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#### STATEMENT OF

#### KENNETH M. DONOHUE

**INSPECTOR GENERAL**

**DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT**

**HOUSE COMMITTEE ON FINANCIAL SERVICES**

**SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS**

**"SAVING TAXPAYER MONEY THROUGH SOUND FINANCIAL MANAGEMENT"**

**THE UNITED STATES HOUSE OF REPRESENTATIVES**

**JUNE 25, 2003**

Thank you for inviting me to submit a statement for the record on areas
where our audits and investigations have identified cost savings
opportunities to the Federal Government. Additionally, we want to
discuss other audit and investigative work where we found the Department
can do more to detect and deter waste, fraud and abuse. My focus will be
on some of our most recent endeavors.

***Remaining obligated funds from expired contracts should be promptly
identified and used to offset future budgetary needs***

Most of HUD's funding obtained through its annual appropriation process
are no-year monies. That is, the funding does not automatically expire
and it is used to cover the obligations throughout the many years of the
contract life.

HUD must recapture any remaining obligated funds when contracts are
completed. Our annual financial audit looks for obligated balances no
longer needed. At the close of fiscal year 2002, we identified more than
\$1.1 billion in obligations no longer valid and subject to recapture.
This is over and above the \$ 2.4 billion in Section 8 recaptures
already identified by the Department (\$1.1 billion project-based and
\$1.3 billion tenant-based). HUD's procedures for identifying and
de-obligating these funds were ineffective. This internal control
weakness has been reported each year in our financial audit since 1998.

Annually, [HUD]{.smallcaps} is required to perform a review of
unliquidated obligations to determine whether the obligations should be
continued, reduced, or canceled. We evaluated [HUD]{.smallcaps}'s
internal controls over this process. This year, as in prior years, we
found: (1) some HUD program offices not performing the required reviews
or not acting timely on review results, and (2) underlying HUD financial
systems not supporting the process for identifying excess budget
authority. As a result, funds that could offset future budgetary needs
were not being identified in a timely manner.

**[Section 8 Program.]{.underline}** HUD's Section 8 Program provides
billions of dollars of rental assistance payments each year to qualified
low-income households. HUD administers its Section 8 program in two
parts. In general, HUD's Office of Public and Indian Housing (PIH)
manages the tenant-based program and the Office of Housing (Housing)
manages the project-based program. A contract for Section 8 assistance
may cover multiple years and HUD reserves funds to cover the estimated
needs. [HUD]{.smallcaps} needs to periodically identify excess program
reserves from expiring Section 8 contracts. These excesses can be used
to offset future budget requirements. Since 1997, HUD has made efforts
to identify and recapture excess Section 8 budget authority. However,
weaknesses in the review process and the lack of automated system
interfaces between the Chief Financial Officer's general ledger and the
subsidiary records maintained by the Office of Public and Indian Housing
and the Office of Housing continues to hamper HUD's efforts.

*[Project-based Program]{.underline}*. Project-based assistance is
linked to specific housing units. Qualified residents in these
subsidized units generally pay 30 percent of their income towards rent
and HUD pays the difference. The project-based contracts---generally
between HUD and the owners of private rental housing---were entered into
beginning in the 1970s and 1980s, typically for 15, 20, or 40 year
terms. For some of these long-term contracts, actual expenditures have
proven to be lower than anticipated. In such cases, HUD can recapture
the unneeded funds and use them to help fund other Section 8 contracts
with insufficient funding. In addition, the long-term contracts that
were entered into during the 1970s and 1980s, began expiring in the
early 1990s. Initially contracts were renewed for several years.
Currently, expiring contracts are being renewed for one year.

The Office of Housing has been hampered in its attempts to evaluate
unexpended Section 8 project-based budget authority balances. The
requirement to evaluate data from two payment methods, managed by two
HUD accounting systems, has made this process difficult. In fiscal year
2002, HUD recaptured \$1.1 billion in unliquidated obligation for
expired contracts. There were other excess funds for Section 8
project-based contracts not being recaptured.

