Paulson: Why Is the Fed the Only Game in Town?

CNBC's Maria Bartiromo interviews Hank Paulson Jr. at the 2013 Aspen Ideas Festival in Aspen, Colorado.
Katie Kramer | CNBC
CNBC's Maria Bartiromo interviews Hank Paulson Jr. at the 2013 Aspen Ideas Festival in Aspen, Colorado.

Former U.S. Treasury Secretary Hank Paulson on Thursday defended the Federal Reserve's efforts to stimulate the economy, but argued its policies of bond buying and near-zero interest rates can't last forever. What's needed to jump-start the economy now is bipartisanship in Congress, he said.

The markets have experienced a broad selloff since Fed Chairman Ben Bernanke told Congress last week the central bank could reduce its $85 billion in monthly purchases of Treasurys and agency mortgages this year. But to Paulson, it seems the selloff came as no surprise.

"When you have a big, ugly problem, there's never going to be a neat, elegant solution that is totally painless or without a cost and to me it's just completely unrealistic to assume that those programs could be phased out without some market volatility and some pain," Paulson told CNBC's Maria Bartiromo on "Closing Bell." "Market participants, some of them, are addicted to these abnormally low interest rates."

(Read More: Market Overreacted to the Fed: Goldman CEO)

The Fed seems to be the "only game in town," Paulson complained, meaning it's the biggest driver of both the markets and economy alike. It will take bipartisanship in Congress to lessen the dependency on the Fed and grow the economy by more than 2 percent, he said.

"We need more action from Congress and the executive branch," Paulson said, adding he thinks a deal on everything from the deficit to tax reform and immigration would help stimulate economic growth. "The Fed has been asked to do a lot because the rest of the government is doing very little, frankly."

When it comes to the housing market, however, Paulson says the government is too involved.

It's been years since the housing bubble burst, and yet the housing-finance system remains largely unchanged with government-run mortgage giants Fannie Mae and Freddie Mac currently backing roughly 90 percent of all new mortgages.

"The key is getting the private sector into this because if government is setting the prices on your mortgages through a subsidy, what you're going to do is you're going to ultimately get things that are not market reality or economic reality and you will get another bubble again in housing and then we'll be setting ourselves up for another big decline in housing prices," Paulson said. He said Freddie and Fannie should be scaled back to the point where the private sector eventually fully takes over the mortgage business.

(Read More: Housing: From Recovery to Bubble–Already?)

"You can't do that all at once, but we should know what the new plan is going to be," he said. "We should have a plan in place to transition to a time when the private sector can play a much bigger role in terms of financing mortgages," he said.

Watch "Closing Bell" Monday through Friday at 3 p.m. ET.

Follow us on Twitter @CNBCClosingBell

By CNBC's Drew Sandholm. Follow him on Twitter @DrewSandholm.

— Reuters contributed to this report.