Freddie: Won’t Buy New York Subprime Mortgages

Mortgage finance giant Freddie Mac (FRE: 1.14 -1.72%) took the first step in what some industry experts expect could be a wider trend in key local markets, and said Tuesday morning that it will not purchase mortgages in the state of New York that fall under the state’s new definition of “subprime.”

“The state of New York has enacted legislation that creates a ’subprime home loan’ category of mortgages,” wrote vice president of customer outreach Patricia McClung in a memo to sellers and servicers. “Freddie Mac will not purchase New York mortgages with note dates on or after September 1, 2008 that fall within the law’s definition of ’subprime home loans.’”

The legislation in question, S.8143-A/A.10817-A, was touted by New York governor David Paterson’s office as “striking the right balance between consumer protection and the availability of affordable credit” when he signed the bill into law last week on Aug. 5.

Apparently, nobody asked Freddie (and likely Fannie) for their opinion on the new law before it was passed; and at the end of the day, Freddie’s move to halt purchases underscores what may become a larger issue as consumer advocates press for more restrictive legislation surrounding lending practices.

“Lenders will just decide to stop lending in certain areas,” said one source, a banking executive that asked not to be named. “We could end up with an entire class of borrowers that I call ‘the unlendables.’”

Freddie Mac said the state’s new definition of subprime, and the pending regulations tied to them, “creates the potential for heightened legal and business risk exposures for the purchasers or assignees of these loans.” Spokesperson Brad German told Bloomberg News the legislation in New York holds lenders liable “in ways we have no way of monitoring and preventing.”

In other words: don’t expect us to voluntarily drive into a bear trap.

HW’s sources suggested more such local market exits may yet be coming, as numerous states are looking to pass various reform packages championed by various consumer groups as needed to protect borrowers; lenders often see the new provisions as amplifying liability to an unacceptable level.

“This was a warning shot of sorts, I think,” said one analyst, that asked not to be named. “It’s sort of a stern reminder that the GSEs are also accountable to shareholders, that they have a private market mission as well.”

Try talking about shareholder accountability to the National Community Reinvestment Coalition: David Berenbaum, executive vice president at the Washington-based consumer advocacy group, would hear none of it and was frustrated over the announcement by Freddie.

“In a market that doesn’t have liquidity right now, it compounds the situation because it forces consumers to go to less responsible third parties,” he told Bloomberg News. “Fannie and Freddie have a responsibility to lead us out of this crisis as public chartered institutions.”

Berenbaum, of course, will want to rethink his statement: both Fannie Mae (FNM: 1.02 -0.97%) and Freddie Mac are, verifiably, chartered as private corporations. But his remarks nonetheless belie a larger struggle that we’ve written about in the past (”Viewpoint: Mortgage Mess Generates War of Entitlement“).

Related links: Freddie Mac seller bulletin

Disclosure: The author was long FRE and held no positions in FNM when this story was published; indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.