HUD auditors find widespread mortgage fraud

As the government’s head of the investigations in the savings and loan industry collapse of the late 1980s and early 1990s, Kenneth Donohue is no stranger to mortgage fraud.

Today, as inspector general for the Department of Housing and Urban Development, Donohue is looking into fraud and abusive lending practices related to mortgages insured by the Federal Housing Administration.

In the past three years, the roughly 650 investigators and auditors in Donohue's office have conducted 190 audits, developed cases leading to some 1,350 indictments and generated some $1.3 billion in restitution orders.

In an interview with MSNBC.com, Donohue reviewed the scope of his office’s work, the root causes of the jump in fraud and abusive lending practices, and his concerns about proposed changes at the FHA in response to the turmoil in the subprime mortgage market.

(Officials of the FHA, a separate agency of HUD, declined MSNBC.com’s request for an interview.)

The following is an edited transcript of Donohue’s remarks:

Why are we seeing more problems with bad mortgages?

I think it’s attributed to what I think is a lack of oversight and aggressive enforcement within the (Federal Housing Administration) portfolios.

My colleagues in the FBI have recently spoken about what they see to be a substantial amount of potential fraud in the commercial paper market — which is what the subprime is. I think they have a more difficult challenge because they’re at the mercy of receiving these referrals from the industry. ... The question is: Do (subprime lenders) work these things out civilly without bringing it to the attention of their shareholders?

FHA is different. We see the portfolios, and we see the folders, and they get referred to us. So we have a better handle on seeing some of this stuff as long as the department cooperates with us.

What has happened to the mortgage lending process that created these problems?

FHA has an outstanding mortgage insurance portfolio of about $396 billion. I’m the first one to say that the lenders, the workout folks, the appraiser — listen, most of them are honest people trying to do an honest day’s job.

But what I found — like I found in the savings and loan industry — is there are those out there that are going to do what they possibly can to bring in the business.

The (mortgage) industry was trying to create additional homeownership. And that’s very nice, and I think that’s a great thing to allow people homeownership. But at what cost? ... I think what happened is that people — unscrupulous people — took advantage of that, and what they did was go out and solicit prospective buyers.

FHA is proposing new rules and procedures. Will these help fix the problem?

There are recommendations in (the proposed Homeownership Act) increasing (insurance) premiums and going back and directing zero down payments. A number of recommendations they’re proposing in this thing give me great concern.

You’ve got to remember something: FHA is not supposed to be profit-driven. They’re a federal program. They’re really designed to reach those people that are first-time buyers.

The potential exists here that much of the subprime paper will be refinanced. So that borrower now comes in contact with another lender, another transaction and potential predatory lending, and then FHA takes that paper over.

A quarter to a third of the portfolio FHA has now is zero down payment. So now the problem you're faced with is you’re now getting paper with subprime risk, and the answer to that is, "Let's just increase the premiums."

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