    [Analytical Perspectives]
    [Crosscutting Programs]
    [7. Credit and Insurance]
    [From the U.S. Government Printing Office, www.gpo.gov]

    [[Page 69]]

                             7. CREDIT AND INSURANCE

      The Federal Government offers direct loans and loan guarantees to
    support a wide range of activities including housing, education,
    business and community development, and exports. At the end of 2007,
    there were $260 billion in Federal direct loans outstanding and $1,202
    billion in loan guarantees. Through its insurance programs, the Federal
    Government insures bank, thrift, and credit union deposits, guarantees
    private defined-benefit pensions, and insures against some other risks
    such as natural disasters.
      The Federal Government also permits certain privately owned companies,
    called Government-Sponsored Enterprises (GSEs), to operate under Federal
    charters for the purpose of enhancing credit availability for targeted
    sectors. GSEs increase liquidity by guaranteeing and securitizing loans,
    as well as by providing direct loans. In return for advancing certain
    social goals and possibly improving economic efficiency, GSEs enjoy
    various privileges, such as possible borrowing from Treasury at
    Treasury's discretion, exemption from State and local income taxation,
    and favorable regulatory treatments of their securities. These
    privileges may leave observers with the impression that GSE securities
    are risk-free. GSEs, however, are not part of the Federal Government,
    and GSE securities are not federally guaranteed. By law, GSE securities
    carry a disclaimer of any U.S. obligation.
      This chapter discusses the roles of these diverse programs and
    assesses their effectiveness and efficiency.
        The first section emphasizes the roles of Federal credit and
              insurance programs in addressing market imperfections that may
              prevent the private market from efficiently providing credit
              and insurance. Although the continued evolution and deepening
              of financial markets may have in part corrected many of the
              imperfections, Federal programs can still play a significant
              role in the areas where market imperfections remain serious
              and at the times when some adverse events disrupt the smooth
              functioning of the market.
        The second section interprets the results of the Program
              Assessment Rating Tool (PART) for credit and insurance
              programs in relation to their distinguishing features.
        The third section presents a special topic--the structure of
              financial regulation which can influence financial
              institutions' competitiveness and ability to innovate.
        The fourth section discusses individual credit programs and
              GSEs intended to support four sectors: housing, education,
              business and community development, and exports. The
              discussion focuses on program objectives, recent developments,
              performance, and future plans for each program.
        In a similar format, the final section reviews Federal
              deposit insurance, pension guarantees, disaster insurance, and
              insurance against terrorism and other security-related risks.

               I.  FEDERAL PROGRAMS IN CHANGING FINANCIAL MARKETS

    The Federal Role

      In most cases, private lending and insurance companies efficiently
    meet economic demands by allocating resources to their most productive
    uses. Market imperfections, however, can cause inadequate provision of
    credit or insurance in some sectors. Federal credit and insurance
    programs improve economic efficiency if they effectively fill the gaps
    created by market imperfections. On the other hand, Federal credit and
    insurance programs that do not effectively address market imperfections
    can be unnecessary, or can even be counter-productive--they may simply
    do what the private sector would have done in their absence, or
    interfere with what the private sector would have done better. Federal
    credit and insurance programs also help disadvantaged groups. This role
    alone, however, may not be enough to justify credit and insurance
    programs; for helping disadvantaged groups, direct subsidies are
    generally more effective and less distortionary.
      Relevant market imperfections include insufficient information,
    limited ability to secure resources, insufficient competition, and
    externalities. Although these imperfections can cause inefficiencies,
    the presence of a market imperfection does not mean that Government
    intervention will always be effective. To be effective, a credit or
    insurance program should be carefully designed to reduce inefficiencies
    in the targeted area without causing inefficiencies elsewhere.

      Insufficient Information. Financial intermediaries may fail to
    allocate credit to the most deserving borrowers if there is little
    objective information about some of the borrowers. Some groups of
    borrowers, such as start-up businesses and some families, have limited
    incomes and credit histories. Many creditworthy borrowers belonging to
    these groups may fail to obtain credit or be forced to pay excessively
    high interest. For very irregular events, such as natural and man-made
    disasters, there may not be sufficient information to estimate the
    probability and magnitude of the loss. This pricing difficulty may
    prevent insurers from covering those risks at reasonable premiums.

    [[Page 70]]

      Limited Ability to Secure Resources. The ability of private entities
    to absorb losses is more limited than that of the Federal Government,
    which has general taxing authority. For some events potentially
    involving a very large loss concentrated in a short time period,
    therefore, Government insurance commanding more resources can be more
    reliable. Such events include massive bank failures and some natural and
    man-made disasters that can threaten the solvency of private insurers.
      Insufficient Competition. Competition can be insufficient in some
    markets because of barriers to entry or economies of scale. Insufficient
    competition may result in unduly high prices of credit and insurance in
    those markets.
      Externalities. Decisions at the individual level are not socially
    optimal when individuals do not capture the full benefit (positive
    externalities) or bear the full cost (negative externalities) of their
    activities. Education, for example, generates positive externalities
    because the general public benefits from the high productivity and good
    citizenship of a well-educated person. Without Government intervention,
    people will engage less than socially optimal in activities that
    generate positive externalities and more in activities that generate
    negative externalities.

    Financial Market Developments

      Financial markets have become much more efficient through
    technological advances and financial services deregulation. By
    facilitating the gathering and processing of information and lowering
    transaction costs, technological advances have significantly contributed
    to improving the screening of credit and insurance applicants, enhancing
    liquidity, refining risk management, and spurring competition.
    Deregulation has increased competition and prompted efficiency-improving
    consolidation by removing geographic and industry barriers.
      These changes have reduced market imperfections. The private market
    now has more information and better technology to process it; it has
    better means to secure resources; and it is more competitive. As a
    result, the private market is more willing and able to serve a portion
    of the population traditionally targeted by Federal programs. The
    benefits of technological advances and deregulation, however, have been
    uneven across sectors and populations. To remain effective, therefore,
    Federal credit and insurance programs should focus more narrowly on
    those sectors that have been less affected by financial evolution and
    those populations that still have difficulty in obtaining credit or
    insurance from private lenders. The Federal Government should also pay
    more attention to new challenges introduced by financial evolution and
    other economic developments. Even those changes that are beneficial
    overall often bring new risks and challenges.
      The role for the Federal government in addressing the information
    problem has diminished steadily over the years. Nowadays, lenders and
    insurers have easy access to large databases, powerful computing
    devices, and sophisticated analytical models. This advancement in
    communication and information processing technology enables lenders to
    evaluate risk more objectively and accurately. As a result, most
    borrowers can easily obtain credit at a fair interest rate reflecting
    their risk. The improvement, however, may be uneven across sectors.
    Credit scoring (an automated process that converts relevant borrower
    characteristics into a numerical score indicating creditworthiness), for
    example, is considered as a breakthrough in borrower screening. While
    credit scoring is widely applied to home mortgages and consumer loans,
    it is applied to a limited extent for small business loans and
    agricultural loans due to the difficulty of standardizing unique
    characteristics of small businesses and farmers. It is also possible
    that banking consolidation adversely affects those borrowers with unique
    characteristics; small, local banks could serve those borrowers better
    if they had more borrower-specific information gained through long-term
    relations. With technological advances such as computer simulation,
    pricing catastrophe risks has become easier, but it remains much more
    difficult than pricing more regular events such as automobile accidents.
    It is still difficult for insurers to estimate with confidence the
    probability of a major natural disaster occurring. The difficulty may be
    greater for man-made disasters that lack scientific bases.
      Financial evolution has also improved private insurers' ability to
    deal with catastrophic losses. Using financial derivatives such as
    options, swaps, and futures, private entities can manage and share
    various types of risk such as price risk, interest rate risk, credit
    risk, and even catastrophe-related risk. An insurer can distribute the
    risk of a natural or man-made catastrophe among a large number of
    investors through catastrophe-related derivatives. However, the market
    for catastrophe-related derivatives is still small, and it has not
    eliminated the difficulty of absorbing catastrophic losses yet.
      Insufficient competition is much less likely to justify Federal
    involvement than was the case only a few years ago due to financial
    deregulation and improved communication and financing technology.
    Financial deregulation removed geographic and industry barriers to
    competition. As a result, major financial holding companies offer both
    banking and insurance products nationwide. Internet-based financial
    services have further lowered the cost of financial transactions and
    reduced the importance of physical location. These developments have
    been especially beneficial to small and geographically isolated
    customers who could not afford to bear large transactions costs and
    otherwise had limited access to financial services. In addition, there
    are more financing alternatives for both commercial and individual
    borrowers that used to rely heavily on banks. Venture capital, for
    example, has become a much more important financing source for small
    businesses. Finance companies have also become a prominent player both
    in business and consumer financing.

    [[Page 71]]

      Problems related to externalities may persist because the price
    mechanisms that drive the private market by definition ignore the value
    of externalities. Externalities, however, are a general market failure,
    rather than a financial market failure. Thus, credit and insurance
    programs are not necessarily the best means to address externalities,
    and their effectiveness should be compared with other forms of
    Government intervention, such as tax incentives and grants. In
    particular, if a credit program was initially intended to address
    multiple problems, including externalities, and those other problems
    have been alleviated, there may be a better way to address any remaining
    externalities.
      Overall, the financial market has become more efficient and stable.
    Financial evolution and other economic developments, however, are often
    accompanied by new risks, as evidenced by the current difficulties
    resulting from the rapid expansion of subprime mortgages. Subprime
    mortgages are a product of several innovations, such as consumer credit
    scoring, securitization, and credit ratings on securities. Properly
    used, subprime mortgages are a beneficial tool helping disadvantaged
    families to become homeowners. Misjudgments and some imperfections in
    financing techniques appear to have led to overextension of subprime
    mortgages. For example, while securitization facilitates the funding of
    mortgages, it also reduces mortgage originators' incentives to screen
    borrowers carefully because securitized loans are off their balance
    sheets. Investors having relied on credit ratings appear to have been
    misguided by high ratings on some complex mortgage-backed securities
    that with the benefit of hindsight were too optimistic. Few financial
    models are perfect. In addition, rating agencies' incentives to protect
    investors may have been attenuated by the fees they collect from
    security issuers. These developments suggest that Federal agencies need
    to be vigilant to identify and manage new risks to the economy and to
    the Budget, arising from financial evolution.
      Recent financial market instability presents both opportunities and
    challenges to Federal programs. Market disruptions have reduced private
    liquidity and credit availability temporarily. In this situation,
    Federal programs can produce larger net benefits. GSEs may inject more
    liquidity into the financial market, and credit programs may accommodate
    more deserving borrowers who are having difficulties in obtaining credit
    in the private market. Challenges include identifying the areas where
    the true needs are (e.g., identifying deserving borrowers), selecting
    the most effective tools, avoiding distortion of private sector credit
    markets, and avoiding excessive burden on taxpayers. To ensure
    significant net benefits, these issues need to be addressed effectively.

                II.  PERFORMANCE OF CREDIT AND INSURANCE PROGRAMS

      The Program Assessment Rating Tool (PART) has rated 38 credit programs
    and nine insurance programs. The PART evaluates programs in four areas
    (program purpose and design, strategic planning, program management, and
    program results) and assigns a numerical score (0 to 100) to each
    category. The overall rating (effective, moderately effective, adequate,
    ineffective, or results not demonstrated) is determined based on the
    numerical scores and the availability of reliable data.
      The ratings for credit and insurance programs are clustered around the
    middle; 77 percent of credit and insurance programs (compared with 59
    percent for other programs) are rated ``adequate'' or ``moderately
    effective,'' while only 11 percent (18 percent for other programs) are
    rated ``effective.'' These results suggest that most credit and
    insurance programs meet basic standards, but need to improve.

                                                 SUMMARY OF PART SCORES
    ----------------------------------------------------------------------------------------------------------------
                                                                          Purpose
                                                                            and     Strategic    Program    Program
                                                                           Design    Planning  Management   Results
    ----------------------------------------------------------------------------------------------------------------

    Credit and Insurance Programs
      Average..........................................................       80.0       76.9        85.8       55.7
      Standard Deviation...............................................       19.4       23.4        18.1       19.0

    All Others Excluding Credit and Insurance Programs
      Average..........................................................       87.6       75.8        83.0       48.9
      Standard Deviation...............................................       18.2       24.3        17.7       26.4
    ----------------------------------------------------------------------------------------------------------------

      Some key features distinguish credit and insurance programs from other
    programs. Credit and insurance programs are intended to address
    imperfections in financial markets. They also face various risks, such
    as uncertain default rates and erratic claim rates. Interpreting PART
    results in relation to these features should help to identify
    fundamental problems and to devise effective solutions.

