helping nearly 835,000 borrowers save an average of $2,500 in interest payments during the next year."

Regardless, the core ethical question remains: Why did Freddie Mac undertake in the first place to bundle and sell securities that bet against taxpayers stuck with high-cost mortgages that they backed, and should have been attempting to help. Its trades may have been aimed at offsetting the bailout it took, but ethical standards would not support such an investment strategy by a government-owned agency.