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OIG Says No Conflict of Interest in Freddie’s Hedging

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The Federal Housing Finance Agency Office of Inspector General has dispelled claims the Federal Home Loan Mortgage Corp. was making bets to profit when borrowers were unable to refinance.

The allegations about collateralized-mortgage obligation trades were first made in a January story co-published by ProPublica and National Public Radio.

Inverse floaters enabled Freddie Mac to use the CMO structure to finance mortgages from smaller sellers and to sell portfolio loans, FHFA said at the time.

But the news story said that the transactions gave Freddie an incentive to keep borrowers in high-rate mortgages.

FHFA noted that Freddie stopped retaining inverse floaters in December 2011, though ProPublica claims that the practice continued until January 2012.

At the request of Sen. Robert Menendez (D-N.J.), the inspector general conducted its own investigation and found nothing wrong with what Freddie was doing.

“FHFA-OIG uncovered no evidence that FHFA or Freddie Mac obstructed homeowners’ abilities to refinance their mortgages in an effort to influence the yields of the inverse floating-rate bonds that the enterprise retained in its investment portfolio,” the inspector general’s report stated. “Inverse floaters represent a small portion of Freddie Mac’s capital markets portfolio.

“To the extent that a tension exists between Freddie Mac’s refinancing and investment policies, inverse floaters are no more likely to adversely impact mortgage holders or discourage borrower refinancing than any of the mortgages or other assets that Freddie Mac holds for investment.”

The report noted that Freddie has an “information wall” in place to prevent its capital markets business from using non-public refinance information to make investment decisions. No evidence indicates that the “information wall” has been breached.

The inspector general recommended ongoing supervision of Freddie’s hedging activity.

But ProPublica reporter Cora Currier wrote today that the inspector general didn’t evaluate the information firewall.

“The inspector general relied on the word of employees it interviewed and conducted no further investigation,” Currier wrote. “It also reported that the agency that oversees Freddie has not tested the firewall’s integrity.”

ProPublica cited a statement from Freddie to the Securities and Exchange Commission indicating that selling floating rate securities enabled it to reduce its balance sheet. But most of the officials from Freddie and FHFA who were interviewed by the inspector general said that reducing its balance sheet was not the motivation for Freddie to create inverse floaters.

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