A frenetic rally in shares of Fannie Mae (FNM) and Freddie Mac (FRE) eased as Wall Street mulled over the details of a regulatory decision to lift caps on the growth of their mortgage portfolios. After earlier rising as much as 16 percent, Fannie and Freddie had given up all their gains and were unchanged action.

Wednesday’s move by the Office of Federal Housing Enterprise Oversight could allow the companies to expand their purchases of mortgage securities. Legislators have been hoping they’ll do just that in a bid to ease the pain of the housing crisis. But merely lifting the mortgage caps is just a first step in the eyes of some. Sen. Chuck Schumer, who last year sponsored legislation that would have forced OFHEO to raise the companies’ mortgage caps, now wants the regulator to reduce the amount of capital it forces the companies to hold to cushion against future losses.

“This is a long overdue step, but certainly a welcome one,” Schumer said in a press statement. “Just as important is OFHEO’s willingness to ease the capital surcharge requirements that continue to hamstring the GSEs. OFHEO should announce a plan to lift that surcharge immediately.”

OFHEO chief James Lockhart has indicated he’s open to reducing the capital surcharge, but not just yet, amid worries that a declining housing market will stick the companies with billions of dollars in credit losses and writedowns of derivative positions. Wednesday morning’s financial update, in which Fannie Mae said it lost $3.56 billion for the fourth quarter, shows those concerns aren’t going away any time soon.

Delta (DAL) and Northwest Airlines (NWA) still can’t get together. The carriers are close to agreeing on a merger, but plans continue to be hung up on the question of pilot seniority, The Wall Street Journal reports. Pilots at the two carriers can’t agree on a formula for determining how their ranks will be combined. The standoff, which stems from pilot anxiety about career advancement — no one wants to get stuck flying regional jets — caused top execs at the two companies to break their silence on the talks. Northwest said for the first time that it is “prepared to consider positively a transaction” that’s good for workers, investors and passengers. Delta, engaging in a bit of posturing, told workers in a memo that no “potential transaction meets all our principles” at the moment.

The waiting is making Wall Street anxious. Investors have sent shares in Delta and Northwest down 14 percent since Feb. 7, when a deal appeared imminent. Still, observers expect the merger to happen, because a combined carrier would be more robust in the face of rising energy prices and tough competition. “We will eventually get an agreement,” airline consultant Julius Maldutis tells Bloomberg television. He says that despite the problems now, he expects to see a merger announced “over the next several days.”

Nortel (NT) is cutting back again. The Toronto-based telecom equipment company said it will cut 2,100 jobs from its 33,000-member workforce, while moving an added 1,000 jobs overseas in its latest bid to reduce costs. The move comes as the company posted a steep fourth-quarter loss and a 4% drop in revenue from year-ago levels, as North American telcos pull back on their network spending. Nortel lost $844 million, or $1.70 a share, for the quarter ended Dec. 31, compared with a year-ago loss of $80 million, or 19 cents a share. That latest quarter was hit by Nortel’s decision to reduce the value of its deferred tax assets - losses that can be carried forward to be applied to cut taxes on future profits - by $1 billion. The company cited “changes in Canadian tax profile” for that move.

“Our ultimate goal is to build a high-performance, efficient and simple organization within a cost structure that allows us to compete and win effectively against any competitor in the world,” said CEO Mike Zafirovski. To that end, Nortel has now cut 5,000 jobs over the past year, and has announced cutbacks in each of the past four years. But like rival Alcatel-Lucent (ALU), Nortel appears to be rapidly losing ground as big customers such as AT&T (T) and Verizon (VZ) emphasize investments in newer technologies that give consumers access to phone, Internet and television service over one line. That’s why the company is reportedly discussing a joint venture with Motorola (MOT) that could give it more scale to compete with bigger rivals. Wednesday’s numbers say Nortel needs to do something, and fast.

Tuesday was a rare good day for stocks in the alternative-investment business. As the private equity industry’s wheelers and dealers met in Munich to talk about the next huge thing, shares of Blackstone (BX), Fortress (FIG) and Och-Ziff (OZM) staged a sharp rally, rising at least 6% each. Och-Ziff, a hedge fund firm that went public back in November and has since seen its shares lose a third of their value, posted a better-than-expected adjusted profit for the fourth quarter, due in part to a lower-than-expected tax rate. It’s not clear that the earnings explain the rise in these stocks, though, which makes it at least plausible that a big institution was buying shares to build a position. Meanwhile, it has been more than three months since another private equity titan, Kohlberg Kravis Roberts, last amended its IPO filing. Sure, the markets are choppy, and yes, the company is dealing with headaches tied to its KKR Financial (KFN) affiliate, which has been trying to refinance some short-term debt. But on a day like today, a rush to feed at the public trough must surely seem tempting to the rich guys who run KKR.

