With the rumors swirling on both Fannie (FNM) and Freddie (FRE), I would offer the following thoughts:

The US Government will not explicitly guarantee the debt of Fannie and Freddie, but rather will either inject capital (super senior preferred stock subordinated debt a la a Continental Illinois style bailout) or provide a “make-whole” guaranty on the assets of both companies (a la an FDIC/RTC style failing bank resolution). The choice of the former suggests a “going concern” for the GSEs, while the latter suggests an orderly wind-down.

In either case there's considerable historical precedence. And either choice implies that the common stock of both companies is worthless and the preferred stock value is at best uncertain.

If Freddie and Fannie are placed into conservatorship and are wound down (the second choice), I expect that the US mortgage market will move quickly to the covered bond format that is common to the Europe mortgage market. (And for a quicker primer click here.)

I believe that Hank Paulson began laying the public groundwork for this on Tuesday when he stated at the FDIC conference that “…as Treasury seeks to encourage new sources of mortgage funding in the United States, improve underwriting standards and strengthen financial institutions' balance sheets, covered bonds have the potential to serve these purposes and reduce the costs for first-time home buyers, and for existing homeowners to refinance.”

As the regulatory treatment and issuing procedures for US covered bonds are still a work in progress (not withstanding such issuance by Wamu (WM)), I would look for both the FHA and the FHLBs to assume a more visible role in support of the US mortgage market in the interim. With 70% of all new mortgages in some way touched by the GSE’s, the government will make sure that whatever perceived gap is created is quickly filled.

Finally, I have no doubt that both the Treasury Department and the Federal Reserve have been working on a contingency plan for the GSE’s for some time. I further believe that key members of Congress are already poised to act with whatever legislation is necessary for a quick, but more importantly certain, resolution of this issue.

Which, given that today is Friday, will come Sunday night before the market open Monday morning in Asia.