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Why Fannie and Freddie Are Hesitating to Help Homeowners

We explain Freddie Mac and Fannie Mae’s role in the housing market, and why it seems as if their actions often go against the interests of homeowners.

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A home for sale in Bollingbrook, Ill. (Scott Olson/Getty Images)

Earlier this week, ProPublica and NPR detailed how Freddie Mac placed bets against homeowners that paid off if borrowers were unable to refinance their mortgage loans. The story highlighted the conflicted role of the huge and now government-controlled Freddie Mac and Fannie Mae: They are supposed to maximize their profits and thus pay back taxpayers, while many feel that, as government wards, they should also be helping millions of struggling Americans stay in their homes.

 

Here's our attempt to explain Fannie and Freddie's role in the housing market, and why it seems as if their actions often go against the interests of homeowners.

What are Freddie Mac and Fannie Mae supposed to do?

Fannie and Freddie were created to make homeownership more accessible. They are Government-Sponsored Enterprises — private companies chartered by the government to expand access to credit, particularly for low- and middle-income homeowners, and to foster stability in the mortgage market. Fannie Mae was founded as a government institution during the Great Depression and privatized in 1968. Freddie Mac has been private since it was founded in 1970. (Freddie was started in part to divide responsibility in the mortgage market, but there's no real difference between the two now, except that Fannie is larger.) But "private" is not exactly the right word — Freddie and Fannie are exempt from most state and local taxes, as well as some SEC regulations, and they have access to a credit line from the federal government. And they still have their chartered obligation to make mortgages more available.

Fannie and Freddie can't make loans directly. Instead, they guarantee existing mortgages, and repackage and pool them into bonds called mortgage-backed securities. Someone who buys the bonds from Freddie gets the interest and the original principal even if a homeowner defaults. In exchange for that guarantee, Freddie collects a fee from the buyer of the bonds and can use that to guarantee more mortgages (or to buy mortgages that stay in their portfolio). This handy New York Times graphic shows the various flows of debt: The idea is that by basically ensuring that someone (often Freddie or Fannie) will guarantee a mortgage, it becomes easier for anyone to get a mortgage.

So, how did they get so big?

Because Fannie and Freddie have been able to borrow lots of cheap money.

For years, investors have loaned them money at lower-than-average interest rates, allowing Fannie and Freddie to expand their portfolio of mortgages and securities. As a history compiled by the Congressional Budget Office shows, investors have treated Fannie and Freddie as essentially risk-free. The assumption, which has turned out to be correct, was that the government would never let Fannie and Freddie fail. The two companies used that windfall not only to invest in more mortgages but to try to increase their profits by pouring money into a variety of fancy financial instruments.

Fannie and Freddie became, as The New Yorker's James Surowiecki described them, the "duck-billed platypuses of the financial world" — strange institutions with the perceived safety of a government guarantee and the high-risk strategies of a private corporation. And that led them to become the giants of the mortgage market, managing a massive portfolio of debt. In 2008, they had a combined $5 trillion in debt and guarantees.

Why are taxpayers on the hook for their mistakes?

The bubble burst — and Fannie and Freddie's execs had overreached.

In the last stretch of the boom, the two companies had loaded up on iffy mortgages. When the housing market began to turn in mid-2006, delinquency rates rose, increasing the chances that Fannie and Freddie would have to make good on their guarantees. Compounding their problems, it became harder for Freddie and Fannie to borrow money as concerns mounted about the companies' health. In the mid-2000s, they admitted to overstating earnings and making billions of dollars' worth of accounting errors.

By 2008, they were in trouble. That $5 trillion in debt and guarantees was backed by only $80 billion in core capital. The federal government took them over, becoming the major shareholder of both companies, while the Federal Reserve bought up most of their debt and the Treasury Department pledged to cover their losses. The taxpayer buyout of the two companies has cost roughly $169 billion.

The SEC filed a lawsuit against the companies' executives in December, accusing them of misleading investors about the riskiness of their investments.

The companies' high compensation of their executives has also been under fire from Congress. Although the bailout calls for Fannie and Freddie to wind down their portfolios of mortgages, they continue to make billions of dollars' worth of risky investments like the "inverse floaters" we described.

So, do Fannie and Freddie actually help homeowners? And why can't the government force their hand?

