Making Big Government a Little Smaller

For those not busy fleeing or fanning the flames of the Ground Zero mosque controversy, the week's big political event was a conference at the Treasury Department about the future of housing finance. Washington will soon make some big decisions that will go a long way toward determining who gets to own a house and how much they'll have to pay for it.

More than any other sector of the economy -- even banking or automobiles--the federal government dominates housing. After the collapse two years ago, it rescued the housing market by essentially nationalizing the mortgage giants Fannie Mae and Freddie Mac at a cost to taxpayers of $148 billion and counting. Today, Wall Street is back on its feet and automakers like GM are turning a profit. But government agencies still back 95 percent of new mortgages.

That's not ideal for anyone. Critics who prefer private markets fault the Obama administration for its continued involvement, while the bailout-weary White House would like nothing better than to satisfy them. But figuring out how government should extract itself and how the system
should be remade is a challenge so daunting that it was left out of the financial reforms that President Obama recently signed into law. Along with difficult questions of policy, overhauling the $11 trillion mortgage market involves confronting the most charged political issue in Washington: the proper size of government and its role in the economy. This is what a group
of luminaries from government, business, and academia undertook at the Treasury.

Ordinarily, liberals favor government and conservatives the free market, and it is along these ideological lines that the debate has played out on political and business cable channels. Since most conservatives would dissolve Frannie and Freddie, and most liberals would grudgingly allow them to, these agencies would not seem long for this world.
      
But at the conference, ideological purity yielded to practical self interest. It's an indicator of just how damaged the housing sector remains that the expected roles were reversed. Shaun Donovan, secretary of Housing and Urban Development, insisted that government had to shrink its ''footprint,'' and Treasury Secretary Timothy Geithner declared, ''This administration will side with those who want fundamental change.''
      
Meanwhile, any proposal entailing government's rapid departure from the mortgage market aroused nervousness, and even alarm, in the assembled financiers. Bill Gross, co-founder of the bond fund Pacific Investment Management Company, implored the government to keep its mortgage guarantee in place and pass another round of fiscal stimulus to prop up housing
prices. Without that guarantee, Gross warned, consumer rates would skyrocket as the risk of lending fell entirely on the market.
      
But the clearest glimpse of the long road ahead came during a discussion on how to manage the transition from the government-dominated market to a private one. No one could quite envision how such a transition would occur, but they did agree that it would take many years -- some thought a generation.
      
Still, it was possible to come away with a sense of how the world will look whenever that day arrives. Government's role will be diminished, although it will continue to support low-income housing, probably through the Federal Housing Administration. Fannie Mae and Freddie Mac will be wound down or consolidated into a single entity. The enormous housing subsidies that government currently provides will be cut, especially for high-income people, possibly by removing the guarantee of large mortgages.
     
''The market is over-subsidized,'' Mark Zandi, chief economist for Moody's Analytics, argued to the panelists. ''It's quite substantial and we're not getting our money's worth.'' But that won't happen anytime soon, he added, because the economy is too fragile.
      
Like voters who demand benefits but object to paying for them, the experts agreed that the private markets must step in, yet none seemed eager to recognize the consequences of their doing so: lenders and investors would be forced to assume more risk, which in turn would be passed along to consumers in the form of higher mortgage rates, and politicians would encounter an unhappy electorate and more pressure on the economy. The message seemed to be that change is coming -- but less radical and far more gradual than everyone has been led to believe.

Joshua Green writes a weekly column for the Boston Globe.