Seduced and Abandoned

What HUD Knew—and Didn’t Do—About the Mortgage-Loan Scandal

Three years ago, even before a gang of Long Islanders began savaging Harlem and Brooklyn with a monumental rehab-loan scam that milked the U.S. Department of Housing and Urban Development's 203(k) program, whistle-blowers and investigators alerted hud officials to case after case of similar 203(k) fraud and corruption elsewhere.

Nationwide, the 203(k) program has helped thousands of people purchase and renovate homes, but it also unleashed unscrupulous contractors and mortgage companies that have left home buyers living in dangerous squalor.

The New York City scheme, in which city and federal prosecutors have arrested 16 people and hint that major arrests are yet to come, isn't a case of faulty rehab, but of real estate "flipping" with no rehab. The alleged selling and quick reselling of properties in sham transactions that drove up the prices has left hundreds of buildings in default and artificially inflated the housing market in Harlem and Brooklyn.

It didn't have to happen on such a large scale. A key element that made the scheme work in New York City—the role of a mortgage company designated by HUD to be a "direct endorser" of loans—was a problem commonly known to HUD officials. And supposed nonprofit organizations were known to sometimes abuse the program.

"The 203(k) Program is highly vulnerable to waste, fraud, and abuse by investors and nonprofit borrowers," a report from the HUD Inspector General's Office concluded in February 1997. "The program design encourages risky property deals, land sale and refinance schemes, overstated property appraisals, and phony or excessive fees. . . . The abuses have not been isolated to any one person, group, or area of the country. . . . Nonprofit borrowers have also made large profits, contrary to their stated motivation. Unfortunately, mortgage lenders have contributed to the abuse."

HUD officials subsequently tried to block investors from the program, but, as prosecutors contend in the New York case, investors simply covered their tracks by paying nonprofit organizations kickbacks for serving as fronts to obtain loans.

The New York scheme gathered steam in early 1998 and continued for about two years. Even after prosecutors began investigating in early and mid 1999, the scam went on for another six months.


A key element that made the scheme work in New York City—the role of a mortgage company designated by HUD to be a "direct endorser" of loans—was a problem commonly known to HUD officials.


A General Accounting Office probe of the program in April 2000 contends that HUD's supervision has been feeble. Whistle-blowers from community groups, not HUD, first uncovered the scandal in New York. But that can be dangerous. Mayor Rudy Giuliani, for example, recently cut off funding to one community organizing group that was critical of his administration's policies. And some of the whistle-blowers in the current HUD scandal work for community groups that receive federal housing money and could face similar cutbacks if the incoming Bush administration doesn't take kindly to their activism.

It's unclear whether whistle-blowers and their agencies will be punished by a HUD that is about to come under a conservative Republican administration.

The whistle-blowers say they got little rhythm from HUD Secretary Andrew Cuomo's underlings when they clued in the agency about the Harlem-Brooklyn scandal. But Bill de Blasio, who may take some heat for being Cuomo's New York-New Jersey representative while the scandal was taking place, is at least publicly supportive of the whistle-blowers.

"The groups are quite critical of HUD, but HUD keeps working with them," says de Blasio. "That shouldn't disqualify them. We need independent groups. We need watchdogs. The Reagan administration came in and reduced programs and defunded community organizing. We should reward groups that blow the whistle."

But during the eight years of Democratic control, HUD didn't exactly reward whistle-blowers either. Jim Hawthorne, a pesky housing inspector in New Jersey, tells the Voice that he brought some HUD officials in D.C. to tears in 1997 when he showed them a videotape of dangerous housing caused by abuses of the 203(k) program.

"The video shows a five-year-old boy and a six-year-old girl and their dog playing in a crawl space, right next to a 220-volt line patched with electrical tape, and with raw sewage draining just a few feet away," says Hawthorne. Ultimately, though, HUD didn't take action on most of his tips, he says.

Hawthorne and other private inspectors have urged HUD to use randomly assigned appraisers and inspectors, rather than letting the mortgage companies pick those crucial people. In the New York transactions, prosecutors say, the same person was either the consultant or inspector for the same company—Mortgage Lending of America, a Long Island lender—in about 200 property deals.

Mostly a paperwork scam, the New York City case may lack drama. But its impact is devastating. Hawthorne describes the 203(k) program nationally as a "free-for-all" for schemers. On a small scale, 203(k) rehab work can be shoddy, the deals bad for home buyers, and inspections and appraisals often not done properly, says Hawthorne. On a big scale, a corrupt mortgage company, once it gets approved by HUD, can milk the program for millions.

HUD Inspector General Susan Gaffney reminded lawmakers in 1998 that she had urged eliminating the entire 203(k) program because of its potential for fraud.

The Harlem-Brooklyn scheme may be the cleverest example of the fraud she warned about because, according to prosecutors, officials of nonprofit organizations were recruited to serve as fronts for a small group of lawyers, investors, a mortgage lender, and an appraiser. Within their tight circle, they "created their own market," as one prosecutor terms it, and fleeced HUD out of federally insured loans for far more than the properties were actually worth.

Because practically no rehab work was done, the loans defaulted. Now the government is stuck with the buildings.

The GAO report on the 203(k) program backs up what Gaffney, Hawthorne, and housing activists have been saying about HUD's failure to spot fraud.

Hawthorne played a role in that report. He says he took GAO official Stanley J. Czerwinski on a tour of homes screwed up by 203(k) schemers in Jersey. But the scariest part of Czerwinski's critical report is that there are 2900 lending institutions around the country that have been certified as "direct endorsers" like Mortgage Lending of America and that HUD is doing a poor job of supervising them.

In December 1999, federal prosecutors announced criminal charges against 39 California mortgage lenders and others in a $110 million fraudulent-loan case. Now comes the New York case, in which just one mortgage company was allegedly at the center of a $70 million scandal.

The 203(k) program, heavily promoted by the FHA and its parent, HUD, has exploded in use in the past few years. Many more scandals may be bubbling under the surface, Hawthorne warns.

Bill de Blasio, who was HUD Secretary Cuomo's New York-New Jersey representative until late 1999, acknowledges that the agency has a long history of failing to grapple with corruption.

"HUD needed law-enforcement pressure decades ago," says de Blasio, who left HUD to run Hillary Rodham Clinton's Senate campaign. "Before we came in, there was mismanagement for 10 to 20 years."

The Czerwinski report indicates that the corruption continues. The GAO prober criticizes HUD officials for not looking for fraud in the right places. Czerwinski writes that HUD workers met their quotas in 1999 for the number of lenders they reviewed but didn't review enough of the lenders that HUD itself had determined to be "high-risk."

No wonder it took outsiders to uncover the scandal. "Community groups often know before the government knows," says de Blasio.


See Also:
HUD: The Horror Movie
A Big Fish Fries the Little Fish in Harlem-Brooklyn Mortgage Scam
by Ward Harkavy
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