Guaranteed Loan Programs Are an Increasing Risk

Published by the Government Accountability Office on 1990-09-18.

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

                      United States General Accounting    Office

For Release      on    Guaranteed    Loan Programs       Are
Delivery               an Increasing     Risk
Expected   at
9:30 a.m.
September     18.

                       Statement    of
                       Donald    H. Chapin
                       Assistant    Comptroller     General
                       U.S. General    Accounting     Office

                       Before    the
                       Committee     on Governmental      Affairs
                       United    States  Senate

                                            "'                      GAO Form 160 W/87)
Mr . Chairman                  and Members                        of      the        Committee:

           We are            pleased               to       be here                 today             to     discuss            the       potential

financial                  burden        the           government                    faces             from           the      billions           of

dollars               in    loans          it     has           guaranteed                      for         business,             education,

housing,               and     other             purposes.                      The        signals                are        Clear--loan

guarantee                  programs              across             government                        are        growing          at      the     same

time       that            some sectors                     of         the         economy             that           rely       on government

guaranteed                  loans        are            faltering                   and         losses            from         uncollectible

loans           are        mounting.

           It         is    unclear,               though,                   the         extent             to    which          losses          from

guaranteed                  loans          will            pinch             taxpayers’                     pocketbooks.                      Rel iabl     e
information                   is     presently                    unavailable                         to     alert            agency       managers,

the       Congress,                and          the        public             to         the      size           of     the      burden          which

might           ultimately                 emanate                from             the      government’s                       expanding                emphasis

on guaranteed                      loans.                  This         need         not          be the              case.           Financial
statements                  prepared                  by    agencies                     using             appropriate                 accounting

principles                  and      sound              financial                   management                    systems             could        provide

information                   with       which              to         identify                 a gathering                    crisis           before         it

becomes            too       overwhelming                         to      effectively                        manage,             whether           it     be

from       guaranteed                 loans                or     for         other             reasons.

           Aside            from       forecasting                           where             tomorrow’s                   bailout        could          erupt,
we must           manage             the          immediate                   problem                 of     maximizing                 the      collection

of     guaranteed                  loans           once           they             have         been         terminated                 by guarantor
lenders.               Agencies              are         permitted               to     use        a number           of       tools

commonly              found          in     the        private            sector            to     collect        debts,              such            as
use of         collection                   agencies,               but      they           are      not      always           using            these
tools       to    the         fullest.                   Amending            the        Debt         Collection                Act         of        1982

to     require          agencies                  to     implement               better            debt       collection

practices              would          help         remedy           this         situation.

          In     addition,                  steps         must        be taken               to      ensure        that          future               loan

guarantees              will          result             in    minimal             government                 losses.             The Office

of     Management               and         Budget            (OMB)        and        the         Department             of      the

Treasury          have          studied                what        actions            can        be taken          to         improve                the

quality          of     loans              agencies            guarantee                and        have       a number               of

initiatives               underway                 to     ensure           that         programs              which        guarantee

loans       are        strengthened                      against           excessive                 loss.

          Particularly                      encouraging                   among         these          initiatives                   is        movement

by OMB toward                   requiring                 annual           audited                financial           statements                      for

the     major          credit              programs.                Time         and        again,           we have           seen            the
benefits          of      having             audited               financial                statements             for         these

programs          and         will          highlight               a few          of       these          instances            this

morning.               Also          important                is    strong            central              leadership             with

responsibil             ity          for     seeing            that        agencies’                 financial                information                    is

reliable,              including                  data        on receivables                       and delinquencies,                                and

that      effective              credit                management                and debt             collection                practices

are     imp1 emented.                       Such         leadership                could           best       be vested                   in    a

legislatively                     established                     Chief         Financial                 officer            position,               which

will         soon        be the           subject             of        testimony              before           the         Committee.



POTENTIALLY                    SIGNIFICANT                   LOSSES

             As the            nation’s             largest              source         of       credit,              the         federal

government                provides             billions                  of     dollars              in    credit            assistance

through         direct                loans         of       federal            funds           to     borrowers              and         by

guaranteeing                    loans         made by private                          lenders.                 Loan         guarantees               are

agreements                by which             an agency                    guarantees                 the      payment              of     portions

or     all     of        the      loan        principal                  and        interest              to    lenders             or      security

holders             in    the      event            of       borrower               default.

