NEW YORK (Reuters) - Investors dumped shares of Fannie Mae FNM.N and Freddie Mac FRE.N on Monday after a newspaper report said government officials may have no choice but to effectively nationalize the U.S. housing finance titans.

The corporate logo for Freddie Mac is seen at its headquarters building in McLean, Virginia in this July 23, 2008 file photo. REUTERS/Larry Downing

A government move to recapitalize the two companies by injecting funds could wipe out existing holders of the largest U.S. home funding companies’ common stock, the weekend Barron’s story said. Preferred shareholders and even holders of the two government-sponsored entities’ $19 billion of subordinated debt would also suffer losses.

Shares of Fannie Mae sank more than 22 percent to a 19-year low on Monday, closing at $6.15, while Freddie’s shares plunged 25 percent to $4.39. Some of their bonds sharply underperformed Treasuries. A $4 billion sale of new Freddie Mac debt drew weak bids compared with similar issues last week.

A spokeswoman for the U.S. Treasury said the department has no plans to use its authority to backstop the two funding agencies. That authority was greatly increased by a rescue plan approved at the end of July.

“The Barron’s article overstated Freddie Mac’s financial situation,” Sharon McHale, a Freddie Mac spokeswoman, told Reuters. “We continue to be adequately capitalized.”

Fannie Mae spokeswoman Janis Smith declined to comment.

The poor performance of the U.S. mortgage market has pulled home loan rates up by about a percentage point from a year ago, just as the worst housing market since the Great Depression struggles to find a bottom.

“Investors have been trying to put the housing and credit crisis behind them. They want to believe we’re in the eighth or ninth inning, but every time news like this comes up, they have to readjust their thinking,” said Paul Nolte, director of investments at Hinsdale Associates in Hinsdale, Illinois.

Overseas central banks have sold nearly $11 billion from their holdings of agency-related securities in the past four weeks, awaiting clarity on the extent and nature of U.S. government backing of the two faltering companies, which are chartered by Congress to support housing by keeping money flowing in the mortgage market.

The two companies, known as GSEs, together own or guarantee more than $5 trillion in U.S. mortgages.

“There is a lot of uncertainty with what happens in terms of capital raising and a lot of investors are in a wait-and-see mode,” said Rajiv Setia, analyst at Barclays Capital. “From a GSE perspective, as long as they get funding it does not matter at what price as they will just pass it on with higher mortgage rates.”

The value of some of the two companies’ debt that is at the biggest risk of loss in the event of a government rescue fell to a record low in comparison with similar Treasury securities. Spreads on some Freddie Mac 10-year subordinated debt widened over Treasury notes to a bid of 400 basis points and offer of 360 basis points, from a close of 285 basis points on Friday, according to one investor, citing a dealer’s data.

An insider in the Bush administration told Barron’s that Fannie and Freddie “are being jawboned” by the Treasury Department and their new regulator, the Federal Housing Finance Agency, to raise more equity.

But government officials do not expect the agencies to succeed, Barron’s reported.

If the GSEs fail to raise fresh capital, the administration is likely to mount its own recapitalization, with the Treasury infusing taxpayer money into the agencies, according to the Barron’s source.

A government infusion would take the form of a preferred stock with such seniority, dividend preferences and convertibility rights that Fannie’s and Freddie’s existing common shares “effectively would be wiped out, and their preferred shares left bereft of dividends,” according to the Barron’s report,

The report said an equity injection by the government would be a quasi-nationalization -- without having to put the agencies’ liabilities on the U.S. balance sheet, and thus doubling U.S. debt.

Merrill Lynch also weighed in on Freddie Mac on Monday, saying the company will likely raise fresh capital in the third quarter, comprised of at least 50 percent common stock. Merrill also cut its price target on the company.

Freddie Mac early on Monday said it will sell $3 billion of five-year notes on Tuesday in a sale that is sure to draw heightened scrutiny to gauge investor interest.

“Lukewarm was my overall characterization,” Nancy Vanden Houten, analyst at Stone & McCarthy Research Associates, said in an e-mail on Freddie Mac’s $4 billion debt sale. “The bid-to-cover ratios were weak for all three bill auctions. Spreads weren’t uniformly bad, however.

“The Barron’s story seems to be getting a lot of attention, rightly or wrongly,” Vanden Houten added.

A bid-to-cover ratio reflects the amount of total bids compared with the amount offered. A lower ratio indicates weaker demand.

“The pricing was in line with where swaps and in accordance with the market, Freddie Mac’s McHale said.

Several U.S. insurance companies have “substantial” exposure to securities issued by Fannie Mae and Freddie Mac but should avoid big write-downs because of the federal government’s backing of much of those securities, A.M. Best Co said on Monday.

The U.S. insurance industry invested $371 billion in securities issued by the mortgage financiers at year end, but $366.4 billion of the sum was in fixed income, A.M. Best said.

“Much of the industry’s exposure represents fixed-income securities, which should benefit from the added financial backing of the federal government,” A.M. Best said.