The government has been trying to find a way to keep the economy and more importantly the mortgage market from crumbling any further. In breakthrough deal decided sometime on Tuesday the Office of Federal Housing Enterprise Oversight (OFHEO) agreed to allow Fannie Mae and Freddie Mac to leverage their estimated $20 billion on hand for $100 billion each. This would allow the two biggest buyers of mortgages to buy mortgages in a market that is mostly illiquid.

The plan was created to try and give the two companies the ability to use some of their capital reserves to buy up sagging mortgage assets. OFHEO is making a big change to capital rules that were created just a few years ago. Under the new deal the two mortgage companies will not be forced to hold 30 percent more capital of the their total holdings. The rules were made in the recent past to try and quell accounting scandals that were running rampant in behind the scenes dealings at both companies.

The new deal was not created without political arm twisting to try and ensure the deal moved forward. During the meetings on Tuesday a letter was brought to light from a New York Democrat, Senator Charles Schumer requesting the companies be given meaningful capital relief. The ties run deep in the political landscape with these companies because they are government-sponsored entities.

Wallstreet made it clear they were expecting good news from the OFHEO meetings. Shares of both mortgage companies rocketed to levels not seen in a quarter century. When the markets closed on Tuesday, Freddie Mac (FRE.N) shares pushed to the height of $26.02, a 26.19 percent raise. Fannie Mae (FMN.N) saw very similar gains with their final price reaching $28.22 with a 27.06 percent raise. Combined with the feds extra cuts on the weekend and on Tuesday the share prices are expected to remain stable if not finding even more upside on Wednesday’s announcement.

The announcement will be made at the regulator’s offices in Washington to announce the removal of the capital rules put in place. At 9 am EST Freddie Mac CEO Richard Syron and Fannie Mae CEO Daniel Mudd will join the Office of Federal Housing Enterprise Oversight at a press conference to tell the whole world the market relief news. Fannie Mae and Freddie Mac will be allowed to dump around $200 billion into the uncertain secondary mortgage market adding liquidity and confidence in a terribly shaken industry.

Information being released about the deal has stated that the $200 billion will equate to a one-third reduction in Fannie Mae and Freddie Mac’s excess capital. As more economists admit that the U.S. economy has slipped into a recession that could go from bad to worse, Fannie Mae and Freddie Mac will have the opportunity to bolster the biggest sort spot in the market, the secondary mortgage market or sub-prime industry.

The deal was being discussed on Tuesday evening on Jim Cramer’s Mad Money Stop Trading show. Mr. Cramer stated, “the $10 billion Fannie has on hand could be leveraged for up to $100 billion to buy its own bonds. The move might help the markets even more than the Federal Reserve’s 75 basis-point rate cut Tuesday afternoon.” You can read more of Jim Cramer’s coverage of his prediction of the deal on Tuesday here.

While the new capital relief for the mortgage companies is great news for the sub-prime market they are still dealing with major losses. The 2007 fourth quarter reports put both companies at $6.1 billion in losses. Further grim views for the future have been announced saying the companies could continue their losing streak well into 2009. With the new deal in play to allow them the freedom to leverage their capital their losses could be all but reversed if Washington has finally made the right move to halt the ailing economy.