The U.S. government has confirmed it's taking over struggling mortgage giants Fannie Mae and Freddie Mac.

Ensuring the companies are sound is "critical to the health of our financial system," U.S. President George W. Bush said in a statement Sunday.  

"Allowing the companies to fail or further deteriorate would damage our home mortgage market, and could weaken other credit markets that are unrelated directly to housing," he said.

That would pose an "unacceptable risk to the broader financial system and our economy."

Treasury Secretary Henry Paulson said the companies have been placed into a government "conservatorship" that will be run by the Federal Housing Finance Agency, created over the summer to regulate the two companies.

In addition, executives of both institutions have been replaced.

It was not clear whether the government would immediately put new capital into the institutions, which together own or guarantee about $5 trillion US of home loans, about half the country's total.

Financial turmoil

Paulson said the government was acting to avert the potential for major financial turmoil amid the growing number of mortgage defaults.

"Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe," Paulson said in explaining the government invention.

The companies buy home loans — mortgages — from banks and other lenders, which enables the lenders to make new loans. If the lenders could not sell the loans, they would be prevented from making new loans, choking the home market.

'Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe.' — U.S. Treasury Secretary Henry Paulson

Fannie and Freddie take the loans they buy and resell them to investors such as other countries and pension funds. Those buyers have reportedly been getting worried about the quality of the loans and the ability of Fannie and Freddie to back them.

Herb Allison, a former vice-chairman of Merrill Lynch, was selected to head Fannie Mae, and David Moffett, a former vice-chairman of US Bancorp, was picked to head Freddie Mac.

The names are based on acronyms for the companies: Federal Home Loan Mortgage Corp. (Freddie Mac) and Federal National Mortgage Association (Fannie Mae). The two companies own or guarantee nearly half the mortgages in the United States.

The Federal Reserve and other federal banking regulators said in a joint statement Sunday that "a limited number of smaller institutions" have significant holdings of common or preferred stock shares in Fannie and Freddie, and that regulators were "prepared to work with these institutions to develop capital-restoration plans."

The two companies had nearly $36 billion US in preferred shares outstanding as of June 30, according to filings with the Securities and Exchange Commission.

Last month, the U.S. House of Representatives approved a bill to help 400,000 homeowners struggling to avoid foreclosure and allow the two mortgage companies to get government money.

Paulson said it would be up to Congress and the next president to figure out the two companies' ultimate structure.