The turmoil at Fannie Mae, the largest force in the U.S. home mortgage market, signals it's time for Congress to address some fundamental issues about the structure of the federally chartered Government Sponsored Enterprises (GSEs).

Fannie's dramatic fall from grace--provoked by regulators' demand for a four-year restatement of its earnings--may require Fannie to accept an after-tax accounting expense of as much as $9 billion, and may trigger Fannie's failure to meet its minimum capital standards. With the forced resignation of Fannie's top leadership, it's time for a searching re-examination of how the GSEs are organized and regulated.

Do the accounting travails of both Fannie Mae and Freddie Mac indicate economic problems in the respective mortgage portfolios--or are they merely the results of debatable, convoluted accounting rules? Opinions differ, but virtually everyone can agree on one thing: The accounting scandals make it nearly certain legislation will be on the agenda next year to update how these GSEs and the $5 trillion housing GSE sector are regulated.

The fundamental problems are structural, but the time has not yet come for the true structural answer: Privatization of Fannie, Freddie and the Federal Home Loan Banks (FHLBs). Legislative ideas are focusing instead on a regulatory reorganization that brings all these housing GSEs under a single new "world class" regulator. Although this would be a less fundamental step than privatization, a well-designed regulatory restructuring could have broad, beneficial effects on mortgage finance.

A new housing GSE regulator could improve oversight, promote greater competition, create greater market discipline and foster improved value to mortgage borrowers. It could also enable reducing the duopoly pricing power and duopoly profits from which Fannie and Freddie have benefited so grandly for so long.

Here is what needs to be done:

First, Congress should create a new, single regulator for Fannie, Freddie and the FHLBs as proposed by the Bush administration and by the Senate Banking Committee in a bill last spring.

That step would replace the existing, separate regulators--the Office of Federal Housing Enterprise Oversight and the Federal Housing Finance Board--which have regulatory domains too narrow to make sense.

The new regulator would have oversight responsibility for Fannie, Freddie and the 12 FHLBs. Together, these GSEs provide most of the financing for the largest credit market in the world--the American residential mortgage market. Next to the U.S. Treasury, they are the world's most important and widely held issuers of fixed-income securities. The new regulator would be able to develop an understanding of the sector as a whole, of individual GSEs in context, and of the overall health of the U.S. housing finance system.

Second, Congress should direct the new regulator to foster as competitive a GSE sector as possible. Because of the substantial economic benefits granted by GSE status, the GSEs should be open to increased competition.

The competition will force the economic benefits through the GSEs and into the hands of the public, where they belong. This will require the regulator to create as level a regulatory playing field as possible among the 14 GSEs. Fannie and Freddie do not get special status for accounting; they should not have special duopoly status, either.

Today the secondary mortgage market dominated by Fannie and Freddie is a well-known duopoly, and it is probably the least competitive of any financial sector in America. A pro-competitive GSE sector would produce more price competition, innovation and customer choice. As they do whenever markets become more competitive, consumers will win.

Third, the legislation should eliminate the government-appointed directors of Fannie, Freddie and the FHLBs. Since such directors have the fiduciary duty to represent shareholders, their public appointment has little, if any, meaning. President Bush has declined to appoint directors to the boards of Fannie and Freddie.

Appointment of FHLB directors by their current regulator is, as the Government Accountability Office and others have consistently said, an obvious and undesirable conflict. A new regulator should have no such conflict.

Fourth, the legislation should address receivership. For more than a decade, the debt of all housing GSEs has grown far faster than the mortgage market or the overall economy. This growth reflects the fact domestic and international investors provide little market discipline because they firmly believe they will be protected by the government if the GSEs get into financial trouble. The Bush administration has consistently maintained legislation must have "effective receivership language" so GSE debt investors exert more market discipline.

If Congress thinks GSEs most resemble banks, the legislation could provide for banklike regulatory receiverships. If GSEs are viewed as financial corporations such as G.E. Credit and GMAC because they take no deposits from the public, a second alternative would be for legislation to address receivership simply by providing the GSEs become subject to the bankruptcy code like other debt issuers. This would be the most straightforward kind of effective receivership language.

The new regulator must address problems created by the complex and, many would say, deeply flawed accounting rules at the center of the GSE accounting issues. But whatever the outcome of the disputes about GSE accounting, the possibility of fundamental change through restructuring today's outdated GSE regulation is much more important. Through this four-step approach, the U.S. secondary mortgage sector--an essential element of the world's largest credit market--can be made better regulated, more competitive and less subsidized.

Alex J. Pollock, a resident fellow at AEI, previously served 12 years as president and chief executive officer of the Federal Home Loan Bank of Chicago.