      Program Purpose and Design. To be effective, credit and insurance
    programs should serve those who deserve to be served but are left out by
    the private market due to market imperfections. Extending credit to
    those who are not creditworthy, for example, would result in economic
    inefficiencies and large budget costs. Lending to those who can obtain
    credit at a reasonable rate in the private market would be unnecessary
    and

    [[Page 72]]

    might interfere with the market mechanism. To achieve intended outcomes
    without causing unintended consequences, therefore, credit and insurance
    programs need to be carefully designed; they should target the intended
    beneficiaries, and all parties in the transaction should face the
    correct incentives.
      The PART indicates that most credit and insurance programs have clear
    purposes (not necessarily economically justifiable purposes) and address
    specific needs. Many credit and insurance programs, however, fail to
    score high in program design. Some are duplicative of other federal
    programs or private sources, and some offer inadequate incentive
    structures.

      Strategic Planning. Financial markets have been evolving to serve
    target populations of Federal programs better and increasingly apply
    advanced technologies to risk assessments. Credit and insurance programs
    need to adapt to these new developments quickly. Falling behind, Federal
    programs can be left with many beneficiaries that do not really need
    Government help and with those that may pose greater risk.
      In subcategories of strategic planning, while most credit and
    insurance programs effectively execute short-term strategies, they are
    less effective in pursuing long-term goals which may be more critical in
    adapting to new developments. Other weaknesses are found in conducting
    stringent performance evaluation and tying budgets to performance
    outcomes.

      Program Management. Risk management is a critical element of credit
    and insurance programs. Cash flows are uncertain both for credit and
    insurance programs. Default rates and claim rates can turn out to be
    significantly different than expected. Credit programs also face
    prepayment and interest rate risks. These risks must be carefully
    managed to ensure the program cost stays within a reasonable range.
      Credit and insurance programs show strengths in basic financial and
    accounting practices, such as spending funds for intended purposes and
    controlling routine costs. However, some weaknesses are found in areas
    that are more critical for effective risk management, such as collecting
    timely information and using sophisticated financial tools.

      Program Results. It is generally more difficult to measure the
    outcomes of Federal programs pursuing various social goals than those of
    private entities seeking profits. Unlike profits, social outcomes are
    difficult to quantify and often interrelated. Credit and insurance
    programs face an additional difficulty of estimating the program cost
    accurately. Since the outcome must be weighed against the cost, an
    underestimation or an overestimation of the cost would make the program
    appear unduly effective or ineffective. Thus, results for credit and
    insurance programs need to be interpreted in conjunction with the
    accuracy of cost estimation.
      Program results, the most important category of performance, are
    generally weak for credit and insurance programs despite a higher
    average score than that of other programs. Many credit and insurance
    programs have difficulty in achieving performance goals and lack
    objective evidences of program effectiveness. These problems may partly
    result from the difficulty of measuring net outcomes. With reliable
    outcome measures, it should be easier to set achievable goals and
    demonstrate effectiveness.

                     III.  STRUCTURE OF FINANCIAL REGULATION

      Several groups including government, industry, and academic
    institutions have expressed concerns about the competitiveness of U.S.
    capital markets in the global financial system, and that financial
    regulations and the regulatory structure in the United States have
    become overly burdensome and complex. Recommendations have been made to
    streamline the U.S. regulatory structure, while acknowledging that a
    strong regulatory regime is critical to maintaining market confidence
    and the U.S. financial markets' preeminence. The analysis below reviews
    the regulatory systems used in foreign countries, in comparison to the
    system currently in place in the United States.

    U.S. Financial Services Oversight

      Financial regulators are responsible for supervising financial
    institutions and financial transactions. Their domain encompasses banks
    and other depository institutions, insurance companies, securities
    firms, pension funds, finance companies, and other entities.
    Historically, regulators specialized in one of three financial service
    categories: banking, insurance, or securities.
      The United States maintains a functionally separated regulatory
    system, with oversight responsibility divided among: five Federal
    banking regulators; two Federal securities/futures regulators; State-
    level insurance and other regulators; and self-regulatory organizations
    (non-governmental). The table below illustrates the multiple regulators
    of each type of financial services provider. The table shows that some
    providers can have up to five different levels of supervision in the
    United States.

    [[Page 73]]

    New Trends in Regulation

      Outside the United States, countries have made recent changes to move
    toward a single, consolidated financial regulator having regulatory
    authority across all areas of financial services. These countries
    include the United Kingdom, Japan, Germany, and South Korea. Other
    countries have consolidated supervision of two or more financial sectors
    such as banking and insurance under one regulator, including Australia,
    Canada, and the Netherlands. Finally, countries that separate regulation
    of banking, insurance, and securities markets, including Hong Kong,
    France, and Italy, typically have only one regulator for each of those
    sectors. The United States has a separated system of regulation, with
    multiple regulators for each financial sector.
      In an effort to provide more efficient and effective oversight of
    evolving markets, countries that have historically used a three- or
    multiple-pronged regulatory system are moving to consolidate regulation
    into one or two entities having the statutory power to supervise at
    least two of the three main types of financial intermediaries. This
    regulator is known as an ``integrated'' regulator; the regulatory system
    may be referred to as an integrated system.
      The main drivers of this consolidation include:
        The need to better supervise the growing complexity and
              importance of financial conglomerates and the blurring
              distinctions among banking, securities, and insurance
              products, as well as the associated systematic risk;
        The desire to maximize economies of scale and scope in
              regulatory efforts; and
        The need to address poor communication between and lack of
              cooperation among existing regulatory agencies.
      Examples of integrated systems are found in Australia, Canada, the
    Netherlands, and Switzerland. The systems in Australia and the
    Netherlands provide examples of the ``Twin Peaks'' model, which
    separates prudential from market-conduct regulation. In this model, the
    prudential regulator oversees systemic risk and the solvency of major
    financial institutions. \1\ For example, a prudential regulator would
    ensure that deposit-taking institutions are able to meet their financial
    obligations by regulating and overseeing bank reserve ratios and inter-
    bank lending rates. The market-conduct regulator oversees institutional
    conduct with respect to markets and shareholders. A market-conduct
    regulator would ensure the accuracy of financial filings and investigate
    market manipulation, insider trading, and customer fraud.
    ---------------------------------------------------------------------------
      \1\ In the case of the Netherlands, the central bank has this
    responsibility.

    ---------------------------------------------------------------------------

    [[Page 74]]

                                          REGULATORS OF FINANCIAL INSTITUTIONS
    ----------------------------------------------------------------------------------------------------------------
                                                           Safety/Soundness        Consumer
                                     Charter and License      Examination         Protection       Market Oversight
    ----------------------------------------------------------------------------------------------------------------
    National Banks.................  OCC                  OCC                 FRB and OCC         SEC and CFTC
    ----------------------------------------------------------------------------------------------------------------
    State Member Banks.............  States               FRB and States      FRB and States      SEC and CFTC
    ----------------------------------------------------------------------------------------------------------------
    Insured Federal Savings          OTS                  OTS                 FRB and OTS         SEC and CFTC
     Associations.
    ----------------------------------------------------------------------------------------------------------------
    Insured State Savings            States               OTS and States      FRB, OTS and        SEC and CFTC
     Associations.                                                             States
    ----------------------------------------------------------------------------------------------------------------
    FDIC-insured State Nonmember     States               FDIC and States     FRB, FDIC and       SEC and CFTC
     Banks.                                                                    States
    ----------------------------------------------------------------------------------------------------------------
    Federal Credit Unions..........  NCUA                 NCUA                FRB and NCUA        SEC and CFTC
    ----------------------------------------------------------------------------------------------------------------
    State Credit Unions............  States               NCUA and States     FRB, FTC and        N/A
                                                                               States
    ----------------------------------------------------------------------------------------------------------------
    Bank Holding Companies.........  FRB                  FRB                 FRB and FTC         SEC, CFTC and FRB
    ----------------------------------------------------------------------------------------------------------------
    Thrift Holding Companies.......  OTS                  OTS                 OTS and FTC         SEC, CFTC and OTS
    ----------------------------------------------------------------------------------------------------------------
    Consolidated Investment Banks..  SEC                  SEC                 SEC                 SEC, CFTC, SROs
    ----------------------------------------------------------------------------------------------------------------
    Broker-Dealers.................  SEC                  SEC                 SEC, FTC and        SEC and SROs
                                                                               States
    ----------------------------------------------------------------------------------------------------------------
    Futures Commission Merchants...  CFTC and SROs        CFTC                CFTC and DOJ        CFTC and SROs
    ----------------------------------------------------------------------------------------------------------------
    Hedge Funds....................  None                 None                DOJ and States      SEC, CFTC and FRB
    ----------------------------------------------------------------------------------------------------------------
    Credit Rating Agencies.........  SEC                  SEC                 N/A                 N/A
    ----------------------------------------------------------------------------------------------------------------
    Treasury Securities Primary      FRB and Treasury     FRB                 N/A                 FRB and Treasury
     Dealers.
    ----------------------------------------------------------------------------------------------------------------
    Insurance Companies............  States               States              States              SEC, CFTC and
                                                                                                   States
    ----------------------------------------------------------------------------------------------------------------
    Mortgage Companies.............  States               States              FRB and States      SEC and CFTC
    ----------------------------------------------------------------------------------------------------------------
    Mortgage Brokers...............  States               States              FRB and States      N/A
    ----------------------------------------------------------------------------------------------------------------
    OCC--Office of the Comptroller of the Currency OTS--Office of Thrift Supervision
    FRB--Federal Reserve Board and Regional Banks FDIC--Federal Deposit Insurance Corporation
    NCUA--National Credit Union Administration States--State Financial Regulatory Commissions
    FTC--Federal Trade Commission SEC--Securities and Exchange Commission
    CFTC--Commodity Futures Trading Commission DOJ--U.S. Department of Justice
    SROs--Self-Regulatory Organizations (e.g. Financial Industry Regulatory Authority, National Futures Association)

      The most extreme form of an integrated system, the ``unified''
    regulatory system, is also gaining in popularity. Of the top 15
    international financial centers (non-U.S.), almost half are overseen by
    a single regulator of all banking, insurance, and securities firms,
    nation-wide. \2\ These include centers in Denmark, Germany, Japan,
    Singapore, South Korea, Sweden, and the United Kingdom. In addition,
    Switzerland approved legislation on June 22, 2007 to create a unified
    financial services regulator from its current integrated system, taking
    effect in 2009.
    ---------------------------------------------------------------------------
      \2\ In some cases, such as Germany, a single, unified regulator has
    the predominant regulatory and supervisory authority over all sectors,
    and shares some supervisory authority with state-level regulators and
    the central bank. The role of the central bank varies among countries
    surveyed; in Singapore, for example, regulatory and supervisory
    responsibilities pertaining to all sectors have been merged into the
    central bank.

    ---------------------------------------------------------------------------
    Conclusion

      The U.S. approach to financial regulation is an outlier in the global
    financial system. The few countries that do have a similar, functionally
    divided system have significantly fewer regulators. Three-quarters of
    countries with the largest financial centers have consolidated their
    regulatory systems, with almost half maintaining a unified regulator for
    all sectors of the financial services industry. The Administration is
    conducting an in-depth review of the Nation's regulatory system and
    looks forward to advancing the dialogue this year.

    [[Page 75]]

                           IV.  CREDIT IN FOUR SECTORS

                        Housing Credit Programs and GSEs

      Through housing credit programs, the Federal Government promotes
    homeownership and housing among various target groups, including low-
    income people, minorities, veterans, and rural residents. A primary
    function of the housing GSEs is to increase liquidity in the mortgage
    market.

