Homeownership: Management Challenges Facing FHA's Single-Family Housing
Operations (Testimony, 04/01/98, GAO/T-RCED-98-121).

Pursuant to a congressional request, GAO discussed the management
problems facing the single-family mortgage insurance programs of the
Federal Housing Administration (FHA), focusing on: (1) FHA's role in
providing mortgage credit to home buyers; (2) management problems
affecting the operations of the Department of Housing and Urban
Development's (HUD) single-family program, including weaknesses in HUD's
oversight of the contractors responsible for safeguarding and
maintaining foreclosed FHA properties, indications that weaknesses may
exist in HUD's oversight of FHA appraisers, and internal control
problems identified in FHA's financial statements audits; and (3) GAO's
observations on HUD's plans for addressing these and other single-family
management problems as part of its agencywide HUD 2020 Management Reform
Plan.

GAO noted that: (1) FHA is a major player in the single-family housing
finance market; (2) during the first half of 1997, 3 out of 10 borrowers
that received insured mortgages selected FHA mortgage insurance; (3)
without FHA mortgage insurance, some of these borrowers might have had
to delay or forgo purchasing a home; (4) over time, FHA's insurance
premiums and other income have more than covered the costs that FHA has
sustained as a result of defaults and foreclosures on the single-family
loans it insures; (5) in fact, the present value of estimated cash
inflows to FHA's single-family mortgage program exceeds the present
value of cash outflows by $1.8 billion for fiscal year 1997; (6)
notwithstanding this strong financial performance, both GAO and the HUD
Inspector General have identified the following areas in which FHA's
management of its single-family program could be improved: (a) GAO's
work on HUD's oversight of real estate asset management contractors, who
are responsible for safeguarding foreclosed FHA properties, indicates
that HUD does not have an adequate system in place to assess its field
offices' oversight of these contractors; (b) GAO's recent work on
appraisals for FHA-insured single-family loans has identified concerns
about HUD's oversight of the appraisal process; and (c) in addition,
annual audits of FHA's financial statements by KPMG Peat Marwick LLP
continue to identify material internal control weaknesses in FHA's
operations; (7) under the HUD 2020 Management Reform Plan and related
efforts, HUD is in the process of making significant changes in all of
its single-family operations, from the initial step of making insurance
endorsements to disposing of properties; (8) these changes are motivated
in part by HUD's goals of downsizing the agency and addressing
long-standing agencywide management weaknesses; (9) while the reforms
being implemented appear to address long-standing problems, it is
uncertain how effective they will be in eliminating the problems in the
single-family programs because the changes are not yet complete and some
of the approaches are untested; and (10) in addition, because FHA's
planned staffing levels are not based upon systematic workload analysis
to determine needs, it is uncertain whether HUD's single-family program
operations will have the capacity to carry out its responsibilities once
the changes are in place.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-RCED-98-121
     TITLE:  Homeownership: Management Challenges Facing FHA's 
             Single-Family Housing Operations
      DATE:  04/01/98
   SUBJECT:  Housing programs
             Mortgage programs
             Reengineering (management)
             Financial management systems
             Federal agency accounting systems
             Mortgage loans
             Federal property management
             Appraisals
             Internal controls
IDENTIFIER:  Mutual Mortgage Insurance Fund
             HUD 2020 Management Reform Plan
             
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Cover
================================================================ COVER


Before the Subcommittee on Housing and Community Opportunity,
Committee on Banking and Financial Services, House of Representatives

For Release
on Delivery
Expected at
10 a.m.  EST
Wednesday
April 1, 1998

HOMEOWNERSHIP - MANAGEMENT
CHALLENGES FACING FHA'S
SINGLE-FAMILY HOUSING OPERATIONS

Statement of Judy A.  England-Joseph, Director,
Housing and Community Development Issues,
Resources, Community, and Economic
Development Division

GAO/T-RCED-98-121

GAO/RCED-98-121T


(385721)


Abbreviations
=============================================================== ABBREV

  ARM -
  FHA -
  HMDA -
  HOC -
  HUD -
  LTV -
  OIG -
  REAM -

============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

We are pleased to be here today to discuss the management problems
facing the single-family mortgage insurance programs of the U.S. 
Department of Housing and Urban Development's (HUD) Federal Housing
Administration (FHA).  Through its FHA, HUD insures private lenders
against nearly all losses resulting from foreclosures on
single-family homes insured by FHA.  FHA-insured single-family home
mortgages were valued at about $361 billion as of September 30, 1997. 
This potential obligation represents a risk to taxpayers because each
year, lenders foreclose on a portion of the FHA-insured mortgages
that go into default and file insurance claims with HUD for their
losses.  While FHA's primary single-family mortgage insurance program
is self-sufficient, requiring no federal funds to operate, poor
program management can contribute to the losses sustained by FHA when
foreclosures occur. 

My statement will discuss (1) FHA's role in providing mortgage credit
to home buyers; (2) management problems affecting the operations of
HUD's single-family program, including weaknesses in HUD's oversight
of the contractors responsible for safeguarding and maintaining
foreclosed FHA properties, indications that weaknesses may exist in
HUD's oversight of FHA appraisers, and internal control problems
identified in FHA's financial statements audits; and (3) our
observations on HUD's plans for addressing these and other
single-family management problems as part of its agencywide HUD 2020
Management Reform Plan.  My statement today is based on reports
recently issued by our office and HUD's Office of Inspector General
(OIG); the preliminary results of work being performed at your
request on HUD's oversight of FHA appraisers; and the results of our
work on HUD's 2020 Management Reform Plan done at the request of the
Ranking Minority Members of the Subcommittee on Human Resources and
the Subcommittee on Civil Service, respectively, House Committee on
Government Reform and Oversight.\1

In summary: 

FHA is a major player in the single-family housing finance market. 
During the first half of 1997, 3 out of 10 borrowers that received
insured mortgages selected FHA mortgage insurance.  As we have noted
in the past, many families with FHA-insured mortgages are low-income,
minority, and first-time home buyers.  Without FHA mortgage
insurance, some of these borrowers might have had to delay or forgo
purchasing a home.  Over time, FHA's insurance premiums and other
income have more than covered the costs that FHA has sustained as a
result of defaults and foreclosures on the single-family loans it
insures.  In fact, the present value of estimated cash inflows to
FHA's single-family mortgage program exceeds the present value of
cash outflows by $1.8 billion for fiscal year 1997. 

