New York’s attorney general, who last week launched a lawsuit against First American Corp. and a subsidiary charging appraisal inflation, today announced an expanded investigation and subpoenas for mortgage entities Freddie Mac and Fannie Mae seeking details about loans they purchased from banks and information about appraisal practices.

The subpoenas announced by Attorney General Andrew M.

New York’s attorney general, who last week launched a lawsuit against First American Corp. and a subsidiary charging appraisal inflation, today announced an expanded investigation and subpoenas for mortgage entities Freddie Mac and Fannie Mae seeking details about loans they purchased from banks and information about appraisal practices.

The subpoenas announced by Attorney General Andrew M. Cuomo seek information on the mortgage loans Fannie Mae and Freddie Mac purchased from banks, including Washington Mutual, and mortgage-backed securities associated with those loans.

The lawsuit filed last week charges that First American and subsidiary eAppraiseIT caved into pressure from Washington Mutual to use a list of preferred appraisers who inflated property appraisals, though First American said in a statement that the lawsuit “has no foundation in fact or law.”

Cuomo said in a statement today that government-sponsored entities Fannie Mae and Freddie Mac have agreed to his office’s demand to allow an independent examiner approved by the office to “conduct a total review of all Washington Mutual appraisals and mortgages” purchased by the entities, which are intended to enhance liquidity in the mortgage market by buying mortgages on the secondary market and pooling and selling them to investors as mortgage-backed securities.

The subpoenas also seek information about the “due diligence practices of Fannie Mae and Freddie Mac,” according to the statement from Cuomo’s office, the appraisals and values by the originating lenders, and policies and procedures relating to valuing properties and appraisals.

In letters to Fannie Mae and Freddie Mac, Cuomo stated that the ability of lenders to sell their mortgage loans into the financial markets “has the effect of making the lender less vigilant against risky loans since any risk is quickly transferred to the purchasers of the loans.”

The letters also charge that the income of mortgage brokers and lenders typically depends on whether a loan closes and the size of the loan, and “brokers and loan production staff have strong personal incentives to pressure appraisers to value a home at the maximum possible amount, so that loans will close and generate maximum commissions.”

Also, the letters state that “investment banks and (government-sponsored entities) may … have an interest in inflating (or at least in not questioning) the value of pooled loans,” as “the values of these loans serve as a basis for the value of their securities.”

In a statement, Fannie Mae spokesman Brian Faith acknowledged that the entity received a letter from the New York attorney general and said, “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.”

The appraisal practices described in the attorney general’s complaint against First American, if true, “would violate Fannie Mae’s requirements for loans we purchase from lenders or securitize,” Faith said.

Faith also said that Fannie Mae intends “to cooperate fully with the attorney general. We also will appoint, with the attorney general’s approval, an independent examiner to review the appraisal practices cited in the complaint. If the examiner determines we own or guarantee mortgages with inflated appraisals, our guide states that the lender must buy back the loans that do not meet our standards and requirements.”

Freddie Mac officials also said in a statement that they will cooperate with the attorney general’s office. “Because Freddie Mac retains the credit risk on the mortgages it securitizes, we depend upon accurate appraisals. In fact, accurate appraisals are fundamental to our effective credit risk management as well as to the long-term success of home buyers,” according to the Freddie Mac statement. “We therefore work closely with our lenders to ensure that all loan information is accurate. We are pleased to cooperate with the New York attorney general’s investigation and have agreed to appoint an independent examiner as requested.”

Freddie Mac and Fannie Mae have been the subject of much congressional testimony and debate, as management and accounting problems — which include the restatement of earnings — have led to legislative discussions about overhauling the entities. Some legislation has targeted a temporary rise in Fannie’s and Freddie’s loan portfolios in response to liquidity problems in the mortgage market.

Cuomo said in a statement, “In order to fulfill their duty to consumers and investors, Fannie Mae and Freddie Mac must ensure that Washington Mutual’s mortgages have not been corrupted by inflated appraisals. Our expanding investigation into the mortgage industry has uncovered that Washington Mutual improperly pressured appraisers to provide inflated values that best served the lender’s interest. Knowing this, 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.”

Washington Mutual is the third-largest provider of loans to Fannie Mae, according to the attorney general’s announcement, selling $24.7 billion in loans in 2007 alone. Washington Mutual is also the 14th-largest provider of loans to Freddie Mac, selling $7.8 billion in loans in 2007.

Cuomo stated, “The integrity of our mortgage system depends on independent appraisers,” and alleges that Washington Mutual “compromised the fairness of this system” by pressuring appraisers to provide inflated values. “Every company that buys loans from Washington Mutual must be sure that the loans they purchased are not corrupted by … systemic fraud,” he stated.

In response to the New York Attorney General’s Office lawsuit and investigation, Washington Mutual announced in a statement today that the company “takes any allegations of improper practices seriously, and is continuing its investigation into this matter.”

Washington Mutual’s legal department, in conjunction with an outside attorney, “is conducting an investigation of the allegations contained in the complaint against eAppraiseIT filed by the New York Attorney General,” the company stated. “The company will continue to pursue its policy of ensuring that its operations comply with all applicable laws. In addition, the company will vigorously defend itself from all unfounded allegations and lawsuits.”

On Nov. 1, company officials said in a statement that they are suspending the company’s relationship with eAppraiseIT. “We are surprised and disappointed by the allegations in the complaint related to eAppraiseIT,” according to the statement. Also, Washington Mutual officials stated, “We have absolutely no incentive to have appraisers inflate home values. In fact, inflated appraisals are contrary to our interests.”

A research paper by Keefe, Bruyette & Woods, an investment bank and broker-dealer company that specializes in the financial services sector, notes that the lawsuit filed by the attorney general’s office, while it does not name Washington Mutual as a defendant, could be damaging to the company.

“We believe that the only reason that Washington Mutual was not named as a defendant in the suit is strong pre-emption laws for thrifts preclude success for state lawsuits against savings and loan institutions,” according to the research report. Also, the report states, “In our view, the lawsuit raises an issue of considerable risk to Washington Mutual: that poorly performing securitized loans will be put back to WaMu from bondholders on the basis of fraudulent appraisals, and WaMu would be forced to put bad loans back on its balance sheet.”

Terry Dunkin, president of the Appraisal Institute, a membership association of about 22,000 appraisers, said in the statement issued today by the New York Attorney General’s Office that “the mortgage industry’s dirty secret has been that banks exert tremendous pressure to extort appraisers,” and this problem “has plagued the appraisal industry for years.”

Back in 2003, the U.S. General Accounting Office released a report that cited problems in the oversight of the appraisal industry. The report revealed that some state regulatory agencies “may be unable to adequately enforce appraiser compliance with the minimum (federal) standards,” and several state regulators cited “lack of funding and resources.”

This year, U.S. Rep. Paul Kanjorski, D-Pa., has introduced legislation, HR 3837, that targets pressure on appraisers and also seeks to eliminate deceptive mortgage servicing practices.

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Send tips or a Letter to the Editor to glenn@inman.com, or call (510) 658-9252, ext. 137.

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