The best way to avoid a worse residential real estate bubble than 2008 is to get get government out of the way and let private investment come to the rescue.

The Fannie Mae Freddie Mac third quarter loss-earnings report has the nation’s largest mortgage holder (9 out of 10 homes) angling hat in hand for another $7.8 billion dollars in Federal bailouts. The newest debacle sends a clear message - it is high time for a private sector solution to the taxpayer-tourniquet approach to recovery for the floundering mortgage industry.

Addressing the housing crisis has at least two dimensions. The current Mortgage Backed Securities (MBS) market discourages needed private investment and there is no clear path to homeownership for many available buyers who are ready and willing to purchase. The U.S. housing market is currently experiencing a median price drop of 4.7% and historic low rates below 4% nationwide. This is inevitable. In 2005-2006, housing nationwide reached roughly double its value relative to historic inflation and replacement cost trends, rents and consumer incomes. Sector bubbles usually burst by returning to their point of origin. If this occurs and more course correction is on the way, housing could potentially fall to 1996-2000 levels or 55% to 65% of the high. Such a correction would be greater than The Great Depression of the 1930s when housing fell around 30%.

The paradox to historically low home prices and interest is that many homeowners, underwater on existing mortgages, are in no position to take advantage of the low rates. Some would-be first time buyers are debt-averse amid the on-going recession and choosing to clean up existing debt. This is, to no small degree, influenced by record student loan commitments caused by soaring education costs. In the past, private real estate lenders responded to government agency guaranteed loan purchases with lax underwriting practices. Now, Fannie and Freddie show prolonged insolvency and new Dodd-Frank regulatory rules are further discouraging private lending through a series of risk retention rules, minimum qualified residential mortgage and higher refinance-ready equity requirements. We’ve come a long way from the days of the interest-only loan. But perhaps the greatest albatross to the housing recovery is that when lenders do make a loan, the current regulatory fiasco makes it difficult for private capital to back it and the risk, more times than not, is thrown back to the taxpayers via Fannie and Freddie. Taxpayers have already footed nearly $169 billion dollars to the two government-backed agencies in what adds up to the largest bailout of any corporations to date and Treasury has pledged limitless resources for the time being. Some estimates are that the bailout could surge to $193 billion through 2014. Clearly, something must give.

While there is no silver bullet, there are several ideas swirling around the housing sector that are geared toward mitigating the bubble’s impact. Movement by the private sector is the key to providing solutions to the mortgage market inactivity that could start to unwind the Fed’s tentacles from one more market that it is strangling alive. Rep. Scott Garrett (R-NJ) is preparing a version of his Private Mortgage Market Investment Act that shifts the dynamic toward more quality underwriting standards in the Mortgage Backed Securities (MBS) markets and assures securities investors of their legal protections by ending regulators’ efforts to stick them or (in the case of Fannie and Freddie) taxpayers with the tab for principal reductions. It also improves transparency and disclosure requirements for MBS so that investors can get a clearer vision of what they’re buying. On the front end, it requires lenders to lean more heavily on debt-to-income, loan-to-value and credit history as indicators of borrower readiness. Altogether, the Act provides investor confidence for entering the market and encourages lending through a renewed system of interested securities buyers.

Despite the credit-aversion of some residential buyers, there are still many applicants (including international residential and private real estate investors) who are standing ready to take advantage of the market opportunities. The 2011 Profile of International Home Buying Activity released by the National Association of Realtors shows a skyrocketing international market totaling $82 billion for the 12 months ending March 2011, up from $66 billion the previous year. With government-backed securities agencies on proverbial (and perpetual) life support, private capital has an opportunity to come roaring back. Lenders need assurances. And when these assurances are met, a bevy of buyers are waiting in the wings.