{"id":27291,"date":"2012-02-10T11:06:44","date_gmt":"2012-02-10T16:06:44","guid":{"rendered":"http:\/\/countingpips.com\/fx\/2012\/02\/10\/freddie-mac-does-not-hate-america-it%e2%80%99s-actually-trying-to-help\/"},"modified":"2012-02-10T11:06:44","modified_gmt":"2012-02-10T16:06:44","slug":"freddie-mac-does-not-hate-america-its-actually-trying-to-help","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/fx\/2012\/02\/10\/freddie-mac-does-not-hate-america-its-actually-trying-to-help\/","title":{"rendered":"Freddie Mac Does Not Hate America: It\u2019s Actually Trying to Help"},"content":{"rendered":"<div align=\"left\"><script type=\"text\/javascript\">\ntweetmeme_style = 'compact';\n<\/script><br \/>\n<script type=\"text\/javascript\" src=\"http:\/\/tweetmeme.com\/i\/scripts\/button.js\"><\/script>\n<\/div>\n<p>Last week a few articles were forwarded to me about the misconduct of government sponsored enterprises (GSEs) \u2013 specifically Freddie Mac. However, when you look closer you should come up with a different conclusion.<\/p>\n<p>On January 30, <em>ProPublica<\/em> and NPR released Jesse Eisinger\u2019s article, <em>Freddie Mac bets against American Homeowners<\/em>.<\/p>\n<p>And it states:<\/p>\n<p><em>\u201cFreddie Mac, the taxpayer-owned mortgage giant, has placed multibillion-dollar bets that pay off if homeowners stay trapped in expensive mortgages with interest rates well above current rates.<\/em><\/p>\n<p><em>\u201cFreddie began increasing these bets dramatically in late 2010, the same time that the company was making it harder for homeowners to get out of such high-interest mortgages.\u201d<\/em><\/p>\n<p>In late 2010, Freddie Mac, according to the <em>ProPublica <\/em>story, started to retain a greater number of \u201cinverse floaters,\u201d an instrument created when mortgage pools are turned into collateralized mortgage obligations.<\/p>\n<p><em>ProPublica<\/em> contended that Freddie Mac\u2019s use of inverse floaters represented a conflict of interests because it would lose money from the hedges if borrowers refinanced to a lower rate mortgage. They implied Freddie could abuse its influence in the housing market to prevent lower-interest refinancing programs, which are better for borrowers.<\/p>\n<p>And from the title and the harsh language you come up with the idea that Freddie Mac is out to get you America. I think once you get a quick overview of what a collateralized mortgage obligation and how they usually work, I think you\u2019ll see the change in their portfolio was the result of a numbers game and not the actions of \u201cBig Brother.\u201d<\/p>\n<h2><strong>What Does Freddie Mac Do? <\/strong><\/h2>\n<p>Hold the jokes\u2026<\/p>\n<p>In a nutshell, Freddie Mac purchases and bundles mortgages into pools of mortgages, then sells the expected mortgage payments to investors in the form of bond-like securities.<\/p>\n<p>This process was and still is a vital component of today\u2019s mortgage market, or most other credit markets for that matter, since securitization frees up capital that can then be used to make more mortgages.<\/p>\n<p>These bundles of mortgages are called collateralized mortgage obligations (CMOs), which are securities issued by the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corp. (Freddie Mac), or the Government National Mortgage Association (Ginnie Mae).<\/p>\n<p>So the structuring of a CMO creates a series of tranches from the cash flows from mortgage securities.<\/p>\n<p>In structured finance of this sort, a \u201ctranche\u201d is one of a number of related securities offered as part of the same transaction. In other words, after you put all the mortgages together, you then slice it into pieces and sell those pieces depending on how risky the tranche. Remember, the set-up of Freddie and Fannie bonds is to tackle interest rate risk. GSEs are guaranteed in regards to principal.<\/p>\n<p>Your tranches will usually look like this: some fixed-interest rate tranche of various maturities (created at a lower interest rate than the yield on the mortgages) and one medium-term maturity fixed-rate tranche, which is then decomposed into a floating rate bond and an \u201cinverse floater,\u201d which consists only of the inverse of the interest rate payments on the floating rate note.<\/p>\n<h2><strong>The Undesirable Feature\u2026<\/strong><\/h2>\n<p>The undesirable feature of a mortgaged-backed security is their prepayment risk. People repay when they refinance. You\u2019re paying off an existing loan to gain another one at a better rate. Prepayments are very unattractive to bond investors, since the time you\u2019re happiest as a fixed-income investor is when <a title=\"Four sectors to avoid when interest rates rise\" href=\"http:\/\/www.investmentu.com\/2011\/August\/4-sectors-to-avoid-when-interest-rates-rise.html\">interest rates<\/a> fall, since your bonds go up in value. But if you hold a simple mortgage pass-through, the bond can disappear due to prepayments.