By David S. Hilzenrath
Washington Post Staff Writer
Monday, March 3, 2008

At a time when the housing market needs them as much as ever, Fannie Mae and Freddie Mac are hunkering down to weather the crisis.

The two government-sponsored financial institutions have a federal mission to keep mortgage markets stable. But they have other things to think about, too -- shareholders, quarterly profits and regulatory constraints meant to keep them out of financial trouble.

As defaults have risen and home prices have fallen, Fannie Mae and Freddie Mac have lost billions of dollars, and they are taking steps to stem their losses. Both companies are tightening lending standards and charging more to guarantee pools of mortgages.

Those changes could contribute to the downward spiral -- or, viewed another way, are a long overdue correction.

In addition, each company's capacity to invest in mortgages is limited by the amount of capital they hold as a cushion against losses, and conserving capital has become a paramount concern.

"We're treating capital a little bit like a scuba diver treats oxygen," Freddie Mac chief executive Richard F. Syron told investors last week. Freddie Mac has enough capital "to provide for modest growth in our business," he said.

Fannie Mae chief executive Daniel H. Mudd put it this way Wednesday as he ranked his company's priorities: "The number one priority is capital; we want to stay long capital."

Both companies took painful steps to shore up their diminished capital late last year. In addition to reducing the dividends they pay shareholders, they sold billions of dollars worth of preferred stock that has the potential to undercut beleaguered holders of their common stock. That is not a move they want to repeat.

Mudd told investors last week that Fannie Mae will concentrate on securitizing mortgages for sale to other investors rather than investing in mortgages itself, because securitizing requires less capital.

Whether securitizing does as much to bolster the market is a separate question. Last year, Fannie Mae was arguing that for the sake of struggling borrowers, it was vital for the government to lift caps on the volume of mortgages the company was allowed to purchase. (Those caps came off Saturday.) Some government officials argued that letting the companies buy more mortgages was unnecessary -- and needlessly risky -- because they could bolster the market simply by securitizing and guaranteeing more loans.

Walter N. Schmidt, a mortgage analyst at FTN Financial Capital Markets, said Fannie Mae and Freddie Mac won't have the maximum impact on the market unless they are free to play their historic role as mortgage buyers of last resort. The price of Fannie Mae and Freddie Mac securities has declined compared with standard benchmarks, suggesting that the supply has been growing much faster than the demand, Schmidt said.

The companies would gain flexibility if their regulator, the Office of Federal Housing Enterprise Oversight, relaxed an extra capital requirement it persuaded them to accept after accounting scandals. But OFHEO Director James B. Lockhart III has cited their recent losses and the market's deterioration as vindication for the requirement, saying the companies could have gotten in much deeper trouble otherwise.

Lockhart last week said he would consider gradually decreasing the requirement, but in the same paragraph he mentioned a variety of reasons why it might be prudent to keep the extra capital -- an added 30 percent -- in place.

The current predicament underscores the tradeoffs inherent in a national housing policy that at times calls for two profit-driven corporations to defy their economic interests.

Mudd spelled out the dilemma last month in Senate testimony.

"We recognize the tensions at the very heart of the [company's] charter -- the tension between the interests of a private enterprise and the public interest; the tension between avoiding risk for safety's sake and embracing risk for the sake of expanding homeownership and affordable housing," he said.