The government's takeover of two troubled mortgage giants yesterday was necessary to protect U.S. financial markets and the overall economy, local banking experts say.

"Fannie Mae and Freddie Mac were not viable institutions for the long run," said J. Alfred Broaddus Jr., former president of the Federal Reserve Bank of Richmond.

"They had gotten so big they posed an overall threat to the financial system," Broaddus said.

The Bush administration seized control of the government-sponsored companies, hoping to stabilize
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on inRich.com housing market turmoil and avert an economic crisis. The takeover is expected to cost taxpayers tens of billions of dollars.

Treasury Secretary Henry M. Paulson Jr., who announced the takeover yesterday morning, is betting that infusing new capital into the two firms will lead to lower mortgage rates, encourage homebuying demand and slow the decline in home prices that has hurt many areas of the country.

Both companies were placed into a government conservatorship that will be run by the Federal Housing Finance Agency, the new agency created by Congress this summer to regulate Fannie and Freddie. The management of both companies has been replaced as well.

The seizure is an opportunity to come away with a healthier and more balanced system, Broaddus said.

"The problem can't be fixed overnight," he said. "It will not be a matter of months. It will be a matter of years."

Meantime, "the government needs to continue to do what it can to make sure the flow of mortgage credit remains strong," Broaddus said.

Fannie Mae and Freddie Mac own or guarantee about $5 trillion in home loans -- about half the nation's total. They have lost $14 billion in the last year and are likely to pile up billions more in losses until the housing market begins to recover.

The reason they had grown so large is because the government subsidized the cost of funds, making it cheaper to borrow money through the two companies than on the open market.

They grew artificially, Broaddus said. "They were financially unnatural."

Once the financial system is stabilized, Fannie Mae and Freddie Mac should be broken up into smaller units, so they will be more balanced, Broaddus said. "It will be good for housing, good for the American financial system overall."

The huge potential liabilities facing each company, as a result of soaring mortgage defaults, continue to grow. However, if the two companies had been allowed to fail, the consequences could be worse, Paulson said, causing great turmoil in financial markets around the globe.

President Bush said failure was "unacceptable."

"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," Bush said in a statement yesterday afternoon.

Kent Engelke, chief economics strategist and managing director of Capitol Securities, an asset management firm in Richmond, said the takeover will stem losses to taxpayers and investors. "Shareholders have already lost their shirts," Engelke said.

Fannie Mae shares have dropped in value to $7.6 billion from $39 billion at the end of 2007. Freddie Mac shares, valued at $22 billion at year's end, are worth about $3.3 billion.

Losses to investors and 401(k) savings plans in general would have dropped precipitously if the government had not stepped in, he said.

"This [the seizure] will take the uncertainty out of the market, Engelke said.

"In general, I am not supportive of government intervention. But this was the right and the only thing to do. You and I will pay for it, but if we pay for it now it will be a lot cheaper than if the companies had been allowed to go under."

The design for the companies was fundamentally flawed, said Neil Murphy, a banking expert and professor emeritus at Virginia Commonwealth University.

"The market historically believed that the securities were backed by the government even though there was no explicit guarantee," Murphy said. "When the companies started to have difficulties, people started to wonder whether the guarantee was explicit or not."

The government has come to the rescue, meeting expectations, even though it was under no obligation to do so, Murphy said.

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.

Paulson was careful not to blame Daniel Mudd, the outgoing CEO of Fannie Mae, or Freddie Mac's departing CEO Richard Syron for the companies' current problems. While both men are being removed as the top executives, they have been asked to remain for an unspecified period to help with the transition.

Contact Carol Hazard at (804) 775-8023 or chazard@timesdispatch.com.

The Associated Press contributed to this report.