A review of the HUD budget estimate of shortfalls and excesses for
project-based Section 8 contracts for fiscal year 2003 and outyears
showed an estimated \$365 million in excess contract authority expected
to be realized during fiscal year 2003 related to expiring Section 8
project-based contracts that would be renewed. HUD's fiscal year 2003
budget request, nevertheless, included full funding for Section 8
project-based contract renewals. Housing did not have a process in place
to estimate recoveries from expired contract authority associated with
this group of contracts. Review of fiscal years 2001 and 2002 contract
renewals showed an additional \$123 million and \$245 million,
respectively, in excess contract authority that was rolled over to
contract renewals.

In addition, our review of other Section 8 project-based contracts
showed 259 contracts that had expired prior to September 30, 2001. These
259 contracts had \$34 million in excess funds potentially available for
immediate recapture. HUD needs to address data and systems weaknesses to
ensure that all contracts are considered in the recapture/shortfall
budget process.

[*Section 8 Moderate Rehabilitation Program***.**]{.underline} The
Section 8 Moderate Rehabilitation Program is another form of
project-based housing assistance administered by local housing agencies
under contract with HUD. The program was created in 1978 to upgrade
assisted rental housing units requiring moderate repair. HUD provides
rental subsidies and administrative fees to contracted housing agencies.
Housing agencies entered into multi-year Housing Assistance Payments
(HAP) contracts with property owners. This program was funded for eleven
years. These contracts require owners to rehabilitate their housing
units and rent them to eligible families. As of fiscal year 2002, the
majority of these assistance contracts had expired and, therefore, many
projects had excess Section 8 reserves.

HUD had not reviewed the unexpended obligations in the Section 8
Moderate Rehabilitation Program since fiscal year 2000 when they
recaptured \$246 million in unexpended funds. As part of our 2002
financial audit, we requested that HUD update their analysis of these
contracts through September 30, 2002. HUD identified an additional \$217
million in unexpended funds for recapture. As a result, HUD adjusted its
2002 Consolidated Financial Statements for \$200 million in excess
unexpended funds. In April 2003, HUD recaptured the \$200 million.

*[Tenant-based Program]{.underline}.* HUD provides funding to Public and
Indian Housing Agencies to administer the Section 8 tenant-based voucher
program. Housing authorities make assistance payments to landlords who
lease their rental units to Section 8 assisted households with vouchers.

In August 2002, HUD performed an analysis of budget authority for all
years related to the Section 8 tenant-based program and estimated that
approximately \$1.3 billion of the unexpended budget authority was not
needed and available for recapture. These funds were recaptured before
the close of the fiscal year.

**[Section 236 Multifamily Mortgage Interest Reduction
Program.]{.underline}** HUD has been hampered in attempts to determine
and account for unexpended Section 236 Interest Reduction Program (IRP)
budget authority balances. HUD's reporting of commitments under the
insured mortgage component of the Section 236 IRP program was not
accurate. There was a difference of approximately \$790 million between
the subsidiary and general ledgers for the Section 236 program at the
end of fiscal year 2002. The cause of the problem was the lack of an
aggressive program to identify excess funds and an ineffective
accounting system.

The Section 236 program was created in the 1960s and ceased new activity
during the 1970s. The mortgage and assistance payments contracts
typically run up to 40 years. This program includes making interest
reduction payments directly to mortgage companies on behalf of
multifamily project owners. Participants were given the right to prepay
their subsidized mortgage after 20 years as an incentive to stay in the
program.

HUD has historically chosen to estimate the amount of commitments
reported in HUD's financial statements due to time needed to review
manual records. Our review found the methodology used to make this
estimate flawed. Consequently, commitments were overstated by
approximately \$128 million, and another \$487 million in contract
authority associated with prepaid mortgages was not identified and
recaptured in fiscal year 2002.

