Regulator: Freddie Ceased Mortgage Transactions ‘On Its Own’

Bloomberg News
Edward DeMarco, acting director of the Federal Housing Finance Agency

By Alan Zibel and Nick Timiraos

Freddie Mac stopped investing in certain mortgage derivatives last spring amid a weak market for such transactions, the firm’s federal regulator said on Friday, as an uproar continued on Capitol Hill about the investments.

The obscure investments known as inverse floaters caused a flurry of angry statements from lawmakers this week after NPR News and nonprofit investigative news outlet ProPublica reported that the mortgage giant’s investments in certain mortgage derivatives created conflicts of interest that amounted to bets against homeowners’ ability to refinance.

The Federal Housing Finance Agency said in a statement that Freddie Mac made the initial decision to suspend the investment strategy in spring 2011.

“Freddie Mac, on its own, ceased structured financing that produced inverse floaters, as there was limited market demand for these structured products,” said Corinne Russell, a spokeswoman for the FHFA. She said there was “no connection” between Freddie Mac’s mortgage financing structures and its refinancing policies.

The “underlying premise” that Freddie had sought to bet against homeowners by holding the investments “is simply incorrect,” said the agency’s acting director, Edward DeMarco, in a letter on Tuesday.

The mortgage-related investments receive a certain piece of the cash flow from interest payments on mortgages. They would be worth less if borrowers refinanced their home loans and paid off loans that carry higher interest rates.

The NPR-ProPublica report said there was no specific evidence that Freddie’s decision to retain exposures to those investments was tied to its decisions to tighten credit policies that made refinancing more difficult.

Freddie Mac says that its portfolio management operations are “walled off” from other parts of the business. In an interview with NPR on Friday, Mr. DeMarco said he was “completely puzzled by the notion that there was something immoral that went on here.”

Mr. DeMarco said in a letter to Sen. Robert Casey (D., Pa.) that regulators had raised their own concerns about over the firm’s ability to manage the risks associated with the complex investments after Freddie Mac ceased retaining the mortgage investments.

“The risk associated with these transactions is inconsistent with FHFA’s goal of having Freddie Mac reduce its risk profile and avoid unnecessary complexity that requires specialized risk management practices,” wrote Mr. DeMarco. Mr. Casey pressed Mr. DeMarco for more detailed answers in a separate letter Friday. He asked Mr. DeMarco to explain Freddie’s rationale for retaining more of those investments in 2010 and 2011 and to clarify FHFA’s oversight of those investments.

Freddie Mac, which buys up mortgages and packages them into securities, has a $650 billion mortgage portfolio. It holds about $5 billion of the derivatives in question.

Will the White House Move the ‘Boulder’ on Principal Write-Downs?

The aversion of the government-controlled mortgage companies Fannie Mae and Freddie Mac, and their regulator, to writing down the loan balances of homeowners has frustrated advocates of a more aggressive response to the housing crisis.

Democratic lawmakers in Congress have prodded the regulator, the Federal Housing Finance Agency, to carry out principal write-downs. Some have even called on President Barack Obama to remove the agency’s acting director, Edward DeMarco, if he doesn’t do more to aid the ailing housing market.

Now the Obama administration is raising the stakes on the issue. The administration on Friday said it would triple payments to the mortgage industry in an effort to encourage more loan forgiveness. And it challenged the FHFA to allow these same incentives for Fannie and Freddie.

To supporters of principal write-downs, this is a deal worth taking. In a blog post, Jared Bernstein, who was previously Vice President Joe Biden’s top economic adviser, says that Mr. DeMarco has been “a big boulder in the path to principal reduction.”

Mr. Bernstein writes:

Now, FHFA acting director Ed DeMarco has consistently resisted reducing principal. …But he’s also said he’d go there if there were incentives to do so—some way to mitigate the losses to the agencies (and the taxpayers) from the loan forgiveness.

Well, here it is, Ed.

Critics, however, aren’t so thrilled. Sen Bob Corker (R., Tenn.) said Monday that he would introduce legislation to ban the government from using taxpayer money to pay for principal write-downs. “The idea that federal tax dollars would be used to reduce the principal on some outstanding mortgages and perhaps even bailout investment properties and beach houses is terrible public policy,” Mr. Corker said. It means “that people who acted responsibly in Tennessee will be paying for the bad behavior of lenders and borrowers in places where reckless housing practices were most prevalent, something I find to be irresponsible.”

For its part, the FHFA said in a statement that it is studying whether the new incentives will provide a benefit to Fannie and Freddie, whose rescue has cost taxpayers $151 billion to date.

The FHFA , in a letter released last week has analyzed how principal write-downs and a principal forbearance program might impact Fannie and Freddie. The regulator indicated its preference for a principal forbearance plan, which does not require lenders to forgive debt. Instead, lenders set aside a portion of the loan, not requiring any payments on it until the borrower sells the home or pays off the loan.

For example, a lender could allow a homeowner to make principal and interest payments on only $150,000 out of a $200,000 mortgage, but the borrower would still owe the remaining $50,000 to the bank.

The FHFA’s analysis calculated that Fannie and Freddie would save $24 billion by enacting a forbearance plan for the 1.4 million of Fannie and Freddie’s borrowers who owed more than 15% more than their property’s current value as of last summer. The analysis found that a principal forgiveness plan for those borrowers would save less — $20 billion over the life of those loans.

