oversight

Liquidation of the Foreign Military Sales Fund

Published by the Government Accountability Office on 1971-07-14.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

lN,-ERNATlONAL     DIVISION



                 B-165731


                 Dear Mr. Secretary:
                        The General Accounting Office has madea review of selected
                 activities  relating  to the liquidation of the Foreign Military Sales
                 Fund. Our review was perfo~~d“pr&5pally       at the Office of the
                 Xssistant Secretary of Defense for International Security Affairs
                 and, to a limited extent, at the Treasury Department and the Export-
                 Import Bank of the United States.
                        The Foreign Military Sales Fund was authorized as a revolving
                 loan fund by the 1965 amendmentto the Foreign Assistance Act of 1961
                 which had the effect of expanding the loan activities authorized by
                 prior foreign assistance legislation.    Initial capitalization of the
                 fund on July 1, 1965, was $ls3,252,OOlwhich had increased to $381,175,080
                 as of June 30, 1968, when the fund was terminated. During this period,
                 direct loans and guarantees of private and Export-Import loans with a
                 25 percent reserve were authorized under the Foreign Assistance Act.
                 Principal and interest proceeds from loan repayments were authorized to
                 be used to make additional loans and guarantees on a revolving basis.
                 Pursuant to this and prior authorizations extending back to 19$, DOD
                 had, by June 30, 1968, financed direct loans and guaranteed loans
                 totaling about $1.5 billion.
                       Authority for the revolving fund to make new loans was terminated
                 as of June 30, 1968, by the 1967 amendmentto the Foreign Assistance
                 Act of 1961. At that point the fund entered an estimated lo-year
                 liquidation period.
                 Unnecessary Retention of Money
                 Excess to Fund Needs
                       Our review showedthat money, which could otherwise have been
                 returned to the general fund of the Treasury during the period of fund
                 liquidation, was being retained because of a questionable anticipation
                 of defaults on repayments by foreign countries. As of June 30, 1970,
                 about $181.6 million of funds was being held in reserve to cover con-
                 tingency defaults on outstanding loans and commitments amounting to
                 about $526.2 million, even though SX)Dhas never experienced a default on




                                       50 TH ANNIVERSARY 1921- 1971
its credit sales.   This amounted to approximately a 35 percent reserve
at June 30, 1970. Additional   funds were being unnecessarily  retained
to cover commitments to make loans directly   from the fund, even though
a cash flow analysis indicates that funds necessary to cover these direct
commitments will be available from repayments received from other loans
outstanding.

      The Foreign Assistance Act of 1967 terminated DOD's authority       to
make loans from the fund as of June 30, 1968, and required that all
assets of the fund be transferred     to a special account of the Treasury.
The assets of the special account are to be available       to discharge
outstanding liabilities   and obligations    incurred by the fund prior to
June 30, 1968, and any monies in excess of the aggregate United States
dollar amount of the liabilities     and obligations  are to be withdrawn
from the special account and deposited to the general fund of the Treasury.

     DOD InterDretation

      This legislation     has been interpreted   by DOD to mean that they should
retain money required for the reserve for guarantee of private and Export-
Import Bank loans in the amount established at June 30, 1968, and they
should also retain money necessary to satisfy direct commitments.          El this
regard, it is DOD's view that only money above these requirements should
be returned to the general fund of the Treasury.          Accordingly, the DOD
transferred   only about $2.3 million      to the Treasury at June 30, 1968, and
approximately    &le6 million   at June 30, 1970.

       DOD officials    informed us that their preference for this
interpretation      as opposed to returning any money not needed currently
or in the foreseeable future, was influenced by the concern of officials
of the Export-Import       Bank of the United States that sufficient reserves
might not be retained and, in that event, defaults could create the
necessity of requesting a supplemental appropriation       to repay the
Export-Import     Bank.
     With regard to the above, Export-Import   Bank officials  informed us
that former Export-Import  Bank officials  had apressed such concern when
the fund was terminated and, in their opinion, the DOD interpretation
seems quite reasonable.   They expressed uncertainty   about availability
of funds in the event defaults were higher than the reserve.




