[Senate Prints 107-44]
[From the U.S. Government Printing Office]

107th Congress                                                  S. Prt.
                            COMMITTEE PRINT                     
 1st Session                                                     107-44




                            PREPARED BY THE

                             MINORITY STAFF

                                 OF THE


                                 OF THE




                           September 25, 2001

75-382                     WASHINGTON : 2001

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               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 FRED THOMPSON, Tennessee
DANIEL K. AKAKA, Hawaii              TED STEVENS, Alaska
RICHARD J. DURBIN, Illinois          SUSAN M. COLLINS, Maine
MAX CLELAND, Georgia                 PETE V. DOMENICI, New Mexico
THOMAS R. CARPER, Delaware           THAD COCHRAN, Mississippi
JEAN CARNAHAN, Missouri              ROBERT F. BENNETT, Utah
MARK DAYTON, Minnesota               JIM BUNNING, Kentucky
           Joyce A. Rechtschaffen, Staff Director and Counsel
         Hannah S. Sistare, Minority Staff Director and Counsel
                     Darla D. Cassell, Chief Clerk



CARL LEVIN, Michigan, Chairman       SUSAN M. COLLINS, Maine
DANIEL K. AKAKA, Hawaii              TED STEVENS, Alaska
MAX CLELAND, Georgia                 THAD COCHRAN, Mississippi
THOMAS R. CARPER, Delaware           ROBERT F. BENNETT, Utah
JEAN CARNAHAN, Missouri              JIM BUNNING, Kentucky
MARK DAYTON, Minnesota
          Linda J. Gustitus, Chief Counsel and Staff Director
     Christopher A. Ford, Minority Chief Counsel and Staff Director
            Claire M. Barnard, Investigator to the Minority
                     Mary D. Robertson, Chief Clerk

                            C O N T E N T S

Executive Summary................................................     1

I. Introduction..................................................     5

  A. What is Flipping?...........................................     5
  B. FHA's Single Family Insured Program.........................     6
  C. Overview of PSI's Investigation.............................     9

II. The ``Players'' in a Flipping Transaction....................     9

  A. Lenders.....................................................     9
  B. Appraisers..................................................    11
  C. Inspectors..................................................    12

III. The Nationwide Scope of Flipping............................    13

  A. New York City: The Story of Lisa Smith......................    13
     (1) Victim of Mortgage Flipping.............................    13
     (2) Problems of HUD Oversight...............................    16
  B. Chicago: The Easy Life Realty Story.........................    18
     (1) Stekeena, Rollins.......................................    19
     (2) Other Easy Life Realty Victims..........................    24
  C. South Florida: The Story of Sonia and Carlos Pratts.........    25
  D. Norfolk.....................................................    28
  E. Southern California.........................................    30

IV. The Federal Housing Authority................................    31

  A. Origin and Structure........................................    31
  B. The Changing Face of FHA....................................    32
     (1) The 1980's: Coming to Grips With Mortgage Fraud.........    32
     (2) Problems with the ``Reinvention'' of HUD under the
       Clinton Administration....................................    33
       (a) Liberalization of Controls Over Direct Endorsement 
  Lenders........................................................    34
       (b) HUD 2020 Management Reform Plan.......................    35
       (c) Soaring Defaults and Foreclosures.....................    36
       (d) HUD's Response........................................    36
         (i) Loss Mitigation Program.............................    37
         (ii) Credit Watch.......................................    38
         (iii) The Homebuyer Protection Plan.....................    39
         (iv) Fraud Protection Plan..............................    41
         (v) Mortgage Credit Scorecard Project...................    42

V. Agency Criticisms of HUD......................................    43

  A. General Accounting Office...................................    43
     (1) GAO on HUD's Lack of Lender Oversight...................    43
       (a) Approval of Lenders to Receive DE Authority...........    43
       (b) Monitoring of Lenders.................................    44
         (i) On-Site Lender Reviews..............................    44
         (ii) Post-Endorsement Technical Reviews.................    44
       (c) Enforcement Actions Against Lenders...................    45
         (i) Suspension of DE Authority..........................    45
         (ii) Credit Watch.......................................    46
         (iii) Mortgagee Review Board............................    47
       (d) Agency Comments.......................................    47
     (2) HUD's Lack of Appraiser Oversight.......................    48
       (a) HUD Has Limited Assurance That Appraisers Are Familiar
          With FHA's Appraisal Requirements......................    49
       (b) HUD's Monitoring of Appraisers Is Limited.............    49
       (c) HUD Sanctioned Few Poorly-Performing Appraisers.......    52
       (d) HUD Has Not Aggressively Enforced Its Policy on
          Lender Accountability For Appraisals...................    53
  B. HUD's Office of the Inspector General.......................    54
     (1) Post-Endorsement Technical Reviews......................    55
     (2) Post-Endorsement Field Reviews of Appraisals............    56
     (3) Quality Assurance Reviews...............................    57

VI. HUD's False Promises to the Subcommittee.....................    57



                           Executive Summary

    In September 1999, under the chairmanship of Senator Susan 
M. Collins, the Permanent Subcommittee on Investigations 
commenced an investigation into the practice of property 
``flipping.'' The term refers to the purchase and quick resale 
of a home at a huge mark-up, often with little work done to 
improve the property, in order to create the false illusion of 
a robust real estate market though the use of phony paperwork 
and deceptive sales practices. The practice of ``flipping'' 
poses significant risks to low-income, first-time home buyers, 
and may affect the overall stability of a neighborhood.
    A series of newspaper articles in the Baltimore Sun 
reported that flippers had purchased rundown houses over a 3-
year period and resold them--sometimes within hours--to 
unsuspecting buyers. After reviewing this issue, Subcommittee 
staff came to suspect that flipping was occurring not only in 
Baltimore but also around the United States. During the 
Subcommittee's 9-month investigation into this subject, staff 
investigators interviewed over 100 witnesses, including home 
buyer victims, real estate brokers, lenders, and attorneys 
involved in mortgage flipping cases, as well as government 
officials, community activists, and other stakeholders. These 
investigative efforts confirmed that the phenomenon of flipping 
is not simply a local, State, or even regional problem. It is, 
rather, a significant nationwide problem.
    Although the purchase and quick resale of a house at an 
increased price are not in and of themselves unlawful, the 
practice can cross into illegality when documents are falsified 
in order to lure lenders or buyers into investing more money in 
a house than it is actually worth. In order to finance the 
transaction, such unscrupulous sellers may also make 
arrangements to secure a mortgage that is insured by the 
Federal Housing Authority (FHA). The principal advantage to 
having an FHA-backed mortgage is that if the buyer defaults, 
the government will reimburse the lender for almost the entire 
amount of the loan. As a result, where the FHA backs mortgages, 
there is minimal risk in lending money to marginally qualified 
borrowers. Designed as a means to facilitate loans to low-
income families with little credit history, this system is 
sometimes subject to abuse where unscrupulous sellers are 
concerned: Too often, the process results in the Federal 
Government either insuring questionable loans or simply 
subsidizing mortgage fraud.
    The Subcommittee's investigation culminated in 2 days of 
Congressional oversight hearings on June 29 and 30, 2000. Among 
the witnesses who testified were three purchasers of flipped 
homes: Lisa Smith, a New York City police officer, and single 
mother; Sonia Pratts, a health care assistant from Hollywood, 
Florida; and Steekena Rollins, a day-care service provider from 
Chicago, Illinois. All three spent their entire life savings to 
buy into the American dream of home ownership, only to have 
their experience transformed into a nightmare. As Chairman 
Collins said in her opening statement:

        L``I find it very troubling that so many citizens in 
        our Nation's cities have been victimized by the 
        predatory practices of unscrupulous real estate 
        agencies, appraisers, and lenders. But what I find most 
        appalling is that the Federal Government has 
        essentially subsidized much of this fraud.''\1\
    \1\ HUD's Government-Insured Mortgages: The Problem of Property 
``Flipping'', hearings before the Permanent Subcommittee on 
Investigations, Committee on Governmental Affairs, 107th Congress, 1st 
Session (June 29-30, 2000) [hereinafter ``Hearing record''], at 3.

    The Subcommittee also heard testimony from the Hon. Barbara 
A. Mikulski, a U.S. Senator from the State of Maryland; Stanley 
J. Czerwinski, Associate Director, Housing and Community 
Development Issues, Resources, Community, and Economic 
Development Division, U.S. General Accounting Office (GAO); 
William C. Apgar, Assistant Secretary for Housing and Federal 
Housing Commissioner, U.S. Department of Housing and Urban 
Development (HUD); and Susan Gaffney, Inspector General, U.S. 
Department of Housing and Urban Development (HUD).
    Senator Mikulski testified that the flipping problem in 
Baltimore was indeed ``horrifying.'' She noted that every time 
a homeowner defaulted on a house, the FHA would have to 
foreclose on the property and the homeowner could lose as much 
as $40,000--ultimately leaving the Federal taxpayer with 
liability. Senator Mikulski also testified that after learning 
of the flipping problem in Baltimore, she met with then-HUD 
Secretary Andrew Cuomo to discuss possible solutions. 
Subsequently, two separate task forces were established to 
investigate the flipping epidemic, and to prevent additional 
foreclosures from occurring.
    In April 2000, HUD joined forces with the Department of the 
Treasury to form the Joint Task Force on Predatory Lending and 
the Baltimore Predatory Lending Task Force. The Joint Task 
Force (JTF) consists of representatives from consumer, civil 
rights, community, and industry groups, as well as State and 
local governments. The Baltimore Task Force (BTF) was launched 
to gather information on the cause and extent of mortgage 
frauds and resulting foreclosures, and to develop information 
that benefits Baltimore and serves as a programmatic reform 
throughout the Nation. FHA imposed a 90-day moratorium on 
foreclosures of FHA-insured loans in Baltimore City, which 
enabled HUD to send what it described as a ``Swat Team'' of 
officials to Baltimore to identify fraud or predatory practices 
involved in FHA-backed loans before foreclosure and to help as 
many homeowners as possible avoid foreclosures.
    At the request of Senator Collins and Representative Rick 
Lazio (R-NY), GAO prepared a report entitled, ``Single Family 
Housing: Stronger Oversight of FHA Lenders Could Reduce HUD's 
Insurance Risk.'' Stanley Czerwinski--accompanied by Robert 
Procaccini, Assistant Director for FHA Insurance Programs, and 
Paul Schmidt, Assistant Director for Single-Family Housing 
Programs--appeared before the Subcommittee to discuss GAO's 
    As the GAO officials made clear, FHA is the principal 
provider of Federal mortgage insurance, and is also the major 
lending source for first-time, low-income, and minority home 
buyers. As such, the agency relies on approximately 10,000 
lenders to carry out its mission, and about 2,900 of those 
lenders are granted ``Direct-Endorsement'' (DE) authority. This 
means that these lenders can gather and process loan 
information, underwrite the loans, and make eligibility 
determinations, all without prior HUD review.
    Given HUD's reliance on private lenders and the authority 
they are given to act on HUD's behalf, oversight is essential. 
GAO's review found problems with HUD's oversight of the 
program. Specifically, GAO identified problems in three 
particular areas: (1) HUD's process for granting FHA-approved 
lenders DE authority provides only limited assurance that the 
lenders are in fact qualified; (2) HUD's monitoring of lenders 
does not adequately focus on the lenders and loans that pose 
the greatest insurance risks to the Department; and (3) HUD has 
not taken sufficient steps to hold lenders accountable for poor 
performance and program violations.
    Senator Collins noted that the problems GAO identified in 
this report were long-standing issues of which HUD had already 
been advised in prior audits and reports. Despite this history 
of studies calling attention to the problem, however, no 
apparent progress had been made to remedy the deficiencies. In 
1993, for example, HUD's Office of the Inspector General (OIG) 
completed an audit of FHA's single-family mortgage program and 
found that HUD's post-endorsement reviews did not consistently 
ensure quality underwriting. In 1997, the GAO evaluated the 
appraisal process and found that HUD was not adequately 
monitoring appraisers--as well as that the agency was not 
moving effectively against faulty appraisers. Finally, in 1999, 
the GAO issued yet another report on the subject. Entitled 
``Single-Family Housing: Weaknesses in HUD's Oversight of the 
FHA Appraisal Process,'' this study similarly found that: (a) 
HUD was still not doing a good job monitoring the performance 
of appraisers; (b) HUD was not holding appraisers accountable 
for the quality of their appraisals, and (c) the Department had 
limited assurance that its appraisers were in fact 
    On June 30, 2000, the Subcommittee heard from FHA 
Commissioner Apgar who testified about the steps HUD has taken 
to combat flipping, and what assistance the agency would 
provide to help victims of mortgage fraud recover. 
Specifically, he identified Credit Watch, a performance-based 
lender monitoring and enforcement system that was launched in 
May 1999, and the Homebuyer Protection Plan, a more 
comprehensive and thorough appraisal process that FHA 
implemented in 1998. He also testified that:

        L``HUD will move aggressively to force lenders to 
        restructure inflated mortgages that result from 
        fraudulent appraisals or the so-called property flips. 
        We will push the loan back to the lender and make him 
        responsible for producing a loan that the borrower can 
        afford. If not, the FHA will intervene directly and 
        make the loan right for the borrower.'' \2\
    \2\ Hearing record, supra, at 45.

    Despite these assurances, however, more than a year later 
this promised relief has yet to appear. Apgar, a Clinton 
Administration appointee, left HUD early in 2001 after the 
change in administrations. Apgar's promises to the 
Subcommittee, and to borrowers across the country, now appear 
to have been empty ones. According to HUD official Laurie 
Maggiano, in fact, the law prevents HUD from forcing lenders to 
reduce loans that FHA insures. On May 14, 2001, during a Senate 
field hearing in Baltimore, Maryland, Maggiano advised Senator 
Mikulski that in Apgar's Subcommittee testimony, ``FHA perhaps 
over committed what it was able to deliver.''
    In those cases where HUD did ask lenders to reduce loans, 
these institutions simply refused, being under no legal 
obligation to comply. After receiving numerous complaints from 
community activists and nonprofit housing agencies that HUD had 
failed to deliver on the promises made during the tenure of HUD 
Secretary Andrew Cuomo, both of Maryland's Senators spoke with 
HUD's new Secretary, Mel Martinez, about the problem. As a 
result of these discussions, Secretary Martinez appointed 
Maggiano to coordinate HUD's response to the problems in 
Baltimore. The agency is currently considering policy and 
regulatory changes that would make properties that have been 
sold within a specific time period ineligible for FHA 
    Throughout the Clinton Administration, HUD was made aware 
on numerous occasions of these problems and vulnerabilities in 
its FHA program, and of the Department's faulty oversight of 
mortgage programs. Instead of cracking down on poor performing 
lenders, however, the agency did little or nothing to stop such 
abuses. The unfortunate result of this failure is that 
unscrupulous sellers, effectively subsidized by FHA-backed 
loans, made property-flipping victims out of many of the very 
people whom HUD's program was supposed to help attain the 
American dream of homeownership.
    The victims of property flipping depended on HUD to protect 
them from the predatory sales and lending practices revealed by 
the Subcommittee's investigation. Unable to obtain the 
conventional mortgages needed to buy their homes, these low-
income Americans had no alternative but to turn to FHA-
supported programs in order to gain any access to the housing 
market. HUD has a duty to protect such home buyers and to help 
keep them from becoming the victims of fraudulent sales and 
lending practices. HUD also has an obligation as to safeguard 
the integrity of the insurance fund, which could be imperiled 
should sloppy oversight of loan-guarantee practices leave the 
fund responsible for covering the cost of many millions of 
dollars' worth of bad loans. Unfortunately, HUD failed, under 
the Clinton Administration, to fulfill these responsibilities. 
Moreover, the Department mischaracterized the assistance it was 
able to provide to those home buyers who fell victim to 
fraudulent practices in the poorly-overseen lending environment 
that HUD had for so long permitted to exist. America's low-
income home buyers deserved better, and it is gratifying to see 
Secretary Martinez and other senior HUD officials taking an 
active role in overseeing efforts to fix these problems.

I. Introduction

    A. What is Flipping?

    The Subcommittee's investigation has exposed a national 
problem with ``flipping,'' \3\ which is a highly complex 
phenomenon involving multiple players who conspire to defraud 
home buyers, lenders, and--in the case of Federal Housing 
Administration (FHA)-backed loans--the Federal Government 
itself. Flipping involves the purchase and quick resale of 
homes at a huge price mark-up, often accompanied by little (or 
only cosmetic) work to improve the properties, in order to 
create the false illusion of a robust real estate market 
through the use of phony paperwork and deceptive sales pitches. 
Flipping poses significant risks to low-income, first-time home 
buyers, and may affect the overall stability of local 
    \3\ In its consumer education materials, the Federal Trade 
Commission (FTC) uses the term ``loan flipping'' to describe a slightly 
different predatory lending practice. The term ``loan flipping,'' as it 
is defined by the FTC, denotes a lender's practice of encouraging a 
borrower to repeatedly refinance his loan, often to borrow more money. 
Each time the borrower references, of course, he pays additional fees 
and interest points, which ultimately increase the borrower's debt.
    In a typical ``flipped'' transaction, an investor purchases 
a dilapidated house in a marginal neighborhood. This investor 
then makes cosmetic and temporary improvements to the house, 
such as carpeting over rotting wood floors or painting over 
termite damage. At this point, the investor teams up with a 
realtor who markets the house as a ``total rehab'' property--
as, at first glance it may appear to be--to a first-time, 
unsophisticated, low-income home buyer. The realtor persuades 
the buyer to trust him by repeatedly assuring the buyer that he 
will handle all aspects of the sale on the buyer's behalf and 
may persuade the buyer to save money by declining to obtain a 
home inspection, to retain counsel, or otherwise to protect 
himself. If the buyer questions the value of the house, the 
investor and realtor can simply point to a deliberately 
inflated appraisal apparently showing that the house indeed was 
worth the asking price.
    Having gained the trust of the purchaser with the help of 
such misrepresentations, the realtor then steers the buyer 
towards a lender with whom the realtor also has ``an 
arrangement.'' This lender arranges for the buyer to obtain a 
mortgage loan--sometimes through manipulation of the buyer's 
financial information or the acceptance of phony gift letters 
documenting non-existent down payments. Finally, the investor 
and realtor may themselves retain an attorney to represent the 
buyer at the closing. Instead of protecting the buyer's 
interest, however, this attorney's function is to reassure the 
buyer of the legitimacy of the transaction, and convince him to 
sign all of the closing documents.
    After the buyer moves into the house, of course, he 
discovers that the ``total rehab'' is in fact a crumbling 
relic. The buyer is forced to make repairs and simultaneously 
struggle to make monthly mortgage payments on a property, the 
actual value of which is significantly less than the mortgage 
itself. The end result for the buyer is often default and, 
ultimately, the loss of his home through foreclosure. In the 
end, the buyer is left with no house and a tarnished credit 
rating, while the neighborhood is left with a vacant, 
deteriorating house. The flippers, by contrast, collect the 
profit from the sale of the house at an unjustifiably inflated 
price after having made only a modest or nominal investment.
    Although the purchase and quick resale of a house at an 
increased price is not itself unlawful, the above scenario 
illustrates how this practice can cross the line into 
illegality when documents are falsified and misrepresentations 
made in order to lure buyers and lenders into investing more 
money in a house than it is actually worth. Flippers who get 
FHA backing for their buyers' mortgages, moreover, are able to 
encourage lenders to put up the full amount of the loan, 
confident that if the buyer defaults, the government will bail 
them out. Lenders, appraisers, and other parties who are guilty 
of such practices may be barred by the U.S. Department of 
Housing and Urban Development (HUD) from participating in 
federally financed or insured business. In order to be barred, 
however, they first have to be caught.

    B. FHA's Single Family Insured Program

    FHA's program for insuring loans for the purchase of 
single-family housing involves a number of elements, and 
operates according to criteria as follows:

         LEligible Loan Purposes: FHA-insured loans may 
        be used to purchase single-family detached homes, town 
        homes, row houses, two-to-four family buildings, 
        manufactured homes and lots, and condominiums in 
        developments approved by FHA. Loans may also be used 
        to: Build a home; to repair, alter, or improve a home; 
        to refinance an existing home loan; to purchase and 
        improve a home simultaneously; or to install a solar 
        heating and cooling system or other weatherization 

    \4\ Bruce E. Foote, Housing Analyst, Domestic Social Policy 
Division, Congressional Research Service, FHA Loan Insurance Program: 
An Overview, Order Code RS20530 (March 30, 2000), at 4.

         LBorrower Eligibility: FHA-insured loans are 
        available to owner-occupants who can demonstrate the 
        ability to repay them according to the terms of the 
        contract. Parties who are in default on previously FHA-
        insured loans are not eligible for new loans unless 
        this default is cleared or the borrower can show that 
        the default was caused by circumstances beyond his 
        control. Likewise, persons who have previously 
        defaulted on non-FHA insured loans are not eligible for 
        FHA-insured loans.\5\
    \5\ Id. at 2.

         LMaximum Mortgage: Mortgage limits for FHA-
        insured loans are set on an area-by-area basis. The 
        limits are indexed to the lesser of two benchmarks: The 
        median home price for the area, or the size of loans 
        that may be purchased by the Federal Home Loan Mortgage 
        Corporation (commonly known as Freddie Mac).