The companies say that by bolstering their finances, they are helping to stabilize the housing market as a whole, but Freddie and Fannie have hampered many of the administration's plans to provide relief for struggling homeowners.

The two report to a regulatory body called the Federal Housing Finance Agency, which has acted since the bailout as their board of directors and shareholders, making their major decisions. In the wake of our story, the White House and several senators have called for more oversight and an explanation as to why Freddie's investment strategy seems to run counter to the mandate to help homeowners.

More broadly, the Obama administration and the acting head of FHFA, Edward DeMarco, have often clashed over the goals of the companies.

This week, President Obama outlined a new set of initiatives aimed at making it easier for homeowners to refinance and encouraging loan forgiveness. But Fannie and Freddie have previously refused to participate in loan forgiveness programs, and they continue to tussle with the administration on the issue. (It seems unlikely that any of Obama's proposals will get through Congress, and ProPublica has documented extensive problems with similar programs aimed at preventing foreclosures.)

The two aims of Fannie and Freddie are continually at odds — policies encouraging refinancing and forgiveness for more mortgage holders can increase costs to the taxpayer-owned companies. While the administration has made relief for homeowners their priority, DeMarco says his agency's priority is to protect Fannie and Freddie's profits, aka taxpayers' assets. Of course, many of those taxpayers are struggling homeowners, and that is at the heart of the dilemma over Fannie and Freddie's future.

Sen. Barbara Boxer, D-Calif., told NPR she was shocked by a recent meeting with DeMarco. "It was the worst meeting I've ever had in my life," said Boxer. "His interest is making sure Fannie and Freddie do well financially."

Will they be around much longer?

Probably, even though there's rare bipartisan consensus that they shouldn't be.

Both the Obama administration and congressional Republicans want to get rid of Fannie and Freddie. Obama's plan gradually winds them down to a position equivalent to private-sector mortgage companies while giving the market time to adjust to their removal. Republicans want a more immediate rollback of their influence.

These plans were unveiled almost a year ago, but the companies are still massively important to the mortgage market, guaranteeing approximately 70 percent of the country's home loans. Their elimination might make it more difficult to get a mortgage loan, and it remains unclear what kind of assistance for homeownership could, or should, replace them.

Richard Careaga

Feb. 2, 2012, 3:45 p.m.

FHFA is justifying its decision to hold on to underwater loans, rather than to modify them to reduce principal (and therefore incur losses, but losses less severe than doing nothing) on the basis that the alternative of forbearance (deferral of principal) is superior because the estimated net present value of the losses is lower.

In the FHFA letter explaining the rationale we read:

“Given that any money spent on this endeavor [principal reduction] would ultimately come from taxpayers and given that our analysis does not indicate a preservation of assets for Fannie Mae and Freddie Mac substantial enough to offset costs, an expenditure of this nature at this time would, in my judgment, require congressional action.”

The model suggested no better result from principal reduction than principal forbearance; it shows principal forbearance is slightly more effective at reducing Enterprise losses.

How much lower?

Under the various scenarios, per loan underwater by at least 15%, on average, about $1,900 for Fannie and $1,000 for Freddie.

What is the reason for the difference?

“principal reduction amounts would most likely be less than reserve amounts [considered on a pool basis, rather than loan-by-loan], so there would be no incremental loss recognition”

(i.e., it has nothing to do with the balance sheet)

But it’s haaard!

“Neither Enterprise can accommodate the new accounting and tracking of principal reduction without operationally challenging changes to the existing IT systems, which are outdated and inflexible. The team did not require the GSEs to provide FHFA with cost projections, but experience implementing the HAMP program suggests that each Enterprise would need substantial funds and would rely upon scarce personnel resources to make the necessary IT modifications.

Principal forbearance, on the other hand, creates no additional accounting losses and offers the Enterprises the opportunity for ultimate recovery of some amount of principal, potentially reversing some losses recognized earlier.”

This is the all-too-human aversion to losses.

Then, there’s the Pollyanna observation that if you assume forbearance is implemented in the first 90 days of delinquency, rather than once the loan is approaching foreclosure, you discover

“Securitized loans that are fewer than 90 days delinquent have the greatest reduction in losses.”

Servicers, however, have a really hard time acting this quickly; a third of that time goes by before the servicer’s systems note that a payment is late the first time.

