Feb. 27 (Bloomberg) -- U.S. regulators removed limits on the combined $1.5 trillion mortgage portfolios of Fannie Mae and Freddie Mac, enabling the companies to increase financing for the slumping housing market.

The asset caps, imposed in 2006 after the two largest mortgage finance companies revealed $11.3 billion of accounting errors, will end on March 1, the Office of Federal Housing Enterprise Oversight said in a statement today. The agency will still require the companies to set aside reserve capital that is 30 percent more than the usual minimum.

Unconstrained by portfolio limits, the government-chartered companies may buy more loans and bonds, replacing buyers who fled the market amid the collapse in subprime mortgages.

``Since they're the only game in town, anything that allows them to play on a more open field is going to be a help for them and mortgage borrowers,'' said Bob Walters, the chief economist at Livonia, Michigan-based Quicken Loans Inc.

Ofheo lifted the constraints after Fannie Mae and Freddie Mac met a demand that they resume timely reporting by the end of the month. Fannie Mae today posted a fourth-quarter net loss of $3.55 billion, as record home foreclosures increased credit losses. Freddie Mac is scheduled to report results tomorrow.

Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac account for 45 percent of the $11.5 trillion U.S. residential mortgage market and were created by Congress to help expand homeownership and to provide market stability. They make money by holding mortgage assets and by guaranteeing securities backed by home loans.

Shares Rise

Fannie Mae rose 30 cents, or 1.1 percent, to $27.27 today in New York Stock Exchange composite trading. Freddie Mac declined 12 cents to $25.09.

Fannie Mae, while eying ``major opportunities'' for investment, plans to manage its capital ``very conservatively'' and expand its business of guaranteeing mortgage bonds faster than its portfolio of home loans and mortgage-backed securities, Chief Executive Officer Daniel Mudd said.

The ``number one priority is capital,'' Mudd said in a conference call with analysts. ``Capital remains king.''

The extra yield, or spread, above benchmark rates that investors demand to buy mortgage-backed securities guaranteed by the companies fell in anticipation of increased demand. Spreads have been near the highest since the 1980s, according to UBS AG analysts, translating to rising mortgage rates for new prime mortgages of $417,000 or less.

The difference between yields on the Bloomberg index for Fannie Mae's current-coupon 30-year fixed-rate mortgage bonds and 10-year U.S. government notes declined about 7 basis points to about 182 basis points. A basis point is 0.01 percentage point.

Stricter Oversight

The decision by Ofheo brings more than three years of remedial oversight closer to an end. The agency tightened constraints after accounting errors caused the firms to restate results. Fannie Mae and Freddie Mac were ordered to fix their accounting and report timely, audited annual earnings by March.

Ofheo on Sept. 19 raised the portfolio limit at each company to $735 billion for the third quarter and granted a 2 percent increase over the next year as part of the Bush administration's response to the deepening housing slump.

Even without a removal of the limits, Fannie Mae and Freddie Mac ``could grow their portfolios by about $100 billion for the next six months and not hit our constraints, so we have not been constraining them through this year,'' Ofheo Director James Lockhart told the Senate Banking Committee on Feb. 8.

Not Enough

The companies' self-restraint has prompted criticism from Senator Charles Schumer and other lawmakers who want Fannie Mae and Freddie Mac to expand purchases of mortgages and help revive the housing market.

The companies ``have a responsibility to use this flexibility to assist those homeowners most in need, period,'' Schumer, a New York Democrat, said in a statement today.

The removal of the portfolio limits ``does not help the credit markets,'' Doug Dachille, who oversees $7 billion in fixed-income investments as chief executive officer of First Principles Capital Management LLC in New York, wrote in a note today. With Fannie Mae and Freddie Mac reporting rising credit losses, ``the binding constraint to the growth of the portfolios is not the Ofheo caps but'' the Ofheo requirement the companies set aside 30 percent more reserve capital than normal.

Fannie Mae's loss for the fourth quarter was its second in a row. Freddie Mac is likely to report a loss tomorrow, according to the average estimate of 12 analysts surveyed by Bloomberg.

More Capital?

Ofheo said it won't lift the reserve capital mandate until it's satisfied with the companies' finances.

``The approach and timing of this decrease will also include consideration of the financial condition of the company, its overall risk profile, and current market conditions,'' Ofheo said.

Fannie Mae, which raised about $7 billion in a preferred shares offerings in December, said today it may need to sell more stock or assets to keep shore up capital. The company's $724 billion portfolio on Dec. 31 was $18 billion below its cap.

Federal Reserve Chairman Ben S. Bernanke today urged the companies to expand their reserves.

``We would certainly encourage them to raise capital,'' Bernanke said in testimony to the House Financial Services Committee in Washington.

The need to bolster capital against the worsening housing market will inhibit growth this year, said Paul Miller, an analyst at Friedman Billings Ramsey & Co. in Arlington, Virginia. He downgraded the stock to ``underperform'' on Feb. 25.

``For me to get very comfortable in recommending this stock, I'd like to see something above $15 billion in capital raising,'' Miller said.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

Last Updated: February 27, 2008 16:22 EST