         LThe maximum mortgage limits for FHA-insured loans are 
        87 percent of the Freddie Mac limits. (Since the 
        Freddie Mac loan limits may change at the beginning of 
        January each year, the FHA mortgage limits may also 
        change annually.) As of January 1, 2001, the mortgage 
        limits for FHA-insured loans are $239,250 for one-
        family properties, $306,196 for two-family properties, 
        $370,098 for three-family properties, and $459,969 for 
        four-family properties. Mortgage limits for loans in 
        Alaska, Guam, Hawaii, and the Virgin Islands may be 
        adjusted up to 150 percent higher. Freddie Mac limits 
        determine the upper and lower FHA limits while the 
        median home price often determines the actual FHA limit 
        for a given area.\6\
     \6\ Id. at 2-3.

         LLoan Term: FHA-insured loans may be obtained 
        for mortgages with terms of up to 30 years. In special 
        cases, low-income borrowers may be eligible for 35-year 
        loans to make the mortgage more affordable.\7\
     \7\ Id. at 3.

         LDown payment: In general, the down payment is 
        3 percent of the first $25,000 of the property value, 5 
        percent of the value between $25,000 and $125,000, and 
        10 percent of the value in excess of $125,000.\8\
     \8\ Id.

         LOwner Occupancy: Generally, for loans closed 
        on or after December 15, 1989, borrowers must intend to 
        occupy the property as a principal residence. FHA may 
        sell property that it has acquired as a result of 
        default or foreclosure to either owner-occupants or to 
        investors. (In some cases, those borrowers may obtain 
        FHA-insured loans.) \9\
     \9\ Id. at 3-4.

         LProgram Funding: The FHA home mortgage 
        insurance program is funded by the MMIF, which in turn 
        is funded by the payment of FHA mortgage insurance 
        premiums, interest earnings, and proceeds from the sale 
        of homes that have been acquired through foreclosure on 
        FHA-insured loans. The MMIF is authorized to fund all 
        operations of the mortgage insurance program, including 
        administrative costs.\10\
    \10\ Id. at 4.

         LInterest Rates: The interest rate on FHA-
        insured loans is negotiated by the borrower, seller, 
        and lender. The borrower has the option of selecting 
        either a loan with an interest rate that is fixed for 
        the life of the loan, or a loan on which the rate may 
        be adjusted annually, known as adjustable rate 
        mortgages (ARMs).\11\ The number of ARMs that FHA may 
        insure in a single year, however, is limited to 30 
        percent of the total number of mortgages insured under 
        FHA's program for conventional housing loans during the 
        preceding fiscal year.\12\ The interest rate for ARMs 
        may be adjusted annually by a 1 percent increase or 
        decrease from the rate in effect during the preceding 
        year, with a lifetime change of a 5 percent increase or 
        decrease from the rate reflected on the note.\13\
    \11\ Id. at 5.
    \12\ FHA is funded under two statutory titles of the National 
Housing Act (12 U.S.C. 1703). Title I is funding for loans for mobile 
homes and improvements. Title II is funding for all other FHA programs. 
Subcommittee staff telephone interview with Judy Heaney, community 
Builder, U.S. Department of Housing and Urban Development (June 16, 
    \13\ U.S. Department of Housing and Urban Development, Mortgagees' 
Handbook, 4000.2 REV-2, Chapter 6, Section 6-20, at 6-22, 6-23 (July 

         LUnderwriting Guidelines: FHA-insured loans 
        must be underwritten in accordance with the accepted 
        practices of prudent lending institutions and FHA 
        requirements. The FHA credit analysis worksheet is used 
        to examine the applicant's personal and financial 
        status, monthly shelter expenses, funds required for 
        closing expenses, effective monthly income, and debts 
        and obligations. As a general rule, the applicant's 
        prospective housing expenses should not exceed 29 
        percent of his or her effective monthly income. The 
        applicant's total obligations, including proposed 
        housing expenses, should not exceed 41 percent of gross 
        effective monthly income. Credit is automatically 
        denied to applicants whose credit report indicates a 
        delinquency of 90 days or more on a non-FHA-insured 
        loan, or foreclosure on such a loan in the past 3 
    \14\ Foote, supra, at 5.

         LCredit Limits: The volume of FHA insurance 
        commitments is subject to a fiscal year ceiling set by 
        Congress. During fiscal year 2000, FHA was permitted to 
        make insurance commitments totaling no more than $140 
    \15\ Id.

         LReimbursement of Lenders: FHA reimburses 100 
        percent of the unpaid principal balance of a FHA-backed 
        mortgage as of the date of default, as well as any 
        costs or fees that may accrue during the time the 
        lender must spend disposing of the property.\16\
    \16\ See 24 CFR Sec. 203.402.

         LProgram Activity: During fiscal year 1999, 
        FHA underwrote $113.2 billion in insurance to insure 
        the purchase or refinancing of 1,219,928 housing units. 
        At the end of fiscal year 1999, FHA had $411.5 billion 
        in insurance in force. From its inception in 1934 
        through the end of 1999, FHA has insured nearly 27.9 
        million home loans at a mortgage volume of about $1,258 
    \17\ Foote, supra, at 5.
    C. Overview of PSI's Investigation

    The Subcommittee began this investigation with the 
establishment of a preliminary inquiry in September 1999, 
pursuant to Rule 1 of the Subcommittee Rules of Procedure. The 
objective of this preliminary inquiry was to evaluate the scope 
and nature of the mortgage flipping problem across the country. 
The Subcommittee's work thus built upon the efforts enforcement 
agencies and an investigation by Baltimore Sun reporter John 
O'Donnell, who is widely credited with exposing the problem of 
flipping in Baltimore. Since that time, Subcommittee staff 
members have interviewed more than 100 witnesses, including 
home buyer victims, real estate brokers, lenders, and attorneys 
involved in mortgage flipping cases, as well as government 
officials, community activists, and other stakeholders. In 
addition, Subcommittee staff reviewed hundreds of records 
documenting specific property flips. These investigative 
efforts confirmed that the phenomenon of flipping is not simply 
a local, State, or even regional problem, but rather is a 
Nation wide crisis.

II. The ``Players'' in a Flipping Transaction

    A. Lenders

    Lenders must obtain approval from HUD to participate in 
FHA's mortgage programs. In addition to an application form and 
fee, lenders must submit to HUD documentation showing that they 
meet FHA's requirements for lending experience, financial 
worth, and adequacy of facilities. As of December 1999, 
approximately 9,950 lending institutions had been approved to 
participate in FHA's mortgage insurance programs for single-
family homes. Most of these lenders are authorized only to 
originate FHA-insured loans, meaning that they can accept 
mortgage applications, obtain employment verifications and 
credit histories on applicants, order appraisals, and perform 
other tasks that precede the loan underwriting process. 
Approximately 2,900 of the FHA-approved lending institutions, 
however, have so-called ``Direct Endorsement'' (DE) authority 
\18\ in addition to loan origination authority. Such lenders 
can underwrite loans and determine their eligibility for FHA 
mortgage insurance without HUD's prior review.\19\
    \18\ Direct Endorsement is authorized under Sec. 203(b) of the 
National Housing Act, codified at 12 U.S.C. Sec. 1709(b),(1). Program 
regulations are located at 24 C.F.R. Sec. Sec. 203.5 and 203.255. The 
program is administered by HUD's Office of Housing-Federal Housing 
Administration. See U.S. Department of Housing and Urban Development, 
Direct Endorsement (visited June 13, 2000), http://
www.hud.gov.progdesc/direct-r.html [hereinafter, ``HUD, Direct 
Endorsement''] at 2.
    \19\ U.S. General Accounting Office, GAO/RCED-00-112, Single Family 
Housing: Stronger Oversight of FHA Lenders Could Reduce HUD's Insurance 
Risk (April 28, 2000), at 7-8.
    Prior to 1983, FHA staff reviewed and approved, or 
``underwrote,'' most loans prior to insurance endorsement. In 
1983, FHA delegated DE authority to approved lenders. As a 
result, lenders with Direct Endorsement authority became 
responsible for virtually all aspects of the loan origination, 
underwriting, and closing process.\20\ HUD describes DE as the 
mechanism that enables HUD/FHA-approved lenders to consider 
single-family mortgage applications without first submitting 
paperwork to HUD, thereby enabling FHA-insured mortgages to be 
processed as rapidly as other mortgages.\21\
    \20\ Office of the Inspector General, U.S. Department of Housing 
and Urban Development, Audit Report # 00-SF-121-001, Single Family 
Production Home Ownership Centers (March 30, 2000) [hereinafter ``HUD/
OIG, Single Family Production Home Ownership Centers''], at 1.
    \21\ HUD, Direct Endorsement, supra, at 1.
    The DE underwriting and endorsement process requires the 
lender to determine that a property is acceptable for mortgage 
insurance by completing an analysis of the property to 
determine its eligibility for endorsement and the maximum 
mortgage amount. The lender must also complete a credit 
analysis of the borrower to determine his or her 
creditworthiness. An underwriter must review the appraisal 
report and mortgage credit analysis, and then certify or 
approve the loan package itself. The lender must execute a 
``mortgagee's certification'' to HUD stating that:

        L``I, the undersigned, as authorized representative of 
        --------, mortgagee, at the time of closing of this 
        mortgage, certify that I have personally reviewed the 
        mortgage loan documents, closing statements, 
        application for insurance endorsement, and all 
        accompanying documents. I hereby make all 
        certifications required for this mortgage as set forth 
        in HUD Handbook 4000.4.'' \22\
    \22\ U.S. Department of Housing and Urban Development, Single 
Family Direct Endorsement Program, 4000.2, at Appendix 4 (Mortgagee's 

The lender then submits the loan case binder to HUD, which 
conducts a pre-endorsement review of the binder. This pre-
endorsement review concludes with endorsement of the mortgage 
for an acceptable submission through completion of a ``Mortgage 
Insurance Certificate,'' which it issues to the lender.\23\ 
After insurance endorsement, HUD reviews select properties and 
mortgage credit analyses through the post-endorsement technical 
review and on-site lender review processes described below. 
Theoretically, the percentage of such cases reviewed depends 
upon the quality of past underwriting and servicing problems on 
earlier loans.\24\
    \23\ HUD, Direct Endorsement, supra, at 1.
    \24\ U.S. Department of Housing and Urban Development, Handbook 
4000.4 REV-1, Single Family Direct Endorsement Program, Chapter 1 
(December 1992), Sec. 1-2, at 1-1, 1-3, and 1-4. (For an examination of 
the adequacy of HUD oversight of high-risk loans and lenders, see 
infra, at Part V.)
    Lenders have an obvious and significant financial interest 
in loan approval. In order to limit the risks inherent in 
transferring so much responsibility to lenders, FHA implemented 
new procedures to monitor Direct Endorsement lenders, primarily 
through pre-closing status reviews, pre-endorsement loan 
screening, post-endorsement technical review, and on-site 
lender monitoring.\25\ Such evaluation tools fall into four 
basic types, as follows:
    \25\ HUD/OIG, Single Family Production Home Ownership Centers, 
supra, at 1.

         LPre-closing reviews: When new lenders apply 
        for DE approval, they are initially placed on ``pre-
        closing'' status. This means that HUD reviews their 
        loan packages prior to closing to determine whether the 
        lenders have the capacity to originate and underwrite 
        loans properly in accordance with FHA guidelines.\26\
    \26\ Id. at v.

         LPre-endorsement loan screening: Endorsement 
        contractors working for HUD are required to ensure that 
        FHA loan file documents are both accurate and complete 
        prior to issuing Mortgage Insurance Certificates to the 
        originating lenders.\27\ The contractors basically 
        determine that certain key loan documents are in the 
        file prior to insurance endorsement. The contractors 
        must also verify the accuracy of certain loan 
        information as included in the loan file documents and 
        as input into HUD's automated system by lenders. The 
        contractors are required to verify that some loan 
        documents are in every file, while other loan 
        documents--such as gift letters--are only required 
        under certain circumstances.\28\
    \27\ Id.
    \28\ HUD/OIG, Single Family Production Home Ownership Centers, 
supra, at 51-52.

         LPost-endorsement technical review: This 
        involves reviewing a sample of cases after insurance 
        endorsement in order to ensure compliance with HUD 
        underwriting and appraisal requirements.\29\
    \29\ Id. at iv.

         LOn-site lender monitoring: HUD's Quality 
        Assurance Divisions perform on-site monitoring reviews, 
        also called field reviews, of Direct Endorsement 
        lenders to identify and correct poor origination 
    \30\ Id.

    B. Appraisers

    FHA originally required appraisals to be an independent 
check on the value and condition of the property for which a 
borrower was seeking an FHA-insured mortgage. Until 1994, for 
each proposed mortgage, HUD selected, on a rotational basis, an 
appraiser from HUD's FHA ``Appraiser Fee Panel'' to appraise 
the property.\31\ To be placed on this panel, HUD required 
appraisers to demonstrate a high level of experience and be 
knowledgeable about the appraisal process and property 
standards that homes being considered for FHA-insured mortgages 
must meet. HUD closely monitored Fee Panel appraisers by field 
reviewing at least 10 percent of their appraisals yearly. In 
addition, HUD trained Fee Panel appraisers in order to ensure 
that homes for which FHA insurance was being sought were safe, 
sound, and sanitary.\32\ Under this system, the lender 
completed an ``Application for Property Appraisal and 
Conditional Commitment,'' and then contacted its local HUD 
office to receive a case number and the name of an 
    \31\ Prior to 1994, HUD-approved appraisers were referred to as 
``Fee Appraisers,'' and the list of HUD approved appraisers was 
referred to as the ``Fee Appraiser Panel.''
    \32\ Subcommittee staff telephone interview with James Smith (June 
6, 2000); Subcommittee staff telephone interviews with Frank DiGiovanni 
(May 17-18, 2000).
    \33\ U.S. Department of Housing and Urban Development, Mortgagees' 
Handbook, 4000.2, Chapter 2, Sec. 1-10 (July 1991), at 2-5.
    In December 1994, HUD implemented regulations mandated by 
1990 amendments to the National Housing Act that transferred 
appraisal selection responsibilities from FHA staff to Direct 
Endorsement lenders.\34\ Under this system, which is commonly 
known as the ``Lender Select'' appraisal system, HUD disbanded 
the list of HUD-approved appraisers and delegated 
responsibility for selecting them to the Direct Endorsement 
lenders themselves.
    \34\ In 1988, when asked why lenders should be allowed to select 
their own appraisers for liability-free HUD insured mortgages, 
Representative Barnard (D-GA) responded that ``[t]he lender wanted to 
have as much control of the transaction as possible--which included the 
appraiser.'' Frank DiGiovanni, Chronological History of Appraisal in 
the Chicago Area, Including HUD/FHA Data, (received May 23, 2000).
    The DE lenders are now allowed to select any appraiser 
licensed by the State in which he practices.\35\ According to 
one appraiser, this delegation has permitted lenders discretion 
to employ the least-qualified appraisers for their FHA-backed 
mortgages.\36\ (In Illinois, for example, an apprentice 
appraiser with little experience is nevertheless licensed.) The 
lender discretion permitted by the Lender Select program, it 
appears, has also encouraged real estate agents to pressure 
lenders to choose certain appraisers--and not others--to 
evaluate their properties, too often thereby obtaining 
appraisals of sub-par properties at inflated values.\37\ One 
appraiser interviewed by Subcommittee staff also opined that in 
his experience, it was not unusual for banks to request that 
the appraised value of a property be increased.\38\
    \35\ Subcommittee staff telephone interview with Frank DiGiovanni 
(May 27, 2000).
    \36\ Id.
    \37\ See Bill Rumbler, Shady Deals Alleged in FHA Appraisal System, 
Chicago Sun-Times (September 28, 1997).
    \38\ Subcommittee staff interview with Robert Skovera in New York 
City, N.Y. (June 8, 2000). Skovera said that it was impossible to 
accommodate some of the requests he received were impossible because 
the property did not justify the specified increase.
    Overall, the results of the Lender Select program have been 
less than satisfactory. A 1999 report by the General Accounting 
Office (GAO) found that ``HUD was not doing a good job of 
monitoring the performance of appraisers'' \39\ and ``is not 
holding appraisers accountable for the quality of their 
appraisals.'' \40\ The report concluded that ``HUD has not 
aggressively enforced its policy to hold lenders equally 
accountable with the appraisers they select,'' \41\ and that 
``HUD has limited assurance that the appraisers on its roster 
are knowledgeable about FHA's appraisal requirements.'' \42\
    \39\ U.S. General Accounting Office, GAO/RCED-00-112, Single-Family 
Housing: Weaknesses in HUD's Oversight of the FHA Appraisal Process 
(April 16, 1999) [hereinafter, ``GAO, FHA Appraisal Process''], at 2.
    \40\ GAO, FHA Appraisal Process, supra, at 2.
    \41\ Id. at 3.
    \42\ Id. at 3.

    C. Inspectors

    FHA does not presently require home buyers to obtain a home 
inspection as a prerequisite to obtaining an FHA-backed 
mortgage, nor has it ever required that they do so. Prior to 
1996, FHA provided home buyers with advisories regarding 
interest rates, discount points, loan fraud, and lead-based 
paint. In December 1996, FHA announced that it would begin 
highlighting the need for home buyers to obtain home 
inspections through distribution of a separate form entitled, 
``Importance of Home Inspections.'' This form explained to the 
buyer the benefits of arranging for a professional inspection 
of the home, but also advised that ``[t]here is no requirement 
that you hire an inspector.'' (FHA required the buyer to sign 
and date this form on or before the date of execution of the 
sales contract, but it did not require retention of the form in 
the FHA endorsement binder.)
    In June 1998, FHA announced as part of its Homebuyer 
Protection Plan that it would replace the ``Importance of Home 
Inspections'' form with a new form entitled ``For Your 
Protection: Get a Home Inspection.'' This updated form advises 
the buyer that FHA does not guarantee the value or condition of 
the property; that an appraisal is not the same thing as a home 
inspection; and that the borrower has the right to have the 
house inspected by a professional home inspector. (In contrast 
to the previous form, this new form must be retained in the FHA 
insurance endorsement binder.) FHA also allows home buyers to 
finance at least a portion of the cost of a home inspection 
through the FHA-backed mortgage that they obtain.
    On May 12, 1999, Representative Rick Lazio (R-NY) 
introduced H.R. 1776, the American Home Ownership and Economic 
Opportunity Act of 2000. This bill, among other things, would 
require GAO to conduct a study regarding the inspection of 
properties purchased with FHA-backed mortgages. The proposed 
study would evaluate such issues as: The feasibility of 
requiring inspections of all properties purchased with FHA-
insured loans; the monetary impact of such a requirement on the 
FHA insurance fund and home buyers; and the impact of mandatory 
inspections on the process of buying a home. This bill passed 
the House by a 417-8 vote on April 6, 2000, and was referred to 
the Senate Committee on Banking, Housing, and Urban Affairs. 
Although the Banking Committee passed some of the portions in 
the bill, the mandatory inspection provision was not.

III. The Nationwide Scope of Flipping

    To illustrate the truly nationwide epidemic that is 
flipping, Subcommittee staff developed case studies of various 
flipping schemes in cities throughout the United States. These 
case studies provide a glimpse of how such frauds are 
perpetrated as well as the financial and emotional toll that 
often results.

