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This week, John Paulson has been the most active among the big banks, as investors look for signs of the housing recovery to pick up traction. Paulson is the head of Paulson & Co., the firm that owns Bear Stearns and Lehman Brothers and is the largest shareholder on the Securities and Exchange Commission.

In his most recent interview to date, Paulson, in which he called the housing market “one of the great bubbles,” described how the Federal Housing Administration had taken $1 trillion in toxic mortgage-backed securities off the market and returned a fraction of the money to investors during the housing downturn. The money was put to use on housing construction and lending. Paulson told Bloomberg News that the $1 trillion bailout and subsequent recovery of U.S. homeowners would be the “most significant single event” in U.S. financial history.

Why haven’t the big banks done better? The big banks are still in trouble, and even the government has noted that they are “overvalued.” To get the economy moving the big banks had to borrow a lot of money, which was hard on the system. That has helped the large banks and created the perception that the big banks are doing pretty well. Paulson says that’s not the reality, as “the reality is that the housing market is way overvalued. … We’re not seeing the impact of that investment. Most of it can’t be turned back.”

Why did the Federal Reserve buy these big banks? In 2010 the Federal Reserve began buying mortgage bonds from large banks, an effort to help get the financial system back on stable footing. The U.S. economy was doing far better under the Fed’s policies than any time before, and it was not enough that the Fed was buying the debt from the big banks for one year. The economy was improving rapidly and the Fed couldn’t stop the economy from growing. “The best we could do was stimulate the system enough to maintain that pace of growth and help it return to the growth that made the economy such a winner.” But by the time the housing bubble burst the economy was already in recession and it was clear that there was going to be a serious economic recovery. The only remaining issue was how to move forward from there.

Why did the Fed stop buying mortgages? The Fed stopped buying mortgage bonds in 2010. As you might imagine, this helped the banks and made a big dent in the housing market at the time because the big banks borrowed from some of the worst borrowers on the

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