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Mortgage Firm Offers Case History of Mismanagement in HUD Program

Times Staff Writer

The company had its headquarters in a stately Georgian brick building on a well-to-do street in Old Georgetown. Its founder, included in The Social List of Washington, was a pioneer in federally subsidized housing programs.

The founder’s son inherited his DRG Funding Corp., known popularly by the initials DRG.

Despite its distinguished pedigree, the company appears to be one of the most glaring examples of mismanagement to emerge in the web of scandals involving the Department of Housing and Urban Development.

Grand Jury Investigates

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Losses to the taxpayer from DRG’s scores of defaulted loans in HUD’s co-insurance program may total more than $500 million--a record for a single company. A federal grand jury is investigating allegations of fraud, theft and money laundering involving DRG.

Belatedly, HUD has canceled DRG’s right to issue mortgages. Today, the once-proud firm’s headquarters is vacant. A sign reads: “Entire Building for Lease.”

Donald Moss DeFranceaux, with the company he inherited from his father virtually in ruins, has refused interviews. DRG also is officially silent. But others have condemned the firm for misconduct and HUD for not doing more to stop the disaster before it happened.

Despite what now appears to have been a long record of flawed operations, DRG seemed to live a charmed existence at HUD.

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While all the evidence is not yet in, there are signs that DRG turned to well-known and well-connected Republicans to intervene with top-level HUD officials and avoid any crackdown on the company. Current U.S. Trade Representative Carla Anderson Hills, once HUD secretary, has been summoned to testify this week about her role in protecting the firm.

Sounds Warnings

As early as 1984, HUD Inspector General Paul A. Adams raised warning signals that DRG and other firms were inflating the value of mortgages to increase their own fees and were violating other government regulations for the co-insurance program. Throughout the eight-year reign of HUD Secretary Samuel R. Pierce Jr., however, little was done to interfere with DRG even when its default rate hit an amazing 29%. DRG’s sour loans eventually accounted for two-thirds of all the defaulted loans in the co-insurance program.

“We are shocked with what DRG got away with,” said HUD Secretary Jack Kemp, who finally suspended DRG from issuing loans late last March. Failure to take stronger action against the firm earlier, he concluded, was inexcusable.

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Co-insurance is a fairly new federal program that began in 1983. Launched as part of former President Ronald Reagan’s privatization effort, it reflected the reality that a sharply pared-down HUD staff of appraisers and clerical workers no longer could provide rapid service to lenders seeking FHA insurance on multi-family projects.

Under the co-insurance program, the lenders take over the appraisals and other underwriting chores from HUD, issue the mortgage and collect the payments in return for fees. They also agree to share the risk with the government if the borrower defaults, with the lenders accepting about 20% of any loss while the government absorbs the remaining 80%.

“The program can work, with good monitoring,” said Rep. Tom Lantos (D-San Mateo), chairman of a House Government Operations subcommittee on employment and housing, which is investigating the HUD scandals.

But, he added, inflated appraisals of a property’s value and inflated projections of rental income by the HUD-approved lenders create “an effective but clearly crooked way to make a lot of money.” Lenders’ fees, for example, are calculated at up to 3.5% of the mortgage amount. So the bigger the loan, the higher the fee.

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Cites Houston Project

The worst example of this mortgage-rigging he has seen so far, Lantos added, involved an apartment project in Houston known as Colonial House.

Despite the fall in oil prices that made Houston a depressed area for housing, DRG issued a $47.2-million loan to the 1,818-unit apartment project known as Colonial House in the fall of 1984. Later, when the borrowers defaulted, the loan was foreclosed. When the property was sold last May, it brought in only $8.9 million, leaving the government to pick up a tab totaling between $30.6 and $38.3 million.

“Somebody at DRG surely had a mighty optimistic view of (the value of) Colonial House, and it was apparently shared by HUD,” Lantos said.

