Lions and Tigers and Mortgages

A recent story by NPR breathlessly reports that Freddie Mac is profiting from the continued troubles in the housing market. They reported that the mortgage giant retained interest in some mortgage derivatives while selling off the super-safe portion. If mortgages refinance more slowly, these bonds do well. And of course, Freddie has tightened their credit standards over the past couple years. So doesn’t this represent a conflict-of-interest?

On the face of it, yes. Owning derivatives that benefit from lower prepayments when you set underwriting standards that permit or deny prepayments for millions of homeowners is a conflict. It looks lousy—and demonstrates the political tin-ear that the mortgage giants have often displayed to the world.

But there are many reasons to own these securities. One reason could be that you can’t sell them. When an originator slices and dices mortgages into various pools, some can be left over. With interest rates at record lows and defaults running high, it might be pretty hard to sell tranches that lose money if prepayments accelerate. So Freddie might have to hang onto them.

Also, the analysis of underwriting overstates Freddie’s control of the market. Fannie Mae is much larger; banks also underwrite a significant portion of the market for their own portfolios. Underwriting standards are part of the competitive banking landscape. If Freddie is too restrictive, they’ll lose business to someone else. Could a .6% portfolio position lead them to tighten them? Not likely.

Once you look at the details, you see a lot of reasons to own these bonds that have nothing to do with profiting from keeping borrowers in “mortgage jail.” Owning the bonds may be foolish, but it isn’t evil.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By | 2014-09-09T16:52:30+00:00 January 31st, 2012|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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