Financial Audit: Federal Housing Administration Fund's 1988 Financial Statements

Published by the Government Accountability Office on 1990-02-09.

Below is a raw (and likely hideous) rendition of the original report. (PDF)


                      United   States   General   Accounting   Office
GAO               *
                      Report to the Congress

February   1990
                      FINANCIAL AUDIT
                      Federal Housing
                      Administration Fund’s
                      1988 Financial

GAO          United States
             General Accounting  Office
             Washington, D.C. 20548

             Comptroller  General
             of the United States


             February 9,199O

             To the President of the Senate and the
             Speaker of the House of Representatives

             This report presents the results of our audit of the Federal Housing
             Administration Fund’s consolidated financial statements as of Septem-
             ber 30, 1988. Reports on the Fund’s internal accounting controls and on
             its compliance with laws and regulations are also provided.

             As a result of the 1988 financial audit, the Federal Housing Administra-
             tion (FHA) adjusted its financial statements from a loss of $858 million to
             a loss of $4.2 billion, which reduced its government equity to a cumula-
             tive deficit of $2.9 billion. The 1988 losses resulted from rising defaults
             in economically stressed regions, sales of foreclosed properties at less
             than carrying values, the failure of several large coinsurers, and pro-
             gram fraud and abuse. The full extent of losses attributable to program
             fraud and abuse through September 30,1988, is not yet known.

             We and Price Waterhouse have declined to express an opinion on WA’S
             1988 financial statements because of an inability to ascertain the extent
             of losses due to fraud and abuse and because of the lack of an accurate
             inventory of foreclosed property. We are also concerned about large
             potential future losses in FHA’SGeneral Insurance (GI) Fund. The audit
             also revealed serious internal accounting control weaknesses in third-
             party monitoring, financial management systems, insurance program
             design, controls over cost and claims settlement, and the performance of
             basic accounting functions. In addition, the audit showed that FHA did
             not fully comply with the Debt Collection Act of 1982.

             The Federal Housing Administration (FHA) was established in 1934
Background   under authority granted to the President by the National Housing Act
             (Public Law 73-479) and became in 1948 a wholly owned government
             corporation for purposes of the Government Corporation Control Act
             (GCCA).FHA and its functions were transferred to the U.S. Department of
             Housing and Urban Development (HUD) in 1965. The GCCAnow provides
             that the Secretary of HUD, when carrying out the duties and powers
             related to the F’HA Fund, is subject to the provisions of the GCCA.~
             basic purpose of FHA programs is to encourage improvements in housing
             standards and conditions, provide an adequate home financing system

             ’ Herein, the FHA Fund. and the Secretary’s administration of it, will be referred to simply as FHA.

             Page 1                                          GAO/AFMD-90-M       Federal   Housing Administration

                        through mortgage insurance, and exert a stabilizing influence on the
                        mortgage market. To carry out this purpose, the Secretary of HUD
                        administers FHAthrough four separate funds for its various mortgage
                        insurance programs. As of September 30, 1988, FHA had $303 billion of

                        Under the provisions of 31 USC. 9105, we are required to audit FHAat
                        least once every 3 years. We were unable to perform an audit of FHA'S
                        fiscal year 1981 financial statements due to significant accounting and
                        reporting changes needed (GAO/AFMD-~~-~~,June 10, 1983). In 1985, we
                        terminated our audit work on FHA’Sfiscal year 1984 financial statements
                        due to numerous deficiencies in FHA’Saccounting systems and financial
                        records and changes in agency systems and staff. Since 1984, FHA has
                        made a number of improvements in agency systems, staffing, and man-
                        agement, which we considered sufficient, to permit an audit of its state-
                        ment of financial position as of September 30, 1987.

                        To fulfill our audit responsibility, we contracted with the independent
The 1987 and 1988       certified public accounting firm of Price Waterhouse to conduct financial
Audits                  audits of FHA for 1987 and 1988. Due to the magnitude of accounting
                        and reporting changes needed, as noted in prior year audits, it was not
                        practical to audit FXA’Sconsolidated statements of operations and cash
                        flows for the year ended September 30,1987. For these reasons, it was
                        deemed necessary to restrict the scope of Price Waterhouse’s work to
                        the audit of FHA’SSeptember 30, 1987, statement of financial position to
                        establish opening balances, and we did not require reports on internal
                        accounting controls and compliance with laws and regulations (GAO/
                        AFMD893, May 12, 1989). However, these reports are presented as part
                        of the consolidated financial statement audit for fiscal year 1988.

                        We determined the scope of the audit work, monitored its progress at all
                        key points, reviewed the working papers of the certified public
                        accountant, and performed other procedures as we deemed necessary.
                        The audits were conducted in accordance with generally accepted gov-
                        ernment auditing standards, except for the previously discussed scope
                        restriction on the 1987 audit.

                        Price Waterhouse has disclaimed expressing an opinion on FHA'S 1988
Disclaimer of Opinion   and 1987 financial statements because it was unable to ascertain the
                        amount of potential losses involved in alleged improper diversions of
                        property sales proceeds by certain private closing agents contracted by

                        Page 2                            GAO/AFMD#X%   Federal   Housing   Administration

HUD to sell HUD-owned properties and other alleged improprieties and
because FHA did not maintain an accurate inventory of foreclosed
properties. We concur with Price Waterhouse’s disclaimer.

As of September 30, 1988, FHA had $3.1 billion of foreclosed property
held for sale ($2.5 billion in 1987) less an estimated allowance for losses
of $1.4 billion ($1.1 billion in 1987). The alleged diversions resulted, in
part, from internal accounting control weaknesses involving HuD’s
inability to properly monitor both the collection and the prompt deposit
of property sales proceeds. As of September 15, 1989, the amount of the
losses that will ultimately be incurred because of the alleged diversions
had not been determined. Further, the amount of losses applicable to
FHA’S1988 and 1987 financial statements is not ascertainable and could
have a significant impact on FHA’s financial position, results of opera-
tions, and cash flows. HUDinvestigations into this matter are currently

Price Waterhouse’s audit of FHA’Sfinancial statements also disclosed a
material uncertainty with respect to FHA’SGeneral Insurance (GI) Fund,
which has incurred substantial losses due to the default of several coin-
suring lenders. Because of insufficient levels of capital required of coin-
suring lenders and the lack of FHAprogram monitoring, additional losses
may result. A provision of $960 million has been recorded in the 1988
consolidated statement of operations for the amount of estimated losses
resulting from existing and probable defaults in the multifamily coinsur-
ance programs. An additional provision of $275 million has also been
recorded for probable defaults of FHA-insured hospital mortgages, based
upon unfavorable financial conditions involving several hospital mort-
gages. HUD’Sactuary has determined that, in the aggregate, the GI Fund
premiums are insufficient to cover its losses, and the Fund must depend
on borrowings from the U.S. Treasury and appropriations to sustain its
operations. However, given the probability that additional losses will
take place, FHA cannot presently estimate the amount of premium defi-
ciency or the level of support it will ultimately require from the 1J.S.

