Henry Paulson, the US Treasury Secretary, has rebuffed reports that the US Government may take control of Fannie Mae and Freddie Mac, the companies that own or guarantee more than $5,000 billion (£2,500 billion)-worth of American mortgages.

Mr Paulson said this afternoon that the Treasury's priority is to back government-sponsored mortgage buyers Fannie Mae and Freddie Mac in their “current form”.

He added: "Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission."

The statement came in response to news stories about “contingency planning” for the fate of the big mortgage finance companies at the Treasury.

Investors in the two banks panicked amid fears that they will have to raise as much as $15 billion each to offset losses they are taking on bad mortgages.

Shares in Fannie Mae dropped 70 per cent to $8.70 on the news - their lowest level for more than 17 years. Freddie Mac fell 43 per cent to $4.55.

The Dow Jones tumbled under the 11000 mark for the first time in two years earlier in the day but rebounded on a report that Fannie and Freddie would be permitted to access the Federal Reserve's discount window. The blue-chip benchmark closed down 128.48 or 1.14 per cent at 11100.54. Freddie closed down 3.13 per cent to $7.75 and Fannie fell 22.35 per cent to $10.25.

The banks were created to ensure Americans had easy access to home loans.

Under a 1992 US law, if the companies ran low on "critical capital", the Office of Federal Housing Enterprise Oversight (Ofheo) could take responsibility for their day-to-day operations. This would render their stock worthless but would enable them to keep running while the taxpayer covered their losses.

But the Wall Street Journal said today that it was unclear how severe Fannie Mae and Freddie Mac's financial decline would have to be to trigger this option, which is called a conservatorship, or whether the companies would be effective once their balance sheets were so severely constrained.

John McCain, the Republican senator and presidential candidate, said yesterday that Fannie Mae and Freddie Mac must not be allowed to fail because they are vital to Americans' ability to own their own homes. Fannie Mae, whose full title is the Federal National Mortgage Corporation, and Freddie Mac, the Federal Home Loan Mortgage Corporation, buy mortgages from mortgage lenders, providing lenders with the cash to continue to provide loans. Fannie Mae and Freddie Mac then securitise these mortgages and sell them to debt investors. They also provide guarantees on the interest and principal payments in the event of a default.

Most of the mortgages owned or guaranteed by the two are prime, fixed-rate loans with low defaults, but the companies reported combined losses of $11 billion for the nine months to March 31 from losses on the sale of foreclosed homes and provisions for future losses. Analysts in the US have predicted further losses and said that they do not expect Fannie Mae and Freddie Mac to be firmly back in profit until 2011.

Because the US has not seen a housing market downturn of this scale since the Great Depression, regulators have not required Fannie Mae and Freddie Mac to hold a huge amount of capital. At March 31, they had just $81 billion in combined capital.

If the US Government did take on Fannie Mae and Freddie Mac's liabilities, it would double the size of America's public debt.

It might be possible for Fannie Mae and Freddie Mac to raise extra cash from shareholders or from a strategic partner, such as a private equity firm, but it would be difficult for any investor to assess the value of their business, given the current turbulence in the US mortgage market. Fannie Mae raised $7.4 billion in April and May through share sales, while Freddie Mac has said that it has plans to raise $5.5 billion in the next few months.

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