Fannie/Freddie Rule Change

More on the screw the prudent front...
http://finance.yahoo.com/expert/article/business/73923

U.S. government-chartered mortgage companies Fannie Mae and Freddie Mac can raise up to $20 billion in capital, according to their federal regulators. The Office of Federal Housing Enterprise Oversight (OFHEO) agreed last week to lower the amount of capital reserves held by the companies to 20 percent, from 30 percent, in a bid to shore up the housing market. (Reuters) Fannie and Freddie own or guarantee almost half the $11.5 trillion in U.S. residential debt. The $20 billion figure is at "the top end of the range," said OFHEO director James Lockhardt. "We felt at this point it was important to add liquidity to the mortgage market."

The classic way to keep people from making rational decisions is to constantly change the rules on everyone so that no one knows what is rational. In fact, decisions that were formally rational can instantly become irrational with a quick rule change. Take for instance the case of the poor shmuck, Ryan Parker of Alabama. When considering what type of mortgage loan to obtain two years ago, he was informed that he could either take a 30-year fixed rate mortgage or a fancy new 3-1 ARM which would LOWER HIS PAYMENTS! Well he, looking at the current credit/mortgage market thought to himself, "Hmmm…with all of the lending being done right now, Freddie and Fannie (who have capitalization requirements mandated by the government) may soon be tapped out. In that case, they will most likely be unable to offer lending on more mortgages. Which will lead to higher mortgage rates as banks have to guarantee mortgages themselves instead of being able to sell them off to Freddie or Fannie. That means mortgage rates should rise. Which means that an ARM would adjust up. Most likely even HIGHER than the fixed rate I can get now." Being the prudent and rational gentleman that he his, Mr. Parker went with the 30-year fixed mortgage.

Well, two short years later, Mr. Parker is viewing a sudden credit crisis and the rising interest rates that accompany such crisises with satisfaction because his initial thought has come to fruition. Freddie and Fannie are in fact tapped out and mortgage rates are in fact rising and people holding ARMs will in fact have to pay higher rates than Mr. Parker's fixed-rate mortgage. "Phew!", he thinks to himself patting his forehead. But wait! What's this? Freddie and Fannie aren't in fact tapped out? But why? How? Well, it turns out that those government-mandated capitalization rules weren't in fact rules but whims and can be changed at the drop of a hat. Mr. Parker's elation turns to regret. He is suddenly confused. "Why have capitalization requirements at all?", he thinks to himself. "To reduce risk" is the answer that he finds out after some study of the issue. "But, wait, has the risk associated with Fannie and Freddie been reduced so that lower capitalization requirements are justified?", Mr. Parker thinks. Well, no. Rather, with sinking real estate values across the country the risk has in fact INCREASED! So, shouldn't Freddie and Fannie be required to INCREASE their capital reserves instead of the opposite? No, see, the risk has been transferred from them so their risk is in fact lower than it used to be. "Where did the risk get transferred to?", asks humble Mr. Parker. Well, to the government or, rather, taxpayers. Or, more specifically to, well….you, Mr. Parker. See now, thanks to a rule change, not only do you pay a higher mortgage than your neighbor down the street with the ARM but you also are subsidizing his loan by paying his risk premium to the IRS every year. All that is left if for Mr. Parker to weep bitter tears of disappointment for so foolishly choosing the 30-year fixed. Poor fella'.