Notwithstanding this strong financial performance, both we and the
HUD OIG have identified the following areas in which FHA's management
of its single-family program could be improved: 

  -- Our work on HUD's oversight of real estate asset management
     contractors, who are responsible for safeguarding foreclosed FHA
     properties, indicates that HUD does not have an adequate system
     in place to assess its field offices' oversight of these
     contractors.  The three HUD field offices we visited varied
     greatly in their efforts to monitor real estate asset management
     contractors' performance, and none of the offices adequately
     performed all of the functions needed to ensure that the
     contractors meet their contractual obligations to maintain and
     protect HUD-owned properties.  Our physical inspection of
     properties for which the contractors in each location were
     responsible identified problems at the properties, including
     vandalism, maintenance problems, and safety hazards, which may
     decrease the marketability of HUD's properties, decrease the
     value of surrounding homes, increase HUD's holding costs and, in
     some cases, threaten the health and safety of neighbors and
     potential buyers. 

  -- Our recent work on appraisals for FHA-insured single-family
     loans has identified concerns about HUD's oversight of the
     appraisal process.\2 Since December 1994, private mortgage
     lenders making FHA-insured loans have been able to select any
     licensed or certified appraiser listed on FHA's roster.  Before
     that time, appraisals for FHA-insured loans were conducted
     almost exclusively by a panel of fee appraisers whom FHA
     assigned to the lenders on a rotational basis.  Since
     implementing the new appraiser selection process, HUD has
     identified, and begun to address, problems relating to its
     evaluation of completed appraisals and the number of minorities
     and women receiving appraisal assignments.  Recent limited work
     we conducted in New Jersey and Ohio showed that some appraisals
     did not reflect conditions we observed that could adversely
     affect the structural soundness and continued marketability of
     the houses and the health and safety of the occupants.  In light
     of these problems, we are planning to conduct a broad assessment
     of HUD's oversight of FHA single-family appraisals. 

  -- In addition, annual audits of FHA's financial statements
     prepared by KPMG Peat Marwick LLP for HUD's OIG, while noting
     progress, continue to identify material internal control
     weaknesses in FHA's operations.  The audit report on FHA's
     fiscal year 1997 financial statements--the most recent
     available--identified three material internal control weaknesses
     applicable, in varying degrees, to both the single-family and
     multifamily programs.  The three weaknesses are as follows:  (1)
     FHA must place more emphasis on early warning and loss
     prevention for insured mortgages, (2) FHA must improve
     accounting and financial management systems,\3 and (3) FHA must
     address staff and administrative resource issues.  For the
     single-family programs, the resource issue centers primarily
     around property management and disposition, staff utilization,
     and the transfer of resources as FHA consolidates activities and
     reduces single-family staffing levels. 

Under the HUD 2020 Management Reform Plan and related efforts, HUD is
in the process of making significant changes in all of its
single-family operations, from the initial step of making insurance
endorsements to disposing of properties.  These changes are motivated
in part by HUD's goals of downsizing the agency and addressing
long-standing agencywide management weaknesses.  While the reforms
being implemented appear to address long-standing problems, it is
uncertain how effective they will be in eliminating the problems in
the single-family programs because the changes are not yet complete
and some of the approaches are untested.  In addition, because FHA's
planned staffing levels are not based upon systematic workload
analysis to determine needs, it is uncertain whether HUD's
single-family program operations will have the capacity to carry out
its responsibilities once the changes are in place. 

Before I discuss these issues in greater detail, let me briefly
explain how FHA's single-family mortgage insurance program operates. 


--------------------
\1 HUD Management:  Information on HUD's 2020 Management Reform Plan
(GAO/RCED-98-86, Mar.  20, 1998). 

\2 Homeownership:  Information on Changes in FHA's New Single-Family
Appraisal Process (GAO/RCED-97-176, July 25, 1997). 

\3 Also, FHA's single-family systems are not capable of generating
the case-specific cash flow data needed to comply with credit reform. 
As a result, HUD has not been able to accurately report the costs of
its credit programs (the primary purpose of credit reform) in its
consolidated financial statements--information important to executive
and congressional decisionmakers. 


   HUD'S SINGLE-FAMILY MORTGAGE
   INSURANCE PROGRAM
---------------------------------------------------------- Chapter 0:1

Unless a buyer can pay cash for a home, he or she must borrow money
to finance the difference between the purchase price and down
payment.  The amount of money borrowed is referred to as a mortgage
loan.  The home is used as the collateral for the mortgage loan,
which is typically repaid in monthly installments, generally over a
30-year period.  FHA helps Americans finance home purchases. 
Established under the National Housing Act of 1934, FHA insures
private lenders against losses on mortgages financing homes and
multifamily and other properties. 

Lenders usually require mortgage insurance when a home buyer has a
down payment of less than 20 percent of the value of the home because
foreclosures are more likely on these loans than on those with higher
down payments.  Appraisals have an influence on the amount of the
mortgage loan.  The amount that FHA can insure is based, in part, on
the appraised value of the home.  The maximum loan amount permitted
under FHA's program for single-family homes in the highest-cost areas
of the continental United States is currently set at $170,362.  In
its fiscal year 1999 budget, HUD proposed legislation to increase the
maximum mortgage amount insurable under the FHA single-family program
in all areas of the country to $227,150. 

