Posted as an article on Source of Title . Not sure how much interest SC will have in the stuff I write nowadays as a part of my duties at my home site; much of it will be related to the title insurance industry, and the rest will probably be mostly related to real estate in some fashion.   In this case, I think there could be some general interest because  1.) FHA's policy portfolio has exploded in the past 12-24 months as the agency has taken over the market for the "subprime" home buyer and the private market for no-money-down loans, option ARMs, NINJA loans and the like have evaporated, and 2.) FHA's financial position is in question as defaults on FHA insured mortgages have spiked, and there have been predictions of a bailout.

Lend America ceased operations earlier this week in the wake of a case brought against it documenting 40 cases of mortgage fraud involving FHA-backed loans, cases which likely only scratch the surface of the true scope of the fraud committed by the company.  The situation prompts the question: how is such widespread fraud possible to maintain for such a long period of time, especially when dealing with a federal agency?  A closer look at FHA's policies, and one might start to wonder why massive frauds like Lend America aren't more common.

To understand why, it's important to understand that the FHA doesn't actually call the shots on which mortgagees it backs, even though it takes the financial hit on mortgages that default.

Rather than maintaining a staff that directly approves or denies FHA insurance on a loan-by-loan basis, FHA outsources the approval process to the lenders themselves-- creating an inherent conflict of interest, as lenders who get paid per loan originated are granted the ultimate authority over which loans get FHA backing.  FHA decides which lenders become "FHA Direct Endorsed Lenders" through an application and approval process, but the process is little more than a rubber stamp. 

Underwriters of FHA Mortgages must carry another government endorsement-- "FHA Direct Endorsed Underwriter".  But the FHA exercises no material controls over who carries that title.  Instead, FHA direct endorsed lenders are granted the authority to nominate employees for FHA Direct Endorsed Underwriter status, and the nominee merely has to register with FHA to earn the title.

Since the FHA is risking its funds largely on the word of underwriters at private lenders, one might expect that FHA would need to exercise significant oversight and enforcement to assure quality underwriting standards are met and to prevent and punish fraud.  But that isn't the case.  When loans go bad, HUD once again outsources oversight-- to the lenders themselves.  FHA rules indicate that "quick defaults "-- loans on which the borrower makes only the first payment or never makes a payment at all before defaulting-- are considered evidence of fraud or material misrepresentation until shown to be otherwise.  But even in cases where HUD follows up on a quick default, HUD leaves the investigation of the potential fraud to the lender, rather than dispatching an investigator to look into the issue.   At one time, HUD had an FHA Fraud Unit numbering 130 people, but it was dismantled in 2003.

A 2000 GAO report noted numerous weaknesses in HUD's FHA Direct Endorsement program, even at a time when the FHA had its own enforcement arm.  The GAO noted that "HUD’s process for granting FHA-approved lenders direct endorsement authority...provides limited assurance that lenders receiving this authority are qualified. "  The GAO also found that among 131 endorsed lenders who had received a "poor" rating for their mortgage credit decisions on 30% or more of their reviewed loans in 1999, none had had their underwriting authority rescinded. 

The case of recently shuttered lender Lend America highlights what can go awry with such a relaxed regime of oversight for lenders.  HUD finally revoked Lend America's FHA endorsement this past Monday, several days after the U.S. Attorney in the Easter District of New York filed suit against Lend America, documenting dozens of cases of mortgage fraud.

Lend America was granted the authority and responsibility of an FHA Direct Endorsed Lender despite the fact that it was run from its inception by Michael Ashley, a man with a conviction for three counts of wire fraud in connection to multiple instances of mortgage fraud.  In that case-- by his own admission-- Ashley repeatedly generated falsified documents showing inflated income for borrowers who would not have qualified for their mortgage otherwise.  Ashley also admitted to falsifying borrowers’ assets and credit in "all different ways", falsifying deposit verifications, gift verifications, income, assets, and owner occupancy.   The purpose of the fraud was to circumvent the standards of Fannie Mae and Freddie Mac, the (then) quasi-federal agencies chartered to create a secondary market for mortgages. 

A trail of fraud continued to follow Ashley after his conviction for mortgage fraud.  In 2002, a HUD review of U.S. Mortgage, where Michael Ashley was Executive Vice President, turned up numerous instances of fraud, including falsified documents.  Ashley was fired by U.S. Mortgage within weeks, and in a response to HUD's findings, U.S. Mortgage singled out Ashley as the responsible party.

Despite this, Michael Ashley was able to seek and receive authority to originate FHA mortgages for his new enterprise, Lend America, in 2004.

In press released and promotional materials, Lend America touted a team of "more the 30 FHA Direct Endorsed Underwriters".  Among this team of FHA Direct Endorsed Underwriters were Dawn O'Halloran, Lisa Burns, and Erika Etzel, all of whom had worked under Ashley during his troubled stint at U.S. Mortgage.  In other words, a whole team likely responsible for numerous instances of fraud at one company-- according to HUD's own past investigations-- was granted HUD's full permission to originate FHA mortgages under the banner of Lend America.

The U.S. Attorney's recently filed civil case against Ashley and Lend America documents 40 cases of blatant mortgage fraud dating back as far as 2006.  Direct Endorsed Underwriters O'Halloran, Burns, and Etzel each signed off on numerous fraudulent mortgages over a period of years, with Ashley serving as an unlicensed shadow underwriter, intervening in some individual loan files.  Many of the mortgages became instances of "quick defaults"-- the borrower in many cases never made a payment, an obvious red flag indicating fraud.  But the FHA did not rescind the underwriters' authority as Direct Endorsed Underwriters.  Nor did FHA revoke Lend America's license to make FHA mortgages.  Instead, HUD required Lend America to indemnify FHA from taking the loss on only three of the 40 fraudulent mortgages.  The remainder of the bad mortgages represent $14 million in claims and potential future claims, paid out by FHA.

The FHA has recently announced a "crackdown" on FHA lenders in the form of plans to "enhance the agency's risk management functions."  But the rules do not substantially address FHA's endorsement policies for companies like Lend America, nor do they address the certification of individual underwriters.