The Department of Housing and Urban Development's inspector general found "systemic problems" in lenders' compliance with underwriting requirements for Federal Housing Administration loans.
Kim Randall, director of the inspector general's civil fraud division, recommended in a report Wednesday that 15 mortgage lenders singled out a year ago for review because of their high default rates pay $23.4 million in potential fines for improperly underwriting FHA-insured loans.
The underwriting review of the lenders also found that HUD had "missed critical opportunities to recover losses" to the FHA insurance fund.
HUD does not have a formal process for reviewing all claims paid on defaulted mortgages or even on the riskiest of loans, "resulting in unrecovered losses to the insurance fund for loans that never should have been insured," Randall wrote in the 21-page report.
"The FHA insurance fund suffered an unacceptable percentage of loans defaulting and resulting in claims that never should have caused losses."
The fund is expected to pay $20 billion in claims this year, up from $14.5 billion last year.
HUD singled out the lenders for high default rates on FHA loans compared to the national average and because foreclosures had occurred early in the life of the loans. A few of the lenders have since gone out of business.
In all, the 15 lenders submitted $794.3 million in FHA insurance claims from 2007 to 2009. The lenders had endorsed more than 183,000 FHA loans valued at a combined $31.3 billion from 2005 to 2009.
As part of its review, known as Operation Watchdog, the inspector general selected between 12 and 20 loans in claim status from each lender to determine whether the company had performed due diligence and complied with FHA requirements.
In a highly unusual rebuke, the inspector general's office blamed HUD for failing to follow previous recommendations that it review missed payments during the first 30 months in the life of a loan.
HUD also failed to verify independently that loans met FHA requirements and were eligible for insurance, the report found.
"Because HUD did not agree with our original recommendation, it is unlikely that HUD would have selected the 140 loans that we reviewed and found noncompliant during the Operation Watchdog initiative," the report said. "Therefore, HUD would not have detected these loans as having caused more than $11 million in unnecessary losses to the FHA insurance fund."
FHA has created an early warning system to identify those lenders that may be violating its requirements. It also is negotiating indemnification agreements with lenders to ensure the agency is protected against bad loans, said Brian Sullivan, a HUD spokesman.
The report found that the lenders failed to comply with even the most basic of underwriting requirements. Half the 284 loans reviewed should have been disqualified because the lenders did not properly calculate or verify the borrowers' income or employment, did not properly document the source of borrowers' funds to close the loan, or did not properly assess the borrowers' financial obligations.
The report criticized HUD's current method of selecting FHA loans for review based on a statistically valid sample of loans with various risk factors.
"This method does not ensure that all claims are reviewed and may not target sufficient loans with claims paid to reasonably protect the fund," the report found.
