Inside the SBA's Monumental Katrina Loan Scandal

In his response to President Barack Obama's speech Tuesday night, Louisiana Gov. Bobby Jindal said his state no longer had a reputation for being half under water and half under indictment.

If he'd seen two new government reports on the Small Business Administration's performance during the aftermath of Hurricane Katrina, he wouldn't have made the joke so lightly. More than three years after the 2005 storms, federal investigators have uncovered what amounts to a good, old-fashioned, "Big Easy" fleecing of federal disaster assistance in Gov. Jindal's home state.

The little-publicized reports by the SBA's Office of Inspector General (OIG) document widespread fraud involving, perhaps, hundreds of millions of dollars in Katrina disaster loans. The money was either misspent or cannot be accounted for by the beleaguered federal agency. A second OIG investigation discovered that scores of borrowers defaulted on loans within 18 months of receiving money, often without making even one payment to Uncle Sam.

The findings are not surprising. Two years ago, I wrote about the Small Business Administration's hasty effort to provide emergency assistance to Gulf Coast small businesses and homeowners. Far from a major humanitarian effort to finally aid Katrina victims (as it was billed), the program was a cynical, contrived campaign to clear a backlog of Katrina loans from the SBA books -- at any cost -- simply to help the Bush administration save political face.

In all, the SBA's Office of Disaster Assistance (ODA) has disbursed more than $6 billion in loans to Gulf Coast disaster victims. The Inspector General's audit of the program was designed to determine whether the ODA had adequate controls in place to reasonably ensure that documents were secured and borrowers checked out before they received taxpayer money.

It was impossible for the OIG's office to inspect every deal, so it focused on 127 disbursements from a pool of 4,252 statistically sampled loans made between Oct. 2005 and Oct. 2007. Inspectors also visited contractors associated with 31 loans to verify that they had completed work as claimed by borrowers, and borrowers' homes to inspect progress made on repairs.

Based on the sample, more than half (54 percent) or 69 loans, were made without proper documents and certifications. "For example, case workers relied on vendor quotes and contractor proposals as evidence of work completed, yet the receipts were of questionable authenticity, and in many instances there was no supporting documentation," the report stated. The disbursements totaled $10.1 million.

The problems arose because the ODA waived its own procedures for approving loans and gave ODA case workers wide discretion to determine whether borrowers had used the money properly to qualify for follow-up loans totaling $50,000 or more, according to the report. As it turned out, haste made for huge waste.

ODA officials said loan review requirements were changed to expedite the disbursement process and to make it easier for borrowers to get subsequent disbursements. They also claimed that that reviews had been completed for all disbursements over $50,000 in aggregate. But OIG investigators said paperwork was often so shoddy or incomplete it was impossible to tell what work had actually been done with the money.

Inspectors found that the loans they examined were either based on false claims, or the work they were supposed to pay for was never done or completed as required. Here are some more glaring examples of Big Easy-style graft that Gov. Jindal claims no longer exists:

• One borrower received $1.5 million without any supporting receipts. The only documentation provided was a letter from the contractor, stating that he was paid by the borrower for work he had performed. However, the letter did not identify how much of the completed work was associated with the SBA loan.
• ODA disbursed $850,000 to a borrower based solely on invoices provided by vendors. However, the borrower did not submit receipts to demonstrate that he had actually paid the vendors.
• A borrower received $1.5 million by submitting primarily canceled checks that he wrote to himself for cash, which predated his SBA loan.

Those examples are far from the most audacious rip-offs. One borrower received $256,517, but actually spent only $1,200 to make the claimed hurricane repairs. Another borrower received $361,600 after submitting a blank form with no receipts or any other documentation supporting his use of the loan proceeds.

In its examination of defaulted loans, the OIG reviewed 117 loan files. They were statistically sampled from 4,985 loans that were at least 90 days delinquent or charged off as uncollectable as of September 30, 2007, two years after the hurricanes.

"Our audit determined that improper loan origination and/or servicing may have contributed to early loan defaults, because all but 4 of the 117 loans reviewed were either improperly originated and/or inadequately serviced," the report noted. Almost two-thirds of the loans (63 percent) were approved even though applicants lacked the ability to repay them or were not creditworthy at all.

"Projecting our sample results to the universe of 4,985 early defaulted loans, we estimate that approximately 3,182 loans, totaling $69 million, were made to applicants who did not meet SBA's repayment and credit requirements," the report states. What's more, eight in 10 loans were inadequately serviced after becoming delinquent.

Again, incredible bureaucratic sloth contributed to the problems. One applicant was approved for a $79,000 loan even though his monthly income was overstated by $1,067 and his monthly debt was understated by $657. The loan officer never bothered to reconcile the loan application with the applicant's pay stub and overlooked a car loan, three student loans, and a credit card balance, which jacked the debt-to-income ratio to 98 percent.

As corrupt New Orleans cop Remy McSwain explained in the 1987 movie The Big Easy: "Just relax, darlin'. This is the Big Easy. Folks have a certain way o' doin' things down here."

Let's hope President Obama isn't as naive as Bobby Jindal, and is intent on changing the SBA's "certain way o' doin' things." The administration has authorized the SBA to disburse billions of dollars in stimulus aid to small businesses, and taxpayers will have little tolerance for another Katrina-scale scandal.