A mortgage loan is commonly considered "in default" when the borrower
misses three consecutive monthly payments and a fourth payment is
due.  At that point, foreclosure proceedings against the borrower
become a serious possibility.  In the case of FHA-insured loans, once
the foreclosure process is completed, the lender files an insurance
claim with HUD for its losses (unpaid mortgage balance and interest,
along with the costs of foreclosure and other expenses).  After the
claim is paid, the lender transfers the title to the home to HUD,
which is responsible for managing and selling the property. 

The purpose of HUD's property disposition program is to reduce the
inventory of acquired properties in a manner that expands
homeownership opportunities, strengthens neighborhoods and
communities, and ensures a maximum return to the mortgage insurance
fund.  To safeguard and maintain the approximately 30,000 properties
HUD has in its inventory at any given time, HUD obtains the services
of real estate asset management (REAM) contractors.  These
contractors are to secure and inspect the properties, report their
condition to HUD, notify interested parties of HUD's ownership,
perform exterior maintenance, and ensure that the properties are free
of debris and hazardous conditions.  REAM contractors are therefore
essential to HUD's achieving its goal of returning these properties
to private ownership as soon as possible, while obtaining a maximum
sale price for HUD. 


   FHA'S ROLE IN THE SINGLE-FAMILY
   MORTGAGE MARKET
---------------------------------------------------------- Chapter 0:2

FHA insured over 740,000 home mortgages representing over $61 billion
in single-family mortgage insurance during fiscal year 1997--ending
the fiscal year with a total of $361 billion in single-family
mortgage insurance outstanding.  During the first half of 1997, FHA
insured about 8 percent of all mortgages made or about 31 percent of
all mortgages that were insured. 

Many changes have occurred in the single-family housing finance
system since the FHA was established.  These changes include the
advent of modern private mortgage insurance, the development of a
secondary mortgage market, and the emergence of a number of public-
and private-sector initiatives designed to expand affordable housing
opportunities for home buyers.  Given these developments, an ongoing
debate has centered on whether there is still a need for FHA's
single-family mortgage insurance program and, if so, what changes, if
any, need to be made to the program.  Critics of FHA contend that
other housing finance players, such as the private mortgage insurers,
are filling the need once filled exclusively by FHA.  Supporters of
FHA argue that its single-family program, which has insured at least
24 million home mortgages since its inception, remains the only way
for some families to become homeowners and should be expanded. 

FHA has been a major player in single-family home financing for over
60 years, and it remains so today--particularly in certain market
segments.  As mentioned above, FHA insured about 31 percent of all
insured mortgages during the first half of 1997.  According to FHA,
76 percent of new mortgages it insured last year were for first-time
home buyers, and FHA provided the primary homeownership opportunity
for central cities' residents.  In our report on FHA's role, we found
that in 1994, FHA-insured loans were concentrated to a greater extent
on low-income and minority borrowers, first-time home buyers, and
borrowers with higher loan-to-value (LTV) ratios than those with
loans insured by private mortgage-insurers.\4

FHA was also the primary insurer in nine states.  In addition, solely
on the basis of the LTV and qualifying ratios of borrowers who
obtained loans in 1995, 66 percent of FHA's borrowers might not have
qualified for private mortgage insurance for the loans they received. 
Recent Home Mortgage Disclosure Act (HMDA) data show that in
comparison with its share of the mortgage market, FHA in 1996
generally served a greater share of the market segments consisting of
minority borrowers, low- and moderate-income borrowers, and borrowers
located in low- and moderate-income neighborhoods and neighborhoods
where minorities represent more than 30 percent of all residents. 

Furthermore, according to Price Waterhouse's 1998 actuarial study,
the Mutual Mortgage Insurance Fund (the Fund)--the insurance fund
supporting FHA's principal single-family insurance program---had an
economic value/reserves of about $11.3 billion as of September 30,
1997.  Over time, insurance premiums and other income have more than
covered costs.  In fact, the present value of estimated cash inflows
to FHA's single-family mortgage program exceeds the present value of
cash outflows by $1.8 billion for fiscal year 1997.\5

FHA's Fund has surpassed the legislative target for reserves (a
2-percent capital ratio by November 2000).  As we have reported, the
Fund's ability to maintain the target ratio will depend on many
economic, program-related, and other factors that will affect the
financial health of the Fund in the future.  The economic factors
include interest rates, unemployment, and, in particular, house price
appreciation rates.  Program-related factors include the introduction
of loss mitigation procedures that may reduce future losses from
claims; changes in underwriting standards, such as the elimination of
"teaser" interest rates for adjustable rate mortgage (ARM) loans; and
the elimination of the Mortgage Assignment Program.  Other factors
that may affect the financial health of the Fund in the future
include the uncertainty surrounding the projections of the
performance of FHA's streamlined refinanced and ARM loans, because
FHA has had less experience with these types of loans than with their
more traditional 30-year, fixed-rate mortgage. 

The greater the extent that FHA can improve the efficiency of its
lending operations, the greater its ability to maintain financial
self-sufficiency in an uncertain future and meet the needs of
lower-income borrowers through either increasing the number of
borrowers served or reducing the cost of insurance for those FHA
serves.  In spite of the overall success of FHA's single-family
mortgage insurance program, both we and the HUD OIG have identified
weaknesses in program management.  I would now like to discuss these
problems. 


--------------------
\4 Homeownership:  FHA's Role in Helping People Obtain Home Mortgages
(GAO/RCED-96-123, Aug.  13, 1996). 

\5 For FHA's mutual mortgage insurance and cooperative management
housing insurance programs. 


   WEAKNESSES EXIST IN HUD'S
   OVERSIGHT OF REAM CONTRACTS
---------------------------------------------------------- Chapter 0:3

Our report on HUD's property management and contract administration,
which you are releasing today, revealed problems with HUD's oversight
of REAM contractors.\6 Our audit work found that HUD does not have a
system in place for monitoring its field offices' administration of
REAM contracts.  HUD's guidance gives headquarters staff the ultimate
responsibility for overseeing the administration of REAM contracts. 
Specifically, the guidance requires regional offices to ensure that
field offices are monitoring REAM contractors, and requires
headquarters staff to review regional offices' oversight actions
through regional reviews.  We found, however, that headquarters staff
have not been conducting these reviews since HUD reorganized its
field office structure in 1995 and eliminated the regional offices. 