Additionally, Price Waterhouse’s report emphasized that FHA’SMutual
Mortgage Insurance (MMI) Fund is operated as a mutual fund and is
required to be “actuarially sound,” so that over the life of the fund, pre-
miums are sufficient to pay claims and expenses. The MMIFund, FDA’S
largest, with $229 billion of a total $303 billion of insurance-in-force,
incurred 1988 losses of $1.4 billion, reducing its equity to $1.8 billion as

Page 3                             GAO/AFMD-90-36 Federal Housing Administration

                         of September 30, 1988. Despite this current loss, HUD'S actuary has esti-
                         mated that future revenue will exceed future claims and expenses for
                         the MMI Fund. However, actuarial studies are currently underway to
                         determine whether there are structural or design weaknesses in the MMI
                         fund that could cause material losses.

                         The 1988 unaudited financial statement amounts released by FHA and
                         reported to the U.S. Treasury in December 1988 disclosed a loss of
                         $858 million for all four FHA funds. During the audit, Price Waterhouse
                         proposed, and FHA recorded, over 100 adjustments to correct FHA'S
                         accounts which, in the aggregate, reduced government equity by $3.4
                         billion and resulted in a cumulative deficit of $2.9 billion. The $3.4 bil-
                         lion of audit adjustments were primarily the result of net increases in
                         accruals for claims not yet reported. FXA must report to the U.S. Trea-
                         sury financial results for the fiscal year ended September 30 by Decem-
                         ber 31 of each year, requiring estimates of incurred but not reported and
                         probable future claims Audit work by Price Waterhouse disclosed the
                         need to report additional claims based upon actual experience and the
                         recognition of losses at the time of default rather than at the time of
                         foreclosure-an     average lag of 15 months.

                         The report by Price Waterhouse on internal accounting controls dis-
Serious Internal         closed six conditions believed to be material weaknesses and made a
Accounting Control       number of suggestions to address those weaknesses. Those weaknesses
Weaknesses Exist         are as follows:

                     l Monitoring of underwriting, property management, and collection of
                       property sales proceeds delegated to private sector third parties is
                     . Financial management systems do not provide timely and accurate
                       information on programs, nor do they hold managers accountable for
                       program results and effectiveness.
                     l Structural or design flaws exist in the multifamily coinsurance program,
                       due to insufficient levels of capital required of coinsuring lenders, and in
                       the hospital mortgage insurance program, due to uncoordinated under-
                       writing practices.
                     l The system for foreclosed property inventory cannot account for
                       acquired properties and their value, and the cash management system
                       does not ensure that proceeds collected by third parties on sales of fore-
                       closed property are promptly deposited in FHA'S Treasury accounts.

                         Page 4                             GAO/AFMD9@36   Federal   Housing   Administration

                      l   Controls over cost are inadequate, multifamily insurance claims benefits
                          are not being paid promptly, and controls are inadequate to detect mis-
                          representations by mortgagees and lenders.
                      l   Routine and basic accounting functions, such as reconciling accounts to
                          supporting records, providing support to justify payments, controlling
                          funds held on behalf of others, and properly recording transactions, are
                          not being performed.

                          Most of these fundamental accounting and financial reporting problems
Problems Are              are the same ones that GAO and the HUD Inspector General have been
Longstanding              reporting since the early 1980s. HUD has not been diligent in correcting
                          problems cited by auditors or in its own Federal Managers’ Financial
                          Integrity Act (FMFIA) reports. While HUD staff members responsible for
                          FHA activities have generally responded to GAO and Inspector General
                          recommendations and to the weaknesses disclosed in the FMFIA reports,
                          resolution of the findings has often been delayed and some findings
                          have not been addressed at all. In addition, in some cases, there were no
                          follow-up reviews to determine if proposed procedures had, in fact,
                          resolved the cited problems.

                          For example, HUD'S 1987 and 1988 FMFIA reports disclosed that inade-
                          quate controls existed which provided the potential for private closing
                          agents to manipulate or otherwise take funds for their own use or to
                          delay the transfer of such funds to HUD. This same weakness was noted
                          during the 1988 audit. Subsequently, a private closing agent, known as
                          “Robin HUD," admitted to embezzling $5.5 million of HUD funds during
                          this period.

                          These weaknesses, findings with which we concur based upon our
                          review of the auditors’ working papers, are discussed in detail in the
                          accompanying report on internal accounting controls.

                          The report by Price Waterhouse on compliance with laws and regula-
Noncompliance With        tions disclosed an instance of noncompliance, which could impact FHA'S
the Debt Collection       ability to effectively collect money it is owed. FHAdid not fully imple-
Act                       ment the Debt Collection Act of 1982 because it failed to take collection
                          action after foreclosed property was acquired. The noncompliance with
                          the Debt Collection Act of 1982, a finding with which we concur based
                          upon (1) our review of the auditors’ working papers and (2) the actions
                          that should be taken to fully implement the act, are discussed in detail in
                          the accompanying report on compliance with laws and regulations. In

                          Page 5                             GAO/AFMD-SW6   Federal   Housing Administration

                  addition, the report notes that there are a number of investigations cur-
                  rently underway regarding alleged improprieties in HUD'S administration
                  of FHA. These investigations may reveal other violations of laws and

                  During the course of its examination, Price Waterhouse also identified
                  several matters which, although not material to the consolidated finan-
                  cial statements, are being communicated for FHA'S consideration in a sep-
                  arate management letter.

                  FHA’Saccounting and financial management problems are long-standing
Current FHA       and well-documented. Correction of these problems will require multi-
Initiatives       year solutions and a long-term commitment by top management. The
                  new management at HUD has started to address various deficiencies to
                  strengthen FHA, which include:

              .   announcing that the Secretary will appoint a Chief Financial Officer at
                  HUD and a Controller at FHA;
              .   establishing a task force to gather data, assess problems, and develop an
                  action plan with milestones addressing the improvements needed in
                  accounting and financial management systems;
              .   increasing monitoring and enforcement activities of private sector third
              .   redirecting FHA’Saccounting and computer systems to generate timely
                  and accurate data for financial and program management;
              .   performing an independent actuarial analysis of the MMI and GI Funds;
              .   reviewing controls over programs, particularly where abuses have
                  occurred, to correct weaknesses or terminate ineffective programs;
              .   publishing annual audited financial statements; and
              .   implementing recommendations resulting from audits.

                  There are a number of serious financial management problems at FHA
Conclusions       which contribute to its losses. These problems are exemplified in the
                  lack of monitoring of responsibilities delegated to private sector third
                  parties; the poor quality of financial information available to manage-
                  ment; the weak financial management systems and internal control pro-
                  cedures; design flaws in the multifamily coinsurance and hospital
                  mortgage insurance programs; the substandard performance of essential
                  accounting functions; and management’s inattention to weaknesses iden-
                  tified by GAO, the Inspector General, and FHA'S own FMFIA reports.

                  Page 6                            GAO/AFMD-96-36   Federal   Housing   Administration

                    As a result of these financial management problems, FHAis susceptible
                    to mismanagement and the unnecessary risk that fraud and abuse will
                    occur and not be detected. Such conditions also impede management
                    from assessing the level of risk arising from normal insurance opera-
                    tions. Accurate and timely financial information for each program and
                    location is essential to effectively manage MA’s insurance programs.

                    It is because FHA has begun to prepare financial statements and, most
                    importantly, that these statements have been independently audited,
                    that the magnitude of FHA'S problems is becoming evident. Annual
                    audits of financial statements would provide the Congress and the pub-
                    lic an objective assessment of management’s performance. Additionally,
                    financial reporting can provide a measurement tool for effective con-
                    gressional oversight.

