The Office of Federal Housing Enterprise Oversight (OFHEO) which oversees operation of Fannie Mae and Freddie Mac late Tuesday announced a major initiative in cooperation with the two government sponsored enterprises (GSEs) to increase, by perhaps as much as $200 billion, the liquidity of the mortgage-backed securities market.

OFHEO announced that it would begin to allow the two GSEs to invest a significant part of the 30 percent capital surplus they have been required by OFHEO to maintain into mortgages and mortgage-backed securities. OFHEO said it was "appropriate" to reduce the capital requirements to 20 percent and that it may consider further reductions in the future.

This reduction combined with the increase of the portfolio caps announced last month should allow Freddie and Fannie to purchase or guarantee about $2 trillion in mortgages this year. This capacity should allow them to assist in subprime refinancing and loan modifications and do more in the jumbo mortgage market which they have been granted temporary permission to enter.

Both GSEs announced that they will begin the process to raise significant capital and would maintain overall capital levels well in excess of requirements.

"Fannie Mae and Freddie Mac have played a very important and beneficial role in the mortgage markets over the last year," said OFHEO Director James Lockhart. "Let me be clear - both companies have prudent cushions above the OFHEO-directed capital requirements and have increased their reserves. We believe they can play an even more positive role in providing the stability and liquidity the markets need right now. OFHEO will remain vigilant in supervising the safe and sound operations of these companies, and will act quickly to address any deficiencies that may arise. Furthermore, we recognize the need to ensure that their capital levels are strong, protecting them from unforeseen risks as the market recovers."