In the aftermath of the financial crisis, American taxpayers poured $187.5 billion into two huge but poorly understood companies: Freddie Mac and Fannie Mae. Now controlled by the government, the companies play an even larger role in the economy than they did before the crisis and their bailout, but they are riven by conflicts of interest and clashing goals. Are they private companies, only out to increase their profits, or are they instruments of government policy, dedicated to keeping home ownership available?

ProPublica has focused on the tensions within Freddie Mac and Fannie Mae, as well as those besetting their regulator, the Federal Housing Finance Agency (FHFA).

NPR's Chris Arnold and ProPublica revealed that Freddie Mac had placed multibillion-dollar bets that pay off only if homeowners stay trapped in expensive mortgages with interest rates well above current rates. Freddie began increasing these bets dramatically in late 2010, the same time that the company was making it harder for homeowners to get out of such high-interest mortgages.

The scoop, "Freddie Mac Bets Against American Homeowners," caused an immediate firestorm. As countless media outlets picked up the story, multiple senators criticized the company and wrote to Edward DeMarco, the acting head of the FHFA, calling for an investigation into the transactions and the company's activities.

The FHFA responded, saying it had told Freddie not to make any more transactions in the kind of securities at issue, called inverse floaters. The agency said it had "identified concerns regarding the controls, including risk management, surrounding the inverse floaters." The agency did not specify those "concerns," but said Freddie agreed in December that "these transactions would not resume pending completion of [FHFA's] examination work." The statement also said that Freddie had ceased making the deals earlier in 2011 but did not explain why.

In response to a letter Sen. Robert Casey, D-Pa., sent to DeMarco, the regulator expanded on its reasons for shutting down the transactions a few days later, saying that "the risk associated with these transactions is inconsistent with FHFA's goals of having Freddie Mac reduce its risk profile and avoid unnecessary complexity that requires specialized risk management practices."

In September, the inspector general of FHFA concluded that there was no deliberate or coordinated effort by Freddie Mac to keep homeowners trapped in high-interest mortgages in order to profit from trades pegged to those rates. A firewall is supposed to separate Freddie employees who make trades from those who set policy for homeowners. In its investigation, the inspector general found no evidence that the firewall had been breached — but conceded it had not independently evaluated the integrity of the firewall but instead relied on interviews with employees who said no one had violated the wall.

Penetrating Freddie's boardroom, ProPublica exposed the internal debates over the company's refi programs. Many economists were pushing for mass refis, because they said they would reduce foreclosures and boost the economy. But some Freddie board members feared they would cut into company profits. In closed door meetings, two Republican-leaning board members and at least one executive resisted a mass refi policy for an additional reason: They regarded it as a backdoor economic stimulus.

In a recent explainer, we looked at how with little discussion or planning, we have nationalized the American mortgage market and what the ramifications of that are. Before the financial crisis, the federal government backed roughly 30 percent of mortgages. Now, the government is backing about 90 percent of new mortgages, with Fannie and Freddie backing the lion's share. What do we do about Fannie Mac and Freddie Mac? Should the government keep insuring so many mortgages? And how do we resolve the conflicts of interest and competing goals that beset Freddie and Fannie? A bipartisan centrist consensus is forming to solve the problem by heading down a path that offers the least resistance but could be the most dangerous: returning to what existed before the housing market imploded.

ProPublica also focused on the FHFA, which regulates Fannie and Freddie, and DeMarco, its acting head. A coalition of progressive groups, housing advocates, Democrats and, later, the White House pushed DeMarco to allow Fannie and Freddie to cut the size of mortgage balances, known as principal reduction. Many economists argue that such debt relief is the key for helping people get back on their feet and the economy going again.

The fight over principal reduction highlights the conflicting goals at Fannie and Freddie. DeMarco has remained steadfastly opposed to principal reductions, arguing that they would be too costly — both to the companies' profit margins and to the taxpayers, whom Freddie and Fannie are still paying back. Critics say DeMarco is putting the Fannie and Freddie's financial interests above struggling homeowners'. His opposition to principal reduction has stymied White House plans to encourage mass write-downs, because Fannie and Freddie together own or guarantee half of the country's mortgages.

As part of its revamped refinancing effort, Home Affordable Refinance Program (HARP), the Treasury Department agreed to supplement Fannie and Freddie to write down principal. In a Propublica/NPR scoop, we revealed that Fannie and Freddie ran the numbers and determined that principal reductions would actually be profitable for the companies, undercutting DeMarco's stated reason for opposing them.

Nevertheless, DeMarco subsequently decided against doing them, citing risks that such reductions would cause other homeowners to voluntarily default on their mortgages.

Because FHFA is an independent regulator, the White House can't simply fire DeMarco over a policy dispute. As an acting director, DeMarco could have been replaced by a new Obama appointee, but the administration's initial pick withdrew himself from consideration as Senate Republicans signaled they would oppose him. The Wall Street Journal recently reported that the White House hopes to have a new nominee early next year.

At the height of the 2008 financial crisis, the country heatedly debated whether to nationalize the failing banking system. Both the George W. Bush and Barack Obama administrations rejected that path as excessive government intrusion into the marketplace.

Yet since then, with little planning and paltry public discussion, the government has almost completely taken over the American home mortgage market. Banks and other for-profit financial services companies lend money to homeowners, but without the guarantees and other support the government provides, the housing market would barely be functioning now.

The Government Takes Over the Mortgage Market

Percentage of all new mortgages backed by the U.S. government

Note: Data for 2012 is through September. Source: Inside Mortgage Finance

Fannie Mae and Freddie Mac, the taxpayer-controlled housing giants, guaranteed 69 percent of new mortgages in the first nine months of the year, up from about 27 percent share in 2006, according to Inside Mortgage Finance. Meanwhile, the Federal Housing Authority and the Department of Veteran's Affairs currently back another 21 percent of mortgages, up from just 2.8 percent in 2006. Altogether, 9 of every 10 new mortgages are backed by the U.S. taxpayer, up from three in 10 in 2006, when the government share hit a decade-low, according to the publication.

"It is creeping nationalization," says Jim Millstein, an investment banker who worked in the Obama administration's Treasury Department as the Chief Restructuring Officer.

The problem isn't just that the market is nationalized. It was nationalized in a slapdash fashion so that now it is riven by conflicts of interest and competing goals.

The possible solutions are well known and have been for years. But during its first term, the Obama White House made a tactical decision — politically astute but tinged with calculation, some say — not to push for change. Now with the election over, a bipartisan centrist consensus is forming to head down a path that offers the least resistance but could be the most dangerous: returning to what existed before the housing market imploded.

After taxpayers pumped $187.5 billion into them starting in 2008, Fannie and Freddie exist today in a limbo state, under government "conservatorship." They aren't fully private, profit-seeking entities, but neither are they explicit arms of government policy. They act both as profit-seeking businesses and as public agencies.

Freddie and Fannie's main business is insuring mortgages, and they back $5 trillion or about half of the American mortgage market. They buy mortgage loans and bundle them to create mortgage-backed securities, earning fees. If a borrower stops making mortgage payments, Fannie and Freddie step in to continue the flow of payments to the mortgage-backed securities investors. The two companies also invest in mortgage-backed securities.

But Freddie and Fannie are also chartered by Congress to implement public policy goals, such as keeping home ownership available for Americans.

The goals of making a profit and enacting public policy create a deep-seated conflict of interest. Under conservatorship, the conflicts and problems have become amplified.

In recent years, Freddie Mac made it harder for homeowners to refinance their high-rate mortgages for fear it would cut into the company's profits and hinder its ability to repay taxpayers.

Under conservatorship, Congress has been tempted to milk the companies. Loathe to raise taxes and eager to cut them, Congress has used Fannie and Freddie as a private kitty, raiding them for cash. In 2011, Congress siphoned off 10 years' worth of part of Fannie and Freddie's guarantee fees to fund a mere two months of a cut in the payroll tax. Recently, the House passed an immigration bill that is funded by their guarantee fees.

"It's a sign of weakness for this country if we can't make hard decisions without using the GSEs" — Washington-speak for Freddie and Fannie — "as piggy banks," says Dave Stevens, the head of the Mortgage Bankers Association and former official in the Obama administration.

The companies are regulated by the Federal Housing Finance Agency, which clears all their major business decisions. That has added to the muddle: The FHFA's acting director Edward DeMarco controversially has interpreted its main goal as preserving the assets of Fannie and Freddie and de-emphasized its mission to "support housing finance and affordable housing, and support a stable and liquid mortgage market," as it puts it on its website. Earlier this year, the FHFA decided against forgiving principal on delinquent mortgages, arguing that the benefits were too small and the risks unknown. The decision drew a rebuke from Treasury Secretary Timothy Geithner.

The longer Fannie and Freddie stay in purgatory, the more likely they are to suffer from key departures of executives, who are frustrated that they cannot make their businesses' key decisions. The worry is that important areas of their businesses erode, such as their risk management, raising the possibility of sudden, large losses for taxpayers.

