Mortgage rates have not been able to hold the early-week low at 5.875 percent, but are no worse than 6 percent for the lowest-fee deals.

The Fannie-Freddie takeover instantly knocked retail mortgage rates down 0.375 percent, but that’s been it. The sky-high spread versus the 10-year Treasury note has compressed from 270 basis points to mere cloud-height 235 basis points — but that’s still 70 basis points too high. I have argued all year that the spread was not a credit matter, instead an artifact of an insolvent banking system unable to leverage positions. I win, and wish I hadn’t.

Economic data are sliding all over the world. U.S. retail sales in August were the worst of the year, minus 0.7 percent excluding autos. Newly surveyed consumer confidence rose here, probably on cheaper gas, but anxiety and confusion among civilians runs deep.

To describe where we are today, begin with a review of the last year: In August 2007, the large end of the banking system suddenly froze. Sixty percent of total U.S. banking assets reside in the top 10 institutions, and the freeze came from sudden awareness that too many of those assets were bad. The bad ones were spread across all large firms, banks and securities dealers alike.

From August to early spring oil spiked from $90 to $145 while the housing bubble blew — one inflationary, the other deflationary. The Fed fought both threats: one by letting the credit freeze slow the economy, the other by slashing its interest rate and making massive loans to the banking system. In that August-March interval, most people thought markets would heal with the Fed’s help. Bottom would be found. The halfway point would be reached. Surely we were in a late inning. Then Bear Stearns blew, and the Fed again rescued the system — extraordinary action in its finest hour.

The political world was not ready. Post-Bear, Congress flayed Bernanke & Co. The average citizen and pol were more angry at perpetrators than in pain. Bailouts, big and inventive ones, never fly through Congress until pain exceeds anger. That moment came in August, the Fannie/Freddie takeover marking the moment. Except for a pair of legislators (Dodd, D-Conn.; Bunning, R-Ky.), congressional reaction has been "well done."

The hell of the politics of bailout: You can’t get permission until it’s really ugly, and then it might be too late.

In public and private messages the authorities now know that the banking system is beyond self-healing, is in a downward and self-reinforcing spiral, and traditional measures are exhausted. Ordinary rate cuts and discount-window lending will not fix the fundamental problem: "Capital" in the banking system is net worth and equity, and the large end of the system is just as underwater as too many homeowners. Truly extraordinary measures are required.

I think I hear the hoofbeats of cavalry. The Fannie-Freddie takeover was routine except for the astounding, plain-English word that the Treasury will begin to buy mortgage-backed securities to drive down spreads. Housing must bottom and it will require cheap credit.

We now know that President Bush, with striking courage at the end of a tough run, has backed Hank Paulson, will not kick the can to January, and will act as necessary in the middle of an election. Well done, indeed.

Lehman Brothers will not exist on Monday. It may be bought whole or in pieces, but it will not receive Bear-style federal assistance and may be liquidated (that’s my guess). It has had a year to sell itself, but the apparent massive arrogance of its CEO and fiduciary failure of its board have brought its end.

Then, right quick, showtime for the cavalry: WaMu, AIG, and several other banks and firms threaten a failure cascade. That spiral must be stopped. Right now.

And it must be done with as little federal cash as possible: T-bill yields are falling on credit fear, but bonds are losing value on fear of a bailout avalanche of Treasury sales. There is no way to know quite how (direct injection of capital, accounting fiction, glom wrecks into a giant workout zombie …), but the authorities have the will, the skill and support.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.

***

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