by Tom Bawden in New York and Gerard Baker in Washington

WASHINGTON - The US Government took dramatic steps to prop up America's financial system last night, announcing that it was prepared to pump billions of dollars into the country's mortgage market in a desperate measure to prevent the economy going into a tailspin.

In a late-night announcement designed to calm increasing panic on Wall Street before today's market opening, the US Treasury Department and the Federal Reserve issued a joint statement in which they pledged to spend billions of dollars of taxpayers' money to bail out the two American mortgage giants that collectively underpin the entire housing market "if needed".

The Fed said it would offer cheap financing to the giants, Freddie Mac and Fannie Mae, through its so-called discount window. The Treasury separately said that it would propose to Congress that lines of credit to the two should be extended temporarily. Furthermore, Henry Paulson, the US Treasury Secretary, said that the Treasury would purchase equity in both organisations if needed.

The two groups together account for more than half of America's $12,000 billion of outstanding mortgages. A failure of Freddie and Fannie would drive up mortgage payments significantly as a crucial source of financing dried up and would have a domino effect across the debt market, affecting everything from car loans to student loans.

The Fed and the Treasury would require approval from Congress for an injection into Fannie or Freddie, which would be done through buying newly issued shares in the groups.

The value of shares that could be bought in the two groups if the recapitalisation goes ahead was not disclosed but is thought to total about $15 billion.

Mr Paulson said: "[Their] continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore, we must take steps to address the current situation as we move to a strong regulatory structure."

The Government also said that it would give the Fed a role in regulating Fannie and Freddie, working with the present regulator, the Office of Federal Housing Enterprise Oversight.

The sweeping measures to restore confidence in Fannie and Freddie - and the housing market in general - came ahead of a critical attempt by Freddie to borrow $3 billion from Wall Street today. The Government worked furiously behind the scenes over the weekend to ensure that Freddie Mac is able to sell the $3 billion of short-term debt in the group in a "Dutch auction" today - and at an acceptable interest rate. Treasury officials took the highly unusual step of calling leading banks and urging them to buy Freddie's debt.

Fannie and Freddie are fundamental to the smooth running of the US housing market. They buy mortgages from banks and other lenders and package them into bonds, which they sell on to pension funds and other investment firms. The banks use the money they receive from selling their mortgages to Fannie and Freddie to make further loans to new homeowners. Fannie and Freddie guarantee payments on mortgage bonds they create, in the event of a default on the underlying home loans, and they also retain on their balance sheets hundreds of billions of dollars of the mortgages they buy.

Expectation of government intervention in the companies last Friday sent their shares plunging. Fannie's shares were down by as much as 50 per cent and Freddie's by 48 per cent at one stage. Fears of wider fallout from the mortgage market problems hit other financial groups, with Lehman's shares falling 20 per cent. The Dow Jones industrial average fell below the psychologically important 11,000 level for the first time since 2006.

The US Securities and Exchange Commission (SEC) last night stepped in to issue a warning against rumour-mongering. The SEC said that it would check that no false information was being spread to enable stock manipulation to take place. It did not name companies it felt might be victimised.
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