Housing: The Next Federal Bailout - Daniel Gross

I found it tough to get excited about the first anniversary of the Lehman Brothers failure. That's because events in the weeks after Lehman's face-plant were more consequential, and much, much more expensive.

Last October, first responders—the Federal Reserve, the Treasury Department, the Federal Deposit Insurance Corporation, Congress—flooded into the financial sector. They deployed every weapon in their arsenal, and invented some new ones, to stanch the 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.

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) under a post-Lehman program. The 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 of money-market funds. With a single press release, it lifted a massive weight from the shoulders of taxpayers—$3.8 trillion in dollar bills weighs about 8.7 billion pounds.

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, 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 the subprime industry may sleep with The Sopranos, there's a new subprime lender in town: the First National Bank of You and Me. 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 should view the glass as half empty. 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." To use a martial analogy, we might declare partial victory after a surge. But we're not decommissioning the forces. We're just pulling them back over the horizon.

Back in 2006, the news that President Bush was reading Albert Camus's The Stranger sent policy wonks flocking to bookstores in search of existentialist works. Today, as we seek insight into our current predicament, we might turn to another such classic: Jean-Paul Sartre's No Exit.