Massive Bailout Planned For Banks

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As a result of all this government-sanctioned activity, total mortgage lending nationwide actually rose in the third quarter of 2007, according to Richard Iley, an economist at BNP Paribas. However, as he pointed out in a recent research note, simply increasing the volume of business was probably not the only goal. "It is no exaggeration to say that the mortgage market was effectively nationalized" in the third quarter, Iley wrote. "The F.H.L.B. acted as a forgiving lender of the last resort, providing the liquidity to sustain mortgage production while Fannie and Freddie acted as risk intermediaries of last resort with record purchases of mortgages."

The government lending operation prevented the mortgage industry from seizing up, but it didn't solve the underlying problems facing the housing market. The question is whether more drastic measures will be needed to help lenders as well as borrowers. For the past three months, the widely watched S&P/Case-Shiller home price index has shown prices sliding at an annual rate of more than 15 percent across the country, with bigger falls in some areas. One in five subprime mortgages is already in arrears, and the delinquency rate is rising. Even more worrying are recent developments involving products like option ARMs, adjustable-rate mortgages that allowed borrowers to make such small monthly payments that their loan balances sometimes increased. The Los Angeles Times reports that in many parts of California, delinquency rates on option ARMs have reached double digits. Even on old-fashioned fixed-rate loans, the number of foreclosures is edging up. "This is turning into a human calamity," says Lou Ranieri, the Wall Street veteran who in the 1970s helped found the mortgage-backed-securities market. "We are looking at numbers that start to rival the Great Depression in terms of people hurt."

In an election year, pressure for more action is sure to intensify. The stimulus package working its way through Congress includes a proposal to let Fannie and Freddie buy mortgages worth up to nearly $730,000.

Hillary Clinton advocates a 90-day moratorium on subprime foreclosures as well as allocating more federal money to alleviate the housing crisis by, for example, purchasing vacant properties and renting them to working families. Other candidates have their own proposals.

Alan Greenspan has pointed out that rather than going through the trouble of negotiating with mortgage lenders and imposing rate freezes, the federal government could just send checks to distressed borrowers, which they could use to meet their monthly payments. The former Fed chairman, a free-market conservative, backed the handout nonetheless: He said that if the government wanted to bail out struggling homeowners, this would be a more efficient and transparent way to go, which is surely true.

A similar argument applies to the quasi-governmental agencies. Instead of relying on Fannie, Freddie, and the F.H.L.B. to ease the credit crunch, the federal government might be well advised to intervene directly in the financial markets. One solution is for the Fed, the Treasury Department, or a new official entity to buy large amounts of mortgage-backed securities, collateralized debt obligations, and other distressed paper from financial firms at bargain-basement prices. By purchasing these assets at a discount, the government could ensure that companies pay heavily for their reckless behavior, while also injecting much-needed liquidity into the system.

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