Fannie, Freddie Settle NY Probe

Government-sponsored mortgage giants Fannie Mae FNM and Freddie MacFRE have agreed to a slew of new standards designed to prevent fraud, ending a probe of their business practices by New York Attorney General Andrew Cuomo.

The companies have agreed to each pay $12 million over the next five years to set up an Independent Valuation Protection Institute to promote accurate appraisals in the U.S. mortgage industry. They also will require lenders that turn around and sell mortgages to Fannie and Freddie in the secondary market to follow a Home Valuation Code of Conduct, designed to ensure that home appraisals are independent and accurate.

In return, Fannie and Freddie will admit no wrongdoing and Cuomo will terminate his investigation into their business practices. Cuomo, who had been investigating billions of dollars in home loans that the government-sponsored entities bought from banks, concluded that fraudulent appraisal practices are widespread in the industry and a root cause for the spike in mortgage foreclosures that are wreaking havoc on financial markets and the U.S. economy.

"Appraisals were often fraudulent because there were conflicts of interest due to relationships between the appraisers and the lenders," said Cuomo at a press conference on Monday. "The bedrock of the housing system is the appraisal. When a consumer buys a house, you want to know what the house is worth. If there's fraud in the primary market for mortgages, then there is fraud in the secondary market where the mortgages are pooled."

The new standards will prohibit mortgage brokers from selecting appraisers, prohibit lenders from using "in-house" staff appraisers and prohibit lenders from using appraisal management companies they own or control.

Cuomo made the announcement with representatives from Fannie and Freddie as well as their federal regulator, the Office of Federal Housing Oversight. He began his investigation into the housing industry about a year ago, and he said he has found evidence of rampant fraud and many "bad acts."

"The mortgage investigation continues," said Cuomo. "Fannie and Freddie have agreed to cooperate. We could always litigate, but I would rather cooperate, and that's what we did here. These are the only agreements we are close to signing with any financial institution today."

In November, Cuomo issued subpoenas to Fannie and Freddie, which together account for 45% of the $11.5 trillion U.S. residential mortgage market. His office also sued First American Corp. FAF and its eAppraiseIT unit for allegedly colluding with Washington Mutual WM, to use a list of preferred appraisers to inflate mortgage appraisals.

Last week, Fannie reported that it swung to a fourth-quarter loss of $3.56 billion, while Freddie logged its own loss of $2.45 billion for the period. The downturn in performance for both companies came amid a spike in mortgage defaults and a sharp decline in the U.S. housing market.

Meanwhile, lawmakers and regulators in Washington, D.C., are scrambling to find ways to mitigate the economic pain of the housing downturn.

OFHEO announced last week it would lift portfolio growth caps on the retained mortgages portfolios at both companies, since they became current in their financial reporting. The caps were imposed on Fannie and Freddie earlier in this decade when they became embroiled in scandals over their accounting practices and were forced to make huge earnings restatements.

Shares of Fannie were recently down 50 cents, or 1.8%, to $27.15, while shares of Freddie were off 75 cents, or 3%, to $24.43.