As a result of our review, HUD processed an adjustment to the 2002
Consolidated Financial Statements for \$705 million in excess unexpended
funds. HUD plans to review the computation of estimated 236 subsidy
payments using the proper amortization factors. In addition, for the
Section 236 program HUD needs to: (1) review and de-obligate, where
appropriate, unexpended funds no longer required; (2) strengthen
procedures to remove expired contracts in a timely manner; and (3)
develop an integrated automated accounting system.

**[Rent Supplement and Rental Assistance Payments (RAP)
Programs]{.underline}**. HUD is not recapturing excess undisbursed
contract authority from the Rent Supplement and Rental Assistance
Payments (RAP) programs in a timely manner. The Rent Supplement program
and RAP, operate much like the current project-based Section 8 rental
assistance program. Rental assistance is paid directly to multifamily
housing owners on behalf of eligible tenants. HUD's subsidiary ledgers
show, for each fiscal year, the amount authorized for disbursement and
the amount that was disbursed. Funds remain in these accounts until they
are paid out or de-obligated by the accounting department. At the end of
fiscal year 2002, the general ledger balances for RAP and Rent
Supplement totaled \$2.18 billion. Our audit projected that at least
\$46 million in excess funds could be recaptured.

**[Other Operating Programs.]{.underline}** Each program and
administrative office was requested to review each outstanding
obligation over \$200,000. Exclusive of Section 8 (discussed above),
\$34 billion in obligations were identified. Our audit found that of the
\$34 billion reviewed; \$94.3 million (1,094 program transactions) could
be de-obligated. We followed up on whether the balances were actually
de-obligated. As of October 11, 2002, 125 of the 1094 transactions with
obligation authority of \$34 million had not been de-obligated.

## Improper Housing Assistance payments

Under the provisions of the U.S. Housing Act of 1937, HUD provides
housing assistance funds through various grant and subsidy programs to
multifamily project owners and housing authorities. These
intermediaries, acting for HUD, provide housing assistance to benefit
primarily low-income families and individuals (households) that live in
public housing, Section 8 assisted housing, and Native American housing.
In fiscal year 2002, HUD spent about \$23 billion to provide rent and
operating subsidies that benefited over 4 million households. Weaknesses
continue to exist in HUD's controls that prevent HUD from assuring that
these funds are expended for rent subsidies in accordance with the laws
and regulations authorizing the grant and subsidy programs.

The Office of Public and Indian Housing (PIH) provides funding for rent
subsidies through its public housing operating subsidies and
tenant-based Section 8 rental assistance programs. These programs are
administered by housing authorities (HAs) that are to provide housing to
low-income households or make assistance payments to private owners who
lease their rental units to assisted households.

The Office of Housing (Housing) administers a variety of assisted
housing programs including parts of the Section 8 program and the
elderly and disabled (Section 202/811) programs. These subsidies are
called "project-based" because they are tied to particular properties,
therefore tenants who move from such properties may lose their rental
assistance. Historically, unlike public housing and tenant-based
Section 8, most of these subsidies have been provided through direct
contracts with multifamily project owners. HUD has responsibility for
processing payments to project owners and ensuring that they provide
support only to eligible tenants and that they comply with the contract,
program laws and regulations. More recently, HUD has been contracting
with "performance based contract administrators" who have begun taking
over significant aspects of Section 8 contract administration. However,
a sizable number of project owners remain that hud must monitor.

Legislation authorizing HUD's housing assistance programs includes
specific criteria concerning tenant eligibility and providing assistance
for housing that meets acceptable physical standards. Moreover,
legislation authorizing HUD's programs also establishes minimum
performance levels to be achieved. For example, subsidized housing must
comply with HUD's housing quality standards.