             The government                    has           about          110      loan        guarantee                  programs,               many

of     which         began          as efforts                     to    revive           the        economy            during            the       Great

Depression.                     Since         that           time,          guaranteed                 loan         programs              have       been

expanded             to        meet       many          of     the       nation’s              vital           social             and     economic

needs.              Federal            guaranteed                    loan       programs               have         grown          dramatically

in     the     last            2 decades--                almost            doubl      ing       during             the      last         10 years

alone.              At    the      end        of         fiscal          year        1989,           loans          guaranteed                 by    the

government                amounted                 to     nearly              $588     billion--with                        the      bulk       of

these         being            almost         $332           billion            in     housing               loans          guaranteed               by

the      Department                of      Housing                 and Urban             Development                      (HUD).

Attachment                      I shows            the     growth              in      outstanding                       guaranteed                 loans

between                  fiscal           years         1985        and        1989.

             Direct               loan          programs            had        also          been         growing               until            recent

years,              when loan                   guarantees               began              to    be used                more      and           more       in
place             of      direct           loans.               (See       attachment                     II.)            For      example,                under

the      Food             Security               Act,      passed              in      1985,            the       Farmers               Home

Administration                            (FmHA)          has       been         gradually                    shifting                from        direct

loans             to      guarantees                of     private                  loans.              Also,            over         the        past

several                  years,           the      Small         Business               Administration                           has         proposed

that         it          stop      making           direct              loans          to        small           businesses                  and        that      it

replace                  those        loans         with          guaranteed                     loans.

             In          November               1989,      we reported1                          that         OMB projected                       that
outstanding                       loan       guarantees                  would          continue                  to      increase.

Currently,                      outstanding                loan          guarantees                     are       expected                  to    total
about             $838          billion            by     the      end      of         fiscal             year           1995,          while           direct

loans             will          decline            to     about          $197          billion             by that               time.

             One effect                    of      this         shift          is      to        reduce           the      current                fiscal

year’s             cash           outlays           and         reported              deficit              because,                under           present

federal                budget             treatment,               loan         guarantees                       appear          to      have           no cost

in     the         year           they       are        made.            However,                 this         does        not          necessarily
represent                  a savings                because              the         government                   will          eventually                 have

1Federal                  Credit     and            Insurance:    Programs   May Require    Increased
 Federal                  Assistance                in the Future    (GAO/AFMD-90-11,    November     16,                                                              1989).
to      pay      for            any               future           guaranteed                    loan     defaults,                and         the     deficit

will          increase                   when              this          occurs.

              This          potential                        future              liability               is      especially                disturbing

because               of        the           upward               trend           in      guaranteed                loans         that         have         been

terminated                      for           default                   during           the      past         several          years.                (See

attachment                      III.)                  Guaranteed                    loan         terminations                    for      default            are

expected                   to     continue                      climbing                 upward          in       future          years         despite             a

sl ight          dip            in       fiscal                 year          1989.              Guaranteed                loans         outstanding

increased                   43 percent                          between                 fiscal          year        1985       and       1989,         whereas

terminations                            for          default               increased                 by about              77 percent--rising

sharply               from            $6 bill                ion         to      almost           $11         billion.             The         1 argest

portion--55                       percent--of                            fiscal            year         1989’s           guaranteed                  loans

terminated                      for               default               related            to     HUD’s          housing             loans,           followed

by 20 and                   18 percent                            for      loans           guaranteed                by     the         Departments                 of

Veterans                   Affairs                   (VA)          and        Education,                 respectively.                         (See
attachment                      IV.)

              Although                       it      is      unlikely                   that      the         government                will         be required

to          provide             assistance                         for        the        entire          $588        billion              in    loans         it        has

guaranteed,                       the              continuing                    and       rising             exposure            to      losses            from

these           loans             cannot                   be       ignored.                   The      following              are        a few         cases            in


       --     About             40 HUD programs                                  are       aimed         at       providing               affordable

               housing                  to          selected               borrowers,                   including              those           of     the
     largest           of    the       government’s                        guarantee              lending             agencies--the

     Federal           Housing           Administration                           (FHA).            While           not       yet

     verified           or        adjusted             through              audit,           FHA reported                     at

     September              30,      1989,           a reserve                  for     future            losses            on

     guaranteed              loans           of      $5.2          billion.                 At     the        end     of      fiscal          year

     1989,       reported              outstanding                    guaranteed                   loans        for         HUD’s

     housing           programs                totaled             almost             $332       billion.

