FHFA Answers Conflict of Interest Charges against Freddie Mac

The
Federal Housing Finance Agency (FHFA) issued a statement late Monday refuting a
story
from ProPublic and NPR
that a complicated investment strategy utilized by Freddie Mac had influenced
it to discourage refinancing of some of its mortgages.  FHFA confirmed that the investments using
Collateralized Mortgage Obligations (CMOs) exist but said they did not impact
refinancing decisions and that their use has ended. (the NPR Story)

Freddie Mac’s charter calls for
it to make home loans more accessible, both to purchase and refinance their
homes but the ProPublica story, written by Jesse
Eisinger (ProPublica) and Chris Arnold (NPR) charged that the CMO trades “give Freddie a powerful incentive to do
the opposite
, highlighting a conflict of interest at the heart of the company.
In addition to being an instrument of government policy dedicated to making
home loans more accessible, Freddie also has giant investment portfolios and
could lose substantial amounts of money if too many borrowers refinance.”

Here,
in a nutshell, is what the story (we are quoting from an “updated” version)
says Freddie has been doing.  

Freddie
creates a security (MBS) backed by mortgages it guarantees which was divided
into two parts.  The larger portion, backed
by principal, was fairly low risk, paid a low return and was sold to investors.  The smaller portion, backed by interest
payments on the mortgages, was riskier, and paid a higher return determined by
the interest rates on the underlying loans. 
This portion, called an inverse floater, was retained by Freddie Mac.

In
2010 and 2011 Freddie Mac’s purchase (retention) of these inverse floaters rose
dramatically, from a total of 12 purchased in 2008 and 2009 to 29.  Most of the mortgages backing these floaters had
interest rates of 6.5 to 7 percent.

In
structuring these transactions, Freddie Mac sells off most of the value of the
MBS but does not reduce its risk because it still guarantees the underlying
mortgages and must pay the entire value in the case of default.  The floaters, stripped of the real value of
the underlying principal, are also now harder and possibly more expensive to
sell, and as Freddie gets paid the difference between the interest rates on the
loans and the current interest rate, if rates rise, the value of the floaters
falls. 

While
Freddie, under its agreement with the Treasury Department, has reduced the size
of its portfolio by 6 percent between 2010 and 2011, “that $43 billion drop in
the portfolio overstates the risk reduction because the company retained risk
through the inverse floaters
.”

Since
the real value of the floater is the high rate of interest being paid by the
mortgagee, if large numbers pay off their loans the floater loses value.  Thus, the article charges, Freddie has tried
to deter prospective refinancers by tightening its underwriting guidelines and
raising prices.  It cites, as its sole
example of tightened standards that in October 2010 the company changed a rule
that had prohibited financing for persons who had engaged in some short sales
to prohibiting financing for persons who had engaged in any short sale, but it
also quotes critics who charge that the Home Affordable Refinance Program
(HARP) could be reaching “millions more people if Fannie (Mae) and Freddie
implemented the program more effectively.”

It
has discouraged refinancing by raising fees. 
During Thanksgiving week in 2010, the article contends, Freddie quietly
announced it was raising post-settlement delivery fees.  In November 2011, FHFA announced that the
GSEs were eliminating or reducing some fees but the Federal Reserve said that “more
might be done.”

If
Freddie Mac has limited refinancing, the article says, it also affected the whole
economy which might benefit from billions of dollars of discretionary income generated
through lower mortgage payments.  Refinancing
might also reduce foreclosures and limit the losses the GSEs suffer through defaults
of their guaranteed loans.

The
authors say there is no evidence that decisions about trades and decisions
about refinancing were coordinated.  “The
company is a key gatekeeper for home loans but says its traders are “walled
off” from the officials who have restricted homeowners from taking advantage of
historically low interest rates by imposing higher fees and new rules.”

ProPublica/NPR says that the
floater trades “raise questions about the FHFA’s oversight of Fannie and
Freddie” as a regulator but, as conservator it also acts as the board of
directors and shareholders and has emphasized that its main goal is to limit
taxpayer losses.  This has frustrated the
administration because FHFA has made preserving the companies’ assets a
priority over helping homeowners.  The
President tried to replace acting director Edward J. DeMarco, but Congress
refused to confirm his nominee. 

The
authors conclude by saying that FHFA knew about the inverse floater trades
before they were approached about the story but officials declined to comment on whether the
FHFA knew about them as Freddie was conducting them or whether the FHFA had
explicitly approved them.”

The
FHFA statement
said that Freddie Mac has historically used CMOs as a tool to
manage its retained portfolio and to address issues associated with security
performance.  The inverse floaters were
used to finance mortgages sold to Freddie through its cash window and to sell
mortgages out of its portfolio “in response to market demand and to shrink its
own portfolio.”  The inverse floater
essentially leaves Freddie with a portion of the risk exposure it would have
had if it had kept the entire mortgage on its balance sheet and also results in
a more complex financing structure that requires specialized risk management
processes.  (Full FHFA Statement)

The
agency said that for several reasons Freddie’s retention of inverse floaters ended in
2011 and only $5 billion is held in the company’s $650 billion retained
portfolio.  Later that year FHFA staff
identified concerns about the floaters and the company agreed that these
transactions would not resume pending completing of the agency examination.

These
investments FHFA said did not have any impact on the recent changes to
HARP.  In evaluating changes, FHFA
specifically directed both Freddie and Fannie not to consider changes in their
own investment income in the HARP evaluation process and now that the HARP
changes are in place the refinance process is between borrowers and loan
originators and servicers, not Freddie Mac.

