Another Day, Another Freddie Mac Scandal

01/31/2012 11:01 am EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

Revelations that the company has been betting against the homeowners it has refused to help warrant the firing of its ineffectual overseer, writes MoneyShow.com senior editor Igor Greenwald.

You know that embarrassing relative you can’t quite disown and most certainly can’t control? It turns out Uncle Sam has a couple of those, known as Freddie Mac and Fannie Mae.

Freddie and Fannie are a power couple all right, with seemingly unchecked power to generate regret.

For conservatives, they’re proof that the housing bubble and subsequent financial crash were the fault of the government. It doesn’t matter how much proof is furnished that Freddie’s and Fannie’s lending was much more prudent than the subprime excesses solicited by Wall Street. It doesn’t matter that Fannie and Freddie didn’t pioneer the synthetic CDO, nor pushed the no-income, no-job approvals.

They’re part of a fantasy narrative about government ruining yet another private-sector success story. To admit otherwise would raise uncomfortable questions about why exactly market failures like the housing crash don’t argue for increased financial regulation.

Liberals have their own score to settle with the government-sponsored mortgage packagers. It has to do with the fact that even though their bankrupt husks were bailed out via federal receivership and backed explicitly by Uncle Sam, these zombie companies have continued to resist sensible proposals that would let many underwater homeowners refinance at the lower current market rates—boosting disposable income, perking up the moribund housing market, and ultimately helping Fannie and Freddie recover more money (after taking some upfront losses).

Fannie and Freddie have resisted such proposals from both the Obama administration and the Federal Reserve, as if they don’t realize where their bread is buttered these days. And they’ve been backed in this intransigence by Edward DeMarco, the acting director of the Federal Housing Finance Agency, who’s in charge only because Republicans in Congress scotched his successor’s nomination.

Now comes news that Freddie has been betting against the struggling homeowners it has refused to help. A joint investigation by ProPublica and NPR News has found that over the last two years, Freddie Mac has gambled $3.4 billion on “inverse floater” securities, which derive cash flow from the high-interest-rate mortgages Freddie has refused to help refinance.

If underwater homeowners keep paying their 7% mortgages, Freddie wins, even as the country loses. If they default or if they we somehow able to refinance, or if currently low interest rates were to rise, Freddie loses—and so too does the country.

The problem here isn’t even that Freddie has been betting against the homeowners it is by charter supposed to help. The real scandal is that the company is betting at all on the taxpayers’ dime.

We already owe more than $160 billion for Freddie’s and Fannie’s mistakes during the housing boom—and they made plenty even as accessories after the fact. Now we’re also on the hook for the “inverse floater” bets that depend on the housing market to stay frozen to succeed, yet will cost Freddie—and therefore us—even more money should home sales ever thaw.

This is the problem with maintaining the fiction that Freddie and Fannie somehow remain private and independent companies. It would have been better to make them part of the Department of Housing—at least they wouldn’t still be supporting gambling—sorry, trading—desks, nor would their top execs have been awarded millions of dollars in bonuses, with DeMarco’s blessings.

The FHFA also countenanced the “inverse floater” trades, an official with the agency told ProPublica and NPR. DeMarco, the cipher in charge of this oppositional and dysfunctional agency, has fought like crazy against expanding refinancing for underwater homeowners and principal forgiveness, even though such steps could help Fannie and Freddie dodge the long-term losses they simply haven’t yet acknowledged.

Washington heavyweights from Treasury Secretary Tim Geithner to Fed Chairman Ben Bernanke would love to see DeMarco sent packing, but the law authorizing the FHFA allows the president to fire him only “for cause,” generally implying some sort of misconduct or malfeasance.

The “inverse floaters” revelation is close enough, for government work. President Obama should remove DeMarco—if only for his many sins of omission—install a more pliant deputy, have him offer the underwater homeowners much more meaningful relief, and let Congressional foes sue if they want.

We the people own Freddie and Fannie. We employ the traders hoping to profit from the unfortunates paying 7% underwater mortgages forever. We might as well act like it.

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