In addition, HUD's field office staff are not consistently providing
adequate oversight of REAM contractors.  We believe this lack of
oversight contributed to some of the poor property conditions,
ranging from graffiti and debris to imminent safety hazards, that we
saw when we visited 66 HUD properties.  Such conditions can decrease
the marketability of HUD's properties, decrease the value of
surrounding homes, increase HUD's holding costs and, in some cases,
threaten the health and safety of neighbors and potential buyers. 
Our report makes recommendations to HUD for improving its oversight
of REAM contractors. 


--------------------
\6 Single-Family Housing:  Improvements Needed in HUD's Oversight of
Property Management Contractors (GAO/RCED-98-65, Mar.  27, 1998). 


      SOME KEY OVERSIGHT
      RESPONSIBILITIES NOT ALWAYS
      PERFORMED
-------------------------------------------------------- Chapter 0:3.1

HUD's field office staff are directly responsible for overseeing REAM
contractors.  We found, however, that some key oversight
responsibilities were not always performed by staff at the three HUD
field offices we visited.  For example, HUD's field staff did not
always conduct evaluations of REAM contractors as required.  Field
office staff are supposed to evaluate the REAM contractor's
performance every year in the month prior to the contract's
anniversary date.  This annual evaluation is used to make decisions
on contract extensions and, if necessary, to act on inadequate
performance.  However, we found in all three field offices we visited
that these evaluations were not always conducted or were not always
completed in time to provide useful information for contract renewal
decisions.  For example, one of the field offices we visited has
evaluated the REAM contractor's performance only once since the REAM
contract was awarded in June 1995, and that evaluation was conducted
several weeks after the contract had already been extended beyond the
base year.  Officials in that field office told us that performance
evaluations were not performed because they did not have the staff
resources or travel funds to visit the contractor's office.  However,
it should be noted that the REAM contractor's office is only 37 miles
from HUD's field office. 

Furthermore, in the one evaluation conducted, field office staff did
not convey the results of the evaluation to the REAM contractor, as
required.  In this evaluation, HUD cited the contractor for failing
to remove debris from some properties.  Our inspection of properties
in this field location revealed that the debris removal problem still
exists.  One property had been shown by realtors eight times while it
contained debris.  In fact, a realtor noted that the only accessible
entrance to the property was blocked with furniture and debris, which
was also the case when we visited the property.  During our August
1997 inspection of 24 properties in this location, we found that most
of the properties contained either interior or exterior debris. 
Consequently, prospective buyers were sometimes viewing properties
littered with household trash, personal belongings, and other debris. 

In addition, HUD's field office staff did not always inspect
properties managed by REAM contractors, as suggested by HUD's
guidance.  Because HUD recognizes that physical inspections are the
best method for monitoring the contractors' work, HUD's guidance
suggests that field office staff conduct monthly physical inspections
of a minimum number of properties assigned to each contractor.  To
help meet this target, the guidance allows the field offices to
contract out for property inspection services.  Without adequate
on-site inspections, HUD cannot be assured that it is receiving the
services for which it has paid.  In two of the field offices we
visited, property files contained evidence that some properties were
being inspected.  However, in the third field office, we found that
of the 42 property files we reviewed, HUD's field office staff had
not inspected any of those properties.  Field office staff told us
they did not get out to inspect properties because they did not have
the travel funds or staff resources to do so.  Subsequent to our
visit, in December 1997, this field office started using contractors
to make property inspections. 

Moreover, HUD's field office staff did not always ensure that the
REAM contractors conducted property inspections and submitted
appropriate reports for HUD's review.  HUD's guidance requires REAM
contractors to submit initial inspection reports within 5 working
days of being notified that a property has been assigned, but it
offers no specific guidance on the submission of routine inspection
reports.  The REAM contractor's submission of initial and routine
inspection reports is essential for HUD to determine its marketing
strategy for the properties and to mitigate potential losses to the
properties.  For example, the initial inspection reports, along with
appraisals, are the primary tools for determining the repairs that
must be made and whether the property meets certain standards that
would allow it to be sold with FHA-insured financing.  We found,
however, considerable differences among the three field offices we
reviewed both in terms of the requirements they placed on REAM
contractors for submitting inspection reports and the extent to which
the reports were actually submitted to the field offices.  For
example, in one location all of the property files we reviewed
contained initial inspections, while in another location, 43 percent
of the files contained no initial inspections.  Without inspection
reports, HUD is unable to readily determine whether the contractors
are conducting inspections as required. 


      REAM'S INADEQUATE
      PERFORMANCE AND WEAKNESSES
      IN HUD'S OVERSIGHT
      CONTRIBUTE TO POOR PROPERTY
      CONDITIONS
-------------------------------------------------------- Chapter 0:3.2

In all three locations that we visited, we found instances of
properties that were not maintained as required by the REAM
contracts.  During our inspection of approximately 20 properties in
each location, we identified properties that (1) were not properly
secured; (2) had physical conditions that did not match those that
the REAM contractor had reported to HUD; or (3) had imminent hazards. 

For instance, of the 66 properties we visited in all three locations,
we found that approximately 39 percent were not sufficiently secured
so as to prevent access to the property.  Failure to properly secure
properties can lead to trespassing, vandalism, and property
deterioration.  In fact, we visited unsecured properties that had
broken windows, graffiti, and exposed walls in the bathrooms where
valuable copper piping had been ripped out. 

In addition, we found physical conditions that did not match those
that the REAM contractors had reported to the three HUD field offices
we visited.  For example, one property contained animal feces, fur,
and personal possessions, while the contractor's inspection report
indicated that the house was free of debris.  If contractors do not
accurately report on the condition of properties, HUD may lack vital
information on which to make disposition decisions and to address
safety hazards.  As a result, the government may sell the property
for less than it is worth or incur unnecessary holding and
maintenance costs because it is not marketable. 