                    We believe that the initiatives discussed above, if properly implemented,
                    should address the problems cited in this report.

                    We recommend that the Congress, through its appropriation, authoriza-
Recommendation to   tion, and oversight committees, hold annual hearings on the actions of
the Congress        FHAto ensure that FHA resolves the financial management problems
                    identified, including evaluating its systems, correcting the material
                    weaknesses identified, and ensuring that similar problems do not occur
                    in the future. To assist in its oversight role, we believe the Congress
                    should require the Secretary to provide audited financial statements,
                    reports on internal accounting controls and compliance, and manage-
                    ment’s report required by the Federal Managers’ Financial Integrity Act.

                    We are sending copies of this report to the Director of the Office of Man-
                    agement and Budget; the Secretary of the Treasury; the Secretary of the
                    Department of Housing and Urban Development; HUD'S Assistant Secre-
                    tary for Housing, who serves as the Federal Housing Commissioner; and
                    HUD'S Assistant Secretary for Administration.

                    Charles A. Bowsher
                    Comptroller General
                    of the United States

                    Page 7                            GAO/AFMD90-36   Federal   Housing Administration

Letter                                                                                                         1

Independent Auditors’                                                                                         10
Auditors’ Report on                                                                                           13
Internal Accounting
Auditors’ Report on                                                                                           26
Compliance With
Laws and Regulations
Financial Statements                                                                                          29
                        Consolidated Statement of Financial Position                                          29
                        Consolidated Statement of Operations and Government                                   30
                            Equity (Deficiency)
                        Consolidated Statement of Cash Flows                                                  31
                        Notes to Consolidated Financial Statements                                            32

Supplemental                                                                                                  48
Information             Consolidating Statement of Financial Position                                         48
                        Consolidating Statement of Operations and Government                                  49
                            Equity (Deficiency)
                        Consolidating Statement of Cash Flows                                                 50


                        CMHI      Cooperative Management Housing Insurance
                        FHA       Federal Housing Administration
                        GI        General Insurance
                        GCCA      Government Corporation Control Act
                        HUD       Housing and Urban Development
                        MM1       Mutual Mortgage Insurance
                        SRI       Special Risk Insurance

                        Page 8                          GAO/AFMD!#O-36   Federal   Housing   Administration
Page 9   GAO/AFMD-9@36   Federal   Housing Administration
Independent Auditors’ Report

         Price Viterhouse

         To the Comptroller General
         of the United States

          and the Secretary
          of Housing and Urban Development
         We were engaged to audit the accompanying consolidated statements of
         financial position of the Federal Housing Administration (FHA), a fund of the
         Department of Housing and Urban Development (HUD), as of September 30,
         1988 and 1987, and the related consolidated statements of operations and
         government equity (deficiency), and of cash flows for the fiscal year ended
         September 30, 1988. These financial statements are the responsibility of FHA’s
         Allegations have been made about improper diversions of property sales
         proceeds by certain private closing agents contracted by HUD to sell HUD-
         owned property. This property is reported in the FHA financial statements.
         The alleged diversions resulted, in part, from internal control weaknesses
         involving HUD’s inability to properly monitor the collection and prompt
         deposit of property sales proceeds, or to maintain an accurate inventory of
         foreclosed properties. The Inspector General has estimated that such improper
         diversions may lead to substantial losses, but to date, the amount of the losses
         that will ultimately be incurred by HUD has not been determined, nor is HUD
         able to ascertain how much, if any, of these losses are already reflected in the
          1988 financial statements. Further, ongoing investigations into this matter have
         not yet been completed. There are a number of other investigations currently
         being conducted about other alleged improprieties involving HUD’s
         administration of FHA. These investigations could reveal violations of laws
         and regulations, but to date, a final determination about such violations has
         not been made. We have been unable to apply other auditing procedures to
         satisfy ourselves regarding the alleged improper diversions of property sales
         proceeds or the extent to which the inventory of foreclose-d property reflected
         in the accompanying financial statements may be misstated, nor were we able
         to determine the possible impact on the financial statements of other
         investigations currently being conducted. These matters could have a
         significant impact on FHA’s financial position, results of operations and cash

         As discussed in Note 8, FHA’s General Insurance (GI) Fund has incurred
         substantial losses primarily relating to its multifamily coinsurance programs, and
         to a lesser degree, to its insurance of hospital mortgages. In September 1988,
         the Government National Mortgage Association (GNMA), a government
         corporation operated by HUD which guarantees securities backed by FHA-

                          Page 10                                     GAO/AFMMW6        Federal   Housing   Administration
                  Independent   Auditors’   Report

To the Comptroller General of the United States
and the Secretary of Housing and Urban Development
Page 2
coinsured multifamily mortgages, declared a major FHA lender/coinsurer in
default of its GNMA obligations. Subsequent to September 1988, GNMA
similarly declared three more large FHA lender/coinsurers in default. Because
FHA insures the mortgages underlying the GNMA securities, substantially all
losses relating to these defaulted lender/coinsurers will be borne by FHA. A
provision of $960 miIlion has been recorded in the fiscal year 1988
consolidated statement of operations for estimated losses resulting from these
and other probable defaults in the multifamily coinsurance programs.
However, because of weaknesses in the multifamily coinsurance programs
involving required levels of capital and coinsurer monitoring, it is possible that
more lender/coinsurers will default and cause substantial additional losses in
the GI Fund. Also, a provision of $275 million has been recorded in the
consolidated statement of operations for probable defaults of FHA-insured
hospital mortgages. Even a limited number of defaults of these large
mortgages could place a serious financial burden on the GI Fund, and could
render the hospital insurance premiums insufficient to cover related losses.
HUD’s actuary has determined that, in the aggregate, the GI Fund’s premiums
are insufficient to cover its losses, and the Fund is dependent on the U.S.
Treasury and on budget appropriations to sustain its operations. However,
given the probability that additional losses will take place, FHA cannot
presently estimate the degree of its premium insufficiency or the level of
support it will ultimately require from Treasury. The accompanying financial
statements do not include any adjustments for these uncertainties which, if
known, could be material in relation to FHA’s financial position and results
of operations.

As discussed in Note 1, FHA comprises four major activities, the MMI, CMHI,
GI. and SRI Funds. The MM1 and CMHI Funds are operated as mutual
insurance funds and are required to be “actuarially sound”. The largest FHA
activity is the MM1 Fund, a fund which insures single family home mortgages
and which comprises $228.5 billion of FHA’s $303.4 billion of insurance in
force. Although the MM1 Fund incurred, on an accrual basis, losses of $1.4
billion for fiscal year 1988, it still reports government equity of $1.8 billion.
Despite its current losses, HUD’s actuary has estimated that the MM1 Fund’s
future revenue will exceed its future expenses. However, there are studies
currently underway to determine whether there are structural weaknessesin the
MM1 Fund that must be addressed. For fiscal year 1988, the CMHI Fund,
FHA’s smallest activity, paid no claims, reported an excess of revenues over
expenses, and showed positive government equity. The GI and SRI Funds are
not mutual insurance funds, have no requirement that they be actuarially
sound, and contain programs that have had continuing losses. Neither the GI
Fund’s nor the SRI Fund’s premiums are sufficient to cover their losses leaving
them dependent on the U.S. Treasury and on budget appropriations to sustain
their operations.

