perspective on program design flaws and HUD management
deficiencies associated with the assisted/insured portfolio.
As I will present later, these problems bring with them
serious consequences for the tenants, their neighborhoods,
and the Federal budget .
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THE PORTFOLIO PROPOSED FOR REENGINEERING
As one of the Nation's oldest and largest financial
institutions, FHA insures mortgage loans for about 15,800
multifamily rental properties with 2 million rental units
which have an unpaid principal balance of about $47 billion.
FHA insurance protects private lenders from losses resulting
from borrower defaults on the mortgages for these
properties. When a borrower defaults, the lender assigns
the mortgage to HUD and receives an insurance claim payment
from HUD for the unpaid mortgage amount. About 75% of FHA
insured projects receive some form of direct subsidy from
HUD in addition to mortgage insurance, including interest
rate subsidies and/or Section 8 rental assistance. The
project-based Section 8 subsidy is covered by contracts
between HUD and the project owners. The owners agree to
house lower income tenants in exchange for rent subsidies
for specific units.
HUD'S reengineering proposal applies to 8,636 properties
that have both FHA mortgage insurance and receive Section 8
rental subsidies for some or all of their units. The
Section 8 subsidy contracts for this portfolio will expire
between 1996 and the year 2010. These properties have
unpaid principal balances totaling almost $18 billion and
contain about 859,000 units. Renewal of these contracts is
expected to cost HUD approximately $42 billion in outlays
during the next 7 years, and likely over $200 billion during
the next 25 years. HUD reports that about 45 percent of
this portfolio consists of older assisted projects with an
unpaid principal balance of about $5 billion while the
balance of the portfolio to be reengineered consists of
newer assisted projects with an unpaid principal balance of
$13 million.
Older assisted properties include those using Section 236
or Section 221 (D) (3) interest rate subsidies intended to
subsidize rents for low income families. Many of these
projects have a serious backlog of needed repairs affecting
tenants and project viability. Over the years, the need for
additional revenues in these projects was satisfied with
Section 8 project based assistance.
Newer assisted properties include mostly projects insured
under Section 221(D) (4) that receive Section 8 assistance on
most or all units. Because Section 8 assistance for these
projects is rather generous, most of these properties are in
better condition both physically and financially when
compared to the older assisted properties.
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PROBLEMS AND CAUSES OF A TROUBLED PORTFOLIO
The insured Section 8 portfolio suffers from several serious
problems, including a declining physical condition,
expensive rental subsidies provided by the Federal
Government, and a significant financial risk to FHA from
mortgage insurance claims. We believe these problems are
the result of two basic problems: first, the flawed design
of the project based Section 8 program, and secondly,
management weaknesses within HUD.
FLAWED PROGRAM DESIGN
The coupling of mortgage insurance and Section 8 project
based rental assistance is flawed in its design and
inherently risky. Insured Section 8 projects are not
subject to the system of market disciplines and incentives
that promote efficient and effective operation of rental
housing.
Under FHA' s insurance program, the Federal Government
assumes almost all financial risk in the event of a default.
Multifamily mortgage insurance programs require only a
minimal equity investment (10%) for profit motivated owners
which usually consists of noncash items such as fees and
profit allowances earned during construction of the project.
In the case of programs for refinancing existing projects,
owners are allowed to withdraw their invested equity as part
of the new mortgage proceeds .
Also, HUD insured mortgages are non- recourse, meaning that
individual owners are not personally liable for the
mortgages in the event of default. So, with minimal upfront
investment or risk and HUD often willing to protect its
investment in the property with more subsidies, owners often
have little to gain by keeping down costs and protecting the
interest of tenants. The overall insurance claim rate to
FHA for the Section 236 program from inception is about 20%,
while the claim rate for the Section 221 (d) (3) program is
about 40% since inception.
Project based rental assistance becomes the primary source
for meeting the growing financial needs of the projects.
