Freddie Mac Caught Betting AgainstStruggling Homeowners

Freddie Mac Caught Betting Against Struggling Homeowners Chris Arnold NPR January 31, 2012 Freddie Mac, a taxpayer-owned mortgage company, is supposed to make homeownership easier. One thing that makes owning a home more affordable is getting a cheaper mortgage.

But Freddie Mac has invested billions of dollars betting that U.S. homeowners won't be able to refinance their mortgages at today's lower rates, according to an investigation by NPR and ProPublica, an independent, nonprofit newsroom.

These investments, while legal, raise concerns about a conflict of interest within Freddie Mac. "We were actually shocked they did this," says Scott Simon, who heads the mortgage-backed securities team at the giant bond trading and investment firm called PIMCO. "It seemed so out of line with their mission, out of line with what Congress wanted them to do."

Freddie Mac, formally called the Federal Home Loan Mortgage Corp., was chartered by Congress in 1970. On its website, it says it has "a public mission to stabilize the nation's residential mortgage markets and expand opportunities for homeownership." The company is owned by U.S. taxpayers and overseen by a regulator, the Federal Housing Finance Agency (FHFA).

In December, Freddie's chief executive, Charles Haldeman, assured Congress his company is "helping financially strapped families reduce their mortgage costs through refinancing their mortgages."

But public documents show that in 2010 and 2011, Freddie Mac set out to make gains for its own investment portfolio by using complex mortgage securities that brought in more money for Freddie Mac when

homeowners in higher interest-rate loans were unable to qualify for a refinancing.

Those trades "put them squarely against the homeowner," PIMCO's Simon says.

Freddie Mac's trades came at a time when mortgage rates were falling to record lows. Millions of homeowners wish they could refinance, but their lenders tell them they can't qualify for today's low rates because of tight rules. Freddie Mac is one of the gatekeepers with the power to set those rules, and lately, it has been saying no more often to homeowners.

That raises concerns among some industry insiders who see a conflict: Freddie Mac's own financial health improves when homeowners can't refinance.

Simply put, "Freddie Mac prevented households from being able to take advantage of today's mortgage rates — and then bet on it," says Alan Boyce, a former bond trader who has been involved in efforts to push for more refinancing of home loans.

Freddie and FHFA repeatedly declined to comment on the specific transactions, but Freddie did say that its employees who make investment decisions are "walled off" from those who decide the rules for homeowners.

When Homeowners Lose, Freddie Mac Wins Freddie Mac, based in Northern Virginia, says its job is to purchase "loans from lenders to replenish their supply of funds so that they [the lenders] can make more mortgage loans to other borrowers." That's one reason why Freddie has a gigantic portfolio containing loans that generate income from mortgage payments. Critics say this investment portfolio has been allowed to grow far larger than necessary to further Freddie's policy mission.

Plus, in 2010 and 2011, Freddie didn't just hold a simple pile of loans. Instead, for hundreds of thousands of home loans, it used Wall Street alchemy to chop these loans up into complicated securities — slices of which were sold in financial markets.

This hypothetical example may help explain what happens: 1) Freddie Mac takes, say, $1 billion worth of home loans and packages them. With the help of a Wall Street banker, it can then slice off parts of the bundle to create different

investment securities, some riskier than others. The slices could be set up so that, say, $900 million worth are relatively safe investments, based upon homeowners paying the principal on their mortgages.

2) But the one remaining slice, worth $100 million, is the riskiest part. Freddie retains that slice, known as an "inverse floater," which receives all of the interest payments from the entire $1 billion worth of mortgages.

3) That riskiest investment pays out a lucrative stream of interest payments. But Freddie's slice also has all the so-called "pre-payment risk" associated with that $1 billion worth of loans. So if lots of people "pre-pay" their old loans and refinance into new, cheaper ones, then Freddie Mac starts to lose money. If people can't refinance, then Freddie wins because it continues to receive that flow of older, higher interest payments.

If the homeowner is unable to refinance, the Freddie Mac portfolio managers win, Simon says.

"And if the homeowner can refinance, they lose."

Refinancing A Path To Recovery In his State of the Union address, President Obama pushed for legislation to allow "every responsible homeowner the chance to save about $3,000 a year on their mortgage" by refinancing without what he called "red tape" or a "runaround from the banks."

