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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Investor Cash Adding Downward Pressure on Home Prices

Cash buyers, principally investors, may
be putting downward pressure on home prices according to the Campbell/Inside
Mortgage Finance Housing Pulse Tracking Survey released Monday.  The survey found that investors with cash in
hand are able to offer something that homeowners dependent on mortgage
financing cannot, a guaranteed sale with a quick closing timeline.  This seems to offset the desirability of a
higher bid with a mortgage contingency.   

The
Housing Pulse survey found that the trade-off between price and speed is
particularly true with offers on distressed properties because the lenders and
servicers liquidating the properties generally prefer transactions that can
settle within 30 days.  The Campbell
report states, “While investor bids may not be the
first offers accepted, they often end up winning properties after other
homebuyers are eliminated because of mortgage approval or timeline problems.
Appraisals below the contracted price are a common reason for mortgage denials.
Most mortgage financing timelines are now in excess of 30 days.”

The
survey reports that 33.2 percent of home buyers in December were cash buyers,
up from 29.6 percent in December 2010. 
However, 74 percent of investors came to the table with cash.  This is especially striking as the survey
found that investors accounted for 22.8 percent of home purchases in December,
changed only slightly from 22.2 percent in November.  But, Campbell says, “Despite their relatively
small share among homebuyers, investors have an outsize effect on home prices because
their bids bring down market prices.”

Real estate agents responding to the
survey commented on the low bids they are seeing from investors.  Campbell quoted anecdotal information from a
few agents indicating they are seeing investor bids 10-20 percent below list
prices, but with quick closings.

The total share of distressed properties
in the housing market in December continued at a three-month moving average of
47.2 percent, the 24th consecutive month that the HousePulse
Distressed Property Index (DPI) was over 40 percent.

The Campbell/Inside Mortgage Finance
HousingPulse Tracking Survey involves approximately 2,500 real estate agents
nationwide each month and provides up-to-date intelligence on home sales and
mortgage usage patterns.

…(read more)

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Momentum Seen for Home Improvement Spending

Spending
on home improvements and remodeling have shown signs of a rebound and the
Remodeling Futures Program at the Harvard Joint Center for Housing Studies is
projecting that sector of the economy will end 2012 on a positive note.

The
Joint Center produces the Leading Indicator of Remodeling Activity (LIRA) each
quarter.  It is designed to estimate
national homeowner spending on improvements for the current quarter and the
following three quarters.  The indicator, measured as an annual rate-of-change
of its components, provides a short-term outlook of homeowner remodeling
activity and is intended to help identify future turning points in the business
cycle of the home improvement industry.

The
figures from the most recent quarter, the fourth quarter of 2011, showed an
estimated four-quarter moving total of $112.4 billion in home improvement
spending compared to $113.8 billion in the third quarter.  This number is expected to dip further in the
first quarter of 2012, to $108.1 billion before starting to build at mid-year.

 “Sales of existing homes have been increasing
in recent months, offering more opportunities for home improvement projects,”
says Kermit Baker, director of the Remodeling Futures Program at the Joint
Center.  “As lending institutions become less fearful of the real estate
sector, financing will become more readily available to owners looking to
undertake remodeling.”

…(read more)

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Florida Loan Officer Sentenced in FHA Fraud Case

A Florida loan officer has been
sentenced to four-and-a-half years in prison and ordered to pay $9.2 million in
restitution
to the Department of Housing and Urban Development (HUD) for his
role in a mortgage fraud scheme that targeted the Federal Housing
Administration (FHA). Alejandro (“Alex”) Curbelo of Miami had pleaded guilty to
one count of conspiracy to commit wire fraud in April.  In addition to 54 months of incarceration he must
serve three years of supervised release.

According to documents filed in the U.S.
District Court in Miami, from approximately February 2006 through July 2008
Curbelo, then a loan officer for Great Country Mortgage Bankers in Miami,
assisted in the sale and financing of condominium units at Dadeland Place and
Pelican Cove on the Bay.   He assisted borrowers to obtain loans who were
unqualified due to insufficient income, high levels of debt, and outstanding
collections. 

Curbelo admitted that he conspired with
others to create and submit false applications and other documents to FHA on
behalf of the borrowers and to offering cash back to the borrowers as an
incentive for them to purchase the units. 
The closing costs were paid on behalf of the borrowers by interstate
wire which enabled the wire fraud charges. 

After the loans closed the unqualified
buyers
failed to meet their required payments and defaulted on their
loans.  HUD, which insured these loans,
was required to take title to the units after foreclosure and pay lenders the outstanding
balance of the loans.  The fraud cost HUD
more than $9.2 million.

The case was investigated by the HUD
Office of Inspector General as participants in the Miami Mortgage Fraud Strike
Force and the Finance Fraud Enforcement Task Force.

…(read more)

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Harvard’s State of Housing Report Says Home Construction Now Adding to GDP

Steadier job growth and improving
consumer confidence are now boosting home sales and home prices may finally
find a bottom this year according to the latest State of the Nation’s Housing report released this morning.  The report, produced by the Joint Center for
Housing Studies of Harvard University, says further that stronger home sales
should pave the way for a pick-up in single-family construction over the rest
of 2012.

