Dec. 9 (Bloomberg) -- Former Fannie Mae Chief Executive Officer Franklin Raines faulted regulators and housing officials for encouraging the mortgage-finance company and its competitor Freddie Mac to expand into riskier loans with limited oversight.

“It is remarkable that during the period that Fannie Mae substantially increased its exposure to credit risk its regulator made no visible effort to enforce any limits,” Raines, 59, who was ousted in 2004 and accused of accounting manipulation, told the House Oversight and Government Reform Committee in Washington today. Raines’s successor Daniel Mudd, and former Freddie Mac CEOs Richard Syron and Leland Brendsel also testified.

The executives said Congress pressured the companies to finance lower-income borrowers while regulators did little to curb the increasing risk that ultimately led to a government takeover that wiped out most shareholders and potentially saddles taxpayers with a $200 billion tab. James Lockhart, the companies’ regulator, said in September that exerting greater control over Fannie and Freddie was impeded by “their lobbying power.”

“While there could have been better regulation of Fannie Mae and Freddie Mac, it seems that Fannie Mae and Freddie Mac did a lot of things to minimize the regulation,” said John Vogel, a professor at the Tuck School of Business at Dartmouth in Hanover, New Hampshire.

Fannie and Freddie spent a combined $174 million on lobbying the government since 1998, more than General Electric Co., according to the Center for Responsive Politics. Lockhart halted all of Fannie and Freddie’s political and lobbying activities when his agency seized control of the companies on Sept. 6.

Dual Roles

Representatives Henry Waxman, 69, and Darrell Issa, 55, began the hearing with an indictment of the CEOs culpability in embracing subprime and nontraditional mortgages, making “reckless bets” that expanded their risk and helped push the housing market into its worst slump since the Great Depression.

“All four of you seem to be in complete denial that Fannie and Freddie are in any way responsible for this,” said Issa of California, the ranking Republican on the committee. “You’re either standing behind the mandate of Congress or your mandate of your stockholders or perhaps the mandate of your bonus packages and you’re telling us everyone’s doing it.”

Mudd, who was ousted as part of the government’s takeover, as well as Syron and Brendsel told the committee that it was a struggle to meet the companies’ dual mandates as profit-making, shareholder-owned corporations that were also required to promote affordable housing, according to the written testimony.

Two Masters

“There was a bigger problem than the regulator, and it was the inherent conflict in the governance structure,” Vogel said. “They were trying to appease their shareholders, and trying to serve their mission.”

Fannie and Freddie, which traded near $70 a share last year, have lost more than 97 percent of market value since as the housing slump deepened and the government took control of the companies and said the focus would be on helping homeowners even at the expense of profitability. Fannie fell 4 cents to 80 cents today in New York Stock Exchange composite trading. Freddie was down 3 cents to 81 cents.

Fannie and Freddie were chartered by Congress primarily to increase the availability of mortgage financing to promote homeownership. The companies own or guarantee $5.2 trillion of the $12 trillion U.S. home loan market and have accounted for 70 percent of all mortgages originated this year, according to the FHFA. The companies primarily buy loans from lenders or help banks package mortgages into securities for investors.

Raines argued that the companies’ main regulator, the Office of Federal Housing Enterprise Oversight, didn’t seek to restrict the amount of credit risk the companies were allowed to assume.

“Indeed, right up until the time Fannie Mae was placed into conservatorship, the director of Ofheo maintained that the company was well capitalized,” Raines said.

Full Compliance

Ofheo, which was reorganized with expanded powers this year as the Federal Housing Finance Agency, placed the companies in conservatorship after regulators discovered that losses at the largest sources of U.S. mortgage financing were preventing them from fulfilling their mission, officials have since said.

Up until the companies were seized, Mudd, 50, said the FHFA “declared us in full compliance with our capital requirements.”

All the CEOs “have an ax to grind, they’re trying to save themselves and save their reputations,” said Bert Ely of Ely & Co., a bank consulting firm in Alexandria, Virginia.

