Aug. 12 (Bloomberg) -- Freddie Mac, the second-largest U.S. mortgage finance company, will stop buying subprime loans issued in New York state as a new law takes effect that holds investors accountable for mortgage fraud.

Freddie won't buy loans dated on or after Sept. 1 that meet the state's subprime definition, the McLean, Virginia-based company said today in a lender bulletin on its Web site. New York Governor David Paterson last week signed new foreclosure and lending laws that tighten legal protections for borrowers.

The legislation holds mortgage buyers like Freddie liable in ways that ``we have no way of monitoring and preventing,'' company spokesman Brad German said in a telephone interview.

Government-chartered Freddie and Fannie Mae, which together own or guarantee 42 percent of the $12 trillion U.S. home loan market, are both slowing their mortgage purchases after last week posting bigger-than-expected losses for the second quarter.

The companies have been battered by record delinquencies and rising losses as they struggle to shore up their weakened balance sheets amid the worst housing slump since the Great Depression.

The state law may disproportionately affect borrowers looking to use state and federal mortgage rescue programs to refinance out of unaffordable subprime loans, German said. It will affect a ``very, very small number'' of loans, he said.

`Compounds the Situation'

A group that advocates affordable housing, the National Community Reinvestment Coalition, is ``very troubled by Freddie Mac's announcement,'' said David Berenbaum, executive vice president.

``In a market that doesn't have liquidity right now, it compounds the situation because it forces consumers to go to less responsible third parties,'' said Berenbaum, whose Washington- based group represents more than 600 housing nonprofits in the U.S. ``Fannie and Freddie have a responsibility to lead us out of this crisis as public chartered institutions.''

Fannie spokesman Brian Faith declined to comment on Freddie's announcement. Paterson spokeswoman Erin Duggan didn't have an immediate comment.

Freddie fell 23 cents, or 4.1 percent, to close at $5.37 on the New York Stock Exchange. Washington-based Fannie declined 38 cents to $8.02. Both have plummeted about 90 percent in the past year and are trading near 17-year lows set last month.

Subprime loans are issued to borrowers with poor credit or high levels of debt.

To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net

Last Updated: August 12, 2008 16:23 EDT