Freddie Mac, a taxpayer-owned mortgage company, is supposed to make homeownership easier. One thing that makes owning a home more affordable is getting a cheaper mortgage.
But Freddie Mac has invested billions of dollars betting that U.S. homeowners won't be able to refinance their mortgages at today's lower rates, according to an investigation by NPR and ProPublica, an independent, nonprofit newsroom.
These investments, while legal, raise concerns about a conflict of interest within Freddie Mac.
"We were actually shocked they did this," says Scott Simon, who heads the mortgage-backed securities team at the giant bond trading and investment firm called PIMCO. "It seemed so out of line with their mission, out of line with what Congress wanted them to do."
Freddie Mac, formally called the Federal Home Loan Mortgage Corp., was chartered by Congress in 1970. On its website, it says it has "a public mission to stabilize the nation's residential mortgage markets and expand opportunities for homeownership." The company is owned by U.S. taxpayers and overseen by a regulator, the Federal Housing Finance Agency (FHFA).
In December, Freddie's chief executive, Charles Haldeman, assured Congress his company is "helping financially strapped families reduce their mortgage costs through refinancing their mortgages."
But public documents show that in 2010 and 2011, Freddie Mac set out to make gains for its own investment portfolio by using complex mortgage securities that brought in more money for Freddie Mac when homeowners in higher interest-rate loans were unable to qualify for a refinancing.
Those trades "put them squarely against the homeowner," PIMCO's Simon says.
Freddie Mac's trades came at a time when mortgage rates were falling to record lows. Millions of homeowners wish they could refinance, but their lenders tell them they can't qualify for today's low rates because of tight rules. Freddie Mac is one of the gatekeepers with the power to set those rules, and lately, it has been saying no more often to homeowners.
That raises concerns among some industry insiders who see a conflict: Freddie Mac's own financial health improves when homeowners can't refinance.
Simply put, "Freddie Mac prevented households from being able to take advantage of today's mortgage rates — and then bet on it," says Alan Boyce, a former bond trader who has been involved in efforts to push for more refinancing of home loans.
Freddie and FHFA repeatedly declined to comment on the specific transactions, but Freddie did say that its employees who make investment decisions are "walled off" from those who decide the rules for homeowners.
When Homeowners Lose, Freddie Mac Wins
Freddie Mac, based in Northern Virginia, says its job is to purchase "loans from lenders to replenish their supply of funds so that they [the lenders] can make more mortgage loans to other borrowers." That's one reason why Freddie has a gigantic portfolio containing loans that generate income from mortgage payments. Critics say this investment portfolio has been allowed to grow far larger than necessary to further Freddie's policy mission.
Plus, in 2010 and 2011, Freddie didn't just hold a simple pile of loans. Instead, for hundreds of thousands of home loans, it used Wall Street alchemy to chop these loans up into complicated securities — slices of which were sold in financial markets.
This hypothetical example may help explain what happens:
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.
If the homeowner is unable to refinance, the Freddie Mac portfolio managers win, Simon says. "And if the homeowner can refinance, they lose."
Refinancing A Path To Recovery
In his State of the Union address, President Obama pushed for legislation to allow "every responsible homeowner the chance to save about $3,000 a year on their mortgage" by refinancing without what he called "red tape" or a "runaround from the banks."
Columbia University economist Chris Mayer supports such an approach. "A widespread refinancing program would have many benefits — not only helping the economy and putting tens of billions of dollars back in consumers' pockets, the equivalent of a very long-term tax cut," he says.
"It also is likely to reduce foreclosures and benefit the U.S. government by having fewer losses that they have to pay," Mayer adds.
In the long term, he says, allowing more Americans to refinance would help taxpayers as well as mortgage giants Freddie Mac and Fannie Mae, because they would suffer fewer losses related to foreclosures. These inverse floater trades, however, give Freddie Mac a short-term incentive to resist such so-called "mass re-fi" programs.
"If there was a mass re-fi program, the bets they made would get absolutely wiped out," PIMCO's Simon says. "The way these bets do the best is if the homeowner is barred from refinancing."
