The New York Times had a disturbing story today on one element of the housing bailout plan Rep. Barney Frank (D-MA) plans to have on the floor by Thursday. The heart of Frank’s plan is the authorization of the Federal Housing Administration (FHA) to assume billions of dollars in new risk in order to artificially prop up correcting housing prices. We’ve already covered how dangerous this idea is since the FHA is already teetering toward insolvency due to bad loans just like the ones Frank now wants them to take on, but it gets even worse.

In addition the FHA program, Frank’s bill also permanently increases the cap on loans that can be sold to Freddie Mac and Fannie Mae. This move, if effective, would be a huge boon to wealthy Americans while doing nothing for middle-income home owners. But as the Times reports today, the temporary raised limit isn’t translating into any help for even wealthy borrowers. The problem:

The reason has to do with the way loans are sold and securitized. Conforming loans carry a lower interest rate in part because lenders can package and sell those loans as mortgage-backed securities directly to either Fannie Mae or Freddie Mac or to private investors who know that the housing finance agencies can buy them later. And some of those loans can be sold even before they are finalized because they qualify for the “to be announced” market that allows fixed-rate mortgage-backed securities to be traded freely as interchangeable commodities.

An influential trade group of the nation’s largest financial institutions, the Securities Industry and Financial Markets Association, recently made a key decision that some critics say has kept those rates from dropping. The association decided that loans above $417,000 — even those jumbo loans now considered by law as conforming — would not be eligible to participate in the “to be announced” market.

Sean Davy, a managing director at the trade association, said that lumping the new loans in with the smaller conforming ones could have created enough uncertainty and instability to drive up rates on the conventional loans.

But critics in Congress counter that lenders and the mortgage-backed securities industry have dragged their feet.

So to recap: The main cause of this whole housing blunder has been loose lending standards. The industry is self-correcting to tighten standards, but Congress wants to prop up artificially high housing prices so they are pushing industry to drop their own self corrective market fixes so that the tax payer can take on more risky bad mortgages.

This makes no sense at all. No wonder this bill is flying through Congress and will probably pass tomorrow.