While Fannie and Freddie aren't permitted to lobby, allies have begun speaking up in their defense. Small banks worry that without the firms, they would have to sell more of their loans to megabanks like Wells Fargo & Co. that would turn around and sell other services such as checking accounts to those borrowers. 'I would be handing my clients to them on a silver platter,' said Mr. Sorrentino of ConnectOne Bank.

Hedge funds and institutional investors that have bought Fannie and Freddie shares represent another unlikely ally. They say that rather than plowing the companies under, the government should instead place new curbs on their activities, subject them to higher capital requirements, and spin them off as private firms.

'It seems like the lawmakers are hellbent on waging this sort of Don Quixote kind of battle against demons that are no longer there,' said Michael Kao, chief executive of Akanthos Capital Management in Woodland Hills, Calif., which has invested in both companies since before their collapse.

All of the alternatives being proposed in Washington 'simply won't work,' says Bruce Berkowitz, chief investment officer of Miami-based Fairholme Capital Management, which sued the Treasury in July to challenge the terms of the government's bailout. The lawsuit alleges that the Treasury is illegally expropriating the company's profits. A Treasury Department spokesman said, 'We fully believe our actions have been lawful and appropriate.'