Washington - In potentially the largest financial bailout in US history, the rescue of mortgage giants Fannie Mae and Freddie Mac was necessary to shore up an economy going through one of its worst crises since the Great Depression, US officials argued.

The decision to place Fannie and Freddie in conservatorship represents the government's most significant intervention to date in the struggling mortgage industry. A series of dramatic steps by the Federal Reserve to provide fresh capital have not been enough to keep the two lenders afloat.

US Treasury Secretary Henry Paulson on Sunday said that taking control of the two government-chartered lenders, which together own or about half of the 12-trillion-dollar mortgage market in the United States, was crucial for stemming the wider fallout from the housing crisis.

Fannie and Freddie were originally created by Congress as privately traded companies with a public mission: to boost home- ownership by offering low-interest loans to lower-income families. But both share blame for the current market turbulence due to an aggressive expansion during a decade-long housing boom that held up until 2006.

Along with other private lending and financial institutions, Fannie and Freddie began offering variable-rate home loans known as subprime mortgages to buyers who could ill afford to pay them off, while at the same time taking on more debt and becoming more dependent on the housing boom continuing.

Home prices have plunged more than 10 per cent over the last year in what some economists have rated as the sharpest housing correction since the 1930s. The price drop sparked a record number of mortgage defaults, which have cost more than 500 billion dollars in banking- sector losses, which in turn has led lenders to cut down on loans to new home buyers.

Fannie and Freddie have already reported about 14 billion dollars in writedowns of mortgage-related assets, and the Treasury has promised up to 200 billion dollars in order to keep them afloat. It is hoped that the move will ease investor concerns, bring down mortgage rates and prevent prospective buyers from losing access to new home loans.

Along with mortgages, US consumers have been struggling with surging energy costs, which have also pushed up retail prices. The result is that 9.16 per cent of all mortgage holders are either facing foreclosure or behind by at least one monthly payment, according to the Mortgage Bankers Association.

The US economy contracted in the fourth quarter of 2007 but recovered to a 3.3-per-cent growth rate in the second quarter of this year. But the improvement came largely on the back of strong exports rather than domestic spending, and some economists still fear a recession if a wider collapse in credit availability is not averted.

"I have long said that the housing correction poses the biggest risk to our economy. It is a drag on our economic growth, and at the heart of the turmoil and stress for our financial markets and financial institutions," Paulson said in Sunday's announcement.

"Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing."

The International Monetary Fund has forecast total losses of 1 trillion dollars in the financial sector before the end of the mortgage crisis. The IMF welcomed the takeover as necessary to ensure market stability but warned that Fannie and Freddie's business model would now have to be reconsidered.

"A key difficulty has been that these privately-owned entities with some public policy objectives have used the low funding costs from a perceived implicit government guarantee to build their portfolios, thereby benefiting their shareholders," IMF Managing Director Dominique Strauss-Kahn said.

"The Treasury plan allows time to build widespread consensus for important reforms to these institutions."

Congressional leaders have already begun the debate over just how important the survival of Fannie and Freddie is to the wider economy - and whether the rescue plan will be enough to solve the ongoing housing crisis.

"Americans need to know," Senate Banking Committee Chairman Chris Dodd said Monday, "if this plan will alleviate, not deepen, our current economic problems." (dpa)