                  Page 11                                    GAO/AFMD-90-36     Federal   Housing Administration
                Independent   Auditors’   Report

To the Comptroller General of the United States
and the Secretary of Housing and Urban Development
Page 3

In our report dated August 12, 1988 except for Note 4, for which the date was
November 15, 1988, we expressed an opinion that the consolidated statement
of financial position at September 30, 1987 presented fairly the financial
position of the Federal Housing Administration in conformity with generally
accepted accounting principles. However, the allegations about the diversion
of property sales proceeds, possible misstatements of the inventory of
foreclosed properties, and the unknown outcome of other investigations
referred to in the second paragraph of this report may have affected FHA’s
financial position at September 30, 1987. Accordingly, with respect to the
September 30, 1987 consolidated statement of financial position, our report as
presented herein, is different from that previously issued.

HUD has not yet determined (1) the extent of the diversion of properry sales
proceeds, (2) the extent to which foreclosed property reflected in the
accompanying financial statements may be misstated, or (3) the effect that the
outcome of other investigations might have on FHA’s financial statements. Nor
were we able to satisfy ourselves about the effect of these matters, which could
have a significant impact on the accompanying financial statements. Therefore
the scope of our work was not sufficient to enable us to express, and we do
not express, an opinion on the accompanying financial statements.

We were engaged for the purpose of forming an opinion on the consolidated
financial statements taken as a whole. The consolidating information is
presented for purposes of additional analysis of the consolidated financial
statements rather than to present the financial position, results of operations,
and cash flows of FHA’s major activities. For the rezons described in the
preceding paragraph, we are unable to, and do not, express an opinion on
whether the consolidating information is fairly stated, in all material respects,
in relation to the consolidated financial statements taken as a whole.

September 15, 1989,
except as to Note 14,
which is as of
December 20, 1989

                Page 12                                    GAO/~90-36         Federal   Housing   Administration
Auditors’ Report on Internal
Accounting Controls

          Price Whter?wuse                                                       0
          To the Comptroller General
          of the United States
          and the Secretary
          of Housing and Urban Development

          We were engaged to audit the consolidated financial statements of the Federal
          Housing Administration (FI-LA), a fund of the Department of Housing and
          Urban Development (HUD), as of and for the year ended September 30, 1988,
          and have issued our report thereon dated September 15, 1989, except as to
          Note 14 to those financial statements, which is as of December 20, 1989.
          In planning and performing our audit of PI-IA’s financial statements for the
          year ended September 30, 1988, we considered its internal control structure in
          order to determine our auditing procedures.

          The management of FHA is responsible for establishing and maintaining an
           internal control structure. In fulfilling this responsibility, estimates and
          judgments by management are required to assess the expected benefits and
           related costs of internal control policies and procedures. The objectives of an
           internal control structure are to provide management with reasonable, but not
           absolute, assurance that (1) obligations and costs are in compliance with
           applicable laws, (2) funds, property, and assets are safeguarded against waste,
           loss, and unauthorized use or misappropriation, and (3) assets, liabilities,
           revenues, and expenses applicable to operations are properly recorded and
          accounted for to permit the preparation of reliable financial reports and to
           maintain accountability over the entity’s assets. Because of inherent limitations
           in any internal control structure, errors or irregularities may nevertheless occur
           and not be detected. Also, projection of any evaluation of the structure to
          future periods is subject to the risk that procedures may become inadequate
          because of changes in conditions or that the effectiveness of the design and
           operation of policies and procedures may deteriorate.
          For purposes of this report, we have classified the significant policies and
          procedures relative to FHA’s internal control structure in the following

             0      General Ledger and Treasury Operations
             0      Financial Reporting
             0      Notes Receivable
             0      Property Held for Sale
             0      Claims Processing
             0      Insurance-in-Force
             0      Premiums, Premium Refunds, and Distributive Shares

                            Page 13                                     GAO/AFMD-90-36     Federal   Housing   Administration
                   Auditors’ Report on Internal
                   Accounting Controls

 Report on Internal Controls
 Page 2

    0      Field Office Operations
    0      Actuarial Branch Operations
    0      Administration and Other
 For all the categories listed above, we obtained an understanding of the design
 of relevant policies and procedures, determined whether they have been placed
 in operation, and assessedcontrol risk.
 We noted certain matters involving the internal control structure and its
 operation that we consider to be reportable conditions. Reportable conditions
 involve matters coming to our attention relating to significant deficiencies in
 the design or operation of the internal control structure that, in our judgment,
 could adversely affect the entity’s ability to record, process, summarize, and
 report financial data consistent with the assertions of management in the
 financial statements.
 A material weakness is a reportable condition in which the design or operation
 of specific elements of the internal control structure do not reduce to a
 relatively low level the risk that errors or irregularities, in amounts that would
 be material in relation to the financial statements being audited, may occur
 and not be detected within a timely period by employees in the normal course
 of performing their assigned functions. We consider the following reportable
 conditions to be material weaknesses.


 Many of HUD’s’ important functions, including certain underwriting functions,
 property management, and collection of property sale proceeds, have been
 delegated to third parties. However, despite the importance of these delegated
 functions and the inherent need to closely watch over them, we found that
 HUD oversight and monitoring has not always been effective and must be
 improved to ensure delegated functions are carried out in the government’s
 best interest.

 The delegated functions in which we noted deficiencies can be broadly
 categorized in three ways. First is delegated underwriting whereby HUD
 allows certain eligible lenders to write FI-IA mortgage insurance without prior
 HUD approval. The largest and perhaps best known program for delegated
 underwriting is the direct endorsement of single family mortgage insurance by

     ’ Hereinafter when HUD is referred to it pertains to HUD’s administration
of FHA activities.

                  Page 14                                     GAO/AFMIMO-36     Federal   Housing   Administration
                   Auditors’ Report on Intermd
                   Accounting Controls

Report on Internal Controls
Page 3
FI-L4 approved lenders (generally known as “mortgagees”). Second is the
delegation of property management functions to third party agents. These
agents are commonly known as Area Management Brokers (AMBs) who, on
behalf of HUD, maintain, manage and sell properties that the FHA Fund
obtained in foreclosure. And third is the delegation of property sale closing
responsibilities to private closing agents. Among the private closing agents’
most important, and from HUD’s standpoint most risky, functions is collecting
property sale proceeds and depositing them in HUD’s account at the U.S.
Treasury. Each of these areas had instances of flawed, deficient, or lackluster
monitoring and oversight. Deficiencies in monitoring sales closing agents are
discussed on page 9 of this report.

