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updated 10/3/2011 11:06:34 PM ET 2011-10-04T03:06:34

Mortgage giant Fannie Mae knew about allegations of improper foreclosure practices by law firms in 2003 but did not act to stop them, a government watchdog says.

Similar allegations are the subject of a probe by state attorneys general into how lenders and law firms ignored proper procedures to handle a crush of foreclosure paperwork.

An unnamed shareholder warned Fannie Mae of alleged foreclosure abuses in 2003, the inspector general for the agency that regulates Fannie says in a report being released Tuesday.

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Fannie Mae responded by hiring a law firm to investigate the claims in 2005. The law firm reported in 2006 that it had found foreclosure attorneys in Florida "routinely filing false pleadings and affidavits."

Fannie officials said they told a government official about the law firm's findings in 2006. That unnamed official, who now works for Fannie's regulator, the Federal Housing Finance Agency, said he couldn't recall the conversation, the report says.

Fannie began using a network of attorneys in 1997 to help handle foreclosures, evictions and bankruptcies. In 2008, the network grew to 140 law firms. And the number of foreclosures in Fannie's portfolio reached historic highs. Foreclosures more than doubled from 2007 to 2008. They grew 50 percent in 2009.

Story: Uncle Sam is a reluctant landlord of foreclosed homes

In June 2010, FHFA officials went to Florida to study the foreclosure crisis. They found that the mortgage industry was overwhelmed by foreclosures; that the average foreclosure processing time had grown from 150 days to more than 400 days; that lenders were beset by flawed documentation; and that law firms weren't devoting enough time to cases.

The worst practices, known collectively as "robo-signing," led some lenders to suspend foreclosures last fall. And it led to an ongoing investigation by all 50 state attorneys general.

Several states, including California, Delaware and New York, oppose a proposed settlement with the lenders. They complain that the lenders would receive unfair immunity from civil litigation under the deal.

Story: Robo-signing scandal may date back to late '90s

Fannie and its sister company, Freddie Mac, own or guarantee about half of U.S. mortgages. That equals nearly 31 million loans worth more than $5 trillion. And they account for nearly all new mortgages.

The Bush administration seized control of the mortgage giants in September 2008, hoping to stabilize the housing industry.

The inspector general's report says FHFA plans to change its oversight policies by the end of 2012. The report is among several government inquiries into the aftermath of the housing crisis.

A broader report into missteps by Fannie and Freddie is expected this fall.

Copyright 2011 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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