05:39 PM EDT on Wednesday, April 6, 2005

By JEANNINE AVERSA / AP Economics Writer

WASHINGTON, D.C. — Federal Reserve Chairman Alan Greenspan urged Congress on Wednesday to restrict the multibillion-dollar holdings of the mortgage companies Fannie Mae and Freddie Mac, warning that their huge debt could imperil U.S. financial markets.

His admonition lent support to an effort in Congress to tighten controls on the two government-sponsored companies following their accounting scandals. Even so, shares of the companies rose in trading Wednesday.

The Fed chairman told the Senate Banking, Housing and Urban Affairs Committee that it might not be enough to just create a strong regulator for the companies, which hold or guarantee more than 45 percent of all mortgage loans in the country.

Legislation recently proposed would set up a regulatory agency with the power to compel the companies to sell off any assets deemed not to be in line with their mission of making homeownership more widely available.

The measures would not have Congress set binding limits on the size of the companies' portfolios, which together have grown to $1.5 trillion. They also have issued $1.8 trillion in debt.

"World-class regulation, by itself, may not be sufficient," Greenspan testified. "Without restrictions on the size of (their) balance sheets, we put at risk our ability to preserve safe and sound financial markets in the United States, a key ingredient of support for homeownership," he said.

Portfolio restrictions would not affect mortgage rates for homeowners because so many big banks and other lenders compete with Fannie Mae and Freddie Mac, Greenspan said, citing a Fed study.

Fannie Mae shares rose $1.87, or 3.6 percent, to close at $54.15 on the New York Stock Exchange Wednesday. Freddie Mac shares gained $2.04, or 3.3 percent, to $63.80.

While the companies' stock prices have fallen as a result of the accounting turmoil, Greenspan noted that "mortgage markets have functioned well."

One committee member, Sen. Charles Schumer, disputed that notion. "It almost defies belief that mortgage rates won't go up," Schumer, D-N.Y., told Greenspan. "On this issue, we don't see eye to eye."

Congress created the companies to inject money into the home-loan market, keeping mortgage rates lower. The companies buy mortgages from banks and bundle the loans into securities for sale to investors worldwide.

The scandals at the companies are behind the renewed regulatory effort on Capitol Hill.

"Given the frequency of major accounting and management problems at both Fannie Mae and Freddie Mac over the past two years, Congress must act to ensure that the (companies) are adequately regulated and do not pose any systemic risk to our economy," said Sen. Chuck Hagel, R-Neb., a committee member.

In the House, Rep. Richard Baker, R-La., chairman of a subcommittee that oversees Fannie Mae and Freddie Mac, is offering a measure similar to Hagel's to tighten oversight of the companies.

Federal regulators last year accused Fannie Mae of accounting problems and earnings manipulation to meet Wall Street targets. The Securities and Exchange Commission ordered the company to restate earnings back to 2001, a correction that could reach an estimated $11 billion.

In 2003, three top executive at Freddie Mac were forced out and the company has found to have misstated earnings by $5 billion for 2000-2002.

On Wednesday, the director of the Office of Federal Housing Enterprise Oversight told Baker's subcommittee that falsified signatures had been found in Fannie Mae's ledgers from 1999 through 2002. Armando Falcon said the company has been ordered "to determine who falsified the signatures on journal entries."

In recent years, the companies have borrowed aggressively, at favorable rates because of their federal status, to finance their purchases of home loans and for other investments.

"We have been unable to find any purpose for the huge balance sheets ... other than profit creation," Greenspan testified.

When the two companies were small, the potential for risk to the financial system and the overall economy was pretty small, Greenspan said. "Regrettably, that is no longer the case," he added.

Because the institutions have grown so large, the risk is that a failure of one probably would put the government in the position of having to bail out investors.