In a written statement, Freddie said it "is actively supporting efforts for borrowers to realize the benefits of refinancing their mortgages to lower rates." It also says it refinanced loans for hundreds of thousands of borrowers just last year.
Fannie and Freddie have taken part in an existing federal program known as "HARP" to help Americans refinance, but many economists say far more homeowners would benefit if Fannie and Freddie were to implement the program more aggressively.
Stuck In 'Financial Jail'
Some homeowners believe the current re-fi game is stacked against them.
Jay and Bonnie Silverstein describe themselves as truly stuck in a bad mortgage. They live in an unfinished development of yellow stucco houses north of Philadelphia. The developer went bankrupt.
The Silversteins bought this home before the housing market crashed, and then couldn't sell their old house. They now say that buying a new home before selling the old one was a mistake — a painful one. Stuck with two mortgages, they started to get behind on their payments on the old house.
"It wound up taking us years to sell that house, so we had two homes and two mortgages for two-and-a-half years," Jay Silverstein says. "It burned up my 401(k) and drained us."
Jay Silverstein has a modest pension, and they haven't missed a mortgage payment on their current home. Still, they are struggling. They could make the monthly payment on their new home if they could just refinance — down from their current interest rate of near 7 percent to today's rates below 4 percent. That could save them roughly $500 a month.
"You know, we're living paycheck to paycheck," he says. A lower rate "might go a long way toward helping us."
But that's the problem — getting approved for a refinancing. Here's why: After the housing market crashed, the Silversteins' old house had to be sold for less than the mortgage was worth. That's known as a short sale.
Freddie Mac has been tightening lending restrictions, and one of its restrictions blocks people with a short sale in their past from refinancing for up to four years following that short sale. So the Silversteins are stranded by the rule.
"We're in financial jail," Jay says. "We've never been there before."
Tight For Homeowners, But Elsewhere, Money Still Flows
Economists say that during the housing bubble, lending standards got too loose. Now many believe the pendulum has swung too far, making rules too tight.
The short-sale restriction may be a good example. For a home purchase, such a rule may be prudent, but allowing people with existing loans to refinance actually lowers the risk that they may default by giving them more affordable mortgage payments.
In a recent analysis of remedies for the stalled housing market, the Federal Reserve criticized Fannie and Freddie for the fees they have charged for refinancing. Such fees are "another possible reason for low rates of refinancing," the Fed wrote, adding that the charges are "difficult to justify."
Meanwhile, even though Freddie is a ward of the federal government, its top executives are highly compensated. The Freddie Mac official then in charge of its investment portfolio, Peter Federico, made $2.5 million in 2010, and had target compensation of $2.6 million for last year — the time period during which most of these inverse floater investments were made. ProPublica and NPR made numerous attempts to reach Federico. A woman who answered his home phone said he declined to comment.
RENEE MONTAGNE, HOST:
This is MORNING EDITION, from NPR News. I'm Renee Montagne.
STEVE INSKEEP, HOST:
And I'm Steve Inskeep.Good morning. We've discovered something surprising in the financial transactions of Freddie Mac. That's one of two giant companies the government created decades ago, to help Americans finance their homes.
Freddie Mac was bailed out by taxpayers during the financial crisis in 2008. Today, many struggling homeowners need help. They are trying to refinance at lower rates. And an investigation by NPR and ProPublica reveals that Freddie Mac is betting that homeowners fail to refinance.
The company has put billions of dollars into investments that do better when homeowners are denied the chance to refinance. Freddie Mac has also made it harder for people to get new loans on their homes. So its investments, while legal, raise concerns about a conflict of interest.
Our coverage starts with NPR's Chris Arnold.
CHRIS ARNOLD, BYLINE: Mortgage rates are at record lows, but millions of homeowners can't qualify to get those low rates. If they could, they'd be saving thousands of dollars a year on their mortgages. And Freddie Mac is one of the gatekeepers. It decides who can qualify, and who can't. Lately, it's been saying no more often to homeowners. And it turns out that at the same time, Freddie has been placing big bets against those homeowners.