A more straigthtforward account would be more along the lines of:

We could cut to the chase and take the probable losses now. It would be hard to implement operationally given the sorry state of the systems we have. The only other option to letting nature take its course is called “forbearance,” which allows us to pretend that somehow things will spontaneously get better. If there are other options we don’t know about them or we’re not telling. Some of the losses may be due to capitalized past-due interest (arrearages) and the attendant servicing fees, but we’re not telling that either. We have this model. Blame someone else for the net present value part of it. There are a lot of assumptions. We list some of them. We want you to believe that the model is precise enough so that we can judge differences to the dollar. As far as we’re telling you, assume that there is no estimation error associated with our model, at all. Putting the losses on the servicer (hint, hint) saves our bacon. This is ugly, and we don’t want to be blamed for any of the possible bad outcomes–you make the tough decisions and we’ll do our best to implement them, but we don’t know how to do principal reductions and resources are scarce.

Nobody believes that Freddie Mac bets against the homeowners.
We have to investigate who is behind this news of ProPublica.

I believe it, I also read it in the Enquirer.
Fannie and Freddie have out lived their
usefullness.

Martha Paschal

Feb. 2, 2012, 5:58 p.m.

The GSEs exist to provide liquidity to the markets in times like these, and to give mortgage originators a place to sell their mortgages (provided that they adhere to GSE underwriting standards, one of which is that there must be borrower income verification).

The GSEs had over 50 years in providing value to the American mortgage finance system and to US homeowners.  That lapsed when the political types decided that an “ownership society” in which over 60% of US households should be homeowners.  This idea flew in the face of a lot of academic research which said that lower-income folks had insufficient household reserves, more employment fragility, and that homeownership would lessen their abilities to move to where jobs are, and this has been borne out over the course of this economic cycle.

I find it amazingly simplistic and even demonstratively clueless for these writers to say that the GSEs have outlived their usefulness in light of their histories and the fact that they’re currently backing over 60% of the mortgage market.  Wihtout GSE support, what do you think will happen?  Do you honestly believe that the private markets would step in and provide this service, especially in light of recent actions by the financial sector?

Propublica, you need to do better research than this!

This is a great example of what ideological and political enmity for its own sake will get you.  The key to our economy turning around is resolving the housing crisis.  Any attempts by the President to put measures in place is blocked either in Congress or by this out of control GSE.  If the housing crisis remains the major impediment, the economy will likely continue to struggle putting President Obama’s re-election in greater jeopardy.  In short, Mitch McDonald and his buddies succeed in their goal of defeating the President even if doing so sells the recovery down the river.

Fannie, Freddie and FHFA where given ample opportunities in 2009 to save the nations housing market but where afraid to do so.  They where all presented, at the highest levels, with a detailed plan to slow foreclosures. Everyone knew there would be losses but if actions where taken in 2009 we would not be in the situation we are in today. Short term thinking by Fannie, Freddie, FHFA and Treasury all contributed to the need for larger principle reduction now. In the 1Q 2009 housing prices where only down about 10% to 15%.  Part of the proposed plan to them all was to tie principle reduction to HAMPs 31% formula. HAMP recommended principle reduction in is original program.

In the beginning one of the problems was that even though Fannie and Freddie was owned by the US taxpayer and FHFA was created as conservator, each had their own modification program. And lets not forget FHA with their own program. Let me ask - how did that strategy workout for the housing market and the taxpayer?

With regard to Freddie and Fannie looking out for the “Taxpayer” - $160B and counting - not even considering the damage to the rest of their portfolio - we are no closer to stopping the slide. What where the housing numbers for last year, 300k.

I was always amazed back in 2009 and 2010 when I was told by all these people that the banks would do the right thing. Most of us knew that would not happen - that it would up to Fannie, Freddie and FHA to fix real estate. Here we are 2012, an election year, with a new refi program, principle reduction arguments and an over all government unwilling to live up to the original language of the TARP legislation with regard to saving housing.  Oh, did I fail to mention the 50 State AG settlement or the OCC foreclosure review process announce 10 months ago.

The Grim Reaper

Feb. 2, 2012, 7:15 p.m.

The key to turning around our economy is not the housing market.  Housing is a consumption item.  It creates ZERO wealth.  In order to be able to consume, one must first produce to have the income and excess savings to consume.  House prices are irrelevant to a sustainable economy.  A sustainable economy will take care of housing without someone tampering in some misplaced effort to fix it.  That’s what created the housing mess in the first place - some bureaucrat with the intellectual capacity of a battery.