Few Democrats, Republicans, housing advocates and economists want to preserve the current situation. Yet while there are dozens of congressional bills, think-tank plans and an Obama administration white paper with proposals to resolve the mortgage giants, there has been little change.

During its second term, the Obama administration has vowed to overhaul how Americans buy their homes — and the central problem is what to do about Fannie and Freddie. Wind them down? Return them to private company status? What role should the government play in the mortgage market, and how big?

Political Machinations Lead to Paralysis

Conservatorship wasn't supposed to last four years. Hank Paulson, Bush's Treasury secretary, took the emergency measure in September 2008, right before Lehman Brothers collapsed. Internally, the administration considered it a short-term solution. In the midst of a much-worse crisis hitting the entire financial system, however, it did not plan an exit.

The Obama administration spent the bulk of 2009 stabilizing the financial system in the aftermath of the panic. Then it confronted the housing crisis, though it has received consistent and bipartisan criticism for its ineffective programs.

The pace of discussions about resolving Fannie and Freddie picked up in 2010. Even though the private sector mortgage market had just failed disastrously in 2008, the most influential voices in the Obama administration's first term advocated returning to a limited government role.

At a meeting in December 2009 with progressives who were pushing for a more active administration role in the housing crisis, Larry Summers, then the director of the National Economic Council, challenged them. "He would ask why housing is different from anything else — than widgets," recalls Andrew Jakabovics, a housing specialist who worked at HUD after having been at the Center for American Progress, a Democratic think tank in Washington that played an active role in advising the administration on housing policy.

It was a classic Summers interrogatory, and the attendees were left unclear whether he was provoking them to think more deeply about the market or reflecting his sincere belief. Internally, when Summers hosted meetings on the issue, he would split the group into the "hawks," who were pushing for a more laissez-faire approach, and the "doves," who favored strong government intervention, according to a person who was involved in the meetings. Summers did not respond to questions about his role in these discussions.

In February 2011, the administration issued a white paper outlining options to remake the American housing finance market, with three options to fix Fannie and Freddie.

Option 1: Largely privatize the market, unwind Fannie and Freddie and remove the government almost completely from the housing finance market.

Option 2: Provide some form of government guarantee for mortgages only in times of crisis.

Option 3: Restore Fannie and Freddie much as they were before the crisis, though with significant protections for taxpayers and with measures to attract private capital into the market.

Many criticize the Obama administration for not choosing one of these options. "Treasury punted," says David Min, a law professor at University of California — Irvine. Phillip Swagel, a former official in George W. Bush's Treasury Department, called the lack of progress on the issue "a failure of the Obama administration."

Privately, the administration came to favor some version of Option 3. But after the Republicans took Congress in the 2010 midterm elections, the administration made a political calculation not to push any specific solution, according to several people familiar with the administration's deliberations.

The Republican Party, the thinking went, is split on Fannie and Freddie. One faction, the tea party and others with a free-market philosophy, want the government out of the mortgage market. Another is made up of small community bankers, realtors and local developers, who would like to see Fannie and Freddie restored to something resembling the way it was before in order to keep the mortgage market flowing and to allow smaller banks to compete with the giant firms.

The big banks make up a third faction. They would like to see the government's role limited to a guarantee. That would allow them to continue to dominate the mortgage origination business without contending with the market power of government-sponsored entities. Before conservatorship, Fannie and Freddie had enormous influence over what kinds of loans banks would offer, which had the effect of restricting bank activity.

Backing a specific plan would have united the opposition against it, the administration felt. "We had deep research on the subject and long, lengthy, fully baked recommendations," says a person involved in the efforts. "The view was any position we took was going to bring out attacks from conservatives and the anti-Obama-ites. It would have polarized the debate."

Democrats also blame Republicans for making intransigence their overarching tactic during the first Obama administration. "The political reality was there was no way to bridge that difference. Could Treasury and the administration have reached out more? Sure, but I'm not sure they would have gotten anywhere. And it would have given them [Republicans] something to be against," says Min.

For their part, Republicans say that the Obama administration didn't reach out to them to discuss options or hear their ideas.

And of course, Democrats have factions as well, though they are less pronounced. The progressive wing wants to push the government to make sure there is sufficient backing to make housing affordable for more families.

Meanwhile, Fannie and Freddie had become politically toxic. Peter Swire, a law professor at Ohio State who was a special assistant for economic policy under Summers in the Obama administration, recalled driving through rural North Carolina during Christmas in 2009. Local talk radio was dominated by diatribes against Fannie and Freddie as symbols of what was wrong with the bailouts. "How the heck do you do any policy work when the topic is so radioactive?" he says.

And so, after the administration issued its white paper in 2011, little happened in Congress or the White House.

Back to the Future

In the meantime, the FHFA is making a series of small decisions that ultimately could shape the future of Fannie and Freddie.

In working to increase the profitability of Fannie and Freddie, the FHFA is restricting mortgage credit and sometimes interfering with homeowner rights, critics say. Recently, the FHFA announced that it was considering a plan to raise its guarantee fee in five states which have high foreclosure costs. One reason for that: These are states where judges oversee foreclosures, which housing advocates argue can provide transparency and due process for homeowners. Without judicial foreclosures, it is unlikely that the banks' "robo-signing" abuses would have come to light back in 2010. In effect, these critics charge, the FHFA is punishing homeowners for living in states that provide crucial judicial oversight of the banks.

In another move, the FHFA has forced banks to put back on their own books the risk on mortgages that Fannie and Freddie have guaranteed. Fannie and Freddie have done this in cases where they later discovered that the firm that originally made the loan violated the terms of its contract. These aggressive "putbacks" have made banks wary of making new mortgage loans, say analysts.

These policies have the effect of working at cross-purposes to other arms of the government, such as the Federal Reserve, which is pushing down rates to increase lending. "The Fed is trying to open up the spigot to bring water to fight the fire. The FHFA is squeezing on the hose, holding credit standards that are tighter than any time in the last 20 years," says Christopher Mayer, a housing economist from Columbia University.

Today, Washington observers think that conventional wisdom is coalescing around something resembling Option 3, a return to the hybrid of a private and public finance market. The view is that private capital is needed in the market. But without a government role, the housing market would wither. Many believe that the 30-year mortgage, a pillar of the American Dream of homeownership, might cease to exist, since banks might be reluctant to offer a loan to be paid back over such a long period without some kind of government insurance.

This time around, private investors would be on the hook for the initial losses and Fannie and Freddie would not in theory charge too little for their insurance, as they did in the lead-up to the crisis.

Given that, Swagel, the former Bush appointee, contends that there is plenty of overlap between the mainstream Democratic and Republican views. A conservative, he agrees that the government should play some role in housing. "That's what the government is there for. Just do it explicitly and do it well," he says.

Swagel argues, contra more hard-right Republicans, that a fully private housing finance market is an illusion. Housing is so important for the economy that the government will inevitably bail it out in a serious crisis. Therefore, even if the government was somehow removed from the market explicitly, the backing would be there implicitly. Conservatives have an interest in pushing for the government to charge the right price for its insurance and to minimize its role.

Such views suggest there is a compromise available for the reaching. "This is one of these areas where a consensus should happen," Swagel says.

But some people, especially outside the Beltway and Wall Street, think twice about reverting to a large private-market role, given that profit-seeking led to the subprime debacle. While hardly anyone is pushing it, there is an Option 4: Expanding the government's role in the mortgage market, perhaps by having the government back home loans more directly. It could be done by a government corporation, akin to the Federal Deposit Insurance Corporation, which has a measure of independence from congressional or executive branch interference, but wouldn't seek profit. In that way it would avoid the conflicts inherent in the Fannie and Freddie public/private hybrid model.

"Profit-seeking is what gets banks and financial institutions into trouble. The government can get into trouble too, but it seems it gets into less trouble," says Susan Woodward, the former chief economist of the U.S. Department of Housing and Urban Development under Presidents Reagan and George H.W. Bush. Moreover, "It's very hard for government to do something that hurts consumers."

David Scharfstein, a professor at Harvard who served in the Obama Treasury, worked on the white paper pushing Option 2, limited guarantees for mortgages only when a crisis strikes. He worries about Option 3, which he calls a "re-do of Fannie and Freddie."

But the forces backing it are powerful. "It's striking — and very unusual — for the housing industry, Wall Street, and consumer groups to all be advocating essentially the same policy," he says.

That doesn't happen much and when it does, he says, look out. His fear is that private for-profit entities would want to grow and expand their market share. They would lobby to reduce the amount of capital they have to reserve for an emergency, and to lower the fees charged for mortgage insurance so they could compete on price. If another crisis hits, lower capital reserves and lower fees would make them far more vulnerable to going bankrupt, leaving the taxpayer to bail them out. "It should be a private market or the government. But the government backstopping private entities," Scharfstein says, "is the worst possible combination."