    Federal Housing Administration

      In June 2002, the President issued America's Homeownership Challenge
    to increase the number of first-time minority homeowners by 5.5 million
    through 2010. During the five years since the goal was announced, nearly
    3.2 million minority families have become first-time homeowners. Through
    2007, the Department of Housing and Urban Development's (HUD's) Federal
    Housing Administration (FHA) helped more than 664,000 of these first-
    time minority homebuyers through its loan insurance programs. FHA
    mortgage insurance guarantees mortgage loans that provide access to
    homeownership for people who lack the traditional financial resources or
    credit history to qualify for a home mortgage in the conventional
    marketplace. In 2007, FHA insured purchase and refinance mortgages for
    more than 532,000 households. Among purchase mortgages, over 79 percent
    were for first-time homebuyers and 30 percent were for minority buyers.
    FHA also insured over 107,000 home equity conversion mortgages for
    elderly homeowners.
      While FHA has been a primary facilitator of mortgage credit for first-
    time and minority buyers since the 1930s, its loan volume fell
    precipitously from 2002 through 2006. This is due in part to lower
    interest rates that made uninsured mortgages affordable for more
    families. Moreover, private lenders--aided by automated underwriting
    tools that allow them to measure risks more accurately--expanded lending
    to people who previously would have had no option but FHA, those with
    too few resources to pay for large downpayments, and/or who had credit
    histories that the private sector considered too risky. The development
    of new products and underwriting approaches has allowed private lenders
    to offer loans to more homebuyers. While this is a positive development
    when the private sector properly assesses risks and offers fair terms,
    some borrowers have ended up paying too much, receiving unfair terms, or
    taking on excessive debts.
      As private lenders expanded their underwriting to cover more
    borrowers, FHA's business changed. First, the percentage of FHA-insured
    mortgages with initial loan-to-value (LTV) ratios of 95 percent or
    higher increased substantially, from 62.7 percent in 1995 to 79 percent
    in 2007. Second, the percentage of FHA loans with downpayment assistance
    from seller-financed nonprofit organizations grew rapidly, from 0.3
    percent in 1998 to nearly 23 percent in 2007. Recent studies show that
    these loans are considerably more risky than those made to borrowers who
    receive downpayment assistance from other sources.
      The FHA single-family mortgage program was assessed in 2005 using the
    PART. The assessment found that the program was meeting its statutory
    objective to serve underserved borrowers while maintaining an adequate
    capital reserve. However, the program lacked quantifiable annual and
    long-term performance goals that would measure FHA's ability to achieve
    its statutory mission. In addition, both the PART and subsequent reports
    by the Government Accountability Office and the Inspector General noted
    that the program's credit model does not accurately predict losses to
    the FHA insurance funds and that, despite FHA efforts to deter fraud in
    the program, HUD has not demonstrated that those steps have reduced such
    fraud. Due to weak housing market conditions today, FHA will record an
    upward re-estimate in the cost of its Mutual Mortgage Insurance Fund
    programs of $4.6 billion in 2008. Cumulatively, FHA has recorded net
    upward re-estimates of $19.7 billion since 1992.
      In response to PART findings, FHA measured its 2007 performance
    against new goals, such as the percentage of FHA Single Family loans for
    first-time and minority homeowners, and exceeded its goals. FHA also
    improved the accuracy of its annual actuarial review claim and
    prepayment estimates. In 2008, it will continue to develop performance
    goals for fraud detection and prevention.

    Response to Mortgage Market Challenges

      FHA plays a valuable role in providing home financing options that
    augment those available in the conventional market. As discussed in the
    section on deposit insurance, conventional credit standards have
    tightened in recent months. Private mortgage insurers have raised
    underwriting standards, reducing the availability of financing options.
    In addition, there are a large number of borrowers who hold adjustable
    rate mortgages and face the risk of foreclosure due to large increases
    in mortgage payments after an interest-rate reset. An estimated 1.8
    million subprime mortgages for owner-occupied homes are scheduled to
    reset in 2008 and 2009.
      FHA is addressing both of these challenges. The FHA guarantee
    encourages lending to borrowers who may face increased difficulty in
    obtaining conventional financing. For borrowers who face difficulty
    making their mortgages payments, re-financing under an FHA-insured loan
    can offer a path that keeps them in their homes and avoids costly
    foreclosures. To broaden the use of this re-financing, the
    Administration announced the FHASecure program in August 2007. This
    program broadens the population eligible to use FHA. Beyond borrowers
    who are current, it also allows credit-worthy borrowers who have fallen
    behind on their mortgages

    [[Page 76]]

    due to interest rate resets to refinance into FHA. Since the
    announcement of FHASecure and as of January 2008, approximately 44,000
    borrowers have successfully refinanced their conventional mortgages into
    FHA. While these actions help the mortgage market in the short-term, FHA
    needs permanent changes to allow guarantees on a wider variety of
    financing options and the flexibility to respond to future changes in
    the mortgage and housing markets.

    Proposals for Program Reform

      In order to enable FHA to fulfill its mission in today's changing
    marketplace, the Administration has proposed legislation that will give
    FHA the ability to respond to current challenges to homeownership among
    its traditional target borrowers: low and moderate-income first-time
    homebuyers. FHA has already taken steps, within its current authority,
    to streamline its documentation requirements and remove impediments to
    its use by lenders and buyers. However, additional reforms will enable
    it to expand homeownership opportunities to its target borrowers on an
    actuarially sound basis.
      To remove two large barriers to homeownership--having limited savings
    for a downpayment or impaired credit--the Administration again proposes
    new FHA options. These options will replace the current flat premium-
    rate structure with one that varies with the risk of default, as
    indicated by the borrower's downpayment percentage and credit history.
    This will create more opportunities for potential homeowners who may
    face limited mortgage options. For example, first-time buyers with a
    strong credit record but little savings could finance a higher percent
    of the purchase than FHA currently allows. Alternatively, a borrower
    with a poor credit history but who has accumulated savings for a larger
    downpayment could qualify for more favorable terms with FHA than are
    available in the conventional market.
      Such a flexible premium structure is a way to more fairly price the
    FHA guarantee to individual borrowers. It creates incentives (lower
    premium payments) for borrowers to take steps to improve their credit or
    save more for a downpayment. At the same time it eliminates the current
    incentive for higher-risk borrowers to use FHA because they are
    undercharged relative to the risk they pose. FHA proposes to base its
    mortgage insurance premiums upon a borrower's consumer credit score from
    the three major credit repositories (using the Fair-Isaac and Company
    (FICO) formula), and on the amount of downpayment. Mortgage insurance
    premiums will be based on FHA's historical experience with similar
    borrowers. This change will decrease premiums for many of FHA's
    traditional borrowers, thereby increasing their access to homeownership.
      This price structure has many advantages. First, FHA will reflect a
    loan's risk via the mortgage insurance premium, not through a higher
    interest rate as done in the subprime market. With mortgage insurance
    through FHA, borrowers will pay a market rate of interest, and, as a
    result, will incur lower monthly payments and lower total costs than if
    they paid a higher mortgage interest rate throughout the life of the
    loan. Second, by using this pricing structure, FHA will promote price
    transparency. Each borrower will know why they are paying the premium
    that they are being charged and will know how to lower their borrowing
    costs--i.e., by raising their FICO score or their downpayment. Third,
    risk-based pricing will allow FHA to review the performance of its
    programs annually in conjunction with the preparation of its credit
    subsidy estimates and adjust its premiums as necessary to assure the
    financial soundness of the Mutual Mortgage Insurance Fund.
      The Administration also proposes to increase the FHA single-family
    loan limit in high-cost areas to the conforming mortgage limit (from
    $362,790 to $417,000). This will enable FHA to offer its insurance in
    some areas that experienced rapid house price appreciation between 2001
    and 2006, and where FHA is no longer a viable option because of overly-
    restrictive loan limits. There are areas of the country, including many
    major cities in California, where FHA used to provide significant
    support to first-time and minority homebuyers, but where it can do very
    little to help them now. This proposed loan-limit increase will also
    allow FHA to offer insurance to a more geographically diverse portfolio.
      A reformed FHA will adhere to sound management practices that include
    a new framework of standards and incentives tied to principles of good
    credit program management. Further, the proposed reforms will better
    enable FHA to better meet its objective of serving first-time and low-
    income home buyers--about 280,000 first-time homebuyers in 2009
    including about 80,000 minority families--by managing its risks more
    effectively.

    VA Housing Program

      The Department of Veterans Affairs (VA) assists veterans, members of
    the Selected Reserve, and active duty personnel to purchase homes as
    recognition of their service to the Nation. The program substitutes the
    Federal guarantee for the borrower's down payment. In 2007, VA provided
    $24.2 billion in guarantees to assist 129,261 borrowers.
      Since the main purpose of this program is to help veterans, lending
    terms are more favorable than loans without a VA guarantee. In
    particular, VA guarantees zero downpayment loans. VA provided 84,858
    zero downpayment loans in 2007.
      To help veterans retain their homes and avoid the expense and damage
    to their credit resulting from foreclosure, VA intervenes aggressively
    to reduce the likelihood of foreclosures when loans are referred to VA
    after missing three payments. VA's successful actions resulted in 57
    percent of such delinquent loans avoiding foreclosure in 2007.

    Rural Housing Service

      The U.S. Department of Agriculture's Rural Housing Service (RHS)
    offers direct and guaranteed loans and grants to help very low- to
    moderate-income rural resi

    [[Page 77]]

    dents buy and maintain adequate, affordable housing. The single-family
    guaranteed loan program guarantees up to 90 percent of a private loan
    for low to moderate-income (115 percent of median income or less) rural
    residents. In 2007, nearly $4.8 billion in assistance was provided by
    RHS for homeownership loans and loan guarantees; $3.6 billion in
    guarantees went to more than 35,000 households, of which 32 percent went
    to very low and low-income families (with income 80 percent or less than
    median area income).
      Historically, RHS has offered both direct and guaranteed homeownership
    loans. However, the direction of Rural Development's single-family
    housing mortgage assistance over the last two decades has been towards
    guaranteed loans. The single family housing guaranteed loan program was
    newly authorized in 1990 at $100 million and has grown into a $3 billion
    plus guaranteed loan program annually, equaling that of the Veterans
    Affairs (VA) guaranteed housing loan program. Meanwhile the single-
    family direct loan program has been stagnant at approximately a $1-
    billion loan level. Consequently, the Administration is proposing that
    Rural Development focus solely on guaranteed loans for single-family
    housing.
      This policy was initially proposed in 2008 because it was consistent
    with the other Federal homeownership programs. In fact, there are no
    Federal single family direct loan home ownership programs for urban
    areas. While some rural areas remain isolated from broad credit
    availability, these areas are shrinking as broadband internet access and
    correspondent lending grow. Therefore, relying on the private banking
    industry to provide this service, with a guarantee from the Federal
    government, is a more efficient way to deliver that assistance.
      The 2009 Budget also re-proposes an increase in the single family
    housing guarantee fee on new purchase loans to 3 percent from 2 percent.
    This change allows the loans to be less costly for the Government
    without a significant additional burden to the borrowers, given that
    they can finance the fee as part of the loan. The guarantee fee for
    refinance loans remains 0.5 percent. The fee proposal on purchase loans
    will allow funding in 2009 to be $4.8 billion, an increase of over $600
    million above 2008.
      The budget also supports $300 million in RHS guaranteed loans for
    multifamily housing construction loans for 2009. This level of support
    can be achieved at a more efficient cost through the removal of the
    subsidized interest authorization and the fee component of the program
    as part of the 2009 request. No funds are requested for the direct rural
    rental housing program or the farm labor housing program because fixing
    the current portfolio is the first priority.

    Government-Sponsored Enterprises in the Mortgage Market

      Homeownership has long been recognized as an important part of the
    American economy and part of the American dream. However, it has not
    always been within reach for the average American. During the Great
    Depression, housing markets were in turmoil. A typical mortgage required
    a downpayment of around 50 percent and a balloon payment of principal
    within a few years. Limitations in financial and communication
    technology and restrictions on financial institutions made it difficult
    for surplus funds in one part of the country to be shifted to other
    parts of the country to finance residential housing. Starting in 1932,
    the Congress responded by creating a series of entities and programs
    that together promoted the development of long-term, amortizing
    mortgages and facilitated the movement of capital to support housing
    finance.
      A key element of this response was the creation of the Federal Housing
    Administration in 1934. Another element was the establishment of several
    entities designed to develop secondary mortgage markets and to
    facilitate the movement of capital into housing finance. These entities
    were chartered by the Congress with public missions and endowed with
    certain benefits that give them competitive advantages when compared
    with fully private companies.
      The Federal Home Loan Bank System, created in 1932, is comprised of
    twelve individual banks with shared liabilities. Together they lend
    money to financial institutions--mainly banks and thrifts--that are
    involved in mortgage financing to varying degrees, and they also finance
    some mortgages on their own balance sheets. The Federal National
    Mortgage Association, or Fannie Mae, created in 1938, and the Federal
    Home Loan Mortgage Corporation, or Freddie Mac, created in 1970, were
    established to support the stability and liquidity of a secondary market
    for residential mortgage loans. Fannie Mae's and Freddie Mac's public
    missions were later broadened to promote affordable housing. Together
    these three GSEs currently are involved, in one form or another, with
    nearly one half of the $11-plus trillion residential mortgages
    outstanding in the U.S. today. Their share of outstanding residential
    mortgage debt peaked at 54 percent in 2003, after which management and
    internal control problems started to surface at Fannie Mae and Freddie
    Mac and originations of subprime and non-traditional mortgages led to a
    surge of private-label MBS.
      As with other financial institutions, the Congress has also
    established regulatory regimes to ensure the safety and soundness of the
    housing GSEs. The Office of Federal Housing Enterprise Oversight
    (OFHEO), established in 1992 as an independent agency within the
    Department of Housing and Urban Development, oversees the safety and
    soundness of Fannie Mae and Freddie Mac while HUD is responsible for
    mission oversight. The Federal Housing Finance Board (FHFB), established
    in 1989, oversees the Federal Home Loan Bank System. Numerous government
    and other reports have pointed to various shortcomings with the current
    regulatory structure and authorities for the housing GSEs. The
    Administration is proposing to strengthen this structure and regulatory
    authorities and combine OFHEO, HUD's regulatory responsibilities for
    mission

    [[Page 78]]

    oversight, and FHFB to create a new regulator to oversee all these GSEs.