--   The     Department                 of      Agriculture’s                         FmHA administers                        19 loan

     guarantee              programs                designed               to    meet        the      needs           of      low-income

     rural       dwellers               and         family           farmers.                As of            September              30,

     1989,       FmHA’s             liability                for       future           losses            on    its         guaranteed

     loans       amounted               to      $1.3         billion.                  At    the         end of            fiscal          year

     1989,       FmHA’s             reported             outstanding                    guaranteed                  loans           totaled

     about       $5.3        billion,                which           is       about         one-third               of      the

     Department              of      Agriculture’s                         $15 billion                   in    guaranteed                  loans.

--   VA’s       loan        guarantee                programs                 have      grown            to    a reported

     principal              total         of        $152      bill         ion        as of        the        end     of      fiscal          year

     1989,       of     which           the         Department                  guaranteed                about            40 percent.

     As of       September                30,        1989,           VA projected                   losses            on      its

     guaranteed              loans             to    be about               $2.7        billion.

--   The     Department                of       Education’s                     guaranteed                student             loan

     program           has        a reported                 $49 billion                    in    outstanding                    loans        at

     the     end of          fiscal             year         1989.              Education             paid          over

           $1.9        billion               for         defaulted              guaranteed               student               loans           in

           fiscal          year             1989,          some of             which        may be recouped                        through

           subsequent                  collection                   efforts.                 Education               expects             its        cost

         of       defaults                  for         fiscal          year        1990      to     reach           $2 billion.

         Further           , the             nation’s               largest            guarantor               of        student           loans,

         the        Higher             Education                  Assistance                 Foundation,                  may need

         assistance                    if         current           steps           being          made to           rescue             this

           guaranty              agency                 from      its     recent             financial               plight          are


AUDITED           FINANCIAL                  STATEMENTS CAN

PROVIDE RELIABLE                            INFORMATION                  ON

           Because           of        deficiencies                      in     financial              management                  systems                and

inconsistencies                        in         the      application                 of     accounting                  principles                  by

some federal                 agencies                     administering                     loan     guarantee                 programs,                  the

full     magnitude                of         losses              incurred            or      expected               to    result           from

these         programs                has         not      been         accurately                 reported.                In     past

testimony              before               this         Committee,                 we have           emphasized                  that         the

concept           of     preparing                      and      auditing            financial            statements                      is    an

integral            part         of         improving               agency           financial            management                     by

promoting              discipline                       and      accountability.

           Accurate              and         reliable               financial                information                  on      the      results

of     operating             loan            guarantee                  programs             is     precisely               the         kind         of

data       agency             managers           and         the        Congress          could         use       to     spot       programs

in     trouble            or    headed           for         trouble.                Once detected,                    problem            areas
could          be monitored                and         strategically                    managed           to      minimize             their

financial                impact       on    the          government                  so that           today’s           declines              do

not      become           tomorrow’s                  failures,

           However,             much       of      the         federal             government’s                 future          liability

for      its      loan         guarantee               programs               may not          yet      be fully               visible.

While          a complete             and        valid             balance           sheet       for      the         federal

government                may not          be available                       at     present,           agencies               could        do a

better           job      of    highlighting                       in    their         financial             reports            potential

liabilities                   which      have          a significant                    future          effect.

           Early          indications                  of      an eventual                breakdown               in     loan       guarantee

program           operations               might             then        be manifested                  through            unusual

shifts           in      financial              trends.                 Symptoms          of     impend ing              d i f f icul       ties
coda           entail,          for      example,               escalating                reserves              for      future           losses,
climbing               receivables               from          guaranteed               loans          terminated               by lenders,

or     burgeoning               delinquencies                       and defaults                 on these              assets.

           Unfortunately,                   agencies                    do not        generally              have        accurate              and

reliable               data     to    use        in         identifying               and      tracking               trends        such        as

these.            The         tendency           has         been        to       manage       programs               based       on

misstated                financial              figures             and,          therefore,            to      allow          a growing

crisis           to      smolder         until           becoming                 unavoidable.                  The      role       of
audited            financial             statements                     in    spot1     ighting           the         likelihood               of    a

disaster           or     the       need          for        future           congressional                  appropriations                     is

vividly          reenforced                    through          recent            financial             statement              audits           at

major       guarantee               lending                agencies.               These         cases         include           the


   --     During          our       audit             of    FHA’s        fiscal           year         1987       financial

           statements,                 we found               that       various           audit            adjustments                were

           needed         to      bring           the        financial             statements                in     line       with

           generally              accepted                 accounting              pr inciples.2                    The       largest

           adjustment               of         $1.1        billion            resulted           from        a more           timely

           recording              of          insurance              losses        for     FHA’s            general           insurance

           and     special               risk         insurance               funds.3            FHA made major

           adjustments                   to     its        financial              statements                again       the      next         year.