Freddie Mac, the taxpayer-owned mortgage giant, made it harder for millions of Americans to refinance their high-interest-rate mortgages for fear it would cut into company profits, present and former Freddie Mac officials disclosed in recent interviews.

In closed door meetings, two Republican-leaning board members and at least one executive resisted a mass refi policy for an additional reason, according to the interviews: They regarded it as a backdoor economic stimulus.

Freddie's policy was financially brutal: During the worst years of the Great Recession, when homeowners most needed the savings they could have gotten from refinancing to lower interest rates, Freddie helped keep millions of borrowers locked in high-interest-rate mortgages.

A more aggressive refi program by both Freddie and its sister company Fannie Mae would have helped an additional nine million homeowners to refinance, saving them nearly $75 billion in interest payments to date, Columbia University housing economist Christopher Mayer estimates. In addition, it would have prevented hundreds of thousands of delinquencies and foreclosures, he says. [UPDATE: Mayer released the estimates behind this calculation here; key information is in the fourth bullet point.]

Freddie's resistance to refis highlights a central conflict of interest that plagues both Freddie and Fannie. That conflict is even more pronounced now that they are owned by taxpayers. The companies, which own or back about 60 percent of U.S. home mortgages, have a mandate to help expand homeownership and also to generate profits. These goals can work at cross purposes.

Freddie and Fannie maintained and erected barriers to refinancings when the Obama administration launched a program in early 2009 specifically designed to make refinancing more accessible — the Home Affordable Refinance Program, or HARP. Freddie continued to hinder refinancings through a late 2011 relaunch of HARP designed to further slash refi costs and paperwork. At that point, Fannie began opening its gates more widely, but Freddie still kept barriers in place.

Only in the last few months, under a new chief executive, has Freddie loosened many of its restrictions on refinancing.

"Almost immediately after taxpayers bailed them out, Fannie and Freddie imposed unprecedented restrictions on refinancing, preventing millions of people from saving money on their mortgages and leaving hundreds of thousands of people to lose their homes unnecessarily," says Mayer. Then after the 2011 HARP relaunch, "Freddie was worse" than Fannie, he said.

The Internal Debate

Now, interviews with former board members and an executive have revealed two reasons why Freddie dragged its feet.

According to interviews, these officials feared that mass refinancing would hurt the company's bottom line and therefore its ability to repay taxpayers, who had bailed out Freddie and Fannie in 2008 to the current tune of almost $142 billion. Fears that borrowers who got refis would suffer high rates of default anyway, costing Freddie, have not been borne out.

Internally, Freddie debated its compliance with HARP for years. Robert Glauber, who left Freddie's board in March, contended in board meetings that aspects of the refinancing program were "designed to be a stimulus" for the economy, said John Koskinen, who served as Freddie Mac's chairman from 2008 to 2011, during which time he also served briefly as its interim chief executive.

Glauber, director Linda Bammann and head of risk management Paige Wisdom resisted mass refis. One executive viewed their objections as colored by partisan unwillingness to help the economy recover, something that would benefit President Obama.

But Koskinen did not regard the discussion as partisan. "I don't think we ever had a discussion of whether this was good for a Democratic administration."

Glauber was a Republican appointee to the Treasury Department under President George H. W. Bush and has had a career in various Wall Street roles. In a brief email to ProPublica, he disputed a quotation attributed to him but did not comment on the substance of the internal debates. He wrote that "it is an outrage that what claim to be confidential discussions in the board room are aired in your publication."

Bammann, who donated $250 to the National Republican Congressional Committee this year, declined to comment. Wisdom did not respond to requests for comment.

Freddie Mac declined to make an executive available. The company is "always trying to find a balance to stimulate borrowing on responsible terms at prices that protect us from risk," a spokesman said. The new CEO, Donald Layton, has made it clear that making changes to the company's refi program is "a major priority," the spokesman said. And he pointed out that Freddie has streamlined its refi process outside of the HARP program as well.

The spokesman declined to comment on Freddie's internal discussions.

HARP was intended to lower barriers to refinancing for borrowers, especially for those who have high loan balances or owe more than their homes are worth, known as being under water. But HARP has disappointed in part because of Freddie and Fannie's restrictive refi rules.

When the program was overhauled late last year, Freddie retained more restrictions than Fannie, puzzling many housing experts.

Still, after the HARP overhaul, refis have risen. Freddie Mac has done more than 284,000 HARP refis this year through August, compared with 185,000 for all of last year. Fannie has done 334,000 in the same period, compared with 215,000 last year. In all, the two companies have done more than 1.6 million refis under the program. The administration's initial goal was to help four to five million.

Concerns about providing a stimulus were not the only reason for Freddie's restrictions. Several company executives and board members worried that doing mass refis would hurt Freddie Mac's bottom line.

To appreciate this concern, it's crucial to understand Freddie's and Fannie's business. The companies are two-headed beasts: One part is an insurance company with a public mission to help the housing market and the other is an investment fund that generates profits by trading mortgage investments. The investment side existed originally to keep the mortgage securities markets flowing. But as the portfolios grew in the years leading up to the financial crisis, the tail began to wag the dog. The huge profits from the portfolios inflated executives' pay packages and began to overshadow the public mission of helping homeowners, critics say.

Refinancings can hurt the value of those portfolios. When a new, lower rate mortgage is issued, the old loan is paid off. The ultimate backer of that original loan — in this case Freddie or Fannie — takes a loss because the loan was "pre-paid," meaning it was paid off earlier than expected. Mortgage securities make money from interest rates paid over time, so they decline in value if the flow of interest payments gets cut off, such as when a refi allows the original loan to get paid off early.

Glauber was concerned about Freddie incurring such losses, because taxpayers were ultimately on the hook. "Bob's position would have been if it has a cost, it is not consistent with conservatorship," Koskinen said.

Bammann, a former executive of JPMorgan Chase, and Wisdom voiced similar objections. Wisdom criticized the refi program, saying that it was "policy, not business," according to the executive.

Board member Nicolas Retsinas, who served in various housing policy positions for the Clinton administration, argued consistently for an expansive refinancing policy, according to people familiar with the meetings. He argued that in calculating the costs of the refi program, Freddie should take into account the benefit from lowering defaults and foreclosures and the improved housing market and stronger economy that would come from refinancings.

Retsinas declined to comment.

Koskinen, a Democrat who served in the Clinton administration, said it was prudent for the board to discuss the costs of a refi program. "The board's view was you could decide to categorize it or ignore it but couldn't say it didn't exist. The intellectually honest thing was to say, 'How large was that cost?'" he said.

Freddie Frustrates Its Regulator

Early in the Great Recession, support for a mass refi program was bipartisan. Refis help borrowers who are current on their loans, scoring them prevailing rates.

Columbia economist Glenn Hubbard, now an economic advisor to Republican presidential nominee Mitt Romney, co-authored op-eds in the Wall Street Journal and later in the New York Times with his colleague Mayer, proposing a mass refi program. Many congressional Republicans supported it.

But the Wall Street Journal editorialized against it in February 2009, arguing a mass refi program amounted to undue government interference with the marketplace and would cause huge losses for taxpayers. Republicans turned against it.

The Obama administration and the Federal Housing Finance Agency (FHFA), which oversees Fannie and Freddie, didn't fix HARP for years.

Under conservatorship, the FHFA has the responsibility to regulate the companies and to approve their major business decisions. Ed DeMarco, the acting head of the agency, has become a political lightning rod, criticized for having been too timid in helping the housing market. Critics contend he underestimated how much such an overall improvement would eventually help Fannie and Freddie's bottom lines.

At the same time, DeMarco has been frustrated by Freddie Mac, according to people who are familiar with his tenure.

"Freddie is the party of 'no.' Fannie is the party of ‘let's make it work,'" said a person familiar with DeMarco and the FHFA.

The FHFA was frustrated when Freddie Mac announced its guidelines in November 2011 because they restricted refis more tightly than Fannie's did.

One example: Freddie was not going to allow certain well-situated borrowers into HARP, borrowers with a "loan-to-value" ratio of 80 or below. In other words, if a borrower had a $100,000 home and had a mortgage loan of $80,000 or less, he or she would not be eligible.

That wasn't the only restriction. Freddie sometimes required properties to be re-appraised, which added cost and delay. And it hindered the ability for borrowers to get a refi from a new bank rather than from the one that had given them the original loan. "We were adding barriers to the homeowner," says the Freddie executive.

Freddie's risk management operation, the division in charge of making sure Freddie doesn't take decisions likely to incur heavy losses, was particularly active in raising concerns over allowing more refis. For example, when Freddie insures a mortgage, it retains the right to void its guarantee and force the bank that made the loan to be responsible for it under certain circumstances, such as if the bank had done poor underwriting and the borrower's income was misrepresented. Facilitating refis under HARP could require giving up those rights. Wisdom, the risk officer, argued that Freddie should not give up such rights lightly, because surrendering them could cost Freddie dearly.

