Jesse Eisinger and Chris Arnold have a really good story about Freddie Mac today (OTCQB:FMCC), a company which is preventing mortgage refis at the same time as it’s making enormous prop bets that homeowners are going to continue to find it hard to refinance.
Back in September I noted that mortgage bonds are trading well above par just because investors are well aware that refis are hard to come by for many homeowners, and said that those investors were “taking unfair advantage of the fact that homeowners are locked into above-market mortgage rates”. What I never dreamed of was that the investors and the rule-setters were the same people — in this case, Freddie Mac.
But here’s what Freddie is doing. In the past two years, it’s bought $3.4 billion of hugely-risky “inverse-floater” notes — essentially bets that homeowners with above-market mortgage rates won’t be able to refinance to market rates. And then it turns around and implements rules which prevent homeowners like Jay and Bonnie Silverstein from refinancing. The Silversteins have made all their mortgage payments on their current home in full and on time, despite the fact that they’re paying an interest rate of 6.875%. They’d love to refinance to get that rate lowered, but Freddie Mac won’t let them — because of the way they sold their previous home.
The Freddie Mac rule certainly maximizes Freddie Mac’s income, but it’s dreadful and unfair public policy. At the same time, it’s also policy which is very much in line with the FHFA’s stance on principal reduction, or anything else which might help homeowners. Given the choice between extracting short-term cashflows from homeowners, on the one hand, and improving the all-over health of the housing market, on the other, the FHFA will always choose the former.
Check out the long-awaited letter from FHFA director Ed DeMarco, for instance, justifying the fact that he won’t allow Frannie or Freddie to do principal reductions. It’s basically a long list of tables with precious little annotation or explanation, but at heart it seems to be based on two ideas. The first is that if you reduce principal to 115% of the value of the home, that doesn’t help very much. Well, duh. The whole point of principal reduction is to give homeowners back some equity in their home, and if they’re still underwater, you’re not doing that. And the second reason is just that Frannie’s computer systems aren’t really set up for principal reductions:
Neither Enterprise can accommodate the new accounting and tracking of principal reduction without operationally challenging changes to the existing IT systems, which are outdated and inflexible. The team did not require the GSEs to provide FHFA with cost projections, but experience implementing the HAMP program suggests that each Enterprise would need substantial funds and would rely upon scarce personnel resources to make the necessary IT modifications.
This is pretty desperate stuff — “we don’t know what the IT costs might be, and we didn’t bother to try to find out, but trust us, they’d be substantial”. In the wake of ProPublica’s story today, I don’t trust the FHFA at all. It signed off on all of Freddie’s trades, and its actions are entirely consistent with a regulator perfectly happy with Frannie taking on massive bets at the expense of homeowners, just to try to make some extra money. Oh, and the chap at Freddie in charge of buying these inverse floaters is paid $2.5 million a year.
It’s all quite a disgusting spectacle, really. Matt Levine attempts some kind of defense of Freddie’s actions, based on the idea that the inverse floaters are just what’s left after Freddie sells off everything it can easily sell — but that’s not what actually happened. In fact, Freddie went out and bought these instruments, on the open market. It almost looks like inside trading: they’ll pay off handsomely, just so long as Freddie continues to make it hard for homeowners to refinance. Which means that refinancings in general, and principal reductions in particular, are still going to be rare to nonexistent going forwards. Which is bad for homeowners, bad for the housing market, and bad for the economy as a whole. Even if it’s good for Freddie’s prop book.