    A. New York City: The Story of Lisa Smith

      (1) Victim of Mortgage Flipping

    Lisa Smith is a New York City police officer and a single 
mother of three who sought to move her family out of their 
apartment and into a house. She testified before the 
Subcommittee on the first day of its flipping hearings.
    Smith was a first time home buyer when she responded to an 
advertisement in a local newspaper by Lenders Realty, a real 
estate agency specializing in the sale of foreclosed 
properties. The former manager of Lenders described it as being 
a speculative business that acquired houses, primarily 
foreclosures, for investment purposes. After purchasing the 
houses, the former manager said, Lenders would renovate and 
sell them.
    After Smith contacted Lenders, its representatives showed 
her a house located at 145-08 123rd Avenue in the Queens 
neighborhood of South Ozone Park. Lenders representatives, 
whose names Smith cannot recall, told Smith that the house had 
been completely renovated during the 3 years it had been 
vacant. They also told Smith that they would assist her with 
everything related to the closing of the property. When Smith 
expressed concern about her lack of understanding of the 
process of purchasing a house to the Lenders representatives, 
all of whom were women, they told her that she could trust them 
because they would not deceive another woman. After Lenders 
representatives showed her the house, they informed her that if 
she did not enter into a contract immediately, the house would 
be sold to another buyer.\43\
    \43\ Telephone interview with Lisa Smith (June 15, 2000).
    On May 5, 1997,\44\ Smith duly signed a sales contract to 
purchase the house for $129,000. The seller, AllBorough Inc., 
had purchased the property in December 1996--only 5 months 
previously--for merely $50,000. Significantly, Smith's sales 
contract contained an ``as is'' clause declaring that Smith had 
inspected the property, was thoroughly acquainted with its 
condition, and agreed to purchase it in that present 
condition.\45\ The contract also stated, however--somewhat 
inconsistently--that the seller agreed to pay for all necessary 
repairs. (According to Smith, no such payments for repair ever 
    \44\ The appraiser who valued Smith's house at this price did not 
specifically remember appraising her house. However, he recalled that 
Smith's lender, Alliance Mortgage Banking Corporation, had in the past 
asked him to increase the appraised value of properties. He did not 
consider Alliance, however, to be one of the worst offenders in this 
respect: Some other lenders were worse. Subcommittee staff interview 
with Robert Skovera in New York City, N.Y. (June 8, 2000).
    \45\ At least one court has noted that the days of caveat emptor in 
real estate are gone. See Gibb v. Citicorp Mortgage, Inc., 518 N.W.2d 
910, 918-19 (Neb. 1994). The Subcommittee staff's review of case law 
evaluating real estate sales contracts containing ``as is'' provisions 
suggests a recent weakening of the protection such clauses bestow upon 
the property seller, particularly where a sale has been predicated on 
fraud or misrepresentation. Furthermore, ``as is'' clauses are 
standard, boilerplate inclusions in real estate contracts for the 
purchase of existing houses, and it is unlikely that Smith would have 
been able to sign a contract that did not contain the clause. See, 
e.g., Subcommittee staff telephone interview with Charles Dale, 
Congressional Research Service (May 9, 2000).
    Smith's contract and its rider also contained clauses 
regarding title inspections and the purchaser's right to have a 
termite inspection. Smith signed a form advising her of the 
importance of a home inspection; she did not, however, check 
either of two boxes appearing on the form indicating that she 
intended to have a home inspection or waive this right. Smith 
did not obtain an inspection of the house because Lenders 
representatives told her that Lenders had already paid for an 
inspection, which had revealed that the house was in good 
condition.\46\ This apparently was not true. The former manager 
of Lenders told Subcommittee staff that it was not part of the 
company's business practice to have inspections performed, and 
that Lenders routinely arranged only for appraisals of 
properties it sold--not inspections.\47\ (Furthermore, Robert 
Skovera, who had appraised Smith's property at the request of 
her lender, told Subcommittee staff that if Lenders had 
characterized his appraisal as a home inspection, that would 
have been a misrepresentation.\48\)
    \46\ Subcommittee staff interview with Lisa Smith in New York City, 
N.Y. (June 8, 2000).
    \47\ Subcommittee staff interview with Howard Krin in New York 
City, N.Y. (June 8, 2000).
    \48\ Subcommittee staff interview with Robert Skovera in New York 
City, N.Y. (June 8, 2000).
    As a New York Police Department (NYPD) employee, Smith is 
entitled to receive free legal services from the Police 
Benevolent Association (PBA). However, Lenders representatives 
falsely told Smith that the PBA attorney whom she had arranged 
to represent her at the closing had disparaged her, thereby 
persuading Smith to replace this attorney with someone Lenders 
selected for her, an attorney by the name of Goodman. Goodman, 
Lenders representatives informed Smith, would represent her 
during the homebuying process free of charge. According to 
Smith, the lawyer repeatedly assured her that he was acting in 
her best interest. When she tried to ask him questions about 
the sales contract, however, he told her not to worry and to 
sign the document.\49\
    \49\ Subcommittee staff interview with Lisa Smith in New York City, 
N.Y. (February 1, 2000).
    In connection with the purchase of the house, Smith signed 
a gift affidavit representing that Bernard Tadell, which the 
affidavit described as a cousin of Smith, would provide her 
with $4,100 in gift money at the closing to use in the purchase 
of the house. In fact, Tadell is not Smith's cousin, but rather 
the father of two of her children. He also did not give her any 
money for use in the purchase of the house.\50\ Smith explained 
to Subcommittee staff that a Lenders representative gave her a 
blank affidavit to sign, and told her that all home buyers 
receiving FHA insured mortgages must sign such gift letters as 
a mere formality. Smith's new attorney, Goodman, was present 
during this exchange. Smith asked him if it was permissible for 
her to sign the affidavit, and he assured her that it was. 
(Additionally, one of the female Lenders representatives 
reassured Smith that completing the form was not illegal.) 
Smith thus took the affidavit to Tadell and asked him to 
complete it. He did so, but, at Lenders' direction, left the 
dollar amount blank. Smith also signed the gift affidavit, then 
returned it to Lenders.
    \50\ Subcommittee staff telephone interview with Lisa Smith (June 
12, 2000).
    In retrospect, Smith wishes she had not signed the 
affidavit, but contends that she did so because she felt that 
her lawyer would not instruct her to break the law.\51\ In 
addition, it is noteworthy that when Subcommittee staff 
provided Smith with a copy of the gift affidavit, she was 
surprised that the affidavit did not reflect her recollection 
of its contents. She recalled that Lenders representatives had 
told her that the purported gift amount would be limited to 
between $500 and $1,000, not the $4,100 that is listed on the 
affidavit (and was apparently added after she and Tadell had 
both signed it). Furthermore, she did not recognize the 
handwriting on the affidavit apart from Tadell's signature 
itself, and the bank account information listed on the document 
was fictitious.
    \51\ Id.
    In July 1997, Smith closed on the house. Lenders arranged 
for Alliance Mortgage Banking Corporation to finance Smith's 
mortgage,\52\ which was guaranteed by the FHA. No one ever 
explained the different types of mortgages available to her. 
(When Subcommittee staff first interviewed Smith, she had no 
idea what ``FHA'' meant despite having obtained an FHA-backed 
mortgage.) Although her attorney, Goodman, represented Smith at 
the closing, his principal role was simply to urge her to sign 
all of the closing documents; he was of no help in explaining 
what she was signing.
    \52\ The Subcommittee's investigation has revealed that Lenders 
ceased operating in January 2000.
    Not surprisingly, Smith encountered numerous problems after 
moving into the house. The basement flooded constantly and raw 
sewage backed up into the house. Smith called Lenders several 
times to complain about this problem, but she never received 
any response. When Smith gave Subcommittee staff a tour of the 
house, the odor in the basement was overwhelming due to this 
constant problem of sewage flooding. A contractor she consulted 
informed her that the problem was essentially unfixable. 
Moreover, the roof of the house leaked, inadequate insulation 
resulted in her having to pay monthly heating bills of between 
$400 and $500, the siding needed replacement, and the floor was 
falling apart. Smith was particularly upset about problems with 
the windows in the house because Lenders representatives had 
told her that they were brand new. After moving in, however, 
she discovered that they were not; in fact, she was forced to 
cover the windows with plastic because of the cold drafts they 
let in during the winter.\53\
    \53\ Subcommittee staff interview with Lisa Smith in New York City, 
N.Y. (February 1, 2000).
    Smith could not afford to make the repairs necessary to 
render this decaying house habitable despite her attempts to do 
so by obtaining two additional loans: In May 1998 from The 
Money Store for approximately $12,000 at an interest rate of 
11.49 percent, and the second in February 1999 from Madison 
Home Equities for approximately $45,000 at an interest rate of 
14.21 percent. Ultimately, Smith could not afford to continue 
making the payments on her mortgage as well as on these 
additional loans. On advice from her new PBA counsel, 
therefore, she stopped making mortgage payments in December 
1999 and, in March 2000, abandoned the house altogether. Smith 
has moved her family back into an apartment. As a result of her 
resulting financial situation, she has declared bankruptcy. 
Smith has also been served with a summons for defaulting on the 
first of her three mortgages.\54\
    \54\ Subcommittee staff interview with Lisa Smith in New York City, 
N.Y. (May 5, 2000).
    Lisa Smith's case highlights the typical elements of a 
mortgage ``flipping'' case. Although Smith is a police officer 
with an associate's degree in liberal arts from LaGuardia 
Community College in New York, she was by no means a 
sophisticated home buyer, and was unable to navigate the 
complex financial transaction of buying a house without 
guidance. Nor did she know that, as a general matter, 
prospective home buyers hire their own representatives to 
protect their interests. This naivete rendered her vulnerable 
to the high pressure tactics--and outright deception--employed 
by Lenders, Alliance Mortgage Banking Corporation, and attorney 
Goodman, whom Lenders itself selected to represent her.
    To make matters worse, Smith was at that point in her life 
particularly vulnerable. She had recently terminated what she 
described as an abusive relationship with the father of her 
youngest child. This relationship had caused tremendous 
emotional distress for Smith and her children, and while she 
was trying to purchase a house, her family was undergoing 
counseling and trying to put the pieces of their lives back 
together. Smith wanted to be able to prove to herself that she 
could increase the quality of life for her family. Smith's 
confusion and her reliance upon the ostensible 
``professionals'' at Lenders, Alliance, and in the form of 
attorney Goodman thus contributed to her victimization at their 

      (2) Problems of HUD Oversight

    Unfortunately, inadequate oversight by the U.S. Department 
of Housing and Urban Development also played a role in this 
story. A preliminary review of Alliance Mortgage Banking 
Corporation's records reveals that its foreclosure rate is 
notably higher than New York State's average foreclosure rate. 
HUD's Office of Lender Activities, in fact, determined that 7 
percent of Alliance's loan originations default within the 
first year--nearly double the 3.62 percent average for New York 
State.\55\ (The FHA national average foreclosure rates for the 
first three quarters of 1999 was even lower: 2.20 percent.\56\) 
While Subcommittee staff were unable to determine what 
percentage of Alliance's foreclosures occurred on FHA-insured 
loans, there were clear red flags that should have suggested to 
HUD that Alliance might be a problem. HUD should have 
scrutinized more closely the loans made--on its behalf, and 
with its guarantee--by a lending institution with such a poor 
foreclosure record.
    \55\ See Office of Lender Activities, U.S. Department of Housing 
and Urban Development, Review of Alliance Mortgage Banking Corporation 
(June 25, 1999).
    \56\ See generally HUD/OIG, Single Family Production Home Ownership 
Centers, supra.
    During the hearing, Senator Collins asked Ms. Smith how she 
chose the lending institution:

        L``Q: How did you select the bank for your mortgage?
        L A: I didn't select a bank. Lenders selected the 
        bank.'' \57\
    \57\ Hearing record, supra, at 21.

(Lenders' affinity for Alliance may, in fact, derive from more 
than simply a shared interest in taking advantage of home 
buyers such as Lisa Smith. Subcommittee staff were advised by 
Robert Skovera, Smith's appraiser, that the former owner of 
Lenders is also a principal at Alliance Mortgage Banking 
Corporation. Subcommittee staff has so far been unable to 
confirm this allegation, however.)
    FHA uses several formulas to assess whether a borrower 
should qualify for an FHA-insured mortgage. For example, an 
applicant's prospective housing expenses should not exceed 29 
percent of gross monthly income. Smith's gross monthly income 
was $3,632.75. Her mortgage payment was $1,061.41, however, 
which totaled 29.218 percent of her gross monthly income--that 
is, just above the threshold that should suggest problems under 
FHA's guidelines. Smith had an adjustable rate mortgage, 
moreover, so while she only just exceeded the 29 percent level 
at the outset, any increase in mortgage interest rates would 
have pushed her increasingly into the danger zone.\58\
    \58\ Pursuant to FHA guidelines, the applicant's total 
obligations--including proposed housing expenses--should also not 
exceed 41 percent of monthly gross income. Smith's monthly obligations 
were calculated by the underwriter to be $1,248.41, however, or 34.365 
percent of her gross monthly income.
    Moreover, pursuant to FHA guidelines, credit should 
automatically be denied to applicants whose credit report 
indicates a delinquency of 90 days or more on a non-FHA insured 
loan. While Smith's report does not reflect a delinquency in 
excess of 90 days, the report does indicate that she might well 
be a credit risk. Specifically, it noted: ``Serious 
delinquency; derogatory public record or collection; proportion 
of revolving balances to revolving credit limits is too high; 
frequent delinquency.'' \59\
    \59\ Credit Decisions, Inc., report prepared for Alliance Mortgage 
Banking (May 5, 1997).
    All in all, therefore, Smith thus fell into the category of 
prospective home buyers who barely meet the FHA guidelines and 
whose loan applications, if predicated on a adjustable rate 
mortgage, should be evaluated on the basis of potential future 
increases to minimize foreclosures. Ordinarily, therefore, a 
lender would have approached her mortgage with great caution--
or have simply refused to loan her the money needed to make 
this purchase. Because FHA backed the loan, however, there was 
no risk to the lender, freeing it to become a costless 
participant in the mortgage flipping fraud perpetrated against 
Smith--with the Federal taxpayer picking up the tab when 
bankruptcy and foreclosure overtook her.

    B. Chicago: The Easy Life Realty Story

    Subcommittee staff interviewed eight Chicago home buyers, 
each of whom purchased a home from either a real estate agency 
known as Easy Life Realty (ELR) or Ace Realty, its successor. 
Richard Nelson and Louis Prus owned both businesses. Prus and 
Nelson began working together in the early 1970's by forming 
the Easy Life Real Estate and Management System, Inc., with the 
intention of managing and selling properties owned by others. 
In the 1980's, they began to acquire, renovate, and sell houses 
that needed only cosmetic repairs. In the 1990's, they began to 
acquire distressed properties that needed much more 
rehabilitation, such as replacement of mechanical systems, 
before they could be sold. Nelson and Prus referred to this as 
their ``REO,'' or Real Estate Owned, program. One of Prus's 
goals was for ELR to become the dominant real estate agency in 
each of several specific ethnic markets. At its peak, ELR 
employed a sales force numbering between 40 and 50 
    ELR acquired properties through its sales force. A 
salesperson would locate and purchase a dilapidated property on 
ELR's behalf using funds approved by Nelson. Prus and Nelson 
claim that the salesperson handled everything from planning and 
implementing the rehabilitation work to marketing and selling 
the property. (ELR's role, he said, was merely to finance the 
venture.) Upon the sale of the property, the salesperson 
accordingly earned a large percentage of the profit, usually 40 
percent. Unfortunately, because the salesperson had to cover 
any rehabilitation costs out of his anticipated share of the 
profit, this arrangement provided the salesperson with powerful 
incentives to minimize rehabilitation costs. (In some cases, in 
fact, it may have led salespersons actually to supply down 
payment money to prospective purchasers who would otherwise not 
qualify for a mortgage, thus helping the salesperson reap his 
percentage of the sale--although Nelson and Prus profess 
ignorance regarding this practice.) Nor did ELR bother to 
obtain building permits for the rehabilitation work it 
conducted on the properties the Subcommittee examined. As a 
result, the City of Chicago conducted no inspections to ensure 
that the rehabilitation work was done properly, or at all.
    In 1996, HUD threatened to bar Nelson and ELR from 
participating in FHA programs as a result of allegations that 
ELR had provided funds to purchasers to use as down payments 
and had falsified documentation. Nelson and ELR entered into a 
settlement agreement with HUD pursuant to which Nelson paid a 
$35,000 penalty. In exchange, HUD agreed to permit ELR to 
continue participating in FHA programs.
    A number of the home buyers with whom Subcommittee staff 
spoke are named plaintiffs in a pending Federal class action 
against Nelson, Prus, ELR, and Ace. This civil lawsuit, which 
was filed in August 1997, alleges violations of the Racketeer 
Influenced and Corrupt Organizations (RICO) Act, the Fair 
Housing Act, and the Civil Rights Act, as well as violations of 
State fraud and consumer protection statutes. The complaint 
avers that the defendants committed these violations by 
systematically defrauding residents of the overwhelmingly 
minority Austin community in Chicago during the last decade 
through various means, including: Running false and misleading 
real estate advertising; misrepresenting the condition of the 
properties that they sold; exerting inappropriate control over 
plaintiffs' financing for their purchases; discouraging or 
preventing plaintiffs from obtaining independent attorneys; 
inspectors or other safeguards in the home purchase process; 
engaging in inflated pricing; performing or controlling 
dangerously shabby construction work; and committing outright 
bank fraud. Some 105 persons have joined the plaintiff class.
    Nelson and Prus each asserted their Fifth Amendment 
privilege against self-incrimination in response to 
Subcommittee subpoenas compelling their appearances at 

      (1) Stekeena Rollins

    Stekeena Rollins purchased a 95-year-old home located at 
130 North Latrobe Street in Chicago along with her mother, 
Shirley Rollins. Stekeena is a high school graduate who 
completed some course work at a community college in Chicago. 
Since graduating from high school, she has worked as a bank 
teller, in child care, and as a nursing home assistant. She was 
a 21-year-old single mother when she purchased the house. Like 
Stekeena, her mother Shirley was also a first time home buyer. 
Although Shirley had attended 2 years of high school, she did 
not graduate. Instead, she completed 2 years of trade school, 
and 3 months of college studying food service. She was 49 years 
old at the time she bought the house, and had custody of five 
grandchildren. Her employment history includes jobs at child 
care facilities, factories, and schools. As of June 2000, 
Shirley had been unemployed since 1998.
    The Rollinses first became aware of ELR in June 1995, when 
they saw one of its advertisements in the Chicago Sun-Times 
proclaiming, ``Kiss Your Landlord Goodbye!'' After seeing the 
advertisement, they visited ELR's office where they met Peter 
Sandow, a real estate agent. They told him that they wanted to 
purchase a house large enough to allow Stekeena to operate a 
day care center from their home. Sandow showed them several 
homes in the Austin neighborhood of Chicago, but the Rollinses 
specifically told him that they did not want to live in Austin 
because of their concerns about local levels of violence and 
drug activity. Sandow then showed them a house that he said was 
in Oak Park, an upper-middle class neighborhood adjacent to 
Austin. This house, which had been converted into two separate 
flats, had been damaged in a fire, was leaning to one side, and 
obviously needed a great deal of work. Nevertheless, it was 
large enough to meet their needs (including their hopes of 
operating a day care center there), and Sandow assured the 
Rollinses that pursuant to an unspecified Federal program, ELR 
would thoroughly rehabilitate the house, pay for an inspection, 
and provide a lawyer to represent them at closing. Pleased to 
hear this, the Rollinses relied upon his assurances in deciding 
to purchase the house. Accordingly, on July 21, 1995, they 
signed a contract for the purchase of the house for $119,000, 
after paying $500 as an ``earnest money'' deposit.\60\
    \60\ Subcommittee staff interview with Shirley and Stekeena Rollins 
in Chicago, Illinois (March 28, 2000).
    The purchase contract Stekeena and her mother signed in 
July 1995 did not include any provisions relating to home 
inspections. Around the time they signed the contract, however, 
they also signed a HUD form encouraging them to obtain a home 
inspection, as well as an Illinois Association of Realtors form 
advising them of their right to request such an inspection. 
Stekeena stated both to Subcommittee staff and during her 
deposition in the pending civil action that, prior to closing, 
she asked Sandow whether she needed to do anything to finalize 
the sale of the house. Sandow told her that ELR would supply a 
lawyer to represent her at closing, an inspection of the home, 
and an examination of the home by a termite control company. 
Stekeena relied on his representation that ELR would follow 
through on these promises, and did not question whether ELR had 
actually taken any of these steps prior to closing. Moreover, 
the Rollinses were given a form to sign, entitled ``Illinois 
Association of Realtors: Residential Real Property Disclosure 
Report'' which did not indicate any defects to the property. 
(The seller of the property also signed this disclosure form; 
not a single problem was highlighted on it.)
    In August, the Rollinses discovered through a family friend 
that the house was actually located in the Austin neighborhood, 
not in Oak Park. When Shirley confronted Sandow with this 
discovery, he replied that they could not renege on their 
agreement to purchase the house because they were ``locked in'' 
as a result of signing the sales contract. He also told her 
that, if she tried to get out of the sale, she would never get 
another FHA-backed mortgage.\61\
    \61\ Deposition of Shirley Rollins, at 79:13 (December 3, 1999).
    Just prior to closing, Sandow explained that because the 
Rollinses were first-time home buyers, the Federal Government 
would provide them with $6,000 to use as a down payment. To 
take advantage of this program, Sandow told the Rollinses to 
enlist the assistance of someone with a bank account whom they 
could trust. The Rollinses secured the aid of 24-year-old 
Valencia Lockhart, a family friend. Sandow accompanied Lockhart 
to the bank, where he gave her $6,000 in cash. At Sandow's 
direction, Lockhart deposited the cash into her account, then 
immediately purchased a cashier's check for $6,000 made payable 
to Stekeena. After the completion of this transaction, Sandow 
paid Lockhart $50 in cash for her assistance.\62\ Lockhart then 
executed a phony gift affidavit documenting her alleged gift to 
the Rollinses. Although the Rollinses' signatures appear on 
this affidavit, they do not remember signing it, and the 
signatures do not match their signatures on the sales contract 
or closing documents.
    \62\ Subcommittee staff telephone interview with Valencia Lockhart 
(June 1, 2000).
    The Rollinses closed on their house on September 29, 1995. 
At the closing, the Rollinses saw an appraisal valuing their 
house at $119,000, a termite inspection certificate indicating 
that there was no visible termite damage, and the results of a 
roof inspection indicating that the roof was in good condition. 
The appraisal had been conducted by James Koechle, who was 
subsequently indicted by a Federal grand jury in the Northern 
District of Illinois on January 26, 2000 for submitting 
inflated appraisals to mortgage lenders in an unrelated 
mortgage-flipping scheme.
    Documents the Rollinses signed at their closing include a 
HUD-1 Settlement Statement reflecting a down payment that 
included the ostensible ``gift'' from Lockhart. Richard Nelson, 
co-owner of ELR and owner of the house, signed through his 
attorney a form called the Addendum to the HUD-1 Settlement 
Statement. This form certified that Nelson had not paid or 
reimbursed the Rollinses for any part of the down payment for 
the purchase of the house--despite the fact that ELR, through 
Sandow, had provide them with $6,000 through the sham 
transaction with Lockhart. (The Rollinses also signed this 
form, thereby falsely attesting that they had not received any 
cash from the seller for any portion of the down payment.) In 
addition, the Rollinses signed a form indicating that they 
understood they were purchasing the house ``as is.''
    Although the Rollinses' signatures on the gift affidavit 
and the Addendum suggest some level of complicity in the very 
fraud that victimized them, Stekeena maintains that she relied 
completely on assurances by Sandow that she was not doing 
anything inappropriate, that ``everybody does it'' in this 
manner, and that this was simply the way houses were normally 
purchased. The lawyer ELR provided to represent the Rollinses 
at closing, Carl Palladinetti, reinforced these 
misrepresentations: Rather than providing legal advice, he 
simply advised them to sign each document placed before them 
without offering any meaningful explanation of what they were 
signing.\63\ (During her deposition in the civil action, 
Shirley testified that, at the closing, she also noted about 
five documents with signatures purporting to be hers which she 
had not signed. When she pointed this out to the attorney, he 
responded that she had probably forgotten about it. Then he 
said, ``Anyway, I have a boat to catch,'' and continued passing 
papers to her for signature.\64\)
    \63\ Subcommittee staff interview with Stekeena and Shirley Rollins 
in Chicago, Illinois (March 28, 2000).
    \64\ Deposition of Shirley Rollins, at 70:14 (December 3, 1999).
    Stekeena and her mother obtained an FHA-backed mortgage 
from a HUD-approved Direct Endorsement (DE) lender \65\ called 
Dependable Mortgage, Inc. This lender, however, was apparently 
already emerging as a potential problem. Within a few months of 
the Rollinses' closing, in fact, HUD felt compelled to notify 
the president of Dependable Mortgage in a letter dated August 
1996, that the company's rate of early payment defaults and 
claims on FHA insured mortgages was in excess of 200 percent of 
the normal rate. Specifically, with regard to loans endorsed in 
1995, as of June 30, 1996, Dependable's overall FHA mortgage 
default rate was 11.49 percent, while the FHA default rate for 
lenders under the jurisdiction of the Chicago HUD office was 
only 2.15 percent, and the national FHA default rate only 2.66 
percent.\66\ For this reason, HUD advised that it intended to 
terminate Dependable's authority to originate FHA mortgages 
within 60 days. (According to HUD staff, after HUD threatened 
to impose these sanctions, Dependable apparently voluntarily 
surrendered its Direct Endorsement authority in June 1997, sold 
its loan portfolio, and ceased operation.\67\)
    \65\ A Direct Endorsement lender has the authority to underwrite 
mortgages for FHA insurance purposes without FHA approval prior to 
    \66\ Letter from Emelda Johnson, Deputy Assistant Secretary for 
Single Family Housing, U.S. Department of Housing and Urban 
Development, to the president of Dependable Mortgage, Inc. (August 9, 
    \67\ Subcommittee staff telephone interview with Janice Ligon, 
Office of Lender Approval and Recertification, U.S. Department of 
Housing and Urban Development (May 7, 2000).
    Interestingly, Deborah Tanke, who was president of 
Dependable at the time the Rollinses purchased their house, 
apparently personally notarized the false gift affidavit 
documenting the alleged gift from Lockhart. In her deposition, 
however, Tanke claimed to have no independent recollection of 
having done this, and could only surmise that she assisted in 
the Rollinses' closing because Dependable was shorthanded at 
the time.\68\ After disbanding Dependable Mortgage, Tanke and 
another employee formed another loan company which was then 
outside the reach of a HUD debarment.
    \68\ Deposition of Deborah Tanke, at 120:1-5 (March 8, 2000).
    During the Subcommittee's hearings on mortgage flipping, 
Chairman Collins advised Senator Durbin that Tanke was still 
operating in the loan business in Chicago--a fact which Senator 
Collins found to be very disconcerting. FHA Administrator Apgar 
professed to be unaware of that development, as indicated by 
the following exchange:

