House Probe Focusing on Fraud in HUD Co-Insurance Program

The House investigation of the emerging scandal at the Department of Housing and Urban Development now is focusing on abuse by private brokers of a co-insurance program that is riddled by fraud and eventually could cost taxpayers as much as $1 billion, congressional sources said Wednesday.

The 6-year-old program, designed to share with private lenders the government’s risk on Federal Housing Administration mortgages on apartment buildings, has “enormous problems,” said Rep. Tom Lantos (D-San Mateo), chairman of the House Government Operations employment and housing subcommittee.

Lantos has scheduled a hearing Friday to examine the program with top HUD officials and a Mortgage Bankers Assn. representative.

At issue is how some brokers were able to inflate appraisals of multifamily projects to increase the size of mortgages and thus earn higher fees, while letting the government take most of the risk of defaults, Lantos said in an interview.

“As it was run, it was a money machine,” he said.

Like the losses suffered in the savings and loan industry, the HUD program provided government guarantees without effective regulation of the private firms that carried out the mortgage underwriting, congressional sources said.

“This is going to be the next big scandal,” said another member of Congress, who asked not to be identified.

One mortgage broker has been indicted on federal fraud charges and three other indictments are expected soon, a subcommittee staff member said. HUD has barred six firms from making government-insured mortgage loans or taking part in any other federal programs.

Under the co-insurance program, holders of 106 of 800 mortgages have defaulted. In 21 claims handled by HUD last year, the government was able to recoup only 45% of the value of the multifamily residences and lost a total of $61 million.

Another 85 claims remain to be settled, and, if the same recovery percentage continues, the cost to taxpayers would be another $330 million to cover losses on the sales of the properties.

With a default rate of 12.8%, the co-insurance program is “very badly managed,” one aide to Lantos said.

The co-insurance program was launched in 1983 as part of the Ronald Reagan Administration’s “privatization” campaign to encourage private firms to take over services being performed by federal agencies. Before that time, brokers could earn a fee equal to 1% of an FHA mortgage on apartment projects by lining up a developer to buy the units, but HUD officials did the appraisal and serviced the mortgage.

Under the co-insurance program, however, HUD’s duties were delegated to private mortgage brokers, who were allowed to submit their own appraisals of projects, underwrite the mortgages and get a much higher fee of 4.3%. They also were required to collect the payments, pay for 20% of the loss and resell properties in case of default.

The brokers, however, were able to receive their fees immediately. If, as HUD charges, some brokers inflated their appraisals without justification, they received larger fees than were merited. But in the event of default, HUD was only able to collect the real value of the property, with taxpayers making up the difference.

In one case, a HUD audit disclosed that 14 projects co-insured by one Knoxville, Tenn., mortgage company were overvalued by an average of 29%, or by $22 million.