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October 2012
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Upside Down Refinance Plan of Freddie Mac Questioned

In a recent Eliot Spitzer article published on Slate, the question of why Freddie Mac did not address underwater mortgage refinancing sooner came up. It’s not like the government sponsored enterprise was unaware of the national crisis of depreciating house values. The truth is that Fannie and Freddie own a “lion-share” of the mortgages sold on the secondary market.

Spitzer questions the “inability to get underwater mortgage loans refinanced on a mass-level.” He asserts that this is one of the signature failures of economic policy of the past four years. In a fascinating and revealing story published by ProPublica on Oct. 25, Jesse Eisinger explains how several board members and executives of Freddie Mac, the now-taxpayer-owned mortgage giant, made essentially impossible to get a high volume of upside-down loans refinanced at the current interest rates. According to Eisinger, one of these board members, Robert Glauber, objected on the grounds refinance programs were “designed to be a stimulus.”

The particular issue in 2002 had to do with spinning, a process whereby CEOs and other senior executives at companies would be given personal allocations of “hot” IPOs by the investment banks underwriting the IPOs. Hot IPOs are those in which the stock is expected to jump when trading opens, and so an allocation leads to instantaneous trading gains—often very substantial in magnitude. Why did the investment banks give the executives this option? The companies run by the CEOs were good clients, and the banks wanted these companies to continue to direct business to the investment banks.

Spitzer believes that the practice had to stop, on the grounds that the particular behavior amounted to little more than commercial bribery. If the investment bank wanted to bestow a gift on the company to maintain the client relationship—something the bank is entitled to do—then the benefit should go to the shareholders, not the CEO. If the CEO takes it individually, as they do when they take the stock granted in a spinning allocation, it is just a fancy form of bribery. Indeed, my office recovered vast sums of money from CEOs on just this theory.

Read the original Slate article.



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