    Mission

      The mission of the housing GSEs is to support certain aspects of the
    U.S. mortgage market. Fannie Mae and Freddie Mac's mission is to promote
    affordable housing, and provide liquidity and stability to the secondary
    mortgage market. Currently, they engage in two major lines of business.

        1.  Credit Guarantee Business--Fannie Mae and Freddie Mac guarantee
          the timely payment of principal and interest on mortgage-backed
        securities (MBS). They create MBS by either buying and pooling whole
           mortgages or by entering into swap arrangements with mortgage
         originators. Over time these MBS held by the public have averaged
        about one-quarter of the U.S. mortgage market, and they totaled $3.5
                          trillion as of November 30, 2007.

        2.  Mortgage Investment Business--Fannie Mae and Freddie Mac manage
         retained mortgage portfolios composed of their own MBS, MBS issued
        by others, and individual, whole mortgages. As of November 30, 2007,
         these retained mortgages totaled $1.4 trillion. Given Fannie Mae's
            and Freddie Mac's serious accounting, internal control, risk
        management, and systems problems, the growth of these portfolios has
             been temporarily constrained through agreements with OFHEO.

      The mission of the Federal Home Loan Bank System is broadly defined as
    promoting housing finance, and the System also has specific requirements
    to support affordable housing. The Federal Home Loan Banks have not
    grown mortgage asset portfolios as large as Fannie Mae or Freddie Mac.
    Their principal business remains secured lending to regulated depository
    institutions and insurance companies engaged in residential mortgage
    finance to varying degrees.

    Risks That GSEs Face and Cause

      Like other financial institutions, the GSEs face a full range of
    risks, including market risk, credit risk, and operational risk. In
    recent years several of the Federal Home Loan Banks and Fannie Mae have
    faced serious market risks due to inadequate hedging. Fannie Mae and
    Freddie Mac have faced serious operational risk. As a result of earnings
    manipulation, poor accounting systems, lack of proper controls, lack of
    proper risk management, and misapplication of accounting principles,
    earnings at Fannie Mae were misstated by $6.3 billion through June of
    2004, and at Freddie Mac by $5.0 billion through December of 2002. The
    housing market downturn in the last year has increased significantly the
    credit risk faced by Fannie Mae and Freddie Mac.
      The GSEs also pose risks to the financial system and overall economy.
    Systemic risk is the risk that unanticipated problems at a financial
    institution or group of institutions could lead to problems more widely
    in the financial system or economy--the risk that a small problem could
    multiply to a point where it could jeopardize the country's economic
    well-being. The particular systemic risk posed by the GSEs is the risk
    that a miscalculation, failure of controls, or other unexpected event at
    one company could unsettle not only the mortgage and mortgage finance
    markets but also other vital parts of the financial system and economy.
    To understand this risk, one must understand the interdependencies among
    the GSEs and other market participants in the financial system and the
    lack of market discipline imposed on the GSEs because investors perceive
    that the GSEs are implicitly backed by the U.S. Government.
      The GSEs are among the largest borrowers in the world. As of September
    2007 their combined debt and guaranteed MBS totaled $6.0 trillion,
    higher than the total publicly held debt of the United States. The
    investors in GSE debt include thousands of banks, institutional
    investors such as insurance companies, pension funds, and foreign
    governments, and millions of individuals through mutual funds and 401k
    investments. Based on the prices paid by these investors, they act as if
    the Federal Government guarantees GSE debt. In fact, there is no such
    guarantee or Federal backing of GSE debt.
      Because investors act as if there is an ``implicit guarantee'' by the
    Federal Government to back GSE debt, investors on average lend their
    money to the GSEs at interest rates roughly 30 to 40 basis points less
    ($300-$400 less per year for every $100,000 borrowed) than to other
    highly rated privately held companies. In addition, investors do not
    demand the same financial disclosures as for other privately owned
    companies. Fannie Mae filed quarterly financial reports for each of the
    first three quarters of the year in November 2007, the first quarterly
    financial statements in more than three years, and has not filed a
    timely annual report (10-K) with the Securities and Exchange Commission
    (SEC) for nearly four years. Freddie Mac still has never registered with
    the SEC as it agreed to in 2002. It has issued quarterly reports during
    2007, but they were all tardy. Yet there has been no significant impact
    on the pricing of GSE debt securities. In past years, the lack of market
    discipline facilitated the growth of the GSE asset portfolios, thereby
    increasing systemic risk.

    [[Page 79]]

    Retained Asset Portfolios Achieve Little for the GSEs' Housing Mission

      Fannie Mae and Freddie Mac have used their funding cost advantage to
    amass large retained asset portfolios. Together these GSEs have $1.5
    trillion in debt outstanding, almost entirely for the purpose of funding
    these portfolios. From 1990 through 2006, the GSEs' competitive funding
    advantage enabled them to increase their portfolios of mortgage assets
    more than ten-fold, which far exceeds the growth of the overall mortgage
    market. Due to the size of and risks associated with the portfolios, the
    Administration is proposing that the new regulatory structure empower
    the regulator to address and mitigate these risks.
      As chart 7-2 shows, 51 percent of Fannie Mae and Freddie Mac's
    combined retained mortgage portfolios at the end of 2006 was comprised
    of holdings of their own guaranteed MBS, which could easily be sold.
      The function of these portfolio holdings is largely to increase
    profits, not facilitate affordable housing. In 1992, the Congress
    broadened Fannie Mae and Freddie Mac's mission to include providing
    liquidity for mortgages that served low-and moderate-income borrowers
    and those living in underserved areas. To measure this performance, the
    Congress mandated that HUD establish three affordable housing goal
    targets that Fannie Mae and Freddie Mac must meet each year. HUD has
    also implemented home purchase subgoals to encourage homeownership
    opportunities for first-time homeowners and minority homeowners. Given
    that Fannie Mae and Freddie Mac have a mission to help more families
    achieve homeownership as well as to expand rental opportunities, their
    retained portfolios should be largely tied to that mission. However,
    currently only about 30 percent of Fannie Mae and Freddie Mac's retained
    portfolio holdings would be eligible to qualify for any of the
    affordable housing goals. About half of the MBS issued by others and
    whole loans held by the GSEs qualify toward their affordable housing
    goals but none of their holdings of their own MBS contribute toward
    meeting the goals because loans backing the MBS are already counted.
    Their performance under the housing goals over time indicate that Fannie
    Mae and Freddie Mac should be doing more to help mission-targeted
    families achieve homeownership or acquire affordable rental housing.

    Debt Issuance Subject to Treasury Approval

      Fannie Mae and Freddie Mac fund their portfolios by issuing debt, and
    the U.S. Department of the Treasury has the statutory responsibility to
    review and approve these GSEs' debt-issuances. The Treasury Department
    also has debt approval over the Federal Home Loan Banks. Treasury is
    developing a more formalized approach to their debt approval authority.
    As part of that approach, Treasury is developing new debt approval
    procedures to enhance the clarity, transparency, standardization, and
    documentation of the debt approval process for Fannie Mae, Freddie Mac
    and the Federal Home Loan Banks.

    Recent Mortgage Market Conditions Highlight Needed Reforms

      In early August 2007, there was a precipitous drop in the liquidity of
    subprime, nontraditional, and prime

    [[Page 80]]

    jumbo mortgages. Faced with sharp increases in the delinquency and
    default rates of subprime and nontraditional loans in 2006 and 2007, as
    well as flat or declining home prices in much of the country, secondary
    market investors reassessed the risk of non-GSE MBS backed by those
    loans, which had previously been mispriced. The illiquidity of non-GSE
    MBS reduced the industry's capacity to securitize newly-originated
    subprime and jumbo loans, although some lenders continued to originate
    jumbo mortgages for portfolio. Freddie Mac and, to a lesser degree,
    Fannie Mae also incurred losses on investments in non-GSE MBS.
      The three housing GSEs have continued to perform their missions during
    the recent market disruption. In the third quarter of 2007, Fannie Mae
    and Freddie Mac supported the liquidity of the secondary market by
    engaging in $343 billion of new business. The Federal Home Loan Banks
    increased their secured lending to mortgage lenders by $184 billion in
    that quarter. As Chart 7-3, shows, the combined activity of Fannie Mae
    and Freddie Mac as a share of single-family mortgage originations rose
    to 60 percent in the third quarter, whereas the Federal Home Loan Bank
    System's share increased to 32 percent. Those increases in market share
    highlight the need for a strong regulator.

      The risks of the GSEs' large portfolios are exacerbated because they
    are not required to hold cushions of capital against potential losses
    comparable to the capital requirements for other large financial
    institutions. Where commercial banks that are part of a financial
    holding company must hold a 5 percent capital-to-total assets cushion,
    Fannie Mae and Freddie Mac's requirement (before the 30% surcharge
    imposed by OFHEO for operational weakness) is half that, whereas the
    Federal Home Loan Banks' is 4 percent. The risk-based capital
    requirements for the GSEs also differ dramatically from those applicable
    to commercial banks. This highlights an important shortcoming of the
    statutory framework governing Federal oversight of the GSEs. The minimum
    capital and risk-based capital rules for the GSEs were written into law
    in 1992. Much has changed since then with regard to financial risk
    analysis, risk modeling, and capital requirements for comparable
    financial institutions. The reforms proposed by the Administration would
    repeal the statutory risk-based capital stress test, and would provide
    the new GSE regulator with the authority and flexibility to establish
    through regulation new risk-based capital requirements for the GSEs to
    help ensure that they operate with sufficient capital and reserves to
    support the risks that arise in the operations and management of each
    enterprise. A world-class regulator needs the flexibility and authority
    to change both the risk-based and minimum capital requirements without
    undue restriction in response to changing conditions.
      The substantial increase in mortgage delinquencies and foreclosures in
    recent months serves as a reminder that mortgage lending involves credit
    risk. Fannie Mae and Freddie Mac are exposed to significant default risk

    [[Page 81]]

    on the mortgages they hold in portfolio or that back the MBS they
    guarantee. The GSEs' asset portfolios pose other substantial risks as
    well. Mortgage portfolios carry considerable interest-rate and pre-
    payment risk. This risk can be mitigated--for example, through purchase
    of interest-rate hedges--but the GSEs protect themselves against only
    some of the interest rate risk of their portfolios. Moreover, hedges are
    imperfect because predicting interest-rate movements and mortgage
    refinancing activity is difficult. As GSE asset portfolios have grown in
    size, the GSEs' participation in the market for hedging instruments has
    become dominant enough to cause interest rate spikes in the event that a
    GSE needs to make large and sudden adjustments to its hedging position.
    Further, Freddie Mac and, to a lesser extent, Fannie Mae hold large
    amounts of non-GSE MBS, which pose significant risks. Many of these
    securities are backed by subprime loans, and market values have declined
    as concerns about those loans have risen. Increased defaults and
    concerns about future defaults have led to significant losses at both of
    those GSEs in the last half of 2007, and led to new preferred stock
    issues raising $16 billion to shore up capital.

