Freddie Mac and Inverse Floaters: a love story

In an interesting twist to the current Freddie Mac situation (which I blogged about here), President Obama has decided to elaborate on his New Housing Proposal that he briefly mentioned in his State of the Union Speech last Tuesday. Obama’s plan to expand the Home Affordable Refinance Program HARP would assist homeowners who are attempting to qualify for refinancing.  According to the HARP website, the program expects to refinance “as many as 2.85 million loans by the end of 2013.”

How does the Freddie Mac bet against homeowners affect this goal?

First, let’s look at Freddie’s questionable position:

Freddie Mac has bought ‘inverse floaters’ which essentially means they invested in packages of mortgages and sold off their right to collect on the principal of those mortgages with the mindset that they would just collect the interest rate payments.  This is a bet that people will continue to pay these interest payments and one way that they may get out of paying those interest payments is to replace them with a new loan with lower interest payments – that’s a little something called ‘refinancing’.  Well, if you or I invested in inverse floaters like those bought by Freddie Mac, we could debate the merits and risks of that investment.  But Freddie Mac is charged with helping people refinance – so why would Freddie Mac make such an investment?  It was likely a hedge – a way to trade off some possible risk in other investments.  But here’s the kick: there should never, ever be even a hint of a conflict of interest in an organization’s positions, even in a hedge.

The answer is simple: as long as Freddie Mac has an role in refinancing, they must remove their hedge against it. 

As I have been writing, I noticed a little piece of news float up: Freddie Mac seems to know this is a bad idea to some extent, although they don’t seem to know why.

Jonathan Marlowe
Financial Advisor Trainee

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp.  The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).

The Federal Home Loan Mortgage Corporation’s Bet Against Homeowners

After a bailout in 2008, tax payers like you and me own Freddie Mac, a government-sponsored enterprise that exists to work with mortgage lenders to help citizens get lower housing costs and a better opportunity for home financing.  However, a National Public Radio and ProPublica exclusive report on Monday, January 30^th, discovered that Freddie Mac, in an attempt to make additional money and potentially hedge itself, has invested in securities that benefit from higher mortgage payments. This is simply an act of betting against the very the purpose it stands for.

 What does this mean?

 With financing rates at a historic low, homeowners across the nation are looking to benefit through refinancing their home mortgages.  Freddie Mac should be fulfilling its mission of making (or keeping) more homeowners by being a resource for refinancing.  Instead, it is betting on mortgages with high-interest rates not being refinanced – an exact opposite of its mission statement.  So now, either Freddie Mac will attend to its own interests and act to prohibit homeowners from attaining lower borrowing costs, or Freddie Mac will act in accordance with its mission and lose money on its in-house investments!

 Should a government entity be betting against the very purpose for which it exists?

Jonathan Marlowe
Financial Advisor Trainee

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp.  The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).