But since many borrowers on these Freddie-backed loans had been making regular payments for a number of years, others argued there would likely be only a relatively small number of cases in which Freddie would need to force banks to take back loans. Thus, Freddie wouldn't be giving up anything of much value.

Freddie Mac produced a memo in the fall of 2011, which was described to ProPublica, estimating that HARP would cause hundreds of millions of dollars in losses. The memo estimated big losses on the portfolio as well as from giving up the rights to return the loans. It minimized the benefits to Freddie's insurance business from an improved housing market and improved economy. It also minimized the costs to the company of trapping homeowners in mortgages with interest rates so high they would eventually default.

That analysis appears to have been overly cautious. A recent New York Federal Reserve study estimated how much refinancings can help reduce future defaults and found that the benefits were greater than expected. "We were too conservative and that's been subsequently borne out," says the Freddie executive.

DeMarco has said he instructed Freddie and Fannie not to take into consideration portfolio losses. In a letter to Sen. Robert Menendez (D-NJ) in May, DeMarco wrote that "FHFA specifically directed both [Fannie and Freddie] to exclude from consideration changes in their own investment income as part of the HARP evaluation process."

The existence of the memo raises a question of whether Freddie ignored that instruction from its regulator. It also raises the question of why FHFA did not act immediately to prevent Freddie from imposing its tighter rules.

DeMarco and the FHFA did not respond to requests for comment.

Freddie's 80 percent loan-to-value barrier had spillover effects. Mortgage experts say it led banks to reject out of hand borrowers who were close to that threshold. If a borrower initially appeared to qualify for a refi, but then the appraisal of the home pushed him below the barrier, Freddie would reject the refi and the mortgage company would have wasted time and money. So banks avoided a wide swath of homeowners whose loan-to-value ratio was near 80 percent.

At the FHFA, "nobody was happy with Freddie under 80 percent but we decided to deal with it later. And we dealt with it," says a person familiar with the FHFA's efforts.

Today, more refis are being done under HARP and the barriers at Freddie have started to come down. The new CEO, Donald Layton, deserves some credit, says the Freddie executive: "Don made important changes in the program and is willing to override narrow risk management. He took a broader view of the benefits and wasn't focused wholly on the costs."

For months now, the White House and the head of the regulator overseeing Fannie Mae and Freddie Mac have clashed over principal reductions for struggling homeowners. The Obama administration says that reducing the amount borrowers owe is essential to the housing recovery. Edward DeMarco, acting director of the Federal Housing Finance Agency, maintains that principal reductions would cost too much for the taxpayer-owned companies.

Frustrated by DeMarco's stance, Democrats in Congress and some state attorneys general have called for his resignation. Rep. Elijah Cummings, D-Md., said recently of DeMarco that "he and he alone stands in the way of hundreds of thousands of people, if not millions, being able to [literally] get a new lease on life."

Democrats have argued that the administration can't get around DeMarco and the FHFA's opposition to principal reduction. Is that really the case?

It wouldn't be easy, but the White House does have options.

The most straightforward thing the White House could do is nominate a replacement for DeMarco, who became acting director of the agency in 2009 after his predecessor stepped down. The administration had picked a successor more than a year ago, but Republican objections led to the nominee's withdrawal. The White House hasn't named a potential replacement since. It also passed on the chance for a recess appointment over the winter.

Obama has never called for DeMarco's resignation, though the administration has consistently urged DeMarco to adopt principal reduction. The Secretary of Housing and Urban Development, Shaun Donovan, said in February, "Our goal is to get a good nominee and get someone in there who shares our view."

The White House can't simply fire DeMarco. Independent regulators are supposed to be immune from political pressure, and it is rare that the president would seek to remove them. In some cases, heads of independent agencies have stepped down amid controversy. Former SEC Chairman Harvey Pitt did so in 2002. But even that is rare.

There's no precedent for it at the FHFA, which was created in 2008 just before the government bailed out Fannie and Freddie. DeMarco said this week that he has experienced "a substantial attempt to influence or direct an independent regulator."

By law, the president nominates the FHFA director for a five-year term, and can remove him only "with cause." But unlike those of some independent agencies, the statutes governing the FHFA don't define "cause." The agency declined our request for comment, while the White House didn't respond.

Even if the president got DeMarco to step down, the administration would only wind up with one of DeMarco's deputies as another acting director, which wouldn't guarantee a shift in policy.

The Obama administration may believe that it can't get a new nominee through Congress. After all, the previous nominee, Joseph Smith, was opposed by some Republican senators precisely because they felt he would be too close to the administration on principal reductions. In the meantime, DeMarco is taking the heat on principal reductions while other shortcomings in Obama's housing policy fall out of focus.

Despite some of the heated rhetoric and criticism, DeMarco doesn't face easy choices. His mandate to protect Fannie and Freddie's bottom line — and thus taxpayer money — can conflict with his agency's duty to promote the stability of the broader housing market.

While DeMarco has opposed principal reductions on the basis that they would be too costly, ProPublica and NPR recently reported that FHFA internal estimates revised their earlier position, and that in light of new government incentives, principal reductions may now actually save the companies money. This week, DeMarco told The Financial Times that principal write-downs would amount to a giveaway to banks — seemingly a new argument for him.

Update: On Friday, following the publication of this story by ProPublica and NPR, lawmakers called on the Federal Housing Finance Administration to provide Congress with the new analyses on principal reductions by Fannie Mae and Freddie Mac. In addition, Illinois Attorney General Lisa Madigan urged FHFA to immediately implement appropriate principal reductions to home loans held by Fannie Mae and Freddie Mac.

A version of this story was co-published with NPR News and broadcast on NPR's Morning Edition.

New analyses by mortgage giants Freddie Mac and Fannie Mae have added an explosive new dimension to one of the most politically charged debates about the housing crisis: Whether to reduce the amount of money beleaguered homeowners owe on their mortgages.

Their conclusion: Such loan forgiveness wouldn’t just help keep hundreds of thousands of families in their homes, it would also save Freddie and Fannie money. That, in turn, would help taxpayers, who bailed out the companies at a cost of more than $150 billion and are still on the hook for future losses.

The analyses, which have not been made public, were recently presented to the agency that controls the companies, the Federal Housing Finance Agency, according to two people familiar with the matter. Freddie Mac’s meeting with the FHFA took place last week.

The decision of whether to allow such reductions rests with Edward DeMarco, the acting director of the FHFA, who has steadfastly opposed so-called principal reductions on the grounds that it’s a bad business decision for the companies and would cost taxpayers money.

Many economists and policy makers contend that cutting principal — the amount of money lent to the homeowner — is one of the best solutions for keeping people in their homes and to bolster the fragile economic recovery.

But this solution has raised passionate opposition: Many borrowers who are paying their mortgages every month feel it is unfair. Why, they ask, should they have to keep paying the full amount while others who took a loan they ultimately couldn’t afford or saw their house plummet in value get a break? Some economists and policy makers argue that borrowers might intentionally stop paying their mortgages to score a reduction. Indeed, the prospect that the government would help troubled homeowners was a spark that created the Tea Party movement.

The companies’ new analyses were prompted by new Obama administration subsidies the government is offering Fannie and Freddie to reduce a homeowner’s loan. But it’s unclear whether DeMarco will take advantage of those incentives.

He declined to be interviewed for this story. But in a statement to ProPublica and NPR, DeMarco said that FHFA is assessing its position in light of the new Obama financial incentives, offered under the Home Affordable Modification Program, or HAMP. “As I have stated previously, FHFA is considering HAMP incentives for principal reduction and we have been having discussions with [Freddie and Fannie] and Treasury regarding our analysis.”

Both Fannie and Freddie declined to comment.

As an independent regulator, DeMarco does not answer to the president and can make policies that the administration opposes. Obama sought to replace DeMarco, but his nominee was blocked by Republicans in the Senate, which must confirm the agency head.

As recently as Feb. 28th, DeMarco told the Senate banking committee, “Both companies have been reviewing principal forgiveness alternatives. Both have advised me that they do not believe it is in the best interest of the companies to do so.”

Overall, principal reductions could help millions of borrowers who owe much more on their homes than their houses are worth, economists estimate.

And principal reductions can help lenders, because foreclosure often leads to bigger losses than reducing the amount owed. The biggest banks have long employed such reductions to curb their own losses.

The new analyses by Freddie and Fannie were done to assess the new financial incentives that the Obama administration announced in late January. ProPublica and NPR have not read the analyses, but two people described key aspects of them. The companies now find that reducing principal on troubled mortgages has a “positive net present value” — in other words, that doing it would bring in more money for the companies over the life of the loans than not doing it.

The two companies’ analyses showed that upwards of a quarter million borrowers who owe more on their mortgages than their homes are worth could benefit from principal reductions. The companies would take a loss upfront, but over the long run these mortgage modifications would save the companies money because they would lead to lower default rates.

Experts have said that principal reductions are one of the best tools for helping homeowners stay in their homes.

