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Oops, They Did It Again (x2): Pro Publica Misunderstands the GSE Mandate
In two stories Pro Publica follows up on their Monday non-story about Freddie Mac’s decision to increase retention rates of the interest-only (IO) arm of pools they bundled in 2010.
I’ve replied to the core problems both here and on nakedcapitalism.
Yesterday Pro Public released two more stories on the subject. Rather than admit any problem with the original they doubled down, or more accurately, tripled down.
The first of the two stories, Why Fannie and Freddie Are Hesitating to Help Homeowners, was released at 4:10pm. After a few hours initial authors Jesse Eisinger and Chris Arnold released Frddie Mac’s Regulator Says Trades Were Shut Down Because They Were “Risky.”
Both stories contain the same theme. Senators from both parties are shocked — shocked! — that Freddie Mac decided to keep the IO arm, putting itself in a position where the GSE stood to lose money if borrowers refi’d into lower interest mortgages.
Quoting Pro Publica’s “why they’re hesitating to help homeowners” story: “Sen. Barbara Boxer, D-Calif., told NPR she was shocked by a recent meeting with DeMarco. ’It was the worst meeting I’ve ever had in my life,’ said Boxer. ‘His interest is making sure Fannie and Freddie do well financially.’”
I can’t imagine why DeMarco would think such a thing: maybe it’s because by law he’s obligated to? Specifically, the Housing and Economic Recovery Act of 2008 (HERA) mandates that the GSE’s attempt to make a profit to pay back the US for the damage their pre-meltdown recklessness caused. Boxer voted in favor of the legislation, along with 84 of her Senatorial colleagues including Sen. Robert Casey, D-Penn., who also criticized Freddie’s behavior.
As I’ve already written it’s far from clear that Freddie’s decision to retain the IO coupons can be construed as harmful to American borrowers for a number of reasons, the most compelling being that by owning the paper Freddie can more easily modify mortgage rates downward without investor liability or interference.
But there’s one point I missed: even if the decision to retain the coupons wasn’t in the best interests of borrowers — even if Freddie Mac was simply trying to make money at the expense of the American Homeowner — that’s exactly what they’ve been ordered to do under the law.
Under laws passed by a Democratic Congress and signed into law by a Republican President Fannie Mae and Freddie Mac must try to make money and pay back the American taxpayer.
There’s a legitimate debate about the best way to help American homeowners. For example, I strongly believe that principal reductions, while politically unpopular, would likely put a floor on the market and — assuming we can figure out a way to address the enormous amount of shadow inventory without torpedoing the market — save the GSE’s more long-term money than they’d cost. Somebody, either at Fannie, Freddie, or the FHFA obviously disagrees.
I don’t entirely understand their reasoning but at least I recognize the constraints that they’re under and, I’m hopeful, that they recognize and understand the argument in favor of principal reduction. Principal reduction is one element that has sharply reduced 12-month re-defaults in the private market, with its lousier borrowers, lowering it below the GSE 12-month re-default rate. In a report they wrote IT problems were partly to blame but I’m sure there’s something deeper than that (if that is the case here’s a short-cut: enter the principal reduction as a one-time negative “fee” in existing systems).
It wasn’t long ago that Fannie and Freddie were running around touting their “affordable housing” initiatives. In cooperation with “strategic partners” to serve as originators, the most notable being Countrywide’s Angelo Mozillo, lots of people purchased lots of houses. They achieved the “American Dream” of home-ownership .. only to see it ripped away when the bubble burst.
Private banks built and financed most of the half-million dollar Chinese drywall 3BR house that went on to rot hopes and dreams the same way they did the house’s wiring. But it was Fannie and Freddie that laid the political, legal, and moral foundation that allowed those banks to put people into homes bankers knew they could not afford.
In Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon, Gretchen Morgenson and Josh Rosner spell out this argument better than I could. Their hypothesis and narrative is substantively different than the normal “Fannie and Freddie did it” oversimplification we’ve become familiar with, and a lot more compelling. Fannie and Freddie really did do it, just not in the way most people understand.
Pro Publica and certain members of Congress are veering dangerously close back to the notion that there is something positive about selling houses to people who cannot afford them, and that the GSE’s should be aiding in that goal. There isn’t, and they shouldn’t.
DeMarco has been described as steely or icy. Given his history, his mandate, and those he has to work with that’s understandable. All things considered he arguably has one of the worst jobs in government. Love him or hate him he should be commended, not condemned, for following the law. If Congress has changed their mind about that law they should revise that law rather than attacking the agency head working to enforce it.