A disturbing number of projects are experiencing
deterioration and neglect by their owners. A recent study
performed by HUD reports that the insured Section 8
portfolio is in need of $3.7 billion in deferred
maintenance. Owners often do not have built-in incentives
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to maintain properties because of a lack of equity-
investment and/or depleted tax benefits. If the rents are
set too low, the project deteriorates and the tenants suffer
and HUD risks paying an insurance claim. If the rents are
set too high, the excessive subsidies pay for the windfall
profits of the owners and deprive other needy families from
receiving assistance.
Over one half of the projects in this portfolio have rents
being subsidized at levels 120% or more above local market
levels. For the newer assisted projects, these rents will
continue to escalate with automatic increases every year
regardless of need. As operating and repair costs rise on
older assisted projects, so do Section 8 costs because of
the need for additional subsidized units or higher Section 8
rents to pay for the added costs.
Unlike tenants paying market rents, subsidized families
living in units receiving project based assistance are
forced to remain in their units, regardless of the quality
of the housing, because they cannot afford to relocate to
other available housing which is not subsidized. Families
become trapped if they are to continue to receive assistance
and are dependent upon HUD's ability to ensure the quality
of the housing.
Program design also impedes enforcement actions for
substandard performance or deliberate noncompliance with
HUD's program requirements. Enforcement actions often have
collateral effects upon the tenants and Federal spending as
HUD attempts to employ corrective actions. Typically HUD's
hands are tied because effective enforcement actions trigger
other events that are not in HUD's interest, such as:
If HUD declares a default of an insured mortgage,
this results in acceleration of the debt by the
mortgagee, the payment of a claim from the FHA
insurance fund, and a lengthy and expensive
disposition process.
If HUD defaults a Section 8 contract, this results
in a recapture and rescission of the contract
authority. However, the subsidized tenants are
then left without affordable housing.
If HUD abates the Section 8 payments on a
significant number of units in an insured project,
the cash flow decreases, the owner cannot pay the
mortgage or repair the units, the residents
continue to live in unacceptable housing and HUD
pays a claim from the insurance fund.
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** If HUD decides, as a last resort, to
foreclose on a project because the owner
refuses to take needed corrective actions,
the owner quickly hides behind Bankruptcy
Act protections to delay HUD action, and
thus costing HUD more as the project
continues to deteriorate. When HUD
does eventually foreclose, acquire and then
sell the property, yet more Section 8 is
placed on the property. All this while
tenants continue to live in substandard
housing .
Another major problem in HUD's multifamily insured housing
programs is the issue of equity skimming. Equity skimming
plays a significant part in the realization of losses to the
FHA insurance funds. Equity skimming is the willful misuse
of any part of the rents, assets, income or other funds
derived from the insured property.
Apart from the fairly obvious financial losses that HUD
incurs when owners collect rents but do not pay the
mortgage, equity skimming generally has other insidious
implications. Most notably, living conditions deteriorate
for the tenants as funds intended to maintain, replace or
repair living units are diverted for the personal use of
owners .
The reasons some owners violate HUD requirements and divert
project funds are multi- faceted. The reasons range from
simple greed to more complex issues associated with the tax
laws. The bottom line remains, however, that when an owner
chooses to misuse project funds, it is almost always with
the idea of personal enrichment and with little worry that
if and when caught, any meaningful consequences will be
paid.
Once an owner gets into the "nothing to lose" position with
a project, HUD must be able to promptly identify project
abuse and take the steps needed to minimize the impact on
the tenants and the insurance funds. HUD has not been able
to respond in this manner. HUD Field Offices do not have
the resources and systems to adequately assess troubled
projects and take effective loss mitigation actions.
In effect, the majority of risk involved in these projects
is taken by the tenants and the taxpayers. Tenants are
seemingly trapped when project conditions deteriorate
because their subsidies are tied to the units they occupy
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and tenants have rarely been able to obtain corrective
actions by the owners. Taxpayers are often asked to pay for
deteriorated units with excessive subsidies and to fund
losses when insurance claims are paid.
