Updated from 11:03 a.m. EDT.

Fannie Mae

(FNM)

and

Freddie Mac

(FRE)

continued their freefall Friday, amid mounting concerns the government would have to bail out the faltering mortgage giants.

Shares of the two government-sponsored entities shed more than 40% in early trading, as investors worried that if the government did step in, investors would be decimated.

The New York Times

reported Friday that Bush administration officials were considering placing the companies in conservatorship, which would strip the value of the stocks and put the responsibility for losses on mortgages they own on the American taxpayer.

The story was later refuted by both federal officials and Freddie Mac, which said in a statement issued after the closing bell that it expects to report a "substantial" capital cushion well over the 20% required by its main regulator, the Office for Federal Housing Enterprise Oversight, when it finalizes its second-quarter results.

"Freddie Mac is adequately capitalized, highly liquid and an essential part of the nation's housing system," the statement said.

Treasury Secretary Henry Paulson said the Bush administration was "maintaining a dialogue with regulators and with the companies" and noted "OFHEO will continue to work with the companies as they take the steps necessary to allow them to continue to perform their important public mission."

"Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission," Treasury Secretary Henry Paulson said in a statement issued Friday morning.

Freddie shares closed down 3.1% to $7.75 and Fannie shares finished 22.4% to $10.25. Freddie shares briefly turned positive after Sen. Chris Dodd (D., Conn.) said officials were considering various options for helping the firms, including allowing them to borrow from the

Federal Reserve's

discount window.

The two stocks have lost more than half their value since the July 3 close. The assault comes even as federal officials, including Fannie's and Freddie's, have repeatedly

sought to assure the market

that the two companies are adequately capitalized.

OFHEO Director James Lockhart called the companies "adequately capitalized" in a statement issued after Thursday's close. Paulson also had reiterated the companies' health in testimony to the House Financial Services Committee earlier Thursday.

The stocks were battered Thursday, however, as ex-St. Louis Federal Reserve President William Poole said in a

Bloomberg

interview that the two major U.S. mortgage finance firms were "insolvent" and may need a U.S. government bailout.

Fannie's and Freddie's recent freefall comes as they were just beginning to get out from under the federal government's thumb, following sanctions imposed after accounting scandals at both companies. Congress allowed the lenders to take on more loans and larger loans, as jumbo lenders like

Thornburg Mortgage

(TMA)

began struggling. On top of that, OFEHO had cut its capital surplus requirement to 15% from 20%. The market in general had been whispering that the companies had more liabilities than it had assets.

Fannie Mae has $29 billion in mortgages and affects roughly $5 trillion in various debt liabilities; the U.S. gross domestic product is $13 trillion, according to the Bureau of Economic Analysis.

Just one year ago, Fannie Mae stock was trading at $70 and Freddie shares were trading at $67.