Treasury Investigates Freddie Mac Investment
The Treasury Department is investigating a report that Freddie Mac, the mortgage giant, bet against homeowners’ ability to refinance their loans even as it was making it more difficult for them to do so, Jay Carney, a White House spokesman, said on Monday.
The report came just as the Obama administration had been escalating its efforts to push Fannie Mae and Freddie Mac to ease conditions for homeowners, including those who owe more on their mortgages than their homes are worth.
Last Friday, the Treasury announced that it would offer increased incentives to lenders to forgive portions of homeowner debt, saying pointedly that for the first time the incentives would be offered on loans held by Fannie and Freddie.
But Fannie and Freddie, which said they would review the increased incentives, have long declined to allow debt reduction on the loans it holds or guarantees, saying that it would create unnecessary losses for taxpayers. The companies, which are financed by taxpayers, have also maintained barriers to refinancing, like risk-based fees for homeowners, even as mortgage interest rates have dropped below 4 percent.
In his State of the Union address last week, President Obama said a new refinancing program would cut through government red tape. He has yet to provide details of the program.
The Obama administration has tried, with scant results, to persuade Fannie and Freddie to ease refinancing restrictions and participate in debt forgiveness programs.
The Federal Reserve, which has made low interest rates a crucial part of its response to the financial crisis, has also objected to some of the barriers to refinancing, including fees it has said are unjustified.
On Monday, ProPublica and National Public Radio reported that Freddie Mac, which maintained slightly tighter restrictions than Fannie on homeowners’ eligibility to refinance, had a multibillion-dollar investment whose value hinged on borrowers continuing to pay higher interest rates.
Beginning in 2010, Freddie bought several billion dollars’ worth of “inverse floater” securities — essentially the interest-paying portion of a bundle of mortgages — for its investment portfolio while selling the far less risky principal portion. Fannie and Freddie are supposed to be decreasing the size of their investment portfolios.
There is no evidence that Freddie tailored its refinancing standards to its investing strategy, but “inverse floaters” make less money if the loans they cover refinance to a lower interest rate.
Freddie issued a statement on Monday defending its commitment to helping homeowners. “Freddie Mac is actively supporting efforts for borrowers to realize the benefits of refinancing their mortgages to lower rates,” it said. The company said refinancing accounted for 78 percent of its loan purchases in 2011.
Christopher J. Mayer, a real estate professor at Columbia Business School who has been a proponent of mass refinancing, said he could see little reason for Freddie to use such a complex investment scheme. “Why are we three years into the crisis and some of the same kinds of complicated derivatives deals that brought down some of our biggest financial institutions are being done by Freddie Mac?” he said.
The Federal Housing Finance Agency, Freddie Mac’s regulator, also had problems with the deals. Late Monday, the agency said it had reviewed the inverse floaters last year and had identified “concerns regarding the controls, including risk management.”
Freddie Mac had already stopped conducting the transactions, and only $5 billion of its $650 billion portfolio was held in inverse floaters, the statement said. It said that the investments had no bearing on recent changes, announced last fall, to the Home Affordable Refinance Program, in which Freddie maintained stricter controls than Fannie on homeowners who owed less than 80 percent of their homes’ value.
Some have advocated principal reduction as a better way to restore equity to homeowners, though it is more expensive. The Treasury’s offer on Friday would triple the incentives paid to lenders that reduce principal, to 18 to 63 cents on the dollar from 6 to 21 cents on the dollar.
Proponents say that reducing principal is the most effective type of loan modification and that it would help the housing market and the broader economy by reducing the $700 billion in negative equity that is weighing down growth.
But Edward J. DeMarco, the acting director of the Federal Housing Finance Agency, has remained unconvinced that principal reduction is consistent with the goal of saving taxpayer money that was used to bail out Fannie and Freddie. Two weeks ago, he wrote in a letter to Congress that principal reduction would cost $100 billion if every single underwater government-backed mortgage were adjusted.
Mr. DeMarco noted that reducing principal could reduce losses not for taxpayers but for third parties, like the holders of secondary loans or providers of mortgage insurance. “F.H.F.A. would reconsider its conclusions if other funds become available,” he wrote.