The Rural Housing Bubble

USDA program’s mismanagement led to nine-figure losses, IG report says

March 4, 2013

A federal program that guarantees home loans to rural borrowers has seen taxpayer losses and foreclosure rates skyrocket, problems federal watchdogs attribute to bureaucratic mismanagement but others say are more fundamental.

President Barack Obama used $10.5 billion in stimulus funds in 2009 to increase federal spending on the U.S. Department of Agriculture’s (USDA) Single Family Housing Guaranteed Loan Program.

USDA spent $27.8 billion on the program, which reimburses private lenders for up to 90 percent of the cost of default for loans made to low- and moderate-income borrowers in rural areas, in the four fiscal years ending in 2011.

The department’s loss claims—its reimbursements for loans in default—increased dramatically in recent years, according to a recent report from USDA’s inspector general. The program paid $103 million in loss claims in fiscal year 2008; that figure had nearly tripled, to $295 million, by fiscal year 2011.

The number of guaranteed loans increased by 131 percent from FY 2008 to FY 2011, while the number of foreclosures increased by 458 percent.

The IG in part blames bureaucratic mismanagement, noting that USDA did not put in place measures to ensure that borrowers were actually eligible for the program and did not undertake required steps to minimize taxpayer losses.

However, financial experts say the program’s losses speak to an inherent problem in federal efforts to extend credit to borrowers who might not qualify absent government intervention.

"Structurally, these programs will always lose money," said Mark Calabria, director of financial regulation studies at the Cato Institute, because they exist to encourage banks to lend to borrowers who would not qualify for home loans if the risk of losses from those loans were not borne by taxpayers.

USDA did not respond to a request for comment. The agency did propose a host of corrective actions in response to the IG’s concerns.

The IG report estimates that USDA staff did not undertake all necessary steps to minimize taxpayer losses for about 70 percent of guaranteed loans. As a result, the report questions another $254 million in loss claims.

Because "the agency did not take steps to verify that lenders had considered all options for assisting the borrower without having to resort to foreclosure," the report states, taxpayers "cannot be assured that losses from these loans were minimized as much as possible to the USDA."

The report also estimates that about 30 percent of guaranteed loans were made to borrowers who may not have been eligible, resulting in $87 million in questioned loss claims.

The USDA agency that administers the program, according to the report, "did not identify these loans as being questionable, and, therefore, paid the loss claims without having them examined by a review committee that may have reduced the losses paid or disqualified the claims entirely."

"Most of these loans had problems that could have been easily identified during a data scan, such as low credit scores, high debt ratios, or short employment histories," the report notes.

Calabria said such problems are perfect examples of the deficiencies inherent in such programs.

"Usually lenders are happy to make safe loans," he said.

Additional financial incentives are needed only for borrowers who, like those identified in the IG report, have credit histories that might disqualify them from a non-guaranteed home loan.

"The intent of the program is clearly to get lenders to make loans they wouldn't make otherwise" due to the heightened risk of default, Calabria said.

John Berlau, senior fellow for finance and access to capital at the Competitive Enterprise Institute, agreed.

"The government subsidize[s] risky home loans that the private sector would never have made without these direct or indirect subsidies," he said. "Republicans and Democrats, though the latter to a much larger extent, pursued the misguided goal that everyone should be encouraged to be a homeowner to achieve the American Dream."

"The USDA's additional souring mortgages should be a wakeup call to these politicos that government’s only role in housing should be to lift crushing regulatory barriers to affordable homes, such as Dodd-Frank and green ‘smart-growth’ regulation," he said.

Update (4:13 p.m.): An earlier version of this article contained incorrect percentage increases in guaranteed loans and foreclosures. Those figures have been corrected.