Conditions, however, will keep this
recovery “subdued.”  The backlog of
nearly 2 million loans in foreclosure means that distressed sales will remain
elevated and will keep a downward pressure on prices and another 11.1 million
homeowners are underwater on their mortgages, dampening both sales of new homes
and investment in existing units.  While
vacancies have been declining the report notes, they still remain well above
normal, holding down demand for new construction in many markets.

What the for-sale market needs most, the
authors say is a sustained increase in employment.  This might in turn bring household formation
back to normal levels.  The depressed
pace of homebuilding has been a major factor in hiring and pulled down growth
in the gross domestic product (GDP) from 2006 to 2010.  Since the beginning of 2011, however, both home
construction and home improvement spending have made a positive contribution to
GDP in four out of five quarters.

Another bright spot is the rental market;
the number of renters surged by 5.1 million over the decade of the 2000s, the
largest decade-long increase in the postwar era.  This reflects not only growth in those
populations which are historically prone to rent – the young, minority, and low
income households, but foreclosures have driven others into the rental market.

Still the rental market has not fully
benefited from the large echo-boom generation because the recession has forced
a lot of young people to put off leaving home which usually means a move into
rental housing.  Once the economy
improves the echo-boomers should give the market a significant lift.

The rising demand for rentals has
sparked rent increases in many parts of the country; 38 of the 64 markets
tracked by MPF research had rent increases that outstripped inflation and all
but one of the remainder (Las Vegas) had at least a nominal increase in
2011.  Even in some cities hard hit by
foreclosures and the economy in general (Detroit, Cleveland) rents are rising.

The increase in rents has, in turn,
helped to stabilize the multifamily property market where prices are were
reported up by 10 percent in the fourth quarter of 2011 from one year earlier
and multifamily construction starts more than doubled from its trough to a
225,000 unit annual rate, providing a welcome boost to construction.

Homeownership continues to slide,
dipping to 66.1 percent in 2011 from 66.8 percent a year earlier and 69 percent
at its peak in 2004, but it is still higher than in the period from 1980 into
the early 1990s.  Rates for older
households continue to climb as the population ages, but the homeownership rate
for younger households will probably continue to decline over the next few
years.

The number of new homes added to the
housing stock in the 2002-2011 period was lower than in any other ten year span
since the early 1970s so it is hard to argue that overbuilding is dragging down
the market.  The excess housing supply is
largely a reflection of the slowdown in housing growth which resulted from the
decline in the rate at which younger people are forming households as noted above
and also because of a sharp drop in immigration.  But over the longer run, the growth and aging
of the current population should support the addition of about 1.0 million new
households per year for the next ten years. 
Immigration remains an unknown in this calculation, but even assuming
net inflows are half what was predicted by the U.S. Census in 2008, household
growth should average 1.18 million per year in 2010-2020.

The recession took a toll on household
income but did little to lessen the burden of housing costs.  Between 2007 and 2010 the number of
households paying more than half of their income for housing rose by 2.3
million to 20.2 million.  While renters
accounted for the vast majority of the increase, the number of severely
cost-burdened owners also rose more than 350,000 as many households took on
expensive mortgages they were later unable to refinance.  In addition, this recent increase is on top
of an increase in cost burdened households of 4.1 million in 2001-2007.

These cost burdened families face a big challenge.  Among families with children in the bottom
expenditure quartile of income and with the most severe housing cost burden,
only about three-fifths of the amount is spent on food, half as much on
clothes, and two-fifth on healthcare as is spent by families living in
affordable housing.

The Joint Center said there are few
prospects for a meaningful reduction in this cost burden
.  Funding for the federal Housing Choice Voucher
Program has increased only modestly since the recession and the only
significant growth in subsidized rental housing is through the Low Income
Housing Tax Credit which continues to add about 100,000 affordable units each
year.  If the current calls for reducing
domestic spending are realized “the nation would move even further away from
its longstanding goal of ensuring decent, affordable housing for all
Americans.”

On the road ahead, with moderate gains
in multifamily and single family construction and improving sales of existing
homes, housing should be a stronger contributor to economic growth than it has been
in years
.  The rental market is back on
track, but the owner occupied market still faces the same pressures it has for
years; distressed properties which hold down prices and owners who are unable
to sell because they are underwater. 

Actions such as changes in the Home
Affordable Modification Program, the servicing settlement, and more rapid
disposition of properties where homeownership cannot be maintained are helping
the market.  However, the greatest
potential for recovery of the for-sale market is its historic
affordability.  The dive in home prices
and record low mortgages rates make homebuying more attractive than it has been
in years but the limited availability of financing that meets the needs of many
borrowers, strict underwriting guidelines, and rising fees are inhibiting
sales. “With key mortgage lending regulations still undefined, it remains to be
seen to what extent and under what terms lenders will make credit available to
lower income and lower-wealth borrowers.”

…(read more)

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