           As a result                   of     the        1988       financial            audit,            FHA adjusted                 its

           financial              statements                   from      a loss           of     $858        million           to      a loss

           of    $4.2          billion--              a 5-fold               increase.                The     increased             losses

           came         from      rising              defaults               in   economically                 stressed             regions,

           sales         of      foreclosed                  properties              at        less     than        carrying            values,

           the     failure               of     several              large        coinsurers,                and       program          fraud

           and     abuse.4

2Financial               Audit:    Federal     Housing   Administration                                              Fund’s            1987
 Statement               of Financial      Position    (GAO/AFMD-89-3,                                              May 12,            1989).

3Loan insurance     is a type                                  of guarantee      in                   which a government
 agency operates      a program                                  of pooled   risk,                     pledging    the use
 of insurance    premiums     to                               secure   a lender                      against   default   by the

4Financial               Audit:     Federal   Housing    Administration                                                Fund’s          1988
 Financial               Statements     (GAO/AFMD-90-36,      February                                            9,    1990).

 --    Our     audit          of        FmHA’s           fiscal               year           1987         financial                 statements

       found          that        the       magnitude                  of         its       total           losses            did      not       come

       to     light          until          then        partially                       because             reasonable                 losses           on

       guaranteed                  loans          were         not       being               recognized                 in      its        financial

       statements.                 5       At     the         time          of        our     audit,             FmHA increased                        its

       provision               for         probable              losses                 on guaranteed                        loans         lO-fold--

       from         $76 million                   to     $764          million,                    or     24 percent                  of     loans

       guaranteed.                      Our       audit          of         FmHA’s                financial             statements                the

       following               year             showed          that             the        farm         loan     portfolio                  remained

       stressed              in        1988       and         an additional                             $628     million              was

       recognized                  in      FmHA’s             financial                     statements                 for      losses           related

       to     its       guarantee                 programs.6

  --   Our      opinion                on the           financial                      statements                for         the      Commodity

       Credit           Corporation                     for          fiscal              years           1988      and         1987        was
       qualified.7                      Among           reasons                  for        the         qualification,                     the

       financial                  statements                  did       not             reflect            the     estimated                 losses

       that         were          likely          to      be sustained                            due      to    the         uncollectibility

       of     a significant                       portion               of        the        $6 billion                 of      guaranteed

        loans         made         to       foreign             countries.                          At     September                 30,     1988,           we

5Financial            Audit:        Farmers   Home Administration’s         Losses Have
 Increased            Significantly         (GAO/AFMD-89-20,       December    20, 1988).

6Financial             Audit:   Farmers Home Administration’s                                                             Financial
 Statements             for 1988 and 1987 (GAO/AFMD-90-37,                                                             January      25,              1990).

7Financial             Audit:   Commodity Credit Corporation’s                                                             Financial
 Statements             for 1988 and 1987 (GAO/AFMD-89-83,                                                             August    4, 1989).

          estimated                the      cumulative                    losses          on these              guarantees                      to      be

          $2.3         billion            to     $3.5          billion.

   --     In     our       report           on VA’s              financial                statements                  for      fiscal                 years

          1988         and       1987,          we expressed                   concern             that,             for      the         loan

          guaranty               fund       component                   of    its        housing           credit             program,                  VA

         might           require               increased                assistance                from         the         Congress                  over

          the      next          several           years           if        home loan             foreclosures                          worsened.8
          Our      current               financial               statement                audit          of     VA disclosed                          that

          these          foreclosures                    did       not        worsen         in      1989            and are              expected

          to     continue                improving.                     However,            we found                 that      VA will                  still

          need         annual            appropriations                       to     operate             the         fund       for            several

          years,           including               an estimate                      of    $ 512.2          mi llion                for         fiscal

          year         1991.

