In the intensifying debate over Fannie Mae and Freddie Mac, critics are stepping up attacks on their practice of buying back their own mortgage-backed securities.

The question of whether it is appropriate for the two government-sponsored enterprises to invest in their mortgage-backed bonds comes as Ginnie Mae, a government agency, is seeking permission to start buying its own mortgage-backed issues.

Meanwhile, the Federal Housing Finance Board is questioning whether the Federal Home Loan banks should be allowed to continue buying mortgage-backeds at all.

The critics of Fannie and Freddie say that by buying the same mortgage-backed bonds they guarantee they are acting as arbitrageurs - and that because an implied U.S. government guarantee keeps their borrowing costs very low, they can earn a huge spread on the bonds.

The result, the argument goes, is that Fannie and Freddie use the perception that they are "too big to fail" to benefit shareholders without serving their government-chartered mission of lowering the cost of homeownership.

When Fannie and Freddie securitize mortgages, they guarantee the credit risk and transfer the interest rate risk to investors. But when they repurchase the mortgage-backeds, they expose themselves - and, critics say, taxpayers - to the risk that if rates rise the market value of the securities will fall.

The same can be said about the enterprises' practice of buying whole loans and holding them in their portfolios. But when they do that they are injecting capital into the mortgage market.

Buying their own mortgage securities does nothing to further that mission, because the capital was already provided when the loans were securitized, said Bert Ely, a banking analyst and co-author of "Nationalizing Mortgage Risk," an anti-GSE tract published this year.

Fannie and Freddie defend the buybacks, arguing that the practice boosts demand for the securities, in turn lowering their yields and ultimately lowering mortgage rates.

"There is no conflict between our mission and shareholder expectations," said Timothy Howard, Fannie's chief financial officer. "They are totally aligned." If anything, Mr. Howard said, shareholder objectives "incent" Fannie to fulfill its mission of lowering homeownership costs.

Bill Stephens, vice president of shareholder relations at Freddie Mac, said the ability to repurchase mortgage-backed securities enables it to ensure stability in the mortgage market.

He cited as an example the liquidity crisis of late 1998, when investors stampeded out of mortgages and into Treasuries. That movement increased the risk that mortgage rates would rise, Mr. Stephens said, but Freddie helped to avert a rise by repurchasing its own mortgage-backed securities, he said.

Mr. Howard said Fannie is better than other investors at managing risk. He noted that his company funds its mortgage holdings with long-term debt, which shields it from the interest rate mismatch problems that plagued many savings & loans in the 1980s.

But Mr. Ely said that by issuing debt, the GSEs drive up interest rates in the agency bond market, canceling out the effects of repurchasing mortgage-backed debt.

A Wall Street analyst said Mr. Ely's argument misses one nuance. Fannie and Freddie have taken great pains to emulate the Treasury's practices, scheduling regular debt auctions and enlisting large syndicates of dealers to support the new issues in secondary trading.

By creating a liquid, predictable market Fannie and Freddie have minimized the impact of heavy issuance, said the analyst.

Fannie and Freddie have consistently increased profits faster than the mortgage market has grown. Mr. Ely said one of the primary ways the two companies have achieved this growth has been by maintaining a strong spread on each mortgage dollar that passes through their books.

He said Fannie and Freddie get a bigger bang for their buck by making portfolio investments - whole loans or mortgage-backed securities - than from their credit guarantee business, and that this is another incentive to invest in mortgage-backeds.

Mr. Howard said, "That's true - we do have an incentive to buy as many [loans and securities] as we can. However, we are unapologetic for the rate of portfolio growth we achieve," he said, because that growth helps Fannie meet its mission objectives.

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