U.S. Treasury Secretary Henry Paulson forced Freddie Mac and Fannie Mae, the two government-sponsored enterprises that manage much of the American mortgage market, into conservatorship Sept. 8. Combined, the two entities hold — either directly or through securities — a $5.4 trillion chunk of the mortgage market, roughly half of the total. It should come as no surprise that the American housing market is not having the best year. While prices have stabilized in a few locations (and prices in some locations never fell), the bottom has yet to be seen in the country's most leveraged locations, such as Florida, Nevada and California. All told, some 9 percent of U.S. mortgages are in a degree of trouble, with 18.7 percent of subprime loans now delinquent (90 days or more behind in payments). One bright shaft of light is the ongoing strength of prime mortgages, the bulk of the market; only 3.9 percent of primes are in delinquency. While this figure is roughly double the norm, it is far from catastrophic. Fannie and Freddie (colloquial names for the Federal National Mortgage Association and Federal Home Loan Mortgage Corp., also called "the twins"), holding as they do half the total, are the housing problem in concentrated form. Despite their size, the twins are in many ways more fragile than much smaller institutions. First, the U.S. Treasury has of late encouraged the twins to become more involved in the subprime mortgage issue in order to take some pressure off the market. Second is an issue of capital. When a loan held by a bank goes bad, the bank can use some of the money it has on hand to write off the asset. The twins — since they do not make the loans themselves and have no depositors — do not have an alternative income stream that they can tap for this (the twins' primary source of income is packaging mortgages for sale as securities, and charging a fee for the service), so they have to go to the market and issue bonds if they are to repair their balance sheets. Paulson decided to force the twins into conservatorship because they have proven unable to find interested investors. No new cash plus too many bad loans means that the firms responsible for keeping the American mortgage market moving were about to go bust. No one — least of all the Treasury Department — seems to believe that this is a permanent solution. Ultimately, the government will need to decide whether to nationalize the sector as a whole, nurse the twins back to health with capital injections and then set them free again, or destroy them completely and allow the private sector to handle all mortgage business in the future. Regardless of choice, and particularly if the latter option is selected, this is a multi-year process. Assets amounting to $5.4 trillion is not one that can simply be disposed of quickly. The only applicable precedent is the savings and loan bailout of the late 1980s. At that time, the government set up a separate institution — the Resolution Trust Corp. — that took all of the assets, bundled them into chunks of similar quality, and auctioned them off to interested investors/buyers. The good news was that all of the loans were ultimately sold off, and most proved profitable (for the government and new owners alike). The bad news is that it took the government six years to feed all the assets — about 5 percent of gross domestic product (GDP) — to the market. The twins hold total assets of about 40 percent of GDP, which means this will be, at minimum, a decade-long transition, and that does not even take into account the fact that investors simply are not interested in many of the worst assets at any price in the current financial environment (if home prices are falling, it takes a great deal of bravery to purchase homes that are certain to be foreclosed on). Without a change in circumstance, therefore, the government will have no choice but to inject capital into the twins to write off the bad debts. Even assuming that the government is able to recoup half the value of these foreclosed homes at auction, that still comes out to a taxpayer bill of about $250 billion. And that figure assumes that things do not get any worse. Luckily, the U.S. government can do more than simply change circumstance; it can change the rules. The Treasury Department, working in league with the Federal Reserve and a sympathetic Congress, can directly alter the definition of what a "delinquency" is. They can loosen repayment requirements to buy breathing room for mortgagees who are putting forth a good-faith effort. They can use their influence over the financial markets to prompt a broad refinancing of some classes of mortgages so that they remain affordable. In short, they can tinker with the system to keep most of these distressed homeowners in their homes. So long as foreclosure is avoided, the bill remains (relatively) low — probably well below the $250 billion cited earlier — and most investors will be more interested in keeping the housing market as a whole afloat. Many investors will undoubtedly scoff at such interventionist measures, but it is unlikely that the banks and other holders of mortgages will be among them. The alternative for many of these loans is foreclosure; most players would prefer that they receive reduced income — and have a floor put under the housing market in general — than simply see their asset become nonperforming. The bottom line is, in one fell swoop, the government has taken direct or indirect control over half of the U.S. mortgage market, marrying ownership with the control to do something about the problem. The devil will, of course, be in the details, and doomsayers are correct in highlighting the problem's sheer scope. But if this spins out of control now, it will be from a lack of imagination — not a lack of tools.