FHA Chases Its Tail

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When it comes to fraud and abuse, government programs are always chasing their tail. In the private sector, businesses have a financial incentive to stop abuses before they happen. No such incentive exists with government programs. Instead, government officials usually uncover abuses after the fact.

A good example of this problem was recently covered by the Washington Post

In 2008, Congress banned the practice of nonprofits taking money from home sellers and giving the funds to home buyers to cover down payments for mortgages backed by the Federal Housing Administration. When home buyers have no skin in the game, they are more likely to default. When the housing market collapsed, this is precisely what happened and the defaults have helped push the FHA closer to a taxpayer bailout.
 
Now these nonprofits have switched their focus to a new scheme: payment protection programs. The Post describes how it works at a nonprofit called the Rainy Day Foundation, which changed its name from the Home Downpayment Gift Foundation in 2007:
The Rainy Day Foundation advertises that it can help lenders remain in the FHA’s good graces. For a fee of about $600 per borrower, paid by lenders, home builders and real estate firms to cover the cost of making mortgage payments for distressed borrowers, the group promises to limit defaults during the two years after a loan is made, the period watched most closely by the FHA…[S] some lenders and housing experts say this kind of “payment protection program” postpones rather than prevents defaults and allows lenders to make riskier loans.
 
The Justice Department has alleged, for instance, that the Rainy Day program was used by a major FHA lender, Lend America, in an attempt to conceal fraud. In a civil lawsuit filed against Lend America in October, the Justice Department charged that the company secured FHA guarantees for loans based on fraudulent underwriting, then paid Rainy Day to hide defaults by some borrowers. The suit said that the FHA is likely to lose millions of dollars as the borrowers eventually default.
 
“The purpose of the Rainy Day Foundation was and is to conceal borrowers’ inability to keep up with mortgage payments during the first two years of the loan, the period of time that HUD monitors its Direct Endorsers’ delinquency and default rates,” the suit said. “Rainy Day purports to be a financial counseling program but on information and belief it is a mortgage lender-funded slush fund.” 
The Post says a HUD official confirmed that the department ruled in 1992 that these payment protection programs are legitimate. In 2005, a HUD consultant questioned the value of these programs for buyers, “but shortly thereafter, a HUD official affirmed the department’s policy.” This supports my finding in a Cato Policy Analysis that HUD is prone to repeating mistakes regardless of which party controls it.
 
As a Cato essay on fraud and abuse in government programs points out, federal housing programs have long been a ripe target: 
In 1971, Time discussed a scandal at the Federal Housing Administration in which “real estate speculators used the program to make huge profits at the expense of the poor through what amounts to sheer fraud.” The article also discussed a scandal from the 1950s whereby “builders pocketed millions of dollars of unearned profit from mortgage loans that exceeded the cost of construction” under a federal program. The magazine concluded that “whenever the government writes a blank check to the housing industry, some sort of scandal is likely to result.” 
The solution isn’t to hire ever more government accountants and lawyers to try and stop a problem that is endemic with HUD programs. The only way to get rid of the fraud and abuse is to dismantle HUD and get the federal government out of the housing business altogether.