Pro Publica’s Misguided Interest In Freddie Mac’s Interest Rates
Yesterday Pro Publica released a piece about Freddie Mac retaining the interest portion of some of their securities, Freddie Mac Bets Against American Homeowners. Their theory is that Freddie Mac has set up a hopeless conflict of interest because by retaining the interest-portion of certain securities they GSE is incentivized to disallow refinances to lower interest mortgages.
As Yves Smith points out in nakedcapitalim, Pro Publica’s Off Base Charges About Freddie Mac’s Mortgage “Bets” this story is simply incorrect.
It’s difficult to defend the behavior of either GSE, Fannie or Freddie, because — borrowing from Abba Eban — the GSE’s never miss an opportunity to miss an opportunity to do the right thing. While I don’t believe they’re anywhere close to the root cause of the housing bubble, they’re definitely the root cause of the foreclosure fraud scandal that followed it. It’s long past time they were shuttered and that we drop this myth that they’re viable independent organizations.
Still, this is one area where Freddie Mac didn’t do anything wrong and the statistics support that their decision to retain the interest portion of the securities in their portfolio is not affecting their modification decisions.
Before digging in to specifically what Freddie is accused of, and why it’s one of the few areas where they did nothing wrong, let’s jump to the end and inspect whether it’s affecting modifications. I wrote a piece of analysis just last week that dug into mortgage modification statistics that partially addressed this issue, Mortgage Modifications: Slaying Zombie Debt.
I’ll summarize key portions of that article; every quarter the Office of the Comptroller of the Currency (OCC) releases a study detailing loss mitigation options, including modifications, for mortgages. Their latest study was release for Q3, 2011. They break modification options down into several buckets, including capitalization, interest rate reduction, interest rate freeze, term extension, principal reduction, principal deferral, and “not reported” (the servicer cannot contractually explain what modification term they offered).
Freddie Mac was accused by ProPublica of making financial decisions that create a conflict of interest for lowering interest rates. This is directly refuted by the fact that Freddie regularly freezes and lowers interest rates in modifications.
Keep in mind, while reviewing the figures, that most modifications involve more than one category of relief, so results add to over 100%.
Freddie reduced interest rates in 74% of the modifications they offered and froze rates in 7.6% of their mods. In contrast Fannie reduced rates in 70.4% of their mods and froze rates in 3.6%. In contrast government-guaranteed (FHA, VHA, etc..) loans lowered rates in 93.7% of their mods, private investors lowered rate in 71.5% of their mods, and portfolio loans lowered interest in 83.6% of their mods.
That is, the facts just don’t support that Freddie is especially stingy about lowering or freeze interest rates when modifying mortgages.
Back to Pro Publica. Summarizing their article, they reported that Freddie retained the interest rate obligations of certain pools of mortgages they’d bundle, but sold off the principal portion.
So what? Pooling and selling mortgage is what the GSE’s do. Love them or hate them their job is to purchase mortgages, bundle those mortgages into pools, then sell those bundles to investors so that they have money to make more mortgages.
Freddie then hedged the interest-rate portion that they kept, so that if rates fluctuated their financial position would not be adversely affected. Not only is there nothing wrong with this, but it would be entirely irresponsible of them to do so.
Finally, it’s important to remember that the new government proposed refinancing programs are refinancing, not modifications. There is nothing Freddie can do one way or another regarding refinancing: borrowers simply take out a new loan at a lower interest rate.
That is, if this issue had any effect on Freddie’s decision-making process — which it appears not to — Pro Publica didn’t even focus on the area where it would matter, modifications, not refinancing.
Finally, because loan modifications arguably run afoul of investors — who have paid for and are contractually entitled to the terms they purchased — retaining the interest bearing portion makes modification of that same interest bearing portion considerably easier than if they sold it.
This akin to running a story that a surgeon is knocking random people unconscious then cutting them open. Technically it’s true but it’s also misleading. It’s especially bad if the surgeon is a hack who routinely botches their operations, which is a fine analogy for the GSE’s behavior.
I’m not sure why Freddie kept the interest bearing portion, but one possible reason is that nobody wanted to purchase it, or that potential buyers wanted even higher rates which Freddie would need to pass on to new borrowers.
There’s lots of reasons to criticize the GSE’s, but retaining the interest bearing portion of mortgages is one of the few areas where they’ve done nothing wrong.