With regard to monitoring of mortgagees to whom underwriting has been
delegated, HUD, on behalf of FI-L4, uses headquarters and regional staff to
perform some oversight functions and to periodically conduct field reviews of
selected mortgagees. However, their functions are often too narrow, rely on
information of questionable veracity, and are not well coordinated. Moreover,
field reviews generally focus on the same mortgagees year after year, and there
are indications that they do not identify the causes of excessive insurance
losses; specifically they do not always identify mortgagees and/or appraisers
who have repeatedly overvalued properties. The system used to monitor
mortgage defaults does not have up to date default information, does not
always identify defaults that have been cured, and has shown differences of
100,000 cases or more with another system that summarizes similar
information. Furthermore, there is little coordination of the oversight and
monitoring functions being performed by various parts of HUD. For example
GNMA has its own monitoring and field review system, yet rarely shares its
findings and information with FHA.         The result of the problems with
mortgagee monitoring is a function that is, in an agency-wide sense, disjointed
and which leaves unclear what an acceptable level of defaults and insurance
losses is or should be.

HUD has been similarly deficient in monitoring area management brokers.
Some AMBs have been allowed to manage excessive numbers of properties.
In one instance a broker was managing over 1,ooOproperties; well in excess
of the HUD-mandated limit of 100. AlIowing a concentration of property
management responsibilities to too few brokers unnecessarily exposes HUD to
excessive losses should one or more of the large brokers decide to abuse HUD
rules. This risk is further exacerbated by the fact that AMBs are paid a fee
based on total properties they manage, and thus they have little incentive to
promptly sell properties. In other instances, AMBs were allowed to incur
expenses well in excess of HUD limits, yet they were still reimbursed for
them. Property inspections to ensure repairs and maintenance were properly
performed on AMB managed properties were also less than that required by
HUD policy. Failure to perform either of these important monitoring
functions at an acceptable level could cause HUD to incur improper or

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unreasonably high property expenses, or could lead to property being sold at
less than its full value because it was inadequately maintained.

The causes of oversight and monitoring deficiencies result in part from a lack
of appreciation of the financial impact of poor underwriting and of the need
to closely coordinate all oversight activities. This is perhaps best exemplified
by the fact field monitoring is largely case-based. There is a focus on the
number of cases that have defaulted or have led to claims, but not so much
on the dollar losses caused by those defaults and claims or on the causes of
those losses, or on how they might be minimized in the future. AMB and
private closing agent oversight suffered, at least partially, from a lack of
experienced staff to handle the large number of foreclosed properties that
came to HUD in economically distressed regions. But there was apparently
no contingency plan to provide additional resources to those regions requiring
Resolving the deficiencies in oversight and monitoring will require a concerted
effort on the part the agency. Therefore we suggest that the Secretary
establish a task force comprised of individuals from the Office of Housing,
Office of Administration, Government National Mortgage Association, and from
the regions to: (1) identify and assessinformation currently gathered by the
various HUD groups about mortgagees to whom underwriting has been
delegated to determine whether it is adequate, timely and useful, (2) identify
other information that might be needed to effect better monitoring, (3) assess
all field monitoring functions to determine whether they are frequent enough,
are properly identifying the causes for insurance losses and are effective in
resolving problems that have caused persistent losses, (4) establish formal
means of communicating review findings among the HUD groups, (5) establish
a method of monitoring findings from field reviews and their subsequent
resolution, and (6) develop, at least conceptually, an informational data base
which can be used by all HUD groups involved with mortgagee oversight
functions. With respect to oversight of area management brokers, the
Secretary should reiterate to the regions HUD’s policy regarding limitations on
the number of properties individual brokers can manage, and require
explanations and take appropriate remedial action where this policy was not
followed. The Secretary should further initiate a study of regional staff
capabilities to determine whether experience and staffing levels are proper in
light of responsibilities and determine whether additional travel funds are
needed to allow regions to properly carry out oversight and property inspection

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While some of FHA’s losses are attributable to specific shortcomings in
particular procedures or processes,in a broader sense not holding responsible
managers or personnel accountable for their actions provides a better
explanation of how FHA’s problems took place. It is difficult to bold anyone
accountable in the organization when financial information is not available to
do so. At present, managers do not know which programs are self sustaining
and which are not because there are no program level financial statements or
other reporting mechanisms that routinely produce information about program
financial results and effectiveness.      Decisions affecting staffing and
administrative support for FHA operations are apparently made without regard
to their financial impact on the FHA fund. And finally, financial systems
which are presumably the basis for measuring how well FHA activities are
carried out, have not adequately considered the needs of the managers who
operate the FHA programs and who are accountable for them.

Financial statements and other iinancial information are periodically produced
only for each of FI-IA’s four major activities (i.e., the MMI, GI, SRI and
CMHI Funds). However, HUD cannot accurately and promptly determine
financial results on a program-by-program or region-by-region basis, and thus
there is a lack of information about program and region effectiveness. The
significance of this is that losses can only be attributed to major activities and
CaMOt be pinpointed with any degree of precision to a particular program or
region. The four major activities encompass some 40 active mortgage
insurance programs, each with its own unique purpose and each with unique
financial attributes as well. It may be that some of these programs are or
should be financially sound while others should not, but the absence of
sufficiently detailed financial information prevents making this determination.
This lack of accountability also prevents identifying the causes for losses and,
therefore, it cannot be determined whether excessive losses are caused by
external conditions or simply by mismanagement.

The manner in which staffing and administrative decisions relative to the
operation of FHA are made provides another example of a split between
responsibility and accountability.      Salary and administrative expenditures
incurred to operate the FHA programs are administered through a separate,
appropriated fund, and management of this fund rests with a group separate
from that which operates FHA. In many respects, the salary and expense
fund is operated like an entity ail its own rather than as a support function for
the operation of the various HUD programs. There are indications of
decisions being made to reduce salary and administrative expense that may
have caused problems in the FHA Fund. For example, some of the regions
have indicated that pressures to make staffing cuts, which may have provided

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salary expense savings on the one hand, may have also reduced the number
of staff available to perform oversight and monitoring functions on the other.
Similarly, restrictions on travel funds to produce small savings, may have
prevented regional personnel from taking trips needed to conduct a sufficient
number of property inspections. Decisions like this which lead to small savings
in one fund but which may cause substantial losses in another, in our view,
constitute a fundamental flaw in the management of the agency. In effect, the
salary and administrative function has the responsibility to provide staff support
and resources to operate FHA properly, but is not accountable for losses that
would result in another fund from inadequate staff support or from providing
insufficient resources.

There are instances where accounting systems have been developed which do
not adequately address the needs of program managers. In some instances two
systems with overlapping functions were implemented -- one for the group
administering the program and another for the group performing finance and
accounting functions. Furthermore, systems used by program managers are
often case-based. That is, they contain information about the number of
defaults or the number of properties on hand but little or no information on
the dollar value of those cases. Some accounting systems that are used to
report financial information and prepare financial statements, are not also
used for program accountability. For example, systems with financial and
accounting information on single family mortgages held by FI-L4 and on
property owned by FI-L4 are not always used by program managers because
their information needs were not appropriately addressed. Rather than
integrate the accounting and programmatic needs, separate duplicate systems
were implemented. To provide for proper accountability, factionalism that
causes systems to be less than fully useful or which leads to the development
of redundant systems must be eliminated. Individuals responsible for program
accountability must be an integral part of financial and accounting systems
development efforts because those systems are, after all, intended to provide
a measure of program effectiveness.

The situations just discussed provide examples of how divisions between those
responsible for program success and those responsible for financial reporting
ultimately lead to inadequate accountability, or worse, mismanagement.
Without any real steps to address and correct organizational issues that may
have created these problems, they cannot finally be resolved. Moreover,
without some consideration of changes in the way PI-IA is fundamentally
managed, accountability problems could again occur. We therefore suggest
that the Secretary initiate a thorough study of HUD’s organization, and of its
present and future information needs with the objective of determining how the
agency can best be run to efficiently and effectively fulfill its mission.