    New Activities and Technological Development Require Oversight

      Over the last decade, Fannie Mae and Freddie Mac have begun engaging
    in a wide range of new activities that were not anticipated when their
    charters were written. To address these changes, HUD developed a new
    activity review initiative under its general regulatory authority. HUD
    has reviewed a number of business initiatives at Fannie Mae and Freddie
    Mac, including international activities; partnership offices; senior
    housing; skilled nursing facilities; employer assisted housing plans;
    third party real-estate-owned programs; Commercial Mortgage-Backed
    Securities (CMBS); Asset-Backed Securities (ABS); multifamily variable-
    rate bond certificates; whole loan REMICs; and patenting programs. HUD
    imposed limitations on some activities and concluded that other
    activities were not authorized. For example, HUD's review of the GSEs'
    Commercial MBS programs resulted in OFHEO seeking Freddie Mac's
    divestiture of certain CMBS holdings, and HUD ordered Fannie Mae to end
    its third party Real-Estate-Owned program based on its review.
      HUD completed a Financial Activities Review in late 2007. The review
    provided a baseline of information on Fannie Mae's and Freddie Mac's
    business and program activities and examined specific transactions to
    determine if these are consistent with the GSEs' charter authorities.
    HUD expects to issue its review results to the GSEs during the second
    quarter of fiscal year 2008.
      Because of their enormous presence in the secondary market, Fannie Mae
    and Freddie Mac are able to exert significant influence in the primary
    mortgage market. First, their unparalleled size in the residential
    mortgage market gives the GSEs a unique level of access to market
    information. The applicability of that information to the management of
    mortgage risk gives them a competitive edge in the development of new
    technology that can change relationships between primary market
    participants as well as the distribution of economic returns between the
    primary and secondary markets. Second, their funding advantage enables
    the GSEs to borrow at reduced rates in order to make investments in new
    areas at below-market prices, thus discouraging competition while
    gaining experience in those areas.
      Through the development and delivery of new technology to the industry
    and by leveraging their funding advantage, there is potential for the
    GSEs to expand their business beyond the limitations of their Charter
    Acts, which prohibits both Fannie Mae and Freddie Mac from originating
    mortgages. Loan origination is the central function of the primary
    mortgage market, and the GSEs' charter acts clearly restrict them to the
    secondary mortgage market. However, technological advancements have
    blurred the line that defines where the primary market ends and the
    secondary market begins. A new level of clarity is required to establish
    the permissible activities under the Enterprises' charter acts,
    including the development of intellectual property.

    New Regulatory Authority

      The Administration continues to support broad reform of the GSE
    supervisory system. In particular, the Administration supports
    establishing a new regulator for all three of the housing GSEs that
    would combine safety and soundness authority with oversight of their
    respective housing missions. The new regulator must have enhanced powers
    comparable to those of other world-class financial regulators,
    including, among others, the ability to put a GSE into receivership
    should it fail, authority to establish and adjust appropriate capital
    standards, and new product approval authority. A new regulator must also
    have clear authority to address the size of and mitigate the risks posed
    by the GSEs' retained portfolios. Finally, a new regulatory structure
    must ensure that the GSEs are adhering to their affordable housing
    mission.

                            Education Credit Programs

      The Federal Government guarantees loans through intermediary agencies
    and makes direct loans to students to encourage postsecondary education
    enrollment. The Student Loan Marketing Association (Sallie Mae), created
    in 1972 as a GSE to develop the secondary market for guaranteed student
    loans, was privatized in 2004.
      The Department of Education helps finance student loans through two
    major programs: the Federal Family Education Loan (FFEL) program and the
    William D. Ford Federal Direct Student Loan (Direct Loan) program.
    Eligible institutions of higher education may participate in one or both
    programs. Loans are available to students regardless of income. However,
    borrowers with low family incomes are eligible for loans with addi

    [[Page 82]]

    tional interest subsidies. For low-income borrowers, the Federal
    Government subsidizes loan interest costs while borrowers are in school,
    during a six-month grace period after graduation, and during certain
    deferment periods.
      The FFEL program provides loans through an administrative structure
    involving over 3,600 lenders, 35 State and private guaranty agencies,
    and over 5,000 participating schools. In the FFEL program, banks and
    other eligible lenders loan private capital to students and parents,
    guaranty agencies insure the loans, and the Federal Government reinsures
    the loans against borrower default. Lenders bear five percent of the
    default risk on all new loans, and the Federal Government is responsible
    for the remainder. The Department also makes administrative payments to
    guaranty agencies and, at certain times, pays interest subsidies on
    behalf of borrowers to lenders.
      The William D. Ford Direct Student Loan program was authorized by the
    Student Loan Reform Act of 1993. Under the Direct Loan program, the
    Federal Government provides loan capital directly to nearly 1,100
    schools, which then disburse loan funds to students. The program offers
    a variety of flexible repayment plans including income-contingent
    repayment, under which annual repayment amounts vary based on the income
    of the borrower and payments can be made over 25 years with any residual
    balances forgiven.
      In 2007, the President signed the College Cost Reduction and Access
    Act (CCRAA) into law. The CCRAA enacted broad programmatic reforms that
    will save $22 billion through 2012 by reducing lender and guaranty
    agency subsidies that had been higher than necessary to ensure that
    loans are available to students in this profitable and competitive
    market. Stemming from proposals included in the President's 2008 Budget,
    the CCRAA reduced interest subsidies and default reinsurance paid to
    FFEL lenders; reduced fees paid to guaranty agencies; and required the
    Department of Education to conduct an auction pilot for the PLUS loan
    program, which primarily makes loans to parents to finance their child's
    education. As implementation of these complex provisions continues, the
    Administration will closely monitor the student loan marketplace to
    ensure it continues to be robust and efficient, and that students have
    access to loans from a variety of lenders. The savings from the CCRAA
    were used to offset the costs of providing several student and borrower
    benefits, including: (1) a historic increase in the Pell Grant program;
    (2) a reduction in student loan interest rates for subsidized loans from
    6.8 percent to 3.4 percent over four years (reverting back to 6.8
    percent thereafter), and (3) increased flexibility in how borrowers
    repay their loans.

             Business and Rural Development Credit Programs and GSEs

      The Federal Government guarantees small business loans to promote
    entrepreneurship. The Government also offers direct loans and loan
    guarantees to farmers who may have difficulty obtaining credit elsewhere
    and to rural communities that need to develop and maintain
    infrastructure. Two GSEs, the Farm Credit System and the Federal
    Agricultural Mortgage Corporation, increase liquidity in the
    agricultural lending market.

    Small Business Administration

      The Small Business Administration (SBA) helps entrepreneurs start,
    sustain, and grow small businesses. As a ``gap lender`` SBA works to
    supplement market lending and provide access to credit where private
    lenders are reluctant to do so without a Government guarantee.
    Additionally, SBA helps home and business-owners, as well as renters,
    cover the uninsured costs of recovery from disasters through its direct
    loan program.
      The 2009 Budget requests $657 million, including administrative funds,
    for SBA to leverage more than $29 billion in financing for small
    businesses and disaster victims. The 7(a) General Business Loan program
    will support $17.5 billion in guaranteed loans while the 504 Certified
    Development Company program will support $7.5 billion in guaranteed
    loans for fixed-asset financing. SBA will supplement the capital of
    Small Business Investment Companies (SBICs) with $3 billion in long-
    term, guaranteed loans for venture capital investments in small
    businesses. At the end of 2007, the outstanding balance of business
    loans totaled $85 billion.
      During the past few years, SBA has implemented several initiatives to
    streamline and improve operations by increasingly delegating
    responsibilities to lenders and centralizing operations while managing
    and mitigating risk. In 2003, SBA implemented a state-of-the-art Lender
    Loan Monitoring System (LLMS) to evaluate individual SBA lenders by
    tracking the expected risk of SBA guaranteed loans in their portfolios
    relative to expected performance of those loans.
      In response to the challenges experienced in making and disbursing
    loans resulting from the 2005 Gulf Coast hurricanes, SBA has made a
    number of improvements, including implementing a case-manager system for
    processing loan applications and new metrics to track performance. By
    summer 2008, SBA expects to implement an Internet-based loan application
    system that will facilitate the collection of data from disaster victims
    and speed processing.
      The Budget builds on these efforts by investing in core technology
    systems and human capital efforts. Increased funding is requested for
    the Loan Management and Accounting System (LMAS), a modern system to
    replace an aged mainframe system and ensure adequate stewardship over a
    loan portfolio that has grown 59 percent since 2001. Funds are also
    requested for a training initiative focused on core competencies and
    other important information technology investments.
      The Budget also proposes to build upon the success of the zero-subsidy
    7(a) program by making the Microloan program self-financing through
    modest increases in the interest rate paid by program intermediaries.
    The Administration is also proposing authorizing legislation to enable
    the secondary market guar

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    antee (SMG) program to charge nominal fees on lenders seeking to pool
    loans; fees are expected to be less than or comparable to fees in other
    secondary market programs and will help stabilize the program from the
    need to make frequent administrative changes.

    USDA Rural Infrastructure and Business Development Programs

      USDA provides grants, loans, and loan guarantees to communities for
    constructing facilities such as health-care clinics, day-care centers,
    and water systems. Direct loans are available at lower interest rates
    for the poorest communities. These programs have very low default rates.
    The cost associated with them is due primarily to subsidized interest
    rates that are below the prevailing Treasury rates.
      The program level for the Water and Wastewater (W&W) treatment
    facility loan and grant program in the 2009 President's Budget is $1.6
    billion. These funds are available to communities of 10,000 or fewer
    residents. No change is proposed to the poverty rate for this program in
    2009. The Community Facility Program is targeted to rural communities
    with fewer than 20,000 residents. It will have a program level of $512
    million in 2009.
      USDA also provides grants, direct loans, and loan guarantees to assist
    rural businesses, cooperatives, nonprofits, and farmers in creating new
    community infrastructures (i.e. educational networks or healthcare
    coops), and to diversify the rural economy and employment opportunities.
    In 2009, USDA proposes to provide $730 million in loan guarantees and
    direct loans to entities that serve communities of 50,000 or less
    through the Business and Industry guaranteed loan program and
    Intermediary Relending program. These loans are structured to save/
    create jobs and stabilize fluctuating rural economies. A recently
    implemented performance assessment tool will be used to calculate their
    impact on income growth in local, state, and national economies.
      The President's Farm Bill proposal includes $1.5 billion in support
    for Rural Development programs over 10 years. Of this, $0.5 billion will
    go to enhance rural infrastructures, alleviating program backlogs, and
    $0.1 billion to support rural critical access hospitals. The other $0.9
    billion will promote renewable energy activities, providing support to
    businesses and farmers who would like to produce renewable energy and
    increase their energy efficiencies.

    Electric and Telecommunications Loans

      USDA's Rural Utilities Service (RUS) programs provide loans for rural
    electrification, telecommunications, distance learning, telemedicine,
    and broadband, and also provide grants for distance learning and
    telemedicine (DLT).
      The Budget includes $4.1 billion in direct electric loans for
    distribution, transmission, and improvements to existing generation
    facilities, $690 million in direct telecommunications loans, $298
    million in broadband loans, and $20 million in DLT grants.
      Since generation has been deregulated and has become a more commercial
    operation, the Administration supports using the commercial market for
    construction of new generation facilities. While the Administration has
    established a loan rate methodology for new non-nuclear generation
    facilities, the Administration has not proposed a loan level or
    requested funding needed to subsidize such loans. A loan level will be
    considered once Congress enacts legislation to authorize a fee on such
    loans and allows RUS to implement existing authority for recertification
    of the rural status of areas served by its borrowers.
      The Budget includes a proposal to replace the 100 percent guaranteed
    electric and telecommunications loans that are financed through the
    Federal Financing Bank (FFB) with loans made directly through the
    Treasury. The proposed new direct loan program would improve the
    operations of USDA's rural utility loans by simplifying the Government's
    processes while providing the same benefits and flexibilities for the
    borrowers.