Private equity firms are hunkering down in the face of a slowing economy and unfriendly debt markets. But Blackstone (BX) sees an opportunity to benefit from the troubles of the Wall Street banks that have made hundreds of millions of dollars arranging buyouts in past years. The firm is hoping to cut out the middleman in future buyouts by borrowing money directly from hedge funds, mutual funds and other institutions, Bloomberg reports. “We’re bypassing the banks,” Blackstone chief Tony James said at the Super Return conference in Munich.

The comments come as banks ranging from Citi (C) and JPMorgan Chase (JPM) to Merrill Lynch (MER) and Goldman Sachs (GS) struggle to rid themselves of a huge backlog of so-called leveraged loans taken on to fund earlier buyouts. Their efforts won’t be made easier if they lose out on fees tied to buyout deals, though it’s hard to imagine many deals happening soon anyway. “I think we are seeing a meltdown in the credit markets that has some life in terms of the downside left to it,” Scott Sperling of Thomas H. Lee Partners told Reuters. Downside is a concept Blackstone shareholders are all too familiar with, having seen their stock drop 55% from its highs since last year’s big IPO. But they’re on the right side of the ledger today, with Blackstone stock up 7%.

Google (GOOG) shares sold off again Tuesday as last year’s favorite stocks continue to get hammered. Google dropped $36 in midday trading to $450, putting the stock just 3% above its 52-week low. Another 2007 favorite, Apple (AAPL), sold off again as well, dropping below $116 in early trading before recovering to $119. The stock has lost 40% of its value this year after more than doubling in 2007. Bespoke Investment Group notes that another leader of last year, Goldman Sachs (GS), is languishing as well, and muses about where new leadership in might come from. “Ambac (ABK) and MBIA (MBI) have been moving markets lately,” a post on the firm’s Web site says, referring to the bond insurers whose good news has fueled late-day marketwide rallies in each of the past two trading sessions. But “they probably are not the type of names we should be pinning our hopes on.”

One group doing well for a change Tuesday: the holdings of hedge fund manager Ed Lampert. Lampert has been selling his shares in Citi (C) after long accumulating the stock, and in recent quarters his other portfolio holdings have been sagging as well. But on Tuesday, a strong earnings report from big holding AutoZone (AZO) sent that stock up 5%, and other Lampert names followed: AutoNation (AN) and Sears (SHLD) each rose 3%, while Citi added 2% and Home Depot (HD) was up fractionally despite a weak earnings report. Only tiny Acxiom (ACXM), Lampert’s smallest position at Dec. 31, was down. It’s early yet, but perhaps the go-to guy is returning to form.

Wall Street could be in for another nasty-tasting serving of alphabet soup. In the wake of the debt market messes tied to collateralized debt obligations, or CDOs, and structured investment vehicles, or SIVs, Bloomberg reports that big banks could now face losses on another obscure asset class: variable interest entities, or VIEs.

The industry has already taken tens of billions of dollars of writedowns on CDOs and other mortgage-related securities. Now, Bloomberg reports, troubles in financing VIEs - another type of financial structure that lets firms keep risky assets off their balance sheets - could add new losses to the toll. Estimates of possible losses range from $30 billion at Moody’s to $88 billion at CreditSights, Bloomberg reports. Firms could have to recognize losses tied to the VIEs if they are forced to provide financing to the entities, as they did in the case of the SIVs that ran into financing trouble this fall. Beyond the usual suspects, such as Citi (C) and Merrill (MER), Bloomberg says the VIE mess could even touch two firms that have largely steered clear of the subprime swamp - Goldman Sachs (GS) and Lehman Brothers (LEH).

One factor working in the banks’ favor is that for now, it appears that bond insurers Ambac (ABK) and MBIA (MBI) are going to hold onto their triple-A ratings, forestalling a downgrade that could have forced the banks to backstop the VIEs. But that doesn’t mean the issue is going away. A top S&P exec told Bloomberg that “the disclosure on VIEs is hopeless,” which means investors in financial firms have just one more worry to add to an already sizable list.

Foster Wheeler (FWLT) slumped in premarket trading after the big engineering firm missed Wall Street’s fourth-quarter profit estimate by a wide margin. The Bermuda-based company made $78 million, or 54 cents a share, for the quarter ended Dec. 31, up from the year-ago $63 million, or 44 cents a share. Excluding certain items, though, earnings fell to 56 cents a share from 60 cents a year earlier. Analysts were looking for a 76-cent profit.

