Trouble at two linchpin mortgage companies is forcing Congress to consider a quick rescue package and in the process reviving an ideological debate about the US government's role in the housing market.
The questions are not merely theoretical. They include: Should the federal government, on top of its existing debt of about $9 trillion, become the explicit backer of home loans – to the tune of $5 trillion and rising?
That's the tally of loans owned or guaranteed by Fannie Mae and Freddie Mac. The two corporations blend private management with a federally chartered role to help an often-volatile mortgage market function smoothly. Despite the word "federal" in their original titles, the government does not explicitly stand behind either one.
In the ongoing housing crisis, it may have to.
With investors losing confidence in Fannie and Freddie, politicians of both parties agree there's little choice but to make sure the firms don't fail – or even approach the brink. Where lawmakers don't all agree is whether that should mean a perpetually larger federal responsibility in the housing market.
"There are certainly a number of different possibilities, rising from outright nationalization to privatization and breaking them up," Federal Reserve Chairman Ben Bernanke said in a congressional hearing this week, summarizing the options. "My main hope is that you'll come to a good consensus and get legislation out."
The most politically feasible choice, analysts say, involves neither dismantling the duo nor turning them into state entities. Among the voices supporting that course is Mr. Bernanke's own.
"I think the right solution is to keep them in their current form but to provide very strong oversight that will ensure adequate capital going forward," he said at the hearing after being asked for his view.
The Bush administration seeks congressional approval for two temporary measures: expansion of an existing line of government credit available to Fannie and Freddie, and permission for the US Treasury to become an investor in the firms if needed. The second move would raise capital so that Fannie and Freddie can cover loan losses and remain in a healthy operating position.
Share prices of the enterprises plunged during the past year, a sign that attracting fresh investor capital will be difficult.
Still, the rescue plan must run a kind of ideological gantlet. Some conservatives oppose the already large role that Fannie and Freddie, as creatures of US intervention, play in the private sector.
Meanwhile, House Democrats have moved to attach the measure to a larger housing bill.
Perhaps the most contentious issue is whether the Treasury should have no limit on the size of any capital infusions to the so-called government sponsored enterprises (GSEs).
Treasury Secretary Henry Paulson used a colorful analogy in making his case to skeptical lawmakers this week. He argued that having the "bazooka" (no limit) would make it less likely that a loss of investor faith would force the Treasury to invest at all. A limit would constitute handing the Treasury a "squirt gun" to deal with the crisis, he argued.
Much is at stake. Some $1.5 trillion in GSE or government housing-agency debts are held by foreigners, and a crisis of confidence in that debt could add weakness in the value of the US dollar. If the GSEs were forced to shrink their mortgage operations, meanwhile, it would disrupt a housing market still slogging through what may be its toughest downturn since the Depression.
"What happened in the past, that is water under the bridge," says economist Ken Mayland of ClearView Economics in Cleveland. "Now we've got to figure out what's right for America and homeowners and the mortgage market in the current situation."
Still, many conservatives hope the current debacle will prompt Congress to reconsider backstopping the GSEs.
"The Treasury secretary is now asking for a blank check to buy as much Fannie and Freddie debt, or equity, as he wants," complained Sen. Jim Bunning (R) of Kentucky on Tuesday. "The Fed purchase of Bear Stearns assets [in March] was amateur socialism compared to this. And for this unprecedented intervention in our free markets, what assurances do we get that it will not happen again?"
Critics also point to accounting scandals and political connections of top GSE executives over the years as signs of the risks of blurring the lines between public and private sectors.
"Fannie Mae and Freddie Mac are very clever players within the Washington circuit," says Peter Van Doren of the libertarian Cato Institute. "In the good times, Congress resists strenuously any attempt to rein them in."
He's an advocate of shrinking their role in the housing market. This may be politically possible, he says, if voters assess the GSEs' costs as well as their benefits.
A chief cost, some economists say, is the risk that their size is so large that it puts the government in the position of needing to bail them out.
.But others see substantial benefits.
"If you look back at the history of housing finance..., things have gone well when there's been a strong presence,... direct or indirect, of the federal government," says Dan Immergluck of the Georgia Institute of Technology in Atlanta.
A key public benefit of Fannie and Freddie, housing experts say, is to reduce volatility in mortgage markets. By buying loans or guaranteeing them for resale, the companies have enabled loans to keep flowing in the past year, at a time when other parts of the mortgage business have been all but shut down.
• Staff writer Gail Russell Chaddock contributed to this story.