Columbia University economist Chris Mayer supports such an approach. "A widespread refinancing program would have many benefits — not only helping the economy and putting tens of billions of dollars back in consumers' pockets, the equivalent of a very long-term tax cut," he says.

"It also is likely to reduce foreclosures and benefit the U.S. government by having fewer losses that they have to pay," Mayer adds.

In the long term, he says, allowing more Americans to refinance would help taxpayers as well as mortgage giants Freddie Mac and Fannie Mae, because they would suffer fewer losses related to foreclosures. These inverse floater trades, however, give Freddie Mac a short-term incentive to resist such so-called "mass re-fi" programs.

"If there was a mass re-fi program, the bets they made would get absolutely wiped out," PIMCO's Simon says. "The way these bets do the best is if the homeowner is barred from refinancing."

In a written statement, Freddie said it "is actively supporting efforts for

borrowers to realize the benefits of refinancing their mortgages to lower rates." It also says it refinanced loans for hundreds of thousands of borrowers just last year.

Fannie and Freddie have taken part in an existing federal program known as "HARP" to help Americans refinance, but many economists say far more homeowners would benefit if Fannie and Freddie were to implement the program more aggressively.

Stuck In 'Financial Jail' Some homeowners believe the current re-fi game is stacked against them.

Jay and Bonnie Silverstein describe themselves as truly stuck in a bad mortgage. They live in an unfinished development of yellow stucco houses north of Philadelphia. The developer went bankrupt.

The Silversteins bought this home before the housing market crashed, and then couldn't sell their old house. They now say that buying a new home before selling the old one was a mistake — a painful one. Stuck with two mortgages, they started to get behind on their payments on the old house.

"It wound up taking us years to sell that house, so we had two homes and two mortgages for twoand-a-half years," Jay Silverstein says. "It burned up my 401(k) and drained us."

Jay Silverstein has a modest pension, and they haven't missed a mortgage payment on their current home. Still, they are struggling. They could make the monthly payment on their new home if they could just refinance — down from their current interest rate of near 7 percent to today's rates below 4 percent. That could save them roughly $500 a month.

"You know, we're living paycheck to paycheck," he says. A lower rate "might go a long way toward helping us."

But that's the problem — getting approved for a refinancing. Here's why: After the housing market crashed, the Silversteins' old house had to be sold for less than the mortgage was worth. That's known as a short sale.

Freddie Mac has been tightening lending restrictions, and one of its restrictions blocks people with a short sale in their past from refinancing for up to four years following that short sale. So the Silversteins are stranded by the rule.

"We're in financial jail," Jay says. "We've never been there before."

Tight For Homeowners, But Elsewhere, Money Still Flows Economists say that during the housing bubble, lending standards got too loose. Now many believe the pendulum has swung too far, making rules too tight.

The short-sale restriction may be a good example. For a home purchase, such a rule may be prudent, but allowing people with existing loans to refinance actually lowers the risk that they may default by giving them more affordable mortgage payments.

In a recent analysis of remedies for the stalled housing market, the Federal Reserve criticized Fannie and Freddie for the fees they have charged for refinancing. Such fees are "another possible reason for low rates of refinancing," the Fed wrote, adding that the charges are "difficult to justify."

Meanwhile, even though Freddie is a ward of the federal government, its top executives are highly compensated. The Freddie Mac official then in charge of its investment portfolio, Peter Federico, made $2.5 million in 2010, and had target compensation of $2.6 million for last year — the time period during which most of these inverse floater investments were made. ProPublica and NPR made numerous attempts to reach Federico. A woman who answered his home phone said he declined to comment.

Economics Lesson 1 Paul Craig Roberts Infowars.com January 31, 2012 Last Friday (January 27) the US Bureau of Economic Analysis announced its advance estimate that in the last quarter of 2011 the economy grew at an annual rate of 2.8% in real inflation-adjusted terms, an increase from the annual rate of growth in the third quarter.

Good news, right?

Wrong. If you want to know what is really happening, you must turn to John Williams at shadowstats.com.

