Seeing Through Data

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.