What's to be done with Fannie Mae and Freddie Mac?

Right now, a cottage industry of analysts, lobbyists, regulators, financiers and elected officials is hard at work formulating a future course for the mortgage finance giants, which have been under government conservatorship since September 2008. White papers are now spewing from think tanks and trade associations, and the Treasury is set to issue its recommendations early next month, to be followed by a round of congressional hearings.

This is likely to become a noisy, ideological debate that reignites the old argument about whether Wall Street greed or Washington meddling is to blame for the financial crisis.

Most of the shouting is likely to come from free-market ideologues, including the House Republican leadership, which is determined to get the government out of the business of providing mortgage guarantees and sell Fannie and Freddie off in pieces.

These leaders will be opposed by a formidable coalition of home builders and community bankers, along with low-income-housing advocates and the Obama administration. Their view is that without some form of government guarantees, loan rates will rise, housing prices will fall and the 30-year fixed mortgage will disappear.

Whatever is decided will have significant impact on the national housing market and the economy. But the much bigger impact could be on the economy of the Washington region. Fan and Fred are among the largest private employers and the pillars of a much larger housing finance cluster that accounts for tens of thousands of high-paying jobs. They have helped to make Washington the capital of the secondary mortgage market and a growing center for banking, finance and asset management. If the conservative ideologues have their way, this engine of the regional economy will be dismantled and shipped north to Wall Street.

This issue belongs at the top of the priority list for the region's business and political leaders. The looming reduction in government spending already casts a menacing cloud over the area's economy, and the dismantling of Fannie and Freddie would be a body blow.

On the other hand, if the mortgage twins were to reemerge as private companies, they would generate hundreds of millions of dollars each year in additional revenue for the District (Fan) and Virginia (Fred) in the form of corporate-profit taxes, from which Fannie and Freddie have long been exempt under their existing federal charters. The fiscal benefits from luring Northrop Grumman's or Hilton's corporate headquarters look like chump change by comparison.

In the past, Fan and Fred needed little help managing their political risk and getting what they wanted from government. They were so good at it, in fact, that you could argue it led directly to their undoing. Now that they are wards of the Treasury, however, it is Fan and Fred who have become politically neutered, discredited in the minds of the public and barred by regulators from participating in the debate about their future. And you can be sure that Wells Fargo, Bank of America and the other big mortgage originators will spare no expense not only to preserve a secondary market in government-guaranteed mortgages but also to ensure that it is they - and not successors to Fan and Fred - that dominate it and capture most of its profits.

As Bethany McLean and Joe Nocera lay out in "All the Devils Are Here," their excellent history of the financial crisis, Wall Street has been trying to kill off Fan and Fred for 30 years, ever since Lew Ranieri of Salomon Bros. and David Maxwell of Fannie Mae pioneered the idea of combining mortgages into packages that are sliced and diced and sold as bonds to pension funds and German dentists. While Fan and Fred dominated the market for fixed-rate prime mortgages that carried a government guarantee, the Wall Street firms built up booming businesses creating and trading "private label" securities backed by variable-rate loans, jumbo mortgages and loans to borrowers with subprime credit ratings. In the end, it was Fan and Fred's desperate attempt to grab a share of this riskier and more lucrative market that led to their undoing and further inflated the subprime bubble. Now that the bubble has burst and the "non-conforming" market has all but disappeared, the banks have again set their sights on Fan and Fred.

As the debate unfolds, here's how things are likely to play out.

One role Fan and Fred have provided - indeed, the original reason for their existence - was to act as the buyer of last resort for mortgages when banks and private investors retreat, herdlike, from the market, which happens with some regularity. In the future, that role could be filled by the Federal Home Loan Banks and the Federal Reserve, as it was during the most recent crisis.

Fan and Fred, alas, weren't just buyers of last resort - they also bought aggressively when everyone else was buying, because it was an easy way to increase profits. In the future, their portfolio of mortgages and mortgage-backed securities will be gradually sold off, allowing the Treasury to recoup some, or perhaps all, of the cost of the government's rescue.

That still leaves the question of who will be in the business of packaging and securitizing mortgages. Most of the proposals envision a limited number of private, federally regulated firms that would be required to hold significant amounts of capital to cover losses from loan defaults that might result from a routine downturn in the economy or housing market. The big debate is over the extent of any government guarantees, or reinsurance, of extraordinary losses if and when the capital of the issuing firms is depleted.

Two other issues, however, are of vital interest for the Washington economy.

One is whether Fan and Fred will be liquidated, their valuable software and databases and customer relationships sold to to Wall Street vultures, or whether the existing enterprises will be able to raise new capital, find new names and emerge as two of the chartered players in the new secondary market.

The other question is whether the big banks that already have big businesses originating mortgages will also be allowed to vie for one of the securitization charters.

If they are, it's a sure bet that the big banks will cleverly use their presence in both markets to gradually drive out competitors in both the secondary market - including Fan and Fred - as well as in the loan origination business, which is of particular concern to regional and community banks.

In Congress, two Republican House members from Virginia will be key players in this fight: Majority Leader Eric Cantor and Robert Hurt, vice chairman of the subcommittee with jurisdiction over Fan and Fred. Virginians might want to ask them why they want to rob their state of jobs and hundreds of millions of dollars in annual tax revenue and ship them up to Wall Street.

In the meantime, the Washington business community might want to rally behind other ideas for restructuring the mortgage finance market, lest Republicans succeed in unnecessarily destroying two of the region's most valuable enterprises.