          Al so,         the       Guaranteed                  Student              Loan     Insurance                     Fund’s              enabling

legislation                  (20    3.S.C.              1082 (b)             (2))        requires              us to          annually                  audit
the      fund’s          financial                statements.                       We have          found,                however,                  that

the      fund’s          financial               statements                   have        been          unauditable.                           Our      last

audit,          which          covered            the      fund’s             fiscal         year             1980         financial

statements,                resulted               in     an adverse                  opinion             because              of         the         serious
accounting               and       reporting               problems                 we encountered.                           A more                 recent

attempt           to     audit           the      fund’s           financial                statements--those                                  for

fiscal          year         1985--was                 terminated                 because          of         the      poor         condition                   of

aFinancial               Audit:            Veterans               Administration’s    Financial                                           Statements
 for Fiscal               Years           1988 and               1987 (GAO/AFMD-89-69,September                                                15, 1989).

the      financial                    records.               More      currently,                 in     a January               23,     1990,
letter          to        the         Committee              (GAO/OCG-90-l),                  we identified                        Education's

guaranteed                 student                 loan      program           as a "high                risk"          area      vulnerable

to     loss      and            have      begun             a financial              statement                 audit       of      the       fund.

We have          not            yet      determined                 whether          the     fund's              fiscal          year        1990

financial                 statements                 will          be auditable              or         data      with         respect            to

loan      guarantees                     is        accurate.

          We have                also          reported             that       the    government's                      overall          loan

picture              is    worse          than            reported           by agencies                 and       that         the

goi7ernment                needs          reliable                 financial          information                      on credit

programs,                 which          would            encompass            guaranteed                loan          programs.g                 To

strengthen                 financial                  reporting              for     these         programs,               we

recomnended                     that      the         Congress             require          agencies               to     provide            it    with

audited              financial                 information                 on their          receivables                   and

delinquencies.                           OMB agreed                 with       our    recommendation                       and         has

expressed                 its         intention              to     take       concrete                steps       toward          annual

audited              financial                 statements               of     the    major             credit          programs.


           In        addition                 to    being          hampered          by poor              financial               information,

managers              of        guaranteed                  loan      programs             face         unique          problems.                 With

gCredit   Management:                                 Deteriorating                Credit            Picture  Emphasizes
 Importance    of OMB's                               Nine-Point               Program             (GAO/AFMD-90-12,    April
 16, 1990).
guaranteed                loans,         agencies               do not            deal      directly            with        borrowers,
as they            do with          d i rect         loans.             Because             they       must         work      through

lenders,            agencies             do not         directly                  manage         such     aspects            of      credit

management                for      guaranteed                loans           as determining                   a borrower’s

credit            worthiness             and       ability             to      repay        a loan        or        ensuring          that

co1 lecti          on action             on problem               loans             is    prompt         and        aggressive.

            To oversee              lender          activities,                     agencies            should           establish

effective                credit         management               standards                for      lenders.                Agencies

should            also      effectively               monitor                lender         practices               to     determine

wlhether           these          standards            are       be ing           met     and,      therefore,               whether

lenders            are      following              agent        ies’         credit         management               policies             and

procedures.                     We have           found,         however,                that      agencies’               programs            to

monitor            lenders’             practices               are         often        weak.          Examples            of     the        types

of        weaknesses              we have          reported                 follow.

     --     In     September             1989,         we reportedlO                      that      problems               found         in

            ETIHA’s         guaranteed               loan        program                demonstrated                that      private

            lenders             could       not      be relied                 on to        manage        the        program.                 We

            recommended                 actions            to    improve                management             of    E’mHA’s

            guaranteed               farm         loans,         including                more      comprehensive                    criteria
            for      approval            of       guaranteed                 loans.

lOFar.mers             Home Administration:                                   Inplications     of the Shift    From
   Direct            to Guaranteed       Farm                    Loans            (GAO/RGED-89-86,    September     11,
  --        In      February               1990,             we reported                     that,            for      its       Single          Family
            Housing             program,                   HUD oversight                       and monitoring                         had       not     been

            effective                and must                    be    improved                to        ensure          that         the       delegation

            of      authority                  to         certain            lenders               to        underwrite               FHA mortgage

            insurance                is        carried                out        in    the         government’s                    best         interest.

            (See        footnote                    4.)          In    addition,                   this         report           disclosed              that

            HUD’s         review               of         lenders            who approve                      guaranteed                 loans         without

            prior         HUD approval                           had        instances                of       flawed,            deficient,               or

            lackluster                 monitoring                      and        oversight.