                                                                         -2-
     GAOAnalysis
       As of June 30, 1968, at the beginnin g of the liquidation period,
funds of about $181.6 million had been reserved to guarantee a contingent
liability   of about 872k.2 million to the Export-Import Bank and private
lending institutions.    The $181.6 million was approximately 25 percent
of the contingent liabilities    to be guaranteed at that date. This was in
accordance with the Foreign Assistance Act of 1961, as amended,which
required a minimum25 percent reserve. The FAA states:
      l~Obligations shall be recorded against the funds available
     for credit sales under this part in an amount not less than
     25 per centum of the contractual liability   related to any
     guaranty, insurance, coinsurance, and reinsurance issued
     pursuant to this part and the funds so obligated together
     with fees and premiums shall constitute a single reserve
     for%the payment of claims under such contracts.lf
The FAAalso specifies that the guarantees are backed by the full    faith
and credit of the United States.-
      By June 30, 1970, the contingent liability to the mart-Import
Bank and private lending institutions  had been reduced to about $526.2
million.
     Based on the Department of Defense interpretation, however, the
reserve was maintained at $181.6 million rather than being proportionately
reduced. While the 1967 amendmentto the Foreign Assistance Act may
permit the interpretation given it by DOD, it appears to us that prudent
managementof Governmentfunds requires that any money excess to actual
needs be returned to the general fund of the Treasury where it can be
madeavailable for other purposes.
      It is our opinion that the reserve should be based on historical
experience and managerial analysis rather than on arbitrary 100 percent
reserve. Historical experience by itself would indicate that no reserve
is necessary because no defaults have ever occurred.
     It seemsto us that the fund should be maintained at the minimum
25 percent required by the Foreign Assistance Act until such time as a
managerial analysis indicates a reserve above 25 percent is necessary.



                                                                    -3-
B-16.5731


       On the basis of a minimum 25 percent, the reserve could have been
reduced by about $24.3 million    by June 30, 1969, and could have been
further reduced by about $50.1 million    by June 30, 1970. Similarly,     as
of June 30, 1969, funds amounting to $83.7 million    were also being
retained in the fund to cover direct comnitments of the fund.       By the
following year, June 30, 1970, funds being retained for this purpose
had increased to $104.8 million.     These funds were being retained even
though a cash flow analysis of the fund prepared by DOD officials
indicates    that they were excess to fund needs as of these dates.
     It is our opinion that retention   of these excess funds is unnecessary
since sufficient money will be available for this purpose from repayment
of other loans outstanding.

     On a combined basis of need plus a cash reserve for guarantees limited
to 25 percent, approximately $107.9 million   was excess to needs at June 30,
1969, and approximately $154.9 million   was excess at June 301 1970.

      We were informed by Treasury Department officials that if excess
money were transferred  to the general fund of the Treasury, it would
be available for other purposes.   As long as the money remains in the
special fund account it must be reserved for possible fund expenditure.
       We believe that prudent management requires retention            of only those
amounts reasonably necessary as opposed to the current practice of
retaining    the maLmum allowable by law. Furthermore, we believe that the
DOD should evaluate this reserve requirement and establish              the level of
the reserve, using historical        experience and analysis of loans outstanding
as the appropriate basis.        It is our opinion that, in view of the Foreign
Assistance Act requiring a minimum 25 percent reserve, the reserve should
be limited    to 25 percent of guaranteed liabilities,         at least until an
analysis of loans or amounts of loans outstanding indicate a real
possibility     of default in excess of 25 percent.        We believe that the amount
of money retained in the fund to discharge outstanding liabilities               and
obligations     should be limited to amounts needed to discharge current direct
obligations,     taking into consideration      normal fluxuations    in fund balances,
as opposed to the present practice of retaining           100 percent of aggregate
direct liabilities      and obligations.     All funds in excess of the 25 percent
reserve and funds retained to discharge current liabilities              and obligations
should be promptly returned to the general fund of the Treasury.




                                                                                 -4-
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    B-165731



    Need for Internal Audit
    of Fund Accounting System

         We were informed that no internal     audit of the fund's    activities
    has been made since its establishment     on July 1, 1965.

          The internal      audit function uniquely supplements routine management
    checks through its independent approach and methods of review.               The
    internal    audit   function is one of the essential tasks of management that
    complements all other elements of management control.             It assists
    management in attaining        its goals by furnishing   information,   analysis,
    appraisals,      and recommendations pertinent     to the adequacy on individual
    performances, policies        and procedures established and other elements of
    control.

           We believe that periodic internal audits are essential      to establish
    an orderly method of winding up fund affairs    in anticipation     of final
    liquidation    in 1978.

          We request that our Office be informed of the actions taken in
    regard to this matter and that we be furnished with the results of any
    internal  audits undertaken, including copies of the internal audit reports.

          Copies of this    letter are being furnished to the Senate Committee
    on Foreign Relations,      the Senate Committee on Appropriations,  the House
    Committee on Foreign     Affairs,  the House Committee on Government Operations,
    the House Committee     on Appropriations,  the Director,  Office of Management
    and Budget, and the     Chairman and President of the Board of the Export-
    Import Bank.

                                           Sincerely   y;urs,

                                                            jab

                                             e V. Stovall

    The Honorable
    The Secretary of Defense




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