NEW YORK/BANGALORE (Reuters) - Former Federal Reserve Chairman Alan Greenspan predicts U.S. house prices will begin to stabilize in the first half of next year, even as he faulted the government's rescue of mortgage market giants Fannie Mae and Freddie Mac, the Wall Street Journal reported on Thursday.
"They should have wiped out the shareholders, nationalized the institutions with legislation that they are to be reconstituted... as five or 10 individual privately held units," which the government would eventually auction off to private investors, Greenspan said in an interview with the Journal.
In a high-profile rescue orchestrated in mid-July, the federal government offered to buttress Freddie and Fannie, the two largest providers of U.S. home mortgage funding, with billions of dollars of capital if the companies were on the verge of collapse.
Greenspan acknowledged that a government backstop for the shareholder-owned government-sponsored enterprises, or GSEs, was unavoidable, the paper said.
Not only are the they crucial to the ailing mortgage market now, but the Fed-financed takeover of investment bank Bear Stearns Cos also made government backing of Fannie and Freddie debt "inevitable," he said.
As private finance has retreated from the mortgage sector, the importance of Fannie and Freddie has grown, and they own or guarantee almost half the country's $12 trillion in outstanding home mortgage debt.
"There's no credible argument for bailing out Bear Stearns and not the GSEs," Greenspan told the Journal in an interview, which was reported on Thursday.
Fear that financial markets would react poorly if the U.S. government nationalized the companies and assumed their nearly $5 trillion debt is unfounded, Greenspan said.
"The law that stipulates that GSEs are not backed by the full faith and credit of the U.S. government is disbelieved. The market believes the government guarantee is there. Foreigners believe the guarantee is there. The only fiscal change is for someone to change the bookkeeping," he told the Journal.
Last month, Congress approved a massive housing market rescue bill, offering emergency financing to the GSEs, and setting up a $300 billion fund to help hundreds of thousands of troubled homeowners.
Greenspan also offered a novel suggestion to bolster the housing market -- increase the number of potential home buyers by admitting more skilled immigrants.
"Home prices in the U.S. are likely to start to stabilize or touch bottom sometime in the first half of 2009," he said.
But Greenspan cautioned that even at a bottom "prices could continue to drift lower through 2009 and beyond."
An end to the decline in house prices, he explained, matters not only to American homeowners but is a necessary condition for an end to the current global financial crisis.
"Stable home prices will clarify the level of equity in homes, the ultimate collateral support for much of the financial world's mortgage-backed securities," he said. "We won't really know the market value of the asset side of the banking system's balance sheet -- and hence banks' capital -- until then," he said.
Greenspan's forecast rests on two pillars of data.
One is the supply of vacant, single-family homes for sale, both newly completed homes and existing homes owned by investors and lenders. He sees that "excess supply" -- roughly 800,000 units above normal -- diminishing soon.
The other pillar is a comparison of the current price of houses -- he prefers the quarterly S&P Case-Shiller National Home Price Index because it includes both urban and rural areas -- with the government's estimate of what it costs to rent a single-family house.
As other economists do, Greenspan essentially seeks to gauge when it is rational to own a house and when it is rational to sell the house, invest the money elsewhere and rent an identical house next door.
In the past, Greenspan's crystal ball has been, at best, cloudy, the Wall Street Journal noted. He didn't foresee the sharp national decline in home prices. But recently released transcripts of Fed meetings do record him warning in November 2002: "It's hard to escape the conclusion that at some point our extraordinary housing boom...cannot continue indefinitely into the future."
Greenspan is currently promoting his book, the paperback version of which is to be issued next month with an epilogue.
Reporting by New York Treasury Desk and Tenzin Pema in Bangalore; Editing by Erica Billingham