    Loans to Farmers

      The Farm Service Agency (FSA) assists low-income family farmers in
    starting and maintaining viable farming operations. Emphasis is placed
    on aiding beginning and socially disadvantaged farmers. FSA offers
    operating loans and ownership loans, both of which may be either direct
    or guaranteed loans. Operating loans provide credit to farmers and
    ranchers for annual production expenses and purchases of livestock,
    machinery, and equipment. Farm ownership loans assist producers in
    acquiring and developing their farming or ranching operations. As a
    condition of eligibility for direct loans, borrowers must be unable to
    obtain private credit at reasonable rates and terms. As FSA is the
    ``lender of last resort,'' default rates on FSA direct loans are
    generally higher than those on private-sector loans. FSA-guaranteed farm
    loans are made to more creditworthy borrowers who have access to private
    credit markets. Because the private loan originators must retain 10
    percent of the risk, they exercise care in examining the repayment
    ability of borrowers. The Administration's recent farm bill proposal
    includes policies to improve credit assistance for farm borrowers, with
    particular emphasis to beginning and socially disadvantaged farmers.
    Specifically, the Administration proposes to double assistance targeted
    to beginning and socially disadvantaged farmers for the direct operating
    loan program and reduce the interest rate for downpayment assistance to
    beginning farmers. Finally, because the cost of production is high for
    many farmers desiring to enter into farming, the farm bill includes
    increased loan levels for direct loan programs.
      In 2007, FSA provided loans and loan guarantees to approximately
    27,000 family farmers totaling $3.1 billion. The number of loans
    provided by these programs has fluctuated over the past several years.
    The average size for farm ownership loans has been increasing. The
    majority of assistance provided in the oper

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    ating loan program is to existing FSA farm borrowers. In the farm
    ownership program, new customers receive the bulk of the benefits
    furnished. The demand for FSA direct and guaranteed loans continues to
    be high due to low crop/livestock prices and some regional production
    problems. In 2009, FSA proposes to make $3.4 billion in direct and
    guaranteed loans through discretionary programs.
      In 2005, to further improve program effectiveness, FSA conducted an
    in-depth review of its direct loan portfolio to assess program
    performance, including the effectiveness of targeted assistance and the
    ability of borrowers to graduate to private credit. The results of this
    review will assist FSA in improving the delivery of its services and the
    economic viability of farmers and ranchers. FSA is currently evaluating
    the feasibility of obtaining a similar independent review of the
    guaranteed loan program. In addition, FSA recently implemented a web-
    based system to track loan applications. The Direct Loan System (DLS)
    replaces the loan making components of other automated systems. A loan
    servicing DLS module is currently under development. FSA successfully
    completed a comprehensive review of all farm loan program regulations,
    handbooks, and information collections. This streamlining initiative was
    one of the most aggressive efforts to enhance both the direct and
    guaranteed programs in the program's 60-year history. This initiative
    will reduce the burden for both applicants and the Agency, resulting in
    an improvement in loan processing efficiencies.

    The Farm Credit System and Farmer Mac

      The Farm Credit System (FCS or System) and the Federal Agricultural
    Mortgage Corporation (FarmerMac) are Government-Sponsored Enterprises
    (GSEs) that enhance credit availability for the agricultural sector. The
    FCS provides production, equipment, and mortgage lending to farmers and
    ranchers, aquatic producers, their cooperatives, related businesses, and
    rural homeowners, while Farmer Mac provides a secondary market for
    agricultural real estate and rural housing mortgages.

    The Farm Credit System

      The financial condition of the System's banks and associations remains
    sound. The ratio of capital to assets decreased to 14.8 percent as of
    September 30, 2007 from 15.7 percent as of September 30, 2006, as asset
    growth outpaced capital growth. As of September 30, 2007, capital
    consisted of $2.5 billion in restricted capital held by the Farm Credit
    System Insurance Corporation (FCSIC) and $24.0 billion of unrestricted
    capital--a record level. Non-performing loans decreased, and earnings
    increased, resulting from growth in the loan portfolio and higher
    earnings on assets. Non-performing loans as a percentage of total loans
    outstanding fell to .43 percent as of September 30, 2007 compared to .50
    percent a year earlier. Assets have grown at a 10.8 percent annual rate
    over the past five years, while the number of FCS institutions has
    decreased due to consolidation. As of September 30, 2007, the System
    consisted of five banks and 95 associations compared with seven banks
    and 104 associations in September 2002. As of September 30, 2007, 98 of
    the 100 FCS banks and associations had one of the top two examination
    ratings (1 or 2 in a 1-5 scale), while two FCS institutions had a 3
    rating.
      The FCSIC ensures the timely payment of principal and interest on FCS
    obligations on which the System banks are jointly and severally liable.
    FCSIC manages the Insurance Fund, which supplements the System's capital
    and the joint and several liability of the System banks. At September
    30, 2007, the assets in Insurance Fund totaled $2.519 billion. Of that
    amount $40 million was allocated to the Allocated Insurance Reserve
    Accounts (AIRAs). At September 30, 2007, the Insurance Fund as a
    percentage of adjusted insured debt was 1.71 percent in the unallocated
    Insurance Fund and 1.74 percent including the AIRAs. This was below the
    statutory Secure Base amount of 2 percent. During 2007 growth in System
    debt has outpaced the capitalization of the Insurance Fund that occurs
    through investment earnings and premiums.
      Over the 12-month period ending September 30, 2007, the System's loans
    outstanding grew by $19.2 billion, or 16.6 percent, while over the past
    five years they grew by $47.2 billion, or 53.6 percent. As required by
    law, borrowers are also stockholder owners of System banks and
    associations. As of September 30, 2007, the System had 472,925
    stockholders. Loans to young, beginning, and small farmers and ranchers
    represented 11.7, 19.4, and 27.7 percent, respectively, of the total
    dollar volume of farm loans outstanding at the end of 2006. The
    percentage of loans to beginning farmers in 2006 remained the same as
    the percentage of loans in 2005, while percentages to young and small
    farmers were slightly lower. Young, beginning, and small farmers are not
    mutually exclusive groups and, thus, cannot be added across categories.
    Providing credit and related services to young, beginning, and small
    farmers and ranchers is a legislative mandate for the System.
      The System, while continuing to record strong earnings and capital
    growth, remains exposed to a variety of risks associated with its
    portfolio concentration on agriculture and rural America. While this
    sector is currently healthy, it is subject to risk due to rapidly rising
    farm real estate prices, volatile commodity prices and input costs,
    uncertainty regarding changes in government farm policy and trade
    agreements, weather-related catastrophes, animal and plant diseases, and
    off-farm employment opportunities.

    Farmer Mac

      Farmer Mac was established in 1988 as a Federally chartered
    instrumentality and institution of the System to facilitate a secondary
    market for farm real estate and rural housing loans. The Farm Credit
    System Reform Act of 1996 expanded Farmer Mac's role from a guarantor of
    securities backed by loan pools to a direct purchaser of mortgages,
    enabling it to form pools

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    to securitize. This change increased Farmer Mac's ability to provide
    liquidity to agricultural mortgage lenders.
      Farmer Mac continues to meet core capital and regulatory risk-based
    capital requirements. Farmer Mac's total program activity (loans
    purchased and guaranteed, AgVantage bond assets, and real estate owned)
    as of September 30, 2007, totaled $8.4 billion. That volume represents
    an increase of 19 percent from program activity at September 30, 2006.
    Of total program activity, $2 billion were on-balance sheet loans and
    agricultural mortgage-backed securities, and $6.3 billion were off-
    balance sheet obligations. Total assets were $5.4 billion at the close
    of the third quarter, with nonprogram investments accounting for $3.3
    billion of those assets. Farmer Mac's net loss for first three quarters
    of 2007 was $6.3 million, a significant change from the same period in
    2006 during which net income was $22 million.
      The currently reported year-to-date loss amount is primarily the
    result of fluctuations in the market value of financial derivatives and
    trading assets that are now recognized in the income statement and is
    not the result of negative developments in its operations or cash flows.
    This change was instituted in November 2006, when Farmer Mac opted to
    change its accounting methods to remove the impact of accounting for
    derivatives as hedges against interest rate movements. Farmer Mac has
    stated that it does not expect the accounting change to impact its
    ability to carry out its business plans or have any effect on its
    business model.

                          International Credit Programs

      Seven Federal agencies--the Department of Agriculture (USDA), the
    Department of Defense, the Department of State, the Department of the
    Treasury, the Agency for International Development (USAID), the Export-
    Import Bank, and the Overseas Private Investment Corporation (OPIC)--
    provide direct loans, loan guarantees, and insurance to a variety of
    foreign private and sovereign borrowers. These programs are intended to
    level the playing field for U.S. exporters, deliver robust support for
    U.S. manufactured goods, stabilize international financial markets, and
    promote sustainable development.

    Leveling the Playing Field

      Federal export credit programs counter subsidies that foreign
    governments, largely in Europe and Japan, provide their exporters,
    usually through export credit agencies (ECAs). The U.S. Government has
    worked since the 1970's to constrain official credit support through a
    multilateral agreement in the Organization for Economic Cooperation and
    Development (OECD). This agreement has significantly constrained direct
    interest rate subsidies and tied-aid grants. Further negotiations
    resulted in a multilateral agreement that standardized the fees for
    sovereign lending across all ECAs beginning in April 1999. Fees for non-
    sovereign lending, however, continue to vary widely across ECAs and
    markets, thereby providing implicit subsidies.
      The Export-Import Bank attempts to ``level the playing field''
    strategically and to fill gaps in the availability of private export
    credit. The Export-Import Bank provides export credits, in the form of
    direct loans or loan guarantees, to U.S. exporters who meet basic
    eligibility criteria and who request the Bank's assistance. USDA's
    Export Credit Guarantee Programs (also known as GSM programs) similarly
    help to level the playing field. Like programs of other agricultural
    exporting nations, GSM programs guarantee payment from countries and
    entities that want to import U.S. agricultural products but cannot
    easily obtain credit.

    Stabilizing International Financial Markets

      In today's global economy, the health and prosperity of the American
    economy depend importantly on the stability of the global financial
    system and the economic health of our major trading partners. The United
    States can contribute to orderly exchange arrangements and a stable
    system of exchange rates through the International Monetary Fund and
    through financial support provided by the Exchange Stabilization Fund
    (ESF).
      The ESF may provide ``bridge loans'' to other countries in times of
    short-term liquidity problems and financial crises. A loan or credit may
    not be made for more than six months in any 12-month period unless the
    President gives the Congress a written statement that unique or
    emergency circumstances require the loan or credit be for more than six
    months.

    Using Credit to Promote Sustainable
    Development

      Credit is an important tool in U.S. bilateral assistance to promote
    sustainable development. USAID's Development Credit Authority (DCA)
    allows USAID to use a variety of credit tools to support its development
    activities abroad. DCA provides non-sovereign loan guarantees in
    targeted cases where credit serves more effectively than traditional
    grant mechanisms to achieve sustainable development. DCA is intended to
    mobilize host country private capital to finance sustainable development
    in line with USAID's strategic objectives. Through the use of partial
    loan guarantees and risk sharing with the private sector, DCA stimulates
    private-sector lending for financially viable development projects,
    thereby leveraging host-country capital and strengthening sub-national
    capital markets in the developing world. While there is clear demand for
    DCA's facilities in some emerging economies, the utilization rate for
    these facilities is still very low.
      OPIC also supports a mix of development, employment, and export goals
    by promoting U.S. direct investment in developing countries. OPIC
    pursues these goals through political risk insurance, direct loans, and
    guarantee products, which provide finance, as well as associated skills
    and technology transfers. These programs are intended to create more
    efficient financial markets, eventually encouraging the private sector
    to supplant OPIC finance in developing countries. OPIC has also created
    a number of investment funds that provide eq

    [[Page 86]]

    uity to local companies with strong development potential.

    Ongoing Coordination

      International credit programs are coordinated through two groups to
    ensure consistency in policy design and credit implementation. The Trade
    Promotion Coordinating Committee (TPCC) works within the Administration
    to develop a National Export Strategy to make the delivery of trade
    promotion support more effective and convenient for U.S. exporters.
      The Interagency Country Risk Assessment System (ICRAS) standardizes
    the way in which most agencies budget for the cost associated with the
    risk of international lending. The cost of lending by the agencies is
    governed by proprietary U.S. Government ratings, which correspond to a
    set of default estimates over a given maturity. The methodology
    establishes assumptions about default risks in international lending
    using averages of international sovereign bond market data. The strength
    of this method is its link to the market and an annual update that
    adjusts the default estimates to reflect the most recent risks observed
    in the market.

    Promoting Economic Growth and Poverty Reduction through Debt
    Sustainability

      The Enhanced Heavily Indebted Poorest Countries (HIPC) Initiative
    reduces the debt of some of the poorest countries with unsustainable
    debt burdens that are committed to economic reform and poverty
    reduction. Under the HIPC process, the debt of most countries is
    restructured before being completely forgiven. While not considered part
    of HIPC relief, a restructuring is often a precursor to HIPC relief. The
    2009 President's Budget uses an improved methodology for estimating the
    long term cost to the Federal Government of HIPC debt restructuring. The
    revised methodology more accurately reflects a country's
    creditworthiness after a restructuring given the likelihood of receiving
    100 percent debt reduction in the future.