        ``Q: What about the lender?
         A: The lender disappeared.
         Q: Well, we [the Subcommittee] found them.
         A: What?'' \69\
    \69\ Hearing record, supra, at 57.

Senator Collins told him that the lenders involved in the 
Rollins episode ``are still operating in the loan business in 
Chicago. So we will help you find them.'' \70\
    \70\ Id.
    A FHA credit analysis ``worksheet'' is used to examine an 
applicant's personal and financial status, monthly shelter 
expense, funds required for closing expenses, effective monthly 
income and debts and obligations. As noted above in connection 
with the Smith case, an applicant's prospective housing 
expenses should not exceed 29 percent of gross effective 
monthly income. An analysis of the Rollinses' mortgage 
application indicated that the prospective housing expenses 
equaled exactly 29 percent of their gross monthly income. 
According to Stekeena, however, the amount listed as their 
monthly income on this form was overstated: It had been falsely 
inflated by approximately $600 per month, which was described 
as ``rental income.''
    Stekeena said she was unaware that this false income amount 
had been included on her loan application, which she did not 
read before signing because ``it was just another form.'' 
Surely not by coincidence, the falsely-attributed additional 
``income'' was precisely the amount required to make the 
Rollinses appear to meet the 29 percent threshold. Under FHA 
guidelines, in other words, they should not have received the 
loan: Without such false ``rental income'' paperwork to pave 
the way for a government-backed loan, ELR would not have been 
able to sell the Rollinses the house.
    At the Subcommittee hearing, Senator Collins asked Ms. 
Rollins about this issue:

        ``Q: LDid you, in fact, receive $618 in rental income 
        every month?
         A: No.
         Q: Did you put that number on the form?
         A: No.
         Q: Did you tell anyone to put that number on that 
         A: No.
         Q: LAnd you weren't even aware that that number had 
        been put on the form to make it appear that you 
        qualified for the mortgage?
         A: No.'' \71\
    \71\ Hearing record, supra, at 28.

    After the Rollinses had signed all the papers at the 
closing, Sandow told them that ``house sitters'' were staying 
at the house and instructed the Rollinses to go to the house, 
ask these persons for the keys, and request that they 
leave.\72\ When the Rollinses arrived there, they observed drug 
paraphernalia scattered around the house. The alleged ``house 
sitters'' also refused to leave, and a 2-hour argument ensued. 
In the end, these persons agreed to leave when Shirley's son 
arrived at the house. The ``house sitters'' were apparently 
drug dealers: To this day, almost 5 years later, strangers 
still periodically visit the Rollinses' house seeking to 
purchase drugs there.\73\
    \72\ Id.
    \73\ Subcommittee staff interview with Stekeena and Shirley Rollins 
in Chicago, Illinois (March 28, 2000).
    The Rollinses had visited the house three times before 
closing, but ELR representatives had never allowed them to see 
the entire house due to what they characterized as ``ongoing 
construction''. When the Rollinses arrived at the house after 
closing, the reason for this refusal became clear: They 
observed termites swarming everywhere--on the front and back 
porches, inside the house, and in the garage. A subsequent 
telephone call to the company that conducted the termite 
inspection proved fruitless; a representative of that company 
simply advised them that ELR often painted over possible 
termite infestation, thereby preventing its detection by a 
normal inspection. This termite damage was so severe, in fact, 
that Stekeena fell on the front porch and severely hurt her 
    \74\ Deposition of Stekeena Rollins, at 35:3-6 (December 8, 1999).
    The Rollinses also soon began discovering other problems 
with the house. Contrary to Sandow's representations, the house 
was not suitable for a day care center because it did not meet 
city standards. Stekeena's business application was accordingly 
denied.\75\ (A substandard furnace in the basement caused 
leaks.\76\ A gas company representative told them that the 
pipes used on the furnaces were old, were not originally 
designed to be gas pipes, and appeared to be connected in a 
slipshod fashion.\77\) A gap also developed between the wall 
and the floor in the living room, actually creating an opening 
to the outside through which snow and rodents entered the 
house. Other problems with the house included water leaks, 
sewage backups in bathrooms, and faulty electrical wiring.\78\ 
An attorney who is attempting to renegotiate the Rollinses' 
mortgage also told them that the house had been illegally 
converted into a two-flat structure.\79\
    \75\ Subcommittee staff interview with Stekeena and Shirley Rollins 
in Chicago, Illinois (March 28, 2000).
    \76\ Id.
    \77\ In December 1997, the Chicago Community Economic Development 
Association repaired and retrofitted the Rollinses' furnace pilot light 
system, insulated the attic, installed a smoke detector, and repaired 
doors. These efforts cost the Rollinses almost $2,500.
    \78\ Subcommittee staff interview with Stekeena and Shirley Rollins 
in Chicago, Illinois (March 28, 2000).
    \79\ Subcommittee staff telephone interview with Stekeena Rollins 
(May 1, 2000).
    The Rollinses complained numerous times to ELR about the 
condition of their house. In response to their first 
complaints, ELR sent workmen to the house on approximately five 
occasions. These workmen repaired water damage to the first 
floor bedroom and dining room ceilings, and damage that had 
resulted from pipes freezing due to lack of insulation. They 
also painted the front porch to cover boards that had been 
damaged by rot, replaced the first- and second-floor carpets 
that had suffered water damage, and stabilized the collapsing 
back stairway.\80\ Eventually, however, ELR stopped responding 
to the Rollinses' continuing complaints.
    \80\ Id.
    After the Rollinses finally contacted the FBI about ELR in 
January 1996, ELR resumed contact. Indeed, Sandow contacted 
them in April, offering them season tickets to the Chicago 
Bulls games and informing them that he would treat them to 
dinner if they stopped complaining. The Rollinses rejected 
these offers. Louis Prus, one of the owners of ELR, then 
stopped by to look at the house with his wife, but nothing 
resulted from his visit.\81\
    \81\ Deposition of Stekeena Rollins, at 128:12-17 (December 8, 
    By October 1999, the Rollinses were 2 or 3 months behind in 
their mortgage payments, but they have not made payments since 
June 2000 on account of a HUD moratorium on foreclosures of 
properties sold by ELR, and because of efforts by their 
attorney to renegotiate the terms of their mortgage.\82\
    \82\ Subcommittee staff telephone interview with Stekeena Rollins 
(May 1, 2000).
    Investigation by Subcommittee staff has revealed that a 
non-profit organization called Pride Allied Educational Program 
had purchased the Rollinses' house from HUD for $11,430 in 
April 1995. Richard Nelson, co-owner of ELR, purchased the 
house from Pride Allied for $14,000 on May 5, 1995. Nelson sold 
the house 5 months later to the Rollinses for $119,000. Thus, 
although the owners of ELR have produced checks purporting to 
show approximately $52,000 in repairs made to the house prior 
to the Rollinses' closing, it is unlikely that even this dollar 
volume of repairs increased the house's market value in such a 
short period of time. Because ELR's records do not delineate in 
detail the types of repairs conducted on the house, moreover, 
it is unclear whether or not any repairs were actually made.

      (2) Other Easy Life Realty Victims

    The stories of the remaining ELR victims are remarkably 
similar in that they all made nominal down payments which ELR 
representatives supplemented with significant cash payments. 
ELR steered each victim to a lender of its choice, and, with 
one exception, provided the victim with an attorney to 
represent him or her at closing. In addition, each victim 
experienced major problems with the structural soundness and 
satisfactions of his home, which ELR failed to rectify.

    C. South Florida: The Story of Sonia and Carlos Pratts

    Sonia Pratts and her husband Carlos purchased their home at 
6121 Jackson Street in Hollywood, Florida, from New Southwest 
Properties, Inc. (NSP) for $80,000 on February 20, 1998. NSP 
had purchased the property on September 2, 1997 from HUD for 
only $40,000.
    Sonia received an associate's degree in liberal arts from 
Boricua College in Brooklyn, New York. She has also taken 
pharmacy courses through ICS International Correspondence 
School, phlebotomy courses at Broward Community College, and 
counseling courses at Florida Bible College. Sonia formerly 
worked as a ``ward clerk'' and ``certified nurse.'' In this 
capacity, she cared for premature, HIV-positive, and drug-
addicted infants by performing such tasks as maintaining a 
sterile environment, monitoring medication and supplies 
inventory, bathing and weighing the infants, and preparing 
discharge and transfer paperwork. As a result of a back injury 
she suffered during the course of her employment, however, 
Sonia now works as a patient care assistant at a health care 
system surgical department, performing such tasks as drawing 
blood, transporting patients between departments, and bathing, 
dressing, and feeding patients. Her gross monthly income at the 
time she and Carlos purchased the house was roughly $1,200.
    Carlos has a sixth-grade education. He was working as a 
driver/warehouse worker at Little Guys Food Service at the time 
he applied for their mortgage. (Sonia was eliminated from their 
loan application for the house because she had filed for 
bankruptcy nearly 10 years earlier after her ex-husband 
abandoned her and their three children.) In addition to his 
gross monthly salary of approximately $1,700, he was receiving 
Supplemental Security Income of $521 per month because he had 
been diagnosed as schizophrenic. He is presently 
    \83\ Subcommittee staff telephone interview with Sonia Pratts (June 
16, 2000).
    The Prattses had been saving to purchase a residence for 
several years. In October 1997, as they were driving through 
various neighborhoods looking at houses, they saw a sign posted 
in front of a house offered for sale by ERA Homeland Realty 
Corporation. The Prattses called the number on the sign and 
subsequently met with two realtors, P. Alias Thomas and ViJayan 
V. Thomas. The Thomases steered the Prattses away from the 
house that had initially attracted their attention to the house 
on Jackson Street that they ultimately purchased. The realtors 
then introduced the Prattses to Joe Kuruvila who, in addition 
to owning ERA Homeland Realty, also owned NSP which owned the 
Jackson Street property.\84\
    \84\ Subcommittee staff interview with Carlos and Sonia Pratts in 
Hollywood, Florida (April 16, 2000).
    The Prattses told Kuruvila that they wanted a property that 
needed no repairs because they were using their entire savings 
for the down payment, and would have no funds left over for 
renovations. When Kuruvila showed them the house on Jackson 
Street, the Prattses realized it was in the process being 
repaired. In response to their inquires, Kuruvila assured them 
that the property had no structural problems and no code 
violations. This was untrue. At one point, Carlos drove by the 
house and noticed a code violation taped to the door.\85\ City 
of Hollywood records confirm that a notice of code violations 
was posted on the Jackson Street property in October 1997. 
These code violations consisted of failing to obtain the 
requisite building permits for an addition to the property and 
for replacement of a window. (The city mailed NSP a letter via 
certified mail, return receipt requested, in November 1997, 
notifying it of the violations. The city again posted a noticed 
of the violations on the property in January 1998.) When Carlos 
confronted Kuruvila about the code violations, Kuruvila 
reassured him that all the necessary repairs would be 
completed, and that the code violations would be remedied.\86\
    \85\ Id.
    \86\ Id.
    On December 20, 1997, the Prattses signed a contract for 
the purchase of the Jackson Street residence. This contract 
included a rider that subsequently became the subject of much 
controversy. This rider disclosed to the Prattses that NSP and 
ERA Homeland Realty were 100 percent shareholders of their 
mortgage lender, Hollywood Mortgage Corporation. In other 
words, Joe Kuruvila owned not only the Prattses' lender, but 
also the seller and the real estate agency. (A third entity 
listed on the rider as owning Hollywood Mortgage, Northeastern 
Properties, Inc., is also owned by Joe Kuruvila.) The Prattses 
told Subcommittee staff that when they signed the rider, they 
did not realize the relationship among the listed companies or 
the significance of Kuruvila's common ownership of them.\87\
    \87\ Id.
    The rider also provided that ``[i]t is expressly understood 
that the property is sold `as is', without any warranty to the 
purchaser, either express or implied'' as to the property's 
zoning, its condition, freedom from defects, or fitness for any 
particular use or purposes. The Prattses contend that neither 
Kuruvila nor the Thomases explained this clause to them, and 
that they thus attached no particular significance to it when 
they signed the rider.\88\
    \88\ Subcommittee staff telephone interview with Sonia Pratts 
(April 24, 2000).
    Shortly after he signed the sales contract, Carlos signed a 
HUD form entitled, ``Importance of Home Inspection.'' This form 
advised that FHA does not warrant the value or condition of a 
home, and encouraged the buyer to obtain an independent home 
inspection. Carlos indicated on the form that he chose not to 
have a home inspection performed. As with the ``as is'' clause, 
the Prattses attached no substantive significance to their 
waiver of a home inspection, particularly in light of 
Kuruvila's repeated assurances regarding the rehabilitation 
work that he was performing on the house.\89\
    \89\ Id.
    At their closing on February 20, 1998, the Prattses 
received virtually no explanation regarding the documents that 
they were being given to sign. They simply signed everything 
put in front of them because they trusted Kuruvila. They used 
their personal savings in order to provide the $3,900 they paid 
as a down payment and in order to cover closing costs; this was 
money they had been accumulating over a 2- or 3-year period.
    The Prattses financed the balance of the purchase price 
through a 30-year mortgage in the principal amount of $79,959. 
Carlos executed an ``escrow buy down agreement'' which provided 
that in exchange for payments of $962.70 each from NSP and 
Hollywood Mortgage, the Prattses' interest rate would be 5.75 
percent for the first year of the mortgage term, with a 
corresponding payment of principal and interest of $572.84 per 
month. For the second year of the mortgage term, the interest 
rate would be 6.75 percent, with a corresponding payment 
principal and interest of $518.61 per month. For the remainder 
of the mortgage term, the interest rate would be 7.75 percent, 
with a corresponding payment of principal and interest of 
$572.84. (This paperwork, as well as a clause in their sales 
contract, notified the Prattses that they were obtaining a 
variable rate mortgage. Sonia admits that she knew that they 
were obtaining a variable rate mortgage, but she says she did 
not believe that the rates would increase.)
    The annual taxes for the property at the time of the sale 
were listed at $1,187.00. The monthly payment of these taxes, 
plus monthly premiums for FHA mortgage insurance and fire 
insurance, increased the Prattses' total monthly payments for 
the first year of the mortgage to $669.20. After the first 2 
years of their mortgage term, their total monthly payments were 
scheduled to rise to $796.00 per month, as indicated on a 
document Carlos signed entitled ``Acknowledgment of Estimate of 
Total Monthly Mortgage Payment.''
    The FHA credit analysis worksheet is used to examine an 
applicant's personal and financial status, monthly shelter 
expense, funds required for closing expenses, effective monthly 
income, and monthly debts and obligations. As a general rule, 
the applicant's prospective housing expenses should not exceed 
29 percent of their gross effective monthly income. An analysis 
of Carlos Pratts's gross monthly income of $2,254.00 per month 
divided by the initial monthly mortgage payment of $669.20 
indicates that his housing expenses were approximately 29.68 
percent of his gross monthly income--in excess of the threshold 
suggested by the FHA guidelines.
    The Prattses have experienced serious problems with the 
house despite the fact that Kuruvila told them that it had been 
completely rehabilitated. The roof--which Kuruvila told them 
was new--is rotting, collapsing, and leaking in several places. 
As a result, the ceilings have begun to crack and fall. When 
Subcommittee staff visited the house, they noted apparent water 
damage to the ceilings in a bedroom and back room of the 
residence. The staff also verified that the house has suffered 
rodent infestation as well as significant termite damage. (The 
living room, in fact, has a hole in the ceiling through which 
Sonia claims rat feces enter the room.) The addition, the rear 
of the house has substantial water damage and is built on top 
of the septic tank, which is a violation of City of Hollywood 
Construction Code and Health Department rules. The roof fascia 
is rotted and has many gaps through with rats and birds have 
gained entrance. The wiring also does not appear to be 
adequate, and several outlets are nonfunctional. So far, the 
Prattses have spent over $2,500 of their own money for various 
repairs, and there is no end in sight: An independent engineer 
they hired to evaluate the house advised them that they would 
need to spend between $40,000 and $50,000 to bring it into 
compliance with the city building code--and that they would 
have to raze part of the house altogether.\90\
    \90\ Subcommittee staff telephone interview with Jim Ward (April 
18, 2000); interview with Carlos and Sonia Pratts, in Hollywood, 
Florida (April 16, 2000).
    After the Prattses moved into their home, they received a 
letter from the City of Hollywood informing them of the 
outstanding building code violations on the property. The 
violations occurred long before either Kuruvila or the Prattses 
owned the house but the Prattses, as current owners, were 
responsible for ensuring compliance.\91\
    \91\ Subcommittee staff telephone interview with Everett Lawson 
(June 19, 2000); interview with Carlos and Sonia Pratts, in Hollywood, 
Florida. (April 16, 2000).
    When the Prattses questioned Kuruvila about the outstanding 
fines for the code violations, he assured the Prattses that he 
would pay them, but to date he has failed to do so. The 
Prattses have filed a civil complaint in State court against 
Kuruvila in an attempt to resolve this matter. In addition, the 
Real Estate Division of Florida's Department of Business and 
Professional Regulation has filed an administrative complaint 
against Kuruvila in his status as a real estate broker--and 
against his companies, NSP and Homeland ERA Realty--alleging 
fraud in conveying this property to the Prattses.
    An appraiser named Raymond G. Wood conducted the appraisal 
of the Prattses' house that Kuruvila submitted in order to 
obtain FHA endorsement of their mortgage. This appraisal 
estimates that the fair market value of the Prattses' house was 
$82,000 as of January 8, 1998, and indicates that ``the subject 
property conforms to all applicable minimum HUD/VA standards.'' 
Wood's appraisal also declares that the house is in overall 
average condition and that it has some new windows, a new roof, 
and new ceilings, although central air conditioning and 
appliances needed to be installed. Many of these claims were 
clearly false at the time. Wood told Subcommittee staff that he 
did not remember the property in question but that he had done 
``hundreds'' of appraisals for Kuruvila until last fall, when 
he stopped because Kuruvila was very slow to pay him.
    (Nor were these apparent misrepresentations the only 
problem with Wood's appraisal of the Prattses' house. In 
addition, the ``comparable'' property that Wood used to 
establish the value of the Prattses house appears also to have 
been a property ``flipped'' by Joe Kuruvila. Kuruvila purchased 
this property, located at 6028 Fillmore Street in Hollywood, 
for $43,200 from HUD on August 15, 1997. He sold it 
approximately 3 months later on November 19, 1997, for $81,000 
to a buyer who had obtained an FHA-insured mortgage. 
Coincidentally, Wood conducted the pre-closing appraisal on the 
Fillmore Street property, subsequently also using it as the 
property against which to assess the purported value of the 
Prattses' home.)

