Yesterday, the Fed said they would loan Fannie Mae (FNM) and Freddie Mac (FRE) as much money as they needed at 2.25%. Meanwhile, the Treasury Department will attach a provision to the current housing bailout bill being marked up by a joint committee of Congress that allows Treasury to buy common or preferred stock in the firms and increases each company’s Treasury credit line from $2.25 billion. The credit lines will probably go up one-hundredfold to $225 billion each.

Both Fannie and Freddie are overleveraged, and on any honest accounting have a negative net worth. But companies with a negative net worth do not have to file for bankruptcy as long as they can get the cash to pay their bills. The Fed loan facility makes it clear there will be no liquidity crisis at Fannie or Freddie. The Treasury equity investment program makes it clear there will be no solvency crisis, either.

Of course, it is in theory a terrible idea to lend even more money to an overleveraged company, because the act makes the balance sheet even worse. But by taking these three steps–a new Fed credit line, a Treasury equity line and an increased Treasury credit line–the government makes it clear that Freddie and Fannie are too big to fail, without having to explicitly guarantee their debt. That’s important, again in theory, because Fannie and Freddie have about $5.3 trillion in debt outstanding, which happens to be about half of all the mortgage debt in the country and is also roughly equal to the entire external debt of the federal government today. A formal guarantee would have doubled the taxpayer-backed debt overnight, with possible bad repercussions on the dollar. After yesterday’s action, it is clear to all that the implicit guarantee is real–no more denials, Secretary Paulson–but it doesn’t have to show on the government’s books.

At the bottom of bear markets, we often see these historic bailouts–Penn Central, Continental Illinois, Chrysler. Now you can add the Bear Stearns bailout, which created the first bottom in March, and the Fannie/Freddie bailout, which will create the second bottom today. This morning, Freddie Mac did a $3 billion short-term debt offering that was “surprisingly” well received. You can bet that over the weekend a lot of arms were twisted to bid in this auction to make sure it was “surprisingly” well received to calm the markets.

Where do we go from here? I expect my bank, Washington Mutual, to be taken over by the FDIC, along with National City and maybe one more. Bank of America, Wells Fargo and Citibank are too big to fail, but not Washington Mutual and National City. They may even let Lehman Brothers go under instead of finding a buyer, but that depends on how big their derivatives exposure is. Yet those will just be ripples on the pond, like IndyMac Bancorp last Friday after Senator Chuck Schumer brought it down almost single-handedly. Western civilization will not go into decline if Washington Mutual goes away.

Intel reports after the close tomorrow, kicking off what should be a series of earnings reports that meet or slightly beat expectations based on cautious guidance, followed by another round of continuing cautious guidance for the September quarter. The financial sector will report terrible earnings, but that is already in the market. So I don’t think earnings reports can derail a rally, and with over $4 trillion in cash on the sidelines, the VIX Fear & Greed Index well over 20 and sentiment indicators about as negative as they get, the market rally should begin. There’s some good news coming on the international front that should lower oil prices, which I will cover in this week’s Radar Report, and help keep the rally going. When the S&P gets up to 1440, we’ll find out if it can break through into a parabolic rally to new highs through next April, which is still my expectation, or if it will fail and spend many more months in the toilet.

Under either scenario, these companies and stocks (all below their buy limits) should do especially well based on their expected news flow and results:

Other stocks either above their buy limits (eResearch, Amgen 2010 $40 LEAP calls) or with less news flow (Affymetrix (AFFX) and SiRF Technology (SIRF)) will do just fine in the rally I am expecting. While I expect a temporary $30 to $40 pullback in oil prices, which kept some of the New Energy Technology MegaShift stocks off this list for now, I think the commitment to alternative energy and oil sources is unstoppable at this point. I’ll have more on that in this week’s Radar Report so stay tuned for Thursday.