As Congress returns from a July 4th recess to again consider a sweeping housing and mortgage reform package that would establish a new regulator for Fannie Mae (FNM) and Freddie Mac (FRE), as well as allow the Federal Housing Administration to endorse up to $300 billion in troubled mortgage debt, an economist at the St. Louis Fed is warning that government intervention might end up doing more harm than good.

Economist William Emmons said Monday that allowing “housing and mortgage markets to sort themselves out as quickly as possible, rather than intervening to prevent house prices and homebuilding activity from finding their natural levels,” represented the fastest way to long-term economic recovery. Capital markets in the U.S. have been battered in recent quarters as both housing and mortgages have deteriorated in tandem; Emmons’ comments appeared in the latest issue of a quarterly journal of business and economic issues published by the Federal Reserve Bank of St. Louis. Calling historic housing price declines observed during 2007 and continuing into 2008 “necessary from an economic perspective,” Emmons also argued that lenders must have the ability to seize a borrower’s property as collateral. Many local cities and counties have looked to stall the foreclosure process, or stop it altogether, as the number of foreclosures have risen and pressure from consumer groups has risen. “Without the possibility of foreclosure, mortgage rates would be more on par with those of credit cards,” Emmons said. Not that government intervention isn’t needed — instead, Emmons argued that any federal funds used to manage through the current crisis should be used to help borrowers land on their feet, rather than trying to protect their home. Because the private market for nonprime mortgages is not likely to recover quickly, he said there is a case to be made for bolstering government agencies and programs that facilitate widespread access to decent housing and mortgage credit. “It is important to keep in mind that there will be those individuals who are truly harmed by the crisis,” said Emmons. “The financial distress to borrowers and communities caused by foreclosure should be addressed directly.” A stronger social safety net — including measures such as income support, vouchers to guarantee access to decent housing, and assistance in re-establishing household financial stability — is the most direct way to deal with the fallout from mortgage foreclosures, he said. Such measures would target what Emmons called the “causes” of the housing mess, rather than treating what he called the “symptoms.” Here at HW, all we can say is that we’ve been advocating the policy stance taken by Emmons since at least August of last year. Those looking for the bottom in housing — those that really understand this mess — have told HW that finding a bottom is a process that will largely depend on any actions coming out of Capitol Hill and in key local governments during the months ahead. Disclosure: The author held no positions in FNM or FRE when this story was originally published. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.