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The Bailout That's FailingThe federal rescue may have saved the banking sector, but it hasn't fixed the housing market.

By Daniel GrossPosted Friday, Sept. 25, 2009, at 9:50 AM ET

Last October, the Federal Reserve, the Treasury Department, the Federal Deposit Insurance Corp., and Congress deployed every weapon in their arsenal, and invented some new ones, to stanch the financial panic: loans, subsidies, direct bailouts, free money, the TARP. In so doing, they exposed taxpayers to massive immediate and potential liabilities. This year's deficit is projected to be $1.58 trillion. The Federal Reserve's balance sheet has swelled from about $880 billion pre-crisis to $2.1 trillion today. Add in the stimulus and all the other measures, concludes Nomi Prins, a former Goldman Sachs managing director and author of the bailout critique It Takes a Pillage, and the public could be on the hook for up to $19.3 trillion.

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Of course, that sum is hyperbolic, for some of the financial and fiscal troops deployed to quell the post-Lehman panic have already been recalled, and central bankers are talking about "exit strategies." Banks have paid back about $70 billion of the $200 billion of "investment" the government made through the TARP's capital-purchase program. In January, the taxpayers were guaranteeing some $350 billion in commercial paper (the vehicle through which companies borrow short-term funds). That balance is now down to $43 billion and falling weekly. "It appears that that market is functioning on its own," says Richard Bove, bank analyst at Rochdale Securities. The FDIC has proposed closing the Temporary Liquidity Guarantee Program, an October 2008-vintage plan under which it guarantees debt issued by financial companies. Most significant, on Sept. 18, the Treasury Department removed its year-old guarantee of $3.8 trillion in money-market funds.

The bad news? While the government has pacified the commercial finance, savings, and plain-vanilla banking sectors, it's sending reinforcements into the vast, restive region where the trouble began: housing.

After Lehman's collapse, the Fed plunged directly into home lending. It pledged to purchase huge quantities of mortgage-backed securities and bonds issued by Fannie Mae and Freddie Mac, the failed mortgage giants. "We're subsidizing housing more than ever," says Ken Rogoff, the Harvard economist and co-author of This Time Is Different, a fine new history of financial debacles.

The Fed's portfolio of mortgage-backed securities has risen from zero last year to $685 billion today. If they go bad, guess who pays? And while many subprime lenders have gone out of business, the federal government is now issuing huge numbers of subprime loans. During the go-go years, the Federal Housing Authority, the agency that helps lower-income people own homes by purchasing loans made by other lenders, found that its 3 percent down-payment requirement was (absurdly) too stringent. And so it lost market share. In the spring of 2006, the FHA accounted for about 9 percent of mortgages for home purchases, according to the Mortgage Bankers Association. In late August 2009, that figure had risen to 40 percent. Like subprime lenders of old, the FHA lends to people who can't always make their payments. In the second quarter, about 14.4 percent of the FHA's loans were at least one month past due. And since the FHA's cash reserves are already model-thin, it may need its own bailout.

Rogoff points out another reason we shouldn't be too sanguine about the banks' recovery. Now that the government has shown the lengths it will go to save bankers from their own mistakes, they'll have faith that it will do so again in the future. "The subsidy is now permanently in place," he says. "There's a sense in which we're not going to be able to exit from any sector completely."

Back in 2006, President Bush made news by reading Albert Camus' existentialist masterpiece The Stranger. Today, as we seek insight into our current predicament, we might turn to another such classic: Jean-Paul Sartre's No Exit.

A version of this article also appears in this week's issue of Newsweek.

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Daniel Gross is the Moneybox columnist for Slate and the business columnist for Newsweek. You can e-mail him at and follow him on Twitter. His latest book, Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation, has just been published in paperback.

COMMENTS

Maybe I'm simpleminded, but it seems to me that housing prices won't stabilize until an average person/family making an average income can buy an average house without having to use an exotic financial instrument that is ultimately unsustainable. There are a LOT of foreclosures that still have to work their way through the system, and as long as the mortgage holders (whoever the hell they are, it's not the people who made the loans in the first place, which is the whole problem) have no financial interest in keeping people in their houses, foreclosures will happen and housing will continue to decline or at least not rise. If the government were serious about stabilizing housing, they'd push through some sort of cram-down provision, to make the lenders take their lumps and move on. But they don't want to piss off the banks too much, so the slow bleed continues.

Works for me...I'm renting, hoping to buy when houses get cheap enough. Sucks for everyone else.

-- babybear
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I've been working as an assistant to a real estate agent lately, and no matter how you follow the trail it all goes back to the banks' lending practices. Some were downright predatory in hindsight - for example, I know of a homeowner who refinanced from a 140k loan to a 300+k loan with the same bank, all conventional (their home's market value now is maybe 160k). The bank did not give them any additional money on this refinancing, merely changed the terms and put a bigger number on paper. The homeowner's foolishness aside (what sort of fool would more than double their debt, even for somewhat lower payments or interest?), why is the bank doing this?

That's just one particularly severe example, and often the homeowners were just as greedy and mendacious. Some of them used their houses as ATMs. However, the bank, like the dealer in a casino, holds all the cards. The problem now is not limited to what has already been foreclosed on, there is a huge number of short sales (which must be approved by all lenders, and frequently the homeowners had more than one).

I don't know if there is any way to fix this - ideally the banks would have to write down their assets to market value and there would be much stricter terms on lending. But in the end you still have the issue of unemployment, which leads to foreclosures and short sales. Some things need to be renegotiated but borrowers need to have some sort of mandatory counseling to know what they're getting into, as it seems obvious that many of them have no idea.

To be honest, I am starting to think the root issue is the combination of a debt-based economy and the massive amounts of federal involvement in all parts of this. The combination of banks and government create a very messy situation - would housing have been such a bubble without FHA and the mortgage interest deduction? The banks are not the only ones at fault, the system is one where the government always has a very large thumb on the scale. Does this system make the so called "American Dream" with the house and car more accessible, or is this just putting us all in deeper debt?

There IS an exit, but that doesn't mean it isn't going to be painful. The question is who bears the pain, how, and when.

-- Adamatari
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