In 2018, an interesting study was published by the nonprofit R Street Institute, which found that the Federal Housing Finance Agency (FHFA) was allowing government sponsored enterprises (GSEs) to issue federal loans without requiring earthquake insurance for borrowers, potentially putting the taxpayer at substantial risk should a catastrophe occur.
Now several years later, a report examining federal loans for flood insurance, has produced similar results. These incidents represent a pattern of behavior by federal regulators that routinely expose the American taxpayer to unnecessary risk. Fortunately, they also provide important lessons for the future.
The latest report, which was released last week by the U.S. Department of Housing and Urban Development (HUD), provides a range of details including background information and objectives, scope and methodology, and the audit’s findings. The results are startling.
After examining a sample of 90 loans issued by the Federal Housing Administration (FHA) to property owners in 2020, HUD determined that 21 of these were for properties in Special Flood Hazard Area (SFHA) flood zones that did not maintain the required policy National Flood Insurance Program (NFIP) homeowner policy, thereby exposing the FHA Insurance fund to substantial risk. Using this data, HUD was then able to determine that for 2020, the FHA insured at least 31,500 loans for properties in SFHA flood zones that did not possess sufficient coverage.
In addition, the HUD report found examples of loans that had private flood insurance that did not meet the minimum amount. Due to these oversights, HUD suggests that the FHA insurance fund was exposed to at least $4.5 billion in loans for properties that did not have adequate coverage. This is an enormous amount of taxpayer money that was put at risk due to a lack of adequate precautions and safety measures. Fortunately, the report ends by providing the FHA with several useful recommendations, some of which could prove useful for other loan issuing agencies.
The first recommendation is for the FHA to require borrowers to show proof of insurance before receiving a property loan. This should be a simple requirement for all agencies when dealing with large sums of money, especially when the agency in question already requires proof of insurance, and it is common practice in the private sector. Yet, the report indicates that the FHA did not take the necessary precautions to safeguard this money, especially with data collection. This must change.
One way the FHA, and other loan issuing agencies, can do this is by establishing quality controls capable of detecting when the borrower lacks proof of insurance. This will protect the FHA insurance fund and the American taxpayer.
The report also recommends that the FHA consult with the HUD Office of General Counsel to review the “language of statutes, regulations, and handbooks.” Routine and consistent communication is a must for any successful operation, especially government.
Connected to this, the report recommends making any needed adjustments to the “Home Equity Conversation Mortgage handbooks.” Regularly updating department handbooks and guidelines is an easy verification procedure that all federal agencies should follow.
These recommendations, and the report’s findings in general, make it abundantly clear that even the most basic level of precautions were not taken by the FHA when issuing federal loans. Had an environmental disaster occurred, the government would have been left liable for billions of dollars. Thankfully this did not occur, and the issue has now been brought to public attention.
It should now be abundantly clear that these are not isolated incidents. Anyone who cares about the efficiency of federal loan system should demand policymakers take action to prioritize safeguarding public tax dollars and refuse loans to anyone who lacks the required insurance. In addition, regular audits should be performed on loan issuing agencies, and the results shared widely so that any needed reforms can be acted on quickly. Most important, agencies like the FHA should be directed to copy the best practices of the private sector when issuing future loans, in order to minimize risk to the American taxpayer. These steps will go a long way towards reestablishing trust of loan issuing agencies, while protecting consumers from disasters and taxpayers from unnecessary losses.