As part of Operation Safe Home, the OIG has initiated an
aggressive proactive effort to pursue affirmative litigation
against owners of multifamily housing projects whose owners
misuse project operating funds. The goal of Operation Safe
Home is to stop major abuses in HUD programs that result in
unacceptable living conditions for the millions of needy
people who look to HUD for help. A primary objective of the
Equity Skimming aspect of Operation Safe Home is to create
an enforcement program that provides an effective deterrent
and recovery mechanism for the misuse of income and assets
at projects having HUD insured or Secretary-held mortgages.
This effort is producing results. In the first 2 years, 10
criminal convictions and over $37 million in judgments,
settlements, and fines involving project owners and managers
have taken place. Another 105 cases are in process
involving over $105 million in misused project funds.
However, much more still needs to be done in program
enforcement .
HUD WEAKNESSES
Serious problems with FHA management and practices have been
the subject of studies, task forces and hearings for the
last 20 years. As reported over and over by OIG, GAO and
others, HUD's resources for the servicing of the insured
multifamily portfolio are seriously deficient. HUD lacks
the capacity to manage and monitor its portfolio of insured
and assisted multifamily properties.
In fact, since 1987, HUD has been reporting the area of
multifamily loan servicing as a "material weakness" pursuant
to the Federal Manager's Financial Integrity Act. Our
semiannual reports to the Congress and our financial
statement audits of FHA have consistently pointed out
systemic weaknesses that impact HUD's ability to manage and
monitor multifamily programs, namely, inadequate staff
resources and data systems, and weak management controls.
To the credit of HUD managers and staff, a newly designed
asset management strategy for the multifamily insured
portfolio is in place for 1996 that should improve their
capabilities for mitigating losses and reducing the
incidents of substandard housing. However, when dealing
with the program flaws inherent to the project based
assistance programs, such strategies are severely challenged
in making a significant difference overall.
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staffing Resources
HUD currently lacks needed staff resources to adequately
service the loans and Section 8 contracts in a manner that
adequately protects the interest of the tenants and the
Federal government. The staffing problems at HUD will
likely worsen with the projected decrease in staffing in the
Agency expected during the next few years. The skill level
of the HUD staff generally does not enable them to
effectively identify and assess physically troubled
projects, and ensure corrective or enforcement action is
taken.
For example, Field Office physical property inspections,
financial statement reviews, and on-site management reviews
have not been performed in a manner that consistently
identifies problems. In addition, follow-up with property
owners and their management agents is not sufficient to
ensure that problems identified through HUD's monitoring are
being addressed in a timely and acceptable manner. This
often contributes to insurance claims, unacceptable housing
conditions, and excessive and wasteful subsidies.
In April 1993, we issued a mult i -region audit report
covering HUD's servicing of insured/assisted multifamily
housing projects. As part of our review, we inspected 28
troubled multifamily housing projects under the jurisdiction
of six HUD Field Offices and determined that the physical
condition of 23, or 82 percent, was unsatisfactory or below
average. Of the 28 projects inspected, we determined that
20 had inadequate preventative maintenance programs. Our
tests also showed that HUD staff had not performed any
recent Housing Quality Standards (HQS) inspections for 17
(61 percent) of the 28 projects we inspected.
The audit also disclosed that HUD-insured multifamily
projects remained in poor physical condition for extended
periods of time and that units receiving Section 8
assistance often failed to meet HUD's housing standards.
With respect to the latter, we inspected 314 Section 8
assisted units and determined that 216, or nearly 69
percent, failed to meet HUD's housing standards.
We reviewed the staffing level at the 6 HUD field offices
included in the audit, and found that the workloads of the
loan servicers widely varied from an average of 105 projects
per servicer in Detroit to 28 per servicer in Kansas City.
The average for the 6 offices was 57 projects per servicer.
