Freddie Mac and Inverse Floaters
By Arnold Kling
A new scandal from reporters for ProPublica and NPR.
In 2010 and ’11, Freddie purchased $3.4 billion worth of inverse floater portions — their value based mostly on interest payments on $19.5 billion in mortgage-backed securities, according to prospectuses for the deals. They covered tens of thousands of homeowners. Most of the mortgages backing these transactions have high rates of about 6.5 percent to 7 percent, according to the deal documents.
The authors describe this as only being bad. It is bad for homeowners because it reduces Freddie’s incentive to refinance loans. It is bad for Freddie Mac because it means taking on more risk from these instruments.
There is another possibility. In its normal course of business, Freddie Mac buys mortgages and issues debt, giving it a duration mismatch. These inverse floaters seem to have negative duration, which helps to offset that mismatch.
The article does not discuss the duration issue at all. Instead, it acts as if inverse floaters were a pure speculative play by Freddie Mac, which I think is unlikely to be the motivation.
I do not know enough about Freddie’s overall hedging strategy to know whether or not it is doing a good job. But neither do the authors of the article. The real scandal here is the lousy journalism.