The U.S. banking system is in hot water. According to the Federal Deposit Insurance Corporation (FDIC), a total of nine banks have failed this year. Five folded in July alone.

To stabilize the situation, the U.S. government is poised to bail out Freddie Mac (NYSE:FRE) and Fannie Mae (NYSE:FNM). This opens up a great opportunity for investor, says Eric Roseman in The Sovereign Society.

He is buying Fannie and Freddie short-term and intermediate-term debt up to a maximum of five years. Yields are at historic highs and the government won’t allow these institutions to fail.

This from Eric…

Later today, the FDIC will update its list of “problem” financial institutions. The list already included a total of 90 “problem” banks as of March 31.

Since then, however, credit strains have accelerated worldwide, especially for interbank lending rates, non-government debt securities and the leveraged loan market. Credit spreads are now trading at multi-decade or multi-year highs this morning.

Indeed, the credit world has deteriorated markedly since March. So imagine how many more banks will join the FDIC’s “problem” list later today.

Bank stocks, of course, remain mired in a secular bear market. Banks are struggling with their worst crisis in a generation. Both credit and real estate assets are still in a freefall. You’ve got to believe many more banks will fail before this bear market is over.

Banks might be cheap but nobody really knows what their true net asset values are or what securities have honestly been booked as mark-to-market.

By the way, dividends mean nothing in this market. The majority of banks still have toxic paper on their books with only a few attempting to really unclog their balance sheets. Merrill Lynch (NYSE:MER) is the only institution to come clean this summer following the huge disposition of distressed assets last month at fire sale prices.

If the United States really wants to stabilize the financial system now, the first place to start is by bailing out Freddie Mac (NYSE:FRE) and Fannie Mae (NYSE:FNM).

A government rescue would protect bondholders and go a long way to instill market confidence and possibly put a floor to this crisis. The systemic risk of letting these huge lenders fail is not even debatable. We’re at the point of no-return here. Freddie and Fannie must be rescued and quickly.

I’m buying Fannie and Freddie short-term and intermediate-term debt up to a maximum of five years. Yield spreads are the highest in history and the government won’t let them fail. Shareholders in company stock, however, will probably get wiped-out eventually.

The crisis of confidence that sent Fannie Mae and Freddie Mac debt costs to record highs above U.S. Treasuries is also providing the mortgage-finance companies with the biggest profits on new investments since at least 1998.

This from Bloomberg:

The current-coupon mortgage bonds Fannie and Freddie buy yield about 40 basis points, or 0.40 percentage point, more than what they pay to borrow by selling benchmark bonds, according to Citigroup Inc. The difference exceeded 20 basis points only twice in the 10 years through 2007 — in 1998 and 2003.

The gap enables the government-chartered companies to offset some of the credit losses on mortgages they own or guarantee and eases pressure on U.S. Treasury Secretary Henry Paulson to step in with a bailout. The companies, which profit from their $1.6 trillion of mortgage investments, have tumbled more than 85 percent this year in New York Stock Exchange trading as mortgage delinquencies grow and the cost of debt rises.

P.S. In a market like this, you really can’t put all your faith in dividends - especially when the largest, favored blue-chips keep slashing their dividend checks. In fact, this year, Fannie Mae already cut the company’s dividends from US$1.40 to a paltry 20 cents. Today at noon EST, Eric’s colleagues Justin Ford and David Newman are hosting a special video webinar to protect yourself from this great dividend theft of 2008. They’ll even be giving actual recommendations to give your portfolio another boost during the bear market. Best of all, the video is FREE to watch. Just let them know you’d like to attend so they can accommodate as many viewers as possible.

Source: Bank Failures: Number 9, and Counting