Accounting changes at

Freddie Mac

( FRE) masked a sharp deterioration in the government-sponsored mortgage giant's portfolio during the first quarter as conditions in the U.S. housing market continue to worsen.

Freddie said Wednesday its first-quarter earnings beat Wall Street expectations, but it also reported that the "fair value" of its net assets fell to negative $5.2 billion at the end of March from $12.6 billion at the end of December. That reflected a drop of nearly $32 billion in value for its mortgage assets and credit guarantees that did not affect the company's net income.

The company, which is viewed by investors as having the implicit backing of the U.S. Treasury, announced it will raise $5.5 billion in fresh capital by selling stock, and its government regulator will lower the amount of surplus capital it's required to hold to protect its balance sheet. Freddie said in March it would not have to raise more capital.

The Office of Federal Housing Enterprise Oversight will lower Freddie's excess-capital requirement to 15% from 20%, with another cut to 10% in store later this year after other steps are taken. Similar news from Freddie's larger counterpart,

Fannie Mae

( FNM), bolstered confidence in the stock market last week despite that company's

$2.19 billion first-quarter loss

and its announcement that it will raise $6 billion in fresh capital.

Shares of Freddie were recently up $1.86, or 7.5%, to $26.82.

Cramer: 18 Months Till Housing's Healed

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The loosening of the regulatory reins on Freddie and Fannie despite dismal earnings performances reflects a sharp reversal in attitudes toward the companies from federal regulators amid the U.S. housing and credit crisis. Before the crisis, regulators were pushing to tighten controls on the two housing giants after they were both caught up in massive accounting scandals in recent years that led to the ouster of their top executives.

Now, Freddie and Fannie are viewed as sources of stability in secondary mortgage markets, where credit has largely dried up amid the steepest declines in U.S. home prices on record since the Great Depression. The implicit backing of the U.S. government for both companies, which was reinforced by the

Federal Reserve's

willingness to help

JPMorgan Chase

(JPM) - Get Report

buy and save

Bear Stearns

( BSC) from bankruptcy in mid-March and extend emergency credit lines to investment banks, allows them to bring much-needed liquidity to the shell-shocked credit markets. (Investment banks like

Citigroup

(C) - Get Report

,

Merrill Lynch

( MER) and

Lehman Brothers

( LEH) have posted billions in losses on investments tied to the mortgage market.)

Foreclosures on the Rise

Meanwhile, conditions in the housing market are only getting worse. RealtyTrac reported Wednesday that U.S. foreclosure filings climbed 65% in April while bank seizures more than doubled from a year earlier as rates on adjustable mortgages increased and deserted homes added to the burgeoning inventories of unsold homes in various markets around the country.

On Tuesday, the National Association of Realtors reported that median prices for a single-family home fell 7.7% in the first quarter, the biggest drop in at least 29 years, and there were 4.06 million U.S. homes for sale at the end of March -- an increase of 40,000 from the prior month.

Mortgage foreclosures "contribute to already bloated inventories of homes for sale, and put downward pressure on home values,'' said RealtyTrac CEO James Saccacio.

Despite the deteriorating market, Freddie reported a net loss for the first quarter of $151 million, or 66 cents a share, compared with a loss of $133 million, or 35 cents a share, in the same quarter last year. The loss was much less severe than the 92 cents per-share loss analysts were expecting, according to consensus estimates reported by Thomson Reuters. Its revenue more than doubled to $1.53 billion.

The first-quarter loss also marked a big improvement from the $2.5 billion loss recorded by Freddie in the fourth quarter. In that period, Freddie's loss included $1.3 billion in losses on credit guarantees, but no such losses were included in the first-quarter results. Also, losses related to trading securities and derivatives fell to $58 million in the first quarter compared with $2.1 billion in the fourth, reflecting an accounting change, and expenses on credit guarantees fell to $258 million from $2.1 billion.

Freddie said the improvement in its first-quarter results compared with its fourth-quarter results reflect "reduced losses related to a change in the guarantee obligation valuation methodology" it uses on its books. It also reflected "lower interest-rate related mark-to-market losses." Both items stemmed from accounting changes the company adopted at the beginning of 2008, when the housing and credit crisis was in full swing.

While those changes in the company's bookkeeping helped its bottom-line, the huge decline in the "fair value" of its net assets showed that the struggle for Freddie's portfolio worsened in the first quarter. Moreover, the company's credit costs quintupled during the quarter compared with last year to $1.45 billion, up 59% from the fourth quarter as delinquencies and foreclosures continued to rise and home prices continued to fall.

"While our expectation is for continued weakness in the housing and economic environment to negatively impact our overall performance through the remainder of this year, we have put Freddie Mac on a better foundation to manage through the current cycle and emerge a successful, long-term competitor," said the company in a press release.