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Watchdogs warn 1.7 million homeowners risk foreclosing, feds unprepared

By By Andrew Phillips and John Solomon

Monday - 6/3/2013, 7:14pm  ET

The government is already struggling to manage the more than 195,000 foreclosed homes it now possesses and is ill-prepared as a new wave of foreclosures looms on the horizon, according to federal watchdogs who paint a less rosy picture of the housing market than politicians.

In fact, the inspectors general at the Federal Housing Finance Agency (FHFA) and the Department of Housing and Urban Development (HUD) warn that a stunning 1.7 million mortgages are 90 days or more delinquent, putting them in danger of foreclosure. Such homes are considered "shadow inventory" in danger of being assumed by the government if the loans default.

"Even a fraction of the shadow inventory falling into foreclosure could considerably swell" taxpayers' liability by increasing the number of foreclosed homes that HUD and the federally-run Fannie Mae and Freddie Mac mortgage giants must maintain, market and sell, the new report warns.

In that event, the bureaucracy risks being overwhelmed. 

The internal watchdogs for HUD and FHFA said the government and the mortgage giants it oversees have done "significant work" to better manage and sell off the properties they have already repossessed because of delinquent federally-backed mortgages. Such properties are known as Real Estate Owned, or REOs.

But the agencies rely heavily on contractors, some of whom have done shoddy work or overbilled for critical functions. 

"Properties may not have always been competitively valued, holding time may not have always been minimized, sales may not have always achieved the highest net return, and properties may have been assigned to contractors that did not perform at a satisfactory performance level," the report concludes.

For instance, the inspectors general found that:

  • HUD failed to properly manage one large contractor responsible for securing and maintaining vacant properties. An audit found nearly 40 percent of the properties the contractors handled "materially failed to meet contract requirements because homes were not secured or properly maintained,” the report said. HUD is in danger of paying $1 million to the contractor over the next year for less-than-satisfactory work, it added.
  • Thirty percent of the money that HUD paid for one subcontractor's termite inspections included administrative fees that were not allowed under the main contractor's deal with the government. The subcontractor was used as a workaround to try to collect the fees, the report said.
  • HUD underpaid its field service managers who handle the foreclosed properties by $500,000 because it "did not develop national standard procedures and did not implement a performance scorecard to assign properties ... based on performance."

In the latter case, the contractors weren't the only losers. Taxpayers may have lost out as well because the errors resulted in properties being held for too long or sold at undervalued prices, the report said.

Such probems could get a lot worse if the number of foreclosures rises significantly, officials said.

The report is the latest example to emerge from the inspector general community warning of poor government performance, weak contractor oversight and tax dollars lost to waste. It could have an impact on the political dialogue over the health of the U.S. economy, especially the housing market.

President Barack Obama and some lawmakers have touted a recent drop in unemployment, a rise in house prices and gains in the stock market as signs that the economy is coming back to life.  "A housing market that was in tatters is showing new signs of real strength," the president declared in his weekly radio and video address Saturday.

Some global economists, however, have warned there may be some euphoria driving the recent gains.

The inspector general's report warns the housing market remains in a delicate state, with the 1.7 million potential foreclosures looming as a new possible challenge. In fact, it noted, the serious delinquency rate (more than 90 days delinquent) has hovered at 9.4 percent, or about 1.4 percent higher than a year ago.

Executives at Fannie Mae told the FHFA inspector general that "due to elevatated numbers of delinquent borrowers, among other challenges in the housing sector," it does not expect its inventory of repossessed houses to "return to pre-financial crisis levels for years," the report said.

With the agencies and mortgage giants already struggling with the current stock of repossessed homes and their contractors, "REO management and disposition are challenging tasks, likely to become more so as shadow inventory is foreclosed upon and becomes REO properties," the report warned.