* U.S. stocks sink on Fannie and Freddie bailout fears
* Bonds rise for third straight day on safe-haven buying
* U.S. dollar off 6-month highs vs euro, commodities weigh (Adds close of U.S. markets)
By Herbert Lash
NEW YORK, Aug 18 (Reuters) - Credit crisis jitters shook Wall Street on Monday, dragging down stocks and lifting safe-haven government debt, as fears mounted that the U.S. Treasury will need to bail out the two largest mortgage finance companies.
The U.S. dollar slid against the yen and euro as relatively steady oil prices weighed on the currency and prompted investors to take profits after the greenback's recent sharp rally.
Oil prices fell after see-sawing around $113 a barrel as fears eased that Tropical Storm Fay would damage major oil and gas infrastructure in the Gulf of Mexico.
Investors dumped shares of Fannie Mae <FNM.N> and Freddie Mac <FRE.N> after Barron's newspaper reported the increasing likelihood of a U.S. Treasury bailout that would approach nationalization of the two housing finance titans, which together own or guarantee more than $5 trillion in U.S. mortgages.
A spokeswoman for the U.S. Treasury said the department has no plans to use its authority to backstop the two federally sponsored funding agencies.
Shares of Fannie fell 22.3 percent to $6.15, the lowest close since May 1989, after earlier falling as low as $6.08. Freddie closed down 25 percent at $4.39.
"Investors have been trying to put the housing and credit crisis behind them," said Paul Nolte, director of investments at Hinsdale Associates in Hinsdale, Illinois. "But every time news like this comes up they have to readjust their thinking."
The Dow Jones industrial average <
> slid 180.51 points, or 1.55 percent, at 11,479.39. The Standard & Poor's 500 Index <.SPX> fell 19.58 points, or 1.51 percent, at 1,278.62. The Nasdaq Composite Index < > shed 35.54 points, or 1.45 percent, at 2,416.98.Equity investors also fretted over a report from The Wall Street Journal that said some analysts are girding for investment bank Lehman Brothers <LEH.N> to announce a third-quarter loss of $1.8 billion or more. Shares of Lehman fell 7.1 percent to $15.03.
The S&P financial index <.GSPF> fell 3.58 percent.
FIRMER EURO WEIGHS ON EUROPEAN STOCKS
European shares edged lower in a volatile session dominated by a brief pick-up in oil prices, which lifted energy shares. But a firmer euro that dented retail and auto stocks quashed the early boost from crude oil.
Auto stocks ranked among some of the biggest individual drags, while banks were the worst performing sector on the broader European market.
The FTSEurofirst 300 index of leading European shares <
> fell 0.09 percent at 1,189.15 points.Declining crude prices eroded some of the gains in oil and gas shares, but provided growing relief that inflationary pressures are receding after crude's record highs around $147.
Index heavyweights Total <TOTF.PA> and Royal Dutch Shell <RDSa.AS> were up 1.1 to 1.8 percent, while StatoilHydro <STL.OL> rose 3.2 percent.
"The oil price is very important and is indeed part of the reason why we've seen investor sentiment look a bit stronger over the course of the last few weeks," said Henk Potts, a strategist at Barclays Stockbrokers.
"Short term it is still a pretty negative picture of slowing economic growth, which continues to be a factor," he said.
Euro zone debt extended last week's rally as evidence the region's economy was losing momentum boosted expectations that the European Central Bank would keep interest rates on hold in the near term before eventually loosening policy.
A similar view on rates has taken hold in the United States, as declining energy prices ease fears of inflation.
The benchmark 10-year U.S. Treasury note <US10YT=RR> rose 8/32 to yield 3.8 percent. The 30-year U.S. Treasury bond<US30YT=RR> added 16/32 to yield 4.44 percent.
Bund futures in Europe rose at one point to their highest level since mid-May, while yields, which move inversely to prices, touched similar lows.
"You have stocks selling off and concerns continuing about the health of financial companies and this stokes the flight-to-quality bid for Treasuries," said David Coard, head of fixed income sales and trading at Williams Capital Group in New York.
Oil prices fell, with U.S. crude <CLc1> down 90 cents to settle at $112.87 a barrel. London Brent crude <LCOc1> dropped by 61 cents to $111.94 a barrel.
U.S. gold futures surged after the previous session's nearly 3 percent fall, closing above $800 an ounce.
The December <GCZ8> gold contract settled up $13.60 at $805.70 an ounce in New York.
The dollar retreated from seven-month highs against the yen as investors took advantage of a rebound in commodities to take profits.
Despite the dollar's pullback, investors remained optimistic on the currency's prospects, convinced that it has turned the corner. Steadier U.S. growth, oil's slide from record peaks in July, and a deteriorating outlook outside the United States have underpinned the dollar in the last few weeks.
"The dollar is in a consolidative mode, and with commodities up investors have taken that as an excuse to take the dollar lower," said Win Thin, senior currency strategist at Brown Brothers Harriman in New York.
The dollar fell slightly against major currencies, with the U.S. Dollar Index <.DXY> down 0.10 percent at 77.076. Against the yen, the dollar <JPY=> slipped 0.45 percent at 109.99.
The euro <EUR=> added 0.10 percent at $1.4703.
Asian stock markets were mixed. Shares outside Japan <.MIAPJ0000PUS> hit a 17-month low on a view that a slowdown in developed economies will likely hit exports even harder.
Japan's Nikkei share average <
> rose 1.1 percent as investors looked for bargains after a recent market sell-off. (Reporting by Ellis Mnyandu, Chris Reese, John Parry, Gertrude Chavez-Dreyfuss in New York and Amanda Cooper, Kirsten Donovan, Bate Felix in London; Writing by Herbert Lash; Editing by Leslie Adler)