Freddie Mac’s Feckless Foray Into Second Mortgages

In 2008, as Senate staff, I helped create a statutory process for Freddie Mac’s regulator to approve or disapprove new products or activities. The process was not meant to be burdensome but instead transparent. It was also meant to ensure that any new products did not conflict with the safety and soundness of either Freddie, Fannie, or the mortgage finance system.

The current proposal fails on that account. As of Q1 2024, Freddie Mac backs almost $3.5 trillion in mortgages. Yet its net worth, or capital, to absorb losses from those mortgages stands at just over $50 billion. That’s leverage of almost 70 to 1. That’s twice the leverage of Bear Stearns in the quarter before its failure in Spring 2008. Make no mistake, Freddie Mac, today, is dangerously leveraged and does not have the capital on its books to support the risk it is currently taking. Responsible supervision calls for shrinking Freddie’s footprint, not supporting an expansion.

The second mortgage and home equity loan market are already adequately served by existing and far better capitalized, lenders. In fact, commercial banks, the primary lender in this market, are experiencing historically low loan to deposit ratios, indicating significant balance sheet capacity to serve this market. It appears the primary reason for the proposal is to benefit not homeowners but nonbank mortgage lenders. I’m not without sympathy for nonbank mortgage lenders, given the depressed state of their business, but to approve this product is to pass along the losses knowingly and intentionally to the American taxpayer.

Perhaps even more puzzling is that the Biden administration only a few weeks ago asserted that nonbank mortgage companies were a potential risk to our financial system, going as far as to call for a Congressional backstop for such lenders. Many of the risks raised by the administration are real and of concern. Yet, if such risks are real, why also propose an expansion of those risks via a Freddie Mac second mortgage product?

If the real purpose of the proposal is to protect borrowers from churning by mortgage lenders, a concern I share, then I would encourage Freddie Mac, and Fannie Mae, to adopt the net tangible benefit test for refinancings that I developed with then Fannie Mae Board Chair Sheila Bair. The reversal of that policy, after my departure, left borrowers vulnerable to equity stripping.

A major contributor to the 2008 mortgage crisis was the continued stripping of equity from mortgage borrowers via refinancings and second mortgages. These practices left many families owing more on their mortgages than their homes were worth. While Freddie promises this new product would still leave borrowers with sufficient equity, 2008 should remind us that home values can fall fast and far. As we are also clearly passing the peak of home prices this cycle, we should not encourage borrowers to reduce their home equity, their safety net, just as the waters are possibly about to get choppy.

Before the mortgage industry starts counting its profits, from dumping this risk onto the taxpayer, consider that, even if approved, this product would likely end under a new administration. Hopefully, the Biden administration will reject another one of Freddie’s feckless forays.