Sept. 19 (Bloomberg) -- Yields on Fannie Mae, Freddie Mac and Ginnie Mae mortgage bonds fell for a third day relative to government notes and benchmark credit-default swap indexes signaled a jump in subprime-bond prices, after the U.S. moved to prop up credit markets.

The difference between yields on Fannie's current-coupon 30- year fixed-rate securities and 10-year Treasuries narrowed 10 basis point to 155 basis points as of 4 p.m. in New York, data compiled by Bloomberg show. The ABX-HE-PENAAA 07-2 index of swaps tied to subprime bonds rated AAA when created in the first half of 2007 rose 3.6 percent to 53.58, a sign those bonds might fetch $53.58 per $100, according to administrator Markit Group Ltd.

The U.S. today took steps representing the biggest expansion of federal power over markets since the Great Depression. Treasury Secretary Henry Paulson proposed the creation of a program in which the government would buy ``illiquid assets clogging our financial system,'' and said Fannie, Freddie and his department would step up their own mortgage-bond purchases.

``I think they potentially saved the financial system,'' said Scott Simon, head of mortgage-bond investing at Newport Beach, California-based Pacific Investment Management Co., the world's largest fixed-income manager. ``Yesterday morning, things were very, very bad.''

So-called agency mortgage-bond spreads fell by record amounts on Sept. 8, after the U.S. government seized control of Fannie and Freddie, and Paulson pledged to buy their mortgage securities in a bid to lower loan rates. Spreads reversed that tightening earlier this week amid the collapse of Lehman Brothers Holdings Inc. and American International Group Inc. Washington- based Fannie and McLean, Virginia-based Freddie have been directed to begin their new ``purchase program immediately,'' the Federal Housing Finance Agency, their regulator, said in an e- mailed statement. It didn't detail the size or type of purchases.

Short-Selling Ban

Agency mortgage bonds, representing a $4.7 trillion market, are guaranteed by Fannie or Freddie or Ginnie Mae, the federal agency. The rest of the U.S. mortgage-bond market is about $2 trillion, including about $560 billion of subprime and excluding derivative versions of the debt. The spread on Fannie's securities fell 12 basis points yesterday, tumbling late in the day after rising as high as 193 basis points and above the level before the bailout, amid reports about the U.S. plans.

Also today, the U.S. temporarily banned short-selling of 799 financial companies, set aside as much as $50 billion to protect investors from losses in money-market mutual funds and began buying Fannie and Freddie's short-term debt, among other moves.

The Treasury will double planned mortgage-bond purchases this month to $10 billion, with the size of future buying ``to be determined,'' Treasury spokeswoman Brookly McLaughlin said.

Reason for Optimism

``Investors now have reason for optimism as the federal government comes together to address the deep-seated problems that have devastated the capital markets,'' Kenneth Hackel, head of fixed-income strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut, wrote in a note to clients today.

ABX indexes indicate prices for credit-default swaps linked to 20 subprime-mortgage bonds, and their levels generally track the prices for similar bonds. The swaps offer protection if the securities aren't repaid as expected, in return for regular insurance-like premiums. The indexes tumbled last year from at or near 100 as investors bet defaults on home loans would surge and property prices would tumble.

Rallies in ABX indexes tied to initially AAA rated securities between mid-July and early September weren't matched by the prices of the bonds they track, as investors buying actual securities faced difficulty borrowing money to make purchases, Jay A. Gladieux, a principal at Smith Breeden Associates Inc., said in an interview earlier this month.

``Except for agencies, most bonds are not that financeable anymore,'' said Gladieux, whose Chapel Hill, North Carolina-based firm oversees about $27 billion.

ABX Bets

Early today, there was ``massive buying'' of ABX contracts from investors including money managers and hedge funds looking to both close out bets on subprime defaults and to start new trades that the securities will perform better than prices indicate, according to a note to clients from Morgan Stanley.

The yield on Fannie's current-coupon mortgage bonds climbed to 5.36 percent today from 5.19 percent yesterday as the government plan drove investors away from the safety of Treasuries, boosting their benchmark yields. The increase in mortgage-bond yields suggests mortgage rates are rising. The yield is still down from 5.63 percent on Sept. 5. A basis point is 0.01 percentage point.

Bloomberg current-coupon indexes represent the average of yields for the two groups of mortgage bonds with prices just above and below face value, the ones lenders typically package new loans into. The spread helps determine the rates offered to homeowners on new prime mortgages of $417,000 or less in most areas, and up to $729,500 in high-cost counties.

Non-Agency Bonds

Prices of non-agency mortgage bonds were at record lows last week, before trading slowed, according to RBS Greenwich. Super- senior securities backed by option adjustable-rate mortgages slipped to 58 to 60 cents on the dollar last week, RBS said in a Sept. 15 report, as other types of initially AAA rated debt created from loans with growing balances were in the ``mid 20s.''

The least protected types of originally AAA rated securities from 2006 and 2007 backed by Alt-A loans with five years of fixed rates traded in the ``hi-20s to mid-30'' cents on the dollar, the report said. Less protected top-rated securities of similar prime-jumbo loans traded in the ``hi 30s/low 40s,'' while super- seniors fetched in the mid-80 cents, the report said.

Prices for AAA rated subprime securities from the first half of last year ranged from 94 cents on the dollar to 47 cents on the dollar, depending on their repayment priority, RBS said. Subprime loans went to borrowers with poor credit or high debt. Jumbo mortgages are larger than what Fannie and Freddie can buy or guarantee. Alt-A loans fall in-between prime and subprime.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net.

Last Updated: September 19, 2008 16:42 EDT