“SAN FRANCISCO (MarketWatch) — Federal regulators have ordered Fannie Mae and Freddie Mac to start buying $40 billion of troubled mortgage bonds each month as the U.S. government tries to revive the economy, according to a published report.

The purchases would be separate from the U.S. Treasury’s $700 billion bailout plan, which was signed into law earlier this month, Bloomberg noted.

Fannie and Freddie were taken over by the U.S. government in early September, in the first of several bailouts the government has launched recently to try to halt the spread of the mortgage-fueled credit crisis.

Regulators initially restricted Fannie and Freddie’s growth when they seized control. To “promote stability� and lower mortgage costs to borrowers, Treasury Secretary Henry Paulson said the two companies would be allowed to “modestly increase� their mortgage portfolios to as much as $1.7 trillion through the end of next year and said they would no longer be run “to maximize shareholder returns.�

Now the reason this is a big deal if it does come to fruition is that it will essentially be a taxpayer bailout with zero oversight.  Through this year, each additional piece of legislation and policy action has led to less and less oversight and more and more reckless behavior.  Take a look:

-July 2008 - with the authorization of nearly $300 billion with the FHA legislation was passed that would allow troubled mortgages to be purchased by the government following these restrictions:  The lender would take a 90% haircut on the CURRENT appraised value of the home.  In addition, they would need a 5% one time fee.  This didn’t work out too well since even these modest restrictions would push many toxic irresponsible lenders into failing.

-September 2008 - Fannie Mae and Freddie Mac bailed out.  Approximate cost will run us up to $200 billion.
-October 2008 - $700 billion bailout package via the TARP that gives the government authority to purchase toxic mortgage with only vague wording and no guidance on how they will value the assets.

-October 2008 (today) - rumor that Fannie Mae and Freddie Mac each will buy toxic mortgages in subprime and Alt-A non-performing loans from lenders.  This is the absolute worst possible scenario for the American taxpayer.  It would be the most expensive program with the littlest bang for the buck.  All that will be done here is buying mortgages from toxic lenders and does little for households.  If the government pays face value, this will be a mess.  If then the government needs to cut the loan of the borrower down, it will be a double whammy.  First, over paying for the note then helping the home owner.  This is essentially what Senator McCain was pushing with bi-partisan rejection since it does nothing for stabilizing the market aside from a brief respite for toxic mortgage sellers.  They need to fail on their own.  This simply frees up their books.

I’m hoping this is simply a rumor.  If this is true, then this is on the level of the $700 billion bailout bill.  I’m surprised few people are reporting this.