By Thomas Frank, USA TODAY

When the Federal Housing Administration stopped a New York mortgage company from making FHA loans in June, the move came nearly three years after agency records flagged the company's lending practices as potentially fraudulent.

The FHA, the government agency created to help increase homeownership, knew since at least October 2007 that Cambridge Home Capital posed a danger to home buyers and repeatedly violated the agency's safe-lending standards. Even so, a USA TODAY investigation found, the agency continued to approve mortgages issued by the company.

In 2008, when Cambridge had one of the worst records of any agency lender, the FHA still approved 528 of the company's mortgages.

It was not the first time an alert from the FHA's "early warning system" - a database that flags problem lenders - failed to move the agency to protect home buyers and taxpayers. Hundreds of companies violated the FHA's safe-lending standards but continued to receive its blessing to lend money in the past three years, USA TODAY found.

The FHA promotes homeownership by insuring the mortgages of borrowers who don't qualify for conventional bank mortgages. But the agency's weak enforcement of its own rules put thousands of home buyers in danger of getting loans based on fraudulent records or sloppy work at a time when lending companies were pushing high-risk loans, USA TODAY found:

• The FHA for years ignored internal warnings about lenders with high rates of failing loans, partly because it worried about discouraging mortgage companies from using the FHA insurance program. As a result, the FHA approved 15,000 mortgages since late 2008 from companies that had violated agency standards for a full year or more by having an excessive number of their mortgages go into default.
• In at least six instances in the past three years, lenders that the FHA flagged as potentially fraudulent were subsequently accused by state or federal authorities of mortgage fraud. The Justice Department sued Cambridge in December, alleging the company had tricked 17 families into buying homes they couldn't afford and pocketed $1 million in fees on FHA loans.
• The FHA has no reliable system for learning when one of its lenders is charged with or convicted of mortgage fraud. Since 2005, at least 13 mortgage companies continued to write FHA-insured loans after federal or state authorities brought criminal or civil mortgage-fraud cases against them.
• Although the agency says it has stepped up enforcement in the past year, many of the companies affected had either closed or stopped making FHA loans by then. During this time, three of the 15 largest FHA lenders have repeatedly violated default standards yet continue underwriting thousands of FHA-approved loans.

The agency's ability to remove bad lenders is under scrutiny after the nation's worst housing bust since the Great Depression. The FHA now insures a record 6.8 million mortgages. Last year, it covered 19.1% of all home-purchase loans, compared with 3.8% in 2006. As the world's largest mortgage insurer, the agency authorizes roughly 3,000 mortgage companies to decide on its behalf whether people they are lending to qualify for FHA insurance.

Tens of thousands of bad loans that the FHA approved from 2006 through 2008 are resulting in record numbers of insurance claims. The FHA traditionally pays all claims from the premiums it collects. But lawmakers fear a billion-dollar taxpayer rescue and want the FHA to get tough on companies with questionable lending records.

"My concern has been that if you have lenders that are continuing to lend, and the borrowers are not even paying their first mortgage payment, who are the people lending the money and what kind of lending standards are they using?" said Rep. Shelley Moore Capito, R-W.Va., a senior member of the House Financial Services Committee. "The last thing we want is the FHA to come to Congress and say, 'We really need a backstop.'"

The FHA has moved to improve its finances by excluding borrowers with the lowest credit scores from its insurance program. It also now requires other risky home buyers to make a 10% down payment, instead of the 3.5% most FHA borrowers make.

Some fear the agency is cracking down more on borrowers than on lenders. "We definitely think right now the FHA needs to focus on lender enforcement rather than tightening underwriting guidelines, because they are the only point of access to credit for low-income and minority folks," said Sonia Garrison of the Center for Responsible Lending, an advocacy group.

A wide loophole
The agency's chief anti-fraud tool is its "Neighborhood Watch Early Warning System," which identifies lenders with a high percentage of mortgages that fail within two years of closing.

The premise is that any borrower who stops paying a mortgage that quickly probably should not have been approved for the loan in the first place. "If a lot of loans are going bad in the first year or two, then that's a pretty good indicator that the lender is not doing the job properly," said John Weicher, FHA commissioner from 2001 to 2005.

The FHA can revoke its approval of any lender with an unusually high percentage of loans that default quickly. Approval is withdrawn only in regions where a lender's default rate is double the regional average for FHA lenders. The FHA has 81 regions.

But Neighborhood Watch has been undermined by loopholes and delays since the day the FHA published a legal notice in December 1992 announcing the program would begin in a month. Seven years later, it finally began.

And when the program started, the Government Accountability Office (GAO), Congress' investigative arm, pointed out that the new system excluded thousands of FHA-approved lenders from having their defaults analyzed. These lenders, called underwriters, make the final decision about approving a mortgage after reviewing documents such as home appraisals and borrowers' income statements and credit reports. The FHA now calls underwriters "the most critical lending party to a mortgage."

The FHA took six years - from 2000 to 2006 - to announce it was going to monitor underwriters' defaults. And then it took another four years, until January 2010, for the agency to actually start. "There hadn't been a whole lot of institutional enforcement," said David Stevens, FHA commissioner since July 2009.

The result: Some large regional underwriters violated default standards for two years or more.

