The former chairman of the Federal Deposit Insurance Corp. who played a key role in healing the U.S. banking system after the savings and loan crisis said Thursday he advocates a breakup of struggling mortgage buyers Fannie Mae (FNM) and Freddie Mac (FRE).

"We need a plan for breaking up Fannie and Freddie and selling them to private investors, so that the government isn't the biggest backer of the housing market," said Bill Seidman in an interview with MarketWatch in Boston's financial district on Thursday.

The former FDIC head who helped revive banking confidence after the S&L debacle in the late 1980s said that "the only real productive alternative" is to nationalize Fannie and Freddie as a first step.

Shares of the government-sponsored mortgage entities have been in a downward spiral this week on mounting fears they will require a bailout that could essentially wipe out shareholders. However, Fannie shares bounced back somewhat Thursday, gaining nearly 9% recently.

Seidman said a government bailout of Fannie and Freddie would dwarf the tab from the S&L crisis, estimating it would involve assets between $5 trillion and $6 trillion.

The government should put in new management and run the companies for the sole benefit of borrowers, while balancing obligations to the housing market with financial costs, he said.

"The government better get a heck of a good guy to run Fannie and Freddie," Seidman said. "That's the biggest financial challenge of the century."

One name he floated was Treasury Secretary Henry Paulson, saying it would be an even bigger job than running the Treasury.

Paulson earlier this summer promoted a plan signed into law that extended a temporary and unlimited line of credit for the two mortgage-finance giants.

Yet Seidman said part of the problem is that the government is "half in, half out" of Fannie and Freddie, which is contributing to market uncertainty.

"For all practical purposes, Fannie and Freddie are nationalized, but the government doesn't have enough control given its interest in the housing market," he said.