[Senate Prints 107-44]
[From the U.S. Government Publishing Office]
107th Congress S. Prt.
COMMITTEE PRINT
1st Session 107-44
_______________________________________________________________________
PROPERTY ``FLIPPING'': HUD'S FAILURE TO CURB MORTGAGE FRAUD
__________
REPORT
PREPARED BY THE
MINORITY STAFF
OF THE
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
OF THE
COMMITTEE ON GOVERNMENTAL AFFAIRS UNITED STATES SENATE
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13
September 25, 2001
-------
U.S. GOVERNMENT PRINTING OFFICE
75-382 WASHINGTON : 2001
----------------------------------------------------------------------------
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpr.gov Phone: toll free (866) 512-1800; (202) 512�091800
Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001
COMMITTEE ON GOVERNMENTAL AFFAIRS
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
ROBERT G. TORRICELLI, New Jersey GEORGE V. VOINOVICH, Ohio
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
------
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
CARL LEVIN, Michigan, Chairman SUSAN M. COLLINS, Maine
DANIEL K. AKAKA, Hawaii TED STEVENS, Alaska
RICHARD J. DURBIN, Illinois GEORGE V. VOINOVICH, Ohio
ROBERT G. TORRICELLI, New Jersey PETE V. DOMENICI, New Mexico
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
PROPERTY ``FLIPPING'': HUD'S FAILURE TO CURB MORTGAGE FRAUD
----------
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
findings.
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
knowledgeable.
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
insurance.
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
neighborhoods.
---------------------------------------------------------------------------
\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
improvements.\4\
\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,
2000).
\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
1991).
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
years.\14\
---------------------------------------------------------------------------
\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
billion.\15\
---------------------------------------------------------------------------
\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
trillion.\17\
---------------------------------------------------------------------------
\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
Certifications).
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
practices.\30\
---------------------------------------------------------------------------
\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
appraiser.\33\
---------------------------------------------------------------------------
\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
occurred.)
---------------------------------------------------------------------------
\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
hands.
(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
salespersons.
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
depositions.
(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
closing.
\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,
1996).
\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
form?
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
leg.\74\
---------------------------------------------------------------------------
\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,
1999).
---------------------------------------------------------------------------
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
unemployed.\83\
---------------------------------------------------------------------------
\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
purchasers.
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
stakeholders.
---------------------------------------------------------------------------
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),
http://www.latimes.com/news/state/199912/16t000114613.html.
\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
insurance.
---------------------------------------------------------------------------
\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
6.
\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
property.\109\
---------------------------------------------------------------------------
\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
Lenders
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
mortgages.\116\
---------------------------------------------------------------------------
\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
foreclosure:
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
default.
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
borrowers.\126\
---------------------------------------------------------------------------
\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
mortgagees.
(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
requirements.\133\
---------------------------------------------------------------------------
\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
property.
---------------------------------------------------------------------------
\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
requirements.\141\
---------------------------------------------------------------------------
\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
endorsement.\144\
---------------------------------------------------------------------------
\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
action.
(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
Risk.''
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
standards.
(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'
operations.
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
authority.
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
violations.
(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
percent.
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
mortgagees.
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
violations.
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
examination.
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
mortgages.
(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
suspension.
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
Board.
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
appraisers.
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
fund.\148\
---------------------------------------------------------------------------
\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
8.61.
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.