The company said fourth-quarter earnings before interest, taxes, depreciation and amortization - a widely tracked measure of cash flow - fell below the levels of the first three quarters of the year as business slowed at its Global Engineering & Construction unit. Foster Wheeler said the unit took an $8.3 million hit on an Italian court ruling and a $5 million reserve on a disagreement with a client. Global Engineering & Construction also “experienced fewer profit-enhancing opportunities such as bonuses and incentives during the quarter as compared to the early part of the year due to portfolio mix and contract timing.” Investors want to see more profit-enhancing opportunities, which is why Foster Wheeler stock - which has more than tripled over the past year as investors pile into the shares of companies plying the global infrastructure trade - was down 8 percent early Tuesday.

The outlook keeps getting dimmer at Home Depot (HD). The Atlanta-based home improvement retailer posted a softer-than-expected fourth quarter profit Tuesday and said it expects per-share earnings to fall as much as 24 percent in the coming year. Home Depot made $671 million, or 40 cents a share, for the quarter ended Feb. 3, down from the year-ago $925 million, or 46 cents a share. Sales rose 1.5 percent from a year earlier to $17.7 billion, as sales in established stores dropped 8.3 percent from a year ago. Analysts were looking for a 43-cent profit on sales of $18.1 billion. The company said sales for the year fell 2.1 percent to $77.3 billion, marking their first-ever annual decline, the Associated Press reports.

“This was a difficult year financially, but I believe the progress we made on our key priorities set the foundation for the long term health of our company,” CEO Frank Blake said. He said he expects Home Depot’s sales to fall by 4 percent to 5 percent for the coming year, as the home improvement market will remain “challenging” with home prices falling and the economy slowing. And unlike rival Lowe’s (LOW), which said yesterday it hoped to see business pick up in the second half of the year as Federal Reserve interest rate cuts work their way through the economy, Blake made no hopeful comments except to say Home Depot intends to “build on the progress we made in 2007.” No wonder the stock was off 2 percent in premarket trading.

MBIA (MBI) is going on the attack. The bond insurer on Monday eliminated its quarterly dividend and sketched out a plan to split its lucrative municipal bond operations from its structured finance side, which handles the increasingly perilous business of insuring mortgage-related securities. The moves came just hours after rating agency S&P affirmed MBIA’s triple-A rating, lifting a bit of the sense of siege that has descended on MBIA in recent months. Shares of MBIA and rival Ambac (ABK) surged as much as 20 percent in trading Monday afternoon.

Good news from the bond insurers has been well received on Wall Street in recent days, which could point to another rise when trading opens Tuesday. On Friday, blue-chip stocks rallied on reports Ambac was close to wrapping up a deal to raise new equity. Monday brought another late-day marketwide rally after S&P announced its decision not to downgrade MBIA. Tuesday could well bring confirmation of a possible capital infusion that could clear the way for Ambac to pursue a split as well.

But under new chief Jay Brown, MBIA appears to be positioning itself for a bigger stage - the one in Washington, D.C. A message to shareholders published late Monday promised that the company will take a responsible position on executive pay, with Brown noting that he has been a buyer of the company’s stock, not a seller like so many U.S. execs. He also returned to a theme hinted at in last Thursday’s surprise announcement that MBIA was dropping out of a key financial-insurance trade group: Brown believes the off-shore insurance industry, based in Bermuda, isn’t paying its fair share, and he’s here to do something about it.

“In a competitive and open market to provide all American public entities with access to the capital markets, it makes no sense to allow foreign competitors with U.S. domiciled operations to operate without paying their fair share of U.S. taxes,” Brown wrote in his Monday evening letter to owners. “After nine years of trying to use mainly logic to make this argument to those who can affect this change, we have decided to enlist help and thus will earmark a minimum of $1 million this year to support the Coalition for a Domestic Insurance Industry. We are prepared to pay more if that proves insufficient!”

And paying more isn’t the only action MBIA is ready to take. Brown threatens that if lawmakers don’t act, he’ll move MBIA from Armonk, N.Y., to Bermuda, because it’s so important to him that MBIA keep its cost of capital down.  “I still don’t look good in Bermuda shorts,” he writes, “but we will eventually have to move the company if the U.S. tax code is not modified.”

Brown certainly has chutzpah. Though the company has raised $2.6 billion in new capital and appears all but certain to keep its triple-A rating intact, at least for now, MBIA is still struggling to find its footing amid a financial storm. Indeed, the company warned in Monday’s letter that it expects to take another mark-to-market writedown of its insurance portfolio in the first quarter. Picking up where former CEO Gary Dunton left off, Brown also accused short-seller Bill Ackman of trying to “destroy our franchise and our industry.”

With those sorts of challenges looming, now seems like an odd time to be devoting scarce management time to changing the tax code, of all things. But as Brown says, “Yes, we’re following our own course, but this shouldn’t surprise anyone.” True enough. By now, no one can be surprised by anything coming out of MBIA.