WASHINGTON ( TheStreet) -- Republicans who have made much ado about their desire to liquidate Fannie Mae ( FNMA.OB) and Freddie Mac ( FMCC.OB) might be surprised to learn that it's already happening - at least in part.

In fact, the main impediment to progress on the liquidation front has been private investors' buyback demands.

As required by their bailout agreement, the government-sponsored enterprises (GSEs) are already in the process of liquidating their so-called "retained" mortgage portfolios. Their chief regulator, the Federal Housing Finance Agency, isn't allowing the two companies to be in the market as active buyers of new mortgage assets for their own portfolios. Instead, Fannie and Freddie have been acting as conduits between mortgage originators and private investors who still need the assurance of government backing to do business with one another.

The original bailout of Fannie and Freddie, sketched out by former U.S. Treasury Secretary Henry Paulson, required the firms to start winding down by 10% a year, starting in 2010, until their portfolio sizes reached a relatively meager $250 billion apiece. But, as the "liquidation" process has moved forward, a few things have gotten in the way.

First, accounting rule changes brought more assets onto the GSEs' balance sheets than they had at the time they entered conservatorship in September 2008. Paulson's successor, Timothy Geithner, took care of that problem. In removing their bailout cap last December, Geithner made a few tweaks to the bailout agreement. The changes effectively slowed the liquidation process and made it easier for Fannie and Freddie to adapt to FAS-166/167 accounting rule changes.

In altering the terms, the Treasury Department said it was trying to make the liquidation process "less burdensome and more transparent in light of impending accounting changes." It also reiterated the fact that Fannie and Freddie are not expected to be active buyers, but "neither is it expected that active selling will be necessary to meet the required targets."

In other words, the write-downs and foreclosures related to mortgage defaults would help take care of the liquidation requirement for the foreseeable future.

Indeed, the two firms appear to be on track to have met the 10% liquidation requirement by the end of December. Freddie said in its quarterly report this week that its portfolio has declined by 6% so far this year - or 8% at an annualized rate - "primarily due to liquidations." The liquidation rate might be higher if not for Freddie's requirement to buy back nearly $390 billion worth of seriously delinquent mortgages from private trusts so far this year.

Still, at Sept. 30, the firm held $710.2 billion in its retained portfolio, vs. $755.3 billion at year-end. It was well within the Treasury Department's requirement to shrink its loan portfolio from a maximum of $900 billion at Dec. 31, to $810 billion a year hence.

"The FHFA has stated its expectation that we will not be a substantial buyer or seller of mortgages for our mortgage-related investments portfolio, except for purchases of seriously delinquent mortgages out of PC trusts," the company said in its quarterly filing.

Fannie Mae hasn't reported third-quarter results yet. However, its retained portfolio moved the opposite way during the first half of 2010 - again, because of put-backs from mortgage trusts.

Fannie's retained portfolio grew 6% through June 30, to $817.8 billion from $772.7 billion at the start of the year. It bought back $170 billion worth of delinquent loans in mortgage-backed securities (MBS) trusts during the first half of the year.

But, meanwhile, both Fannie and Freddie continued to "liquidate" holdings of subprime, Alt-A and other "toxic" mortgage debt by tens of billions of dollars. There are a couple of ways Fannie and Freddie can go about doing so. They can sell related MBS in the market - though there are few buyers, usually offering pennies on the dollar. Additionally, when a property enters foreclosure to become "real-estate owned," or REO, it is also considered liquidated.

At Sept. 30, Freddie Mac had nearly 75,000 of REO properties, worth $7.4 billion - up 19% over the past three months and up 77% year-over-year. At June 30, Fannie Mae had nearly 130,000 single-family properties considered REO, worth $13 billion - more than double the year-ago level.

The trends are telling in several ways.

First, Fannie and Freddie are providing the support needed for the housing market's recovery by acting as a conduit for mortgage finance. But they're also trying to get rid of a huge number of bad loans in a friendlier manner than their banking peers - one with "integrity," as official statements say.

Secondly, Fannie and Freddie are also getting lots of pushback from private investors in the MBS they stand behind. The hundreds of billions' worth of buybacks Fannie and Freddie have accepted make the amount of loans they're pushing onto large servicers like Bank of America ( BAC), JPMorgan Chase ( JPM), Wells Fargo ( WFC) and Citigroup ( C) look like relative chump change.

Finally, while the chorus of conservatives demanding the liquidation of Fannie and Freddie grows ever louder, lawmakers might want to consider that the process is already occurring. Rep. Spencer Bachus (R., Ala.), the likely successor to House Financial Services Committee Chairman Barney Frank (D., Mass.), became the latest high-profile lawmaker on Wednesday to say he'd like to see the two firms liquidated . Bachus joins other Republicans like Sen. Richard Shelby, ranking member of the Senate Banking Committee, Sen. John McCain (R., Ariz.), Sen. Jud Gregg (R., N.H.), Sen. Orrin Hatch (R., Utah) and Rep. Jeb Hensarling (R., Texas), who have been banging the drums against Fannie and Freddie since financial-reform proceedings were under way.

They seem to be rallying on a point where there's little disagreement.

Since a housing-finance reform conference in August, top guns in Obama administration have signaled a desire to liquidate the two firms and start from scratch as well. Even longtime Fannie-Freddie cheerleader Rep. Barney Frank (D., Mass.) said he thought the two firms ought to be "abolished" in a television interview a few months ago.

"I think they should be abolished," Frank said on the Fox Business Network in August. "The only question is what do you put in their place. This is a situation where given the importance they had come to play in housing, you can't tear down the old jail until you build a new one."

If not for Fannie and Freddie's crucial role in the housing market - and the absence of other, private-market liquidity providers - the process of dismantling the two firms might already be well under way. It is likely to accelerate in the coming years, once a comprehensive reform plan is on the table and buyback demands have abated. But the point of "conservatorship" is just that - conserving assets of a company until a decision is made about the future of the GSEs.

-- Written by Lauren Tara LaCapra in New York.

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