Furthermore, almost 71 percent of the properties we visited in one
field office and about 37 percent in another, contained imminent
hazards, such as broken or rotting stairs.  Inspection reports
submitted to HUD for one property noted that the front steps were
dangerous, a condition warranting immediate repair by the contractor. 
Nonetheless, when we inspected the property about 3 months after the
contractor initially reported the problem, the stairs still had not
been repaired.  Other imminent hazards we saw included a refrigerator
on a back porch with the door intact and properties containing
household waste, food, soiled diapers, and paints and solvents. 
Failure to address imminent hazards endangers would-be buyers as well
as neighbors and puts the government at risk of litigation. 

On the basis of our review of files and properties in three
locations, we found that the properties were generally in better
condition in the locations where staff more actively monitored the
contractors' performance.  We recognize, however, that the condition
of the properties is not totally attributable to HUD's oversight of
the contractors.  Other factors can contribute to the condition of
the properties, including the overall quality of the contractor's
work and the susceptibility of the neighborhood to crime and
vandalism. 


   CONCERNS ABOUT HUD'S OVERSIGHT
   OF SINGLE-FAMILY APPRAISALS
---------------------------------------------------------- Chapter 0:4

Our recent work on appraisals for FHA-insured single-family loans has
also identified concerns about HUD's oversight capabilities. 
Appraisals are an important aspect of the underwriting process for
FHA-insured mortgages because they influence the amount of the loan
and FHA's corresponding financial exposure.  Since December 1994,
private mortgage lenders making FHA-insured single-family loans have
been able to select any licensed or certified appraiser listed on
FHA's roster.  Before that time, appraisals for FHA-insured loans
were conducted almost exclusively by a panel of fee appraisers whom
FHA assigned to the lenders on a rotational basis.  In our July 1997
report cited earlier, we reported on the new appraiser selection
process, including problems relating to HUD's evaluation of completed
appraisals and the number of appraisals assigned to minorities and
women.  Recent limited work we conducted in New Jersey and Ohio in
response to concerns voiced by some former fee panel appraisers
raises additional questions about HUD's oversight of the appraisal
process. 


      HUD'S EFFORTS TO ADDRESS
      IMPLEMENTATION PROBLEMS
-------------------------------------------------------- Chapter 0:4.1

The Congress enacted the change to lenders' selection of appraisers
to improve both the efficiency of FHA lenders and the quality and
reliability of appraisal services.  Our July 1997 report noted that
HUD had identified two problems since implementing the new system. 
First, some HUD field offices were conducting few or no field reviews
of completed appraisals.  HUD uses the results of these reviews to
assess the performance of appraisers and identify those appraisals
that do not accurately assess the condition and value of appraised
properties.  We recommended that HUD require its field offices to
select a specific percentage of appraisals for review and establish a
process for ensuring that field offices meet this requirement.  In
response to this recommendation, HUD established a policy which
requires the field offices to review no less than 10 percent of all
the appraisals conducted within their jurisdiction.  An official from
HUD's Office of Insured Single-Family Housing told us that to ensure
compliance with this policy, HUD had made the 10-percent requirement
part of the criteria used to rate the performance of field office
staff. 

The second problem noted in our report was that minority and women
appraisers were not obtaining appraisal assignments under the new
selection process in the same proportion as they did when FHA
assigned the appraisers.  To help address this situation, HUD
announced in November 1997 that it would post lenders' appraiser
selections on its Internet site.  For lenders that complete five or
more appraisals per month, HUD intends to list the number and
percentage of appraisals performed by white males and females, and
minority males and females, along with the number and percentage of
each group represented on the field office's appraiser roster.  HUD
plans to begin posting these data around the end of April 1998. 


      RECENT WORK IN NEW JERSEY
      AND OHIO
-------------------------------------------------------- Chapter 0:4.2

Some former fee panel appraisers are opposed to the change in FHA's
appraiser selection process because they believe that some lenders
are selecting appraisers who are not accurately reporting the value
and physical condition of the homes they appraise.  They believe that
if left uncorrected, this situation will increase financial risks to
FHA if borrowers default on their mortgage loans.  They also contend
that inaccurate reporting on the physical condition of homes results
in borrowers not knowing the extent and cost of needed home repairs. 

In response to the concerns raised by these individuals, we recently
visited six homes in New Jersey and three homes in Ohio to determine
the extent to which the appraisals for these properties completely
and accurately described their condition.  The properties were
selected by the fee panel appraisers in order to illustrate their
concerns and therefore were not representative of all properties
appraised for FHA mortgage insurance.  Nevertheless, the problems we
found during the course of our work raise questions about the quality
of some appraisals and HUD's oversight of the appraisal process. 

The purpose of an FHA appraisal is to (1) determine the property's
eligibility for mortgage insurance on the basis of its condition and
location and (2) estimate the value of the property for mortgage
insurance purposes.  In performing these tasks, the appraiser is
supposed to identify any deficiencies impairing the safety,
sanitation, structural soundness, and continued marketability of the
property and assess the property's compliance with FHA's other
minimum property standards.  According to HUD's guidance, if an
appraiser finds noncompliance with these standards, the appraiser
should include in the appraisal report an appropriate and specific
action to correct the deficiency.  It further states that the
appraiser should reject a property for purposes of FHA mortgage
insurance when compliance with FHA's minimum standards is not
feasible or would require major repairs or alterations.  To be listed
on HUD's roster, appraisers are required to sign a document
stipulating that they have read pertinent HUD guidance. 