      --    In      January               1988,            we reportedll                       that           Education’s                   on-site

            reviews             of        lender             activities                    had decreased                      steadily--from

            over        800       lender                  reviews            in       fiscal             year         1981       to      fewer         than

            200       such        reviews                   in    fiscal              year          1987.             More       recently,              we

            reported                 (see           footnote                9)    that,            by        the      end     of      fiscal           year

            1389,           Education                     had       increased                its         monitoring                 to      519 lender
            reviews,              with              a total            of        700       additional                  reviews              being

            conducted                by        its         guaranty               agencies                   during          fiscal          years           1988
            and       1989.

            Adding           to      agencies’                    difficulties                          in    managing              loan        guarantee

programs              are       difficulties                          in     collecting                      loans       after           they         have

been        ter,minated                   by        lenders.                 These           loans            are      already              problems           or

the        lender           would          not            have        ceased           collection                     activities.                     Also,

1lGuaranteed                    Student                   Loans:             Potential                   Default          and Cost
      Reduction              Options                  (GAO/HRD-88-52BR,                                 January          7, 1988).

the     longer           a debt             remains             delinquent                  the        more       difficult                    it

usually           is     to     collect.                   In    many          instances,                    guaranteed                   loans            that

are     terminated               by         lenders             because             of     borrowers'                 defaults                      have

been      delinquent                  for      several               months          before             being         given               to        federal

agencies           for        collection.

          Thus,          agencies              must         quickly                and      forcefully                   use        all        debt

co llection              practices                 available                  to    them          to    attempt                to     collect

these       debts.               In doing             this,           agencies               are        permitted                   by     the         Debt

Collection               Act         of     1982,          enacted             under         leadership                   of        this
Committee,               and      are         directed               by OMB Circular                           A-129,           "Managing
Federal           Credit             Programs,"                 to      use        a range             of      practices                  in

collecting               debts            owed      to      the         government.

          However,              our         work      over           the       years         has            identified                a litany                 of
weaknesses               in     agencies'                  collection                   activities.                      Of     special

concern           is     that         agencies              are         not        always          using          the          collection

tools       available                 to      them         to     the         fullest             extent.                In     this

connection,                we recently                     reported                instances                 where        agencies,

including               those         with         major          guaranteed                 loan            programs,                were           not,

for     example,               (1)        effectively                   using           private              collection                   firms,              (2)
reporting               information                 on delinquent                         debts         to      credit              bureaus,                 (3)
Using       tax         refund            offsets           to       collect              delinquent                 debts,               and

(4)     charging              add         tional           interest,                penalties,                  and       administrative

costs       to     delinqu            e nt     debtors.                    This          situation              must           be turned
around.                In our         April          1990         report            (see          footnote               9),        we

recommended               strengthening                       the     Debt           Collection                  Act      of      1982.
Further,            OMB agreed                  with       these           recommendations.

THE ADMINISTRATION'S                              INITIATIVES                 FOR

           The need               to     improve           management                   of       the         government's              credit

proyrams            has       the        administration's                         attention.                     Both          OMB and

Treasury            have          analyzed              agencies'             problems                   in     operating             loan

guarantee             programs                 and have             made      sound              proposals               and

recommendations                         to     strengthen                 them.

           Improved               management               of       the      government's                       credit           programs,
which       encompass                   both      direct            and      loan         guarantee                   programs,             has

been       an OMB priority                        for      a number               of      years.                Its      activities               in

this       area       have             included          actions             such         as       (1)         issuing           Circular          A-

129 to         set      forth            administration                      policies                  for      managing            credit

pro.grams,             (2)        formulating                 a nine-point                       credit          management                 program

to     guide         management                 of      credit            programs,               and          (3)     establishing                the
Economic             Policy             Council          Working             Group           on Federal                  Credit        Policy            to

review         major          federal             credit            policy             issues.

           OMB recently                      began       to      stress           resolving                   problems            related          to
agencies'             guaranteed                  lending            operations.                         For         instance,         in     a June
1990       report            to        the     Congress             on the           status              of     credit           management

and deot             collection,                  OMB stated                 that,           while            guarantees              make        the

government              ultimately                  liable        for         loan         defaults,                    agencies           have     not

historically                viewed         management                   of        guaranteed                      loans       as their

direct         responsibility.                         They       have            not      provided                 strong          oversight

of     lenders,          guarantee                  agencies,            and            other             third         parties

interacting              with        the       borrower            on behalf                        of     the      government.                  OMB

commented            further            that         agencies            have            not         been          rigorous           in    setting

and      enforcing             lender           requirements                      and         in     monitoring                lender

performance.                   At    the        same time,               many            lenders,                  knowing          that     the

loan      repayment             is     guaranteed,                 have            not         been          diligently               screening

applicants              and     servicing                accounts                 or     aggressively                      pursuing


          To hel,s          correct             these         problems,                  OMB has                  proposed          a nine-

point       program            aimed          squarely            at     guaranteed                         loan        management.                This

program         would          guide          all      aspects           of        loan             guarantee              operations

from      establishing                  lender           standards                 and monitoring                          lenders          to

screening            loan       applicants.                     Also,             to     produce                  accurate          and

consistent              data        on guaranteed                      loan        program                  operations              for     use     in

making         informed             decisions                thereon,              OMB's                 proposed          program          would

require         annual          audited               financial               statements                      of     credit         programs.