    Self-Sufficient Export-Import Bank

      The Budget estimates that the Bank's export credit support will total
    $14 billion, and will be funded entirely by receipts collected from the
    Bank's customers. The Bank estimates it will collect $164 million in
    2009 in excess of expected losses on transactions authorized in 2009 and
    prior years. These amounts will be used to: (1) cover the estimated
    costs for that portion of new authorizations where fees are insufficient
    to cover expected losses; and (2) to cover administrative expenses.

                             V.  INSURANCE PROGRAMS

                                Deposit Insurance

      Federal deposit insurance promotes stability in the U.S. financial
    system. Prior to the establishment of Federal deposit insurance,
    failures of some depository institutions often caused depositors to lose
    confidence in the banking system and rush to withdraw deposits. Such
    sudden withdrawals caused serious disruption to the economy. In 1933, in
    the midst of the Depression, the system of Federal deposit insurance was
    established to protect small depositors and prevent bank failures from
    causing widespread disruption in financial markets.
      Since its creation, the system has undergone a series of reforms, most
    recently in 2006. The Federal Deposit Insurance Reform Act of 2005
    allows the FDIC to better manage the Deposit Insurance Fund. For
    example, the Act authorizes the FDIC to charge premiums for deposit
    insurance on a risk-adjusted basis regardless of the level of the FDIC's
    reserves against its insured deposits, and ensures that all financial
    institutions pay premiums for Federal insurance on their insured
    deposits. The FDIC completed implementation of these reforms during
    2007.
      The FDIC insures deposits in banks and savings associations (thrifts).
    The National Credit Union Administration (NCUA) insures deposits
    (shares) in most credit unions (certain credit unions are privately
    insured). FDIC and NCUA insure deposits up to $100,000 per account.
    Under the Federal Deposit Insurance Reform Act of 2005, the deposit
    insurance ceiling for retirement accounts was increased to $250,000. In
    addition, beginning in 2010, and every five years thereafter, FDIC and
    NCUA will have the authority to increase deposit insurance coverage
    limits for retirement and non-retirement accounts based on inflation if
    the Boards of the FDIC and NCUA determine such an increase is warranted.
    As of September 30, 2007, FDIC insured $4.24 trillion of deposits at
    8,560 commercial banks and thrifts, and NCUA insured $556 billion of
    deposits (shares) at 8,163 credit unions.

    Current Industry Conditions

      Significant challenges have confronted the financial sector throughout
    the second half of calendar year 2007. Although to date the challenges
    have not caused a large number of failures of insured depository
    institutions, the outlook for the industry remains uncertain as of the
    beginning of 2008. During the summer of 2007, a slowdown in the U.S.
    housing market began to trigger concerns. Rising defaults on
    ``subprime'' loans led to markdowns on the value of debt securities
    backed by these loans. These securities had been packaged by financial
    institutions and sold to investors around the world. Uncertainty about
    the value of these complex financial instruments and lack of
    transparency about who held them led to a much lower appetite for risk
    and a clear preference for the most liquid and safe

    [[Page 87]]

    investments. This reassessment of risk caused widespread volatility in
    financial markets. \3\
    ---------------------------------------------------------------------------
      \3\ For a much more detailed discussion of the problems in credit
    markets during 2007 and their implications, please see Chapter 2 of the
    2008 Economic Report of the President.
    ---------------------------------------------------------------------------
      Many depository institutions entered this period of market uncertainty
    with strong profitability and a significant capital cushion. The period
    from 2004-2006 was one of record growth and profitability for many banks
    and thrifts, and this previous strong performance has to date provided a
    cushion. As of September 2007, total risk-based capital ratios in the
    industry averaged 12.75 percent, versus a minimum required level of 8
    percent. Depository institutions are also insulated by the fact that
    many had sold their mortgages--and hence their risk exposure--to the
    secondary market. In addition, many of the subprime mortgages losing
    value were originated by state-chartered mortgage companies rather than
    depository institutions. Thus the risk has been spread beyond the core
    banking system subject to Federal deposit insurance.
      In the current market environment, institutions with a significant
    presence in structuring and trading mortgage-backed securities
    (especially the major investment banks) have recorded losses on their
    portfolios of mortgage-backed securities, as well as lost the fees
    earned in repackaging and reselling these loans. In the 3rd and 4th
    quarters of calendar year 2007, major investment banks recorded nearly
    $70 billion in writedowns due to losses on investments linked to
    subprime mortgages and structured credit products. While the Federal
    Government has no direct risk exposure from investment bank losses, many
    banks and other firms have also encountered difficulty raising cash
    through the short-term corporate debt markets.
      Due to the increasing consolidation of the U.S. banking industry in
    recent years, the largest institutions have accounted for a growing
    share of total assets--whereas in 1984 depository institutions with over
    $10 billion in assets accounted for 42 percent of total assets in the
    industry, by 2004 the share of those institutions had risen to 73
    percent. This consolidation, combined with the fact that many of the
    larger institutions with significant market and trading presence are
    those most affected by the current market conditions, has increased the
    potential risks of a major failure that could put a significant strain
    on the resources of the Federal deposit insurance funds.

    Administration and Regulatory Responses

      The financial regulators and the Administration have taken a number of
    steps to address the underlying problems in the credit and mortgage
    markets. The President's Working Group on Financial Markets (including
    the Treasury Department, the Federal Reserve Board, the Securities and
    Exchange Commission and the Commodity Futures Trading Commission) has
    the responsibility to examine the recent uncertainty in credit markets
    and work to ensure that market integrity and efficiency are not
    compromised. In regard to mortgage markets, in addition to the
    Administration proposals for modernization of the Federal Housing
    Administration and reform of the oversight of the housing GSEs
    (mentioned earlier in this chapter) the Administration has partnered
    with the private sector to assemble a group of lenders, loan servicers,
    mortgage counselors, and investors (the HOPE NOW Alliance) to identify
    troubled borrowers and help them refinance or modify their mortgages, so
    more families can stay in their homes. The HOPE NOW Alliance consists of
    four counseling organizations, 21 mortgage servicers and lenders
    (comprising 65 percent of the U.S. market for mortgage servicing and
    almost 85 percent of the subprime servicing market), three investor
    groups (including the American Securitization Forum, which represents
    over 370 members), and 10 trade associations. These efforts should
    reduce foreclosure rates and support the continued flow of capital to
    mortgage markets.
      To aid this effort, during December 2007 Congress passed the Mortgage
    Forgiveness Debt Relief Act of 2007, an Administration proposal that for
    the next few years (through 2010) will allow borrowers to obtain relief
    from taxes on writedowns of loan principal during a refinancing. The
    Administration has also proposed to allow state and local governments to
    temporarily broaden their tax-exempt bond programs to include mortgage
    refinancings.
      The Federal banking regulators (Federal Reserve, Office of the
    Comptroller of the Currency (OCC), Office of Thrift Supervision (OTS),
    and FDIC) have been closely monitoring banks' core capital levels as
    well as their potential susceptibility to market disruptions. During
    2007, the regulators jointly issued final guidance addressing non-
    traditional and subprime mortgage practices, as well as guidance
    encouraging their institutions to proactively aid borrowers to refinance
    subprime mortgages.
      The Federal Reserve and other Federal banking regulators have been
    developing new regulations to improve disclosure of mortgage and credit
    card terms, restrain certain practices in mortgage lending, and address
    unfair and deceptive lending practices more broadly. Complementing these
    efforts, this year HUD will also propose clearer disclosure of mortgage
    lending and home purchase closing costs, as mandated by the Real Estate
    Settlement Procedures Act. The draft text of the regulations on credit
    cards and mortgage lending were released for public comment in 2007, and
    the regulators will likely finalize these regulations during 2008.

    Recent Performance of the Federal Deposit Insurance Funds

      From July 2004 through January 2007, the performance of the Federal
    deposit insurance program was strong. No banks or thrifts failed during
    this period--the longest interlude without a failure in the 73-year
    history of the FDIC. However, there has been a deterioration of
    conditions in the industry since summer 2007. As of September 30, 2007,
    the FDIC classified 65 institutions with $18.5 billion in assets as
    ``problem institutions'' (institutions with the highest risk ratings), a

    [[Page 88]]

    level of problem assets more than four times higher than the comparable
    statistics from September 2006. The largest institution to fail since
    the early 1990s, NetBank (a Georgia thrift with $2.5 billion in assets)
    was placed in FDIC receivership in September 2007, and overall three
    institutions failed during 2007.
      At the end of September 2007, the Deposit Insurance Fund reserve ratio
    (ratio of insurance reserves to insured deposits) stood at 1.22
    percent--$1.2 billion below the level that would meet the target reserve
    ratio. Taking the redemption of credits into consideration, along with
    continued growth in insured deposits and a higher rate of potential
    failures given current conditions in the industry, the Budget projects
    that the FDIC will collect approximately $4.7 billion in new revenue
    from premiums during 2008 and 2009 combined.
      The National Credit Union Share Insurance Fund, the Federal fund for
    credit unions that is analogous to the Deposit Insurance Fund for banks
    and thrifts, ended September 2007 with assets of $7.4 billion and an
    equity ratio of 1.31 percent, topping the NCUA-set target ratio of 1.30
    percent. Over the past five years, the Share Insurance Fund's equity
    ratio has gradually risen from about 1.27 percent, reflecting few losses
    due to failures in the credit union industry. Recent market volatility,
    however, may increase observed losses in the credit union industry. The
    number of problem institutions reported by the NCUA has steadily risen
    during 2007, and the Share Insurance Fund has set aside more than $57
    million to cover potential insurance losses from January through
    November 2007, versus only $2.5 million in loss expenses for all of
    calendar year 2006.

    Basel II: Transition to a New Bank Capital
    Regime

      A major regulatory initiative is currently underway in the banking
    sector, which is likely to have a significant impact on the banking
    sector as a whole and, by extension, on the Federal deposit insurance
    system. The Federal banking regulators are implementing an international
    agreement called the Revised Framework for the International Convergence
    of Capital Measurement and Capital Standards (``Basel II'').
      Since equity capital serves as a cushion against potential losses,
    banks with riskier asset portfolios should hold more equity capital. The
    original Basel Capital Accord (Basel I) adopted in 1989 is an
    international accord among financial regulators establishing a uniform
    capital standard for banks across nations. Under Basel I, bank assets
    are grouped into a small number of broad risk categories. A bank's
    regulatory capital requirement is tied to the amount of its asset
    holdings in each risk category.
      During 2007, the Federal banking regulators completed issuance of the
    rules implementing the Basel II advanced approach, the first half of the
    US effort to implement the Revised Basel Capital Accord. In the final
    Basel II advanced rule, U.S. regulators require the ten or so largest
    banks (including those that have major international operations, complex
    financial structures and expertise) to use an advanced internal ratings-
    based approach to calculate their credit risk capital requirements. The
    Basel II rulemaking allows for greater sensitivity to risk in the
    portfolios these banks hold. Rather than grouping assets into broad risk
    categories, capital requirements are tied to banks' internal assessments
    of the likelihood and severity of default losses from the assets they
    hold. The rules are also intended to allow capital requirements to more
    accurately account for the benefits or risk-mitigation activities
    undertaken by banks. The rulemaking also requires banks to hold capital
    to cover operational risk, which is not covered under the existing
    (Basel I) requirements.
      Implementation of the Basel II standard in Europe began during 2007.
    Implementation of the U.S. Basel II rulemaking will begin with a
    ``parallel run'' on April 1, 2008 and formally go into effect for the
    first of three transitional years on January 1, 2009. This delay has led
    to concerns about a competitive imbalance between U.S. and foreign
    banks. There are also concerns about competitive imbalance between U.S.
    banks, and for that reason, regulators are expected to allow banks other
    than the ten largest U.S. banks to be able to choose between adopting
    the ``Basel II advanced'' approach, the current ``Basel I'' system, and
    an alternative ``Basel II standardized'' approach.
      The ``Basel II standardized'' approach is intended to be more risk-
    sensitive than Basel I, but easier to implement than the advanced Basel
    II approach. The ``standardized'' approach is intended to be broadly
    based upon a system proposed by the Basel committee that provides
    additional risk-sensitivity through use of external credit ratings, and
    internal risk measures for some types of assets (i.e., loan-to-value
    ratios for mortgages). This alternative approach would allow banks to
    potentially lower their capital requirements and provide small- and mid-
    sized banks a means to stay competitive with the larger Basel II banks.
    The regulators are working to develop the standardized approach and are
    expected to release the draft text for public comment during 2008.

