07/15/2010 11:43 pm ET Updated May 25, 2011

Whither Fannie and Freddie?

Frannie and Freddie are here to connect lenders and borrowers. They aren't here to borrow money, promise to repay, and then make mortgages that are highly risky and require taxpayers to cover potential losses. Such casino banking just brought the global economy to its knees.

Like all incorporated financial intermediaries, Fannie and Freddie need to be limited to their legitimate purpose -- financial intermediation.

Fixing Fannie and Freddie is simple. As I discuss in my book, Jimmy Stewart Is Dead, they should be reconstituted as Limited Purpose Banks, i.e., as mutual fund companies. The job of mutual fund companies is to market mutual funds. Hence, Fannie and Freddie would set up large numbers of mutual funds, in this case closed-end mortgage mutual funds, that would invest in mortgages in different regions of the country. Since the individual mutual funds will end up holding pools of mortgages, Fannie and Freddie will continue to securitize mortgages.

These mortgages mutual funds would compete with one another, purchasing their mortgages via public auctions run by Fannie and Freddie. By running public auctions, Fannie and Freddie would ensure that home buyers get the best rate available on the market.

Fannie and Freddie would be market makers, not profit makers. They would also assist other Limited Purpose Banks in establishing mortgage mutual funds and have them participate in their mortgage auctions.

Prior to a mortgage going up for auction, all the particulars of the mortgage would be established, verified, and fully disclosed on the web for close inspection. These particulars include the mortgage applicant's employment status, her credit history, her recent tax returns, the appraised value of the home she is buying, and the credit rating of the mortgage she is selling.

Fannie and Freddie would organize/oversee this real time, micro-level, full disclosure.

The Fannie/Freddie mortgage mutual funds would raise funds to bid for mortgages in the same manner as the 8,000 mutual funds now operating in the U.S. They would sell shares to investors. Because mutual funds are 100 percent equity financed, they are like little banks that are never leveraged and can, therefore, never fail. Their holdings can go to zero, but they can't go bankrupt.

Fannie and Freddie would only be able to borrow to expand their mutual fund businesses. Hence, they too would never go bankrupt. Moreover, given the disclosure and verification procedures, liar loans, NINJA mortgages, no doc mortgages, etc., would be history.

This is what a healthy mortgage market would look like. We don't need financial intermediaries to take us gambling, where they grab all the winnings. We don't need rating companies to sell their opinions. We don't need claims of proprietary information to keep us inspecting the financial securities we are buying. And we don't need top management of Fannie and Freddie extracting exorbitant compensation for doing precisely the wrong thing, namely playing high-class croupiers.