What does the architect of the Fannie Mae and Freddie Mac bailout think should happen with housing policy? Former Treasury Secretary Hank Paulson gives his two cents in a Washington Post op-ed today. Here's the heart of his recommendation:

Any entity that Congress creates to serve a public policy goal of reducing mortgage costs cannot also be driven by shareholder returns. We must eliminate the inherent conflict between public purpose and private ownership that was destabilizing to the GSEs. Congress could eliminate that tension by restructuring Fannie and Freddie to create one or two private-sector entities that would purchase and securitize mortgages with a credit guarantee explicitly backed by the federal government and paid for by the new entity. These privately owned entities would be set up like public utilities and governed by a rate-setting commission that would establish a targeted rate of return.

So he wants private firms that back mortgages and rely on an explicit government guarantee. That sounds an awful lot like the old system, but with one key difference. In Paulson's case, these private mortgage guarantors would pay for that insurance. It's like depository insurance, but for all mortgages. Good luck with pricing those guarantees. After all, the government has done such a smash-up job of understanding mortgage risk in the past -- what could go wrong?

In fact, this is similar to the plan a couple Georgetown economics professors offered back in May. As explained here, so long as the mortgage market's risk is a burden borne by U.S. taxpayers, a subsidy is unavoidable. Without a subsidy, a government guarantee would be pointless.

Until someone can explain why mortgages must be guaranteed by the government, it's hard to justify such plans. And since you don't find these sorts of housing market structures relying on government backstops outside of the U.S., there are plenty of counterexamples to choose from. If banks simply price the risk of default into mortgages, then there's no need for federal guarantees. Yes, mortgages would be a little more expensive, but then those who want to buy a home would pay that risk premium instead of all taxpayers.

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