    D. Norfolk

    A flipping scheme run by Wendell Chick in Norfolk, 
Virginia, illustrates the extent to which smaller cities are 
also susceptible to flipping frauds--and how such activities 
can inflict great harm upon entire neighborhoods. Wendell Chick 
was a real estate broker and principal in multiple companies he 
utilized to inflate the value of properties he had purchased, 
minimally rehabilitated, and then resold. (Chick is currently 
serving a 60-month prison sentence as a result of his 1997 
guilty plea to Federal wire fraud and money laundering 
conspiracy charges that arose from this conduct.) \92\
    \92\ See United States v. Wendell Chick, Case No. 2:97CR00124-001 
(E.D. Va. Dec. 15, 1997) (judgment).
    Between May 1993 and April 1997, Chick owned or controlled 
corporations through which he purchased approximately 34 
properties in relatively poor condition in Norfolk, Portsmouth, 
and Chesapeake, Virginia. The purchase price of these 
properties ranged from $9,000 to $69,900, with an average price 
of approximately $30,500. Chick and his associates executed and 
recorded deeds purporting to convey the properties from one 
Chick-controlled company to another. Each time the properties 
were ``sold'' to a new company Chick controlled, their prices 
were inflated incrementally in order to create the illusion of 
a steadily increasing market value. These property transfers 
were solely paper transactions; no money ever changed hands, 
and the properties never left Chick's control.
    Once a property's value had been sufficiently inflated by 
these means, Chick and his associates recruited purchasers whom 
they helped obtain mortgage loans through fraudulent means. 
Typically, Chick and his cohorts made cash, loan, and credit 
card payments--generally totaling several thousand dollars--to 
or on behalf of each of these purchasers, who thereupon falsely 
attested on their sales contracts that they had paid ``earnest 
money'' deposits on the properties out of their own funds.
    Chick caused his purchasers to submit 34 different 
fraudulent mortgage applications for loans totaling 
approximately $2,746,564. (Nineteen of these loans were FHA 
insured.) Chick and his associates used a number of means to 
obtain such loans: They submitted to the lenders copies of 
checks that falsely purported to be ``earnest money'' deposits 
made by the purchasers; they paid outstanding credit accounts 
on behalf of the purchasers; and they provided funds to the 
purchasers to deposit into bank accounts in order to inflate 
apparent balances--thus leading lenders to believe that the 
purchasers were more solvent than was in fact the case. (To 
explain the source of funds in the purchasers' accounts, Chick 
produced forged gift letters and prepared fictitious 
certificates of title to motor vehicles, as well as receipts 
documenting non-existent sales of those vehicles to third 
parties.) In addition, at the loan closings, Chick and his 
associates themselves made the cash payments required of the 
    Apparently, Chick also misled lenders about HUD policy. In 
express contravention of HUD policy, for example, Chick told 
buyers that although they had to represent to the lenders that 
they intended to live in the houses they were buying, in 
actuality HUD ``didn't care whether they lived there only 1 
day.'' Most of the HUD settlement statements also listed false 
debts secured by the properties.
    E. Southern California

    While exploring such problems of mortgage fraud, 
Subcommittee staff attended a number of conferences devoted to 
assessing the impact of--and preventing--predatory lending 
practices.\93\ Among other events, Subcommittee staff attended 
the monthly meeting of the Los Angeles Housing Task Force. This 
group, which includes representatives from HUD/OIG, the Los 
Angeles Police Department, the California State Bar, the 
Southern California Consumer Law Center, and the Los Angeles 
Sheriff's Department, was created to combat mortgage fraud in 
the State of California. The task force discussed how Los 
Angeles has been successfully targeting mortgage fraud through 
training and consumer awareness.
    \93\ Among these conferences was a HUD forum in Los Angeles on May 
3, 2000. This conference featured an address by a member of the Joint 
Task Force, case studies on predatory lending, participation by a 
variety of local and national industry representatives, and a consumer 
panel that included AARP, Bet Tzedek Legal Services, the Consumers 
Union, the Southern California Consumer Law Center, and Neighborhood 
Housing Services of Los Angeles. The focus of this event was the effect 
of predatory lending on elderly communities. During the conference, 
Subcommittee staff discussed the problem of flipping with various 
    According to these experts, local and Federal law 
enforcement have traditionally been reluctant to prosecute 
flipping and other types of mortgage fraud cases because they 
are highly technical and difficult to prove. Many local 
district attorneys told Subcommittee staff that they required 
special training in order to acquire the level of understanding 
necessary to prosecute these cases (much as was the case with 
Medicare fraud cases in the late 1980's). In response to this 
need for training, Manuel Duran, a consultant for the Southern 
California Consumer Law Center, successfully lobbied for the 
passage of a bill through the State legislature that imposes a 
$2 surcharge on each property deed filed in the State. The 
funds this surcharge generates are used to train law 
enforcement to investigate and prosecute mortgage fraud cases. 
Duran and members of the task force reiterated their belief 
that the answer to combating mortgage fraud lies in training 
law enforcement to prosecute these highly specialized 
criminals. (These officials indicated that pre-purchase 
counseling for homeowners is not by itself an adequate 
response, inasmuch as it rarely provides an effective deterrent 
to mortgage criminals.)
    According to Nicholas Aquino--a Supervising Investigator 
who heads the Real Estate Fraud Section of the Los Angeles 
County Department of Consumer Affairs, which is responsible for 
addressing real estate fraud complaints--southern California 
has been plagued by an increasing number of mortgage fraud 
cases that have been perpetrated through the use of stolen 
identities. Investigating and prosecuting flipping, 
particularly when victims' misappropriated identities are used 
for straw purchases, is complicated for law enforcement 
officials because the victims may not actually know that they 
have been victimized until long after the ``flip'' occurs. 
(Meanwhile, evidence becomes stale, and witnesses forget key 
details about the transactions at issue. This places special 
burdens upon prosecutors.)
    Aquino sees flipping as being a ``huge'' problem in Los 
Angeles County. In one scheme that is currently under 
investigation, for example, perpetrators placed advertisements 
in local newspapers and canvassed neighborhoods offering low-
income, first-time home buyers the opportunity to purchase a 
house. The individuals who responded to the offer completed a 
mortgage application, only to be told that they did not qualify 
for a loan. The perpetrators then used the victims' 
identification data on the mortgage application to purchase 
houses themselves, using the victims' names. These properties 
were then resold at inflated prices.\94\
    \94\ Subcommittee staff telephone interviews of Nicholas V. Aquino, 
Supervising Investigator, Real Estate Fraud Section, Los Angeles County 
Department of Consumer Affairs (February 2 and June 14, 2000).
    In December 1999, a Federal grand jury charged 39 persons 
with obtaining more than $110 million worth of fraudulent FHA 
insured loans through the execution of multiple fraudulent 
schemes through Allstate Mortgage Company.\95\ Allstate set up 
straw companies to enter into purchase agreements to acquire 
apartment buildings, typically worth $100,000 to $180,000. It 
then hired its own appraisers who inflated the value of the 
buildings, usually from $100,000 to $150,000 greater than the 
actual market value of the properties. (Allstate also 
instructed appraisers to certify that properties contained four 
residential units even though many had more than four units. It 
knew that under HUD's single-family insurance program the 
Department insured only mortgages on properties with four or 
fewer units.) Allstate then recruited low-income individuals to 
serve as straw buyers and apply for FHA mortgages in amounts 
equal to as much as $150,000 above the actual property values 
in question. As the FHA-insured loans were being arranged, 
Allstate simultaneously closed on its original purchase of the 
properties for the actual price, pocketed the difference 
between its purchase price and the taxpayer-insured loan 
proceeds, and then sold the fraudulent loans to legitimate 
mortgage companies.\96\
    \95\ See David Rosenzweig, ``Thirty-Nine Charged in Crackdown on 
Fraud in FHA-Backed Loans,'' Los Angeles Times (December 16, 1999), 
    \96\ Office of the Inspector General, U.S. Department of Housing 
and Urban Development, Audit Memo. # 00-SF-121-0802, Internal Audit--
Single Family Housing: Los Angeles Area Office and Santa Ana Home 
Ownership Center (April 6, 2000), at 4.
    The Federal grand jury charges stemmed from a concentrated 
probe by teams of HUD/OIG auditors, FBI agents, and IRS agents 
in Southern California. At a news conference announcing the 
indictment, HUD Inspector General Susan Gaffney suggested that 
these charges were only ``the tip of the iceberg.'' The U.S. 
Attorney for the Central District of California noted that this 
type of fraud ``takes money from needy parents who dream of 
providing a house for their children and puts it into the 
pockets of people who have been licensed as professionals, but 
who really are just greedy criminals.'' \97\
    \97\ See Rosenzweig, supra.

IV. The Federal Housing Authority

    A. Origin and Structure

    The Housing Act of 1934 established FHA in order to broaden 
home ownership, protect lending institutions, and stimulate the 
building industry. By insuring lenders against loss on home 
loans, FHA contributed to the institution of the 30-year 
mortgage as a standard mortgage product. When HUD was created 
in 1965, FHA became an agency of HUD. All FHA programs are 
administered through the HUD Office of Housing.\98\ Since its 
inception in 1934, FHA has insured nearly 27.9 million 
loans.\99\ FHA is organized into four major mortgage insurance 
fund activities. The largest activity is the Mutual Mortgage 
Insurance Fund (MMIF), which provides single family housing 
    \98\ U.S. Department of Housing and Urban Development, About 
Housing (visited June 19, 2000) http://www.hud.gov/fha/fhaabout.html.
    \99\ Foote, supra, at 1.
    The MMIF was designed to be actuarially sound and self-
supporting. In fiscal year 1987, however, the fund barely broke 
even, and in 1988 the MMIF suffered its first net loss. In 
1989, the MMIF's income remained insufficient to cover 
losses.\100\ The MMIF had about $4 billion in reserves at the 
end of fiscal year 1987. Thanks to its slide into deficits, 
however, by the end of fiscal year 1991, the MMIF reserves had 
shrunk to $871 million.\101\
    \100\ Subcommittee staff telephone interview with Joe Rothchild, 
Office of Evaluation, Office of the Comptroller, U.S. Department of 
Housing and Urban Development (June 16, 2000).
    \101\ Foote, supra, at 4.
    In 1991, as a result of these problems, Congress authorized 
HUD to increase FHA insurance premiums in order to keep the 
fund solvent. Prior to that time, on a 30-year mortgage, a 
borrower paid a one-time Mortgage Insurance Premium (MIP) of 
3.8 percent of the amount borrowed. As of July 1, 1991, 
however, the borrower had to pay an additional annual premium 
of 0.5 percent in addition to the 3.8 percent one-time payment 
already required.\102\
    \102\ Subcommittee staff telephone interview with Joe Rothchild, 
Office of Evaluation, Office of the Comptroller, U.S. Department of 
Housing and Urban Development (June 16, 2000).
    In 1994, Congress enacted legislation to change the MIP 
calculations again in order to reflect the risk of the loans 
being insured.\103\ For any loan insured on or after October 1, 
1994, therefore, the borrower pays an up-front mortgage 
insurance premium of 2.25 percent of the loan amount. 
Thereafter, the borrower pays an annual insurance premium the 
amount and duration of which are determined by the size of the 
down payment: (a) a borrower who makes a down payment in excess 
of 10 percent will pay an annual insurance premium of 0.5 
percent of the loan balance for the first 11 years of the loan; 
(b) a borrower who makes a down payment of 5 percent to 10 
percent will pay an annual premium of 0.5 percent for the first 
30 years of the loan; and (c) a borrower who makes a down 
payment of less than 5 percent will pay an annual premium of 
0.55 percent of the loan balance for 30 years.\104\
    \103\ Foote, supra, at 4.
    \104\ Id.

    B. The Changing Face of FHA

      (1) The 1980's: Coming to Grips With Mortgage Fraud

    Fraud involving FHA-backed mortgages for single-family 
residences, unfortunately, is nothing new. A 1986 HUD/OIG 
semiannual report, for example, described a case in which a 
house in Milwaukee was purchased for $13,950 and resold to an 
unqualified buyer for whom the seller had falsified a gift 
letter as evidence of a down payment to secure an FHA-backed 
mortgage. The buyer defaulted, the lender foreclosed on the 
house, and the FHA insurance fund suffered a loss of 
$43,100.\105\ (This case looks very much like the mid/late-
1990's case studies identified by the Subcommittee's 
investigation.) Another type of scheme that was prevalent in 
the 1980's involved ``equity skimming.'' Equity skimming is the 
term used to describe frauds in which an investor who acquires 
a property, rents it to tenants, and then collects rent 
payments while not making the mortgage payments. The investor 
eventually allows the property to go into foreclosure, but only 
after he has collected enough rent to amortize his equity in 
the property.\106\
    \105\ Office of the Inspector General, U.S. Department of Housing 
and Urban Development, Semiannual Report to the Congress (October 1, 
1985-March 31, 1986) [hereinafter ``HUD/OIG, 1985-86 Semiannual''], at 
    \106\ Office of the Inspector General, U.S. Department of Housing 
and Urban Development, Semiannual Report to the Congress (April 1986-
September 1986), at 5.
    In response to such reports of widespread and growing abuse 
of the FHA mortgage program, HUD Secretary Samuel Pierce 
announced the formation of HUD's Single Family Task Force in 
fiscal year 1985. The mission of the Task Force was to conduct 
reviews of single family policy issues and analyze data from 
loans endorsed since 1980. On April 3, 1986, Secretary Pierce 
announced that the Task Force had issued a report recommending, 
among other things, that: (i) HUD should aggressively pursue 
sanctions against those who abuse HUD programs, including 
seeking deficiency judgments against defaulting mortgagors; 
(ii) HUD should publicize actions taken against mortgagors, 
mortgagees, and others who abuse HUD programs; and (iii) the 
Mortgagee Review Board should take a firmer stand against 
mortgagees who violate HUD programs.\107\
    \107\ HUD/OIG, 1985-86 Semiannual, supra, at 7.
    In addition to implementing the Task Force recommendations, 
the HUD Office of Housing issued internal directives requiring 
closer monitoring of early defaults on FHA-backed mortgages and 
lender claims as a means of detecting fraudulent schemes.\108\ 
The Office of Housing duly stepped up its enforcement efforts 
in order to focus quickly upon imprudent lenders and other 
parties, and to impose stringent monetary and administrative 
sanctions. That office also agreed to make instrumental 
programmatic changes to curb fraud, such as requiring detailed 
reviews of mortgage applications for previously owned HUD 
properties and eliminating a property owner's ability to 
refinance his mortgage by taking all the cash equity out of a 
    \108\ The Office of Housing is the office within HUD--under the 
direction of the Under Secretary for Housing/Federal Housing 
Commissioner--that carries out FHA programs.
    \109\ 1985-86 Semianual, supra, at 8.

      (2) LProblems With the ``Reinvention'' of HUD Under the 
Clinton Administration

    A number of developments have occurred since 1992 that 
gravely damaged the monitoring and oversight systems HUD had 
implemented in order to protect its Single Family Insured 
Programs against fraud and abuse. In February 1993--in the 
first flush of ``Reinventing Government'' enthusiasms promoted 
by Vice President Gore--HUD Secretary Henry Cisneros initiated 
a ``reinvention'' effort to make HUD more efficient and, 
apparently more importantly, to show Congress that HUD should 
not simply be dismantled.
        (a) LLiberalization of Controls Over Direct Endorsement 

    In 1995, FHA issued Mortgagee Letter 95-7, which 
significantly liberalized Direct Endorsement lender 
underwriting requirements.\110\ HUD claimed that these changes 
would eliminate unnecessary barriers to home ownership, provide 
the flexibility to underwrite creditworthy nontraditional and 
underserved borrowers, and clarify certain underwriting 
requirements so that they are not applied in a discriminatory 
manner.\111\ Significant changes implemented by this letter 
included the following:
    \110\ HUD/OIG, Single Family Production Home Ownership Centers, 
supra, at 1.
    \111\ U.S. Department of Housing and Urban Development, Mortgagee 
Letter 95-7 (January 27, 1995), at 1-6.

         LElimination of 5-year test for income 
        stability: Previously, only those sources of income 
        reasonably expected to last for at least 5 years could 
        be included in determining the borrower's income for 
        qualifying purposes. The letter reduced this standard 
        to an income expectation of 3 years.\112\
    \112\ Id. at 1.

         LRecognizing income from overtime and bonuses: 
        Previously, bonuses and overtime over a 2-year period 
        (received or expected) could be counted as income. 
        After the promulgation of Mortgagee Letter 95-7, 
        periods of less than 2 years could be considered for 
        income calculations.\113\
    \113\ Id. at 1-2.

         LRecognition of part-time income: Jobs 
        consisting of less than a 40-hour work week can now be 
        considered for income calculations. (The lender must 
        determine, however, that the continuance of this income 
        is likely.) \114\
    \114\ Id. at 2.

         LElimination of child care as recurring debt: 
        Child care is no longer considered in the computation 
        of debt-to-income ratios because, according to HUD, 
        most families assessing their financial priorities will 
        find alternate means of caring for their young children 
        if such costs become burdensome.\115\
    \115\ Id. at 2.

         LUse of automated underwriting systems and use 
        of artificial intelligence in underwriting: HUD 
        approved lenders were also given permission to use 
        automated underwriting systems for approving FHA-
        insured mortgages as long as the criteria were met for 
        loan approval. (Artificial intelligence systems may be 
        used for loan approvals only, and loans rejected by an 
        artificial intelligence system must be reviewed by a 
        human underwriter.) A DE underwriter must still execute 
        the normal documents required on FHA-insured 
    \116\ Id. at 4.

         LDE approval for branch offices: Once a lender 
        obtains unconditional DE status for any one of its 
        offices, additional branch offices that become approved 
        to do business with HUD are now automatically granted 
        DE approval.\117\
    \117\ Id. at 5.

         LAlternative documentation--revised 
        instructions: If a former employer is no longer in 
        business at the time of the underwriting, and if a 
        verification of past employment cannot thus be made, 
        the underwriter need only verify by telephone all 
        current employment. Also, the requirement that the 
        lender obtain bank statements covering the most recent 
        3-month period for bank statement transactions can now 
        be met merely by obtaining the two most recent two bank 
        statements. (The lender may also utilize an electronic 
        retrieval service for W-2 and tax return information, 
        although it cannot charge the borrower for this 
        service.) \118\
    \118\ Id.

        (b) HUD 2020 Management Reform Plan

    The HUD ``reinvention'' effort expanded further--with 
rather problematic results--under Secretary Andrew Cuomo. On 
June 26, 1997, Secretary Cuomo announced a new management 
reform plan for HUD.\119\ The plan--dubbed ``HUD 2020''--aimed 
to transform HUD from what Cuomo called ``the poster child for 
inept government that has been plagued for years by scandal and 
mismanagement'' into ``a new HUD, a HUD that works.'' \120\ The 
2020 Management Reform Plan included several specific steps: 
The creation of a new Enforcement Division to fight waste, 
fraud, and abuse; the consolidation of over 300 HUD programs 
and activities into 71; the establishment of a new financial 
information management system; and the reduction of the size of 
HUD's staff from 10,500 to 7,500 by the end of the year 2000. 
In addition, the 2020 Management Reform Plan called for the 
consolidation of all single-family operations from 81 locations 
across the country into three Home Ownership Centers (HOCs). 
(The number of HOCs was later increased to four; they are 
presently located in Philadelphia, Pennsylvania, in Atlanta, 
Georgia, in Denver, Colorado, and in Santa Ana, California.)
    \119\ U.S. Department of Housing and Urban Development, press 
release, ``Cuomo Announces Historic Management Reforms For HUD To Stamp 
Out Waste, Fraud and Abuse and Improve Performance'' (June 26, 1997), 
http://www.hud.gov/pressrel/pr97-109.html, at 1.
    \120\ Id.
    The Real Estate Assessment Center (REAC) is responsible for 
assessing the overall physical and financial condition of HUD's 
vast housing portfolio, theoretically enabling HUD better to 
target its monitoring and enforcement resources. Because other 
HUD organizations are so dependent upon its work, REAC was the 
linchpin of HUD's 2020 Management Reform Plan.
    REAC's functions regarding HUD's Single Family Insured 
Programs, however, are largely limited to appraiser oversight. 
REAC's Single Family Appraisal Quality Assessment Team (QAT) 
conducts reviews of appraisals for FHA-insured single family 
homes. The reviews assess the accuracy and completeness of FHA 
appraisal reports in order to reduce the probability of costly 
and unexpected repairs to home buyers. (Inadequate appraisals 
make it that much harder for home buyers to become aware of 
extensive repairs that may be required to make their homes 
habitable. If they purchase housing in ignorance of such 
defects, they may be unable to afford the costs these problems 
impose, and are thus much more likely subsequently to default 
on their FHA-insured mortgages.) In addition, the QAT created a 
standard for appraisal knowledge by requiring appraisers to 
pass the FHA appraiser examination in order to be eligible to 
perform FHA appraisals. These activities support the reforms 
initiated in the Homebuyer Protection Plan, which 
``reinvented'' FHA's appraisal process.\121\
    \121\ U.S. Department of Housing and Urban Development, Single 
Family Appraisal Quality Assessment (visited June 19, 2000), http://
www.hud.gov/reac/products/prodsfa/cfm, at 1.

