There is growing concern that the U.S. government handling of the current economic crisis is fomenting moral hazard and therefore arguably sowing the seeds of a future bubble. It all started with the Fed's decision to bail out Bear Sterns earlier in the year and followed soon after with the announcement of unwavering Fed and Treasury support for the country's twin government sponsored mortgage behemoths.
A quick glance at the sequence of events may give the impression that with the bailouts, the rewards have been grossly disproportionate to the risks taken during the heydays of the housing boom, but one would be naive to jump to such straightforward conclusions.
The reality on the ground is far more complex than it may seem. In the case of the Bear bailout, the Fed was concerned about the large number of open contracts the bank had with counter-parties. Its failure would have triggered systemic risk with profound economy-wide repercussions.
The mortgage institution pledges were also carried out in the same spirit, to avert systemic risk by nipping it at the bud. The government, it seems, is on a mission to buy enough time for the housing market to stabilize itself as it becomes increasingly clear that there are no effective tools in their arsenal that would effectively put a stop to the deflationary spiral (it will have to bottom out naturally).
Question is, do the institutions have enough power to keep the economy on life support long enough for housing prices to bottom out? After all, with the Fed's new discount window lending policy, its books are accumulating a growing amount of illiquid paper.