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HUD’s inspector general issued reports of “serious deficiencies” in DRG’s lending operation. A report in November, 1985, warned that eight mortgage loans totaling $120 million were overappraised by a total of $36 million. The risk for HUD was that a default would leave it holding the financial bag--or 80% of a larger loss than necessary--because the property could not be sold for enough to cover the unpaid amount of the mortgage.

But the response from HUD officials at the time, he said, was that the inspector general’s concerns about DRG and other firms were unjustified and unfair.

Required Strong Action

Janet Hale, who was then assistant housing commissioner, acknowledged Friday that the problem required stronger action than she agreed to take at the time. HUD set up a special unit to monitor co-insurance lenders, Hale said, but demurred at taking stronger measures against DRG or other rule-breakers.

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“Management should have taken strong, effective action and it didn’t,” she said.

But DRG did not go entirely unchecked. Its early record was so poor that HUD demanded that it submit new loans for approval before they could be issued. Bridling at this restriction, the firm, early in 1985, hired Hills, former HUD secretary under Republican President Gerald R. Ford who was then a Washington lawyer in private practice, to try to get relief.

Hills sought a meeting with Shirley M. Wiseman, then HUD’s acting housing commissioner, to plead DRG’s case. But she failed to persuade her or HUD’s professional staff that the requirement for prior approval should be lifted.

“It was not a convincing argument,” Wiseman, now president of the National Assn. of Home Builders, testified Friday at a House hearing. “We felt nothing had changed at DRG.”

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But Hills managed to appeal directly to Pierce, in a meeting that excluded Wiseman and her staff. Restraints on DRG’s lending were eased. Hills argued that the company had a good default record at the time since only two of its loans were foreclosed.

Later, the firm retained Lynda M. Murphy, another former HUD official, to help it fend off proposed enforcement actions. Murphy had close personal ties to Deborah Gore Dean, the powerful assistant to Pierce.

DRG also found a defender in Thomas T. Demery, who became assistant secretary for housing in mid-1986 and resisted pressure from other HUD officials for a crackdown on the firm that was the biggest single issuer of co-insured loans.

Before he came to HUD, Demery received fees from DRG for brokering loans on several occasions, he has said. But he took part in decisions on DRG because of a ruling by the HUD general counsel that he did not have a continuing relationship with the firm. Demery said that he received all of the DRG payments long before he took the HUD post overseeing DRG’s conduct.

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By January, 1988, the HUD inspector general recommended that DRG be suspended as its default rate was soaring, eventually hitting 29% of its 272 co-insured loans, which amounted to $538 million in principal and accrued interest.

Demery resisted, however, and still refused to drop DRG even after the Government National Mortgage Assn. revoked DRG’s authority to issue its securities in September, 1988. The association, commonly called Ginny Mae, took over DRG’s loan portfolio to prevent further losses.

“I did not shield DRG,” Demery insisted recently.

One former HUD official defended Demery’s judgment, saying: “There was a sense on the department’s part that DRG would go under if we came down on them and it would create a ripple effect that would damage many other projects . . . DRG was funneling tons of its own cash into some projects to keep them going. . . . You really can’t blame Demery or the department for keeping them afloat for awhile.

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“But it was a house of cards. The deeper in trouble DRG got, the more loans they kept making to collect the fees.”

Last January, the FBI obtained a search warrant for DRG and sent a platoon of agents to the fashionable Georgetown address to seize the records of the company founded by George W. DeFranceaux. Even then, HUD refrained from acting.

Finally, more than a month after Kemp took over as HUD secretary, he suspended DRG from the program. Yet for four years, a company that was under constant fire from HUD’s financial police managed to make millions of dollars from government-guaranteed loans that have gone sour.

And, as the inspector general’s report said at the close of 1988: “Enforcement measures have been negligible.”

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The question that House and Senate investigators will be asking of those who were in charge at HUD in those days is simple: How did DRG get away with it?

Staff writers Ronald J. Ostrow in Washington and Douglas Frantz in Los Angeles contributed to this story.


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