“Principal reduction works,” said Mark Zandi, chief economist of Moody’s Analytics. “If someone gets a reduction in their principal amount, it gives them a real powerful hook to really fight to try to hold onto the home, even if things aren’t going financially right for them.”

The re-default rate for homeowners who receive a principal reduction is lower compared with the rate on other types of types of mortgage modifications, Zandi said.  

Zandi estimates that principal modification could benefit 300,000 to 500,000 homeowners whose mortgages were backed by Fannie and Freddie. “And that would make a substantive difference,” he says, in helping the housing market and boosting the economy.

“It saves taxpayers money and makes homeowners less likely to default,” said Zandi. Given the Obama Administration’s policy changes, “I’m now perplexed why DeMarco is not more fully engaged” in supporting principal reductions.

Not everyone supports principal modifications. Anthony Sanders at George Mason University says that implementing such reductions risks triggering a wave of strategic defaults, where people stop paying on their homes in order to qualify for a break. “DeMarco is absolutely right,” he says.

The Obama administration’s new initiative triples the subsidies. They now range from 18 cents to 63 cents on the dollar, based on conditions such as how deeply underwater a borrower is. The subsidy works out so that generally the Treasury would pick up about half of Freddie and Fannie’s principal reductions, according to a person familiar with the incentives.

The subsidies are funded through HAMP, which used money from the Troubled Asset Relief Program (TARP), widely known as the bank bailout.  Much of that money has not been spent.

Under DeMarco, the FHFA has allowed Fannie and Freddie to do principal forbearance, rather than principal reductions. In such a modification, borrowers’ monthly payments are reduced, but they still must eventually pay back the entire loan. Critics contend that such modifications don’t provide as much incentive as principal reductions for borrowers to keep paying.

Despite the new findings, it still might not make sense for Fannie and Freddie to do principal reductions. Such a program might require substantial and expensive changes to their computer and accounting systems and might distract from the core business. In his statement, DeMarco said, “FHFA’s previously released analysis concluded that principal forgiveness did not provide benefits that were greater than principal forbearance as a loss mitigation tool. FHFA’s assessment of the investor incentives now being offered will follow the previous evaluation, including consideration of the eligible universe, operational costs to implement such changes, and potential borrower incentive effects.”

Yet even before the Obama administration’s new subsidies, the FHFA’s own data supported principal reductions for some borrowers, despite its opposition to using them, some argued. An American Banker analysis of the FHFA study, which the agency sent to Congress in January, suggested that principal reduction shouldn’t be rejected so unequivocally.

Sen. Robert Menendez, D-N.J., had sharp words for Freddie Mac's investment practices and conflicts of interest at a Senate Banking Committee hearing Thursday.

The senator's concerns came in the wake of a ProPublica and NPR report that Freddie, the giant taxpayer-owned mortgage company, had made concentrated investments in complex mortgage securities that benefited from the inability of homeowners in high-rate mortgages to get refinancing. During the same period, Freddie also made it harder for people to get refinancing. Freddie said the decisions were separately made and that there was a firewall between them.

"I don't understand why you make a bet that you can largely control the outcome of, and want your bet to lose," Menendez said. "I think that's against human nature, so I'm not quite sure these firewalls exist in a way that aren't affecting policies. And that's a problem."

Speaking earlier to NPR, the senator called the investments "outrageous."

The issue is heating up in Washington. On Tuesday, 10 senators sent a letter to Edward DeMarco, the head of the Federal Housing Finance Agency, the regulator that oversees Freddie Mac, calling the report "deeply troubling."

"If the inability of homeowners to refinance their homes enhances Freddie Mac's bottom line, this is especially troubling," the letter said. "Freddie Mac exists to support the housing market, and it should not have a financial incentive to make it more difficult for struggling homeowners. Such actions by Freddie Mac are contrary to the best interests of American homeowners, sound economic policy, and its mission." (Read the full letter.)

And the inspector general for the FHFA confirmed Wednesday that it is looking into Freddie Mac's investments. "We currently have an open evaluation on capital markets, which encompasses this issue. We'll know more when the evaluation is completed," the government watchdog said.

Separately, Freddie Mac's chief executive, Charles Haldeman, disputed the ProPublica and NPR story in a piece on the American Banker's website.

"The major claim is that Freddie Mac worked against homeowners' ability to refinance in order to boost the performance of specialized securities that make up roughly 1% of our investment portfolio," Haldeman wrote. "This is just not true."

He added: "The securities in question helped us protect the value of our investment portfolio and reduce our need for taxpayer support."

ProPublica and NPR's story did not actually claim that Freddie's efforts to tighten mortgage standards were done to boost the investment value of its securities, called "inverse floaters." The story reported that decisions to limit credit were made at the same time that the company ramped up its investments, but the story said there was no evidence that the two actions were coordinated. As the story noted, Freddie says there is a strict firewall between the two businesses.

Last week, ProPublica and NPR raised questions about a risky investment strategy at Freddie Mac that would pay off if homeowners stayed trapped in expensive mortgages. It's just the latest example of how government-owned Freddie Mac and Fannie Mae have frustrated many by not putting homeowners first.

Fannie and Freddie are required to help homeowners while earning profits so they can pay back the taxpayers who bailed them out. Here is our guide to the little-known federal regulator, Edward DeMarco, ultimately in charge of the two companies. You may have never heard of him, but as The Washington Post put it, he's "the most powerful man in housing policy."

The basics

In the summer of 2008, as part of a larger economic stimulus bill amid the subprime mortgage crisis, President George W. Bush created the Federal Housing Finance Agency, combining several agencies overseeing housing policy, and increasing regulation of government-sponsored enterprises like Fannie and Freddie. When the government bailed out Fannie and Freddie a few months later, the FHFA took charge of them.

DeMarco, a lifelong regulator, was named the acting head of the FHFA roughly a year after the bailout when his Bush-appointed predecessor stepped down. Obama nominated a consumer-friendly replacement for DeMarco in October 2010, but Republicans blocked him. (Republican opposition to Obama's nominee for DeMarco's successor stemmed in part from concerns that he would push banks and others too far to help homeowners, unfairly rewarding reckless borrowers.)

As head of the FHFA, DeMarco has a three-part mission: to promote the soundness of Fannie and Freddie, and to support affordable housing and a stable and liquid mortgage market (in other words, to expand access to home ownership loans and make it easier to buy and sell mortgages).

The last two goals, though, can clash with the fact that under the bailout, DeMarco is the "conservator" of Freddie and Fannie, meaning he has to protect their finances for the benefit of their shareholders. (And the majority shareholder is now the federal government.) According to The Washington Post's Brad Plumer and Ezra Klein, there is "a conflict tucked deep into DeMarco's job description: The head of the FHFA is stuck between the narrow needs of Fannie and Freddie and the broader needs of the housing market."

DeMarco has focused almost solely on that first goal, telling Congress many times that "as conservator, FHFA has a statutory responsibility to preserve and conserve the enterprises' assets." In plainer terms, he told NPR last week that his role is to "make sure Fannie Mae and Freddie Mac undertake activities that don't cause further losses for the American taxpayers."

DeMarco has strongly asserted his independence, insisting that he is promoting needed fiscal discipline. (He did not respond to our latest requests for comment on his role with the FHFA).

Clashes with Congress and Obama

Democrats and Obama administration officials have been frustrated with DeMarco, saying the FHFA's narrow focus on Fannie and Freddie's health has hurt the housing market.

The Obama administration has repeatedly tried to push principal reduction — reducing the size of a borrower's mortgage — as a way to help homeowners, especially those with homes worth less than their mortgages. But as ProPublica and others have reported, time and again, Fannie and Freddie wouldn't participate: a crippling problem, since the two companies own or guarantee about half of the country's mortgages.

Last month, the administration unveiled yet another plan to encourage principal reduction, but a former administration adviser called DeMarco "the boulder" in the way of making it happen.

DeMarco says principal reduction could cost taxpayers $100 billion. Some economists counter that while principal reductions might lead to a short-term hit for Fannie and Freddie, it would ultimately result in fewer underwater mortgages, fewer foreclosures and a healthier housing market — all good for Fannie and Freddie's bottom line.

On another administration plan, to allow more borrowers to refinance at lower rates, DeMarco shifted somewhat toward the White House's position. He agreed to lift some fees on refinancing and make it easier to qualify. Freddie Mac told ProPublica in a statement that it has helped more than 830,000 families refinance, but as we noted, critics say that the refinancing effort could be helping millions more.

As DeMarco told Politico, he's been no "particular friend" of banks. He brought a massive lawsuit against 17 banks, alleging fraud over $200 billion in toxic mortgages sold to Fannie and Freddie. The case is ongoing.

DeMarco is also charged with helping Fannie and Freddie go gently into the night. As part of their bailout, the two companies are supposed to wind down their operations. And just as DeMarco has resisted Democratic calls for more aggressive help for homeowners, he's also pushed back against Republican calls to spin off the companies more quickly. He's also rejected GOP plans to cap executive pay at Fannie and Freddie.