The appraisals for eight of the nine properties we visited in New
Jersey and Ohio did not reflect conditions we observed that could
adversely affect the structural soundness and continued marketability
of the houses and the health and safety of the occupants.\7 As of
February 1998, five of these eight properties had been purchased with
an FHA-insured mortgage.  For the remaining three properties, the
mortgage lender had either not approved the mortgage or had not
submitted the case to HUD for approval of mortgage insurance. 
Examples of conditions we observed that were not reflected in the
appraisals included termite damage, masonry and foundation damage,
makeshift structural supports, rotted siding, and deteriorated
roofing shingles.  In one instance, the appraisal report did not
mention, or call for repair or inspection of, an approximately
30-inch wide, 4-inch deep notch that had been cut into a load-bearing
beam.  In another instance, the appraisal made no mention of an
uncovered, pull-cord light fixture located above a bathtub and
shower. 

Our work at HUD's Camden, New Jersey, and Cleveland, Ohio field
offices revealed apparent weaknesses in their oversight of
appraisers.  For example, a HUD contractor who performed field
reviews on the appraisals for three of the six New Jersey homes
concluded that the appraisers overlooked serious deficiencies and
should have rejected the properties.  Although field reviews are an
important tool for identifying poor-performing appraisers, HUD's
Camden office could locate only one of the three field review reports
in its files.  Moreover, HUD's Philadelphia Homeownership Center
(HOC) subsequently approved FHA mortgage insurance for one of these
three properties, even though the center's staff had information
about the problems with the appraisal and the condition of the home. 
After we brought this situation to the attention of the homeownership
center's director, he acknowledged that the property should not have
been insured and removed the appraiser from FHA's roster.  The
homeownership center also instructed the mortgage lender to pay for
the repairs that were necessary to bring the property into compliance
with FHA's standards. 

At HUD's Cleveland office, we found that the appraiser for two of the
three Ohio properties had received four "unacceptable" ratings on
field reviews conducted in fiscal year 1997, grounds for possible
removal from FHA's roster of appraisers.  However, a single-family
housing specialist from HUD's Cleveland office told us that because
of staffing constraints, none of the four field review reports had
been reviewed by HUD's technical staff and that no disciplinary
action had been taken against the appraiser.  The official also
stated that field reviews were generally not a reliable monitoring
tool because of the poor performance of some field review contractors
and their high turnover rate.  It is important to note that as HUD
consolidates its single-family housing activities into four
homeownership centers and reduces its single-family housing staff,
HUD may need to rely even more heavily on field review contractors
and lenders to oversee the appraisal process. 

Mr.  Chairman, because of the problems we found during the course of
this work, we are planning to conduct, as you requested, a broad
assessment of HUD's monitoring and oversight of FHA single-family
appraisals. 


--------------------
\7 The remaining property did not have any significant deficiencies,
and the appraisal accurately reflected the condition of the home. 


   FINANCIAL STATEMENT AUDITS HAVE
   IDENTIFIED INTERNAL CONTROL
   WEAKNESSES
---------------------------------------------------------- Chapter 0:5

Annual audits of FHA's financial statements, while noting progress,
also continue to identify weaknesses in FHA's operations.\8 The audit
report on FHA's fiscal year 1997 financial statements--the most
recent available--identified three material internal control
weaknesses applicable, in varying degrees, to both the single-family
and multifamily programs.\9

  -- FHA must place more emphasis on early warning and loss
     prevention for insured mortgages.  According to the report, FHA
     does not have adequate systems, processes, or resources to
     effectively identify and manage risks in its insured portfolios. 
     Timely identification of troubled insured mortgages is a key
     element of FHA's efforts to target resources on insured
     high-risk mortgages.  Troubled insured mortgages must be
     identified before FHA can institute loss mitigation techniques
     that can reduce eventual claims.  The report notes that although
     the single-family insured mortgage portfolio is large, automated
     monitoring using statistical and trend analysis can be used
     effectively. 

  -- FHA must improve accounting and financial management systems. 
     According to the report, some of FHA's automated systems either
     do not provide needed management information or do not produce
     reliable information.  The report also stated that better
     information systems for strategic decision-making would make
     monitoring more productive and staff more efficient.  Also,
     FHA's single-family systems are not capable of generating the
     case-specific cash flow data needed to comply with federal
     credit reform.\10 As a result, HUD has not been able to
     accurately report the costs of its credit programs in its
     consolidated financial statements.  This information is
     important to executive branch and congressional decisionmakers
     for budget decisions. 

  -- FHA must address staff and administrative resource issues. 
     According to the report, FHA's staffing needs continue to be
     critical in the multifamily insured portfolio monitoring area. 
     In the past, FHA's staffing issues have included staffing
     shortages (in the case of single-family, the shortages primarily
     existed in the note servicing area), barriers to effective
     redeployment of staff, mismatches between skill sets and skill
     needs, and inadequate training resources.  According to the
     report, for the single-family program, the issue now centers
     primarily around property management and disposition, staff
     utilization, and transfer of resources as FHA consolidates
     activities and reduces 1995 single-family staffing levels by
     almost 60 percent by 2002.  The reduction of staffing levels in
     single-family housing programs, according to HUD, stems
     primarily from the elimination of most loan servicing and
     property disposition activities. 


--------------------
\8 The Chief Financial Officers Act of 1990 required HUD and some
other agencies to report annually to the Congress on their financial
status and any other information needed to fairly present the
agencies' financial position and results of operations.  To meet part
of this requirement, HUD's Office of Inspector General contracts with
a public accounting firm to conduct annual audits of FHA's financial
statements. 

\9 Federal Housing Administration Audit of Fiscal Year 1997 Financial
Statements, prepared by KPMG Peat Marwick LLP for the Office of
Inspector General (98-FO-131-0003, Mar.  9, 1998). 

\10 Problems with financial data and systems have impaired HUD's
ability to comply with both the Credit Reform Act of 1990 and the
requirements of Statement of Federal Financial Accounting Standards
Number 2, Accounting for Direct Loans and Loan Guarantees (Credit
Reform), which generally mirrors the act.  Credit reform relates
primarily to how HUD budgets and accounts for losses and costs
associated with its direct loan and loan guarantee programs.  A
primary purpose of credit reform is to more accurately measure the
costs of federal credit programs. 


