WASHINGTON — Since the government seized Fannie Mae and Freddie Mac in September, the debate over what to do next has focused on privatization or nationalization.

But with less than two weeks remaining in office, Treasury Secretary Henry Paulson encouraged policymakers on Wednesday to consider a third option: replacing Fannie and Freddie with private-sector mortgage guarantors regulated like utility companies.

His comments sparked a fierce debate about the future of the government-sponsored enterprises, with some arguing that Mr. Paulson's suggestion is a quick and easy solution and others calling it impractical.

"It is the easiest way out of the public-private conundrum," said Karen Shaw Petrou, the managing director of Federal Financial Analytics Inc.

David Shulman, a senior economist at UCLA Anderson Forecast, called Mr. Paulson's idea "intriguing" and said it could become part of the debate over how to reform the financial services sector.

"It solves some of the public-private issues," he said. "This is a reasonable way of thinking about it, where you retain Fannie or Freddie as a private entity and it's run more as an insurance company, which is more like what the original function was."

But others immediately raised concerns, suggesting that the idea is too extreme. Mr. Paulson said Wednesday that the two new entities should not have investment portfolios. Though Republicans have argued for much smaller mortgage portfolios in the past, having none at all struck some observers as going too far.

"What happens in 2050 when the market falls apart?" asked Paul Miller, an analyst at Friedman Billings, Ramsey & Co. "Then you won't have Fannie and Freddie to play the market again."

Jim Vogel, the head of fixed-income research at First Horizon National Corp.'s First Financial Capital Markets Corp., said it is a mistake to assume that the mortgage market can be regulated in much the same way as power companies.

"We have public utilities because of economies of scale in power and utility production and distribution and because everyone needs it," he said. "So you need a common capital pool to produce utilities. I'm not sure how mortgages fit into any of those economic categories unless we've just changed the whole nation's housing system."

The ultimate impact of Mr. Paulson's suggestion remains unclear. President-elect Barack Obama has not specified how his administration will approach Fannie and Freddie. House Financial Services Committee Chairman Barney Frank and Senate Banking Committee Chairman Chris Dodd did not respond to requests for comment Wednesday.

Mr. Paulson's speech to the Economic Club of Washington served as a reminder of the many policy challenges posed by the government's decision to seize the GSEs as the market began to crumble last fall.

Though privatizing the companies is "appealing," Mr. Paulson said, "it is difficult to envision a sound, practical, private-sector mortgage insurance business of any significant size that does not require large amounts of capital and, consequently, generates only a modest return on capital."

On the other hand, full nationalization "eliminates the necessary private-sector evaluations of credit risk and the private market stimulus to innovation," he said.

The best solution, he said, is "a public utility-like mortgage credit guarantor."

The new companies could be privately owned but regulated by a commission "that would establish a targeted rate of return," he said. This would eliminate the conflicting interests critics say the GSEs faced between their shareholders and their congressionally chartered mission, according to Mr. Paulson.

He also left the door open to using the GSEs to reduce mortgage rates to as little as 4%, though he said the government would have to issue "very large volumes" of Treasury securities to make that plan work.

"A targeted program such as one that purchases only new mortgages made for home purchases, as opposed to refinancing, for a one-year period would require less but still substantial funding," he said.

Mr. Paulson also said the incoming Obama administration could choose to work with Congress to explicitly guarantee the GSEs' debt so long as they are in conservatorship. Since the takeover, policymakers have engaged in a Kabuki dance of sorts over whether the government stands directly behind the debt issued by Fannie and Freddie.

Such an approach might be no better than the existing GSE structure, however.

"Developing risk-sharing parameters compatible with profit incentives," he said, "would be as problematic, and potentially as inefficient, as in the current GSE structure."

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