What the presstitute media did not tell us is that almost the entire gain In GDP growth was due to “involuntary inventory build-up,” that is, more goods were produced than were sold.

Net of the unsold goods, the annualized real growth rate was eight-tenths of one percent.

And even that tiny growth rate is an exaggeration, because it is deflated with a measure of inflation that understates inflation. The US government’s measure of inflation no longer measures a constant standard of living. Instead, the government’s inflation measure relies on substitution of cheaper goods for those that rise in price. In other words, the government holds the measure of inflation down by measuring a declining standard of living. This permits our rulers to divert cost-of-living-adjustments that should be paid to Social Security recipients to wars of aggression, police state, and banker bailouts.

When the methodology that measures a constant standard of living is used to deflate nominal GDP, the result is a shrinking US economy. It becomes clear that the US economy has had no recovery and has now been in deep recession for four years despite the proclamation by the National Bureau of Economic Research of a recovery based on the rigged official numbers.

A government can always produce the

illusion of economic growth by underestimating the rate of inflation.

There is no question that a substitution-based measure of inflation understates the inflation that people experience. More proof that there has been no economic recovery is available from those data series that are unaffected by inflation. If the economy were in fact recovering, these date series would be picking up.

Instead, they are flat or declining, as John Williams demonstrates.

For example, according to the government’s own data, payroll employment in December 2011 is less than in 2001. Meanwhile, there has been a decade of population growth. The presstitute media calls the alleged economic recovery a “jobless recovery,” which is a contradiction in terms. There can be no recovery without a growth in employment and consumer income.

Real average weekly earnings (deflated by the government’s CPI-W) have never recovered their 1973 peak. Real median household income (deflated by the government’s CPI-U) has not recovered its 2001 peak and is below the 1969 level. If earnings were deflated by the original methodology instead of by the new substitution-based methodology, the picture would be bleaker.

Consumer confidence shows no recovery and is far below the level of a decade ago.

How does an economy recover without a recovery in consumer confidence?

Housing starts have remained flat since 2009 and are below their previous peak.

Retail sales are below the index level of January 2000.

Industrial production remains below the index level of January 2000.

To repeat, the only indicator of economic recovery is the GDP deflated with an understated measure of inflation.

The US economy cannot recover, because the US economy depends on consumer expenditures for more than 70% of its activity. The offshoring of middle class jobs has stopped the rise in middle class income and caused a drop in consumer spending power.

The Federal Reserve under Alan Greenspan compensated for the absence of US consumer income growth with a policy of easy credit

and a policy of driving up home prices with low interest rates.

This policy allowed people to refinance their homes and to spend the inflated equity in their homes that Greenspan’s policy created.

In other words, an increase in consumer indebtedness and dissavings drove the economy in the place of the missing growth in consumer incomes.

Today, consumers are too indebted to borrow, and banks are too insolvent to lend. Therefore, there is no possibility of further debt expansion as a substitute for real income growth. An offshored economy is a dead and exhausted economy.

The consequences of a dead economy when the government is wasting trillions of dollars in wars of naked aggression and in bailouts of fraudulent financial institutions is a government budget that can only be financed by printing money.

The consequence of printing money when jobs have been moved offshore is an inflationary depression. This catastrophe could begin to unfold this year or in 2013. If Europe’s problems worsen, flight into dollars could delay sharp rises in US inflation until 2014.

The emperor has no clothes, and sooner or later this will be recognized.

Paul Craig Roberts was Assistant Secretary of the Treasury for Economic Policy and associate editor of the Wall Street Journal.

He was columnist for Business Week, Scripps Howard News Service, and Creators Syndicate. He has had many university appointments. His internet columns have attracted a worldwide following.

Worship of the Mob Ben O’Neill 1. informationliberation.com January 31, 2012 Several months ago, I was visiting some friends in Sydney and was invited to the house of a friend-of-a-friend for some late night drinks and a chat. My host and his friends were left-wing bohemian types and had been informed by my friend that I am a “free-market anarchist,” or something like that. They found this notion intriguing, and so they quizzed me on what that means, and this naturally led into a discussion of the merits of a free market versus a democracy.

