Shares of Fannie Mae, Freddie Mac Sink

The two companies, which buy and sell home loans, generally have stuck with less risky loans than many of the mortgage lenders and Wall Street banks that have been hit with growing mortgage losses this year.

Nevertheless, investors are getting worried about how a surge in home loan defaults will affect the two mortgage finance companies.

On Monday, Fannie Mae's shares, which hit a 10-year low last week, fell $3.11, or 7.6 percent, to $37.58 after Friedman Billings Ramsey analyst Paul J. Miller Jr. downgraded the company's shares to "Market Perform" from "Outperform" and reduced his price target to $35 from $60.

Shares of Freddie Mac, which reports its third-quarter earnings Tuesday, fell $3.22, or 7.9 percent, to $37.50 after Credit Suisse analyst Moshe Orenbuch projected Freddie Mac could take up to $5 billion in losses from securities backed by mortgages given to borrowers with weak credit.

Orenbuch reduced his price target on Freddie Mac shares to $45 from $68, but kept a rating of "Neutral" on the stock.

Fannie Mae's shares tumbled last week amid fears that a new accounting methodology disclosed by the company masks the number of bad loans it holds.

While Miller said Fannie and Freddie will ultimately benefit from a shift to more traditional lending practices, "investors will first have to get a certain comfort level" that mortgage-related losses are stabilizing, he wrote.

Fannie disclosed its new calculation for potential mortgage losses Nov. 9, when it submitted several hundred pages of documents to the Securities and Exchange Commission, bringing the company's financial reporting up to date for the first time since 2004.

But a bookkeeping change and its potential impact received significant attention last week, and Fannie executives held a conference call on Friday to explain the changes.

Using the new method, Fannie reported a so-called "annualized credit-loss ratio" of 0.04 percent for the first nine months of this year, meaning the value of four out of every 1,000 mortgages it holds declined during that period.

Under the company's old method, the credit-loss ratio for that period would have been 0.075 percent -- far exceeding Fannie's forecasts on the $2.4 trillion worth of mortgages it owns.

As mortgage market turmoil continues, Fannie Mae's losses are likely to rise, Miller predicted. He forecast Fannie Mae's credit losses will rise as high as 0.15 percent in 2009, above the record high of 0.12 percent in the late 1980s.