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Correction to This Article
A Dec. 5 Washington Business story on Fannie Mae and Freddie Mac incorrectly stated that the companies had to remove a combined $16 billion in profit from their books. It should have said they had to restate a combined $16 billion in profit. Fannie Mae had to erase $10.8 billion in profit, while Freddie Mac added $5 billion in profit. As a result, Freddie Mac did not have to reduce its portfolio holdings to meet capital requirements, as stated in the article.

New Paths for Mortgage Giants

Daniel H. Mudd, Fannie Mae's chief executive, acknowledges that the company must change the way it does business.
Daniel H. Mudd, Fannie Mae's chief executive, acknowledges that the company must change the way it does business. (By Lois Raimondo -- The Washington Post)
By Annys Shin
Washington Post Staff Writer
Monday, December 5, 2005

Struggling through the aftermath of multibillion-dollar accounting scandals, officials at Fannie Mae and Freddie Mac say their most difficult decisions may lie ahead. With stiffer competition from other companies and the changing tastes of home buyers in the types of loans they want, the companies face a choice between moving into riskier types of investing and acknowledging to stockholders that their potential for growth is limited.

In either case, company officials say, the business model that has generated record profit in recent years -- buying standard 30-year mortgages from banks so bankers would have more money to lend -- must change.

"Where in the olden days, you had a choice of selling your mortgage to Fannie Mae or Freddie Mac, in the future, there are lots of alternatives," a fact that has prompted a search for ways to diversify, Fannie Mae chief executive Daniel H. Mudd said in a recent interview.

The companies' options include becoming more deeply involved in the adjustable-rate mortgages that many consumers have preferred in recent years, financing more multifamily developments, and changing the standards for granting mortgages to take more risks with consumers who have spotty credit records.

The companies are even concerned about sustaining their staple business -- bundling mortgages into securities that are sold to investors throughout the world -- now that large institutions such as Countrywide Home Loans Inc., Lehman Brothers Inc. and Bear Stearns & Co. have moved into it. Fannie Mae and Freddie Mac's share of the mortgage-backed-securities business has fallen from more than 60 percent in 2000 to around 40 percent this year, according to the trade publication Inside Mortgage Finance.

District-based Fannie Mae and McLean-based Freddie Mac are two of the area's largest and most visible businesses, employing more than 8,000 in the region.

"The challenge for us is to reassert our presence in those areas where we've lost a bit of competitive advantage," said Patricia L. Cook, Freddie Mac's executive vice president for investment and capital markets.

The companies have not faced such fundamental questions about their underlying business model since the 1980s, when the collapse of the savings and loan industry under billions of dollars in bad debt pushed Fannie Mae into the red.

The current dilemma, in contrast, follows an era of explosive earnings growth at both firms, which helped turn a pair of bread-and-butter, government-chartered mortgage finance companies into high-performing growth stocks and prompted Fannie Mae chief executive Franklin D. Raines to promise Wall Street similar results far into the future. The companies' earnings, it was later disclosed, were inflated through accounting techniques that masked some investment losses.

Top executives, including Raines, were forced out, and the companies had to remove a combined $16 billion in profit from their books. Freddie Mac officials say they are nearing the point where they can produce reliable financial results. Fannie Mae is further behind and remains the subject of several federal investigations.

As they emerge from those crises, executives say part of their post-scandal life is to set more realistic expectations. Fannie Mae's stock is down about 30 percent this year, closing Friday at $47.99 a share. Freddie Mac's share price is off by slightly over 7 percent for the year and ended the week at $62.90.

"We've transitioned from growth to a value stock," Cook said. "The investment and analyst community appropriately expects us to be getting back to business."

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