McCain Pushes Ban on Fannie, Freddie Bonuses

Reuters
Sen. John McCain wants to ban executive bonuses at Fannie Mae and Freddie Mac while the companies remain under federal control.

An effort to bar bonuses for executives at Fannie Mae and Freddie Mac could move forward in the U.S. Senate this week.

Sen. John McCain (R., Ariz.), a long-standing critic of the mortgage giants, said Tuesday he would try to advance a measure that would bar senior executives at Fannie and Freddie from receiving bonuses while the companies remain under federal control. (Video.)

Mr. McCain and Sen. Jay Rockefeller (D., W.Va.) sought to attach the restriction on pay to a bill prohibiting members of Congress from trading on inside information about government activities that could impact stocks. That bill easily cleared a 60-vote procedural hurdle on Monday and could pass by the end of this week.

Lawmakers became outraged last fall over nearly $13 million in bonus and incentive pay for Fannie’s and Freddie’s top executives granted last year.

“I find it hard to believe that we can’t find talented people with the skills necessary to manage Fannie and Freddie for good money…without the incentive of multi-million dollar bonuses,” Mr. McCain said on the Senate floor on Tuesday. “There are many examples of intelligent, well-qualified, patriotic individuals working in our federal government who make significantly less than the top executives at Fannie and Freddie with just as much responsibility.”

Representatives for Fannie and Freddie declined to comment. Their regulator, the Federal Housing Finance Agency, didn’t immediately comment.

The FHFA has defended the current pay packages as appropriate given the technical expertise needed to oversee two companies that guarantee $5 trillion in mortgages and the fact the executives couldn’t be paid in the companies’ stock, which essentially is worthless.

Taxpayers, who have put about $151 billion into Fannie and Freddie since their takeover in fall 2008, “would not be better off if we provoke a rapid turnover of senior management by further slashing compensation,” said Edward DeMarco, the FHFA’s acting director, at a November hearing.

Fannie CEO Michael Williams announced in mid-January his plans to step down as soon as the Fannie board finds a successor. His counterpart at Freddie Mac, Charles E. Haldeman Jr., said last fall that he would leave sometime in 2012. Both executives took their jobs in 2009, less than a year after the government put the companies under federal control.

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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HAMP Changes: Treasury Increases Incentives for Principal Reduction

The Federal Housing Finance Agency announced on Friday that it was extending
the Home Affordable Modification Program (HAMP) for another year – through December
13, 2013 – and that Freddie Mac and Fannie Mae would continue as financial
agents for Treasury in implementing the changes it then announced.  The press release also said the two GSEs
would “extend their use of HAMP Tier 1 as the first modification option through
2013” and that they were already in alignment with HAMP Tier 2 and no further
changes were necessary.

However, the Treasury Department, which jointly
administers HAMP, simultaneously announced what appear to be some significant
changes in the program.  Perhaps Timothy G. Massad, Assistant Treasury Secretary
for Financial Stability, was merely providing the English translation of
the FHFA press release or perhaps there is a division in the ranks.  In either case, here is the information he
provided in his blog posting.
 

The Treasury Department intends to triple the incentives offered to
investors holding distressed loans to encourage them to participate in reducing
the principal for those loans.  Under the
new guidelines, Treasury will pay from 18 to 63 cents on the dollar to
investors, depending on the degree of change in the loan-to-value ratio of the
individual loans.

While principal reduction has always been
available for modifying proprietary loans under the HAMP program (it even has
its own acronym, PRA) it has not been widely used.  Of over 900,000 permanent modifications
completed since the program began, only 38,300 are classified as utilizing principal
reduction

As we have previously reported,
FHFA has resisted all suggestions that the GSEs also include principal reduction
in their tools for dealing with distressed loans where borrowers are upside
down in their mortgages.  According to
Massad, Treasury has notified FHFA that it will pay principal reduction incentives
to Fannie Mae or Freddie Mac as well if they allow servicers to forgive principal
in conjunction with a HAMP modification. 

In its press release FHFA said of the
Treasury proposal

“FHFA has
been asked to consider the newly available HAMP incentives for principal
reduction. FHFA recently released analysis concluding that principal
forgiveness did not provide benefits that were greater than principal
forbearance as a loss mitigation tool. FHFA’s assessment of the investor
incentives now being offered will follow its previous analysis, including
consideration of the eligible universe, operational costs to implement such
changes, and potential borrower incentive effects.”

Again,
according to Treasury, HAMP will be expanding its eligibility to reach a
broader pool of borrowers.  An additional
evaluation process is being implemented that will allow servicers to recognize that
some borrowers who can afford their first mortgage payments still struggle because
of other debt.  Some analyses of HAMP
have found that many borrowers could not qualify for a modification solely because
their housing expenses were already below the 31 percent ceiling allowed by
HAMP guidelines.  This ceiling will now
be flexible enough to include secondary debt such as medical expenses or second
liens in the evaluation ratio. 

Eligibility
will also be expanded to include properties that are tenant-occupied as well as
vacant properties that the owner intends to rent.  According to Massad, this will serve to
further stabilize communities with high levels of vacant and foreclosed
properties as well as expanding the rental pool as has been suggested by the
Federal Reserve and others.

…(read more)

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