Freddie Mac Has To Answer One Huge Ethics Question

Sad Homeowner Foreclosure

A report from NPR and ProPublica is raising concerns about a conflict of interest within Freddie Mac

The outlets point to public documents from 2010 and 2011 that show the taxpayer-owned mortgage company placed bets that would pay off if homeowners were not able to refinance.

The big question is whether Freddie limited refinance offerings in order to make money on this trade.

So far there is no evidence that these decisions were coordinated.

Reporters Jessie Eisinger and Chris Arnold were told that Freddie has “walled off” its traders from the officials who have recently imposed higher fees and new rules.

Here’s an example of how Freddie’s trade might have worked, from NPR:

1) Freddie Mac takes, say, $1 billion worth of home loans and packages them. With the help of a Wall Street banker, it can then slice off parts of the bundle to create different investment securities, some riskier than others. The slices could be set up so that, say, $900 million worth are relatively safe investments, based upon homeowners paying the principal on their mortgages.

2) But the one remaining slice, worth $100 million, is the riskiest part. Freddie retains that slice, known as an “inverse floater,” which receives all of the interest payments from the entire $1 billion worth of mortgages.

3) That riskiest investment pays out a lucrative stream of interest payments. But Freddie’s slice also has all the so-called “pre-payment risk” associated with that $1 billion worth of loans. So if lots of people “pre-pay” their old loans and refinance into new, cheaper ones, then Freddie Mac starts to lose money. If people can’t refinance, then Freddie wins because it continues to receive that flow of older, higher interest payments.

Now see 8 money lessons from homeowners who bounced back after foreclosure >