The U.S. government is taking over struggling mortgage giants Fannie Mae and Freddie Mac.

Treasury secretary Henry Paulson and Jim Lockhart, director of the new independent regulator, the Federal Housing Finance Agency, announced Sunday that the two troubled lenders would be placed in conservatorship, the government would shore up its capital, and the firms’ management would be replaced.

Paulson attributed the need for a bailout primarily to the inherent conflict and flawed business model embedded in the firms’ structure, and to the ongoing housing correction.

Along with placing the firms in conservatorship, Treasury and FHFA have established preferred stock purchase agreements to ensure that each company maintains a positive net worth. Treasury also established a new secured lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. And, it initiated a temporary program to purchase their mortgage-backed securities. Former vice chairman of Merrill Lynch, Herb Allison, is to be the new CEO of Fannie Mae and David Moffett, vice chairman and CFO of US Bancorp, will be the CEO of Freddie Mac.

“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. This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation. That is why we have taken these actions today,” Paulson said. In response to the move, the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision said that they are prepared to work with the firms to develop capital-restoration plans.

Fed chairman Ben Bernanke, said, “I strongly endorse both the decision by FHFA director Lockhart to place Fannie Mae and Freddie Mac into conservatorship and the actions taken by Treasury secretary Paulson to ensure the financial soundness of those two companies. These necessary steps will help to strengthen the U.S. housing market and promote stability in our financial markets. I also welcome the introduction of the Treasury’s new purchase facility for mortgage-backed securities, which will provide critical support for mortgage markets in this period of unusual credit-market uncertainty.”

The Financial Services Roundtable and its Housing Policy Council also expressed support for the actions to stabilize Fannie and Freddie. “This strong and comprehensive action is necessary to enable the GSEs to provide liquidity to the housing market which is an essential component of the effort to stabilize and strengthen the economy,” it said.

“We have some concerns about the potential impact on preferred stockholders, but the overall action should strengthen the mortgage and housing markets,” it added.