U.S. Plan for Subprime Loan Susceptible to Fraud (Update1)
A Bush administration plan to offer low- and middle-income home buyers an alternative to subprime loans may be susceptible to fraud, the inspector general for the U.S. Department of Housing and Urban Development said. The proposal, incorporated in legislation introduced last month, would make it easier for borrowers to get mortgage insurance from the Federal Housing Administration but do little to assure adequate oversight of lenders, appraisers and lawyers, Kenneth Donohue said in a telephone interview.

U.S. Plan for Subprime Loan Susceptible to Fraud (Update1)
By Neil Roland

April 12 (Bloomberg) -- A Bush administration plan to offer low- and middle-income home buyers an alternative to subprime loans may be susceptible to fraud, the inspector general for the U.S. Department of Housing and Urban Development said.

The proposal, incorporated in legislation introduced last month, would make it easier for borrowers to get mortgage insurance from the Federal Housing Administration but do little to assure adequate oversight of lenders, appraisers and lawyers, Kenneth Donohue said in a telephone interview.

``The FHA has to go back and make sure the same thing that has happened with subprime loans doesn't happen with its program,'' said Donohue, who conducts internal audits and criminal investigations of HUD programs. ``The FHA has to make sure it doesn't get taken by the lenders, and it has to make better reviews of loan portfolios.''

Legislators and federal regulators are grappling with how to help subprime mortgage borrowers facing foreclosure. State authorities also have opened fraud investigations against brokers and lenders for allegedly misleading consumers about the terms of their loans.

The FHA reviews only 6 percent or 7 percent of its loan portfolios a year to ensure that they have been properly administered, Donohue said.

More Resources Needed

The agency needs more resources to review loans and claims, and to try to recover losses. It also should require the housing industry to exercise tougher oversight of mortgage brokers, some of whom are practicing without criminal background checks, he said.

``I believe we may be approaching the fourth quarter'' in terms of regulators' opportunity to stem housing fraud, said Donohue, 60, who has been inspector general since 2001, and was chief investigator for the Resolution Trust Corp.

The FHA, which is part of HUD, is trying to recover market share lost in recent years to subprime loans, which are often offered by mortgage brokers to borrowers with poor or limited credit histories. The popularity of subprime loans has led to a sharp increase in delinquent payments and foreclosures as consumers struggle to pay their mortgages.

The FHA's share of all home financing plunged to 3.8 percent from 14.1 percent from fiscal 1999 to 2006, according to FHA data. The number of households buying homes with FHA loans dropped to 302,000 from 911,000 during this period.

FHA Proposal

The agency insures loans that finance home purchases and refinancings for low- and moderate-income individuals, many of them first-time home buyers. It offers down payments as low as 3 percent.

Its proposal would eliminate the 3 percent down payment and raise the maximum loan amount. It also would give the FHA flexibility to charge a lower premium for low-risk borrowers and a higher premium to higher-risk consumers.

HUD Secretary Alphonso Jackson said on Aug. 10 in an online White House forum that the FHA ``is undergoing a historic transformation to give homebuyers who do not qualify for prime financing a better alternative to high-cost, high-risk loan products.''

The delinquency rates for both subprime and FHA loans rose in the fourth quarter of 2006, with the FHA delinquency rate reaching a record, according to a Mortgage Bankers Association survey released in March.

Past Due Loans

Subprime loans past due rose to 13.3 percent of all loans from 12.6 percent in the third quarter, while delinquent FHA loans climbed to 13.5 percent from 12.8 percent, the survey said.

The FBI's mortgage-fraud investigations doubled to 1,036 from fiscal 2004 to fiscal 2006, FBI spokesman Stephen Kodak said.

The FHA proposal was incorporated into legislation passed by the House 415-7 last year before languishing in the Senate. The initiative was renewed in February when the Bush administration submitted its budget to Congress.

New legislation with the FHA plan, including a bill co- sponsored by House Finance Committee Chairman Barney Frank, was reintroduced in the House on March 29.

Some executives say they expect home buyers to switch from subprime loans to FHA-insured credit, whether the new legislation is passed by Congress.

More Government Business

``We're quickly moving to a lot more government business,'' KB Home Chief Executive Officer Jeffrey Mezger told reporters Aug. 10 at the company's Los Angeles headquarters. KB Home is the fifth-largest U.S. homebuilder.

Jackson's spokesman, Stephen O'Halloran, didn't respond to a request for comment.

``We respect the IG's right to have an opinion,'' said Jerry Brown, a spokesman for FHA Commissioner Brian Montgomery.

Representative Judy Biggert, an Illinois Republican, introduced a bill containing the FHA plan on March 29 that is identical to the one that passed the House last year.

The same day, Representative Maxine Waters, a California Democrat, introduced a similar bill. In addition, it would eliminate fee increases from last year's measure, let HUD require pre-purchase counseling for riskier borrowers, and require cost and risk disclosures. Frank, a Massachusetts Democrat, is co-sponsoring the legislation.

Biggert's spokeswoman, Shauna Riley, declined immediate comment, as did Frank spokeswoman Heather Wong. Waters's spokesman did not immediately respond to a request for comment.

To contact the reporter on this story: Neil Roland in Washington at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it .

Last Updated: April 12, 2007 11:19 EDT

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