Fannie Mae and Freddie Mac are up in arms over a proposed rule that could reduce investors' demand for their mortgage-backed securities, but Wall Street and private mortgage-backed issuers favor it.

The rule, drafted last fall by the Federal Financial Institutions Examination Council, the umbrella group for banking and thrift regulators, would cut by more than half the amount of capital banks must hold against private-label mortgage-backed securities, or MBS, that are rated AA-minus or higher.

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