The GSEs should be nationalized and turned into a publicly-owned mortgage bank owned by the American people and out of reach of political idiots.  ie, Protected by an economic constitution of written rule of law.  And, then said bank, a non-profit organization, could and should buy all mortgages in the U.S. up to some dollar amount and turn those mortgages into interest-free mortgages and offer new interest-free mortgages to any American who qualifies.  Then, just as with unemployment insurance, said bank could extend similar benefits to those who have temporarily lost gainful economic means.  This would expand ownership and give a better appreciation of the Constitution and property rights. Expanded ownership or democracy for ALL Americans is a GOOD THING if done properly and not under the duress of corruption. 

Criminals on Wall Street get interest-free loans from the Federal Reserve and then turn around and rape Americans with their endless schemes and leave us with the bill.  We the People should be getting the interest-free loans by bypassing private, for-profit banking…. an afront to democracy that is nothing more than privatized looting of a society’s wealth.

Thomas Jefferson wanted to GIVE everyone their own land because he thought the understanding and participation in property rights was so important to all people.  There is NOTHING wrong with an ownership society.  We just need to get the GSEs out from under the control of political idiots and their corporate masters on Wall Street who created the mess at both Freddie and Fannie.

T G - please do not go there, the President, his Treasury Secretary a democratic house and Senate had the power from the start to solve this problem but they did not. They all - including the Republicans should be ashamed of themselves - bank money wins every time.

Grim Reaper - all due respect Real Estate has lead the country out of the last three recessions.  How can you say it does not create wealth when we have already lost $7 trillion in equity.  Equity is wealth, and besides the millions of job lost due to the downturn in the housing market equity in ones house creates consumer confidence which is crucial to any meaningful recovery.

The Grim Reaper

Feb. 2, 2012, 7:49 p.m.

With all do respect, you don’t have any idea what you are talking about.  This isn’t about opinion.  It is economic FACT.  Do you understand anything about the concept of economic capital?  Apparently not.  And, you use your own data to shoot yourself in the foot.  We didn’t have anything “lead” us out of the last three recessions because we have been in a recession for thirty years.  What led us out of your supposed recessions wasn’t housing but endless money printing that covered over the fact that the United States is broke courtesy of rampant corruption.  And, now there is no “leading” us out of anything because the system as it is configured doesn’t respond any more money printing.  It’s game over until we see transformational reform.  Watch and learn.

You hit the nail on the head, Martha!  The problem here is not the existence of a GSE on the model of the original Fannie Mae, or its usefulness to society, that is a known quantity with clear benefits, historically.  the problem is the failure to implement basic underwriting standards, such as income verification.  In addition there is outright mortgage and securitization fraud, which is rampant among large financial institutions, in general, and the mortgage and mortgage- servicing “industry”, in particular.

How and why are these catastrophes happening now, after so many years of success and tangible benefit to society?

I would say there are three fundamental reasons:

1.) Deregulation of the financial sector and the rise of the shadow banking system, devoid of transparency and accountability, paving the way

2.) Serious, fundamental conflicts of interest, where officials who run government agencies, as well as, officers of companies (GSEs), are assigned conflicting and, often, contradictory directives, such as maximizing profits versus making home ownership more accessible or helping homeowners stay in their homes in a housing bubble crash (one that was engineered by the financial sector to goose front-end profits).  And I haven’t even mentioned the revolving door, er archway, between government and it’s corporate sponsors/patrons

A servant (especially a public one) cannot serve two masters. And it is not wise to let a fox guard the chicken coop.  Need we anyone to tell us these things??

3.) The separation of investment and profit-making from its inherent risk - and what ordinarily would and should be responsibility and accountability for the risk and potential losses. 

This last flaw creates a serious moral hazard and is begging for trouble.  Off-loading risk and losses to ‘the government’, i.e., citizens, is not only outrageous, it is incredibly foolish and costly - not only for the suckers left holding the bag, but for our domestic economy and society, as a whole.

Let’s face it, we have a bunch of con artists and fraudsters (sociopaths) running our country’s government and banking/financial institutions for their own, private, massive gain - at our expense and massive loss.  They not only gamble recklessly with ‘other people’s money’, but they lie, cheat, defraud and steal from us to get their ill-gotten gains.  They are in it together - and we are not.