        (c) Soaring Defaults and Foreclosures

    Between fiscal years 1997 and 1999, the number of single 
family mortgage loans that FHA insured grew from approximately 
800,000 to nearly 1.3 million--a 63 percent increase. (For 
these 3 years combined, FHA insured over 3 million mortgages 
with a total value of $292 billion.) \122\ This dramatic 
increase in endorsements, however, has been accompanied by a 
similar increase in delinquency and foreclosure rates. In fact, 
as the HUD/OIG reported in 2000, there has been
    \122\ U.S. General Accounting Office, Oversight of FHA Lenders: 
Single Family Housing, GAO/RCED-00-112 (April 28, 2000), at 6.

        L``an increase of over 50 percent in FHA loan 
        foreclosure rates over the last 5 years from 1.45 
        percent in 1994 to 2.20 percent through three quarters 
        of 1999. Similarly, Mortgage Banker Association data 
        shows an increase of over 18 percent in FHA delinquency 
        rates (from 7.26 percent to 8.57 percent) during the 
        same period.'' \123\
    \123\ HUD/OIG, Single Family Production Home Ownership Centers, 
supra, at iii.

The Mortgage Bankers Association National Delinquency Survey 
report for the fourth quarter of 1999 explains further that,

        L``[t]he inventory of loans in foreclosure at the end 
        of the quarter declined for conventional loans, but 
        rose for FHA and VA loans. The percentage of FHA loans 
        in foreclosure increased 3 basis points to 2.01 
        percent.'' \124\
    \124\ Mortgage Bankers Association, National Delinquency Survey for 
the 4th Quarter of 1999 (last modified March 29, 2000), http://
www.mbaa.org/marketdata/nds/0499.html, at 1.

Thus, although FHA points to the aggregate increase in American 
home ownership as a measure of success, the associated rise in 
defaults and foreclosures HUD has permitted through lax 
oversight suggests that FHA is subjecting the MMIF to greater 
risks by endorsing mortgages made to unqualified borrowers. 
Findings by both the U.S. General Accounting Office and HUD's/
OIG support this conclusion.

    (d) HUD's Response

    In response to these criticisms, then-Secretary Cuomo 
simply denied the accuracy of the figures produced by MBA, and 
quoted by the OIG, that indicate this steady rise in FHA 
defaults and foreclosures. Implicitly acknowledging the 
criticism, however, HUD has announced a series of programs 
designed to curb fraud and waste in the Single Family Insured 
Program, as follows:

          (i) Loss Mitigation Program

    Until April 1996, FHA-insured homeowners who encountered 
financial difficulties had the benefit of the FHA Assignment 
Program, which was designed to provide temporary relief for 
mortgagors who experience financial difficulties resulting in 
mortgage default. The relief offered by this program was in the 
form of a mortgage assignment to HUD with a forbearance plan 
that offered reduced or suspended payments for a period of up 
to 36 months.
    The Assignment Program was terminated in April 1996 by the 
Balanced Budget Downpayment Act. Its replacement, FHA's Loss 
Mitigation Program, is designed to reduce the number of 
foreclosures and the costs associated with foreclosures. Under 
this program, lenders are compensated for using one of five 
loss mitigation tools to help borrowers in default avoid 

         LSpecial forbearance: This allows a period of 
        reduced (or even suspended) payments for the borrower, 
        and is designed to provide relief to borrowers with 
        temporary financial problems.

         LMortgage Modification: This results in the 
        lowering of the interest rate, or the extension of the 
        term of the mortgage, so as to reduce monthly payments 
        to affordable levels for the mortgagor. Mortgage 
        modifications are designed for borrowers who have 
        recovered from financial distress, but whose net income 
        has permanently dropped from its level prior to 

         LPartial claim: This provides what is 
        essentially a second loan on the property. In such 
        cases, FHA pays the amount necessary to cure the 
        default, and a promissory note is issued to secure 
        repayment of the partial claim. The second loan is 
        interest free, and need not be paid until the first 
        mortgage matures, is prepaid, or the borrower vacates 
        the property.

         LPreforeclosure sale: In these cases, a 
        borrower's home is sold prior to foreclosure and the 
        borrower is relieved of his mortgage obligation. The 
        borrower's debt is forgiven.

         LDeed-in-lieu of foreclosure: This provides 
        for voluntary transfer of the deed to the lender; used 
        primarily when pre-foreclosure sale fails.\125\
    \125\ Office of the Inspector General, U.S. Department of Housing 
and Urban Development, Audit Report # 99-DE-121-0001, Department of 
Housing and Urban Development's Loss Mitigation Program (September 30, 
1999) [hereinafter ``HUD/OIG Loss Mitigation Program''], at 1.

As part of the HUD 2020 Management Reform, the National 
Servicing and Loss Mitigation Center became fully operational 
in Oklahoma City in February 1998. This Center consolidated 
HUD's loss mitigation function into a single centralized office 
and created a single point of contact for lenders and 
    \126\ Office of the Inspector General, U.S. Department of Housing 
and Urban Development, Semiannual Report to the Congress (April 1, 
1999-September 30, 1999), at 10.
    Unfortunately, HUD had difficulty in ensuring proper 
oversight even over the programs it developed in order to 
mitigate the foreclosure problems caused by its failure 
properly to oversee its FHA-backed single-family loan program. 
A September 1999 HUD Office of the Inspector General (HUD/OIG) 
report, for example, found that the utilization of home 
retention and loss mitigation tools had increased dramatically 
in the preceding year. The report, however, also found a lack 
of program oversight and weaknesses in the monitoring of 
mortgagees.\127\ Specifically, the report found that HUD needed 
to improve its review of loss mitigation claims, and its 
monitoring and oversight of lenders' use of loss mitigation 
tools. Furthermore, the HUD/OIG also raised concerns that HUD's 
ability to effectively monitor the FHA loan portfolio is 
compromised because of inaccurate and incomplete information 
contained within its Single Family Default Monitoring System 
(SFDMS).\128\ Unreliable default status information, which it 
transmitted by servicing mortgagees to HUD, clearly makes it 
difficult to assess the potential risk and cost to the FHA 
insurance fund.
    \127\ HUD/OIG, Loss Mitigation Program, supra, at i.
    \128\ Servicing lenders must report to HUD monthly on the current 
status of all loans that are in default for 90 days or more. The SFDMS 
is the only database that stores and maintains default status codes. 
HUD's only other means of obtaining default status data is from the 
Government National Mortgage Association default data, which is 
compiled on a quarterly basis, or by calling the lender directly to 
determine the status of individual FHA loans. See generally HUD/OIG, 
Loss Mitigation Program, supra, at 23-24.

          (ii) Credit Watch

    Credit Watch is a computer system HUD implemented in May 
1999 to evaluate the performance of lenders and track loans 
they have made so that, even when a loan is sold to another 
lender and later goes into default, the originating lender for 
that loan will be credited with the default.\129\ Credit Watch 
is designed to enable HUD to terminate the loan origination 
authority of lenders with excessive defaults and insurance 
claims on FHA-insured mortgages. Pursuant to the program, HUD 
may terminate the loan origination authority of any lender 
whose default and claim rates on FHA-insured mortgages during 
the preceding 24 months exceeds both the national average and 
300 percent of the average rate for the HOC serving the 
lender's geographic location. (Similarly, HUD may place on 
``credit watch'' the lenders whose default and claim rates 
exceeds both the national average and 200 percent of the 
corresponding HUD field office average.) While on credit watch, 
a lender can continue to originate FHA-insured loans, but its 
performance receives greater scrutiny from HUD. Because the 
program regulations pertain only to lenders that originated the 
troubled loans, however, HUD does not always hold accountable 
the DE lenders that underwrote and approved the loans.
    \129\  William Apgar, Federal Housing Commissioner, U.S. Department 
of Housing and Urban Development, remarks at HUD/OIG Manager's 
Conference (June 7, 2000).
    The first round of Credit Watch terminations occurred on 
September 15, 1999, when HUD ended its relationship with 26 FHA 
lenders because they had default/claim rates that exceeded the 
national rate and 300 percent of the HOC rate. Another 100 
lenders were placed on the Credit Watch list for monitoring. 
One of the 26 FHA lenders, Capitol Mortgage Banks, Inc., 
however, successfully challenged HUD's authority to take this 
action in Federal court in Baltimore.\130\ Specifically, the 
court found that FHA exceeded its authority in terminating that 
lender, and declared the Credit Watch basis for termination was 
unlawful and invalid. The court also ruled that HUD must in the 
future give lenders an opportunity to take corrective action 
before termination occurs. For these reasons, the court ordered 
the reinstatement of Capitol Mortgage Bankers as an FHA-
approved lender.
    \130\ See Capitol Mortgage Banker, Inc. v. Cuomo, 77 F.Supp. 690 
(D.Md. 1999).
    The decision was appealed by HUD, and in September 2000, 
the Fourth Circuit Court of Appeals in Richmond, Virginia ruled 
that HUD had acted appropriately and overturned the District 
Court decision. In July 2001, the Senate Appropriations 
Committee included language in the fiscal year 2002 Veterans 
Affairs-HUD Appropriations Bill, S. 1216, that would allow HUD 
to review early defaults and claims, and if appropriate, result 
in the automatic suspension or termination of poor performing 

          (iii) The Homebuyer Protection Plan

    In June 1998, HUD announced a new Homebuyer Protection Plan 
``to improve home appraisals for over 1 million families who 
purchase homes each year with HUD-insured mortgages.'' \131\ 
HUD described this plan as featuring six key components:
    \131\ U.S. Department of Housing and Urban Development, press 
release, ``Cuomo Announces New Initiative to Protect Consumers from 
Buying HUD-Insured Homes with Undetected Defects'' (June 10, 1999) 
[hereinafter ``June 10, 1999 press release''] http://www.hud.gov/
pressrel/pr99-99.html. at 1

         LA new consumer education campaign about 
        appraisals and inspections conducted by HUD, the 
        National Association of Realtors, and the Mortgage 
        Bankers Association of America.\132\
    \132\ June 10, 1999 press release, supra, at 1.

         LMandatory testing of all appraisers to 
        determine whether they are qualified to perform FHA 
        appraisals. Approximately 30,000 private appraisers 
        around the Nation, who perform mandatory appraisals 
        before the sale of every home financed with an FHA 
        mortgage, will be tested. Appraisers failing this test 
        will not be certified to perform FHA appraisals until 
        they pass the exam, which is intended to help ensure 
        that appraisers know and understand FHA 
    \133\ Id.

         LMore thorough and reliable appraisals 
        designed to uncover significant defects in homes.\134\ 
        HUD sought to accomplish this change through revision 
        of its comprehensive valuation package (CVP), which 
        consists of three parts. Its first part is the Uniform 
        Residential Appraisal Report (URAR), which was not 
        modified. The second part is the ``Valuation 
        Conditions--Notice to the Lender'' form (``VC sheet''), 
        which the appraiser is required to complete to reflect 
        readily observable information relevant in determining 
        the property's ``as-repaired'' value. HUD revised the 
        VC sheet to reflect more specific conditions relevant 
        to determining whether the property meets HUD's Minimum 
        Property Standards or Requirements (MPS/MPR), but HUD 
        nevertheless maintains that the requirements of the new 
        VC sheet are not materially different from the previous 
        version of the VC sheet.\135\ The third and final part 
        is the Homebuyer Summary, which the appraiser must 
        prepare if he notes any MPS/MPR nonconformity on the 
    \134\ Id.
    \135\ Office of the Assistant Secretary for Housing-Federal Housing 
Commissioner, U.S. Department of Housing and Urban Development, 
Mortgagee Letter 99-32 (November 12, 1999) [hereinafter ``Mortgagee 
Letter 99-32''], http://www.hudclips.org/sub--nonhud...MLET&u=./
hudclips.cgi&p=1&r=28&f=G, at 1.

         LMandatory disclosure of detected home defects 
        to home buyers through the Homebuyer Summary.\136\ The 
        appraiser must sign the Homebuyer Summary and provide 
        it as part of the CVP to the lender. The lender is then 
        responsible for providing each prospective borrower 
        with the Homebuyer Summary when the appraiser has noted 
        a nonconformity on the property. The lender's Direct 
        Endorsement underwriter must review the Homebuyer 
        Summary to assure that it is complete. Borrowers must 
        receive the Homebuyer Summary at least 5 days prior to 
        the loan closing, and must sign and date it to 
        acknowledge their receipt. (The lender must also 
        include a copy of the summary in the case binder it 
        submits to FHA for insurance endorsement.) Repair items 
        must be completed prior to the loan closing.\137\
    \136\ June 10, 1999 press release, supra, at 1.
    \137\ Office of the Assistant Secretary for Housing-Federal Housing 
Commissioner, U.S. Department of Housing and Urban Development, 
Mortgagee Letter 99-18 (June 28, 1999) [hereinafter ``Mortgagee Letter 
99-18''], http://www.hudclips.org/sub--nonhud...MLET&u=./
hudclips.cgi&p=1&r=43&f=G, at 2.

         LAutomated evaluation of appraisals. HUD will 
        establish a system that enables it to collect appraisal 
        data electronically and to track trends in appraisal 
        quality. The new system is designed to enable HUD to 
        perform high-speed computer-generated reviews of the 
        performance of all appraisers, so that appraisers found 
        to make inaccurate appraisals can be spotted and 
        targeted for further review and possible enforcement 
        action. HUD has developed a series of statistical 
        indicators to help target its appraiser oversight 
        activities, particularly its field review activities. 
        These indicators work by comparing home values derived 
        by appraisers and the techniques used to establish the 
        values. Individual indicators are then combined into a 
        single appraisal score using a statistically-derived 
        weighting system.\138\
    \138\ June 10, 1999 press release, supra, at 1.

         LStricter enforcement action to suspend poorly 
        performing appraisers from working for FHA.\139\
    \139\ Id.

    Although at the time of its announcement, HUD planned to 
phase in all aspects of the Homebuyer Protection Plan ``over 
the next few weeks[,]'' \140\ HUD ultimately delayed until 
March 1, 2000 implementation of the regulatory changes relating 
to its enforcement actions against appraisers who perform 
appraisals that are not in compliance with FHA 
    \140\ Id.
    \141\ Mortgagee Letter 99-32, supra, at 2
    In addition, under HUD's plan, home buyers are now required 
to sign and date a new informational form entitled, ``For Your 
Protection: Get a Home Inspection,'' before they purchase a 
home with an FHA mortgage.\142\ (This form replaced the 
``Importance of Home Inspections'' form that was previously 
required.) According to HUD, this new form ``advises [home 
buyers] in plain English to get a home inspection in addition 
to an appraisal.'' \143\ It informs buyers that FHA does not 
guarantee the value or condition of the property, that an 
appraisal is not a home inspection, and that the borrower has 
the right to have the house inspected by a professional home 
inspector. For all transactions involving FHA mortgage 
insurance on existing property, the home buyer must sign and 
date this form on or before the date that the sales contract is 
executed. The lender must also include a copy of the signed and 
dated form in the case binder it submits to FHA for insurance 
    \142\ Mortgagee Letter 99-18, supra, at 2.
    \143\ June 10, 1999 press release, supra, at 1.
    \144\ Mortgagee Letter 99-18, supra, at 2-3.

          (iv) Fraud Protection Plan

    HUD's Fraud Protection Plan is an outgrowth of its 
Baltimore Task Force. Working with Senator Mikulski as a result 
of constituent complaints and reports that appeared in the 
Baltimore Sun, HUD launched the Baltimore Task Force in April 
2000. Its purpose was to gather information on the cause and 
extent of mortgage frauds and resulting foreclosures, and to 
develop recommendations that would both benefit Baltimore and 
serve as a model for FHA programmatic reform throughout the 
Nation. FHA declared a 90-day moratorium on foreclosures of 
FHA-insured loans in Baltimore, which enabled HUD to send a so-
called ``SWAT Team'' of departmental officials to Baltimore to 
identify fraud or predatory practices involved in FHA-backed 
loans before foreclosures and to help as many homeowners as 
possible avoid foreclosures. HUD staff intensively reviewed 
case files for the 350 FHA borrowers in Baltimore who had 
received a notice of intent to foreclose after January 1, 2000, 
and found evidence of fraud or predatory lending in 50 to 60 
cases. To help defaulting Baltimore homeowners avoid 
foreclosure, FHA attempted to contact all borrowers facing 
impending foreclosures in order to better focus resources on 
loss mitigation assistance. In ``Hot Zone'' areas, which it 
defines as areas with high concentrations of FHA foreclosures, 
FHA undertook to establish teams of loss mitigation specialists 
to work with lenders and borrowers to ensure that every effort 
is made to help families remain in their homes. In addition, 
FHA contacted the corresponding lender for each borrower to 
ensure that the lenders were properly evaluating borrowers and 
offering appropriate foreclosure avoidance options.
    At its public forum in Baltimore on May 19, 2000, HUD 
announced its Fraud Protection Plan, which seeks to apply the 
Baltimore Task Force's recommendations to the rest of the 
country. The Plan has two primary foci: (1) Providing relief to 
FHA borrowers who are already in default, especially those who 
have been victimized by abusive lending practices; and (2) 
strengthening FHA endorsement and fraud detection procedures to 
prevent predatory practices from occurring in the first place.
    To achieve its first goal of assisting FHA borrowers 
already in default, HUD proposed to issue vouchers for fund 
foreclosure avoidance counseling at HUD-approved locations. By 
expanding the availability and improving the quality of such 
counseling, HUD sought to help homeowners make better use of 
currently available loss mitigation tools, such as mortgage 
modification and partial loan forgiveness.
    For FHA borrowers saddled with inflated mortgages that stem 
from inflated appraisals, HUD plans to direct mortgage lenders 
to write down their mortgages to a level consistent with fair 
market appraisals. In situations where the lender refuses to 
honor this demand, FHA intends to intervene, cancel the 
existing mortgage, and refinance the property with a mortgage 
at the fair market value. The FHA insurance fund would bear the 
cost of redeeming the mortgage at the fair market value, and it 
is estimated that the cost in Baltimore alone could reach $30 
million. In addition, HUD will instruct lenders to issue a 
``credit repair'' letter, which is designed to help ensure that 
the victim's credit record is not harmed simply because the 
victim fell prey to fraud and predatory lending practices. HUD 
also intends to send teams of loss mitigation specialists to 
``Hot Zones'' with high default and foreclosure rates, in order 
to ensure that every effort is made to help families remain in 
their homes.
    To achieve its second goal of stopping predatory practices 
from undermining FHA's ability to promote housing opportunity, 
FHA will implement an automated system to review the sales 
price history of properties prior to FHA insurance endorsement. 
This may be one of the Plan's most promising initiatives, 
insofar as such a system would reveal when a house purchased 
for a very low price is quickly resold for a much higher price. 
Through such tracking of the warning signs of a potential 
``flip,'' officials would be able to intervene much more 
rapidly to both protect victims and punish wrongdoers. In 
addition, FHA will form additional ``SWAT Teams,'' modeled on 
the Baltimore effort, to target abusive appraisal practices in 
Hot Zones around the country. (FHA also intends to suspend 
abusive real estate brokers from future participation in FHA 
programs, although it has not provided any specific information 
regarding how it plans to accomplish these suspensions.) 
Additionally, FHA intends to study its data on housing sales 
with an eye to developing early warning indicators of 
foreclosure ``Hot Zones.''
    Finally, FHA is launching a new Appraisal Watch system 
modeled after the Credit Watch system now targeted to lenders. 
The goal of Appraisal Watch is to identify appraisers with a 
record of faulty appraisals and abusive practices, terminate 
them from FHA programs, and, if appropriate, pursue legal 

          (v) Mortgage Credit Scorecard Project

    The Mortgage Credit Scorecard Project is a new automated 
underwriting system that gives credit scores for lenders. To 
accomplish this, it establishes lender profiles to be used to 
evaluate loan information that has been entered into the 
automated underwriting system. At present, one third of all FHA 
loans are processed through this system, and the number of 
mortgages processed through the system is expected to increase 
to 50 percent within the next year.\145\ (According to HUD, 
this reform is still in the ``drawing board'' stage.\146\)
    \145\ Federal Housing Administrator William Apgar, remarks at HUD/
OIG Manager's Conference (June 7, 2000).
    \146\ Subcommittee staff telephone interview with Judy Heaney, 
Community Builder, U.S. Department of Housing and Urban Development, 
Chicago, Illinois (June 16, 2000).

V. Agency Criticisms of HUD

    A. General Accounting Office

          (1) GAO on HUD's Lack of Lender Oversight

    Recent cases of mortgage fraud across the country have 
raised concerns about HUD's oversight of FHA-insured lenders. 
For example, in December 1999, HUD's Office of the Inspector 
General and the Department of Justice announced criminal 
charges against 39 California mortgage lenders, real estate 
professionals, and other persons they accused of obtaining more 
than $110 million in fraudulent FHA-insured loans. At the 
request of Senator Collins and Representative Rick Lazio (R-
NY), GAO prepared a report entitled, ``Single Family Housing: 
Stronger Oversight of FHA Lenders Could Reduce HUD's Insurance 
    GAO's report addressed the following questions: (1) How 
well does HUD ensure that lenders granted DE authority by FHA 
are qualified to receive such authority? (2) To what extent 
does HUD focus on high-risk lenders in monitoring the lenders 
participating in FHA's mortgage insurance programs? (3) To what 
extent is HUD holding lenders accountable for poor performance? 
To address these questions, GAO reviewed the activities of HUD 
headquarters and its four Home Ownership Centers located in 
Atlanta, Georgia; Denver, Colorado; Philadelphia, Pennsylvania; 
and Santa Ana, California.

