NPR and ProPublica released an explosive report Monday that found government-owned mortgage giant Freddie Mac betting against the very homeowners it is supposed to help. According to the news article, the investment division of Freddie Mac (or as Henry calls it, Freddie's "gambling desk") placed billions of dollars of bets against homeowners who were trying to refinance their mortgages at lower rates.
NPR/ProPublica's review of public documents found that Freddie Mac invested in securities called "inverse floaters," which receive all the interest payments from specified mortgage-backed securities. "If lots of people 'pre-pay' their old loans and refinance into new, cheaper ones, then Freddie Mac starts to lose money," ProPublica's Jesse Eisinger and NPR's Chris Arnold explain. "If people can't refinance, then Freddie wins because it continues to receive that flow of older, higher interest payments."
Although Freddie Mac's bets are legal, they're highly offensive. Rightly or not, many Americans blame Freddie Mac and Fannie Mae -- which was not mentioned in the NPR/ProPublica report -- for the housing boom and subsequent bust. Nearly all Americans would agree that these companies should not be focused on generating profits, especially now that they're officially wards of the state and are using taxpayer dollars to make these bets.
Freddie Mac plays a significant role in determining mortgage rates and is one of the "gatekeepers" with the power to decide whether a homeowner can refinance at a lower rate. If homeowners can reduce their mortgage payments, then Freddie Mac loses money. Hence the conflict of interest and the concern that Freddie has been turning down refi requests in order to benefit its proprietary trades.
Freddie Mac Spokesman Michael Cosgrove provided this response to the NPR/ProPublica report:
"Freddie Mac is actively supporting efforts for borrowers to realize the benefits of refinancing their mortgages to lower rates. During the first three quarters of 2011, we refinanced more than $170 billion in mortgages, helping nearly 835,000 borrowers save an average of $2,500 in interest payments during the next year. Refinancing accounted for more than 70 percent of our loan purchases during the first nine months of 2011. We remain committed to reducing our retained portfolio and appropriately managing its risks. Our retained portfolio has declined by about $200 billion since its peak, and at the end of 2011 was more than $60 billion below the cap required by the U.S. Treasury."
Washington stepped in to shore up the balance sheets of the troubled mortgage lenders in 2008, spending $169 billion at the height of the housing market collapse, according to the NPR/ProPublica report. Any risky bets Freddie makes will technically affect all taxpayers. Freddie Mac has asserted its investment arm, the division that places bets against homeowners via complex mortgage securities, is "walled off" from the mortgage-lending unit and other Freddie Mac personnel. The government mortgage buyers guarantee more than half of all the $10.3 trillion in outstanding U.S. home loans, as reported by the Wall Street Journal.
Many economists and policymakers say the number of foreclosures will drop if Americans are able to refinance their high-interest rates. For the week ending Jan. 26, the rate on the 30-year-fixed mortgage averaged 3.98 percent. President Obama reiterated his administration's commitment to helping homeowners in last week's State of the Union.
"I'm sending this Congress a plan that gives every responsible homeowner the chance to save about $3,000 a year on their mortgage, by refinancing at historically low rates," Obama said. "No more red tape. No more runaround from the banks." (See: Taken to Task: Getting a Mortgage Shouldn't Be This Hard)
Both companies have been in the hot seat before over payments to their CEOs and top executives. The salaries for Michael Williams and Charles Haldeman Jr., the departing CEOs of Freddie Mac and Fannie Mae, were expected to be as high as $6 million each last year although both companies reported deep financial losses. California has filed a suit against Freddie and Fannie last December, asking the firms to provide extensive rejoinders about the properties they own and foreclosed in the state. The Securities and Exchange Commission has brought civil fraud charges against former Fannie CEO Daniel Mudd and former Freddie CEO Richard Syron, stating that the mortgage giants were untruthful about their subprime exposure.