WASHINGTON -- James B. Lockhart III has spent the past two years telling almost anyone who would listen that the obscure federal agency he heads needed more power to do its job -- regulating the two government-backed providers of funding for mortgages, Fannie Mae and Freddie Mac.

Now Congress, after years of deadlock, is finally about to grant more power to the minders of Fannie and Freddie. And Mr. Lockhart will have to figure out how best to use that power.

The toughest challenge is likely to be deciding how much capital Fannie and Freddie need to hold. Their share prices collapsed earlier this month as investors fretted that default-related losses would gobble up their meager capital. The shares stabilized only after the Treasury and Federal Reserve pledged two weeks ago to prop up the companies with loans or equity if needed.

NEW ON THE BEAT Legislation approved by the House of Representatives and expected to be approved by the Senate soon will create the Federal Housing Finance Agency to regulate Fannie Mae, Freddie Mac and the Federal Home Loan Banks.Some highlights:• The regulator will have authority to raise capital requirements for Fannie and Freddie.• The bill creates procedures for putting the companies into receivership if they become insolvent.• The regulator will have new powers to restrict executive pay at the companies.• The maximum size of single-family-home mortgage loans that Fannie and Freddie can buy or guarantee in the highest-cost areas is set at $625,500, effective Jan. 1, 2009. That is down from a temporary ceiling of $729,750 set by Congress earlier this year but well above the prior cap of $417,000.• A slice of profits from the companies will go to a trust fund that is to finance housing for low-income people.

In the past, Mr. Lockhart has noted that Fannie and Freddie weren't required to hold much capital compared with banks. When asked Thursday whether he would use the new agency's powers to jack up capital levels, he declined to make any predictions. "I want to go into this with a fresh mind," he said.

Fannie and Freddie, both chartered by Congress but owned by private-sector shareholders, are the main suppliers of funding for U.S. home mortgages. They buy home loans from lenders and package them into securities for sale to investors world-wide. The Bush administration spent years trying to scale them down but now says they can't be allowed to fail.

A housing bill passed by the House of Representatives Wednesday -- and expected to be approved soon by the Senate -- would create the Federal Housing Finance Agency. That agency is to replace the Office of Federal Housing Enterprise Oversight, or Ofheo, which is headed by Mr. Lockhart and regulates Fannie and Freddie, as well as the Federal Housing Finance Board, which oversees the 12 regional Federal Home Loan Banks.

The legislation specifies that the director of Ofheo, Mr. Lockhart, will become director of the new agency, until the president appoints a successor, subject to Senate confirmation. The White House is expected to keep Mr. Lockhart in place for now and leave it to the next president to appoint a successor.

Mr. Lockhart has known President Bush since they were classmates in the early 1960s at Phillips Academy, a private high school in Andover, Mass. Mr. Lockhart managed a school baseball team that also included Mr. Bush. The two later attended Yale University and Harvard Business School at the same time.

Before becoming head of Ofheo two years ago, Mr. Lockhart worked at insurance and securities firms, co-founded a financial risk-management firm and held federal posts at the Social Security Administration and the Pension Benefit Guaranty Corp.

Mr. Lockhart arrived at Ofheo as Fannie and Freddie were overhauling their books in the wake of accounting scandals. He said their financial controls were "in shambles." Despite Ofheo's limited powers, he clamped tighter controls on them and only recently loosened his grip.

Sen. Richard Shelby, a Republican from Alabama, said Mr. Lockhart "has done a good job, considering the tools he has." Rep. Barney Frank (D., Mass.), chairman of the House Financial Services Committee, said the new agency's next director should have more expertise in housing finance.

Current law sets minimum capital requirements for Fannie and Freddie at levels that appear low in relation to the recent losses caused by a surge in foreclosures and falling home prices. The law puts the minimum capital at 2.5% of assets held on their balance sheet plus 0.45% of the mortgage securities held by other investors but guaranteed by Fannie and Freddie.

The legislation passed by the House gives the new agency power to raise those minimums, though it will have to write regulations spelling out the criteria for any increase.

At the end of the first quarter, the companies' capital, as defined by their regulator, stood at a combined $81 billion. That works out to just 1.5% of the $5.2 trillion of mortgages they own or guarantee. They reported losses of a combined $11 billion in the nine months ended March 31. Those losses required them to replenish capital by selling preferred shares in December. By March, with losses still mounting, Mr. Lockhart and the Treasury prodded them into commitments for a second round of share offerings to raise more capital; Fannie has done so, while Freddie still hopes to raise more than $5 billion in the near future.

Because of their unusual status, there are no real peers to serve as benchmarks to determine capital needs. If the minimum levels are set low, critics will accuse the regulator of risking the need for a future federal bailout at taxpayers' expense. If the levels are set high, the housing industry will complain that Fannie and Freddie are being shackled in a way that makes it more expensive for Americans to finance home purchases.

The new agency also will have more scrutiny over compensation for Fannie and Freddie executives. Mr. Lockhart suggested he would be careful with that authority to avoid driving away talent. Freddie is looking for a new chief executive.

Write to James R. Hagerty at bob.hagerty@wsj.com and Damian Paletta at damian.paletta@wsj.com

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