        (a) Approval of Lenders to Receive DE Authority

    HUD's process for granting FHA-approved lenders DE 
authority provides limited assurance that lenders receiving 
this authority are in fact qualified. According to HUD's 
guidance, FHA-approved lenders seeking DE authority must 
demonstrate ``acceptable performance'' in underwriting at least 
15 mortgage loans, which undergo evaluations, known as 
preclosing reviews, by HUD's HOCs. The guidance does not, 
however, define what would constitute overall acceptable 
performance on the 15 loans.
    In the absence of such a clear definition, the various HOCs 
have interpreted what constitutes acceptable performance 
differently, and their standards for approving lenders for DE 
authority have thus been inconsistent. In the 6 months prior to 
GAO's 1999 visits, for instance, the HOCs granted DE authority 
to a total of 36 lenders. While many of these lenders had 
demonstrated proficiency in underwriting mortgages, many others 
made multiple and serious underwriting errors. Overall, 12 of 
the 36 lenders had received 4 or more ``poor'' ratings from the 
HOCs for their last 15 preclosing reviews.
    According to GAO, the vagueness and inconsistent 
application of HUD's approval standards constitutes a risk to 
the insurance program. GAO recommended that HUD improve the 
process for granting lenders DE authority by developing 
specific standards for overall acceptable performance in pre-
closing reviews and ensuring that the HOCs comply with these 

        (b) Monitoring of Lenders

          (i) On-Site Lender Reviews

    Contrary to HUD's guidance, the HOCs' monitoring of lenders 
does not adequately focus on the lenders and loans that pose 
the greatest insurance risks to HUD. On-site evaluations of 
lenders' operations--known as lender reviews--are one of HUD's 
primary tools for assessing the quality of lenders' mortgage-
lending practices. HUD's guidance states that 85 percent of the 
lender reviews should be targeted at high risk lenders, while 
15 percent should be selected randomly. HUD's guidance also 
stresses the importance of using risk analysis to allocate a 
larger share of monitoring resources to program activities that 
pose the highest risk to HUD. GAO found that lender reviews by 
HUD have increased in recent years, as HUD has placed greater 
emphasis on performing on-site evaluations of lenders' 
    Nevertheless, GAO found that the HOCs have often not 
bothered to review the lenders and loans that they themselves 
consider to present the highest risks. For example, although 
the Philadelphia HOC conducted reviews of 228 lenders during 
fiscal year 1999, it reviewed only 39 of the 131 high-risk 
lenders (about 30 percent) that it had designated as high 
priorities for review that year. HUD officials told GAO that 
the lack of experienced staff and limited travel funds impeded 
HUD's ability to visit and review the riskiest lenders--
although the HOC apparently had no problem devoting staff and 
financial resources to reviewing 189 lower-risk lenders instead 
of increasing the proportion of high-risk ones it evaluated. 
GAO also noted that HUD placed too much emphasis upon meeting 
numeric goals (e.g., being able to claim a higher aggregate 
number of lenders reviewed) instead of actually targeting high-
risk loans. GAO recommended that HUD more effectively monitor 
lenders' performance by developing procedures to identify and 
prioritize high-risk lenders for review and ensuring that the 
HOCs consistently apply these procedures.

          (ii) Post-Endorsement Technical Reviews

    Desk audits to evaluate the underwriting quality of 
individual loans already committed to FHA insurance by DE 
lenders--known as post-endorsement technical reviews--are 
another important lender oversight tool. The large majority of 
HUD's technical reviews are performed by firms under contract 
with the HOCs. Technical reviews that reveal deficiencies may 
result in HUD requiring the lenders to compensate it for 
financial losses, or in HUD simply suspending the lenders' DE 
    Although all four HOCs met HUD's goal to perform technical 
reviews of no less than 10 percent of all loans insured in 
fiscal year 1999, they generally did not target these reviews 
either toward loans that exhibit high-risk characteristics, or 
toward loans that were made by high-risk lenders, such as those 
with known performance problems. The HOCs also did not comply 
with HUD guidance specifying that all loans by newly approved 
DE lenders should be subject to technical reviews. As a result, 
according to GAO, underwriting practices that significantly 
increase HUD's insurance risk may be going undetected.
    One reason for this failure to target risky loans and 
lenders is that HUD's computer system currently cannot 
automatically identify and select high-risk loans for review. 
HUD has advised GAO that it is developing a ``mortgage 
scorecard'' computer system which, it believes, will make 
identification of high-risk loans easier.
    Another problem GAO found concerned HUD's oversight of the 
contractors that conduct the bulk of its technical reviews. 
Each such contract contains specific performance standards 
expressed as the maximum accepted percentage of reviews that 
can contain significant errors, or omissions. GAO found that 
three of the four HOCs were not tracking the contractors' work 
against these standards. Without this information, the HOCs 
were not in a position to provide the contractors with adequate 
performance feedback or, if necessary, to enforce the 
contracts' performance clauses.
    GAO recommended that HUD develop procedures and enhance 
FHA's management information systems in order to identify and 
select for technical review loans and lenders within each HOC 
jurisdiction that pose a high insurance risk to HUD. GAO also 
recommended that HUD comply with guidance to perform technical 
reviews of all the FHA-insured loans that are made by lenders 
that possess newly granted DE authority. In addition, GAO 
recommended that HUD track the performance of contractors 
conducting technical reviews against performance standards in 
the contracts, and take appropriate actions against contractors 
whose performance is not acceptable.

        (c) Enforcement Actions Against Lenders

    To hold lenders accountable for program violations or poor 
performance, HUD may (1) suspend their DE authority, (2) 
terminate their loan origination authority through its Credit 
Watch program, or (3) take enforcement action through its 
Mortgagee Review Board. Despite the availability of these 
measures, GAO found that HUD has not taken sufficient steps to 
hold lenders accountable for poor performance and program 

          (i) Suspension of DE Authority

    Although HUD's guidance allows the HOCs to suspend the DE 
authority of lenders who fail to comply with FHA's underwriting 
requirements, the HOCs have made only limited use of this 
authority. In fiscal year 1999, for example, the Philadelphia 
HOC suspended the DE authority of eight lenders--but it was the 
only HOC to suspend any lenders. Furthermore, HUD's technical 
review ratings for fiscal year 1999 showed that lenders 
frequently failed to comply with FHA's requirements, suggesting 
that many other lenders may by candidates for suspension.
    GAO also found that the HOCs had not developed consistent 
criteria for evaluating lenders' ratings for mortgage credit 
analysis and suspending lenders' DE authority. Nearly 20 
percent of the loans subject to HUD technical reviews received 
``poor'' ratings for mortgage credit analysis, meaning that the 
lenders were found to have made mistakes in evaluating the 
borrowers' credit worthiness that significantly increased HUD's 
insurance risk. This proportion, however, apparently 
understates the problem. In its own assessment, GAO identified 
206 lenders that received ``poor'' ratings for their mortgage 
credit decisions in more than 30 percent of the loans HUD 
reviewed in fiscal year 1999. On the basis of this sample, a 
HUD review of all of the lenders' fiscal year 1999 loans should 
have found that the percentage of poor ratings exceeded 30 
    Despite the high proportion of ``poor'' ratings, moreover, 
the HOCs took little action against the problem lenders. Of the 
206 lenders identified by GAO as having received poor ratings, 
131 had made 10 or more FHA-insured loans in fiscal year 1999. 
As of October 1, 1999, however, the HOCs had not suspended the 
DE authority of any of these 131 problem lenders. Accordingly, 
GAO recommended that HUD strengthen its enforcement efforts by 
clarifying and implementing guidelines for identifying lenders 
whose DE authority should be suspended.

          (ii) Credit Watch

    As noted previously, HUD implemented its Credit Watch 
program in May 1999 in order to terminate the loan origination 
authority of lenders with excessive defaults and insurance 
claims on FHA-insured mortgages. Specifically, HUD planned to 
terminate the loan origination authority of any lender whose 
default and claim rates on mortgages insured by FHA during the 
preceding 24 months exceeded both the national average and 300 
percent of the average rate for the HOC serving the lender's 
geographic location. Similarly, HUD planned to place on 
``credit watch'' status the lenders whose default and claim 
rates exceeded both the national average and 200 percent of the 
corresponding HUD field office average. While on credit watch 
status, a lender can continue to originate FHA-insured loans, 
but its performance receives greater scrutiny from HUD. 
(Because the program regulations pertain only to lenders that 
originated the troubled loans, however, HUD does not always 
hold accountable the DE lenders that underwrote and approved 
the loans.)
    HUD officials recognize that DE lenders contributed to 
excessive defaults and insurance claims, but that the Credit 
Watch program did not extend to DE lenders. HUD officials have 
also indicated that HUD has considered regulatory changes in 
order to solve this problem. Among other issues, the lender 
challenging the program has contended that HUD has exceeded its 
statutory authority when it issued its Credit Watch regulations 
and that the manner in which HUD terminated the lender's 
authority deprived the lender of due process. In October 1999, 
a U.S. District Court ruled that the regulations were invalid 
and set aside HUD's termination decision. The decision was 
appealed by HUD, and in September 2000, the Fourth Circuit 
Court of Appeals in Richmond, Virginia ruled that HUD had acted 
appropriately and overturned the District Court decision.
    In July 2001, the Senate Appropriations Committee included 
language in the fiscal year 2002 Veterans Affairs-HUD 
Appropriations Bill, S. 1216, that would allow HUD to review 
early defaults and claims, and if appropriate, result in the 
automatic suspension or termination of poor performing 
    GAO recommended that, once the legal basis for the Credit 
Watch program is resolved, HUD revise these regulations to 
cover DE lenders that underwrite FHA-insured loans with 
excessive default and claim rates, as well as those lenders who 
originate such loans.

          (iii) Mortgagee Review Board

    HUD's Mortgagee Review Board can impose administrative 
actions against FHA lenders who commit program violations. Most 
of the Board's actions result in settlement agreements, which 
require lenders to indemnify improperly originated loans, pay 
fines, and/or take actions to prevent future lending 
    GAO found, however, that the Mortgagee Review Board's 
process for sanctioning lenders is overly time consuming. 
Administrative actions against FHA lenders who commit program 
violations frequently take more than 1 year to impose. As a 
result, some of these lenders continue making FHA-insured loans 
for 1 year or more after FHA has identified them as violators 
before being held accountable for past violations. HUD does not 
maintain guidelines for the time it should take the Board to 
take enforcement actions against lenders.

        (d) Agency Comments

    HUD responded that, while it did not always agree with the 
GAO report's characterization of its practices and procedures 
for overseeing FHA lenders, it generally agreed with GAO's 
recommendations. Among HUD's specific objections, however, were 
the following:

         LHUD took issue with GAO's statement that its 
        selection of loans for post-endorsement technical 
        review was not based on risk. HUD maintained that it 
        performs technical reviews of all higher default-rate 
        type loans.

         LHUD disagreed with GAO's finding that it was 
        not monitoring the performance of technical review 
        contractors. (GAO responded that it had not, in fact, 
        claimed that HUD did no monitoring.)

         LHUD commented that GAO's discussion of 
        technical lender reviews did not adequately recognize 
        that its targeting guidance requires HOC staff to 
        consider several factors in addition to lenders' 
        default and claim rates.

         LHUD disagreed with GAO's recommendation that 
        it clarify and implement guidelines for identifying 
        lenders whose DE authority should be suspended. HUD 
        said that it has threatened suspension in several dozen 
        cases in an attempt to improve lenders' performance. 
        According to HUD, the threat of a suspension has proven 
        to be a constructive and successful means of improving 
        lenders' performance.

         LFinally, HUD agreed with GAO's recommendation 
        to revise its Credit Watch program to hold both loan 
        underwriters and loan originators accountable for 
        excessive default and claim rates.

      (2) HUD's Lack of Appraiser Oversight

    The purpose of an FHA appraisal, which is required for each 
property the agency insures, is (1) to determine the property's 
eligibility for mortgage insurance on the basis of its 
condition and location, and (2) to estimate the value of the 
property for mortgage insurance purposes. In performing these 
tasks, the appraiser is required to identify any visible 
deficiencies impairing the safety, sanitation, structural 
soundness, and continued marketability of the property and to 
assess the property's compliance with FHA's other minimum 
property standards. According to HUD guidance, if an appraiser 
finds noncompliance with these standards, he should include in 
his appraisal report an appropriate and specific action to 
correct the deficiency.
    On-site assessments of completed appraisals, known as field 
reviews, are HUD's principal tool for monitoring the 
performance of the appraisers on FHA's roster. In conducting a 
field review, a HUD official or contractor visits the appraised 
property to evaluate all aspects of the appraisal, including 
whether the value determination was reasonable and whether all 
needed repairs were identified. The field reviewer is required 
to document these findings on a standard HUD form and recommend 
a score using a scale from 1 to 5 to assess the quality of the 
appraisal (with 1 being unacceptable and 5 being excellent).
    The four Home Ownership Centers are expected to play 
important roles in HUD's oversight of the FHA appraisal 
process. According to HUD, its Real Estate Assessment Center is 
responsible for analyzing and tracking appraisal quality and 
appraiser performance, and its Enforcement Center is 
responsible for sanctioning appraisers, mortgage brokers, and 
lenders who do not comply with HUD's requirements.
    On June 1, 1999, HUD announced a Homebuyer Protection Plan 
that HUD intended to implement in order to improve the FHA 
appraisal process. Specifically, the plan: (1) requires that 
appraisals include a more thorough basic survey of the physical 
condition of homes; (2) requires lenders to inform potential 
home buyers of defects found during appraisals; (3) requires 
appraisers to recommend complete, detailed inspections of homes 
if the appraisers find significant problems with the 
properties; (4) allows up to $300 of home inspection costs to 
be financed through FHA mortgages; and (5) imposes stricter 
accountability on appraisers and tougher sanctions on those who 
act improperly, including fines and potential prison sentences. 
HUD's announcement did not identify a specific timetable for 
implementing the plan.
    Pursuant to a congressional request, GAO reviewed FHA's 
appraisal process, focusing on (a) how HUD ensures that 
appraisers on its roster are qualified to perform FHA 
appraisals; (b) how well HUD is monitoring the performance of 
the appraisers on its roster and implementing procedures for 
addressing consumers'complaints about FHA appraisals; (c) the 
extent to which HUD is holding appraisers accountable for poor-
quality FHA appraisals; and (d) the extent to which HUD is 
holding lenders responsible for the quality of the FHA 
appraisals they use. On April 16, 1999, GAO presented its 
findings in a report entitled, ``Single-Family Housing: 
Weaknesses in HUD's Oversight of the FHA Appraisal Process.''

        (a) LHUD Has Limited Assurance That Appraisers Are 
        Familiar With FHA's Appraisal Requirements

    Only appraisers approved by FHA may evaluate homes for FHA 
insurance endorsement purposes. To be eligible for FHA's roster 
of approved appraisers, appraisers must be State licensed or 
certified in accordance with the minimum criteria established 
by the Appraiser Qualifications Board of the Appraisal 
Foundation. The Qualifications Board's minimum licensing 
criteria require that appraisers have 90 hours of classroom 
education in subjects related to real estate appraisals, have 
2,000 hours of appraisal experience, and pass the 
Qualifications Board's endorsed examination or an equivalent 
    Unlike appraisals for conventional mortgages, appraisals 
for FHA-insured mortgages must include an assessment of the 
properties' compliance with FHA's property standards as well as 
appropriate and specific actions to correct conditions not in 
compliance with these standards. In addition, the value that an 
appraiser assigns to a property must reflect its value with all 
the required repairs completed.
    HUD relies largely on the States' licensing process to 
ensure that appraisers are qualified. The States' minimum 
licensing standards, however, do not include proficiency in 
FHA's appraisal requirements. In conjunction with its Homebuyer 
Protection Plan, HUD developed a new appraisal report, known as 
the ``valuation condition'' report, to record the results of 
appraisals. The new report lists specific physical conditions 
for which the appraiser should check, and requires the 
appraiser to recommend whether a complete home inspection or 
some other type of more specific inspection (e.g., electrical, 
roofing, or structural) should be conducted. HUD will require 
lenders to provide a summary of this appraisal report to home 
buyers so that they will have information about needed repairs 
and recommended inspections.
    HUD has also implemented a requirement that appraisers pass 
a test on FHA appraisal requirements and procedures in order to 
be deemed qualified to appraise FHA-backed properties. Some 
questions remain about the efficacy of this solution, however. 
During the Subcommittee's investigation, staff was informed by 
a number of experienced appraisers that the new FHA-required 
test is much too easy to pass. Moreover, some appraisers were 
permitted to take the test in an ``open book'' setting. Under 
the circumstances, therefore, it is hard to tell whether this 
test will appreciably increase the quality of appraisals at 
FHA-backed properties.

        (b) HUD's Monitoring of Appraisers Is Limited

    GAO found that HUD was not doing a good job of monitoring 
the performance of appraisers, thereby limiting its ability to 
assess the quality of appraisals used to qualify properties for 
FHA-insured loans. For example, the Philadelphia and Denver 
HOCs' records for 126 field reviews that rated appraisals as 
``poor'' showed that HUD nonetheless approved mortgage 
insurance for 96 of the homes covered by these unsatisfactory 
reviews. (In 37 of the 96 cases, the field reviews were 
performed after mortgage insurance had been approved.)
    Specifically, GAO found that weaknesses existed in the 
scope of field review coverage. In September 1997, HUD 
established a policy requiring its field offices and their 
successors, the HOCs, to conduct field reviews of no less than 
10 percent of the appraisals conducted within their 
jurisdictions. In fiscal year 1998, HUD performed about 81,000 
of these reviews, but three out of the four HOCs did not meet 
the 10 percent requirement in fiscal year 1998. HUD also did 
not conduct field reviews of the work of many of the appraisers 
with the highest workloads. For example, HUD did not field 
review the work of thousands of appraisers who conducted 10 or 
more FHA appraisals during the period from October 1, 1997, 
through June 30, 1998. While HUD's procedures do not require 
field reviews for appraisers doing a higher volume of 
appraisals, higher-volume appraisers presumably inherently have 
less time to spend on any particular appraisal. Since HUD never 
bothered to assess the performance of these high-volume 
appraisers, however, it had little assurance that those 
appraisers were conducting accurate and thorough work.
    Philadelphia and Denver HOC officials told GAO that several 
factors contributed to problems with field review coverage. 
These factors included: (1) HUD's reliance upon contractors to 
conduct field reviews and the unavailability of contract funds 
during the first several months of the fiscal year; (2) the 
reassignment of personnel during HUD's reorganization, which, 
in some instances, left no one responsible for ordering field 
reviews; and (3) the lack of emphasis that some field offices 
placed on field reviews once they knew their functions would be 
transferred to the HOCs.
    GAO also found that many field reviews were not timely--a 
problem that appears to have gotten worse over time. Although 
HUD guidance states that timeliness is essential to ensure 
quality field reviews, half of the field reviews conducted in 
fiscal year 1998 did not occur until at least 77 days after the 
appraisals had been performed. In six of HUD's field office 
jurisdictions, the corresponding figure was 140 days or more. 
(By contrast, HUD reported in fiscal year 1997 that all field 
reviews were being completed within 45 days of the appraisals.) 
Philadelphia and Denver HOC officials plausibly told GAO that 
the reduced timeliness of field reviews made it difficult to 
prevent the approval of FHA mortgage insurance for loans based 
on faulty appraisals and reduced the usefulness of field review 
reports as a monitoring and enforcement tool.
    In addition, GAO found that HUD's oversight of field review 
contractors was limited. At the Philadelphia and Denver HOCs, 
HUD staff did not routinely visit appraised properties to 
verify the observations of field review contractors or take 
other measures systematically to evaluate the contractors' 
performance. Officials at both the Philadelphia and Denver HOCs 
told GAO that they rarely conducted such evaluations because 
they lacked sufficient staff and travel resources. As a result, 
they neither tracked the percentage of each contractor's work 
that received an on-site review nor evaluated contractors' 
performance with a numerical rating system.\147\ (Because HUD 
found it difficult to monitor such a large number of 
contracts--estimated at 250--it planned to contract out the 
field review function to a small number of large appraisal 
firms. It also planned to have HUD staff perform quality 
assurance reviews of the contractors.)
    \147\ HUD's policy guidance stresses the importance of evaluating 
the work of field review contractors and states that 5 percent of every 
contractor's work should be reviewed and rated on scale from 1 to 5 
(with 1 being unacceptable and 5 being excellent). The purpose of this 
rating system is to document performance problems and justify 
disciplinary actions against field review contractors, if necessary.
    Moreover, GAO found that the Philadelphia and Denver HOCs 
did not fully implement HUD guidance on handling and tracking 
consumers' complaints, including those relating to appraisals. 
In October 1998, HUD officials told GAO that the Philadelphia 
HOC was developing a set of written procedures for all four 
HOCs to follow. GAO found that the Philadelphia and Denver HOCs 
did not have complaint tracking systems containing the 
information required by the December 1997 policy memorandum. 
Both HOCs maintained logs showing, among other things, the HOC 
official assigned to follow up on a complaint and the date the 
follow-up action was completed. These logs did not include 
other required information, however, such as the nature of the 
complaint, the actions taken to address it, or the final 
disposition of the complaint. (If made available, this 
information would enable HOC management readily to determine 
the frequency of different types of complaints and ensure that 
all complaints were being resolved in an appropriate manner.) 
As a result of GAO's work, however, HUD implemented changes to 
help ensure the recording of this information. According to 
departmental officials, these changes have greatly improved the 
HOCs' ability to handle complaints.
    GAO concluded that the weaknesses it found in HUD's 
oversight of the FHA appraisal process increased FHA's risk of 
insuring properties that are overvalued or whose owners may 
default on their FHA-insured loans because of unexpected repair 
costs. The consequence of this increased risk is higher 
potential losses to FHA's insurance fund. GAO recommended that 
HUD achieve better field review coverage of FHA's appraiser 
roster by (1) ensuring that each HOC reviews the required 
percentage (currently 10 percent) of the FHA appraisals 
conducted annually within its geographic jurisdiction, and (2) 
requiring that when selecting appraisals for field review, HUD 
staff give higher priority to the work of appraisers who have 
done a substantial number of FHA appraisals but have not been 
field-reviewed within the past year. GAO also recommended that 
HUD make field reviews of appraisals more timely by 
establishing a process to ensure that HUD staff obtains copies 
of appraisal reports and perform field reviews prior to FHA's 
approval of mortgage insurance. In addition, GAO recommended 
that HUD better assess the quality of appraisal field reviews 
by insuring that a portion of each field review contractor's 
work is verified through on-site evaluation of properties 
reviewed by the contractor.
    In commenting upon GAO's recommendation that HUD achieve 
better field review coverage of FHA's appraiser roster, HUD 
indicated that it would implement a revised field review 
process by July 1, 1999, to improve its sampling and targeting 
of appraisers for field review. In response to GAO's 
recommendation that HUD conduct on-site evaluations of a 
portion of each field review contractor's work, HUD indicated 
that it would begin performing supervisory reviews of 
contractors in conjunction with a national field review 
contract scheduled to begin in July 1999. Implementation of 
both of these changes was delayed until March 2000. HUD 
disagreed with GAO's recommendation to improve the timeliness 
of appraisal field reviews by obtaining copies of the appraisal 
reports and performing field reviews prior to loan closings and 
the approval of FHA mortgage insurance. HUD indicated that the 
collection of all appraisals and the performance of field 
reviews before the approval of mortgage insurance would be 
impractical and inconsistent with HUD's Direct Endorsement 
Program, which allows qualified mortgagees to process and close 
FHA loans without prior review by HUD. In turn, GAO modified 
this recommendation to reflect the fact that it may be 
difficult for HUD to field review appraisals before the lenders 
close on the loans.

