Freddie Mac announced last week that it had unknowingly purchased mortgages with "unacceptable refinance practices." National City Mortgage, a customer of the GSE, discovered the tainted loans that were made through a California-based mortgage broker. Analysts said that this situation is a reflection of the post-refinancing wave environment where mortgage brokers have to keep origination volumes up, with some resorting to unethical practices.

"The lesson here is that as refinancings decline, brokers are under a certain amount of financial stress to boost their income," said Art Frank, head of mortgage research at Nomura Securities International. Frank added that both the mortgage banks and the GSEs should carefully scrutinize the loans that they purchase. Frank added that in this particular case, prosecutors could help to the extent that fraud was involved and the civil court system could also help in correcting the situation.

However, Frank said that the overwhelming majority of mortgage brokers have maintained ethical practices and that investors will not be negatively impacted as Freddie Mac has promised to buy back the affected pools. The GSE has identified 48 pools worth $177.9 million where at least 5% of the unpaid balance is backed by mortgages that could have been subject to these refinance practices.

In a statement Freddie Mac said, "Based on an ongoing investigation, it appears that a mortgage broker entered into arrangements with borrowers in California that provided financial incentives designed to result in quick refinancings of mortgages. The mortgages were originated at above market interest rates for such borrowers." It was during the investigation that National City - who is currently working closely with the GSE to resolve the situation - discovered these unethical refinance practices and brought them to Freddie's attention.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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