<\/p>\n<p>Both Freddie and Fannie have a long standing practice of hedging their prepayment risk.<\/p>\n<p>Moreover, the inverse floater is the portion of the CMO that is most exposed to prepayment risk. Given the uncertainty about government intervention in the mortgage market, investors in both straight pass-throughs and in CMOs would be more leery than usual of taking prepayment risk.<\/p>\n<h2><strong>Why the Increase in Inverse Floaters?<\/strong><\/h2>\n<p>The article tried to argue that the increase in the last two years of inverse floaters on Freddie\u2019s books were a sign of the GSE positioning itself to bet against homeowners. But they didn\u2019t tell the story of an increase in Freddie\u2019s CMO issuance during this period \u2013 it appears the increase in inverse floaters was due to an increase in mortgage funding.<\/p>\n<p>I think what Freddie tried to do was keep the &#8220;refinancing risk&#8221; to itself, and since Freddie controls the levers and can obstruct refis, it can package securities that are attractively <a title=\"Does low volatility put your portfolio at risk?\" href=\"http:\/\/www.investmentu.com\/2012\/January\/low-volatility-portfolio.html\">low-risk<\/a> for investors while retaining the high-risk stuff and &#8220;game&#8221; the risk-management for its own benefit.<\/p>\n<p>Is this evil? No. Can this be done in a different manner? Yes. But this style of <a title=\"Financial Risk Management\" href=\"http:\/\/www.investmentu.com\/2007\/June\/20070611.html\">risk management<\/a> isn\u2019t out to harm Americans. Innovative finance is complex and hard to explain. I believe that Freddie Mac\u2019s inability to explain the subject matter is at the heart of the misunderstanding and maybe with a little more due diligence on the part of <em>ProPublica<\/em> and NPR, this would all be a moot point.<\/p>\n<p>Good Investing,<\/p>\n<p>Jason Jenkins<\/p>\n<div>\n<a href=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?a=iklgNUvW4yw:kQIqZIEPsqU:yIl2AUoC8zA\"><img decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?d=yIl2AUoC8zA\" border=\"0\"><\/img><\/a> <a href=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?a=iklgNUvW4yw:kQIqZIEPsqU:V_sGLiPBpWU\"><img decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?i=iklgNUvW4yw:kQIqZIEPsqU:V_sGLiPBpWU\" border=\"0\"><\/img><\/a> <a href=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?a=iklgNUvW4yw:kQIqZIEPsqU:qj6IDK7rITs\"><img decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?d=qj6IDK7rITs\" border=\"0\"><\/img><\/a> <a href=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?a=iklgNUvW4yw:kQIqZIEPsqU:gIN9vFwOqvQ\"><img decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?i=iklgNUvW4yw:kQIqZIEPsqU:gIN9vFwOqvQ\" border=\"0\"><\/img><\/a> <a href=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?a=iklgNUvW4yw:kQIqZIEPsqU:F7zBnMyn0Lo\"><img decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?i=iklgNUvW4yw:kQIqZIEPsqU:F7zBnMyn0Lo\" border=\"0\"><\/img><\/a>\n<\/div>\n<p><img loading=\"lazy\" decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~r\/InvestmentU\/~4\/iklgNUvW4yw\" height=\"1\" width=\"1\" \/><\/p>\n<p>Article by <a href=\"http:\/\/www.investmentu.com\/\" target=\"_blank\">Investment U<\/a> <\/p>\n","protected":false},"excerpt":{"rendered":"<p>Last week a few articles were forwarded to me about the misconduct of government sponsored enterprises (GSEs) \u2013 specifically Freddie Mac. However, when you look closer you should come up with a different conclusion. On January 30, ProPublica and NPR released Jesse Eisinger\u2019s article, Freddie Mac bets against American Homeowners. And it states: \u201cFreddie Mac, &hellip; <\/p>\n<p class=\"link-more\"><a href=\"https:\/\/www.investmacro.com\/fx\/2012\/02\/10\/freddie-mac-does-not-hate-america-its-actually-trying-to-help\/\" class=\"more-link\">Continue reading<span class=\"screen-reader-text\"> &#8220;Freddie Mac Does Not Hate America: It\u2019s Actually Trying to Help&#8221;<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-27291","post","type-post","status-publish","format-standard","hentry"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/27291","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/comments?post=27291"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/27291\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/media?parent=27291"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/categories?post=27291"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/tags?post=27291"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}