Why he's still there

Last week, DeMarco described his job as a "balancing act." It's certainly thankless. While Democrats have called for DeMarco's head, the FHFA is an independent agency, meaning the Obama administration can't just get rid of him over policy disputes such as his stance on refinancing or principal reduction. He could also be replaced if Obama decides to offer another nominee and the Senate confirms the choice. Barring that, DeMarco will likely remain where he is for some time, walking his own line on Fannie and Freddie's contradictory mission.

Sen. Robert Casey, D-Pa., sent a list of questions about Freddie Mac’s controversial trades to the mortgage giant’s regulator, highlighting how much remains unknown even after a flurry of statements from the regulator.

ProPublica and NPR reported on Monday that Freddie Mac, the taxpayer-owned mortgage-insurance company, placed multibillion-dollar bets that pay off if homeowners stay trapped in expensive mortgages with interest rates well above current rates.

Questions the senator put to the regulator, the Federal Housing Finance Agency, include why Freddie made the deals in the first place, when the FHFA learned of the trades, what role, if any, the FHFA played in them, and what the FHFA plans to do about the billions of dollars worth of deals Freddie still has on its books.

Freddie began increasing those deals, called inverse floaters, deals dramatically in late 2010, the same time that the company was making it harder for homeowners to get out of such high-interest mortgages.

No evidence has emerged that these decisions were coordinated, and Freddie says that they weren’t.

But the trades highlight a conflict of interest: Freddie’s charter calls for the company to make home loans more accessible, but Freddie also has giant investment portfolios and could lose substantial amounts of money if too many borrowers refinance.

Freddie and its sister company, Fannie Mae, are regulated by the Federal Housing Finance Agency. But with those companies in government conservatorship, the FHFA is more than a regulator. It also acts essentially as Freddie’s board of directors.

In a letter to Casey dated Tuesday, FHFA Acting Director Edward DeMarco said Freddie’s trades, known as inverse floaters, had raised “concerns.” He explained that the FHFA believed “that the risk associated with these transactions is inconsistent with FHFA’s goals of having Freddie Mac reduce its risk profile and avoid unnecessary complexity that requires specialized risk management practices.”

In a previous statement, DeMarco said those concerns forced Freddie to agree not to engage in any new inverse floater deals. Freddie had stopped making the deals a few months earlier, according to the FHFA, but it is unclear why. Freddie retains about $5 billion worth of the floaters on its books.

In his letter today to DeMarco, Casey wrote:

… I would appreciate you addressing some additional questions:

· What rationale did Freddie Mac have for its increased purchase of inverse floaters in 2010 and 2011?

· What was FHFA’s involvement in the sale? Please detail for me when FHFA was made aware of these purchases, and when they intervened.

· What type of oversight does FHFA practice over Freddie Mac’s investment division? Are potentially risky trade pre-approved by you or other FHFA officials?

· Although Freddie Mac has ceased their purchase of the types of securities in question, they are still in their portfolio. How does FHFA plan to address these securities moving forward?

· What steps will you take to ensure that in the future FHFA is able to intervene before risky trade take place?

Freddie Mac’s regulator gave new detail today on why it halted the company’s controversial trades in complex mortgage-backed securities last year. In a letter to Senator Robert Casey (D-Pa), the Federal Housing Finance Agency said the trades were risky and required specialized risk management.

ProPublica and NPR reported on Monday that Freddie Mac, the taxpayer-owned mortgage giant, placed multibillion-dollar bets that pay off if homeowners stay trapped in expensive mortgages with interest rates well above current rates. With Freddie in government conservatorship, the FHFA is more than its regulator. It also acts essentially as its board of directors.

“FHFA’s concerns arose through its supervisory process, which found that the risk associated with these transactions is inconsistent with FHFA’s goals of having Freddie Mac reduce its risk profile and avoid unnecessary complexity that requires specialized risk management practices,” FHFA acting director Edward DeMarco wrote.

As part of the government bailout, Freddie and its sister company Fannie Mae were required to sell down their investment portfolios every year. In the mortgage-backed securities transactions at issue, known as inverse floaters, ProPublica and NPR reported that Freddie had sold off some investments yet retained most of the risk – possibly violating the spirit, if not the letter, of the government agreement. Freddie is below the portfolio threshold mandated by the government agreement.

It is unclear if DeMarco was referring to the portfolio-reduction mandate that Freddie operates under. FHFA didn’t respond to a request for comment about the letter to Senator Casey.

Senator Casey was not satisfied with the response from FHFA, according to a congressional staffer, because questions remain unanswered.

In his letter to Senator Casey, DeMarco wrote that Freddie’s investment “did not – and was not intended to – have any impact on homeowners’ ability to refinance.” He wrote that “the underlying premise of the ProPublica story, that Freddie Mac securitization and investment practices are meant to inhibit mortgage refinancing, is simply incorrect.”

ProPublica and NPR did not state that the transactions “did” or were “meant to inhibit mortgage refinancing.” Here’s what the original story said:

Freddie began increasing these bets dramatically in late 2010, the same time that the company was making it harder for homeowners to get out of such high-interest mortgages.

No evidence has emerged that these decisions were coordinated. The company is a key gatekeeper for home loans but says its traders are “walled off” from the officials who have restricted homeowners from taking advantage of historically low interest rates by imposing higher fees and new rules.

According to the FHFA, Freddie has ceased making new inverse floater investments. However, the agency says that Freddie retains $5 billion of these investments on its books. They continue to require the same “specialized risk management” that prompted the FHFA to halt any new inverse floater deals, raising the question of whether the FHFA will force Freddie to sell them.

Earlier this week, ProPublica and NPR detailed how Freddie Mac placed bets against homeowners that paid off if borrowers were unable to refinance their mortgage loans. The story highlighted the conflicted role of the huge and now government-controlled Freddie Mac and Fannie Mae: They are supposed to maximize their profits and thus pay back taxpayers, while many feel that, as government wards, they should also be helping millions of struggling Americans stay in their homes.

Here's our attempt to explain Fannie and Freddie's role in the housing market, and why it seems as if their actions often go against the interests of homeowners.

What are Freddie Mac and Fannie Mae supposed to do?

Fannie and Freddie were created to make homeownership more accessible. They are Government-Sponsored Enterprises — private companies chartered by the government to expand access to credit, particularly for low- and middle-income homeowners, and to foster stability in the mortgage market. Fannie Mae was founded as a government institution during the Great Depression and privatized in 1968. Freddie Mac has been private since it was founded in 1970. (Freddie was started in part to divide responsibility in the mortgage market, but there's no real difference between the two now, except that Fannie is larger.) But "private" is not exactly the right word — Freddie and Fannie are exempt from most state and local taxes, as well as some SEC regulations, and they have access to a credit line from the federal government. And they still have their chartered obligation to make mortgages more available.

Fannie and Freddie can't make loans directly. Instead, they guarantee existing mortgages, and repackage and pool them into bonds called mortgage-backed securities. Someone who buys the bonds from Freddie gets the interest and the original principal even if a homeowner defaults. In exchange for that guarantee, Freddie collects a fee from the buyer of the bonds and can use that to guarantee more mortgages (or to buy mortgages that stay in their portfolio). This handy New York Times graphic shows the various flows of debt: The idea is that by basically ensuring that someone (often Freddie or Fannie) will guarantee a mortgage, it becomes easier for anyone to get a mortgage.

So, how did they get so big?

Because Fannie and Freddie have been able to borrow lots of cheap money.

For years, investors have loaned them money at lower-than-average interest rates, allowing Fannie and Freddie to expand their portfolio of mortgages and securities. As a history compiled by the Congressional Budget Office shows, investors have treated Fannie and Freddie as essentially risk-free. The assumption, which has turned out to be correct, was that the government would never let Fannie and Freddie fail. The two companies used that windfall not only to invest in more mortgages but to try to increase their profits by pouring money into a variety of fancy financial instruments.

Fannie and Freddie became, as The New Yorker's James Surowiecki described them, the "duck-billed platypuses of the financial world" — strange institutions with the perceived safety of a government guarantee and the high-risk strategies of a private corporation. And that led them to become the giants of the mortgage market, managing a massive portfolio of debt. In 2008, they had a combined $5 trillion in debt and guarantees.

Why are taxpayers on the hook for their mistakes?

The bubble burst — and Fannie and Freddie's execs had overreached.

In the last stretch of the boom, the two companies had loaded up on iffy mortgages. When the housing market began to turn in mid-2006, delinquency rates rose, increasing the chances that Fannie and Freddie would have to make good on their guarantees. Compounding their problems, it became harder for Freddie and Fannie to borrow money as concerns mounted about the companies' health. In the mid-2000s, they admitted to overstating earnings and making billions of dollars' worth of accounting errors.

By 2008, they were in trouble. That $5 trillion in debt and guarantees was backed by only $80 billion in core capital. The federal government took them over, becoming the major shareholder of both companies, while the Federal Reserve bought up most of their debt and the Treasury Department pledged to cover their losses. The taxpayer buyout of the two companies has cost roughly $169 billion.

