It is commendable that senior government officials candidly acknowledged the major role of flawed government policies in spawning today’s housing crisis. Treasury Secretary Paulson didn’t try to shift all of the blame elsewhere. Instead, he said with respect to the government rescue of Fannie Mae and Freddie Mac: “I attribute the need for today’s action primarily to the inherent conflict and flawed business model embedded in the GSE structure.”This refers to the long-term cost, and predictable consequences, of well-intentioned politicians trying to be all things to all people. Congressmen of both parties promoted the “right” of every American to own a home. To that end, they promoted cheap and readily available mortgage financing. There was simply not enough mortgage money available through local banks and S&Ls. Thus the government would add trillions to the pool of funds by creating Fannie and then Freddie to buy and guarantee mortgages, and expand those government-sponsored entities (GSEs) especially after the S&L crisis of the early 1990s.It is wonderful to create maximum opportunities for home ownership, but the government pushed these agencies to keep increasing lending capacity to a point where creditworthiness was too often overlooked by mortgage originators. This policy had two unfortunate effects. First, it created artificial demand for housing that pushed prices beyond where they otherwise would have gone. Second, it led to unsustainable mortgages that were unlikely to be timely repaid. At some point, there are no more creditworthy buyers out there, and demand has peaked. As Econ 101 teaches us, prices decline when demand has peaked. So here we are.The whole of the housing mess is infinitely more complicated. By packaging mortgage-backed securities, the federal agencies expanded the pool of capital to finance housing by encouraging private sector investors to invest in mortgage-backed securities. That is a good thing, but again, within limits. Part of what went wrong is that initial lenders, such as your local bank, sold entire mortgages to Fannie or Freddie, and they got bundled into packages that backed mortgage-backed securities. The local bank was no longer on the hook for any of the mortgage, and thus had no incentive to make loans that were creditworthy. They were able to get their origination fee, and cut and run.Meanwhile, the Federal Reserve contributed to the housing bubble by cutting interest rates too aggressively in the wake of the dot-com bubble. The thinking must have been to avoid at any cost having a stock market meltdown lead to a severe recession, and worry some at a later date about cheap financing pushing housing prices too high.In pursuit of the praiseworthy goal of home ownership, the federal government caused an over-allocation of capital into housing, and that caused an unsustainable pyramid in prices that is no different than a bubble in stocks or any other asset class.The better way to encourage home ownership is to build wealth throughout the economy, and to assure that the fruits of economic growth are fairly distributed. The federal government invests remarkably little in education and infrastructure, the two keys to long-term economic growth. Instead, we’ve chosen to finance foreign wars and entitlement payments that promise an end-game that could lead to even more instability than the current housing mess.The good news is that Secretary Paulson has crafted an intelligent rescue plan which stabilizes the mortgage market in the near term, and appropriately de-leverages Fannie and Freddie over time as existing mortgages mature. Housing stocks have begun to stabilize, the decline in housing prices seems to be moderating, and there is light at the end of the tunnel. But the root of the problem is that when politicians promise things that are not financially sustainable, we can wind up with troubles that we did not expect.