The federal regulator for government-backed mortgage giants Fannie Mae and Freddie Mac said Tuesday that he would not allow the firms to reduce loan balances of troubled borrowers, saying there would be no clear-cut financial benefit and that such a move could cause some homeowners to intentionally default in hopes of getting taxpayer aid.

“We concluded that the potential benefit was too small and uncertain, relative to the known and unknown costs and risks,” said Edward DeMarco, acting director of the Federal Housing Finance Agency.

The decision came after months of internal analysis at FHFA and sustained pressure from the Obama administration, Democratic lawmakers on Capitol Hill and housing advocates, who argued that so-called “principal reduction” was an essential tool needed in helping to soften the fallout of the housing crisis.

Reaction to DeMarco’s decision came swiftly Tuesday afternoon.

Treasury Secretary Timothy Geithner struck an unusually personal tone in chastising DeMarco for his decision, even while acknowledging DeMarco’s role as an independent regulator of Fannie and Freddie.

“Five years into the housing crisis, millions of homeowners are still struggling to stay in their homes and the legacy of the crisis continues to weigh on the market,” Geithner wrote in a letter to DeMarco on Tuesday. “You have the power to help more struggling homeowners and help heal the remaining damage from the housing crisis.”

Geithner noted that FHFA’s own analysis showed that Fannie and Freddie could save $3.7 billion by participating in the administration’s housing program — and taxpayers could save $1 billion.

A Treasury analysis accompanying the letter said up to a half-million homeowners could benefit from the program.

In announcing his decision, DeMarco also released an 18-page paper detailing the internal analyses that FHFA officials had performed in determining the costs and benefits of allowing principal reduction at Fannie and Freddie.

DeMarco acknowledged that under some scenarios, principal reduction could indeed save money by keeping people in their homes. But he noted that such savings could disappear if only a small percentage of homeowners strategically defaulted on their mortgage payments.

“We certainly have seen commentators actually encouraging borrowers to consider this kind of activity,” he said.

DeMarco also raised the question of what the long-term effects of principal forgiveness might be, saying that rewriting valid contracts could spook investors and increase mortgage costs in the future.

Principal reduction has stirred intense passions since early on in the financial crisis. Consumer advocates and some economists have argued that it is the only way to finally end the housing crisis and bolster economic growth — by freeing borrowers of excessive mortgage debt.

But many conservatives have been resistant to the idea, arguing that it would represent an unfair bailout for undeserving homeowners.

About a quarter of the nation’s homeowners are underwater, representing excessive mortgage debt of about $700 billion.

Initially, the Obama administration was skeptical about principal reduction. It included only a modest — and ultimately ineffective — principal reduction measure in its first housing rescue in 2009.

As the housing market continued to struggle, it tweaked the program to try to encourage more principal reduction.

The federal regulator for government-backed mortgage giants Fannie Mae and Freddie Mac said Tuesday that he would not allow the firms to reduce loan balances of troubled borrowers, saying there would be no clear-cut financial benefit and that such a move could cause some homeowners to intentionally default in hopes of getting taxpayer aid.

“We concluded that the potential benefit was too small and uncertain, relative to the known and unknown costs and risks,” said Edward DeMarco, acting director of the Federal Housing Finance Agency.

The decision came after months of internal analysis at FHFA and sustained pressure from the Obama administration, Democratic lawmakers on Capitol Hill and housing advocates, who argued that so-called “principal reduction” was an essential tool needed in helping to soften the fallout of the housing crisis.

Reaction to DeMarco’s decision came swiftly Tuesday afternoon.

Treasury Secretary Timothy Geithner struck an unusually personal tone in chastising DeMarco for his decision, even while acknowledging DeMarco’s role as an independent regulator of Fannie and Freddie.

“Five years into the housing crisis, millions of homeowners are still struggling to stay in their homes and the legacy of the crisis continues to weigh on the market,” Geithner wrote in a letter to DeMarco on Tuesday. “You have the power to help more struggling homeowners and help heal the remaining damage from the housing crisis.”

Geithner noted that FHFA’s own analysis showed that Fannie and Freddie could save $3.7 billion by participating in the administration’s housing program — and taxpayers could save $1 billion.

A Treasury analysis accompanying the letter said up to a half-million homeowners could benefit from the program.

In announcing his decision, DeMarco also released an 18-page paper detailing the internal analyses that FHFA officials had performed in determining the costs and benefits of allowing principal reduction at Fannie and Freddie.

DeMarco acknowledged that under some scenarios, principal reduction could indeed save money by keeping people in their homes. But he noted that such savings could disappear if only a small percentage of homeowners strategically defaulted on their mortgage payments.

“We certainly have seen commentators actually encouraging borrowers to consider this kind of activity,” he said.

DeMarco also raised the question of what the long-term effects of principal forgiveness might be, saying that rewriting valid contracts could spook investors and increase mortgage costs in the future.

Principal reduction has stirred intense passions since early on in the financial crisis. Consumer advocates and some economists have argued that it is the only way to finally end the housing crisis and bolster economic growth — by freeing borrowers of excessive mortgage debt.

But many conservatives have been resistant to the idea, arguing that it would represent an unfair bailout for undeserving homeowners.

About a quarter of the nation’s homeowners are underwater, representing excessive mortgage debt of about $700 billion.

Initially, the Obama administration was skeptical about principal reduction. It included only a modest — and ultimately ineffective — principal reduction measure in its first housing rescue in 2009.

As the housing market continued to struggle, it tweaked the program to try to encourage more principal reduction.