We continue to report concerns that HUD's intermediaries are incorrectly
calculating housing assistance payments. HUD's control structure does
not adequately monitor to ensure acceptable levels of performance are
achieved. Also, there is an absence of an on-going quality control
program that would periodically assess the accuracy of rent
determinations by intermediaries. We also found significant control
weaknesses in HUD's income verification process. These weaknesses
related to tenant income, which is the primary factor affecting
eligibility for, and the amount of, housing assistance a family
receives, and indirectly, the amount of subsidy HUD pays. Generally,
HUD's subsidy payment makes up the difference between 30 percent of a
household's adjusted income and the housing unit's actual rent or, under
the Section 8 voucher program, a payment standard. The admission of a
household to these rental assistance programs and the size of the
subsidy the household receives depend directly on its self-reported
income.

A significant amount of excess subsidy payments occur as a result of
undetected, unreported or underreported income. This year we reported on
HUD's measurement of erroneous payments resulting from intermediaries'
housing assistance billings for HUD's subsidy payments. HUD identified
significant errors in the billings and payments processes, which also
results in excess subsidy payments. By overpaying rent subsidies, HUD
serves fewer families. The impact of payment errors of this magnitude
takes on added significance in light of a HUD estimate that the "worst
case housing needs" is around 5.4 million households; that is,
unassisted very low-income renters who pay more than half of their
income for housing or live in severely substandard housing.

A contract study completed in November 2000, substantiated there was
significant risk in HUD's reliance on intermediaries to ensure that rent
calculations for assisted households were based on HUD requirements. The
study estimated that HUD incorrectly paid \$2.3 billion in annual
housing subsidies of which about \$1.7 billion in subsidies was overpaid
on behalf of households paying too little rent, and about \$600 million
in subsidies was underpaid on behalf of households paying too much rent
based on HUD requirements. Last year, HUD revised this estimate to
report an additional \$978 million in overpayments resulting from
underreported and unreported income.

With regard to detection of unreported income, HUD, Housing Authorities
and project owners have various legal, technical and administrative
obstacles that impede them from ensuring tenants report all income
sources during the certification and re-certification process. Since
unreported income is difficult to detect, HUD began pursuing statutory
authority from Congress to access and use the Department of Health and
Human Service's National Directory of New Hires Database to detect such
income. In addition, HUD continues to encourage HAs to verify income and
to computer match with State wage agencies to detect underreported and
unreported income.

In fiscal year 2001, HUD initiated a Rental Housing Integrity
Improvement Project (RHIIP). The project plans to address the problems
surrounding Housing Authorities and project owners' rental subsidy
determinations, underreported income and assistance billings. The
Department also continued operations for large-scale income verification
and matching involving Social Security (SS) and Supplemental Security
Income (SSI) information. This information is made available to Housing
Authorities, project owners and administrators of the Office of
Housing's rental assistance programs who access the SS and SSI
information via a secure Internet facility as a "front-end" way to
verify income and annual tenant re-certifications. Our financial audit
details the many efforts underway in the Department to improve the
accuracy and reliability of subsidy calculations. We are encouraged by
the Department's on-going actions.

## Investigative initiative to focus on Section 8 Housing Assistance fraud {#investigative-initiative-to-focus-on-section-8-housing-assistance-fraud .unnumbered}

In concert with the President's Management Agenda, the OIG is announcing
a newly focused, prioritized effort to detect and prevent fraud in
Housing Assistance Programs. Prior to my tenure, rental subsidy fraud
cases were generally assigned a low investigative priority. There had
been a somewhat reluctance to investigate these tenant fraud cases
because of limited financial payoff; that is, significant recoveries or
prosecution were unlikely. We have received input from various Public
Housing Executive Directors across the country that a more focused and
publicized OIG effort would have a positive effect on accurate
reporting. (We have decided to refocus our efforts in this area due to
the increasing growth in tenant fraud.)

In an effort to outreach with the Public Housing community, I have
addressed conferences of major public interest groups including the
National Association of Housing and Redevelopment Officials and the
Public Housing Agency Directors Association. It is well understood that
HUD serves only a portion of those families needing housing assistance.
Consequently, it is important that every dollar be spent for deserving
participants with zero tolerance for fraud. Prosecutions will send a
message that there are consequences for failing to report income.
Persons not entitled to federal benefits will be removed to make way for
eligible tenants.