The SEC filed a lawsuit against the companies' executives in December, accusing them of misleading investors about the riskiness of their investments.

The companies' high compensation of their executives has also been under fire from Congress. Although the bailout calls for Fannie and Freddie to wind down their portfolios of mortgages, they continue to make billions of dollars' worth of risky investments like the "inverse floaters" we described.

So, do Fannie and Freddie actually help homeowners? And why can't the government force their hand?

The companies say that by bolstering their finances, they are helping to stabilize the housing market as a whole, but Freddie and Fannie have hampered many of the administration's plans to provide relief for struggling homeowners.

The two report to a regulatory body called the Federal Housing Finance Agency, which has acted since the bailout as their board of directors and shareholders, making their major decisions. In the wake of our story, the White House and several senators have called for more oversight and an explanation as to why Freddie's investment strategy seems to run counter to the mandate to help homeowners.

More broadly, the Obama administration and the acting head of FHFA, Edward DeMarco, have often clashed over the goals of the companies.

This week, President Obama outlined a new set of initiatives aimed at making it easier for homeowners to refinance and encouraging loan forgiveness. But Fannie and Freddie have previously refused to participate in loan forgiveness programs, and they continue to tussle with the administration on the issue. (It seems unlikely that any of Obama's proposals will get through Congress, and ProPublica has documented extensive problems with similar programs aimed at preventing foreclosures.)

The two aims of Fannie and Freddie are continually at odds — policies encouraging refinancing and forgiveness for more mortgage holders can increase costs to the taxpayer-owned companies. While the administration has made relief for homeowners their priority, DeMarco says his agency's priority is to protect Fannie and Freddie's profits, aka taxpayers' assets. Of course, many of those taxpayers are struggling homeowners, and that is at the heart of the dilemma over Fannie and Freddie's future.

Sen. Barbara Boxer, D-Calif., told NPR she was shocked by a recent meeting with DeMarco. "It was the worst meeting I've ever had in my life," said Boxer. "His interest is making sure Fannie and Freddie do well financially."

Will they be around much longer?

Probably, even though there's rare bipartisan consensus that they shouldn't be.

Both the Obama administration and congressional Republicans want to get rid of Fannie and Freddie. Obama's plan gradually winds them down to a position equivalent to private-sector mortgage companies while giving the market time to adjust to their removal. Republicans want a more immediate rollback of their influence.

These plans were unveiled almost a year ago, but the companies are still massively important to the mortgage market, guaranteeing approximately 70 percent of the country's home loans. Their elimination might make it more difficult to get a mortgage loan, and it remains unclear what kind of assistance for homeownership could, or should, replace them.

This story was co-produced with NPR News.

Freddie Mac agreed last month to stop making new bets against American homeowners after its regulator, the Federal Housing Finance Agency, raised concerns, according to a statement the agency issued late Monday. Freddie, the taxpayer-owned mortgage giant, still retains $5 billion worth of such bets.

The agency, responding to an investigation by ProPublica and NPR, said it had "identified concerns regarding the controls, including risk management, surrounding the inverse floaters," as the investments at issue are known. The agency did not specify what it had found, but said Freddie agreed in December that "these transactions would not resume pending completion of [FHFA's] examination work." The statement also said that Freddie had ceased making the deals earlier in 2011 but did not explain why.

Separately, the White House said the Department of the Treasury is "looking into" Freddie's investments, and at least three senators called on Freddie not to bet against struggling homeowners.

The mortgage-insurance company bought billions worth of complex mortgage-backed securities that profit if borrowers stay trapped in high interest rate home loans. The $5 billion figure released Monday afternoon is more than had been reported in the ProPublica-NPR investigation.

In late 2010 and early 2011, Freddie began dramatically increasing these multibillion-dollar deals. At the same time, Freddie also made it harder for homeowners to get out of their high-interest mortgages and into more affordable loans that could save them thousands of dollars a year. No evidence has emerged that these decisions were coordinated at the company, and Freddie has denied that they were.

But the deals highlight a conflict of interest: While Freddie's charter calls for the company to make home loans more accessible, the company also has giant investment portfolios that could lose large amounts of money, at least in the short run, if too many borrowers refinance into more affordable loans.

At a press briefing today, White House spokesman Jay Carney was asked whether Freddie Mac's investment strategy contradicted President Barack Obama's stated commitment to make homeowner refinancing more affordable. In his response, Carney stressed that the president does not directly control FHFA.

"This is an independent institution with independent governance, so we don't make those kinds of decisions," Carney said.

Meanwhile, Sen. Bob Casey, D-Pa., sent a letter to the White House today demanding an explanation of the Freddie Mac investments. Referring to the head of the company, the senator wrote, "I question the leadership that would position the government-backed organization to bet against homeowners."

Sen. Casey wants the administration to "exercise influence over the FHFA, and make sure that Freddie is not making these kinds of bets," his spokesman said.

Sen. Johnny Isakson, R-Ga., said in an interview that if Freddie "bet on keeping everybody in the loans they're in, and not allowing them to refinance, that would be wrong. Particularly for those people that are qualified to refinance." And Barbara Boxer, D-Calif., fired off a letter to the acting director of the FHFA expressing "outrage" over Freddie's deals.

In its statement today, the FHFA confirmed that Freddie, in making these investments, retained significant risks. When Freddie was taken over by taxpayers in 2008, Freddie Mac entered into an agreement with the U.S. Treasury to reduce the company's investment holdings. The inverse floater deals leave "Freddie Mac with a portion of the risk exposure it would have had if it simply held the entire set of mortgages on its balance sheet," the FHFA said.

In fact, mortgage experts said that inverse floaters burden Freddie with new risks. With these deals, Freddie has taken mortgage-backed securities that are easy to sell and traded them for ones that are harder and possibly more expensive to offload.

ProPublica and NPR found $3.4 billion of Freddie's inverse floater deals, and their value is based mostly on interest payments on $19.5 billion of mortgage-backed securities. The new statement suggests that Freddie retained exposure to greater than $19.5 billion, but it is unclear how much more.

Jan. 30: Read the update to this article, "Bets Against Homeowners Must Stop, Freddie Mac Was Told." This story is not subject to our Creative Commons license. This story was co-published with NPR News.

Freddie Mac, the taxpayer-owned mortgage giant, has placed multibillion-dollar bets that pay off if homeowners stay trapped in expensive mortgages with interest rates well above current rates.

Freddie began increasing these bets dramatically in late 2010, the same time that the company was making it harder for homeowners to get out of such high-interest mortgages.

No evidence has emerged that these decisions were coordinated. The company is a key gatekeeper for home loans but says its traders are “walled off” from the officials who have restricted homeowners from taking advantage of historically low interest rates by imposing higher fees and new rules.

Freddie’s charter calls for the company to make home loans more accessible. Its chief executive, Charles Haldeman Jr., recently told Congress that his company is “helping financially strapped families reduce their mortgage costs through refinancing their mortgages.”

But the trades, uncovered for the first time in an investigation by ProPublica and NPR, give Freddie a powerful incentive to do the opposite, highlighting a conflict of interest at the heart of the company. In addition to being an instrument of government policy dedicated to making home loans more accessible, Freddie also has giant investment portfolios and could lose substantial amounts of money if too many borrowers refinance.

“We were actually shocked they did this,” says Scott Simon, who as the head of the giant bond fund PIMCO’s mortgage-backed securities team is one of the world’s biggest mortgage bond traders. “It seemed so out of line with their mission.”

The trades “put them squarely against the homeowner,” he says.

Those homeowners have a lot at stake, too. Many of them could cut their interest payments by thousands of dollars a year.

Freddie Mac, along with its cousin Fannie Mae, was bailed out in 2008 and is now owned by taxpayers. The companies play a pivotal role in the mortgage business because they insure most home loans in the United States, making banks likelier to lend. The companies’ rules determine whether homeowners can get loans and on what terms.

The Federal Housing Finance Agency effectively serves as Freddie’s board of directors and is ultimately responsible for Freddie’s decisions. It is run by acting director Edward DeMarco, who cannot be fired by the president except in extraordinary circumstances.

Freddie and the FHFA repeatedly declined to comment on the specific transactions.

Freddie’s moves to limit refinancing affect not only individual homeowners but the entire economy. An expansive refinancing program could help millions of homeowners, some economists say. Such an effort would “help the economy and put tens of billions of dollars back in consumers’ pockets, the equivalent of a very long-term tax cut,” says real-estate economist Christopher Mayer of the Columbia Business School. “It also is likely to reduce foreclosures and benefit the U.S. government” because Freddie and Fannie, which guarantee most mortgages in the country, would have lower losses over the long run.

Freddie Mac’s trades, while perfectly legal, came during a period when the company was supposed to be reducing its investment portfolio, according to the terms of its government takeover agreement. But these trades escalate the risk of its portfolio, because the securities Freddie has purchased are volatile and hard to sell, mortgage securities experts say.