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PI-IA’s multifamily coinsurance programs and its hospital mortgage insurance
programs recorded significant loss provisions during 1988 of $960 miIIion and
$275 million, respectively. These losses related, at least in part, to flaws in
way the programs were structured and administered. In the case of the
multifamily coinsurance programs, the flaws related to insufficient levels of
capital required of coinsuring lenders, to other deficiencies in quantitative
controls designed to reduce portfolio risk, and to inadequate qualitative
controls notably involving ongoing monitoring of coinsuring lenders. The
hospital mortgage insurance flaws pertain to a division of responsibility
between the department performing underwriting functions, the Department of
Health and Human Setices (HI-IS), and the department which bears insurance
losses resulting from poor underwriting, HUD. The multifamily coinsurance
and hospital mortgage insurance programs are operated through FHA’s
General Insurance (GI) Fund, a fund which, as of September 30. 1988, had
negative equity of some S3.1 billion.
 Under the multifamily coinsurance programs, various loan functions are
 delegated to eligible lenders including underwriting, servicing, management and
property disposition functions. The lenders then “coinsure” approximately 20%
 of the mortgage amount thereby assuming responsibility for a portion of any
 insurance losses resulting from defaulted mortgages. Because so many of
HUD’s functions are delegated for these programs, there is a particular need
for proper quantitative controls, in the form of sound capital and leverage
requirements, and effective qualitative controls, involving sufficient monitoring
of program participants. Both GAO and OMB recognize the need for these
types of controls. GAO’s standards define internal controls as “...methods and
procedures adopted by management to ensure..that resources are safeguarded
against fraud, waste, and misuse...” Similarly, Oh4B requires the establishment
of an appropriate level of “financial and other management controls.” In
applying these standards to the coinsurance programs, we believe they
necessitate that: (1) capital requirements be established at such a level that
coinsuring lenders will be induced to make sound loans; (2) criteria be
established that will deter the concentration of loans (and thus risk) among too
few lenders; and (3) that delegated responsibilities be continually and
thoroughly monitored. The importance of these controls becomes apparent
when bearing in mind that if coinsurers mismanage their 20% risk, that means
they have mismanaged HUD’s 80% risk as well.
During 1988,the combination of insufficient capital requirements, concentration
of risk among a few large coinsuring lenders and the lack of an effective
monitoring function led to loss levels that neither present lender capital
requirements nor any other as yet imagined capital requirement would have

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been sufficient to cover, much less protect FHA from excessive losses.
Furthermore, other quantitative controls that might have mitigated the losses
were also missing. For example, there might have existed an overriding
leverage limitation which would have begun to curtail the incentive for volume
inherent in FHA’s liberal capital accumulation formula, and which probably
would have limited the concentration among a few large lenders. But because
no such control existed, FI-L4 suffered severe losses when a large coinsuring
lender with a disproportionate share of the programs’ coinsured mortgages
defaulted. Without a reasonable leverage limitation or a large enough capital
requirement, the temptation to expand an increasingly lucrative revenue stream
in relation to capital-at-risk can be expected to become overwhelming. If
there is also an absence of adequate surveillance and monitoring (as we found
to be the case), the temptation to grow, without regard to the quality of that
growth is unbounded. Such circumstances constitute a fundamental program
flaw, the responsibility for which cannot be delegated, nor can it be blamed
entirely on the existence of fraud.
FI-L4’s hospital insurance program contains flaws of an organizational nature.
Insurance in this program is not initiated by HUD. Instead, hospitals apply
to HHS for mortgage insurance, who effectively make decisions about which
mortgages should be insured, and HUD later provides that insurance. HHS
is responsible for reviewing the underwriting of these loans, and is also
primarily responsible for subsequent loan monitoring. Despite the fact that
HHS determines which loans should be insured, it is HUD that has the risk
of default, pays insurance claims and bears any losses. After claims are paid,
HUD assumes added responsibility to perform loan seticing functions for
defaulted hospital mortgages, since they are typically assigned to HUD rather
than being foreclosed upon. The division of the underwriting and insuring
activities effectively cuts the link between responsibility, which presumably
belongs to HHS because of its involvement with the underwriting, and
accountability which belongs to HUD because it reports resultant losses.

We understand that HUD has assessedcapital deficiencies and shortcomings
in monitoring for its multifamily coinsurance programs and will shortly be
making program revisions to address these issues. These changes, if properly
administered, should go a long way toward resolving the programs’ structural
flaws and we encourage their quick implementation. With respect to hospital
mortgage insurance, we believe a decision must be made about which
organization, HI-IS or HUD, should assume m responsibility. Once this
decision is made, all mortgage insurance functions should be shifted to the
responsible agency and staff necessary to conduct both insurance and finance
functions should be hired and trained.

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                 MUST BE IMI’~

Apart from directly monitoring those individuals to whom property
management and sales functions have been delegated, HUD’s own internal
property and cash management systems and procedures are weak and require
improvement. HUD has not done enough, through the use of its own systems,
to ensure that proceeds collected by third parties are promptly deposited in
FI-L4’s Treasury account, nor does HUD have enough information to allow for
proper accountability over the management, maintenance and sale of foreclosed
single-family properties. There are widely varying amounts, depending upon
which system or set of records is used, on the number of properties FI-L4 owns
at any given time with the result that managers do not know, with precision,
how much property they are responsible for or how much that property is
really worth.

HUD has followed the policy of accepting sales packages and of recording
sales before sales proceeds are actually deposited in its Treasury account.
Follow-up of case-by-casesituations where sales have been processed but where
no cash has been received has been inconsistent across regions. Indeed,
reports of sales for which proceeds have not yet been located contain over
8.000 cases, some dating back to 1983. One region, in particular, was so
deficient in this regard that a private closing agent was allegedly able to
embezzle a sizable amount of sale proceeds without prompt detection. This
shortcoming provides a partial explanation of why embezzlements of the
magnitude seen can take place yet not be detected for a long period of time.
The reason this is only a partial explanation is that there are other controls
HUD might have used, as fundamental as reconciling a monthly bank
statement, which also would have detected missing cash. For example, if one
were to note that a wire transfer or other promised deposits never in fact
made it into their bank account, they would presumably seek an explanation
and look for the missing funds. HUD has the ability to perform a similar
reconciliation each month, albeit on a much larger scale, yet it has not
consistently done so. And differences of as much as $6.2 million have
remained unreconciled and unexplained.

