Got a high interest rate mortgage and want to refinance? Too bad! Fannie and Freddie stand to profit if you can't.
Based on some dynamite investigative reporting by Propublica and NPR, it now is public knowledge that many people who are locked in with higher than market interest rate mortgages are being told they can't refinance by publicly owned companies Fannie Mae and Freddie Mac. The really ironic part of this commonplace event is that both agencies have effectively bet against the homeowners by purchasing investment instruments which pay off when homeowners remain locked into high interest rate mortgages.
While not illegal, the investments are easy to categorize as counter to the mission of both publicly owned companies. Freddie Mac and cousin Fannie Mae were bailed out in 2008 and are now owned by the taxpayers (that's you and me). The companies insure most home loans with the intent of making it more likely that banks will lend money to house purchasers. Freddie's charter calls for the company to make home loans more accessible and yet, recent investment actions seem to give the lie to this public-service oriented goal.
Mortgages are commonly accumulated in so-called "tranches." These tranches can contain a large number of mortgages which are then used as the basis for securities which are sold as investments. The securities are divided into two separate types. Type one is backed by the principal of the underlying mortgages and is fairly safe, but pays a low return to investors. Type two is backed by the interest payments on the mortgages and is risky. To compensate for this risk, this security pays far higher rates than type one.
The problem is that the high risk securities benefit most when the home owners who are paying the high interest rates on their mortgages continue to pay the high rates. In short, there's more profit in keeping the home owners on a high rate loan then there would be if they were allowed to refinance.
Now here's the point: Who controls at least part of the rules which permit or prohibit home owners from refinancing? If you said, "Fannie and Freddie," you get a gold star and go to the head of the class.
If you're prone to high blood pressure, take some medication prior to reading the next part.
Guess what investment instruments seem to be in vogue at Fannie and Freddie? In the last two years, Freddie purchased a few billion worth of so-called inverse floater securities based on high interest rate mortgages. If people pay off their loans early, this stops their interest payments which are the basis of inverse floater securities and Fannie and Freddie loose. Their interest is best served if John Q. Public can't refinance.
Based on that potential for loss, any rational individual or business would try to minimize the number of people refinancing and it seems as if both companies are working to make it harder for borrowers to get loans. This has been accomplished in several ways ranging from tightening lending criteria to raising settlement charges.
One is tempted to ask, "Why is this happening?" The individual in charge of Freddie's investment portfolio made $2.5 million in 2010. His bonus is tied to "supporting and providing liquidity and stability in the mortgage market," if you believe the annual SEC filing for Freddie. It doesn't really seem as if locking people in to high rates furthers this goal. My natural instinct is to follow the money and when I don't quite understand something, I just naturally assume that there is some kind of financial benefit for the companies and individuals involved. In this case, it doesn't seem in the public's best interest.
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