ALAN BOYCE: So to state it simply, Freddie Mac prevented households from being able to take advantage of today's mortgage rates, and then bet on it.
ARNOLD: Alan Boyce is a former bond trader who's been involved in efforts to push for more refinancing of home loans. And he's not alone in being upset after finding out about these trades.
SCOTT SIMON: We were actually shocked that they'd done this.
ARNOLD: That's Scott Simon. He's the head of mortgage securities for the giant bond investment firm PIMCO - which makes him one of the biggest mortgage bond traders in the world. He says he was very taken aback when he saw what Freddie Mac was doing.
SIMON: Because it seemed so out of line with their mission - out of line with what Congress wanted them to do, out of line with what we perceived to be in the best interest of the stakeholders of Fannie and Freddie as well as the homeowner.
ARNOLD: Freddie Mac and Fannie Mae were taken over by the government in 2008. It's taken about $169 billion in taxpayer bailout money to keep them afloat. For a long time, the firms have had a policy mission to make lending more available for homeowners. But they also have giant investment portfolios. They have hundreds of billions of dollars' worth of loans and other kinds of investments that can get hurt if too many homeowners refinance.
In Freddie's case, this apparent conflict is more extreme. Freddie isn't just holding loans in its portfolio. Instead, Freddie Mac has used Wall Street alchemy to take tens of thousands of loans, and slice and dice them up into complicated securities. So mortgages that people want to refinance are now tied up in these securities. And the slice that Freddie invested in hinges completely on whether those homeowners stay stuck in higher interest rate loans. That's their bet. Scott Simon...
SIMON: They actually put themselves squarely on the opposite side of the homeowner. So if the homeowner lost and was unable to refinance, they win; and if the homeowner could refinance, they lose.
ARNOLD: Freddie Mac is now controlled by its regulator, the Federal Housing Finance Agency. The FHFA and Freddie both declined to talk about the company's trading portfolio. Freddie, in a statement, though, said that the company, quote, is actively supporting efforts for borrowers to realize the benefits of refinancing their mortgages to lower rates. And Freddie says it refinanced loans for hundreds of thousands of borrowers just last year.
Still, many homeowners feel trapped. And we actually tracked down one of these homeowners that Freddie Mac is effectively betting against. It was a couple, it turns out - Jay and Bonnie Silverstein.
JAY SILVERSTEIN: Well, we're truly stuck. I mean, obviously, financial jail is no fun.
BOYCE: The Silversteins live in an unfinished development of yellow stucco houses north of Philadelphia.
BONNIE SILVERSTEIN: Chris, let me have your jacket.
ARNOLD: OK. Thanks.
JAY SILVERSTEIN: Sure...
ARNOLD: The developer went bankrupt, leaving some of the home lots here surrounded by orange, plastic construction fencing. The Silversteins bought this home back before the market crashed, and then they couldn't sell their old house. They now know that buying before selling was a mistake, and the price that they've paid for it was painful.
JAY SILVERSTEIN: You know, it wound up taking us years to sell that house. So we had two homes and two mortgages for two and a half years.
JAY SILVERSTEIN: It just drained us. It just burned up my 401(k), and drained us.
ARNOLD: Jay was a manager at Johnson and Johnson, and he has a modest pension. The couple havn't missed any mortgage payments on this house but eventually, they did on their old one. Their current interest rate is near 7 percent, and so if they could refinance at today's rates - below 4 percent - that would save them about $500 a month.
JAY SILVERSTEIN: You know, we're living paycheck to paycheck. Most of the stress has been on you. I know you feel it, and I've seen it. And I feel...
BONNIE SILVERSTEIN: My hair didn't get white for nothing.
JAY SILVERSTEIN: I feel badly about that. Mine just fell out. So there's...
(SOUNDBITE OF LAUGHTER)
JAY SILVERSTEIN: But 5, 6, $7,000 might go a long way toward helping us.
