Loan Rangers.(The Talk of the Town)(Fannie Mae and Freddie Mac)

Just before the start of last week's All-Star Game, Jim Bunning, a Major League Hall of Fame pitcher and, for the past decade, Kentucky's junior Republican senator, served up a high inside fastball to Treasury Secretary Henry Paulson, who was on Capitol Hill defending the Bush Administration's latest effort to bolster the ailing financial system. Cutting Paulson off in mid-sentence, Bunning said, in effect, Mr. Secretary, come next January, you will be gone, but some of us will still be here, and we will have to pick up your tab. I, for one, am not willing to give the federal government a blank check.

Bunning was objecting to Paulson's proposal that Congress empower the Treasury Department to lend an unspecified, but presumably vast, sum of taxpayers' money to Fannie Mae and Freddie Mac, the two troubled mortgage lenders. Bunning's financial logic was questionable--given that the lenders own or guarantee mortgages worth about five trillion dollars, letting them go under is not an option--but his political point wasn't. Policymakers now face a series of decisions that will determine not merely the fate of this particular cycle but the nature of the federal government's role in the economy for the next generation.

In a political system as balkanized as ours, it is only in moments of genuine danger that meaningful reforms get enacted. The economic malaise of the nineteen-seventies facilitated the Reagan revolution. The budget crisis of the late nineteen-eighties persuaded first George H. W. Bush and then Bill Clinton to adopt some fiscal discipline, and Congress to go along with them. In some ways, the current situation is more alarming than either of those, but, so far, neither of the Presidential nominees has taken up the call for appropriately bold measures. The best that can be said of John McCain's economic plan is that it remains a work in progress. Barack Obama has advocated a second stimulus package, together with more aid for struggling homeowners, but the rest of his program was largely put together before the current downturn began.

When the subprime squall swept through Wall Street, last summer, many described it as a "liquidity crisis," by which they basically meant that, although lenders and investors were too traumatized to put their money at risk, the financial system remained fundamentally sound. Today, we are facing something far more serious: a crisis of solvency. Having lent trillions of dollars to homeowners, developers, and condo-flippers who were busy inflating the largest housing bubble in recent American history, many financial institutions are saddled with huge bad debts. The I.M.F. has called the mortgage imbroglio "the biggest financial crisis in the United States since the Great Depression.'' Moreover, the banks' growing reluctance to extend more credit to their remaining customers risks making the situation even worse. Such downward spirals are what turn slumps into depressions.

The government's response has been to lend to the banks--openly through the Federal Reserve, indirectly through the Federal Home Loan Banks. But lending is only a temporary solution; unless the housing market improves, more drastic measures will be needed. Specifically, the federal government may have to take over the loan books of many stricken institutions, separate the good debts from the bad, sell off the latter to bottom-feeding investors, and recapitalize the businesses that remain so that they can go out and resume lending.

This is essentially what the Resolution Trust Corporation did ...