In addition to their loan servicing duties these staff had
also been assigned additional duties to administer newer
programs such as the Preservation Programs (Titles II and
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VI) , monitoring State Housing Finance Agencies, along with
other functions transferred to the field from Headquarters
such as foreclosures, review of proposed project sales, and
workout agreements.
Another factor hampering performance was the skill level of
the loan servicing staff. Managers and staff must maintain
a level of competence that allows them to accomplish their
assigned duties. Managers in three of the six offices
included in our audit reported that their staffs were not
adequately trained to perform their jobs. We also learned
that 4 of the 6 offices did not have any financial analysts
on their staffs. Much has been done by HUD in the last few
years to design and conduct training for loan servicers.
However, budget constraints on HUD will continue to impact
this area.
The high project to servicer ratio, the added
responsibilities, and lack of training hampers the
servicers' ability to prevent or remedy problems. In the
search for yet new product lines and larger market shares,
FHA staff can expect to be further burdened with new loans
to service and new programs to learn. For example, the
Secretary has decided to make health care facility
financing, including mortgage insurance for hospitals,
nursing homes and community health centers an important
component in his recent plans to transform HUD. These and
other programs distract HUD from improving the delivery of
its core programs for providing decent, safe and sanitary
housing for low- income persons.
Another demonstration of the scope of HUD's staffing
shortages in this regard was contained in a 1993 Price
Waterhouse audit report on FHA. That report pointed out the
wide disparity between staffing levels at HUD and at other
entities involved in multifamily housing lending. Whereas
state housing finance agencies have staff/loan ratios of 1
to 20 and private institutions of 1 to 15, each HUD staff
person has an average workload of 50 loans. Price
Waterhouse went on to point out that HUD loans are typically
much riskier, more troubled and thus more staff intensive,
making the noted disparity even greater.
Management Controls
Management controls in the form of supervision and
performance measurements have not been effective in ensuring
that the mission and objectives of HUD's loan servicing
function are being properly carried out.
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The use of performance measurements is relevant to the
administration of HUD's multifamily mortgage insurance
programs for determining whether what is being done is
making a difference. Our audit of loan servicing activities
in 1993 disclosed that 5 of the 6 offices examined did not
measure the performance of loan servicing qualitatively.
HUD'S measures used for evaluating performance in its
multifamily programs focused on such activities as the
amounts of funds expended, units subsidized, on-site reviews
performed, management reviews completed and physical
inspections performed during the year. Although 5 of the 6
offices achieved the goals established for them during the,
year, their success in correcting project deficiencies was
dismal. These offices could not identify for us those
projects having substandard living conditions, the length of
time projects remained in disrepair, or the amount of
insurance claims paid for the last 3 years or even the
current year.
While recent OIG surveys of the Office of Housing's
performance measurement and resource management found an
improvement in the reporting of some program input and
output measures, there is a continuing need for outcome
measures and the use of performance measures in day-to-day
program and resource management . The annual Housing
Management Plan is the primary means of setting priorities
and monitoring accomplishments. Field operating units set
their own goals, and headquarters does not review the
reasonableness of the goals relative to available resource
levels and the volume and complexity of workload. Essential
functions are still inadequately performed in many offices,
such as reviews of subsidy payment requests, and follow-up
and enforcement action on the results of contracted project
monitoring activity.
In our audit of HUD's loan servicing activities, we also
found that most financial reviews and on-site management
reviews that we examined had no evidence of any supervisor
review to ensure these assignments were properly performed
by the staff. Supervisors attributed their lack of
oversight to a lack of time and no established system
requiring supervisory review.
Data Systems
The impact of staffing shortages could be offset somewhat
through economies relating to the use of automated data.
However, HUD does not have effective and integrated
automated data systems that can be relied upon to provide
relevant, timely, accurate, and complete information.
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Financial performance data on projects, while improving,
continues to be inadequate. Data systems do not provide
information usable for the early detection of troubled
projects, and assessing and resolving project difficulties.