• Great Country Mortgage Bankers of Miami, the largest FHA lender in South Florida in 2008, violated FHA standards in that region from early 2008 to early 2010.
• First Alternative Mortgage of New Rochelle, N.Y., the third-largest FHA lender in Upstate New York in 2008-2009, violated agency standards in that region from late 2007 to late 2009.

Even some lenders subject to monitoring since 1999 have escaped sanction. Those companies, called originators, assemble loan documents and send them to underwriters.

A total of 821 violations of FHA standards have gone unpunished since late 2007, while the agency has taken action in 222 instances of violations, USA TODAY found. The number of lenders violating FHA standards is a small portion of the 11,600 companies now with FHA approval.

But some say the inaction helped create a lax atmosphere.

"They had a system that they put in place, but they never used it," said Peter Lansing, president of Universal Lending Corp., an FHA-approved lender in Denver. "None of the lenders out there really cared about it that much."

A September report by the Housing and Urban Development (HUD) inspector general said that the FHA didn't pursue underwriters at a time when it had lost enormous business to subprime lenders offering no-down payment loans. More important than enforcement, the report said, the agency wanted to "attract and retain lenders to originate and underwrite FHA loans."

Charges fall below radar
The FHA also has been unaware of lenders' legal problems. The agency has no system to learn when federal prosecutors charge or convict FHA lenders, spokesman Brian Sullivan said. The mortgage companies themselves are supposed to tell the FHA when they are charged. But, Sullivan noted, "many lenders fail to report."

For example:

• U.S. Mortgage Corp. of New Jersey got agency approval for more than 1,300 mortgages over four years after a company loan officer pleaded guilty in 2005 to falsifying mortgage applications for unqualified borrowers to get FHA-insured loans. The FHA continued to approve U.S. Mortgage's mortgages even after the loan officer and two other employees, including part-owner Gerald Carti, pleaded guilty to charges related to getting fraudulent FHA mortgages for borrowers.

Homeowners have defaulted on 119 of the 1,300 mortgages so far, records show.

• The FHA approved 138 loans from Fidelity Home Mortgage of Baltimore over a six-month period in 2008 after company owner Stan Mavroulis was indicted on federal tax-fraud charges that he skimmed $1.9 million from his business.

As Mavroulis negotiated a guilty plea that year, his company retained its FHA approval even as it violated default standards in seven regions, from eastern Pennsylvania to Georgia to central Texas. Fifty-seven of the 138 loans went into early default.

"There are people out there doing things that are just awful - I mean, totally illegal, and it takes HUD a long time to recognize a lawbreaker," said John Councilman of the National Association of Mortgage Brokers.

That concern is growing as individuals who ran shady subprime lending operations have formed new businesses specializing in FHA-insured mortgages.

"A lot of the unscrupulous types that were doing the subprime stuff have migrated over to the FHA," said Bryan Howell, chief attorney for HUD's inspector general, which scrutinizes the agency.

The FHA inspects only a small sampling of mortgages to ensure they comply with procedures. Last year, HUD's inspector general looked into 284 loans that had defaulted within two years. The result: 140 of them had serious problems. Borrowers' income and assets were overstated; liabilities and credit problems were minimized. The FHA had to pay $11 million in claims on the 140 questionable loans, the inspector general found.

"There are a lot of lenders who take shortcuts," Howell said.

Punishing dead firms
Stevens, the FHA commissioner, said he's stepped up enforcement aggressively, noting that he launched the program to monitor underwriter defaults after he had been on the job for six months. Under his watch, the FHA shut down two major lenders, LendAmerica and Taylor, Bean & Whitaker, in 2009 for multiple violations of FHA rules.

The FHA in late 2009 hired its first "chief risk officer" - former Freddie Mac executive Bob Ryan - and in 2010 increased the minimum net worth for FHA lenders in an effort to weed out mortgage companies with weak finances.

The FHA has issued 22 revocation orders against underwriters since June. Fifteen were against companies that had not made an FHA loan in nine months or more. One company, Popular Mortgage of Miami, was barred from underwriting in December - nearly three years after it had made its last FHA mortgage.

"This is all a big show to prove they're doing some enforcement," said Sheri Hughes, operations manager of Access Mortgage. The FHA in November barred the company's New Jersey branch from originating FHA mortgages - a year after the company had stopped doing FHA loans, agency records show.

"Why did they go through all the trouble and time to terminate somebody who isn't doing FHA business anyway?" Hughes says.

In 2010, the FHA issued a record 117 revocation orders - against both underwriters and brokers. During the decade from 1999 to 2008, the agency issued an average of 31 orders a year.

But 56 of last year's orders were against entities that had closed or stopped doing FHA loans, including 27 companies that had not made an FHA-insured loan in six months, FHA records show.

Sullivan, the FHA spokesman, said the agency reviews the default records of any company that is listed as active.

Stevens said his actions "are having a significant impact" and have forced lenders to pay closer attention to their defaults. "My general view is it takes time," he said. "You're having to create a culture that wasn't necessarily as predominant in past regimes."

Two weeks ago, Stevens announced his resignation from the FHA to become president of the Mortgage Bankers Association, which lobbies the FHA on behalf of 2,400 mortgage companies, brokers and commercial banks. He will leave the FHA Thursday.

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