Shortcomings in the cash management and control process are further
hampered by weaknesses in the automated systems used to manage and
account for FHA-owned foreclosed properties. Two separate systems are
currently used to do so, one by the office of housing and another by the office
of finance and administration. Apart from the complexities and redundancy
introduced by using two systems to perform similar functions, the system used
by the office of housing, the groupreallyresponsiblefor propertymanagement
and sales contains little or no dollar information (i.e., it has information only
on the number of properties). Property transactions do not become dollarized

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until they pass to the finance part of HUD. Furthermore, the two systems
routinely show large differences in the number of properties FHA owns at any
given time, and only recently have attempts been made to try to explain these
differences. Collectively the problems with the property systems cause
uncertainties about the number and dollar value of the properties FHA
actually owns, leave questions about how property can be properly managed
and sold with no information about its true value, and further exacerbates the
cash management problems should properties not picked up by either system
be sold without HUD’s knowledge.
The cash management problems resulted, in our view, from a lack of
appreciation for the need to closely control cash transactions, particularly those
that have been delegated. Insufficient management emphasis on the need to
perform very basic Treasury reconciliation functions thoroughly and timely was
also a contributing factor. However proper control was also constrained by a
split between responsibility for cash and property management functions and
accountability over them. Moreover, the use of case level information by those
primarily responsible for property management, and then later dollarizing
property transactions when another group needed to report property
transactions constitutes an unjustifiable split between those responsible for
property management and sales and those whose job it is to report this

We understand that HUD is now implementing a new automated system which
will eliminate the two redundant property systems and which will facilitate
better cash control and more timely reconciliation to Treasury information.
However, this new system will not be fully operational for several more
months, and we believe that HUD must take some near term action to address
the problems that still exist in cash and property management. Therefore,
until the new system is fully operational we suggest that the Secretary direct
FHA management to: (1) Perform a complete physical inventory, perhaps on
a region by region basis, of FHA-owned single family properties. This will
allow HUD to identify properties which should be in its inventory but are not,
and will also facilitate the identification of properties which may have been
sold without I-IUD’s knowledge. Furthermore, obtaining an accurate property
inventory is essential to ensuring that the new system will contain accurate
property information; (2) Prepare a report on a quarterly basis of property
held in inventory for longer than one year. The regional offices should then
research each case to determine if the identified property has really been sold
but not reported as such to HUD or, absent that, they should identify the
problems causing the identified properties to remain in inventory for an
excessively long period of time; and (3) Require headquarters management to
prepare a monthly summary of properties sold for which no proceeds have
been received, together with a summary actions being taken to recoup missing

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Our review of the HUD’s multifamily claim payments process indicated that
multifamily claims for insurance benefits are not being paid in a timely manner
and that the existing claim review and examination process is inadequate in
detecting misrepresentations by mortgagees/lenders. Both GAO and OMB
require that internal controls provide reasonable assurance that government
resources are protected from fraud, waste and mismanagement.
With respect to payment delays there is a significant backlog of claims cases
awaiting final settlement and payment. These are cases where the mortgagee
has complied with all HUD filing requirements and for which legal clearance
has been received from the Office of General Counsel but which have simply
not been paid because of delays in final processing. Since the delays in
processing are due to reasons not controllable by mortgagees, HUD has to pay
interest on the claim. We have estimated that HUD has incurred additional
interest costs ranging from $6 to $10 million as a result of these delays.

The inadequacies in claim review process pertain to the fact that HUD does
not verify all fiscal data provided by mortgagees with the claim submission.
For example, we noted an instance where a mortgagee failed to disclose
information about a special escrow account when submitting the claim for
insurance benefits. As a result, the claims examiners failed to reduce the
claim amount by the remaining balance in this escrow account and the claim
was eventually overpaid by some $2.8 million.

Delays in processing claims were caused by insufficient staffing levels, which
were not quickly addressed and which caused the backlog of cases awaiting
settlement to build to unacceptable levels. Shortcomings in the claims
examination process were caused by a lack of diligence in verifying all
submitted information. In the interest of saving time, some claim examiners
did not verify all claim financial data to supporting documents submitted by
Some steps have been taken to address the staff shortages that caused the
claim backlog. HUD is seeking to hire ten additional accountants to augment
the claim payment staff and there have been organizational realignments to
ensure better supervisory control over the process. In addition outside help
is being sought to bolster the claims examination function. However, over the
longer term, this problem can only be eliminated with improved financial
information at the individual program level which would indicate (1) impending
defaults which may require allocating more resources to the claim examination
and payment functions, (2) excessive interest cost being incurred, and (3)
unusual increases in claims costs relative to insurance in force.

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Any operation the size of FHA has a number of routine accounting functions
that must be continually performed to ensure that financial statements and
other financial reports are accurately produced. Routine accounting functions
include very basic procedures - reconciling accounts to supporting records,
diligent record keeping, controlling funds held on behalf of others, and making
sure transactions are properly recorded -- to name just a few. The need to
perform these procedures would appear obvious and further, GAO’s policy and
procedures manual specifically requires that they be performed. However,
HUD staff who perform FHA accounting functions have been deficient in
performing many of these functions, and our audit identified nearly 100
adjustments that were necessary to correct resultant errors. More specifically,
we noted that:
-- Documentation supporting several account balances was missing or
   incomplete. Among the many unsupported balances, for example, there was
   inadequate support for $10.8 million of interest payable balances and for
   S1.l million of accounts payable to the public.

-- Reconciliations of general ledger balances to supporting records were not
   performed timely, and in some cases not at all. Virtually every account in
   the financial statements had transactions that were neither reconciled nor

-- There was very poor accountability of distributive share payments.
   -Payments were made without proper support or justification. In some cases
    payments were made with no evidence that the individuals receiving them
    had, in fact, insured their mortgages through PHA

-- Forbearance agreements, agreements which restructure the terms of
   defaulted mortgages in the interest of providing some sort of work out,
   were not properly recorded in the loan system, thus misreporting mortgagor
   account balances.
-   Escrow accounts maintained by HUD to fund repairs on properties financed
    by HUD mortgages were not properly accounted for. Account balances
    shown by the banks holding the funds, recorded in the PHA’s records, and
    reported to mortgagors on the yearly statement all differed without

It is unclear why these functions have not been performed. There was not
enough emphasis placed on properly performing them in prior years, and now
errors emanating from the past, and old, unexplained transactions have built

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up and will be difficult to correct. There was a similar lack of emphasis, in
our view, on financial and accounting matters and on financial statements in
general, and it is for this reason that we believe problems in performing very
basic and fundamental accounting functions have persisted.
NormaIly shortcomings in some accounting functions would not necessarily
cause significant problems, but because these shortcomings were so pervasive
in FHA’s case, they could cause material misstatements in financial reports.
Moreover, in certain cases significant adjustments had to be made to reflect
a more accurate situation. Performance of these procedures should be a
continuous process, and attention to them should not just be devoted in
anticipation of a financial audit.

To correct these problems, responsibilities for performing accounting functions
must be firmly established. Supervisory reviews should then be initiated to
ensure accounting functions are properly performed and on a timely basis.
Year-end closing procedures should be enhanced to include developing specific
requirements for the year end close out, with a subsequent supervisory review
of the closing process to ensure all closing procedures have been properly
carried out. All this should be done before financial reports are released to
other Federal Agencies or to the public.

                                     *   l   *   *   l

Our consideration of the internal control structure would not necessarily
disclose all matters in the structure that might be reportable conditions and,
accordingly, would not necessarily disclose all reportable conditions that are
also considered to be material weaknesses as defined above.

We also noted other matters involving the internal control structure and its
operation that we have reported to FHA’s management in a separate letter.

This report is intended for the information of the Congress, the U.S. General
Accounting Office and the management of the Department of Housing and
Urban Development. This restriction is not intended to limit the distribution
of this report, which is a matter of public record.

