the 5-Yr TIPS is now carrying around a +0.13% real yield, which is to say that investors in that market are discounting real economic growth of just more than 1/10 of 1% over the next 5 years. the slowest period of real economic growth since ww2 is +1.6%, or about 12.3 times greater than what's currently being discounted. possible? yes. likely? no way.
there are many ways to stand behind mortgage paper besides saying "we explicitly guarantee" it. the fed can buy it and take it out of circulation. the fed can suspend, temporarily, the capital requirements for holding this stuff. we see covering on fridays--typical bear market behavior-because the shorts are worried that paulson wakes up and says something like this: something to the effect of "the government stands behind this paper." it would be a nightmare scenario to be short if the treasury did that.
more on irrational pessimism: earlier today, the yield on the three-month T-bill dropped down to 1.1% (it's come up a bit since). the yield on the five-year note dropped below 2.4%. think about that. there are people (or foreign central banks) who are willing to lock-in a 2.4% return for the next five years. even if the Fed cuts by 75 points, it will still be well above market rates. just amazing.