Refi Claims Against Freddie Mac Expose GSEs' Public-Private Conflict

Was the nation’s second largest mortgage company betting against mortgage refinancing? Allegations supporting the affirmative which were made public this week have prompted the U.S. Treasury to launch an official probe.

An investigative story published jointly by Pro Publica and NPR suggests Freddie Mac instituted restrictions on refinancing which were intended to prevent homeowners from taking advantage of lower mortgage rates in order to reap greater profits from investments that banked on high-rate loans.
The two nonprofit media outlets say public documents reveal that in 2010 and 2011, Freddie Mac began purchasing “inverse floaters,” financing instruments structured as collateralized mortgage obligations (CMOs) that pay out based on the difference between the rate being paid by the borrower and a global benchmark rate, which has fallen to extremely low levels.
With most of the loans packaged into these deals carrying interest rates ranging from 6.5 to 7 percent, Pro Publica and NPR assert Freddie’s investment earnings would take a hit should the borrower refinance at today’s lower rates. The publications accuse the GSE of raising and instituting new fees for refinancing over the past two years to deter borrowers, at a time when the company was told its duty was to foster a housing recovery by assisting distressed homeowners.
Celia Chen, a senior director at Moody’s Analytics, says the “revelations actually come as little surprise, but they do highlight the ambiguous status of Freddie and its sister agency, Fannie Mae.”
The GSEs’ main business is guaranteeing mortgage credit risk, which ensures money is available for mortgage refinancing, Chen explained. But the companies need profits to stay in this business, as well as to minimize the cost to taxpayers, she says. To earn money Fannie and Freddie trade in residential mortgage-backed securities [RMBS] – and herein lies the conflict, according to Chen.
“When homeowners refinance, RMBS returns go down,” Chen explained. “Thus the credit-risk side of the company could potentially help keep profits up by making refinancing harder. This looks bad at a time when millions of households are struggling and mortgage rates are at record low levels; and worse given that policymakers are encouraging refinancing as a way of shoring up the housing market.”
Chen says the story is less sensational than it appears — Freddie’s potential conflict has long been recognized, and the agency operates its guarantee and investment businesses independently of each other.
“Yet the issue does highlight a broader problem with both Freddie’s and Fannie’s current status: Neither fully public nor fully private, they serve neither interest well,” according to Chen.
She suggests a remedy is for the GSEs’ investment arms to be spun off from the rest of the company. “Congress needs to chart a course for the agencies’ future, and the sooner the better,” Chen said.
At a White House press briefing following Pro Publica’s publication and NPR’s broadcast of the story, spokesman Jay Carney told reporters that the Treasury Department is looking into the allegations.
Freddie Mac’s regulator, the Federal Housing Finance Agency (FHFA) issued a statement saying the GSE ceased retaining inverse floaters in 2011. The agency says of Freddie’s $650 billion retained portfolio, only $5 billion is currently held as inverse floaters.
FHFA says both Fannie and Freddie were instructed not to consider changes in their own investment income as part of the evaluation process for the Home Affordable Refinance Program (HARP).
“FHFA and the Enterprises remain fully committed to the success of HARP as it is a valuable tool to lessen the Enterprises’ credit risk and provide assistance to borrowers seeking to refinance,” the regulator said. “Now that the HARP changes are in place, the refinance process is between borrowers and loan originators/servicers, not Freddie Mac.”
Freddie says it “is actively supporting efforts for borrowers to realize the benefits of refinancing their mortgages to lower rates.” The company points out that 78 percent of its loan purchases last year were refinancings.
The GSEs’ latest report to Congress shows that from March 2009 to September 2011, Fannie and Freddie refinanced nearly 928,600 loans through the HARP program. The two companies’ total refinances over that period tally 9,010,227, of which Freddie Mac lays claim to 3,629,438.