Stephen Foley: Time Fannie and Freddie are sold off

US Outlook: The nationalisation of Fannie Mae and Freddie Mac, the US mortgage giants, one year ago this week was the most shocking event ever in American finance – for precisely seven days. Unlike for Lehman Brothers, there have been no television dramatisations of the last days of Fannie and Freddie, but the anniversary was marked by a provocative report from the independent Government Accountability Office here, which sets out the options for restructuring these enormous institutions.

Before they collapsed, Fannie and Freddie owned or guaranteed almost half of all outstanding mortgage debt. They had an implicit government guarantee, which meant they could borrow at close to Treasury rates, and that meant the plain vanilla mortgages they bought and packaged into securities were, in effect, subsidised by the US government, making home ownership cheaper. They were private companies, though, and their shareholders got fat as the firms dabbled with riskier mortgage investments. It was an extraordinary public-private hybrid and it ended in disaster.

Under the current government "conservatorship", Fannie and Freddie are more important than ever in keeping mortgage rates down because private lenders have fled. The Obama administration has kicked restructuring proposals into next year.

What's to do? The choice must surely be between selling them off and turning them into a department of the government. I can't think of a better example of moral hazard than the old hybrid model. Full absorption by the government is superficially attractive, particularly if Fannie and Freddie are given a much more explicit counter-cyclical mission. They could ramp up their purchases of mortgages next time there is a private-sector famine. They could also reinvigorate the part of their mission that charges them to subsidise mortgages for particular disadvantaged groups and regions.

Those important roles can be achieved via other means, however, and should be. The Federal Reserve is a better institution for managing the economic cycle and governing the amount of credit in the economy, and it can attack specific credit markets and specific asset prices if it wants. Under quantitative easing, it has been buying mortgage-backed securities directly, not just Treasuries. Likewise, home ownership programmes can be channelled through other agencies, such as the Federal Housing Administration.

Breaking up and privatising Fannie and Freddie has the added advantage of removing a government-supported competitor to Wall Street, which might mean the banks spend more time buying and selling socially useful mortgages, and less time dreaming up exotic mortgage derivatives based on the exploitation of people who can't afford home loans in the first place.