The latest flurry of stories about Freddie Mac and their use of interest rate floaters is one example of how very technical aspects of the mortgage backed securities market can be used to create greater turmoil unnecessarily. The story below gives further detail of the accusations, but let me try to explain how inverse rate floaters are not only common practice, but without them, mortgage rates on 30 year fixed rate mortgages would likely be higher.
Many investors have interest in owning government guaranteed securities, but due to charter restrictions or other investment management restrictions, are not investing in long term instruments. As a result, mortgage backed securities will often be structured into two pieces. One is a short term, variable interest, piece often tied to LIBOR for these investors. The GSEs then have to find investors for the remainder of the interest rate strip. Here’s an example: Suppose it’s a 4% fixed rate and the primary investor wants to buy a mortgage security (due to the guarantee) but can only go short term. The rate they may be paid for their short term investment may be, say, 1%. The other 3% then will be sold to another investor who is willing to invest for the difference in term.
This second piece is structured into something called an inverse floater. These will be sold to any number of investors and sometimes the GSEs will by them. There is nothing sinister here, it’s simply the only way to get investors to buy mortgage backed securities. While many investors may want to buy only government guaranteed bonds such as Treasuries, GNMA, of Freddie/Fannie MBS, most do not want to lock up their funds into a long term investment for 30 years. This “structuring” keeps money flowing into mortgages but, more importantly, keeps 30 year fixed rate mortgage product avaliable for consumers to buy homes.
Look, I am not defending the GSEs here, just telling the facts about this latest accusation related to a practice that all GSE’s do and have done for years to keep liquidity coming into the mortgage market. Without this practice rates would simply be higher due to lack of buyers for the mortgage bonds.
Report: Freddie Mac bets against homeowner refinancings
NPR and ProPublica investigation shines light on investment practices
By Inman News, Monday, January 30, 2012.
In 2010 and 2011, mortgage giant Freddie Mac invested billions of dollars on bets that homeowners with high-interest mortgages would not be able to refinance at today’s lower interest rates, according to a joint investigation conducted by NPR and ProPublica, a nonprofit, independent news agency.
While legal, the bets appear to be in direct conflict with the taxpayer-backed company’s public mission, as stated on its website, “to stabilize the nation’s residential mortgage markets and expand opportunities for homeownership and affordable rental housing,” the news agencies said, noting that refinancing terms have been getting more restrictive of late and include higher fees and new rules that prevent some homeowners from taking advantage of historically low interest rates.
Freddie Mac is regulated by the Federal Housing Finance Agency (FHFA). Officials at both Freddie Mac and FHFA repeatedly declined to comment on the specific transactions, the news agencies said, though Freddie Mac did say that its employees who make investment decisions are “walled off” from those who determine the terms under which homeowners can get loans.
And in a written statement, Freddie Mac said it “is actively supporting efforts for borrowers to realize the benefits of refinancing their mortgages to lower rates,” noting that it refinanced loans for hundreds of thousands of borrowers in 2011, according to the news agencies’ report.
HousingWire writer Jacob Gaffney accused NPR and ProPublic of conducting a “witch hunt” of Freddie Mac……..read rest of story in link