Fannie Mae and Freddie Mac, the biggest sources of money for Americans buying homes, are becoming the white elephants of the mortgage bond market as regulators and competitors take away their privileged position selling securities.

The federally-sponsored companies, which leveraged their political advantages into control over 40% of all housing loans, are shrinking after billions of dollars in accounting mistakes led to the ouster of their chief executive officers and calls from the Bush administration for increased regulation.

Nowhere is the decline more evident than in the market share Fannie Mae and Freddie Mac have lost. The companies accounted for 38% of mortgagebond sales this year through June, down from a record 70% in 2003, according to data service Inside MBS & ABS. The bonds, which help determine rates homeowners pay on loans, have risen 51% since 2001 to $6.2 trillion, Bond Market Association data show.

“It’s unlikely they will resume a role where they dominate the whole marketplace,” said Andrew Woodward, former head of the mortgage lending unit at Bank of America Corp., the second-largest American bank by assets after Citigroup Inc.

The declines at Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac may continue as the first real estate slump since the 1990s causes lending to contract by 19% this year, according to the Mortgage Bankers Association, a Washington-based trade group.

Homebuyers increasingly prefer adjustable-rate loans to the fixed-rate debt Fannie Mae and Freddie Mac typically buy. A quarter of this year’s loans will be so-called ARMs, the association says. ARMs took off because homebuyers want lower rates and more flexibility after housing prices rose 57% in the past five years. Fannie Mae and Freddie Mac, dogged by three years of federal investigations, failed to adapt, losing share to Seattle-based Washington Mutual Inc. and Countrywide Financial Corp. in Calabassas, California.

“Because of their well-publicized problems,” Fannie Mae and Freddie Mac “have been distracted,” said John Olinski, executive vice president at Indymac Mortgage Bank in Pasadena, California.

The unit of IndyMac Bancorp Inc. issued $22.2 billion of mortgage bonds in the first half of the year, giving it a 3.8% market share, up from 2.8% in 2005.

Yesterday, New York-based Merrill Lynch & Co. agreed to pay $1.3 billion for the home lending unit of Cleveland’s National City Corp. to catch up with competitors in the business of bundling loans into securities.

Fannie Mae and Freddie Mac sold a smaller share of mortgage-backed securities than rivals for the first time last year.

Fannie Mae created $510 billion of securities, down from a record $1.2 trillion in 2003, while Freddie Mac issued $397.8 billion, compared with $713.8 billion, according to the Office of Federal Housing Enterprise Oversight, their federal regulator.

Mortgage bond sales by all issuers rose to $1.96 trillion, based on data provided by the Bond Market Association, a New York-based trade group of underwriters and dealers.

Fannie Mae shares fell 5 cents today to $51.91 at 10:15 a.m. in New York Stock Exchange composite trading, down 42% from their all-time high of $89.38 in 2001. Freddie Mac’s fell 14 cents to $63.37, or 14% below their peak of almost $74.20 in 2004. They were losing market share just as a growing economy and low borrowing rates fueled a boom in housing. The amount of residential mortgage debt rose to a record $9.17 trillion last year from $5.57 trillion in 2001, according to the Federal Reserve.

ARMs grew to 30% of new loans last year from 17% in 2002, data from the Mortgage Bankers Association show.

More than 80% of the loans backing the bonds sold by Fannie Mae and Freddie Mac have fixed rates.

The companies say they are purchasing a wider variety of debt, and this year Freddie Mac said it would start to buy 40-year mortgages that require no down-payments from consumers. A $200,000 loan under the program would require 3.5% less in monthly income compared with a standard 30-year loan, Paul Mullings, senior vice president of Freddie Mac’s single-family mortgage business said in May.

We “feel very good about where we are and where we’re going,” Freddie Mac spokesman Michael Cosgrove said.

Thomas Lund, who runs the singlefamily mortgage business at Fannie Mae, said at a Mortgage Bankers Association conference in May that the company was buying more ARMs. The company used to shun them because homeowner defaults may increase when borrowing costs rise. Fannie Mae turned $3.7 billion of them into bonds in the first three months of this year, up from $2.9 billion in all of 2005, Mr. Lund said.

“We will work very hard to win back” business, Mr. Lund said at the conference. Fannie Mae declined to make its executives available to comment.

Fannie Mae was created in 1938 during the Great Depression by President Franklin Roosevelt, who wanted to help rescue the economy by funneling money into housing. Congress created Freddie Mac in 1970 when interest rates were rising and real estate prices were slumping. The companies say they make homes more affordable for Americans because their government ties lower borrowing costs by an average of a half percentage point.

The companies help homebuyers by purchasing mortgages from banks and other financial institutions, providing money for more loans. Fannie Mae and Freddie Mac profit by taking those mortgages and turning them into bonds that they either hold as investments or sell to investors.

Fannie Mae and Freddie Mac have enjoyed an advantage over other financial institutions because of their government ties. Their charters give the Treasury the authority to buy as much as $2.25 billion of their securities in times of distress.

This “implied federal guarantee” meant Fannie Mae and Freddie Mac borrowed money at rates 40 basis points, or 0.40 percentage point, less than firms that lacked federal sponsorship from 1999 until the first half of 2003, a Fed study concluded.

That edge helped fuel an expansion that pushed Fannie Mae’s holdings of mortgages and mortgage assets to $901 billion in 2003 from $286.5 billion in 1996. Freddie Mac’s rose to $660.5 billion from $137.8 billion.Fannie Mae and Freddie Mac “were on pace to basically absorb the entire mortgage market,” said Scott Simon, a managing director at Newport Beach, California-based Pacific Investment Management Co., which oversees the world’s biggest bond fund.

Pimco’s Total Return Fund, which invests $93 billion, has 55% of its assets in mortgage securities.

Competitors complained about the preferential treatment. Fannie Mae and Freddie Mac fought back, hiring 46 lobbying firms in 2003 and spending $24.6 million to influence Congress, more than any other company or group, according to PoliticalMoneyLine, a nonpartisan group that tracks spending.

The money helped stall legislation in 2003, 2004 and 2005 that would have created a tougher regulator.

The Bush administration has asked lawmakers to create a tougher regulator with the power to shrink the companies because of concern Fannie Mae and Freddie Mac could trigger financial market turmoil. They are the largest borrowers in America after the federal government, with a total of about $1.61 trillion of debt.