   PLANNED AND ONGOING EFFORTS TO
   REFORM SINGLE-FAMILY HOUSING
   OPERATIONS
---------------------------------------------------------- Chapter 0:6

Under its HUD 2020 Management Reform Plan and related efforts, HUD is
in the process of making significant changes in single-family housing
operations, from the initial step of making insurance endorsements to
disposing of properties.  These changes are motivated in part by
HUD's goals of downsizing the agency and addressing long-standing
management weaknesses. 


      HUD'S 2020 MANAGEMENT REFORM
      PLAN PROPOSES SIGNIFICANT
      CHANGES
-------------------------------------------------------- Chapter 0:6.1

In June 1997, HUD announced its HUD 2020 Management Reform Plan, a
sweeping set of proposals intended to, among other things, address
identified management weaknesses and continue downsizing the
Department from about 10,500 (fiscal year 1996 levels) to 7,500 by
2000 (subsequently extended to 2002).  The plan outlined a number of
organizational changes, including the consolidation of similar
functions within and across the agency's main program areas, as well
as staff reductions and target staff levels for each of the areas. 
For single-family housing, the 2020 plan identifies and seeks to
address flaws in the current structure and operations, including
delays and problems in processing insurance endorsements, information
systems that do not help staff effectively monitor compliance, and
poorly controlled and monitored disposition of properties.  Under the
plan, HUD is consolidating all single-family housing operations from
81 locations across the nation into four single-family HOCs;
privatizing or contracting out most property disposition activities;
and eliminating most loan servicing functions by selling the
inventory of HUD-held mortgages. 

Once fully operational, the consolidation of functions in the HOCs
and planned technology improvements are expected to address the
problems facing single-family housing programs.  For example, each
HOC will have a Processing and Underwriting Division that provides
insurance endorsements, operational post-endorsements, fee panel
oversight, and underwriting guidelines.\11 This change is expected to
address the delays and other problems with processing insurance
endorsements. 

Also, each HOC will have a Quality Assurance Division to perform
quality control post-endorsement technical reviews, monitor lenders,
impose sanctions, and perform audits/investigations.  Overall, the
quality assurance staff will be increased by 33--from February 1998
staffing of 43--by the end of fiscal year 1998.  Also, the Denver HOC
will have a Servicing and Loss Mitigation Division for servicing
advice and guidance to mortgagees, loss mitigation, and loan
servicing.  These changes may help address the material internal
control weakness concerning early warning and loss prevention for
insured mortgages.  In any event, for these initiatives to be
successful, FHA must implement effective information systems to
support them.\12

Furthermore, each HOC will have a Real Estate Owned Division to
handle property disposition.  Although all property disposition
activities are planned to be transferred to the HOCs by September
1998, HUD is considering alternative methods for disposing of its
single-family housing inventory.  Specifically, according to HUD
Single-Family Housing Division officials, the Department plans to
sell the rights to properties before they enter inventory, thus
enabling them to be quickly disposed of once they become available. 
Although the details of these sales, which HUD refers to as
"privatization sales," remain to be developed, HUD envisions that
properties would be pooled on a regional basis and purchased by
entities that could use their existing structures to sell the
properties in the same way that the Department currently does,
through competitive sales to individuals.  In addition, as a part of
its budget request for fiscal year 1999, HUD is proposing new
legislation to allow the Department to take back notes when a claim
is paid, rather than requiring lenders to foreclose and convey
properties.  HUD would then transfer the note to a third party for
servicing and/or disposition.\13 According to the single-family
housing officials, as a result of these proposed changes, HUD
anticipates having only a minimal inventory of properties in the
future and, therefore, only a limited need for REAM contractors'
services. 

The 2020 plan also calls for HUD to modernize and integrate outdated
financial management information systems with an efficient
state-of-the-art system, incorporating such features as efficient
data entry, support for budget formulation and execution, updates on
the status of funds, standardized data for quality control, and
security control.  The plan also states that information and
accounting systems that do not comply with the Federal Managers'
Financial Integrity Act--which includes single-family housing
systems--would be overhauled to correct deficiencies, consolidate
functions into the new accounting systems, or be eliminated. 
Recently, the Department decided to forgo purchasing a new software
package to integrate its financial systems.  Instead, it will
continue to implement the Federal Financial Systems software, which
it began using in 1995.  Current plans call for fully implementing
this system as HUD's core financial system and integrating it with
the program feeder systems by September 1999.  As you know, at your
request we are currently reviewing HUD's effort to integrate its
systems. 

Prior to the 2020 plan, FHA developed an overall integration strategy
along program lines (single-family, multifamily and Title I housing). 
The strategy is designed to eliminate outdated systems and save the
systems that provide current, reliable data.  In our February 1997
High-Risk series report on HUD, we reported that the estimated
completion date for FHA's systems' integration project was 2001.\14
In the March 1998 report on FHA's fiscal year 1997 financial
statements, the auditors stated that although progress had been made
in systems' integration, including bringing new systems on line, much
work remained to be done.  The auditors also noted that FHA's
inability to quickly develop or acquire more modern information
technology will continue to deter its efforts to be a more efficient
and effective housing credit provider. 


--------------------
\11 Each HOC will also have a Marketing and Outreach Division for
promoting homeownership through home buyer education and
implementation of partnership agreements with state/local
governments, nonprofits, community organizations, and local
industry/trade groups. 

\12 Information Technology:  Streamlining FHA's Single Family Housing
Operations (GAO/AIMD-97-4, Oct.  17, 1996). 

\13 Although the legislation is proposed for enactment in 1999, the
program would not take effect until 2002, to allow HUD time to issue
regulations and mortgage lenders time to adjust to the new
procedures. 

\14 High-Risk Series:  Department of Housing and Urban Development
(GAO/HR-97-12, Feb.  1997). 


