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* Watt will replace FHFA Acting Director Edward DeMarco
* Obama nominated Watt in May to regulate Fannie, Freddie
* More Fannie, Freddie mortgage aid expected under Watt
By Margaret Chadbourn
WASHINGTON, Dec 10 (Reuters) - The U.S. Senate on Tuesday confirmed Representative Mel Watt to lead the agency that regulates taxpayer-owned mortgage financiers Fannie Mae and Freddie Mac, providing greater leeway for the Obama administration's mortgage aid initiatives.
The vote to approve Watt as regulator of the Federal Housing Finance Agency was 57-41. Only two Republicans - including Richard Burr, who is from Watt's home state - voted in favor of the North Carolina Democrat.
President Barack Obama nominated Watt in May to head the independent regulator. But Republicans worried he would be too beholden to the White House and blocked a final vote when Democrats brought the nomination up in October.
Last month, however, Democrats changed the rules to allow nominees like Watt to overcome filibusters with a simple majority in the chamber, which they control 55-45.
"Watt's confirmation will provide the housing market more certainty as our economy continues to recover from the financial crisis," Senator Tim Johnson, the Democratic chairman of the Senate Banking Committee, said in a statement.
Watt will be the agency's first permanent director since 2009. He replaces FHFA Acting Director Edward DeMarco, a career civil servant whose focus during his four-year tenure has been on limiting taxpayer losses.
Fannie Mae and Freddie Mac, which currently back about half of existing U.S. home loans, were seized by the government in 2008 as mortgage losses mounted. They have received $187.5 billion in taxpayer funds to stay afloat, while paying about $185.2 billion in dividends to the government for that support.
Watt's confirmation would be a victory for the Obama administration, which has at times been at odds with DeMarco. Last year, DeMarco blocked an administration plan to allow Fannie Mae and Freddie Mac to reduce mortgage principal for some borrowers who owe more than their homes are worth.
Watt, in contrast, is expected to consider a targeted principal forgiveness program.
The mortgage industry also anticipates that he will expand federal programs that allow borrowers with loans backed by Fannie Mae and Freddie Mac to lower their interest rates even if they are "under water" on their loans, meaning they owe more than the value of their homes.
"He's the right person to protect Americans who work hard and play by the rules every day, and he'll be the right regulator to make sure the kind of crisis we just went through never happens again," Obama said in a statement.
Republicans have argued that Watt, a lawyer who has served in the House of Representatives since 1992, lacks the expertise to oversee the mortgage giants, and some have said they worry he would be unable to resist White House pressure to pursue the administration's policy goals.
"This is not a cabinet position where the nominee is supposed to be an advocate for the president. Instead, this is an independent agency with a highly complex task - impacting our entire economy," said Senator Mike Crapo of Idaho, the top Republican on the banking panel.
When the Senate attempted to advance Watt's nomination in October, he was backed by 56 senators, just shy of the 60 votes needed at the time to overcome filibusters. His rejection marked the first time since the Civil War that the Senate denied a sitting member of Congress an executive branch position.
Watt will take the reins at the regulator in the middle of a debate over the future of Fannie Mae and Freddie Mac, and he could have a big impact on a planned overhaul of the $10 trillion U.S. mortgage market.
The Bush administration felt obligated to bail out Fannie Mae and Freddie Mac at the height of the financial crisis, given their dominant position in the housing market. Without them, analysts agree the housing bust would have been much deeper.
But Democrats and Republicans alike see a need to curtail the government's support for the housing sector, and there is a bipartisan effort under way in the Senate to wind down both companies, even though they are now posting record profits.
DeMarco, who is expected to stay on during Watt's transition, has aimed to shrink the roles of the two mortgage giants by raising the fees they charge lenders and scaling back the maximum size of the loans they can back.
Homeowner and consumer advocacy groups have repeatedly called on Obama to fire DeMarco, who they say has not done enough to help troubled homeowners. The calls grew as DeMarco stood firm in his decision to block Fannie Mae and Freddie Mac from reducing loan principal.
The Obama administration had tried to replace DeMarco before. Obama nominated Joseph Smith, a former North Carolina banking commissioner, for the post in 2010, but he withdrew in the face of stiff Republican opposition.