The GAO now lists rental subsidy overpayments as one of the Department's
high risk areas. While the amount attributable to fraud is unknown, the
Department estimates losses linked to improper housing assistance
payments to exceed one billion dollars annually. It is clear that OIG
must address this problem using a systemic, multi-dimensional approach
that not only addresses the individual cases referred, but also calls
for a partnership with the Department to implement measures that will
reduce the overall problem.

This multi-year initiative includes the following steps to assure a
comprehensive approach to the problem:

1)  **Identify the scope of the problem**. HUD has an automated tenant
    certification database and the authority to conduct income computer
    matches with IRS data. OIG will partner with the Department to
    statistically estimate the extent of rental subsidy fraud. HUD's
    Office of Policy, Development and Research is already conducting
    such studies, but this focuses primarily on subsidy miscalculations,
    not potential fraud. OIG will encourage them to expand their sample
    to include the fraud rate. By verifying the existence of fraud in
    the statistical sample, a nationwide fraud baseline can be
    established. This rate should be recalculated annually or
    bi-annually in order to measure progress and to determine which
    detection and prevention techniques are most effective.

2)  **Use analytic techniques to extract the most egregious cases.**
    Income computer matching will be used to identify cases where
    tenants report little or no income, but wage data indicates
    significant unreported income. Various U.S. Attorneys offices have
    already been contacted to coordinate our activities. These cases
    will provide the basis for a tenant awareness campaign that should
    serve to deter future crimes.

3)  **Identify systemic weaknesses in HUD directives/controls, or in
    PHA/management agent execution.** Problems often occur because HUD's
    instructions are not strong enough or program administrators may
    lack the know-how or will to implement controls effectively. OIG
    auditors and agents are working with program management staff to
    develop stronger controls and detection methods. By reviewing
    entities with high error rates, HUD will have the leverage to
    correct those administrators who are reluctant to conduct strong
    tenant screening and verification procedures.

4)  **Develop a Rental Fraud training program.** HUD must invest in
    training new staff by creating certification standards that will
    continue to provide and enhance a skilled and educated workforce to
    administer HUD subsidy programs. HUD and its contractors need to
    teach PHA and management agent staff on ways to prevent, and to
    detect, fraud and errors. Awareness alerts could also serve as a way
    to reinforce a strong detection and sanction program, and to signal
    tenants that HUD will not tolerate fraud in its programs.

5)  **Use various computer-matching techniques to test for the most
    effective methods to reduce crime.** OIG is currently working
    directly with the Executive Directors of various Housing Authorities
    in New York, Indiana, Illinois, Virginia, and the District of
    Columbia. OIG is also working cooperatively with the Department's
    Rental Housing Integrity Improvement Program (RHIIP) staff.
    Presently, HUD is conducting a pilot program with 20 PHAs in
    Florida, Texas and Ohio to obtain State wage base data. The PHAs
    will conduct matching programs and will then make referrals to OIG.

OIG Special Agents' in Charge in all ten Regions are making Section 8/
housing assistance fraud an investigative priority, whether committed by
a tenant, the Section 8 administrator, the Management Company, or the
PHA employee. By announcing this today, it is my hope that our strategy
will send a message that this is a high priority for our organization.

***Timely and effective communications can go a long way in deterring
program fraud***

A recent investigative case in Charlotte, North Carolina, involved a
major fraud scheme against Ginnie Mae and The Federal Housing
Administration (FHA) whereby a mortgage lender placed fraudulent loans
in mortgage-backed securities pools. Better communications between the
two HUD organizations, FHA and Ginnie Mae, might have prevented this
scheme from continuing for more than two and a half years and reduced
the nearly \$30 million in losses.