…(read more)

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Hope Is Rising for Mortgage Accord

New York Attorney General Eric Schneiderman said he is confident his main concern with a pending settlement of alleged bank- foreclosure abuses would be resolved, but he didn’t commit to participating in an agreement.

U.S. Mortgage Probe Gains

New York Attorney General Eric Schneiderman Friday said he is confident his main concern with a pending settlement of alleged bank- foreclosure abuses would be resolved, but he didn’t commit to participating in an agreement.

Proposal to Seize Underwater Mortgages via Eminent Domain not Well Received

The Board of Supervisors in the California county of San Bernardino has,
perhaps unintentionally, picked a fight with some of the giants of the real
estate industry.  The Board unanimously
approved a plan two weeks ago that would use eminent domain to seize underwater
mortgages
and restructure them for homeowners unable to sell or refinance the properties.

The Homeowner Protection Program, in which San Bernardino would partner with
the cities of Ontario and Fontana within its borders, is only broadly sketched
out at present but it has already provoked a strong reaction from the Securities Industry and Financial Markets
Association (SIFMA).  SIFMA claims to
represent the interests of hundreds of securities firms, banks and asset
managers.  The trade association fired
off a letter to the Board on Friday, cosigned by more than a dozen of its
member organizations, protesting the proposed actions.  “Based on publicly available information on
the Agreement,” the letter said, “we are very concerned that the good
intentions of the Board of Supervisors will instead result in significant harm
to the residents the Agreement intends to help.”

The thrust of the letter is that such an action as proposed in San
Bernardino would significantly reduce access to credit for mortgage borrowers.  “If eminent domain were used to seize loans,
investors in these loans through mortgage-backed securities or their investment
portfolios would suffer immediate losses and likely be reluctant to provide
future funding to borrowers in these areas. 
It is essential to remember that investors in mortgage-backed securities
channel the retirement and other savings of everyday citizens through their
investment funds.  This program may cause
loans to be excluded from securitizations, and some portfolio lenders could
withdraw from these markets.  In other
words, this program could actually serve to further depress housing values in
the county by restricting the flow of credit to home buyers”

The Los Angeles Times quotes David
Wert, a spokesman for the county as saying the country would use eminent domain
to condemn mortgages on properties that are underwater, that is the owner owns
more on the mortgage than the value of the home, and would then renegotiate the
mortgages at a lower amount.  Only
homeowners who are current on their mortgage payments would be eligible for the
program.

The move is intended to help stimulate the region’s hard-hit economy by
freeing up people who have been stuck in their homes, Wert said. “Real estate
is the foundation of the inland economy, 
 [It] is based on the building and
selling of homes, and this is one way to stimulate that again.”

The program is still in its initial stages and additional details will be
hashed out in public the spokesman on said. 

Among those signing the SIFMA letter one were the Mortgage Bankers
Association, American Bankers Association, National Association of Realtors®,
The Financial Services Roundtable, American Securitization Forum, and the
Residential Servicing Coalition.

…(read more)

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Regulators to Coordinate Large Bank Oversight Under Dodd-Frank

Five federal agencies, each of which has a supervisory responsibility vis-à-vis large financial institutions, have signed an agreement as to how their regulatory functions will be carried out under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank.)  The five agencies signing the Memorandum of Understanding (MOU) are the Federal Reserve Bank Board of Governors, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of Comptroller of the Currency, collectively referred to as the Prudential Regulators, and the new Consumer Financial Protection Bureau (CFPB).

The five have overlapping examination responsibility for insured depository institutions with more than $10 billion.  Under the MOU the agencies will coordinate examinations and other activities and share certain material supervisory information about consumer related activities including compliance with federal consumer financial laws and some laws that regulate consumer financial products and services and consumer compliance risk management programs.  Also covered by the MOU are activities such as underwriting, sales, marketing, servicing and collections if they are related to consumer financial products or services.  

The objectives of the MOU are to:

  • Fulfill the Dodd-Frank requirement that examination schedules must be coordinated and if possible done simultaneously unless the financial institutions prefer otherwise;
  • Establish voluntary arrangements for coordination and cooperation between CFPB and the Prudential Regulators
  • Minimize regulatory burden on covered institutions;
  • Avoid unnecessary duplication of effort;
  • Ensure that the CFPB and other regulators carry out their responsibilities effectively and efficiently.
  • Decrease the risk of conflicting supervisory directions by the CFPB and Prudential Regulators;
  • Increase the potential for synergies and alignment of related activities of the CFPB and Prudential Regulators.

The MOU sets out guidelines for simultaneous and coordinated examinations for the CFPB and the Prudential Regulators including that each designate a point of contact for covered institutions and will consult with the institution and agree on a reasonable timetable for sharing information.  Agencies will share with each other information about the scope, dates, estimated staffing and other details of their examinations and the established points of contact will coordinate material changes in that information.

While the agencies will generally carry out examinations in a simultaneous manner, the MOU stresses that nothing is intended to compel agencies to conduct examinations jointly.

Under the agreement the Agencies also agree to share drafts of examinations reports and each will have at least 30 days to comment on the reports of others before the initiating agency issues a financial report.  Prior to issuing a final report or taking supervisory action in connection with an examination the agencies shall take into consideration any concerns that are raised in the comments by any other Agency.

The regulators’ monitoring of institutional performance in carrying out responsibilities under the Community Reinvestment Act (CRA) is also covered in the MOU.  The Prudential Regulators are expected to routinely share CRA performance evaluations, but the 30-day comment period above does not apply to Reports of CRA Examination.

A joint press release from the five agencies said “These coordination undertakings should lead to greater uniformity and efficiencies in supervision and help to minimize regulatory burden on covered depository institutions.”

 

…(read more)

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