News Gets Worse for Freddie As Shareholders File Lawsuit

By Thomas Heath
Washington Post Staff Writer
Thursday, November 22, 2007

One day after reporting a $2 billion quarterly loss, Freddie Mac found itself the target of a shareholder lawsuit accusing the mortgage-funding giant of misleading investors about its risk-management practices.

The lawsuit in a Manhattan federal court seeks damages on behalf of investors, and it comes after a formal investigation by New York State Attorney General Andrew M. Cuomo into loan appraisals for banks that sold mortgages to Freddie Mac and its larger rival Fannie Mae.

The suit filed by the law firm of Coughlin Stoia Geller Rudman & Robbins alleges that Freddie Mac "made false and misleading statements concerning . . . its risk management and the procedures it put in place to protect the Company from problems in the mortgage industry," according to a statement on the firm's Web site. "Freddie Mac was not adequately implementing risk control measures. Moreover, the Company's procedures for appraisals led to many inflated appraisals, increasing the risk of defaults."

Cuomo earlier this month issued subpoenas to Fannie Mae of the District and Freddie Mac of McLean, and demanded they appoint independent examiners to review appraisals on the loans they purchased from banks. The attorney general's subpoenas also seek information on the due diligence performed by Fannie Mae and Freddie Mac and their evaluations of appraisals.

Freddie Mac spokesman David R. Palombi declined to comment on the lawsuit, but said the company would cooperate fully with Cuomo's office and has agreed to appoint an independent examiner.

"Accurate appraisals are fundamental to our effective credit risk management as well as to the long-term success of the homebuyers we are chartered to serve," Palombi said in an e-mail. "Freddie Mac has no incentive to accept inflated appraisals on the loans we purchase and guarantee. Indeed, Freddie Mac has a long-standing commitment to fighting mortgage fraud, as evidenced by its leadership role in the industry through our active internal fraud investigations, quality control activities, Freddie Mac-instituted remedial steps, and assistance with criminal prosecutions."

Freddie Mac and Fannie Mae were chartered by the federal government to keep money flowing to mortgage lenders. Their roles have been curtailed in recent months as their losses from bad loans grew and they were forced to write down the value of their vast portfolios.

Freddie Mac on Tuesday reported a third-quarter loss of $2 billion and said it was considering cutting its annual $2 dividend in half to shore up reserves. The company also had retained Goldman Sachs and Lehman Brothers to help it raise additional capital.

Freddie's executives said losses from bad mortgages could eventually exceed $10 billion. Freddie and Fannie had a hand in more than 60 percent of all mortgages originated in the last quarter.

Freddie Mac shares plunged this week. The stock dropped 2.8 percent yesterday to close at $26, down more than 30 percent this week and more than 60 percent for the year. Fannie Mae rose 3.5 percent yesterday to close at $29.23, but the stock is down 50 percent since it reported a $1.4 billion quarterly loss earlier this month.

Freddie Mac and Fannie Mae are involved with $4.8 trillion in housing loans, either by buying them or by guaranteeing pools of loans, which are then sold to investors as securities.

Most of their business is in higher-quality loans, and the companies are prohibited from investing in jumbo mortgages, which exceed $417,000. They make most of their money by charging fees on the loans they have bought or securitized.

© 2007 The Washington Post Company