By last spring, city officials knew it, Department of Housing and Urban Development officials knew it. The District of Columbia's low-interest, Section 312 housing rehabilitation loan program was a mess.

Contractor were walking off the job part way through, leaving gouged walls and exposed wiring. Homeowners complained of new roofs that leaked, of shiny fixtures attached to rotting plumbing. Loan packages arrived at HUD full of arithmetic errors - sometimes miscalculating monthly loan payments, so that at the end of 20 years a client might discover he had still more to pay.

It has to stop, HUD officials said, and in June, 1976, they did something they had never done before in Washington. They cancelled the city's funding for the program.

Hundreds of thousands of dollars in low-interest, rehabilitation loans - money that might have shored up walls, replaced faulty wiring, repaired rotting porches - were withheld from Washington while HUD officials waited for the city to improve its performance. For nine months, funding for the city's Section 312 loans, which had previously been doled out at up to $1 million a year, simply stopped coming.

Two months ago, when HUD officials decided Washington had shown considerable improvement, they reopened funding and Section 312 got shakily back on its feet, although no new loans have been committed yet. It is being carefully watched by HUD officials, local contractors, and the city residents who want badly to make it work - because what happened to Section 312 is a case history in the complicated and easily bungled business of government efforts to hel rehabilitate the inner city.

Section 312 is a very dry name for what has been generally been a very successful nationwide federal loan program. Begum in 1968 as part of the housing act, the program allows homeowners, mostly in urban renewal areas, to borrow up to $17,400 per unit for repair of their propeties. The loans are granted at 3 per cent interest, with up to 20 years to repay - a considerable savings over private lending that are now about 9 per cent or more.

Since its inception, the program has poured about $6 million into Washington's community development areas around 14th Street, Shaw, H Street NE, and (for a limited time) Trinidad. Like other low-interest loan programs, it has the potential to draw moderate-income homeowners into the city's recent massive surge of rebuilding.

But by last June, housing officials say, Section 312 had been felled by poorly trained employees, badly administered loan processing, and by the economics of government involvement in what is really a private rehabilitation boom.

Ask Percy Johnson about Section 312 - and then step back.

"That fiasco," Johnson said bitterly, as he told the story of his loan last week. "I'll never borrow from them again as long as I live."

An office service manager for the Department of Commerce, Johnson bought a three-story brick house eight years ago at 1503 12th St. NW, just off Logan Circle. The place had two family units, badly in need of repair, and Johnson figured he would rent it out until he could afford to renovate and then move in.

In 1974, as Johnson remembers it, a city housing inspector presented him with a list of more than 100 code violations in the house. Doors, walls, plumbing - everything needed repair. Johnson had heard about Section 312, and calculated that under the program he was eligible for two loans (one of each unit) of $17,400 each. It seemed like a fine idea.

Johnson was approved for the program, and a city rehabilitation expert told him it would take about $34,000 to properly repair his house. Johnson asked that he be allowed to do the work himself, but the city said no, the rules required competitive bidding. So the bids went out, and although most were around $35,000 to $40,000, one contractor offered to do the job for $21,500. Under the rules, Johnson had to accept the low offer.

"That man didn't touch the job, because he knew he had underbid it," Johnson said. "The dummies should have known." The contractor stalled for a full year, Johnson said, while the house sat empty and deteriorating. Finally, in despair, Johnson pleaded to be allowed to do the work himself. "I go in there, and I say, "Look, I'm paying this money back - either cancel the loan or let me go in there," he said.

In May, 1976, on the condition that he complete the work agreed on by the low-bidding contractor, Johnson himself was finally allowed to begin rehabilitating his house. He had to take out two additional loans and sell another piece of property he owned to pay for the work, because it had been so bady underbid. A month ago, with new pipes and wiring and a completely renovated interior, Johnson's Logan Circle house was finished. He moved in with a very succinct analysis of Section 312: "The whole program stinks."

What Johnson encountered was the contractor problem, which both officials and contractors themselves say is still troublesome. Unlike most private customers seeking renovations, the District requires contractors working for a Section 312 recipient to present a fixed, final price for their work - in advance. The contractors are paid in three installments, with part of the payment reserved until completion of the work.

It's not profitable," said Robert Miller, a contractor who specializes in rehabilitation work. "You cannot forecast your costs. There are so many unknowns - we can open up a wall, and my God, we've got twice as much brickwork there as we thought."

So some contractors working on 312 loans last year apparently gave up part way through the jobs, unable or unwilling to continue jobs whose prices they underestimated. To avoid this, the city now requires that contractors be bonded, which means they must obtain from private companies bonds that will guarantee completion of the jobs.

But bonds are not easy to buy, especially for the smaller contractors willing to take on the 312 renovations that are often smaller and slower-paying than private work. "People who can make the money otherwise say, 'Man, why should I pay this [WORD ILLEGIBLE] ?" Miller said. "The people who want to do the work can't get the bonds, and the people who can ger the bonds don't want to be bothered with the work."

"It's a difficult situation, acknowledged Abe Greenstein, who works with the city's Neighborhood Improvement Administration. "The purpose of it (requiring bonding on the complete job) is solely to insure that the homeowner, to whom we have a responsibility, will get a quality job and get it done in a time- [TEXT OMITTED FROM SOURCE]

Greenstein said many of last year's contractor difficulties were also caused by poorly trained city rehabilitation specialists, who draw up the requirements for the work to be performed. "The specifications were prepared were not as complete or as accurate as they might have been," he said, adding that "this was not rampant."

Again, Greenstein acknowledged that "we had some problems with management systems." The city was under pressure to complete as many loans as possible, he said, because HUD's funding each year has a deadline built in, and the more loans a city can commit, the more money it is likely to receive.

"I don't want to minimize the errors," Greenstein said. "But it wasn't as if it was the rule rather than the exception." Cases are receiving "a tighter review" now, he said, "all the way up through (Carroll) Swanson," head of the Neighbood Improvement Administration.

And Jerry Bauer, assistant area director of HUD here, said that they are indeed improving. The new loans are "not particularly" well done, he said, "but they're a lot better than what they were."

Since last summer the city has been retraining its rehabilitation specialists. Greenstein said, and has lost some through attrition. "Some of those people have left for one reason or another," he said. "I don't think anybody was actually fired."

And they are working, he said, on better loan applications. Poorly prepared loan forms were the second reason HUD cancelled funding last year - forms often scattered with arithmetic errors, said Sarah Underwood, director of community planning and development for HUD's area office here. "Quite frequent," he said, recalling the numbers of mistakes. "I would say in the majority of cases."

Washington's new Section 312 funding limit is $500,000 - about half what the city would have received if its performance last year had been betters, Underwood said. That money, like all HUD 312 funding, remains contingent on a satisfactory handling it now. But the fact that the money was granted at all, Underwood pointed out, meant "we felt they had made improvements in the system."

There are new eligible areas in the program, too - Anacostia, Stanton Park, the 1700 block of Seaton Street, and near Southeast have been included, and Trinidad has been brought in again. The city has until August to commit loans there, and "we fully expect to use it all," Greenstein said. He is convinced Washington will make it this time.