The government should continue to play a role in any new system of housing finance Congress develops, Treasury Secretary Timothy Geithner told lawmakers on Tuesday as they began to debate an overhaul of the way Americans buy their homes.

Despite the need for some government role, mortgage finance giants Fannie Mae and Freddie Mac should not be fully nationalized, the Treasury chief said.

I think there is a quite strong economic case, quite a strong public policy case, for preserving, designing some form of guarantee for the government to help facilitate a stable housing finance market, Geithner told the House of Representatives Financial Services Committee.

Geithner said the central role the housing sector plays in the U.S. economy and its vulnerability to financial shocks justified a degree of government backing.

I think we will be likely to conclude, as our predecessors have, that there will be some role for a guarantee of some weight, he said.

His comments follow a call by Republican lawmakers to phase out the two the two government-sponsored enterprises, Fannie Mae and Freddie Mac, and replace them with a housing finance market where private capital is the primary source of funding.

The panel, chaired by Representative Barney Frank, is looking at ways to improve the two mortgage finance companies seized by the government at the height of the financial crisis in 2008 as their losses on bad loans mounted.

We have two jobs here today. One is to figure out the best way to wind down Fannie Mae and Freddie Mac. But an equally important job is to decide what goes in their place, said Frank, a Massachusetts Democrat. You can't really tear down the old jail until you've built the new one.

The hearing marks a first step in what is expected to be a long debate on how best to build a system to ensure a liquid source of home mortgage finance.

The public bailout was supposed to buy time for policymakers to figure out what to do with the two entities. Fannie Mae and Freddie Mac own or guarantee about half of all U.S. mortgages and are critical to the housing sector and the entire U.S. economy.

In the year and a half since the firms were placed under government control, the Obama administration has been relatively mum on its plans for the future.

Representative Spencer Bachus, the panel's top Republican, called the lack of action creating a new system unacceptable.

Without reform, the bailouts will not stop, the housing market will not find its footing and the American economy will not recover, Bachus told Geithner.

The government has so far injected more than $125 billion into the two entities and is expected to continue, possibly providing as much as $200 billion by the end of the year as losses continue.

The Obama administration has pledged unlimited support for Fannie Mae and Freddie Mac, no matter how high their losses go.

Geithner laid out broad principles for reform and said the administration would eventually propose a comprehensive plan to overhaul the housing finance system.

The Treasury chief said any effort to overhaul the housing finance system should ensure that mortgage credit is widely available and should promote affordable housing, consumer protection and financial stability.

Any new system aiming to achieve those goals should have a diversified investor base, accurate and transparent pricing, secondary market liquidity and clearly defined goals and objectives, he said.

I suspect we are going to find very strong support for reform, Geithner said. The challenge is going to be just to design something that we think is going to work better in the future.

(Reporting by Corbett B. Daly; Editing by Kenneth Barry)

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