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Mortgage Appraisal Probe Expands to Fannie and Freddie

Attorney General Andrew M. Cuomo announced today that his office sent Letters of Notice and Demand to both Fannie Mae and Freddie Mac as his mortgage appraisal probe widened further.

According to Cuomo, Fannie and Freddie have agreed to the demand to retain an Independent Examiner to conduct a thorough review of all Washington Mutual appraisals and related mortgages purchased by the financiers.

“Fannie Mae and Freddie Mac must ensure that Washington Mutual’s mortgages have not been corrupted by inflated appraisals,” Cuomo said in a statement today on his office’s Web site.

The probe could result in more bad news for the struggling thrift, which saw its shares fall to their lowest level since 2000, and record their biggest single-day decline since the stock market crash of 1987.

If the investigation determines that Fannie owns or guarantees mortgages with overstated appraisals, the company’s rules would order those loans to be bought back by the lender that sold them.

That could spell big trouble for WaMu, who announced this morning that it expected further credit losses for both the current quarter and the first quarter of 2008.

“Fannie Mae and Freddie Mac cannot afford to continue buying Washington Mutual mortgages unless they are sure these loans are based on reliable and independent appraisals,” Cuomo said.

The subpoenas will also look into the due diligence practices of Fannie Mae and Freddie Mac, as well as policies and procedures in regard to valuing properties and appraisals.

The probe calls for information on not only Washington Mutual loans, but all mortgage loans purchased by Fannie Mae and Freddie Mac from any bank, as well as the accompanying mortgage-backed securities.

Fannie Mae said it was concerned about the allegations that if true, would violate their requirements for loans it purchases from mortgage lenders and/or securitizes.

“It is against our interest to purchase or guarantee mortgages with inflated appraisals, and so it is in Fannie Mae’s interest that these appraisal practices be investigated,” said Brian Faith, Fannie’s managing director for communications.

The probe comes just two days before Fannie Mae is due to report financial results for the first three quarters of 2007, finally bringing it up to date after overstating earnings from 2001 to mid-2004.

Unfortunately, the news will likely curtail any portfolio boost the government-sponsored entities had hoped to gain as the investigation now takes center stage.

Terry Dunkin, President of the Appraisal Institute, said, “I wish I could say I am shocked by the discoveries made by the Attorney General and his staff. Sadly, what allegedly happened between First American and Washington Mutual is not an isolated incident. Rather, it is symbolic of a problem that has plagued the appraisal industry for years.”

“As the allegations against First American show, the mortgage industry’s dirty secret has been that banks exert tremendous pressure to extort appraisers.”

Shares of both Fannie and Freddie were rattled by the news, with Fannie dropping roughly 10 percent, and Freddie off about seven percent.

Update: Stock guru Jim Cramer labeled New York Attorney General Andrew Cuomo a “communist” who “wants to shut down the mortgage market.”

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