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Freddie Mac Preferred Punishing Banks To Helping Homeowners

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ProPublica has a new story about Freddie Mac and it's good, go read it if you like getting angry about mortgages. The gist is that Freddie were big jerks about not letting people refinance their mortgages, which everyone kind of knew already; what this reveals is that:

  • They were jerks mostly to increase their own profits, which I submit to you everyone also knew. Actually I submit to you that's pretty much a tautology. But also
  • They were also jerks a little bit to screw with Obama, which is news:

[Board member Robert] Glauber, director Linda Bammann and head of risk management Paige Wisdom resisted mass refis. One executive viewed their objections as colored by partisan unwillingness to help the economy recover, something that would benefit President Obama.

Everyone denies everything etc. etc.

You can have both efficiency and allocation questions about refinancing mortgages. Allocation is just "there is a pot of money; it can go to mortgage owners in the form of keeping interest rates on existing mortgages the same, or to homeowners in the form of lowering those interest payments"; this is a boring question of interest-group power but one that is weird for Freddie Mac's conservator to answer? But I guess who else would? Anyway "these officials feared that mass refinancing would hurt the company's bottom line and therefore its ability to repay taxpayers" so I guess they picked mortgage owners - i.e. taxpayers who owned Freddie who owned mortgages, which is a somewhat attenuated path to "taxpayers"1 - over homeowners.

Efficiency is "lowering the interest rates on existing mortgages [ will | will not ] lower default rates, revive the economy, and make the pot of money bigger for everyone"; this is an interesting economics question and the evidence suggests that the answer is, yes, HARP-y refinancing programs probably do reduce defaults. You could have a good-faith empirical disagreement with that, though your good faith might be called into question if you thought that refi programs were "designed to be a stimulus" but then assumed no stimulative effect.

My favorite weird point is this:

[W]hen Freddie insures a mortgage, it retains the right to void its guarantee and force the bank that made the loan to be responsible for it under certain circumstances, such as if the bank had done poor underwriting and the borrower's income was misrepresented. Facilitating refis under HARP could require giving up those rights. Wisdom, the risk officer, argued that Freddie should not give up such rights lightly, because surrendering them could cost Freddie dearly.

But since many borrowers on these Freddie-backed loans had been making regular payments for a number of years, others argued there would likely be only a relatively small number of cases in which Freddie would need to force banks to take back loans. Thus, Freddie wouldn't be giving up anything of much value.

This is not exactly new news but strange in the context of this story. You can tendentiously characterize this as:

  • Freddie expected some seasoned loans would turn out badly: some $200K mortgages were going to default and return only $150K, or whatever.
  • Freddie would rather make good their expected losses on those loans by foreclosing and demanding the missing $50K from the banks who wrote the loan, rather than by letting homeowners pay off the full $200K by refinancing into a new, cheaper mortgage.2

Why? I want the answer to be "because Freddie hated the banks more than it loved homeowners" but of course that's not actually the answer; Freddie was stuffed with ex-bankers.3 "Freddie just hated homeowners full stop" is I suppose possible but unlikely; despite the anthropomorphic name I doubt Freddie could feel love or hate.

I feel like the real answer is just a good old fashioned love, felt deeply by both bureaucrats and certain sorts of bankers, for legal formalism. If, as seems increasingly clearly to have been the case, a whole lot of agency guaranteed mortgages were shoddily underwritten, then Freddie was covered on any losses - it shouldn't lose any money on defaults because it could demand putbacks from the underwriters, at least some of whom were still solvent. Of course some weren't, and many putbacks are hotly disputed, so that's a bit of a flaw in the plan of just holding lenders to their reps and warranties, but otherwise the plan is lovely in its simplicity. Your contracts say that if the loans violate the reps and warranties, the lenders have to take them back. They violate the reps and warranties. Take them back. It's right there in the contract.

If Freddie allowed refinancing without reps and warranties carrying over, there was no contract to protect it. In that case it would have to rely on making intelligent forecasts of future economic conditions, and on making intelligent decisions to bring about those better conditions. That's hard! Why do that when you've got a contract letting you avoid it?

Why Freddie Mac Resisted Refis [ProPublica]

1.ID EST the paycheck and career prospects of a Freddie Mac executive might have a higher beta to returns on MBSes than does your tax bill.

2.Tendentious because the real issue is that Freddie is of course then on the hook for the new $200K mortgage, but doesn't have any putback claims against the bank. Not clear how serious an issue that is:

FHFA explains that nearly all HARP-eligible borrowers have been paying their mortgages for more than three years, and most for four or more years. The federal agency says these are “seasoned loans made to borrowers who have demonstrated a capacity and commitment to make good on their mortgage obligation through a period of severe economic stress and house price declines,” which makes them a safe bet.

3.ProPublica darkly characterizes anti-refinancing board members as having "had a career in various Wall Street roles" or "a former executive of JPMorgan Chase."