ARNOLD: Economists say it could help millions of other Americans, too. Jay says it would feel like getting a raise.
JAY SILVERSTEIN: Remember that? Remember when everybody used to get a raise? It's like a raise.
ARNOLD: But the Silversteins' old house was finally sold at a loss through what's called a short sale. And Freddie Mac, over the past two years, has tightened restrictions about that, which even prevent the couple from refinancing their new house.
Meanwhile, Freddie Mac has been benefiting because the Silversteins are stuck paying this higher-rate mortgage of nearly 7 percent.
INSKEEP: That's NPR's Chris Arnold. He's in our studios. We're also joined by Jesse Eisinger of ProPublica, who also reported on this story. Jesse, welcome to you.
JESSE EISINGER: Hi. Thanks for having me.
INSKEEP: And let me just make sure I understand the kind of homeowner who you say is being harmed here. We're talking about people who are in a house with a mortgage, and currently making the payments?
EISINGER: Right. These people are current on their mortgages. These aren't the subprime borrowers who bought houses they couldn't afford with crazy mortgages.
INSKEEP: OK. And so Freddie Mac is making it harder for them to refinance. Freddie Mac is also, you say, betting to make money that they will fail to refinance. What, Chris Arnold, is the investment exactly? How does it work?
ARNOLD: Well, the investment's complicated and that's why it's - probably - been below the radar. But one, simple way to look at this: Let's say Jesse and I were going to loan you, Steve, $100,000 to buy a house.
ARNOLD: And you would pay us principal, and you would pay us interest. And we'd collect that. And we'd be happy, and you'd be happy.
Let's say a little ways down the road, you decide to refinance.
INSKEEP: OK, lower interest rate...
ARNOLD: Lower interest rate, OK - you know, that happens. We would get the principal back, right? We would get our whole $100,000 that we loaned you, back.
ARNOLD: That's how it normally works. Now, what Freddie did is very different in that they sold off their right to collect that $100,000 back. They sold that to somebody else, and all they kept was the revenue from that 7 percent interest that you're paying.
INSKEEP: And so now, they're desperate to make sure I keep paying that 7 percent. Otherwise, they lose their bet.
ARNOLD: That's all they've got.
INSKEEP: Jesse Eisinger, is this undermining government efforts by the Obama administration, by people in Congress, to actually help people get into cheaper loans so they can make their mortgage payments?
EISINGER: This certainly gives Freddie a financial incentive to not support those programs, because they've made these bets, and these bets are highly concentrated. And in fact, Freddie has made it harder, through a lot of added rules and fees, for people to refinance - simultaneously.
INSKEEP: Is there some argument, though, that this is good for taxpayers? Because Chris Arnold mentioned, this is a company that has been bailed out to the tune of many billions of dollars. They're desperate to make money, and they're making these investments that may harm some homeowners - or, many homeowners - but at least, they're hoping to make a profit.
EISINGER: There is an argument for that. And the Obama administration, and the regulator that controls them, have to weigh helping out taxpayers generally and more specific, homeowners. But as Chris said, it's very possible that a lot of refinancings could help the economy, and taxpayers, in the long run.
INSKEEP: So this could be counterproductive for the public as a whole, Chris Arnold?
ARNOLD: Sure. I think there's one other thing that's important to understand - is that buying a house is very different than refinancing a house, and that the government is already on the hook for these mortgages. So to keep millions and millions of people stuck paying higher rates - some of them are going to be more likely to default. So in the long term, the argument is, look - short term, yes, it might cost a little money; long term, you're probably going to save the government money by allowing more people to refinance.
INSKEEP: NPR's Chris Arnold, thanks very much.
ARNOLD: Thank you.
INSKEEP: And Jesse Eisinger of ProPublica, thank you.
EISINGER: Thank you.
(SOUNDBITE OF MUSIC)
INSKEEP: It's MORNING EDITION, from NPR News. Transcript provided by NPR, Copyright National Public Radio.