Numerous past attempts to develop a useful system have not
been successful. Management must establish accountability
and responsibility for project management, technical
support, data quality, documentation, and training.
Inadequate data systems has contributed to fraud, waste and
mismanagement in many of HUD's programs, including the
Section 8 -assisted multifamily housing programs.
GUIDING PRINCIPLES FOR ACTION
As can be seen very plainly from the many years of problems
that have plagued insured Section 8 projects, drastic
changes are needed in the way HUD provides housing
assistance to low income families. The expiring Section 8
contracts for these projects and the sizable impact that
renewals will have upon the Budget have brought these
problems to the forefront. We commend HUD for recognizing
this problem and for their work in trying to develop a
solution during the last 2 years.
Even as the budget crisis comes upon us, however, real
progress toward achieving an agreed upon solution appears
exceedingly slow. There seems to be agreement that this
system of assisted/insured multifamily housing is costing
too much. But there is concern that moving away from the
current system will mean losing this stock of "affordable
housing"; place tenants - many of them elderly - in the
position of fending for themselves with tenant-based
certificates and vouchers; and force owners to pay
substantial amounts of capital gains taxes. There is also
significant anxiety about what the costs would actually be.
This is turn relates to HUD's lack of good data on a project
level; HUD's management inadequacies; HUD's understanding of
private sector motivations and probable reactions to
portfolio reengineering; and HUD's ability to work with
third parties as partners in portfolio restructuring.
If the OIG had a silver bullet policy solution, I would
offer it now. We don't, of course; but we do offer the
following considerations, which we believe are essential to
devising the appropriate policy.
Expiring Section 8 contracts provide an opportunity to
implement new housing assistance policy that fits within the
total welfare reform debate. Currently, HUD rental housing
assistance benefits only one-third of the households in need
10
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in this country despite the billions a dollars expended each
year. And HUD reports the number of households spending
over 50% of their incomes for housing continues to rise each
year. With the reduction of Federal funds available for
welfare programs, the future looks bleak for those many in
need. Transitioning from Federal assistance programs to
self-sufficiency must be ingrained in to our housing
assistance programs if there is to be any chance of having
enough resources to benefit all the families who deserve
help.
As discussed earlier, many of the project in the portfolio
have rents in excess of the market and are in need of a
great deal of rehabilitation. Clearly this is not a stock
of affordable housing when the rents are neither affordable
to private renters or the Federal government . Where housing
is available at market rates, the need to preserve the
housing as project based assistance should be closely
examined before committing additional Federal support.
During the last two years, the debate over the usefulness of
vouchers has continued without resolution. HUD reports
that, in large part, tenant based assistance provides a good
mechanism for meeting the housing needs of low income
families. Yet, too often, there are examples of families
that have found vouchers to be unusable. Some cases would
indicate this form of subsidy does not provide the level of
assistance needed to make available housing affordable,
while others find landlords reluctant to accept vouchers
because of the additional costs or burdens placed upon them
by the Federal government when compared to renting to
unsubsidized tenants. These problems need to be addressed.
The combination of mortgage insurance and housing
subsidies leads to unbusinesslike stewardship and
additional subsidies. Congress and HUD must develop
programs that take full advantage of market forces to ensure
the quality and cost of housing is reasonable. We must
understand what brought us to this point and what factors
are likely to influence the future of the portfolio.
Keeping project based assistance programs in place while
only reducing Section 8 payments by restructuring mortgages
will not fix the problem. Rather this is just a shuffling
of the cost of the program from one appropriation to
another. Much more needs to be done.
HUD'S difficulties in designing a proposal to deal with the
expiring Section 8 contracts and in estimating the costs of
its restructuring proposal are indicative of the
inadequacies of its data systems and lack of information on
rental markets and the condition of projects in its
portfolio. However, HUD's recently completed study on a
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sample of the portfolio to be reengineered has been a