* Bipartisan group recommends winding down Fannie, Freddie
* MBS issuance would be taken over by private sector
* Public guarantor for MBS under catastrophic circumstances; funding from premium payments
WASHINGTON, Feb 25 (Reuters) - A bipartisan panel called on Monday for winding down government-controlled mortgage finance firms Fannie Mae and Freddie Mac as part of an effort to have private lenders take on more of the risk of supplying credit to the U.S. housing market.
The proposal from the Bipartisan Policy Center, a Washington-based think tank, aims to jump-start a stalled debate on the government's role in housing and help build a consensus for change.
Under the plan, banks and other private companies would take the lead not only in originating mortgages, but in issuing mortgage-backed securities as well.
Those firms and private insurers would then bear the risks of default, except in extreme cases when they are unable to absorb further losses, in which case a "public guarantor" funded by premium payments would provide a backstop.
"The problems in housing remain both severe and urgent," said former Senator George Mitchell, a Democrat who co-chaired the panel. "We think this proposal is a good basis to begin a national discussion and to get it on the radar screen."
Fannie Mae and Freddie Mac buy mortgages from lenders and repackage them as securities for investors, which they guarantee. The firms were seized by the government in 2008 as mortgage losses threatened their solvency, and they have since drawn almost $190 billion from the U.S. Treasury.
The latest proposal, which was pulled together over the last 16 months by a 21-member commission of retired lawmakers and former housing officials, would attempt to shrink the government's footprint in housing and have private capital play a larger role, a process that promises to take years.
Fannie Mae, Freddie Mac and the Federal Housing Administration currently back nearly nine of 10 new mortgages. At a news conference to unveil the report, members of the commission said winding down Fannie Mae and Freddie Mac would be a five to seven-year process.
A Treasury Department official said the White House hopes the proposal moves the debate on housing finance reform forward and helps build a political consensus for change.
However, with Congress focused on budget debates and with immigration and gun control top priorities, action on housing is not likely to come until at least 2014. After years of red ink, Fannie Mae and Freddie Mac are now profitable and the housing market is recovering, taking away the urgency for action.
Still, both Democrats and Republicans generally agree the system needs to change.
"A greater federal intervention was necessary when the housing market collapsed, but the dominant position of the government which currently exists is unsustainable," said panel co-chairman Mel Martinez, a former Republican senator and U.S. housing secretary.
In a first step to open the door wider for private capital, the report said Congress should gradually reduce the loan limits for government-guaranteed mortgages. It suggests limits of about $275,000 for loans eligible for government backing, down from $417,000.
Later, Fannie Mae and Freddie Mac would be replaced with a public entity that would provide a limited and explicit government guarantee for mortgage-backed securities, but would only step in if private companies were unable to cover losses.
The public guarantor would oversee the mortgage market, set standards for the mortgages backing government-guaranteed securities, and determine which loan products would be eligible for federal backing. The guarantor would bear a risk only if private sector credit-risk bearers were wiped out.
To ensure taxpayers are protected, fees would be levied on mortgage-backed securities to fund the federal backstop.
Many Republicans dislike the idea of an ongoing government guarantee for the mortgage market. But the commission saw a need for the government to step in under unusual circumstances.
Senator Bob Corker, a Republican on the Senate Banking Committee, said the bipartisan proposal "appears to be headed in the right direction." He supports placing substantial private capital in front of the government and wants to resolve the "legal limbo" presented by Fannie Mae and Freddie Mac.
The panel members made it clear they believed it would be important to ensure U.S. home buyers had access to 30-year fixed-rate mortgages. They also proposed new approaches for the distribution of federal rental subsidies and called for greater attention to the rental housing sector.
Industry groups have also put forward housing finance blueprints. They include the National Association of Realtors and the Mortgage Bankers Association, which both support a government backstop for the mortgage market.