As recession looms, government slowly reacts

updated 3:09 p.m. ET Dec. 23, 2007

WASHINGTON - After a slow and stumbling start, official Washington is scrambling to try to prevent the unfolding mortgage crisis from pushing the country into recession during an election year. There is a strong feeling, though, that the government will need to do more to avert a financial disaster.

One former Treasury secretary advocates temporary tax cuts and emergency spending on the order of $50 billion to $75 billion. Such action could help the U.S. from slipping into what Lawrence Summers, who served under President Clinton, fears could become the worst downturn since the steep 1981-82 recession.

Some Republicans are worried, too.

From both Martin Feldstein, who was President Reagan's top economic adviser, and former Federal Reserve Chairman Alan Greenspan have come calls for deeper government intervention to deal with the threat.

Before it is all over, the government may have to resort to measures last used in the savings and loan crisis of the 1990s. Back then, it was a new agency to take over failing thrifts sunk by bad loans. Today, it could mean a government agency to buy up billions of dollars of mortgage-backed securities that investors are shunning.

The Bush administration thus far has opted for less dramatic measures. In fact, the administration came reluctantly to the biggest step taken to date — the "teaser freezer" announced two weeks ago.

A deal with the mortgage industry will freeze the low introductory "teaser" rates for five years on some subprime mortgages — loans to people with spotty credit histories. The rates were to climb much higher, making the mortgages unaffordable for many people and putting their homes at risk of foreclosure.

The hope is that this agreement will buy time for the housing market to rebound. That would make it easier for these homeowners to refinance to more affordable fixed-rate loans.

But estimates are that only about 250,000 people will end up getting a rate freeze — a fraction of the 3.5 million home loans that could go into default over the next 2 1/2 years.

The administration also is working with Congress to increase the $417,000 cap on the size of loans that the big mortgage companies Fannie Mae and Freddie Mac can handle. This step could help in high-cost housing areas such as California.

In addition, the administration is supporting legislation that would boost aid to lower-income homeowners by increasing the scope of mortgage insurance programs handled by the Federal Housing Administration.

These efforts may help at the margins. They do not, however, address one of the biggest threats to the economy: a spreading credit crisis triggered by the soaring defaults on subprime mortgages.

Some of the biggest names in finance have suffered multibillion-dollar losses as a result, and critical segments of the credit markets have frozen up. Banks and investors fear making further loans or buying securities backed by debt because they do not know how many more loans might go into default.

Ben Bernanke, facing his first major test as Fed chairman, is getting mixed reviews. The Fed was embarrassed when the credit crisis hit in August. That happened only two days after the central bank had decided to keep interest rates unchanged and declared that inflation was a bigger risk than weak economic growth.

The Fed has cut interest rates by a full percentage point since that time. But only the September cut — a bigger-than-expected one-half of a percentage point — elicited cheers on Wall Street. The two quarter-point moves brought about market declines as investors worried the Fed did not recognize the severity of the problem.

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