United States General Accounting Office

GAO Testimony

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

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

1

HUD Management: Information on HUD’s 2020 Management Reform Plan (GAO/RCED-98-86, Mar. 20,

1998).

Page 1 GAO/T-RCED-98-121
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

2

Homeownership: Information on Changes in FHA’s New Single-Family Appraisal Process

(GAO/RCED-97-176, July 25, 1997).

Page 2 GAO/T-RCED-98-121
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.

HUD’s Single-Family

Mortgage Insurance

Program

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

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.

Page 3 GAO/T-RCED-98-121
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.

Page 4 GAO/T-RCED-98-121
FHA’s Role in the

Single-Family

Mortgage Market

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

4

Homeownership: FHA’s Role in Helping People Obtain Home Mortgages (GAO/RCED-96-123, Aug. 13,

1996).

Page 5 GAO/T-RCED-98-121
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.

5

For FHA’s mutual mortgage insurance and cooperative management housing insurance programs.

Page 6 GAO/T-RCED-98-121
Weaknesses Exist in

HUD’s Oversight of

REAM Contracts

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.

Some Key Oversight

Responsibilities Not

Always Performed

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

6

Single-Family Housing: Improvements Needed in HUD’s Oversight of Property Management

Contractors (GAO/RCED-98-65, Mar. 27, 1998).

Page 7 GAO/T-RCED-98-121
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

Page 8 GAO/T-RCED-98-121
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

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

Page 9 GAO/T-RCED-98-121
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

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

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

Page 10 GAO/T-RCED-98-121
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

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

Page 11 GAO/T-RCED-98-121
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.

7

The remaining property did not have any significant deficiencies, and the appraisal accurately

reflected the condition of the home.

Page 12 GAO/T-RCED-98-121
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.

Page 13 GAO/T-RCED-98-121
Financial Statement

Audits Have Identified

Internal Control

Weaknesses

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

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).

10Problems 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.

Page 14 GAO/T-RCED-98-121
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.

Planned and Ongoing

Efforts to Reform

Single-Family Housing

Operations

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

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

Page 15 GAO/T-RCED-98-121
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

11Each 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.

12Information Technology: Streamlining FHA’s Single Family Housing Operations (GAO/AIMD-97-4,

Oct. 17, 1996).

13Although 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.

Page 16 GAO/T-RCED-98-121
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.

Effectiveness of Planned

Changes Is Uncertain

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

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

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

1998).

Page 17 GAO/T-RCED-98-121
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,

16Fannie 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.

Page 18 GAO/T-RCED-98-121
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.

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,

17According 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.

Page 19 GAO/T-RCED-98-121
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.

(385721) Page 20 GAO/T-RCED-98-121
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