Waxman cited internal documents that show Fannie and Freddie’s then CEOs Mudd and Syron ignored warnings as the companies delved deeper into subprime and other nontraditional mortgage products in the pursuit of higher profits.

Waxman Documents

“These documents make clear that Fannie Mae and Freddie Mac knew what they were doing, Waxman said. “Their own risk managers raised warning after warning about the dangers of investing heavily in the subprime and alternative mortgage markets.”

A June 27, 2005, internal presentation by Fannie shows the company at a “strategic crossroad” to either “stay the course” or “meet the market” by increasing risk and entering the subprime market. In staying the course, Fannie noted that it would continue to lose market share, and generate lower revenue and profits. In meeting the market, the document shows that Fannie identified the subprime market as a source of growth.

“The choice was presented relatively starkly in order to identify what the key issues were,” Mudd said in response to a question from Representative John Tierney, 57, a Massachusetts Democrat.

Perfect Hindsight

The companies ramped up their business with risky loans as the housing boom turned into a boost. Freddie’s purchase of subprime and Alt-A securities totaled $158 billion in 2006 and 2007, or 13 percent of all those bonds created. Fannie’s share was 5 percent. Fannie and Freddie also guarantee $470 billion to $873 billion of debt backed by borrowers with credit scores below 700 out of a possible 850, less than 20 percent of the starting equity in their homes, or both, according to calculations by FTN Financial in Memphis, Tennessee, based on public disclosures.

Representative Carolyn Maloney, a New York Democrat, asked Syron whether he regretted his decision to purchase $150 billion in low-documentation loans that she said cost Freddie at least $8 billion.

“In perfect hindsight, I think we always wish that we hadn’t bought them,” Syron said. “But given the information that we had at the time and given the balance we were trying to achieve, we thought we were making the right decision.”

Sharing the Blame

Issa did say that Congress deserves some of the blame for repeatedly pressuring Fannie and Freddie to extend mortgage credit to disadvantaged borrowers.

“We have to recognize that what we’ve done with the GSE’s hasn’t worked,” Issa said. “We in the Congress have to look in the mirror, because part of the blame is on our doorstep.”

Mudd said the takeover of Fannie was unnecessary, and a “more modest” form of government action would have been enough to keep the business sound.

“While I deeply respect the myriad challenges facing the Treasury Department and the regulator, I did not believe that conservatorship was the best solution for Fannie Mae,” Mudd said in his testimony. Mudd said he argued for “more modest government support” that could have been used to raise private capital, “basically something more like the program many banks are eligible for now,” according to the testimony.

As part of the government’s takeover, the Treasury committed to providing as much as $200 billion in capital to keep Fannie and Freddie solvent, and the Federal Reserve later agreed to buy as much as $600 billion of their mortgage-backed securities and corporate debt. FHFA must decide by the end of next year if the companies should be removed from conservatorship.

No Man’s Land

Mudd said lawmakers ought to rethink the structure of Fannie and Freddie as shareholder-owned companies with a public mission and “whether the economy would be better served by fully private or fully public” government-sponsored enterprises. With the U.S. housing market in a “freefall,” he said the companies could not “flourish” under the constraints of a business model that required them to support the entire market.

“I would advocate moving the GSEs out of No Man’s Land,” Mudd said. “Events have shown how difficult it is to balance financial, capital, market, housing, shareholder, bondholder, homeowner, private and public interests in a crisis of these proportions.”

Raines and the other executives echoed that sentiment.

“The GSE model is a far from perfect way to achieve the goal of using private capital to achieve the public purpose of homeownership and affordable rental housing,” Raines said. “However, if the public policy goal remains the same, it will be hard to find a model that has more benefits and fewer demerits than the model that worked reasonably well for almost seven decades at Fannie Mae.”

To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net.

Last Updated: December 9, 2008 14:08 EST