A large cloud of confusion has hit consumers trying to make sense of the government’s billion-dollar bailout of mortgage guarantors Fannie Mae and Freddie Mac.

Even slightly informed Americans are well aware of the fact that billions of their tax dollars will foot the bill for the mortgage giants’ rescue, but for many -- how or why the collapse happened remains a mystery.

Financial expert Nicole Middendorf of Strategic Financial Inc. said it’s the same “financial illiteracy” that sunk the housing market in the first place.

“The two big camps that are at fault are the consumer -- for not being educated or understanding what they’re doing to themselves financially and also the mortgage companies for loaning out money and selling products to borrowers who really couldn’t afford homes,” Middendorf said.

The sub-prime mortgage confusion has lead to record foreclosures and an ongoing housing crisis. The Mortgage Bankers Association reported that one in 10 homeowners were late on their mortgage payment in the second quarter of 2008. This is the highest figure in the 39 years the group has recorded information.

Brief History Of Mortgage Giants

In order to understand the current situation, here is a brief history of Fannie Mae and Freddie Mac.

As banks began to recover in the midst of the Great Depression in the late 1930s, President Franklin D. Roosevelt wanted to restore widespread home ownership in America. Too few banks were providing loans to aspiring homebuyers.

Roosevelt’s administration alleviated this problem by creating Fannie Mae in 1938, a company that would guarantee mortgage loans by private banks.

Thirty years later, the government unleashed Fannie Mae from its control and privatized the company. Fannie Mae then became just like any other bank, but instead of making money by offering mortgages directly to the public, Fannie Mae’s revenue was generated from purchasing mortgages from private banks or in the “secondary mortgage field.”

Because of high economic growth and rising incomes, home ownership skyrocketed in the late 1960s. To keep Fannie Mae from becoming too large of a company, the government replicated Fannie Mae with a company called Freddie Mac.

Fannie Mae and Freddie Mac were both private enterprises up until Sept. 7, when Treasury Secretary Henry Paulson announced the government’s plan to take over both companies.

The Treasury Department will immediately pump $200 billion of fresh capital into both companies. This money is in exchange for warrants that the government can exercise to gain an 80 percent controlling stake in both companies.

Avoiding Catastrophe

Because Fannie Mae and Freddie Mac own or guarantee more than $5 trillion in mortgages, almost half of those in the United States, many of the mortgages they own will never be repaid. As a result of holding so much bad debt, they are, in effect, bankrupt.

Even rumors of their demise could be enough to trigger a panic in the financial markets in the U.S. and overseas, and worsen those affected by the housing crisis.

"Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe," Paulson said.

Light At The End Of The Tunnel

Only time will tell if he is right, but Paulson said, the takeover was put in place to protect the taxpayer. According to the Treasury Department’s plan, the government will be repaid before the shareholders of Freddie and Fannie get a penny.

Asian investors have been relieved of their anxieties, and the Asian stock markets have surged in the days following the government takeover.

Now that the U.S. government will be creating more demand in the marketplace by buying Fannie and Freddie mortgage bonds, homeowners and buyers should start seeing lower mortgage rates and enhanced mortgage options.

"If you plan on staying at a place for a while and you have a mortgage you haven't refinanced -- now may be the time to do it," Middendorf said.