Fannie Mae's federal regulator is a "divided" agency that used leaks to the media about the government-chartered company for its own gain, according to a report by the inspector general for the Department of Housing and Urban Development.

The Office of Federal Housing Enterprise Oversight is split between those who favor its past approach as a "collegial" bank examiner and those who would turn the agency into a "much more aggressive regulator," according to the inspector general. OFHEO is a division of HUD.

OFHEO Director Armando Falcon Jr., the focus of the investigation, and his top deputy, Stephen A. Blumenthal, redirected the agency toward a combative approach beginning in June 2003, after disclosures of accounting errors at Freddie Mac that OFHEO failed to uncover, the HUD report said. Freddie Mac, based in McLean, last year revealed that it understated profit from 2000 until 2002 by $5 billion in an effort to reduce earnings volatility.

Freddie Mac's revelations were a "turning point" at OFHEO, the report says, quoting former OFHEO chief examiner G. Scott Calhoun.

Falcon and Blumenthal adopted an approach of "no more worrying about having a working relationship" because "you're the cop on the beat," Calhoun said, according to the inspector general. "You whack them in the head with a nightstick."

Senator Christopher S. Bond, a Missouri Republican, requested the probe in April because of his concerns about possible political pressure on OFHEO, which in September accused Fannie Mae of accounting errors. Fannie Mae is a District-based, government-chartered company that purchases mortgages from lenders and resells them to investors. It is the largest source of U.S. mortgage money.

A copy of the report was provided by Rep. Barney Frank (Mass.), the senior Democrat on the House Financial Services Committee, which oversees OFHEO, Fannie Mae, and Freddie Mac. HUD Secretary Alphonso Jackson on Nov. 15 determined that the report didn't warrant action against OFHEO, said Douglas P. Duvall, a spokesman for HUD.

Frank has said the inspector general's report "raises very serious issues" and advocated withholding additional funds for OFHEO until after public release of the document.

Falcon said in a statement that OFHEO "will . . . not divert our attention from the serious matters before the agency." He said he is "pleased a determination has been made that I followed the law, acted wholly within my authority as director, and that this is now a closed matter."

Fannie Mae is the second-largest debtor in the U.S. after the government, with $942 billion in debt as of July 31. The District-based company and Freddie Mac, its smaller rival, own or guarantee almost half of the $7.6 trillion mortgage market. Congress created the two companies to help promote homeownership by acquiring mortgages from banks with the proceeds from bond sales.

OFHEO said in September that Fannie Mae had wrongly accounted for hedging transactions on its $913 billion mortgage portfolio, used improper "cookie jar" reserves, and deferred expenses to trigger executive bonuses. Fannie Mae chief executive Franklin D. Raines denied wrongdoing in Oct. 6 testimony before Congress.

Fannie Mae said Monday it would have to report an after-tax loss of $9 billion since January 2001 should the Securities and Exchange Commission determine it violated accounting rules when using derivatives to hedge against changes in interest rates. Derivatives are contracts whose value is derived from debt or equity securities, commodities or currencies.

On Monday, Fannie Mae missed an SEC deadline for filing its third-quarter financial statement after its auditor, KPMG LLP, declined to certify the results until the completion of an SEC accounting investigation. Fannie Mae also said it misapplied accounting rules in calculating the amortization of premiums and discounts on loans it acquired.

Allegations of accounting missteps at Fannie Mae will strengthen support in Congress for creation of a stronger regulator, said Rep. Christopher Shays (R-Conn.), a member of the House Financial Services Committee.

"Fannie Mae and Freddie Mac are huge, they can manipulate the market, and no one was really watching so it become very tempting for management to cross the line," Shays said.

Shays's district is home to the finance arm of General Electric Co., which is a competitor to Fannie Mae and Freddie Mac.

A Bush administration proposal to create a stronger regulator stalled in Congress this year partly because of opposition from Fannie Mae and Freddie Mac. The regulator would set capital standards, review new lines of business, and wield other new authority.

OFHEO Director Armando Falcon Jr. said he is pleased that the report found that he acted within his authority.