FHA insures nearly 1.3 million mortgages each year with an outstanding
mortgage insurance portfolio of nearly \$600 billion. The secondary
market for these FHA loans is under another HUD organization, Ginnie
Mae. The vast majority of FHA mortgages are pooled by Ginnie
Mae-approved issuers. An issuer will group a pool of mortgages to form a
mortgage-backed security. The sale of these securities frees up funds
for additional mortgage loans. Approved Ginnie Mae issuers take the FHA
monthly mortgage payments for those pooled mortgages and pass the
payments through to securities holders. Ginnie Mae guarantees the pass
through of these funds.

First Beneficial Mortgage Corporation (FBMC) of North Carolina was an
approved FHA direct endorsement lender as well as an approved Ginnie Mae
issuer. At the time the fraud was detected, this issuer had a Ginnie Mae
mortgage-backed security portfolio worth \$45 million. This issuer saw a
window of opportunity to originate fraudulent FHA mortgages and then
pool them into mortgage-backed securities. By using the investor
proceeds from the sale of securities, the issuer was able to continue a
"pyramid" scheme by appearing to pass through mortgage proceeds. Over
100 of the pooled mortgages in 11 Ginnie Mae pools were in fact
fraudulent. FMBC systematically recruited strawbuyers to sign fraudulent
and fictitious mortgage notes for vacant parcels of land. FBMC would
then submit these false notes to their registered document custodian as
backing for their securities as required by Ginnie Mae.

FBMC, as the issuer, was permitted to sell millions of dollars of Ginnie
Mae securities without verification through, or by, FHA that these
mortgages were appropriately insured. FBMC was continuing to issue pools
using false documents. FHA and Ginnie Mae communications might have
detected the fraud earlier. A simple verification by Ginnie Mae that the
FHA pooled loans were in fact insured would have raised a red flag.
Because of this case, Ginnie Mae has started a process of checking to
see that Ginnie Mae pooled mortgages are, in fact, FHA insured. This
control should detect improper pools within a few weeks of their
origination.

***FHA Single-Family mortgage fraud and debt collection activities***

Single-Family mortgage fraud continues to be an investigative priority
for the OIG. Our investigations of perpetrators of fraud include title
companies, loan officers, mortgage companies and brokers, real estate
agents, closing attorneys, and appraisers who through a variety of
schemes submit fraudulent loan applications, appraisals, and other
falsified loan documents and/or utilize straw buyers and other
conspirators to effect the schemes.

Our Semiannual Report to Congress for the period ending September 30,
2002 reflected investigative recoveries of \$59 million. During the same
period, approximately 60% of our cases and 90% of our investigative
recoveries was attributed to Single-Family mortgage fraud cases. During
the first 6 months of this fiscal year, investigative recoveries are
approximately \$65 million, a figure which already exceeds our
recoveries for all of fiscal year 2002.

Recent statistical information gathered from our ten regional offices
shows that investigative efforts expended on these Single-Family cases
involve approximately 1400 subjects who have originated more than \$1
billion in loans affecting nearly 36,000 FHA- insured properties. These
investigations are worked in coordination with 148 Assistant United
States Attorneys and with numerous other federal law enforcement
agencies.

\* \* \* \* \* \* \*

In conclusion, we are continuing to work jointly with Departmental
officials to correct the many problems I have discussed. It is my
understanding that the Department will be offsetting future
appropriations with excess obligated balances. I am glad that our work
with the Department and the Committee prior to this hearing contributed
to this development. This week, my senior managers along with senior
program managers in the Department are meeting in Philadelphia. We have
characterized this meeting as a "fraud symposium" where we will identify
fraud prevention and detection opportunities and work toward making HUD
a more efficient and effective agency.

I have been the Inspector General at HUD for little more than a year. It
has been a productive time. I have a well-trained and dedicated staff.
Our goal is to ensure that the billions of taxpayers\' dollars
appropriated by the Congress for HUD programs are used effectively to
provide safe, decent, and sanitary housing for millions of Americans.
The structure of HUD and the diversity of its programs make this a
formidable task. But working together with program staff and the
Congress, I think we can take positive steps to make HUD operate in an
optimum manner.