I wonder how long will we put up with this???

thank you for enlightening me.

@Steve-You need no enlightening. I know who you are and what you’re about. You gave it an honest try…at helping people work through this problem. Only wish your plans would have been accepted…even in a small way to have got established. We all would have certainly fared far better than where we are now. I do remember you and hope you are doing well.

William R. Maloni

Feb. 3, 2012, 12:31 a.m.

In its simplification of complex issues, the article overlooks some facts.

The Fannie/Freddie mortgage market model , i.e a national secondary mortgage market serving thousands of primary mortgage lenders in every community in the nation, making loans available using F&F underwriting standards implemented via electronic underwriting platforms, worked and worked well through 2005.

That model standardized US mortgage products and prices everywhere and helped achieve a 67% US homeownership rate, with increasing numbers of minorities joining that demographic.

That wasn’t the model which failed, despite a ton of misleading political rhetoric—mostly coming from the Right—which demonized the two giant mortgage investors.

The wheels came off the trolleys when F&F—with the blessing of their former regulator—began buying the worthless Wall Street “private label securities,” which promised Fannie and Freddie and hundreds of other institutional investors around the world low risks and high yields. Instead all they earned was red ink and spreading and contagious financial disaster.

It should be noted—at the time, under President Bush—that not one federal financial regulator (the Fed, Treasury, SEC, FHFA and its predecessor, OTS or the Credut Union Administration) prohibited the Wall Street firms from using their own mortgage brokers, avoiding the superior F&F underwriting systems, to create and sell hundreds of billions in soon to be worthless mortgage bonds

Study after study showed that it was the “subprime” outside loans, not th F&F bonds, originated by their own underwriting systems, which performed miserably and failed 6 times more than the two companies “prime” securities.

Since 2008, F&F have been run by the government, not their boards or senior management. So,  all blame should be born by either their immediate regulator, the Federal Housing Finance Board (FHFA) or the US Treasury.

But FHFA Director Ed DeMarco has been given two missions which totally conflict.

In 2008, the Bush White House (and later the Obama Administration) put the two companies into “conservatorship,” which required their regulator to run the two with an eye to cutting down losses and conserving their assets, presumably with an eye toward some future functional.

Lately, DeMarco’s been given orders to turn them loose and have them restructure their portfolio assets (mortgage loans)—which likely will generate more losses—but nobody has told him which “priority” needs to prevail.

Added to that, the nation’s large banks—despite regularly scolding and excoriating F&F and being part of the political “hanging parties”—have failed to invest in mortgage loans (save those they can sell to F&F) or provide any alternative to the functions performed by the two captives.

And this, despite having loaded coffers, much of which came from taxpayers three years ago.

The Bush and Obama Treasuries made no reciprocal demands on the large banks regarding lending to their communities for business or mortgage loans, something the banks still haven’t done despite our nation’s macro economic needs.

I was told a long time ago by a friend of mine that Freddie & Fannie would help us buy our first home. Because of unforeseen financial difficulties, my wife & I still have not purchased a home. We have been renting because we can’t afford a mortgage, and taxes, and upkeep. At a time when we’re being asked to buy a particular home, this year, an article like this is forcing me to consider other options to buy in this economy. Thank you ProPublica!

I said it before (in response to the previous story on this topic)... Freddie Mac is a thing.  You refuse to name any names but DiMarco.  There are people behind these decisions.  People who are venal and make these decisions to enrich themselves but you continue to ascribe all causation to a depersonalized thing, Freddie Mac.  Bricks and mortar do not make decisions, people do and as long as they can hide behind the thing for the people, you enable them.  Name names.

It would be instructive for many to read “Wall Street and the Financial Crisis”
“Anatomy of a Financial Collse”
This the official Seanate staff report, US Senate Permanent Subcommittee on Investigations.
(Cosimo Reports 2011)

Nice summary Richard Careaga! You add osme interesting details about an IT system that cannot adjust to principle reduction.  You don’t deal with the issue of making a profit versus reducing bad loans and losses; but I assume you think this is implicit in your response. 
To what extent does the Obama adminsitration want to get rid of DeMarco, and cannot because Congress is refusing to confimr his nominations?

This article is part of an ongoing investigation:
Freddie Mac

Freddie Mac

The taxpayer-owned mortgage giant made investments that profited if borrowers stayed stuck in high-interest loans while making it harder for them to get out of those loans.

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