March 3 (Bloomberg) -- Fannie Mae and Freddie Mac, the biggest sources of financing for U.S. home loans, reached an agreement with New York Attorney General Andrew Cuomo to buy mortgages only from lenders that adopt new standards intended to ensure independent home appraisals.

The new rules announced today prohibit mortgage brokers from selecting appraisers and lenders from using in-house staff to do valuations for any home loans the government-chartered companies purchase. In most cases lenders will also be barred from using appraisal management firms they own or control.

Cuomo opened an investigation of the U.S. mortgage industry last year as foreclosures among subprime borrowers climbed to a five-year high. The New York probe strikes at the foundation of the mortgage business, which profited from lending money to homeowners and repackaging the debt into securities sold to investors.

``The goal of the office is to find out what went wrong and how to fix the problem,'' Cuomo said today at a news conference. ``What we identified as the common denominator, if you will, was appraisal valuation.''

Banks so far have recorded more than $180 billion in writedowns on securities linked to home loans. Inflated appraisals undermine the mortgage-backed securities market because bonds and derivatives based on artificially high home valuations don't have enough collateral behind them.

New Oversight Group

``We believe the appraisals were often fraudulent because there were conflicts of interest and pressure on the appraisers,'' Cuomo said.

Mortgage lenders that own appraisal companies include Countrywide Financial Corp., the nation's largest home-loan originator. Countrywide did not respond to telephone or e-mail messages seeking information about what the new rules might mean for LandSafe Inc., the lender's appraisal subsidiary. Fannie Mae spokeswoman Amy Bonitatibus declined to comment on whether the rules might force Countrywide or other lenders to sell their appraisal units.

Countrywide said in its annual earnings filing with the Securities and Exchange Commission on Feb. 29 that LandSafe, which also provides credit and title reports, contributed $109 million to pretax earnings in 2007.

Fannie Mae and Freddie Mac also will pay $24 million to create an independent organization to implement and monitor the new standards, Cuomo said. The accord covers appraisals for mortgages originated on or after Jan. 1, 2009.

Shares Fall

Shares of both companies fell. Fannie Mae, based in Washington, declined $1.21, or 4.4 percent, to $26.44 in New York Stock Exchange composite trading today. Freddie Mac of McLean, Virginia, dropped $1.46, or 5.8 percent, to $23.72.

``We are pleased to work with regulators to do our part to ensure sound, accurate, independent and reliable appraisals,'' Fannie Mae General Counsel Beth Wilkinson said in a statement today.

Cuomo said his probe is continuing. It includes the securities market that packages mortgages into bonds.

The attorney general, a former secretary of the U.S. Department of Housing and Urban Development, started investigating the home loan industry as data from the Washington-based Mortgage Bankers Association showed an increase in delinquencies among subprime borrowers and a record rate of late payments by buyers who purchased houses with minimal down payments.

In November, he sued First American Corp., the largest U.S. title insurer, for allegedly inflating home values under pressure from Seattle-based Washington Mutual Inc. First American has since asked the U.S. District Court in the Southern District of New York to dismiss the lawsuit, saying only the U.S. government has authority to regulate savings and loans and appraisers.

Ratings Companies

Cuomo, elected in 2006, also has subpoenaed ratings companies and investment banks. The ratings firms have been criticized for giving high ratings of subprime-mortgage securities that sank in value.

Fannie Mae and Freddie Mac own or guarantee about 40 percent of the $11.5 trillion in U.S. residential-mortgage debt. Congress created the companies to increase financing and provide market stability.

A day after Cuomo announced his November subpoenas, James B. Lockhart III, director of the Office of Federal Housing Enterprise Oversight, criticized the attorney general for issuing the subpoenas without consulting with the office.

U.S. Senator Charles Schumer, a senior Democrat on the Senate banking committee, stepped in and urged Ofheo to cooperate with Cuomo. Ofheo signed onto the Cuomo agreement reached today.

`Restore Confidence'

``Accurate, independent appraisals are very important to ensuring the safety and soundness of Fannie Mae, Freddie Mac and the mortgage market,'' Lockhart said in a statement. ``The agreements should help restore confidence in the mortgage market by enhancing underwriting practices, reducing mortgage fraud and making home valuations more reliable.''

Schumer praised the according saying it ``represents one of the first major blows against the types of predatory lending that were so prevalent in the mortgage business of the last few years.''

Today's agreement between could serve as a model for deals between other mortgage securitizers and lenders, Cuomo said.

``Fannie and Freddie are the industry leaders,'' Cuomo said. ``I think the rest of the market place will say over time, `You know what, if it makes sense for Fannie and Freddie, it makes sense for us.'''

To contact the reporters on this story: Karen Freifeld in New York at kfreifeld@bloomberg.net; Sharon L. Lynch in New York at sllynch@bloomberg.net.

Last Updated: March 3, 2008 17:43 EST