Courtesy of the US Treasury, Americans were informed on Christmas Day that they had added a whopping big gift under their Christmas tree for Fannie Mae and Freddie Mac, the mortgage giants that are now wards of the state. The gift is truly one that keeps on giving: it has no price tag because the Treasury defines it as an "unlimited" promise to cover any losses these two companies may experience.

How big could this gift be? Fannie and Freddie have issued or guaranteed over $6 trillion worth of mortgage securities. If the losses were this big next year, we would have to fork over about 40% of the wealth built up in the US in 2010 to keep Fannie and Freddie solvent. Fortunately, most of the mortgage securities guaranteed by these mortgage companies are the pre-2004, fixed rate varieties that are still performing as required. That is, assuming these homeowners still have a home value greater than the mortgage due. If not, they may be tempted in the next few years to walk away - to "strategically default" - to do a Morgan Stanley - and turn the losses back on to Fannie and Freddie.

It makes you think the Treasury is just a little bit worried about the behavior of the American homeowner. What if they started to behave like corporations do, and walk away from their mortgage debts without a moral care in the world? Right now, about 25% of all homes are underwater, with mortgage debt exceeding what the home is worth in the market. If these homeowners strategically defaulted, the Fannie/Freddie losses could easily exceed $2 trillion.

I looked to see under what authority you, the taxpayer, through your representatives in Congress, gave the US Treasury to issue unlimited guaranties of any sort. Apparently this is Treasury's "interpretation" of the powers given to the them in the bank bailout approved by Congress in 2008. Whatever these powers are, they are expiring at the end of this year, so Treasury is using them now in order to avoid going before Congress next year to seek approval for this unlimited bailout promise.

It's always fun when your government does something momentous like this based on interpretations of the law, timing things on Christmas Day when newsrooms are shut down and families aren't paying attention to what's happening in Washington. It's going to be even more fun to see if Congress really cares. Fannie Mae and Freddie Mac are, after all, creatures of the Congress. They ran into a bit of trouble last year - let's call it incipient bankruptcy - but fortunately for them they are particular favorites of the Democrats who run Congress. There had been some complaints that Fannie and Freddie had been hobbled by their new position in government. They aren't issuing mortgage securities the way they used to in the good old days before they ran out of capital, and they are operating under a cap that limited Treasury bailout money to $400 billion for both of them. This cap supposedly kept them on a tight leash.

Now that the cap is gone, the two of them can act like their sister agency, the Federal Housing Authority, and get back into the business of propping up the housing market. The FHA has almost single-handedly kept the housing market alive, by guaranteeing new mortgages that have only 3.5% down payments, and in some cases do not require verification of the home owner's income (sound familiar?). About 90% of all mortgages issued in the US this year are backed by the FHA.

Of this $400 billion cap, the Treasury has had to cover $110 billion in losses for Fannie and Freddie so far. What does that tell you? If the Treasury is removing the cap, they obviously expect the losses to skyrocket (even though they deny this publicly). This could be happening because the Treasury already knows how much Fannie and Freddie are going to declare as losses this quarter. It could also be happening because of anticipated policy changes from the government.

One such change could be underway to deal with the problem of high value homes. Fannie, Freddie and the FHA specialize in mortgages in the $100,000 to $200,000 range, and that's where virtually all the "recovery" has been in the housing market this year. People with million dollar homes and million dollar mortgages are stuck because no one in the government is coming to rescue them, and this is a big problem in expensive markets like California. Maybe we will learn a month or so from now that Fannie and Freddie are lifting their guaranty limits so that now they can cover million dollar homes.

Another party sitting on a potload of troublesome mortgages is the Federal Reserve. They took over $1 trillion in distressed mortgage securities from the likes of JP Morgan Chase, Goldman Sachs, Bank of America, and Citigroup. They've written down some of these securities, but would obviously feel much better if they could offload these on to Fannie and Freddie at close to their current carrying value. Then at some convenient date - say the Fourth of July when no one is paying attention - Fannie and Freddie can announce a $500 billion write-down.

All sorts of wonderful things can happen in government when the taxpayers provide unlimited access to their wallets and purses. Congress, which constitutionally has the power of the purse, merely has to sit back quietly while these unlimited guaranties are being offered to bankrupt institutions in order for these wonderful things to occur. Maybe Fannie and Freddie will alter their mission statement and start guaranteeing commercial mortgages for failed strip malls, bankrupt property developers, empty office buildings, and half-filled condominiums. Yes friends, anything is possible because that is precisely the meaning of unlimited guaranties.

In the interest of full disclosure, the Treasury has said that this unlimited guaranty is only going to last for the next three years, and that they don't expect total losses to exceed $170 billion. As we've said earlier, this really doesn't make sense; you don't provide unlimited taxpayer support if you have great confidence that losses are going to be fixed. Which tells us we can't put a lot of faith in what the Treasury is saying, including the three year limit on the unlimit.

Instead, we can only put our faith in what the Treasury is doing: "Watch what we do, not what we say." On that basis, the housing market recovery is bogus. It's not a market recovery at all; it's a market that is as dead as ever, and shows any signs of improvement only because of government support. We can also divine something of the future from all this: the housing market is going to get much worse before it gets better, and there may be big losses coming soon from the commercial real estate market.

We are getting very used to watching the federal government operate with only the sketchiest information on what it is doing. Most everything seems to be done behind doors and in secrecy. That's what makes this brief announcement about Fannie Mae and Freddie Mac so troublesome. When the federal government starts talking about unlimited guaranties to cover future losses, our biggest worry ought to be that whatever large number we can contemplate is included under the word "unlimited", the government has an even larger number in mind.