The prodigal twins of the U.S. financial system,Fannie Mae and Freddie Mac, were rescued from their financial ruin by a dramatic Federal government bailout that pledges capital and oversight to manage the companies through their rehabilitation.

“Our economy and our markets will not recover until the bulk of this housing correction is behind us,” said Treasury Secretary Henry Paulson, who was joined by Federal Housing Finance Agency Director James Lockhart in Washington today. “Fannie Mae and Freddie Mac are critical to turning the corner.'' The FHFA will have oversight over Fannie and Freddie.

That Paulson was saying it on a Sunday made the statement easily mistaken for a prayer. As the U.S. housing market plunged and the credit markets fell into crisis, the fates of Fannie and Freddie became crucial to the market and the nation’s economy. Now, the execution of the plan–the paring back of risk and the mantra of new management–will have to win over nervous Americans and their bankers.

By putting the full weight of the Treasury behind the pair, Paulson is wagering that mortgage rates will ease and the nation’s banking system will get enough breathing room to lend again. He’s also gambling that removing the incentive of increasing shareholder value to focus more on stability and risk management will win a repaired Fannie and Freddie, and the U.S. economy, greater confidence at home and abroad.

No stranger to risk while he was head of Wall Street giant Goldman Sachs, Paulson stands to carve out a unique legacy with the move. He’ll either be the man who saved the U.S. economy or the fool who doubled down in a market where falling asset prices dragged down all the leverage connected to them.

Paulson and his Capitol Hill cohort have put restrictions on the size of the twins’ mortgage portfolios—limiting them to $850 billion as of the end of 2009 and requiring them to decline by 10 percent each year until it hits $250 billion—and appointed new chiefs to the operation to begin the process. Fannie's portfolio was $758 billion at the end of July, and Freddie's was $798 billion.

Former Merrill Lynch president and TIAA-Cref CEO Herbert Allison, will take over Fannie's top post and David Moffett, who was vice chairman of US Bancorp, will head Freddie. They will work with existing management. They will replace Daniel Mudd and Richard Syron, respectively, but the pair will stick around as consultants to walk their successors through the muck of their balance sheets.

The plan's other key moves include eliminating the companies’ dividends; allowing Treasury to buy up to $100 billion of a special class of stock in each company as needed to maintain a positive net worth; providing secured short-term funding to the pair and 12 federal home-loan banks, and purchase mortgage-backed debt in the open market.

The common stockholders of Fannie and Freddie won't be eliminated under the conservatorships, but they will be last in line for any claims, Paulson said.