September 15, 1989

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and Regulations

                                                     0th~ of Governmn: Sewes     Telen3w2022960800
                                                     180' K Slree! lu W
                                                     WasMglo:     DC 20006

         Bite   Ibterhouse                                                       0
         To the Comptroller General
         of the United States
         and the Secretary
         of Housing and Urban Development
         We were engaged to audit the consolidated financial statements of the Federal
         Housing Administration (FHA), a fund of the Department of Housing and
         Urban Development (HUD), as of and for the year ended September 30, 1988,
         and have issued our report thereon dated September 15, 1989, except as to
         Note 14 to those financial statements, which is as of December 20, 1989.

         Compliance with laws and regulations applicable to FHA is the responsibility
         of FHA’s management. We performed tests of FHA’s compliance with certain
         provisions of applicable laws and regulations. However, our objective was not
         to provide an opinion on overall compliance with such provisions.

         Material instances of noncompliance are failures to follow requirements, or
         violations of prohibitions, contained in applicable laws and regulations that
         cause us to conclude that the aggregation of the misstatements resulting from
         those failures or violations is material to the financial statements. While the
         following instance of noncompliance may not necessarily be material to the
         financial statements, it is, nevertheless, reported herein because it could
         significantly impact FHA’s ability to effectively collect money it is owed.

                  ULD PURSUE FULL IMPLEMENTATION                    OF
                EBT COJJ,ECTlON Aa

         During fiscal year 1988, FHA did not achieve full implementation of the Debt
         Collection Act of 1982 (Public Law 97-365) with respect to how it applies
         collection procedures to claims emanating from FHA-insured mortgage defaults.
         When FHA-insured mortgages default, claim payments are made for the
         unpaid principal balance plus any costs (principally unpaid interest) incurred
         by the insured mortgagee between the time of default and foreclosure. In
         most cases, the claim payment made by FHA exceeds the amount recovered
         when the foreclosed property is subsequently sold. However, the shortfall
         between claim payment and the amount ultimately recovered is not recorded
         in the accounting records as a claim of the U.S. Government, and thus very
         few collection efforts are made against mortgagors.

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The Debt Collection Act requires that the head of an executive or legislative
agency “shall try to collect a claim of the United States Government for money
or property arising out of the activities of, or referred to, the agency.” Claims
are defined by the Act as including “amounts owing on account of loans
 nsured o uanteed           by the government and other amounts due the
kovemme~t” (emphasis added). The Act further stipulates the types of
collection procedures that should be applied to such claims including, among
other things, administrative offset (such as against IRS refunds), assessing
interest and penalties on delinquent amounts, and the use of collection
 It has been HUD’s general practice to effectively forgive the debt by not
 taking collection action after the foreclosed property is acquired. For example,
 HUD has not required mortgagees to obtain deficiency judgments in all cases,
 nor has HUD pursued such judgments on its own. We have been informed
 that HUD has initiated a new policy of pursuing deficiency judgments in
 certain circumstances, and where they are allowed to do so by applicable state
 law. To fully implement the Debt Collection Act, HUD should record the
 debts as claims in appropriate claims files and document any subsequent
 decisions to terminate collection action and forgive the debts.           Where
 deficiency judgments have been obtained, the claims should be established as
 receivables in FHA’s accounting records and the collection actions authorized
 by the Act should be taken. This may entail developing systemic means of
 accounting for numerous claims, but we encourage HUD to do so. Other
 agencies, most notably the Department of Veterans Affairs, have done so and
 have collected some portion of the claim, however small the amount. By not
 fully documenting the debts owed to it and the reasons for taking or not
taking collection actions, and by not establishing receivables when deficiency
judgments are obtained, FHA may be missing opportunities to take more
effective collection action.

Therefore, we suggest that FHA develop a systemic means of documenting
when collection actions are not being taken, of recording deficiency judgments
as receivables, and of applying the collection provisions of the Act to such

                                   *   l   l   l   *

The results of our tests indicate that, with respect to the items tested, FHA
complied, in all material respects, with the provisions referred to in the second
paragraph of this report. With respect to the items not tested, except as
described below, nothing came to our attention that caused us to believe that
FHA had not complied, in all material respects, with those provisions.

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There are a number of investigations currently being conducted about alleged
improprieties involving HUD’s administration of FHA. These investigations
could reveal other violations of laws and regulations, but to date, a final
determination about such violations has not yet been made. The outcome of
these investigations could have a material effect on FHA’s financial statements,
however HUD is not yet able to determine what the effect might be. Nor
were we able to satisfy ourselves about the effect of the outcome of these

September 15, 1989

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l?inmcid Statements

Consolidated   Statement     of Financial       Position

                                                              SEPTEMBER      30, 1988 AND 1987
                                                                     (Dollars in Thousands)

                                                                                                    1988                1987

                           Fund Balance with the U.S. Treasury                                %     113.108     $       175,331
                           Investments in U.S. Government Securities
                             Principally Non-marketable (Note 3)                                  6208,004            6,651,427
                           Foreclosed Property Held for Sale, Net (Note 4)                        1,696,364           1,432,116
                           Mortgage Notes Receivable, Net (Note 6)                                2,913,127           2,808,597
                           Appropriations Receivable (Note 7)                                       587,813             400,586
                           Other Assets and Receivables                                             268,339             437,629
                            Total Assets                                                      $ 11,786,755      $ 11.905.686

                           LIABILITIES AND GOVERNMENT EQUITY:

                           Claims Payable                                                           628,692             525,759
                           Loss Reserves (Note 8)                                                 5,411,ooo           2.047.392
                           Unearned Premiums (Note 9)                                             3,994,668           3.983.749
                           Debentures Issued to Claimants (Note i0)                                 119,545             175,743
                           Accounts Payable, Accrued Expenses
                            and Other Liabilities                                                   35 1,472            302.775
                           Distributive Sharesand Premium Refunds Payable                           142,133             150,158
                           Borrowings from the U.S. Treasury (Note 11)                            3,993,268           3,531.434
                            Total Liabilities                                                     14,640,778        10,717,010

                           Government Equity (Deficiency) (Note 13):
                            Mutual Funds Equity                                                    1.806.811         3,375,571
                            Subsidized Funds Cumulative Losses                                    (9.941.681)       (7,117.649)
                            Appropriated Capital                                                   5,280,847         4,930,754
                            Total Government Equity (Deficiency)                                  (2.854.023)         1.188.676

                            Commitments and Contingencies (Note 12)

                            Total Liabilities and Government Equity                           $ 11,786,755      $ 11,905,686

                       The notes to the financial statementsare an integral part of this statement.

                                                           Page 29                                    GAO/AFMD99-36     Federal   Housing   Administration
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       W0.L                        @)O.L         aluasaa                                                        pund
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uow~1ww~v   BenoH   P-pad            981)6~/0v9                                                                                  f3 a%pd

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           19S.8                               8PCZE9'Z $                                                  FJ0.J.

            LP'6                               9S8’L6Pb1                                         +n=u
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            OO’L                               660‘LOE                                                  1661
            19’1                               68LX6Z                                                   1661
            80'8                               &WE81                                                    0661
          %61-L                                ELS’DI           s                                       6861

       am namuf                        OZJB?A--W                                                    J-A r==!J
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