The U.S. government's role in housing finance should undergo fundamental change, but it should still provide some guarantees in the mortgage market, Treasury Secretary Timothy Geithner said on Tuesday.

Setting the stage for what promises to be a long debate about fixing Fannie Mae and Freddie Mac, Geithner convened a conference of housing industry leaders and heard a range of ideas about reforms for the $10.7 trillion mortgage market.

Almost two years after the government seized Fannie and Freddie to save them from collapse, there is a widely held view that reform is needed, but the agreement ends there.

It's safe to say there's no clear consensus yet on how best to design a new system. But this administration will side with those who want fundamental change, Geithner said.

Fannie and Freddie -- recipients of $150 billion in taxpayer bailout money since being taken over by the Bush administration in 2008 -- pose a vexing policy challenge to the Obama administration as November elections approach.

The firms' pursuit of growth and profits helped precipitate the financial crisis of 2007-2009, but their vast resources also helped minimize its impact. And since their takeover, the two have only become more prominent in the market.

Together, the two companies and the Federal Housing Administration now back 90 percent of new U.S. home mortgages.

We will not support returning Fannie and Freddie to the role they played before conservatorship, where they took market share from private competitors while enjoying the perception of government support, Geithner said.

We will not support a return to the system where private gains are subsidized by taxpayer losses.

But Geithner backed some government guarantee for mortgages and U.S. support for housing more broadly, setting early limits on the reform discussion.

There is a strong case to be made for a carefully designed guarantee, he said. The challenge is to make sure that any government guarantee is priced to cover the risk of losses, and structured to minimize taxpayer exposure.

As the administration works to draft a housing overhaul by January, the key question, Geithner said, will not be whether government has a role to play in supporting the mortgage market and the American dream of home ownership.

In Geithner's view, government has a key role since private markets, as shown in the 2007-2009 credit crunch, left to their own devices, find it hard to resolve financial crises.

NEW MODEL SOUGHT FOR FANNIE, FREDDIE

The conference, including some of the mortgage sector's top lenders and investors, was billed as a listening session to help the administration develop its overhaul plan.

It comes amid signs of persistent weakness in housing markets -- an issue that could weigh on voters headed to the polls in November, especially in Florida and California.

Housing starts nationwide rose in July from a downwardly revised level in June, but the pace of new construction was much weaker than forecast and permits for future building fell to their lowest level in more than a year, according to a U.S. Commerce Department report on Tuesday.

A Deutsche Bank study looked at mortgage delinquency rates in the country's 435 congressional districts, all of which are up for grabs in November. More than 15 percent of mortgages were delinquent by 90 days or more in 60 of those districts, with Florida and California accounting for 44 of them.

The average U.S. congressional district had more than 9 percent of its mortgages delinquent by 90 days or more -- over 2-1/2 times the delinquency rate on Election Day in 2008.

Bill Gross, co-founder of Pacific Investment Management Co., which operates the world's biggest bond fund, told the conference the administration should move quickly on a new refinancing program for current mortgages backed by Fannie and Freddie.

The U.S. economy is approaching a cul-de-sac unless a positive fiscal stimulus comes soon, he said.

This home financing to my way of thinking ... where you take 5, 6 and 7 percent mortgages and turn them into 4 percent mortgages, basically will provide a crucial stimulus of $50-60 billion in consumption, as well as potential lift of 5-10 percent in terms of housing prices.

He later told reporters he does not expect the administration to do anything like the large-scale refinancing effort he mentioned.

NO CLEAR CONSENSUS-GEITHNER

With Congress focused on elections in November, federal spending coffers depleted and nerves on edge about avoiding another housing crash, lawmakers looked unlikely to take on a housing finance overhaul until 2011, analysts said.

Enthusiasm in some quarters for removing government from housing finance was certain to collide with the political reality that housing subsidies, such as the mortgage interest tax deduction, are deeply entrenched in U.S. economic life.

It is clear that the government should continue to play a very large role in the housing market, said Mark Zandi, chief economist at Moody's Analytics and a conference participant.

At the same time, he said, The housing market is, in my view, over-subsidized. ... We're not getting our money's worth. ... It's key for us to scale back the subsidies.

The problems and costs of Fannie Mae and Freddie Mac were not addressed in the sweeping Wall Street reform legislation approved by the U.S. Congress in July -- a yawning gap in the Democratic bill that Republicans have sharply criticized.

Bank and mortgage-backed securities investors are watching warily as the administration weighs options, ranging from full nationalization at one extreme to privatization with no government support at the other, and alternatives in between.

Opinions differ as to whether or not the federal government should continue in its role supporting the conventional mortgage market once all this crisis passes, said Mike Heid, co-president of Wells Fargo Home Mortgage.

Wells Fargo believes that the maximum use of private capital is essential, but we also believe that an explicit government guarantee will be required to ensure that there's reliable flow of mortgage credit, Heid said.

(Additional reporting by Lucia Mutikani, Dave Clarke and Emma Ashburn. Editing by Leslie Adler)

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