          In    addition,               the         Department                of        the         Treasury              completed           in

June      1990,         a comprehensive,                        governmentwide                              assessment              of

guaranteed              loan        management.                   Agency                guidance                  and     oversight          of

lenders           was     a speciEic                  emphasis               of     the            study,          which          found     wide
disparities               in    program               standards               and         operations                    among       agencies
and concluded                     that      agencies                 provide           only         general           guidance                to
their         guarantee                lenders             and       exercise               minimal          oversight.

Treasury's              assessment                    report          contained               nearly           100 governmentwide

or      program-specific                         recommendations                       and        proposed                standards                for

better          managing               lenders             and       servicers               and monitoring                       their


           One way the                    Treasury             study          suggests               for     improving                 lenders'

performance                  is     to     require             them       to       share           a greater               amount            of     the

risk       involved               in      the     loans           the     government                   guarantees.                     A lender

might,          for     example,                 be    responsible                    for      20 percent                  of     a loan             loss,

while          the     government's                    share            would       be 80 percent.                              Treasury's

belief          is     that         not         having         all       or     the         majority           of         the      risk       borne

by the          government                 would           also         ensure         greater              diligence               on the               part

of      the     lender            in      making           and       collecting                   loans.        As envisioned                            by

Treasury,              lenders             would           be encouraged                     to      shoulder              more        of     the

risk          burden         if     paperwork               and         review          requirements                      for      guarantee

programs              were        reduced             to    the         minimum             necessary               for         proper        program


              The government,                      and      consequently                      the      taxpayer,                 has        suffered

enornous              losses             through           defaulted               loans            which      are         guaranteed                    by

federal              agencies.                  Loan       guarantees                 afford           an often                 essential

vehicle             for        accomplishing                        important             program            objectives,                   but        such

loans         can         also        carry        a hefty              price          tag     when          borrowers                default--to

be paid             in        years       long          after          loans        have       been          guaranteed.

Nevertheless,                       a number              of        actions         can       be taken              to     lessen              the

government’s,                       and      ultimately                 the        taxpayer’s,                vulnerability                          to
greater,             unexpected                   losses             which         may already                be deeply                   rooted          in

the        government’s                   multi-billion                       dollar          loan          guarantee                programs.

Important                 components                of         improved            loan       guarantee              programs                  entail

the        following.

      --    Guarantee                 lenders             have         historically                   not     had         the        incentive
            needed             to     ensure            the         quality         of       loans          they         ask     the

            government                 to      guarantee.                     At    the       same time,                  agencies               have

            done          a poor           job      of        overseeing               lenders’              activities                   in

            granting                and      collecting                  loans         the     government                  has

            guaranteed.                       Thus,           OMB and           Treasury              initiatives                    to    improve

            all          aspects          of      loan          guarantee              programs,              especially                   through

            greater              emphasis               on lender               monitoring                  and     risk         sharing,

            should             be vigorously                        pursued         by       the      administration                       and

            supported                 by the            Congress              through              periodic              oversight


      --    Agencies                have         also         not      always          been         aggressive                  in     collecting
            defaulted                 guaranteed                    loans       once         lenders              have      terminated
            their             collection                efforts.                Therefore,                  the     Debt         Collection
            Act          of    1992         should            be amended               to     require              use      of       collection

     practices             that          could          improve            collecting                amounts              due      which

     stem      from       guaranteed                    loans,            as well            as other              debts         owed          to

     the      government.                     This       would            help       ensure           that         good         collection

     practices            are           used      to     the        fullest           extent           possible.

