WASHINGTON — Two former Fannie Mae executives said that competing demands to boost profits and to satisfy a public mission created an "impossible" balancing that led to the company's demise as the housing downturn worsened.

"I was the CEO of the company and I accept responsibility for everything that happened on my watch," ex-Fannie chief executive Daniel Mudd said a hearing Friday investigating the causes of the financial crisis.

Fannie Mae and its smaller rival, Freddie Mac, were unlikely to have escaped losses during a prolonged national housing downturn, though those losses would have been less severe if Fannie hadn't made a big foray into riskier loans, Mr. Mudd said.

But he said the companies' were ultimately doomed by their flawed setup. As the housing crisis deepened, the companies were taken over by the government in September 2008 as rising losses threatened to wipe out their capital levels.

"I am sorry for that," Mr. Mudd said.

But a former top regulator rejected the view that Fannie Mae and Freddie Mac were unwitting victims of the housing bust and instead blamed a "deeply rooted...culture of arrogance and greed" at the companies. "I should be clear that this was a failure of leadership," Armando Falcon, the former head of the companies' regulatory agency, said in prepared testimony.

Friday's hearing by the Financial Crisis Inquiry Commission on the collapse of Fannie Mae and Freddie Mac comes as policy makers struggle to figure out what to do with the failed companies. So far, both companies have required more than $125 billion in taxpayer infusions and that number could grow.

Douglas Holtz-Eakin, a commissioner on the panel, predicted that the collapse of Fannie and Freddie would leave taxpayers with the "single largest bill we will face in this episode."

The hearing is likely to influence the debate over how to restructure the companies and the entire U.S. mortgage market. Commissioners attempted to shed more light on why the companies made the ill-fated decisions to boost their exposure to riskier "Alt-A" loans for borrowers with good credit but little documentation of income or assets.

Executives decided that new, riskier loans were "not a fad, but a growing and permanent change" that the companies couldn't ignore, Mr. Mudd said in his testimony. Faced with the prospect of becoming irrelevant as private lenders fueled by Wall Street took over a larger share of the market, the company opted to strike a "middle course" by trying to offer less risky versions of loans.

"Could we really sit out?" said Robert Levin, a 27-year Fannie veteran who retired in 2008. "That's what we were grappling with."

Taxpayers could pay a steep price for those decisions. Alt-A loans accounted for just 9% of Fannie's loan guarantee business, but represented nearly 40% of credit losses in the fourth quarter of 2009. Nearly 23% of Alt-A loans originated by Fannie Mae in 2007 were 90 days or more delinquent at the end of 2009. Mr. Mudd said that those loans still performed substantially better than those originated by private lenders.

As the housing crisis deepened in 2007 and 2008, Mr. Mudd said the company increasingly faced decisions that offered "horrible" choices between "unsavory alternatives." Those decisions often pitted taking on more risks to support the housing market as private lenders withdrew versus joining in the retreat and precipitating a far more severe damage to the market.

While they are now wards of the state, Fannie and Freddie are playing a critical role in helping to heal broken housing markets and, together with the Federal Housing Administration, they enable nine in 10 new mortgages. The Obama administration, which is shepherding a financial-regulatory overhaul through Congress, has said it won't propose legislation to revamp the mortgage-finance market until next year.

Commissioners also tried to sort out the degree to which government mandates to support affordable housing were at fault for the companies' collapse. Alan Greenspan, the former Federal Reserve chairman, said on Wednesday that the companies had "paid whatever price was necessary" to meet those affordable-housing goals.

But some commissioners and witnesses challenged that point of view on Friday. "The firms would not engage in any activity, goal fulfilling or otherwise, unless there was a profit to be made," Mr. Falcon said in prepared testimony.

Commissioner Heather Murren said that executive compensation standards were pegged to profit goals and not public mission. "I don't see that reflected anywhere in how you actually got paid," she told Mr. Mudd.

The former Marine and current chief executive of private-equity firm Fortress Investment Group LLC ascended to the top job at Fannie in 2004 after an accounting scandal prompted a management shakeup. He was forced to resign when the government took over the companies in September 2008.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.