The discussion was a cordial one, and went as most of these discussions do when one is chatting with people who have never previously been exposed to consistent libertarian philosophy. My host and his friends raised most of the standard objections to the free market and to the idea of a stateless private-law society, and I explained why I regard each of those objections as erroneous.

1. [1] Though the attending group appeared to find my arguments on these individual points thought provoking, they remained unconvinced. The main sticking point to the discussion was a pervasive concern that the free market does not allow for democratic state action — that “the people” should have the right to collectively determine “the rules of the game” by voting their preferred politicians into power, and that their determinations should legitimately bind the members of the society they are in.

The Sanction of the Victims This discussion would have been fairly routine — much like countless similar discussions I have had on these issues before — except for one interesting peculiarity. As I argued for the virtues of noncoercion as a governing principle for society, and my host and his friends rallied in favor of unlimited democracy, every one of them happened to be concurrently occupying themselves by snorting lines of cocaine through their rolled-up monopoly-issued fiat currency. (They graciously offered me some, but my recreational drug of choice is alcohol, so I declined.) This gave the discussion an interesting tinge that illustrates an important aspect of people’s love affair with mob rule: “Does it bother any of you,” I asked them, “that under your own preferred political system you’re all considered criminals? What you’re doing right now is considered a crime, and you could be fined or even go to prison for it.”

The answer was no; it didn’t bother them. It doesn’t really bother anyone who accepts mob rule as a desirable form of social organization.

The reason is that democrats never regard existing democracy as their preferred political system — they regard it only as a transitory state to a democratic utopia in which the elected leaders will agree totally with their own values and social-political views. Mises has observed that “the critics of the capitalistic order always seem to believe that the socialistic system of their dreams will do precisely what they think correct.”[2] Hence, when people talk about the importance of democracy, it is never democracy as it has ever actually functioned, with the politicians that have actually been elected, and the policies that have actually been implemented. It is always democracy as people imagine it will operate once they succeed in electing “the right people” — by which they mean, people who agree almost completely with their own views, and who are consistent and incorruptible in their implementation of the resulting policies. This is what allows an intelligent group of people to espouse mob rule as a desirable principle, even as they simultaneously commit acts that brand them as criminals worthy of imprisonment under the very social system they maintain.

Ayn Rand referred to this phenomenon[3] as the “sanction of the victim” — a person can occupy himself snorting lines of cocaine in his own home, while simultaneously accepting the view that it is morally proper for those in his society to use violence against him if they catch him doing it.

The reason for this is a mistaken view in the desirability and moral legitimacy of mob rule as a governing principle for society. With this in mind, let us examine the real nature of this muchlauded democracy.

Unlimited Democracy Is a Form of Socialism Democracy, of the unlimited kind lauded today, 1. [3] is a form of socialism, in the sense that it arrogates ultimate power over all decisions to the government. Implicit in the notion of people’s present love affair with mob rule is the assumption that government, through the collective “will of the people,” should have the prerogatives of ownership of all resources in society, should it choose to exercise these. The democrat brooks no limitation on the legitimate powers of government and hence gives total ownership over all of society to this institution. The only limitation in his mind is the limitation of democracy itself — that the rulers in control of the government apparatus must guard against being displaced by another set of rulers, at the behest of the demands of the mob.

The socialistic nature of democracy is true regardless of the size of governments elected under a democratic order or their particular policies. It is true even when a democratic government chooses policies that are relatively liberal and purportedly support the ownership of private property. For such property ownership is regarded as conditional. Supporters of the system of democracy assert their right to forcibly interfere in the lives of others whenever they have sufficient support from the mob to do so, or are otherwise capable of capturing political power. By supporting the existence of a democratic order they implicitly sanction an arrogation of ultimate ownership of all society to the government, whether decisions over particular resources are exercised by government or not.

Any private property or personal autonomy allowed under democracy exists only with the permission of the government, and under the constant threat of the whims of the mob, rather than existing as a recognized enforceable moral right against the government. The ideal of democracy dictates that a person’s private rights are always subject to being overruled by the government, and so it is actually the government that is the implicit owner of all the resources (and people) in its territory. Such a society is implicitly socialist in character, unless and until people reject the legitimacy of government power over their resources, a view which requires the rejection of mob rule as a governing principle.

