The damage to the U.S. economy if government-sponsored mortgage companies Fannie Mae and Freddie Mac collapsed would be devastating, Wall Street economists and financial analysts said Friday.

In a worst case scenario, it would severely hamper the U.S. government’s ability to do business, and have far wider ramifications than if the government had allowed damaged investment bank Bear Stearns to implode -- not to mention making the costs for people to buy homes go through the roof.

A government takeover of the entities, whose stocks have lost 75% of their value this week alone, is also viewed as a poor option.

Fannie Mae’s or Freddie Mac’s “insolvency or a nationalization would, in our opinion, destroy investor confidence in the U.S. economy, cause a run on the dollar and force the Fed to raise rates significantly,” said Howard Shapiro, an analyst with Fox-Pitt Kelton in Chicago, in a note.

The New York Times reported Friday that the federal government is considering taking control of Fannie Mae (FNM) and Freddie Mac (FRE) as the two companies appear threatened with insolvency due to soaring mortgage default rates and increased costs for borrowing capital.

Click here to read more about the New York Times report

Market watchers said that move is unlikely, however, especially in an election year, given the message it would sent to global investors.

“It’s a huge nightmare in an election year to have the government step in and nationalize these entities,” said Axel Merk, manager of the $400 million Merk Hard Currency Fund. “Politically it would be very difficult.”

Fannie Mae and Freddie Mac, often referred to as government-sponsored enterprises, buy mortgages issued by banks, package them and sell them as mortgage-backed securities.

With their origins in the Depression, the entities were created to help a wide swath of Americans obtain affordable mortgages and help banks take mortgages off their books.

“They have kept mortgages within the reach of millions of consumers,” said Adolfo Laurenti, chief U.S. economist with Miserow Financial.

Fannie and Freddie have always served as a source of fresh capital for banks when other channels of the mortgage market have dried up. This has taken on increasing importance now that such as American Home Mortgage and Countrywide Financial are gone.

Seventy percent of the mortgage securitization business now goes through the Fannie and Freddie, up from less than half the business a year ago, and less than 30% two years ago.

“There’s just Freddie and Fannie left,” said Gus Faucher, an economist with Moody’s Economy.com.

Fannie and Freddie hold or guarantee more than half of all mortgages issued in the U.S. – a balance sheet worth more than $5 trillion dollars. In comparison, the U.S. government’s 2007 budget was $2.7 trillion.

The government on Friday stressed the importance of Freddie and Fannie to the health of the U.S. housing market.

In a statement as the two companies stocks plunged, U.S. Treasury Secretary Henry Paulson said the federal government’s “primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission.”

Click here to read Paulson's full statement

In effect, Paulson was saying the government has no immediate plans to takeover the two companies.

If the two government-sponsored companies collapsed, the impact on the mortgage and housing markets would be immediate.

“Without them, the cost of mortgages would skyrocket,” Laurenti said. “Fannie and Freddie have created a standardized product that’s easy to price. It’s allowed the mortgage market to expand over the years.”

Added Merk, “We need Fannie and Freddie to operate, otherwise people can’t buy homes."

While the two companies are publicly traded, there’s an implicit guarantee that as government-sponsored enterprises they are backed “by the full faith and credit of the U.S. government.” That implicit guarantee has always been hypothetical, up until now.

If the government took over responsibility for all the loans guaranteed by Fannie and Freddie, it would effectively double the size of the national debt, economists said, and severely impair the ability of the government to do business.

“We have heard talks about a second tax rebate in 2009, or extending the Bush tax cuts, or at the very least the candidates are talking about not increasing taxes while the economy is weak. But we cannot afford these things if we add $5 trillion to our national debt,” Laurenti said.