The financial crisis in 2008 was made worse when Wall Street traders made bets against their customers and the American public. Now, some see similar behavior, only this time by traders at a government-owned company who are using leverage, which increases the potential profits but also the risk of big losses, and other Wall Street stratagems. “More than three years into the government takeover, we have Freddie Mac pursuing highly levered, complicated transactions seemingly with the purpose of trading against homeowners,” says Mayer. “These are the kinds of things that got us into trouble in the first place.”

'We’re in financial jail'

Freddie Mac is betting against, among others, Jay and Bonnie Silverstein. The Silversteins live in an unfinished development of cul-de-sacs and yellow stucco houses about 20 miles north of Philadelphia, in a house decorated with Bonnie’s orchids and their Rose Bowl parade pin collection. The developer went bankrupt, leaving orange plastic construction fencing around some empty lots. The community clubhouse isn’t complete.

The Silversteins have a 30-year fixed mortgage with an interest rate of 6.875 percent, much higher than the going rate of less than 4 percent.  They have borrowed from family members and are living paycheck to paycheck. If they could refinance, they would save about $500 a month. He says the extra money would help them pay back some of their family members and visit their grandchildren more often.

But brokers have told the Silversteins that they cannot refinance, thanks to a Freddie Mac rule.

The Silversteins used to live in a larger house 15 minutes from their current place, in a more upscale development. They had always planned to downsize as they approached retirement. In 2005, they made the mistake of buying their new house before selling the larger one. As the housing market plummeted, they couldn’t sell their old house, so they carried two mortgages for 2½ years, wiping out their savings and 401(k). “It just drained us,” Jay Silverstein says.

Finally, they were advised to try a short sale, in which the house is sold for less than the value of the underlying mortgage. They stopped making payments on the big house for it to go through. The sale was finally completed in 2009.

Such debacles hurt a borrower’s credit rating. But Bonnie has a solid job at a doctor’s office, and Jay has a pension from working for more than two decades for Johnson & Johnson. They say they haven’t missed a payment on their current mortgage.

But the Silversteins haven't been able to get their refi. Freddie Mac won’t insure a new loan for people who had a short sale in the last two to four years, depending on their financial condition. While the company’s previous rules prohibited some short sales, in October 2010 the company changed its criteria to include all short sales. It is unclear whether the Silverstein mortgage would have been barred from a short sale under the previous Freddie rules.

Short-term, Freddie’s trades benefit from the high-interest mortgage in which the Silversteins are trapped. But in the long run, Freddie could benefit if the Silversteins refinanced to a more affordable loan. Freddie guarantees the Silversteins' mortgage, so if the couple defaults, Freddie — and the taxpayers who own the company — are on the hook. Getting the Silversteins into a more affordable mortgage would make a default less likely.

If millions of homeowners like the Silversteins default, the economy would be harmed. But if they switch to loans with lower interest rates, they would have more money to spend, which could boost the economy.

“We’re in financial jail,” says Jay, “and we’ve never been there before.”

How Freddie's investments work

Here's how Freddie Mac’s trades profit from the Silversteins staying in “financial jail.” The couple’s mortgage is sitting in a big pile of other mortgages, most of which are also guaranteed by Freddie and have high interest rates. Those mortgages underpin securities that get divided into two basic categories.

One portion is backed mainly by principal, pays a low return, and was sold to investors who wanted a safe place to park their money. The other part, the inverse floater, is backed mainly by the interest payments on the mortgages, such as the high rate that the Silversteins pay. So this portion of the security can pay a much higher return, and this is what Freddie retained.

In 2010 and '11, Freddie purchased $3.4 billion worth of inverse floater portions — their value based mostly on interest payments on $19.5 billion in mortgage-backed securities, according to prospectuses for the deals. They covered tens of thousands of homeowners. Most of the mortgages backing these transactions have high rates of about 6.5 percent to 7 percent, according to the deal documents.

Between late 2010 and early 2011, Freddie Mac’s purchases of inverse floater securities rose dramatically. Freddie purchased inverse floater portions of 29 deals in 2010 and 2011, with 26 bought between October 2010 and April 2011. That compares with seven for all of 2009 and five in 2008.

In these transactions, Freddie has sold off most of the principal, but it hasn’t reduced its risk.

First, if borrowers default, Freddie pays the entire value of the mortgages underpinning the securities, because it insures the loans.

It’s also a big problem if people like the Silversteins refinance their mortgages. That’s because a refi is a new loan; the borrower pays off the first loan early, stopping the interest payments. Since the security Freddie owns is backed mainly by those interest payments, Freddie loses.

And these inverse floaters burden Freddie with entirely new risks. With these deals, Freddie has taken mortgage-backed securities that are easy to sell and traded them for ones that are harder and possibly more expensive to offload, according to mortgage market experts.

The inverse floaters carry another risk. Freddie gets paid the difference between the high mortgages rates, such as the Silversteins are paying, and a key global interest rate that right now is very low. If that rate rises, Freddie's profits will fall.

It is unclear what kinds of hedging, if any, Freddie has done to offset its risks.

At the end of 2011, Freddie’s portfolio of mortgages was just over $663 billion, down more than 6 percent from the previous year. But that $43 billion drop in the portfolio overstates the risk reduction, because the company retained risk through the inverse floaters. The company is well below the cap of $729 billion required by its government takeover agreement.

How Freddie tightened credit

Restricting credit for people who have done short sales isn’t the only way that Freddie Mac and Fannie Mae have tightened their lending criteria in the wake of the financial crisis, making it harder for borrowers to get housing loans.

Some tightening is justified because, in the years leading up to the financial crisis, Freddie and Fannie were too willing to insure mortgages taken out by people who couldn’t afford them.

In a statement, Freddie contends it is “actively supporting efforts for borrowers to realize the benefits of refinancing their mortgages to lower rates.”

The company said in a statement: “During the first three quarters of 2011, we refinanced more than $170 billion in mortgages, helping nearly 835,000 borrowers save an average of $2,500 in interest payments during the next year.” As part of that effort, the company is participating in an Obama administration plan, called the Home Affordable Refinance Program, or HARP. But critics say HARP could be reaching millions more people if Fannie and Freddie implemented the program more effectively.

Indeed, just as it was escalating its inverse floater deals, it was also introducing new fees on borrowers, including those wanting to refinance. During Thanksgiving week in 2010, Freddie quietly announced that it was raising charges, called post-settlement delivery fees.

In a recent white paper on remedies for the stalled housing market, the Federal Reserve criticized Fannie and Freddie for the fees they have charged for refinancing. Such fees are “another possible reason for low rates of refinancing” and are “difficult to justify,” the Fed wrote.

A former Freddie employee, who spoke on condition he not be named, was even blunter: “Generally, it makes no sense whatsoever” for Freddie “to restrict refinancing” from expensive loans to ones borrowers can more easily pay, since the company remains on the hook if homeowners default.

In November, the FHFA announced that Fannie and Freddie were eliminating or reducing some fees. The Fed, however, said that “more might be done.”

The regulator as owner

The trades raise questions about the FHFA’s oversight of Fannie and Freddie. But the FHFA is not just a regulator. With the two companies in government conservatorship, the FHFA now plays the role of their board of directors and shareholders, responsible for the companies’ major decisions.

Under acting director DeMarco, the FHFA has emphasized that its main goal is to limit taxpayer losses by managing the two companies’ giant investment portfolios to make profits. To cover their previous losses and ongoing operations, Fannie and Freddie already had received $169 billion from taxpayers through the third quarter of last year.

The FHFA has frustrated the administration because the agency has made preserving the value of the companies’ investment portfolios a priority over helping homeowners in expensive mortgages. In 2010, President Barack Obama nominated a permanent replacement for acting director DeMarco, but Republicans in Congress blocked him. Obama has not nominated anyone else to replace DeMarco.

Even though Freddie is a ward of the state, top executives are highly compensated. Peter Federico, who was in charge of the company’s investment portfolio when most of these leveraged investments were made, earned $2.5 million in 2010. He left the company in May 2011.

One of Federico’s responsibilities — tied to his bonuses —  was to “support and provide liquidity and stability in the mortgage market,” according to Freddie’s annual filing with the Securities and Exchange Commission. Mortgage experts contend that the inverse floater trades don’t further that goal.

ProPublica and NPR made numerous attempts to reach Federico. A woman who answered his home phone said he declined to comment.

The FHFA knew about the trades before ProPublica and NPR approached the regulatory agency about them, according to an FHFA official. The FHFA has the power to approve and disapprove trades, though it doesn’t involve itself in day-to-day decisions. The official declined to comment on whether the FHFA knew about them as Freddie was conducting them or whether the FHFA had explicitly approved them.

Liz Day of ProPublica contributed to this story.

Correction Feb. 3, 2012: Peter Federico, who was in charge of Freddie Mac’s investment portfolio, left the company in May 2011. A previous version of this story incorrectly said he still held that position.