        (c) HUD Sanctioned Few Poorly-Performing Appraisers

    GAO found that HUD was not holding appraisers accountable 
for the quality of their appraisals. A poor field review score 
(i.e., a score of 1 or 2 on the abovementioned 1 to 5 scale) 
indicates that the appraiser did not adequately support the 
value assigned to the home, overlooked serious repair 
conditions, and/or made other errors and omissions that could 
result in an unacceptable insurance risk to FHA. A poor field 
review rating indicates that HUD's HOCs may impose an 
administrative sanction, called a limited denial of 
participation, that bars an appraiser from participating in FHA 
programs for up to 1 year. HUD's policy states that appraisers 
who receive two or more poor scores in field reviews during any 
12-month period should be issued a limited denial of 
participation temporarily prohibiting them from conducting 
further FHA appraisals for a period of time determined by FHA.
    Despite the danger of allowing poor appraisers to continue 
conducting FHA appraisals, however, appraisers who received two 
or more poor ratings in field reviews were frequently not 
prohibited from conducting additional FHA appraisals. During 
the first three quarters of fiscal year 1998, 246 of the 5,768 
field-reviewed appraisers within the Philadelphia and Denver 
HOCs' jurisdictions received two or more poor field review 
scores. As of the end of that fiscal year on October 1, 1998, 
however, HUD had issued limited denials of participation to 
only 11 of those 246 appraisers.
    GAO found that poor record-keeping by HUD field offices was 
the primary reason for the HOCs' inability to pursue 
enforcement actions against other poorly performing appraisers. 
HUD's policy was apparently to sanction appraisers only when 
there existed substantial evidence and documentation of 
performance that is less than acceptable. Philadelphia and 
Denver HOC officials told GAO, however, that a lack of 
supporting documentation had hampered their efforts to sanction 
appraisers. GAO verified this assertion through its review of 
appraisers' files at both the Philadelphia and Denver HOCs. 
This GAO review disclosed that most of the field review reports 
supporting the poor field review scores recorded in HUD's files 
were missing altogether.
    GAO concluded that HUD's ability to sanction poorly-
performing appraisers was seriously impaired by the loss or 
misplacement of records prior to and during HUD's field 
consolidation. Consequently, hundreds of appraisers whose work 
may be creating an unreasonable underwriting risk for FHA 
apparently continued to conduct appraisals for FHA-insured 

        (d) LHUD Has Not Aggressively Enforced Its Policy on 
        Lender Accountability for Appraisals

    HUD's policy is that lenders are responsible, equally with 
the appraisers they select, for the accuracy and thoroughness 
of appraisals. In October 1994, HUD issued regulations 
implementing a legislative provision that allowed lenders to 
choose the appraisers of properties to be insured by FHA. While 
the legislation did not address this issue, HUD's regulations 
stated that lenders who selected their own appraisers were 
equally responsible, along with the appraisers, for the 
accuracy, integrity, and thoroughness of the appraisals. In May 
1996, HUD repealed these regulations as part of a larger 
Federal effort to reduce the regulatory burden of participating 
in government programs. According to HUD, the regulations were 
not necessary because many of the standards in the regulations 
were already in HUD's handbook guidance and mortgagee letters 
issued to lenders. Despite the repeal, therefore, it remained 
HUD policy to hold lenders accountable for the actions of the 
appraisers they select.
    Accordingly, HUD issued mortgagee letters to lenders in 
November 1994 and again in May and November 1997 reiterating 
its policy that lenders were equally responsible for the 
quality of appraisals. HUD's Deputy Assistant Secretary also 
indicated that the failure of a lender voluntarily to resolve 
the appraisal deficiencies raised by HUD would result in 
enforcement action against the lender--including probation and 
    Nevertheless, according to GAO, HUD did not aggressively 
enforce this policy because of disagreement within HUD over its 
authority to do so. In May 1998, the Philadelphia HOC requested 
that HUD's Mortgagee Review Board sanction a lender who refused 
to correct property deficiencies that an appraiser had 
overlooked. This was the first case of this type that had been 
referred to the Board. Ultimately, however, the Board never 
reviewed or acted on this request because its staff was 
concerned that HUD might now have the authority to hold a 
lender accountable for the quality of an appraisal simply 
because the lender selected the appraiser in question. As a 
result, HOCs became reluctant to refer similar cases to the 
    To improve HUD's oversight of lenders participating in 
FHA's programs, GAO recommended that HUD (1) determine the 
extent of its authority to hold FHA-approved lenders 
accountable for poor-quality FHA appraisals performed by the 
appraisers they select from FHA's roster, and (2) issue policy 
guidance that sets forth the specific circumstances under which 
HUD may exercise this authority. HUD responded that it would 
target for monitoring those lenders that used poorly performing 

    B. HUD's Office of the Inspector General

    HUD's/OIG, led by Inspector General Susan Gaffney, has been 
vocal in its criticism of HUD's management of the Single Family 
Mortgage Insurance Program. The OIG notes that HUD has 
undertaken major structural and organizational changes in 
single family operations over the last 5 years. These changes 
include the consolidation of field operations into the four 
HOCs, significant staffing cuts in headquarters and field 
operations, and the delegation to contractors of major portions 
of its workload. During this period of change, the single 
family program has been particularly vulnerable to fraud, 
waste, and abuse. Fortunately, a high mortgage insurance 
premium structure, FHA's abandonment of traditional insurance 
fund mutuality principles, and a very strong economy in the 
late 1990's enabled FHA easily to meet its capital reserve 
requirements. An economic downturn, however, could seriously 
affect the financial well-being of FHA's mortgage insurance 
    \148\ Office of Inspector General, U.S. Department of Housing and 
Urban Development, Semiannual Report to the Congress (October 1, 1999-
March 31, 2000) [hereinafter ``HUD/OIG, 1999-2000 Semiannual''], at 2.
    Over the past 2 years--through audits, investigations, and 
its Housing Fraud Initiative,\149\--the HUD/OIG has examined 
nearly every aspect of the single family program. All in all 
the OIG feels that its work clearly demonstrates (1) a high 
incidence of fraud, waste, and abuse in FHA's single family 
operations, and (2) a clear need for HUD to tighten controls 
over this multi-billion dollar mortgage-insurance program.\150\
    \149\ The OIG's Housing Fraud Initiative (``HFI'') is described as 
``a proactive law enforcement effort using a unified approach to the 
detection and prosecution of fraud in HUD programs.'' HUD/OIG, 1999-
2000 Semiannual, supra, at 12. HFI seeks to combine OIG audit and 
investigative resources with the investigative and prosecutive skills 
of the Federal Bureau of Investigation (FBI) and U.S. Attorney's 
Offices in designated Federal judicial districts in order better to 
root out fraud in HUD-funded activities. HFI was the result of concern 
by members of the House Appropriations Subcommittee on VA, HUD, and 
Independent Agencies that HUD funds may not be reaching those needing 
Federal assistance due to pervasive fraud. HFI began in October 1998 
with the designation of six Federal judicial districts to serve as 
initial HFI sites.
    \150\ Id. at 2.
    In 1999, HUD/OIG audited the Loss Mitigation Program. This 
audit found a growing use of loss mitigation tools by servicing 
lenders, but a lack of program oversight by HUD staff. Loss 
mitigation tools, of course, are intended to help prevent 
foreclosures. Yet, while the use of these tools has more than 
tripled in fiscal year 1999, HUD's foreclosure rates continue 
to rise. The National Delinquency Survey conducted by the 
Mortgage Bankers Association showed a 39 percent rise in FHA 
foreclosure rates over 5 years, from 1.45 percent at the end of 
calendar year 1994 to 2.01 percent at the end of calendar year 
1999. During the same period, MBA data show an increase of 
about 19 percent in FHA delinquency rates, from 7.26 percent to 
    The OIG acknowledged that HUD has developed two measures 
that may strengthen the FHA program. One is the Homebuyer 
Protection Plan, which is designed to protect borrowers from 
bad appraisals. The other is the Credit Watch program, which is 
discussed at length above, which terminates lenders with 
excessive default rates from FHA programs. Both plans, however, 
are relatively new, and thus a thorough evaluation has not yet 
been done. Moreover, although the Homebuyer Protection Plan is 
making strides to improve the quality of appraisals, the 
enforcement aspect of the plan has been slow to develop. The 
Credit Watch Program will also take action only against those 
lenders with the most egregious default record. Very few 
actions have been taken to date, and--as discussed in more 
detail above--two actions terminating lenders have led to 
serious legal challenges by the lenders. Moreover, neither of 
these initiative substitutes the need for HUD staff to better 
monitor lender performance.\151\
    \151\ Id.
    HUD/OIG's audit and investigative work have disclosed that 
HUD's current procedures for monitoring lenders and conducting 
oversight of contractors are less than effective. In HUD/OIG's 
view, this lack of oversight clearly contributes to fraud and 
abuse of the FHA Single Family Program. This is because FHA's 
mortgage insurance risk depends almost exclusively on the 
reliability of work performed by its DE lenders, who underwrite 
nearly all FHA insurance. FHA mitigates its risk through lender 
oversight. Three important HUD monitoring tools should be 
working to prevent the insurance of fraudulent loans: Post 
endorsement technical reviews of loan underwriting 
documentation, field reviews of appraisals, and quality 
assurance reviews of lenders. When used effectively, these 
tools can highlight problem loans or lenders. The OIG has 
found, however, that HUDs monitoring was not properly focused 
upon lender and appraiser high risk indicators. Instead, HUD 
merely emphasized meeting numerical review goals set forth in 
its Business and Operating Plan.\152\
    \152\ Id. at 4.

      (1) Post-Endorsement Technical Reviews

    Post-endorsement technical reviews underwriting and 
property appraisals are key controls in monitoring DE lenders. 
These technical reviews typically consist of a desk review of 
FHA case documentation after insurance endorsement to assess 
lender compliance with HUD underwriting and appraisal 
requirements. HUD has retained contractors to perform most of 
this work at a price ranging from $15 to $35 per case.\153\ If 
the technical review discloses an improper endorsement or other 
problems, then HUD staff is supposed to take remedial actions--
e.g., seeking identification from lenders for loans not meeting 
FHA endorsement criteria or referring lenders to the Quality 
Assurance Division for on-site review.\154\
    \153\ Id.
    \154\ HUD/OIG, Single Family Production Home Ownership Centers, 
supra at 7.
    The OIG, however, found that HUD relied too uncritically 
upon the work of these contractors and did not do enough to 
review contractor performance. The effects of such over-
reliance were demonstrated in a recent case in which Allstate 
Mortgage Company fraudulently originated over 400 FHA loans 
totaling $97 million. Seventeen of these loans had undergone 
post-endorsement reviews by a contractor. The contractor found 
no significant problems with these loans, even though the loan 
files showed obvious fraud indicators. None of these 17 cases 
had even been re-examined by HUD contract monitors.\155\
    \155\ HUD/OIG, 1999-2000 Semiannual, at 4.
    The OIG's reexamination of 151 post-endorsement reviews 
found that 70 of these reviews failed to disclose material 
underwriting errors. Thirty-two reviews failed to identify 
significant fraud indicia.\156\ The OIG review found several 
reasons why HUD's controls over the post-endorsement technical 
review process were not providing meaningful results. These 
included: The presence of inexperienced staff in critical HUD 
control positions; increased loan volume accompanied by the 
allocation of fewer staff members for monitoring lenders; the 
lack of clear operating policies or procedures for HOC 
operations; outdated handbooks; emphasis on quantitative goals; 
and the existence of financial disincentives for contractors to 
find problematic endorsements. Even when significant technical 
review problems were noted, the OIG found HUD implemented few, 
if any, corrective actions.\157\
    \156\ Id. at 32.
    \157\ Id. at 4.

      (2) Post-Endorsement Field Reviews of Appraisals

    Another critical control feature is the systematic testing 
of property appraisals by HUD. The DE lender selects the 
appraiser that sets the value of the property for FHA 
insurance. With the high loan-to-value ratio of most FHA loans, 
an accurate appraisal is critical to minimizing HUD's insurance 
risk. HUD's procedures call for field reviews of 10 percent of 
all appraisals,\158\ and 5 percent of each appraiser's 
work.\159\ In addition, all appraisers receiving a ``poor'' 
rating during the post-endorsement technical review process are 
supposed to be subject to field review.\160\
    \158\ Id. at 5.
    \159\ HUD/OIG, Single Family Production Home Ownership Centers, 
supra at 38.
    \160\ Id.
    The OIG found, however, that the HOCs did not have a 
systematic procedure for selecting appraisals for review to 
ensure that the required 5 percent of each appraiser's work was 
reviewed. This is because the HOCs did not have contracts for 
field review of appraisals in all areas of their jurisdictions. 
Moreover, lenders did not always provide a second copy of the 
appraisal (as they were required to do) and appraisal reports 
were not always complete--though this apparently did not stop 
the HOCs from accepting the cases instead of rejecting them. In 
addition, the OIG found that the HOCs' primary emphasis was 
upon being able to declare that they had completed their goal 
of completing field reviews of 10 percent of the total 
appraisals. Little emphasis, it seems, was put on ensuring that 
the program was working properly.\161\
    \161\ Id. at 39.
    Even when field reviews disclosed problems with appraisers, 
HUD failed to use the results to take action. Branch chiefs at 
three of the four HOCs told the OIG that they did not have 
enough staff to monitor appraisers or to sanction poor 
performers. As a result of these deficiencies, HUD lacks 
assurance about the quality of appraisals supporting loans 
processed and approved by lenders.\162\ For example, as of 
March 30, 2000, two appraisers named in a criminal indictment 
returned against the principals of Allstate Mortgage Company in 
December 1997--appraisers who apparently provided numerous 
fraudulent appraisals--had not been removed from HUD's approved 
appraiser listing, issued a limited denial of participation, or 
debarred.\163\ HUD's lack of action against problem appraisers 
is also evident from its own numbers. According to HUD's Single 
Family Data Warehouse information system, during the 2-year 
period ending September 30, 1999, 15,526 appraisals received 
``poor'' desk review ratings. However, 13,007, or 83.8 percent, 
of these appraisals were never subjected to field review.\164\ 
Instead, these poor ratings were entered into HUD's database 
without any subsequent action.\165\
    \162\ HUD/OIG, 1999-2000 Semiannual, supra, at 5.
    \163\ The individuals indicted included Douglas Estrada (the 
president and owner of Allstate Mortgage), Victor Noval (the owner of 
Noval and Associates and four other companies used in straw purchases), 
Shirley da Silva (Noval's ex-wife), James Weatherley (a former Oakland 
Raiders football player who located properties and straw buyers), Louis 
Valladares (a loan officer at Allstate Mortgage) and Alberto Jose Rivas 
(another loan officer at Allstate Mortgage Company). Allstate Mortgage 
was not itself indicted, and action by the Mortgagee Review Board 
appears to be pending the results of the criminal case against the 
principals. PSI staff has learned that the two appraisers are both 
engaged in plea negotiations with the U.S. Attorney's Office.
    \164\ HUD/OIG, Single Family Production Home Ownership Centers, 
supra, at 42.
    \165\ Id. at 43.

      (3) Quality Assurance Reviews

    A third important control over DE lender activity is on-
site monitoring reviews. These reviews, which are conducted by 
the HOCs' Quality Assurance Divisions (QADs), are intended to 
identify and correct poor origination practices. After 
completion, the QADs communicate their review results to 
lenders and request written responses. Lenders are asked to 
explain the problems noted, list actions taken to prevent 
future problems, and/or agree to indemnify HUD for possible 
losses associated with improperly originated loans.
    This process, too, appears to have been impeded by poor HUD 
oversight. While the QADs are supposed to focus upon lenders 
with high default and foreclosure rates, the OIG discovered 
that the QADs instead reviewed numerous low-risk lenders 
because this permitted them more easily to claim that they had 
met HUD's numeric review goals. Even when the QADs identified 
deficiencies during on-site reviews, they did not follow-up 
when lenders failed to respond to their findings and 
recommendations.\166\ The OIG also determined that the 
Approval/Recertification/Review Tracking System (ARRTS) HUD 
uses to track the status and results of QAD reviews contained 
significant errors, and therefore did not provide sufficient 
accountability for audit and staff evaluation purposes.\167\
    \166\ Office of Inspector General, U.S. Department of Housing and 
Urban Development, Semiannual Report to the Congress 5 (October 1, 
1999-March 31, 2000).
    \167\ Office of Inspector General, U.S. Department of Housing and 
Urban Development, Semiannual Report to the Congress 32-33 (October 1, 
1999-March 31, 2000).

    VI. HUD's False Promises to the Subcommittee

    The Subcommittee's hearings on the subject of mortgage 
flipping focused upon these and other related problems of HUD 
oversight of the FHA-back single family loan program. Faced 
with this criticism--and the numerous GAO and Office of 
Inspector General findings during the past several years 
demonstrating HUD's failure properly to protect the program 
against fraud, waste, and abuse--FHA Commissioner Apgar 
reassured the Subcommittee in sweeping terms on June 30, 2000 
about the steps HUD has taken to combat flipping the assistance 
his agency would provide to help victims of mortgage fraud.
    In his testimony, Apgar discussed Credit Watch and the 
Homebuyer Protection Plan as being particularly promising 
initiatives, but took particular pains to promise that HUD 
would in fact compel the restructuring of mortgages the value 
of which had been artificially inflated by ``flipping'' schemes 
of the sort outlined hereinabove. Specifically, Commissioner 
Apgar declared that:

        L``HUD will move aggressively to force lenders to 
        restructure inflated mortgages that result from 
        fraudulent appraisals or the so-called property flips. 
        We will push the loan back to the lender and make him 
        responsible for producing a loan that the borrower can 
        afford. If not, the FHA will intervene directly and 
        make the loan right for the borrower.''\168\
    \168\ Hearing record, supra, at 45.

    Despite his promises, however, this promised relief had yet 
to appear more than a year later. When Apgar, a Clinton 
Administration appointee, left HUD early in 2001 along with 
Secretary Andrew Cuomo, nothing had been done.
    The Subcommittee has since learned that Apgar's promises to 
the Subcommittee, and to borrowers across the country, appear 
to have been empty ones. According to information provided to 
the Subcommittee by HUD official Laurie Maggiano, in fact, 
Apgar couldn't possibly have followed through on his sweeping 
reassurances because the law prevents HUD from forcing lenders 
to reduce loans that FHA insures. On May 14, 2001, Maggiano 
advised Senator Barbara Mikulski that in Apgar's Subcommittee 
testimony a year previously, ``FHA perhaps over committed what 
it was able to deliver.'' Apgar's disingenuous promises, 
therefore, stand perhaps as the final legacy of Secretary Cuomo 
and his fellow Clinton Administration appointees at the 
Department of Housing and Urban Development--a legacy of lax 
oversight and poor management upon which the Subcommittee 
Minority hopes new HUD Secretary Mel Martinez and the Bush 
Administration will be able greatly to improve.