February 6, 2012

In an interesting twist to the current Freddie Mac situation (which I blogged about here), President Obama has decided to elaborate on his New Housing Proposal that he briefly mentioned in his State of the Union Speech last Tuesday. Obama's plan to expand the Home Affordable Refinance Program HARP would assist homeowners who are attempting to qualify for refinancing. According to the HARP website, the program expects to refinance "as many as 2.85 million loans by the end of 2013."

How does the Freddie Mac bet against homeowners affect this goal?

First, let's look at Freddie's questionable position:

Freddie Mac has bought 'inverse floaters' which essentially means they invested in packages of mortgages and sold off their right to collect on the principal of those mortgages with the mindset that they would just collect the interest rate payments. This is a bet that people will continue to pay these interest payments and one way that they may get out of paying those interest payments is to replace them with a new loan with lower interest payments - that's a little something called 'refinancing'. Well, if you or I invested in inverse floaters like those bought by Freddie Mac, we could debate the merits and risks of that investment. But Freddie Mac is charged with helping people refinance - so why would Freddie Mac make such an investment? It was likely a hedge - a way to trade off some possible risk in other investments. But here's the kick: there should never, ever be even a hint of a conflict of interest in an organization's positions, even in a hedge.

The answer is simple: as long as Freddie Mac has an role in refinancing, they must remove their hedge against it.

As I have been writing, I noticed a little piece of news float up: Freddie Mac seems to know this is a bad idea to some extent, although they don't seem to know why.

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).