Do you believe that Freddie Mac’s investment in inverse floaters is ethical?

  • No (80%, 74 Votes)
  • Yes (20%, 19 Votes)

Total Voters: 93

Freddie Mac (Freddie) waged billions of dollars that homeowners with expensive mortgages would not refinance their home loans at lower interest rates. These bets were in the form of inverse floater deals, which Freddie made while at the same instant restricting the ability of homeowners to refinance by hitting them with additional risk-based fees and rules.

Inverse floaters are securities backed by interest payments and have the potential of paying a higher return than the rate of interest – provided the underlying mortgages are not refinanced. These are contrasted against securities backed by principal, which pay a low return but are a safer investment and less volatile.

Freddie Mac continues to profit from inverse floaters only if their mortgage borrowers do not refinance their higher-than-market interest rate mortgages, since refinancing creates a new loan, stopping interest payments on the original loan and an immediate loss for Freddie on that bet.

In late 2010 and early 2011, Freddie purchased 29 securities of inverse floater deals, an exponential increase from the seven inverse floaters purchased in 2009 and mere five in 2008.  Five billion dollars of its $650 billion portfolio was invested in inverse floaters, according to a statement by the Federal Housing Finance Agency (FHFA), Freddie’s overseer.

Freddie’s stated goal is to encourage a stable mortgage market and assist financially distressed families reduce their mortgage costs. However, the inverse floaters that Freddie is betting on are diametrically opposed to Freddie’s supposed role in the market, according to mortgage experts. Their high-stakes bet against homeowners also involved a high level of risk which is passed on to the taxpayer, since inverse floaters are more difficult to sell and potentially more expensive. [For a history of the real estate downturn, see the April 2009 first tuesday article, Lenders vs. owners in 2000-2010: the real estate interest of each]

These high-risk trades are legal. However, since Freddie benefits from high interest rates of inverse floaters only if homeowners fail to refinance their mortgages, a conflict of interest exists between the company’s profits and its purported goal to help homeowners attain the best mortgage terms possible. [For more information on the inherent adversarial relationship between lenders and borrowers, see the September 2011 first tuesday article, Rentiers and debtors: why can’t they get along?]

Freddie has helped some of its borrowers refinance. It participated in the Home Affordable Refinance Program (HARP), claiming to have refinanced 835,000 loans, saving each participating homeowner an average of $2,500 in interest in 2011. However, this is far short of the program’s stated goals and critics insist that Freddie could have helped millions of homeowners if they had used the program more effectively.

Unfortunately, as the inverse floater investments reveal, helping more borrowers refinance is not in the immediate interest of Freddie.

first tuesday take: Little Freddie always seems to be in trouble. From the lawsuit California’s Attorney General (AG) brought against Freddie and Fannie Mae (Fannie) at the end of last year to the current investment debacle, Freddie has received its share of negative press lately. However, it’s hard to say Freddie wasn’t asking for it. [For more information on the California AG’s lawsuit, see the January 2012 first tuesday article, California AG: “Happy holidays, Frannie, you got a lawsuit.”]

These inverse floater deals are a bit like a quarterback betting against his own team in the Super Bowl. Inevitably, Freddie and the homeowners both stand to lose. Furthermore, while Freddie claims to have helped borrowers refinance through HARP, its efforts are miniscule in comparison to the actual needs of homeowners. [For more information on HARP, see the November 2011 first tuesday article, HARP 2.0: bringing band-aids to a war zone]

Freddie’s high-risk investments seem to be an ill-founded attempt to keep up with the questionable investment practices created by Wall Street. Sustaining Wall Street’s red tide, Freddie’s inverse floater deals place homeowners’ hard-earned finances in peril and benefit no one. [For more information on the adverse effects of Wall Street, see the February 2012 first tuesday article, Why should we hate Wall Street?]

For now, there is little we can do except to shake our heads and wonder: what were you thinking, Freddie?

Re: ”Freddie Mac Bets Against American Homeowners” from ProPublica and NPR News and “Treasury Investigates Freddie Mac Investment” from The New York Times