WASHINGTON – Fannie Mae agreed yesterday to cap its mortgage portfolio at $727 billion and pay a $400 million fine to the Office of Federal Housing Enterprise Oversight and the Securities and Exchange Commission.

The portfolio cap could likely be seen as a huge concession made by the company, which has long argued that such limits constrain growth and might ultimately hurt the housing market.

In its agreement with the regulators, Fannie Mae said it would cap its mortgage portfolio at December 31,2005 limits. According to Fannie Mae records, the company held $727 billion in its portfolio then. Fannie Mae holds $721 billion in its portfolio now. In October 2004, the portfolio peaked at $913 billion.

The cap was one of the top recommendations made by OFHEO, which yesterday released a blistering 340-page report criticizing Fannie Mae’s accounting, management and corporate culture.

“The penalty and settlements represent a major step in correcting a dangerous course that had been followed by one of the largest financial institutions in the world,” OFHEO acting director James Lockhart said in a statement. “Unprincipled corporate behavior and inadequate controls will simply not be tolerated.”

Mr. Lockhart could modify or lift the portfolios, according to the agreement. For example, within 60 days, Fannie Mae could submit a business plan to OFHEO requesting a “moderate per annum increase” in the portfolio for liquidity reasons, among other things.

In another effort to constrain Fannie Mae’s growth, the government-sponsored enterprise agreed to retain the 30% capital surplus that OFHEO established in September 2004.

Portfolio limits have emerged as the most divisive issue in Congressional attempts to create a new regulator for Fannie Mae and its smaller rival, Freddie Mac (FRE).

The House of Representatives passed a bill in October that would allow the new regulator to limit the portfolios of Fannie and Freddie if the size threatened the safety and soundness of either government-sponsored enterprise.

This differed from a bill the Senate Banking Committee narrowly passed in July, which would put stricter limits on the portfolios by restricting which assets each GSE could hold. The Federal Reserve Board and White House support the Senate bill, but some Senate Democrats have indicated they would try and block the bill on the Senate floor.

Combined, Fannie Mae and Freddie Mac hold close to $1.4 trillion in their portfolios.

Fannie Mae also agreed to “undertake a comprehensive reform program aimed at top-to-bottom change, from corporate culture and tone to specific changes” in accounting and board management.

Fannie Mae will also begin a new review of “current and separated employees.” Fannie Mae said it did not admit or deny wrongdoing in the agreement with regulators.