      EFFECTIVENESS OF PLANNED
      CHANGES IS UNCERTAIN
-------------------------------------------------------- Chapter 0:6.2

At the request of the Ranking Minority Members of the Subcommittee on
Human Resources and the Subcommittee on Civil Service, respectively,
House Committee on Government Reform and Oversight, we reviewed HUD's
support underlying specific features of the 2020 plan.  In our March
1998 report,\15 we reported that the proposed changes in
single-family housing operations are based on some empirical analysis
as well as other factors.  According to the Deputy Assistant
Secretary for Single-Family Housing, an in-house team of senior
managers developed the homeownership center concept on the basis of
the regional office structure of the Federal National Mortgage
Association (Fannie Mae).\16

Fannie Mae serves the entire United States through offices in
Atlanta, Georgia; Chicago, Illinois; Dallas, Texas; Pasadena,
California; and Philadelphia, Pennsylvania.  Certain functions
performed by FHA generally parallel some of those performed by other
organizations in the single-family mortgage industry, such as Fannie
Mae.  In 1994, as a pilot project, FHA began consolidating its loan
processing operations for single-family housing that were performed
in 17 of its field offices into the Denver HOC.  According to HUD,
the pilot showed that consolidating work at one site and increasing
the use of technology could reduce insurance endorsement processing
time from 2 weeks to as little as 1 day. 

The 2020 Management Reform Plan includes steps to downsize the
agency.  In our work for the House Government Reform and Oversight
subcommittees, we found that proposed staffing levels for each of
HUD's program areas, including Housing, are generally not based on
systematic workload analyses to determine needs.  While the HUD teams
that helped develop the 2020 plan were instructed by the Deputy
Secretary to determine staffing requirements on the basis of
workload, they were also instructed to work within targeted staffing
levels and the Department's staffing constraints.  FHA's proposal to
carry out single-family housing activities with the reduced staffing
level stems primarily from the elimination of most loan servicing and
property disposition activities.  According to the Deputy Assistant
Secretary for Single-Family Housing, the proposed staffing level is
based on past experience, input from the planning team, and staffing
levels at the Denver HOC.  A report by the team reviewing Housing
operations indicates that the loan processing functions in the Denver
HOC were carried out with half the number of the staff who were
responsible for those functions in the 17 field offices. 

There is uncertainty about the degree to which HUD will continue to
rely on contractors for property disposition activities.  According
to Single-Family Housing officials, until new approaches are fully
implemented, HUD staff will be responsible for disposing of the
current inventory and any new properties coming into the inventory by
using property management and marketing contracts similar to those
issued under a recent pilot program, which tests the approach of
contracting out all property management and marketing services.\17
Furthermore, even after the privatization sale approach is
implemented, there will likely continue to be a relatively small
number of properties that HUD does not dispose of through these
sales.  Such properties would be managed and disposed of using
contracts similar to those used in the pilot.  Accordingly, it
appears that HUD's property disposition operations will continue to
rely on contractors' services to some extent for the foreseeable
future.  Furthermore, if the alternative approaches do not operate as
well as hoped, according to Single-Family Property Disposition
officials, HUD will rely heavily on contracts similar to those issued
under the pilot.  However, as discussed in the previous section, HUD
headquarters has no mechanisms for regularly monitoring field
offices' oversight of contractors' activities.  As of December 1997,
none of the ongoing or planned changes to the property disposition
process established a system to ensure adequate monitoring by
headquarters of field offices' oversight. 


--------------------
\15 HUD Management:  Information on HUD's 2020 Management Reform Plan
(GAO/RCED-98-86, Mar.  20, 1998). 

\16 Fannie Mae is a government-sponsored enterprise that helps ensure
that funds are available to home buyers by buying mortgages from
mortgage originators, such as savings and loans, commercial banks,
and mortgage bankers. 

\17 According to Single-Family Property Disposition officials, field
offices with fewer than 10 remaining staff responsible for management
and sales of properties in inventory will use contracts similar to
those issued under the pilot, but field offices with 10 or more such
staff will continue to use REAM-type contracts. 


-------------------------------------------------------- Chapter 0:6.3

In closing, Mr.  Chairman, FHA is a prominent player in the home
mortgage loan market, particularly for low-income and minority
borrowers, first-time home buyers, and borrowers with high LTV
ratios.  Also, FHA has been able to serve such borrowers without the
need for any federal funds.  While the Fund supporting nearly all of
FHA's single-family mortgages is financially healthy and is projected
to continue to improve at least in the near term, improving FHA's
management over its single-family mortgage insurance operation would
enhance the Fund's ability to maintain financial self-sufficiency in
an uncertain future.  This is important because forecasts to
determine whether FHA will have the funds it needs to cover its
losses over the 30-year life of an FHA mortgage are uncertain.  Loan
performance will depend on a number of economic and other factors
over that period, such as changes that affect losses from claims. 

While HUD has formulated approaches and initiated actions to address
its single-family housing management problems, efforts are far from
reaching fruition and uncertainties exist.  Correcting these problems
would help reduce the risks associated with FHA's single-family
mortgage insurance operations as well as reduce its vulnerability to
waste, fraud, abuse, and mismanagement.  In addition, FHA is making
or proposing major changes in its single-family insurance operations
that will affect its organization, processes, and the maximum
mortgage amount insurable while reducing its staff.  Because the
changes are not yet complete and full operations of the HOCs are
untested, the extent to which they will address the problems of
single-family housing management is uncertain.  In addition, because
the downsizing target for FHA's single-family mortgage insurance
operations is not based on systematic workload analysis to determine
need, it is uncertain whether single-family housing will have the
capacity to carry out its responsibilities once the changes are in
place.  FHA's challenge is to implement such changes in an era of
diminishing resources, while managing existing commitments and
improving its management of the single-family mortgage insurance
program. 

Mr.  Chairman, this concludes my statement.  We would be pleased to
respond to any questions that you or Members of the Subcommittee may
have.  As indicated earlier in our statement, we are continuing to
review issues related to HUD's single-family mortgage insurance
operations and look forward to sharing the results of our work with
the Subcommittee. 


*** End of document. ***