--   Agencies           have            placed          too      little            emphasis            on reliable

     accounting              and         financial               reporting,                  including               accurate

     financial             information                   on direct                 and       guaranteed                 loan

     programs.               Accordingly,                      the        Congress            should              require          that

     annual        financial                   statements                 be prepared                 for         each      agency’s

     operations              using             appropriate                 accounting                 principles                 and

     sound        f inane         ial      systems,              and       that        the      financial                 statements

     be audited.                   Audited              financial                statements                 not      only        present

     the      overall             financial                results            of     an agency’s                    operations,                 but

     are      especially                 critical              in     providing               an accurate                   picture             of

     the      financial                 condition              of     credit           programs               for        early       warning

     of     any    direct               and      loan         guarantee              problems,                    Legislative
     enactment             of      5.2830,              currently                being        considered                   by     the

     Committee,              would             help        accomplish                this       objective.

--   The      current             cash-based                  budget          misrepresents                       the      costs         of

     credit        activities.                         Loan      guarantees,                   for      example,                appear              to

     be cost-free                   and        are      excluded              from       the         budget’s              cash         flow

     totals        until           default              payments              are      made.            Therefore,
     budgetary             controls                 over       federal              credit           programs              can     be

     improved           by estimating                         the     total          credit           subsidy              costs          for

        proposed              direct              loan         and     loan         guarantees                 and       appropriating

          funds        for     the          subsidy             costs         before             the      loans          and      guarantees

        are       made.12              Thus,             the      credit            decisions              of      the         COngKeSS

          would        be based              on estimates                     of        final          projected               costs         of      both

        direct          and      guaranteed                     loans,            and      adequate              reserves               would            be

          available             to      finance                defaults             when         they      occur.

          In    addition              to     these             actions,             financial              management                   at         the

agencies          needs         to      be strengthened.                                A legislatively                        backed              Chief

Financial          Officer                 (CFO)         is     needed             to     improve           the         loan         guarantee

programs.              The CFO would                      be responsible                         for      ensuring               that          (1)

necessary          resources                 are         available                 to     properly              carry          out      fiscal

accountability,                      such         as monitoring                     of      guarantee                lenders,                (2)

agencies          do     a better                 job     of      collecting                    debts,          including               those

loans       terminated                by      lenders                for     borrower              default,              and

(3)     agencies’             financial                  information                    and      systems             are       improved,

including          those             related             to      receivables                    and      delinquencies                       for         loan

guarantee          programs.

          The     CFO must                 also         have         counterparts                  in     the        agencies.

Otherwise,             the      CFO will                 only         be able             to     encourage                 actions            in

agent ies,         and        will          lack         the         clout         necessary              to      get       the        job         done.

Strong,         well         qualified                  agency             CFOs are             an essential                   part      of          the


l*This      proposal     is endorsed    in H.R.3929,                                               introduced  in the                              2nd
   session      of the 1Olst     Congress   and H.J.                                               Res. 324, a joint
   resolution        passed  by the Senate on July                                                   31, 1987.

          We have             worked         with        the   Committee            as    it    endeavors         to

improve          the     government’s                    financial          management            through

legislation.                   S.2840,             if    enacted,          would       help     tremendously           in

dealing          with         the      government’s              serious           financial         management

prOblC?ITis,           including             those        related          to   loan      guarantees.             As you

know,      the        draft          bill      has       our   wholehearted               support,          and   we look

forward          to     testifying                 on its      considerable              merits       before       this


          MK.     Chairman,                 that        concludes          my formal           statement.          I will   be

glad      to     answer             any     questions           you may have.

--   -   ..-_   --.

GAO Guaranteed Loans Outstanding

            Dollars in Billions
                                     Fiscal Years          Percent
            Agency                1985          1989       Increase
            Agriculture          $ 11.2        $ 15.0          34
            Education          _   35.8
                                   ~~ ~~__.       48.5
                                         ._~~.~ ~~..~~~        35
            HUD .__~-~~. ~.--~ - 204.4           331.8         62- ---.
            SBA                      9.1          11.0         21
            VA                    1~30.6
                                   - ~--.___     152.1         16
            Other                   19.3          29.2
            Total            - $410.4          $587.7         43

            Note: Amounts may not total due to rounding.
GAO Direct and Guaranteed Loan
    Programs for FY 1965-l 989
     600 Dollars in billions

         Fiscal Years               :M
         -       Direct Loans       Y
         - - - - Guaranteed Loans   t-l
                        ATTACHMENT   III

                               Ilo :::::::

     GAO Guaranteed Loan Terminations for
          Default by Agency for FY 1989


          -    HUD 55%         @@‘jSBA 4%
          II   VA20%           I   Agriculture 2%
               Education 18%   0   Other 1%