The fact that most democratic governments ban the possession, trade, and consumption of cocaine — and treat those who engage in these activities as criminals — is just one minor corollary to the implicit assumption that democratic government owns you. Those in control of the government don’t need to worry too much if you disagree with their “public policies,” so long as you concede the legitimacy of their power to impose these policies on you. It is not enough to dislike or disagree with their specific programs — to attain genuine enforceable rights, people need to reject the moral legitimacy of government interference in their lives.

Do Not Consent to Be Ruled Those who support democracy tend to conflate the issue of the method of selection of rulers with the preliminary question of whether

political power is legitimate in the first place. Hence, it needs to be clearly understood that objection to democratic rule does not mean that one prefers dictatorship — it means than one does not consent to have others initiate force against them, regardless of the method of selection of those with the power to do this. Indeed, one may quite rightly prefer democracy to dictatorship while still regarding both of these systems as inferior to a society without political rulers.

If you are inclined to believe that democracy will function justly when “the right people” are elected, then bear in mind that each political party is elected precisely because its candidates are regarded as the best people available by the majority at the time. Look around you at the people who are elected, and look at the actions of these people. This is your democracy, and the destruction and domination occurring under its imprimatur are the natural consequences of the view that the desires of the mob should override the rights of the individual.

When chatting about this issue with my hosts over late-night drinks, I was one-too-many beers away from sobriety to put the case well. But if I had mustered the presence of mind to do so, I would have told them that instead of concerning themselves with how their rulers should be chosen, they have another choice available to them: reject the idea that you require rulers at all!

Most people don’t spend their Friday nights snorting lines of cocaine. But virtually every adult person contravenes the ubiquitous regulations of democratic government at many times in their life. And regardless of their actions, everyone living under unlimited democracy is treated as the property of the government, with rights that are disposable at the whims of the mob. Under democracy, everyone is subject to the rule of any group that can acquire large numbers and become adept at capturing political power.

People still have not absorbed the lesson of democracy that should have been learned when Socrates was condemned to death by his fellow Athenians for his impiety.[5] Might is not right: whether expressed through raw physical power or through the voting booth, it is illegitimate and undesirable for people to aggress against their fellow human beings. Rejecting the rule of the mob is an important step towards peace and prosperity. __ Ben O’Neill is a lecturer in statistics at the University of New South Wales (ADFA) in Canberra, Australia. He has formerly practiced as a lawyer and as a political adviser in Canberra. He is a Templeton Fellow at the Independent Institute, where he won first prize in the 2009 Sir John Templeton Fellowship essay contest. Send him mail.

Notes

[1] Objections included the assertion that free competition leads to giant corporate monopolies, the claim that big corporations would rule the world, the notion that private protection providers would form organizedcrime groups akin to the Mafia, the delusion that poor people would die in the streets for want of food and medical care, and a host of other objections that have been refuted ad nauseam in libertarian works too numerous and diverse to mention. I do not provide answers to these arguments here, though they can easily be found in other literature.

[2] Ludwig von Mises, A Critique of Interventionism (1977), Arlington House: New York, pp. 156–157.

[3] Rand’s reference to the “sanction of the victim” was used to refer more specifically to the fact that victims supply the tools of their own destruction to their destroyers, who are incapable of production themselves. Though Rand would not have regarded cocaine consumption as a productive activity that provides tools to one’s destroyers, she did regard the moral sanction of the victim as being a necessary tool supplied to one’s destroyers. It is in this sense that I use the term.

[4] Most democratic states today maintain some form of constitution that purports to limit their powers. However, these are increasingly strained by the widespread acceptance of unlimited democracy as a political ideal, and by the capacity of the elected executive government to choose the judicial officers who interpret this alleged limiting device. In fact, no such device can limit the power of government in its own right, because it is an instrument of public law itself and is administered by government officials. Events in democratic countries repeatedly demonstrate that such constitutions exert no real constraint on the power of government, even when the ruling officials in government act in ways that are unmistakably in conflict with the prohibitions in these documents.

[5] For an account of Socrates defense at his trial, see Plato’s Apology in J.M. Cooper (ed) Plato: Complete Works (1997), Hackett Publishing Company: Indianapolis, pp. 17–36.