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Friday, February 10, 2012 - 16:12

US Academic: GSEs Conflict Of Interest May Be Understated

WASHINGTON (MNI) - Conflicts of interest that face Fannie Mae and Freddie Mac were addressed during a Senate hearing Thursday and an academic suggested efforts to preserve their retained portfolios may sometimes conflict with other housing goals.

Christopher Mayer, a professor at Columbia Business School told a Senate Banking Committee during a hearing that "this is a very big concern," adding there is a "significant conflict of interest."

Mayer cited a recent report done by National Public Radio and ProPublica, which revealed that Freddie Mac created risky securities called inverse floaters which would continue to pay off as long as the loans underlying the security were not refinanced.

In response to the story, the FHFA said, "Of Freddie Mac's $650 billion retained portfolio, only $5 billion is held as inverse floaters."

During the hearing, Mayer said that statement may have understated the true impact of the securities and Freddie Mac's interest in its investments may be adding barriers for borrowers to refinance.

"I would not follow the conservators argument that this is $5 billion in a $650 billion portfolio so who cares," Mayer said, adding, "I think that argument is not right because these are derivatives so they are based on probably $26 to $30 billion of mortgages not $5 billion."

Further, in his written testimony Mayer dissected the FHFA's statement regarding the report, saying, "It is important to understand what the statement says and what it does not."

The FHFA in its statement said, "Freddie Mac's retained portfolio investment in inverse floaters did not have any impact on the recent changes to the Home Affordable Refinance Program (HARP). In evaluating changes to HARP, FHFA specifically directed both Enterprises not to consider changes in their own investment income as part of the HARP evaluation process."

However, Mayer points out that the statement does not imply that credit decisions prior to HARP 2.0, which was enacted last November, were not impacted by its portfolio.

"The statement does not deny that the conflict of interest between lending and portfolio management might have impacted Freddie Mac's past practices," Mayer wrote in his testimony, adding "the retained portfolio appears to be the only plausible reason to impose many of the lending restrictions that the GSEs have imposed over time."

The FHFA in its statement said that FHFA staff identified concerns regarding the inverse floater investments and that "FHFA and Freddie Mac agreed that these transactions would not resume pending completion of the examination work."

The report by NPR and Propublica also caught the eye of members of Congress and further raised already existing concerns over conflicts of interest that may exist.

Senator Robert Menendez on January 31 requested the Inspector General to investigate whether transactions done by the Fannie and Freddie are consistent with homeowners interests.

The of the conflicts of interest at Fannie and Freddie arise from the agencies two main businesses of guaranteeing mortgages while managing large retained portfolios.

The Federal Reserve in a January white paper wrote that "easing some of these obstacles could contribute to the gradual recovery in housing markets."

Mark Zandi, chief economist at Moody's Analytics who testified alongside Mayer on Thursday said, "I think it is very important for Congress to resolve Fannie and Freddie as long as they remain in conservatorship nothing good happens."

However, Zandi noted the many moving parts that still need to be worked out and the GSEs ongoing support of the housing market.

"The private residential mortgage securities market is dead in the water and that needs to be revived before we can resolve Fannie and Freddie," he said.

** Market News International Washington Bureau: 202-371-2121 **

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