There is a huge reality gap between the happy talk about green shoots, banks passing stress tests, the rise in unemployment slowing -- and what's happening out in the real economy, especially if you take a close look at banking and housing, ground zero of the economic crisis. Credit remains tight for all but the most blue-chip borrowers. Despite the Fed's policy of keeping short term interest rates at just above zero, average rates on conventional 30-year mortgages, now above 5.5 percent, have jumped nearly a full point since April.

Last Wednesday, the FDIC quietly folded a program that was the centerpiece of Treasury Secretary Tim Geithner's effort to get toxic assets off the books of banks.

The program, whose details were unveiled in late March after six awkward weeks of delay while the administration worked out the details, included special incentives for what Geithner delicately termed "legacy assets." These are the junk securities on banks' balance sheets, mostly backed by sub-prime loans, for which ordinary buyers cannot be found.

The Treasury drafted the Federal Reserve to provide special loans, and the FDIC to run a pilot program to attract speculators to bid on the securities. All told, the government was prepared to put up 94 percent of the capital if private investors would put up 6 percent. Government would guarantee most of the losses, and split the gains 50-50.

The plan took Geithner full circle to something like the original strategy attempted by his predecessor, Treasury Secretary Hank Paulson, when Paulson came to Congress last September asking for $700 billion to buy up toxic assets from banks. But after Paulson got Congress to approve the money, he concluded that he couldn't make the original plan work. Instead, the Treasury pumped several hundred billions into the banks directly. The toxic assets stayed on the banks' books.

Now, Geithner's do-over seems to have collapsed, too. There are a couple of reasons why.

First, the government has bent the accounting rules to allow the banks to carry nearly worthless securities on their books at their nominal full value. The Wall Street Journal ran a terrific investigative piece June 3 on how the banking lobby and legislators of both parties pressured the Financial Accounting Standards Board (FASB) to suspend its rules requiring assets to be carried on banks' books at their current market value.

With this change, banks had no incentive to sell these deeply depressed securities at anything like their actual market value. So if a speculator, armed with Fed funding and a government guarantee against losses was prepared to take a speculative flyer in a bond by bidding, say, 30 cents on the dollar, the bank was not prepared to sell at less than 90. Hence, no deal.

Second, some hedge funds and private equity companies sniffed around these deals and concluded that they weren't worth the bad publicity or government scrutiny if the deals resulted in big windfall profits (the only kind that hedge funds pursue).

Cooking the books to inflate the value of depressed securities also explains how zombie banks like Citigroup could pass the government's "stress tests" with flying colors. Citigroup, which has depended on $45 billion in straight government cash and hundreds of billions more in guarantees, was found by the stress-testers from the Fed and the Treasury to need only $5 billion more to be adequately capitalized. This is, of course, preposterous if you value the junk on its books accurately.

So the banking sector, despite the pretty picture painted by the stress-tests and the banks' recent success in selling stock to investors reassured by the government's too-big-to-fail actions, remains weak. As a result, banks are hesitant to lend. And this weakness keeps dragging down the rest of the economy.

The flipside of weak banks is a depressed housing sector. Just as the administration chose bailout over government takeover of failed banks, the administration opted for an entirely voluntary effort to induce banks to refinance sub-prime and other mortgages that homeowners could not afford. The program, announced by President Obama February 18, aims to help at-risk homeowners keep their homes.

But the terms of the plan exclude the most hard-hit homeowners. Today, one homeowner in four owns a house worth less than the mortgage on it. However, you can qualify for a refinancing only if the home's value is within five percent of the value of the loan. In other words, if you have a $300,000 mortgage on a house valued at $250,000, forget about help. And you are also excluded from help if you are behind in your payments - the situation of most people who need help.

Worst of all, the program depends entirely on the voluntary cooperation of banks. The administration will spend up to $75 billion on inducements to banks to vary the terms of loans. But at this writing, well under 100,000 loans have been modified, out of the several million at risk of foreclosure. As a consequence, people continue losing their homes, depressing the value of other homes. The Times recently reported on a woman who heard about the administration, approached her lender, Countrywide (one of the worst sub-prime offenders and now part of Bank of America) and asked for a refinancing. The bank offered a new loan that would save the woman all of $79 a month, and in return the bank wanted $18,000 up front.

Basically, the banks seem to be viewing refinancings as new profit opportunities. The one stick in a plan full of carrots was a provision empowering bankruptcy judges, as a last resort, to vary the terms of a mortgage. The banking lobby went all out to kill this provision. In the end, twelve Senate Democrats voted against it, and the administration made no political effort to save it.

Rep. Alan Grayson of Orlando, one of the hardest-hit parts of the country in terms of foreclosures, tells the story of a woman with a $300,000 mortgage on a house now worth perhaps $60,000. She could afford the payments on a $60,000 mortgage. But the bank would rather foreclose, bear the expenses of carrying the house which will be at risk of vandalism and deterioration until is it is sold. The bank would actually be better off writing down the mortgage to $60,000 and allowing the woman to stay in the house. But few banks see it that way. In similar circumstances in the 1930s, the Roosevelt Administration created the Home Owners Loan Corporation, and the government refinanced mortgages directly. But the Obama administration prefers to work through the private sector, and the private sector is averse to refinancings in most circumstances.

Another progressive Member of Congress, Rep. Marcy Kaptur of Toledo, tells of cascading foreclosures in her district, where banks are selling foreclosed homes at a few cents on the dollar to syndicates of speculators, some from the very sub-prime lenders who caused the collapse. Rather than sell to local government or local non-profits, which want to keep people on their homes, the banks want to get a few bucks onto their balance sheets fast. The situation cries out for more effective national leadership, and the government's failure to provide that leadership means that the downward spiral in housing will continue.

The weakness of the mortgage relief program and of the banks' balance sheets have one big thing in common--an administration that is far too deferential to the big banks. For the crisis to be solved soon, rather than lingering on and on, we need direct government refinancing of mortgages, and direct government restructuring of zombie banks.