WASHINGTON (AP) – July 11, 2008  Shares of Fannie Mae and Freddie Mac plummeted Friday as Wall Street became more convinced that the government is likely to bail out the United States’ key mortgage financiers.

Freddie Mac shares fell $2.91, or 36.4 percent, to $5.09 in late-morning trading, while Fannie Mae fell $3.80, or 28.7 percent, to $9.40. Both are at 17-year lows.

Treasury Secretary Henry Paulson sought for the second-straight day to calm investors panicked about out the financial state of Fannie Mae and Freddie Mac, saying the agency aims to keep the mortgage finance companies “in their current form” without a government takeover.

The financial health of the companies is of critical concern to Washington policymakers because of the crucial role Fannie and Freddie play in the housing market.

The pair hold or guarantee more than $5 trillion worth of mortgages. That’s roughly half of the $9.5 trillion debt of the United States. The fear is that a failure of one or both would wreak havoc on the nation’s financial system and the broader economy.

Paulson’s comments came amid reports that the government was considering a plan to take over one or both of the companies and place them in a conservatorship.

The Treasury chief said his department is “maintaining a dialogue with regulators and with the companies.” The companies’ main regulator will continue to work with Fannie Mae and Freddie Mac “as they take the steps necessary to allow them to continue to perform their important mission,” Paulson said.

“I think everybody’s just holding their breath in expectation that something substantive from the government will happen today or over the weekend,” said Karen Shaw Petrou, managing partner of consulting firm Federal Financial Analytics in Washington.

The companies’ troubles are more a result of market perceptions than a changed financial picture at the two companies, Petrou said.

“External reality doesn’t warrant such an action, but external reality seems no longer to matter,” she said.

Under a 1992 law, if either company fell into financial trouble, the government could take over their operations by placing it in a conservatorship. That process could be used to keep operations going at Fannie and Freddie, but shareholders would likely see their investments erased, and the companies’ ability to support the mortgage market could be reduced.

“Typically when this happens the business is a shell of its former self,” said Louisiana State University banking professor Joseph Mason. “Shareholders aren’t going to like it, managers and directors aren’t going to like it, but it’s not about whether they like it.”

Wachovia Corp. economist Jay Bryson said the two mortgage giants could face a replay of the near-collapse in March of investment bank Bear Stearns Cos. A lack of market confidence could make it difficult for Fannie and Freddie to raise funding through debt sales, he said.

“It becomes a liquidity issue, rather than a solvency issue,” Bryson said.

The New York Times reported Friday the government was considering taking over the operations of one or both of the companies, adding to fears that have mounted this week. Representatives from Fannie and Freddie were not immediately available for comment Friday morning.

Fannie and Freddie play a crucial role in providing funding for home loans by buying up mortgages and packaging them as investments. If they are unable to operate, the implications could be dire.

“Without them, our economy would collapse,” Piper Jaffray analyst Robert P. Napoli said in a note to clients. Napoli lowered his target on Freddie to $9 per share from $28, and on Fannie to $15 per share from $30.

On Thursday, the Office of Federal Housing Enterprise Oversight – the companies’ chief regulator – said both remain “adequately capitalized,” after Paulson and Federal Reserve Chairman Ben Bernanke sought to calm investors jitters in testimony on Capitol Hill.

Reassurances by government officials do not appear to be working.

“We doubt anyone will listen as fear is so high,” Napoli said.

Congress created Fannie in 1938 and Freddie in 1970 to keep money flowing into the home-loan market by buying up mortgages and bundling them into securities for sale to investors worldwide – thereby making home ownership affordable for low- and middle-income Americans.

But under a 1992 law they are required to hold only a fraction of what is mandated for commercial banks as a financial cushion against risk.

Friedman, Billings, Ramsey & Co. analyst Andrew Parmentier said the question of capital-raising plans at either company remains a “moving target.”

“In an instance where equity capital is not raised and investors see a meaningful change in debt spreads, it is clear to us that government action would be undertaken to ensure that the institutions would not fail,” Parmentier said in a note to clients.

Copyright 2008 The Associated Press, Alan Zibel (Associated Press Writer). All rights reserved. This material may not be published, broadcast, rewritten or redistributed. Associated Press Writers Jeannine Aversa, Ernest Scheyder and Christopher S. Rugaber contributed to this report.

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