March 6 (Bloomberg) -- Fannie Mae and Freddie Mac, the largest sources of money for U.S. home loans, should sell most of their $1.4 trillion in assets to refocus on homeownership among low-income Americans, Federal Reserve Chairman Ben S. Bernanke said.

The companies could destabilize financial markets should they fail to hedge their assets against risks like shifts in interest rates, Bernanke said in a speech to a meeting of the Independent Community Bankers of America in Honolulu today.

Bernanke cited data from regulators showing that less than 30 percent of the government-chartered companies' mortgage assets, or about $420 billion, promotes affordable housing.

Congress should anchor the ``portfolios to a clear public mission'' and ``require Fannie and Freddie to focus their portfolios almost exclusively on mortgages and mortgage-backed securities that support affordable housing,'' said Bernanke, who reiterated many of the Fed's views and research on the firms since 2003.

The Fed chairman took a harder line than Treasury Secretary Henry Paulson, who in November dropped a demand that Fannie Mae and Freddie Mac reduce their holdings as part of legislation creating a stricter regulator. Instead, the Treasury would allow a new regulator to decide whether their assets should be cut.

No Recommendation

Unlike former Fed chairman Alan Greenspan, Bernanke didn't specify an optimal smaller size for the mortgage holdings. Greenspan in 2005 said each of the companies' portfolios should be cut to as little as $100 billion.

The mortgage holdings constitute one of the two biggest businesses for Washington-based Fannie Mae and McLean, Virginia- base Freddie Mac, which own or guarantee about 40 percent of the $10.5 trillion residential mortgage market. Fannie Mae's assets generated 43 percent of profits in 2004. Freddie Mac doesn't release such data.

Fannie Mae shares rose $1.71, or 3.22 percent, to $54.83 on the New York Stock Exchange, while Freddie Mac shares rose 75 cents, or 1.22 percent, to $62.11.

Freddie Mac's ``entire portfolio is critical to our mission of providing liquidity, stability and affordability to America's housing finance system,'' Freddie Mac spokesman Douglas Duvall said. ``More than two thirds directly supports the affordable housing aspects of our mission.''

Fannie Mae spokesman Brian Faith declined to comment.

Bernanke in his speech didn't comment on the outlook for economic growth or interest rates.

No Vote

The Bush administration has failed to persuade Congress to create a stronger regulator since 2003 and the beginning of disclosures of $11.3 billion in accounting errors at Fannie Mae and Freddie Mac.

The House of Representatives passed legislation creating a stricter regulator in October 2005. The Senate version never went to a vote because of opposition to portfolio reductions.

The Senate Banking Committee, which also oversees the companies, ``would be well-advised to give great weight to the Fed's unique perspective,'' Senator Richard Shelby of Alabama, the panel's senior Republican, said today in a statement. ``I share many of the concerns'' of Bernanke.

The Treasury's insistence last year that Congress reduce the size of the companies was the biggest obstacle to passage of legislation because it was opposed by Representative Barney Frank of Massachusetts and other Democrats, who gained control of the House and Senate in November. The firms also opposed the cuts.

Frank, chairman of the House Financial Services Committee that oversees Fannie Mae and Freddie Mac, plans to bring the bill to a vote before his committee on March 28 after completing negotiations on the measure with Treasury.

`Key Principle'

The ``key principle'' is that the senior debt of Fannie Mae and Freddie Mac, ``which investors view as government-backed, should be used only to finance assets such as affordable-housing mortgages that have, in the view of the Congress, a clear and measurable public benefit,'' Bernanke said.

Growth in the mortgage holdings of Fannie Mae and Freddie Mac and a ``lack of market discipline'' toward the firms ``raise substantial systemic risk concerns,'' Bernanke said.

The companies are large users of derivatives, he noted. Derivatives are instruments based on underlying securities such as interest-rate swaps.

The companies' ``portfolios appear to have no material effect on the cost or availability of residential mortgages,'' according to Bernanke.

James Lockhart, director of the Office of Federal Housing Enterprise Oversight that regulates the companies, said yesterday they probably won't be subject to ``drastic cuts.''

``There certainly could be some changes in the portfolios, not only in reallocation but some decrease in size,'' Lockhart told reporters in Washington. ``But it is not going to be as drastic.''

Fannie Mae and Freddie Mac wouldn't need to compromise their credit standards as they construct portfolios that better expand affordable housing, Bernanke said. ``I am not advocating a change in the exposure of'' the companies ``to subprime loans.''

To contact the reporter on this story: James Tyson in Washington at jtyson@bloomberg.net

Last Updated: March 6, 2007 17:49 EST