                               Pension Guarantees

      The Pension Benefit Guaranty Corporation (PBGC) insures pension
    benefits of workers and retirees in covered defined-benefit pension
    plans sponsored by private-sector employers. PBGC pays benefits, up to a
    guaranteed level, when a company with an underfunded pension plan meets
    the legal criteria to transfer its obligations to the pension insurance
    program. PBGC's claims exposure is the amount by which qualified
    benefits exceed assets in insured plans. In the near term, the risk of
    loss stems from financially distressed firms with underfunded plans. In
    the longer term, loss exposure results from the possibility that healthy
    firms become distressed and well-funded plans become underfunded due to
    inadequate contributions, poor investment results, or increased
    liabilities.
      PBGC monitors companies with underfunded plans and acts to protect the
    interests of the pension insur

    [[Page 89]]

    ance program's stakeholders where possible. Under its Early Warning
    Program, PBGC works with companies to strengthen plan funding or
    otherwise protect the insurance program from avoidable losses. However,
    PBGC's authority to prevent undue risks to the insurance program is
    limited.

                   LARGEST TEN CLAIMS AGAINST THE PBGC'S SINGLE-EMPLOYER INSURANCE PROGRAM, 1975-2006
    ----------------------------------------------------------------------------------------------------------------
                                                                                                         Percent  of
                                                                   Fiscal Years  of                         Total
                            Top 10 Firms                          Plan  Terminations  Claims  (by firm)     Claims
                                                                                                         (1975-2005)
    ----------------------------------------------------------------------------------------------------------------

      1.  United Airlines.......................................               2005      $7,484,348,482      22.90%
      2.  Bethlehem Steel.......................................               2003       3,654,380,116      11.20%
      3.  US Airways............................................         2003, 2005       2,690,222,805       8.20%
      4.  LTV Steel*............................................   2002, 2003, 2004       2,136,698,831       6.50%
      5.  National Steel........................................               2003       1,275,628,286       3.90%
      6.  Pan American Air......................................         1991, 1992         841,082,434       2.60%
      7.  Weirton Steel.........................................               2004         690,181,783       2.10%
      8.  Trans World Airlines..................................               2001         668,377,106       2.00%
      9.  Kaiser Aluminum.......................................               2004         600,009,879       1.80%
      10.   Kemper Insurance....................................               2005         568,417,151       1.70%
                                                                 ---------------------------------------------------
    Top 10 Total................................................  ..................     20,609,346,871      63.20%
    All Other Total.............................................  ..................     12,017,433,400      36.80%
                                                                 ---------------------------------------------------
    TOTAL.......................................................  ..................    $32,626,780,271     100.00%
    ----------------------------------------------------------------------------------------------------------------
    Sources: PBGC Fiscal Year Closing File (9/30/07), PBGC Case Administration System, and PBGC Participant System
      (PRISM).

    Due to rounding, percentages may not add up to 100 percent.

    Data in this table have been calculated on a firm basis and include all plans of each firm.

    Values and distributions are subject to change as PBGC completes its reviews and establishes termination dates.

    * Does not include 1986 termination of a Republic Steel plan sponsored by LTV.

      As a result of a flawed pension funding system and exposure to losses
    from financially troubled plan sponsors, PBGC's single-employer program
    incurred substantial losses from underfunded plan terminations in 2001
    through 2006. The table below shows the ten largest plan termination
    losses in PBGC's history. Nine of the ten have come since 2001.
      The program's deficit at 2007 year-end stood at $13.1 billion,
    compared to a $9.7 billion surplus at 2000 year-end. This is actually a
    $5 billion improvement from 2006. PBGC's operating results are subject
    to significant fluctuation from year to year, depending on the severity
    of losses from plan terminations, changes in the interest factors used
    to discount future benefit payments, investment performance, general
    economic conditions and other factors such as changes in law. While the
    improvement may give the impression that PBGC's financial condition has
    improved, in fact its long-term loss exposure and flawed funding system
    continue to threaten its financial sustainability. \4\
    ---------------------------------------------------------------------------
      \4\ In addition, the airline relief provisions in the Pension
    Protection Act of 2006, which resulted in large plans previously
    classified as probable terminations being changed to the reasonably
    possible classification in 2006, likely postponed rather than eliminated
    losses, as it is likely that the airlines will eventually relapse and
    present a claim to the PBGC. If PBGC's deficit were calculated without
    regard to PPA airline provisions, PBGC estimates that its net deficit
    shown in this report would be approximately $8 billion higher (assuming
    2006 underfunding levels for the specific airline plans remained
    constant).
    ---------------------------------------------------------------------------
      In February 2005 the Administration proposed comprehensive reforms to
    address structural flaws in the statutory plan funding requirements and
    in the design of the insurance program. The proposal sought to
    strengthen funding for workers' defined-benefit pensions; provide more
    accurate information about pension liabilities and plan underfunding;
    and enable PBGC to meet its obligations to participants in terminated
    pension plans. Many of the President's reforms were incorporated into
    the Deficit Reduction Act (DRA) of 2005, enacted in February 2006, and
    the Pension Protection Act of 2006 (PPA), enacted in August 2006. This
    legislation made significant structural changes to the retirement
    system, but did not fully address the long-term challenges facing PBGC.
    While the PBGC has sufficient liquidity to meet its obligations for a
    number of years, neither the single-employer nor multiemployer program
    has the resources to satisfy fully the agency's long-term obligations to
    plan participants.
      Further reforms are needed to address the current $14 billion gap
    between PBGC's liabilities and its assets. The Budget proposes to give
    PBGC's Board the authority to raise premiums to produce the revenue
    necessary to meet expected future claims and retire PBGC's deficit over
    ten years. The current rate-setting mechanism is inflexible and does not
    allow the PBGC to respond to changing conditions in the defined benefit
    plan universe, in the financial markets in which pension plans invest,
    or in its own financial condition.
      Under this proposal, PBGC's Board would have the flexibility to make a
    broad range of changes to pre

    [[Page 90]]

    miums in an effort to improve PBGC's financial condition and safeguard
    the future benefits of American workers. The Administration is committed
    to restoring the solvency of the pension insurance system and avoiding a
    future taxpayer bailout.

                               Disaster Insurance

    Flood Insurance

      The Federal Government provides flood insurance through the National
    Flood Insurance Program (NFIP), which is administered by the Federal
    Emergency Management Agency of the Department of Homeland Security
    (DHS). Flood insurance is available to homeowners and businesses in
    communities that have adopted and enforced appropriate flood plain
    management measures. Coverage is limited to buildings and their
    contents. By the end of 2007, the program had over 5.5 million policies
    in more than 20,200 communities with over $1 trillion of insurance in
    force.
      Prior to the creation of the program in 1968, many factors made it
    cost prohibitive for private insurance companies alone to make
    affordable flood insurance available. In response, the NFIP was
    established to make affordable insurance coverage widely available. The
    NFIP requires building standards and other mitigation efforts to reduce
    losses, and operates a flood hazard mapping program to quantify the
    geographic risk of flooding. These efforts have made substantial
    progress. However, structures built prior to flood mapping and NFIP
    floodplain management requirements, which make up 26 percent of the
    total policies in force, pay less than fully actuarial rates.
      DHS is using three strategies to increase the number of flood
    insurance policies in force: lender compliance, program simplification,
    and expanded marketing. DHS is educating financial regulators about the
    mandatory flood insurance requirement for properties that are located in
    floodplains and have mortgages from federally regulated lenders. These
    strategies have resulted in policy growth of over 3 percent in 2007 with
    an increase of more than 180,000 policies.
      DHS also has a multi-pronged strategy for reducing future flood
    damage. The NFIP offers flood mitigation assistance grants to assist
    flood victims to rebuild to current building codes, including base flood
    elevations, thereby reducing future flood damage costs. In addition, two
    grant programs targeted toward repetitive and severe repetitive loss
    properties not only help owners of high-risk property, but also reduce
    the disproportionate drain on the National Flood Insurance Fund these
    properties cause through acquisition, relocation, or elevation. DHS is
    working to ensure that all of the flood mitigation grant programs are
    closely integrated, resulting in better coordination and communication
    with State and local governments. Further, through the Community Rating
    System, DHS adjusts premium rates to encourage community and State
    mitigation activities beyond those required by the NFIP. These efforts,
    in addition to the minimum NFIP requirements for floodplain management,
    save over $1 billion annually in avoided flood damages.
      The program's reserve account, which is a cash fund, has sometimes had
    expenses greater than its revenue, forcing the NFIP to borrow funds from
    the Treasury in order to meet claims obligations. However, since the
    program began in 1968 and until 2005, the program has continued to repay
    all borrowed funds with interest. However, hurricanes Katrina, Rita, and
    Wilma generated more flood insurance claims than the cumulative number
    of claims from 1968 to 2004. These three storms resulted in over 234,000
    claims with total claims payments expected to be approximately $20
    billion. As a result, the Administration and the Congress have increased
    the borrowing authority to $20.8 billion to date in order to make
    certain that all claims could be paid.
      The catastrophic nature of the 2005 hurricane season has also
    triggered an examination of the program, and the Administration is
    working with the Congress to improve the program, based on the following
    principles: protecting the NFIP's integrity by covering existing
    commitments; phasing out subsidized premiums in order to charge fair and
    actuarially sound premiums; increasing program participation incentives
    and improving enforcement of mandatory participation in the program;
    increasing risk awareness by educating property owners; and reducing
    future risks by implementing and enhancing mitigation measures. Although
    flood insurance reform was not achieved in 2007, the Administration
    looks forward to continuing to work with the Congress to enact program
    reforms that further mitigate the impact of flood damages and losses.

    Crop Insurance

      Subsidized Federal crop insurance administered by USDA's Risk
    Management Agency (RMA) assists farmers in managing yield and revenue
    shortfalls due to bad weather or other natural disasters. The program is
    a cooperative effort between the Federal Government and the private
    insurance industry. Private insurance companies sell and service crop
    insurance policies. These companies rely on reinsurance provided by the
    Federal Government and also by the commercial reinsurance market to
    manage their individual risk portfolio. The Federal Government
    reimburses private companies for a portion of the administrative
    expenses associated with providing crop insurance and reinsures the
    private companies for excess insurance losses on all policies. The
    Federal Government also subsidizes premiums for farmers.
      The 2009 Budget reflects the Administration's Farm Bill proposals,
    which include specific proposals for Crop Insurance. These include
    allowing farmers to purchase supplemental insurance that would cover
    their deductible in the event of a county-wide loss, reducing the
    expected loss ratio to 1.00 from 1.075, allowing the private insurance
    companies access to their data mining information, allow the Standard
    Reinsurance Agreement to be renegotiated once every 3 years, along with

    [[Page 91]]

    a continuation of a series of crop insurance reforms that have been
    proposed in the past that will increase program participation and at the
    same time control program costs.
      The 2009 Budget also includes language to open up authorized purposes
    under the mandatory R&D funds provided by Agriculture Risk Protection
    Act of 2000 (ARPA). Expansion of authorized uses will include data
    mining activities, the Common Information Management System (CIMS), and
    other IT cost related to reducing fraud waste and abuse and IT
    modernization.
      In addition, the 2009 Budget includes a proposal to implement a
    participation fee in the Federal crop insurance program. The
    participation fee would be charged to insurance companies participating
    in the Federal crop insurance program; based on a rate of about one-
    third cent per dollar of premium sold, the fee is expected to be
    sufficient to generate about $15 million annually beginning in 2010. The
    existing IT system is nearing the end of its useful life and recent
    years have seen increases in ``down-time'' resulting from system
    failures. New plans of insurance such as revenue and livestock insurance
    have greatly increased the size and complexity of the crop insurance
    program. These changes place a greater burden on the aging IT system
    resulting in increased IT maintenance costs and limit RMA's ability to
    comply with Congressional mandates pertaining to data reconciliation
    with the Farm Service Agency. The participation fee will help alleviate
    these problems.
      There are various types of insurance programs. The most basic type of
    coverage is catastrophic coverage (CAT), which compensates the farmer
    for losses in excess of 50 percent of the individual's average yield at
    55 percent of the expected market price. The CAT premium is entirely
    subsidized, and farmers pay only an administrative fee. Higher levels of
    coverage, called buy-up coverage, are also available. A premium is
    charged for buy-up coverage. The premium is determined by the level of
    coverage selected and varies from crop to crop and county to county. For
    the ten principal crops, which accounted for about 80 percent of total
    liability in 2007, the most recent data show that over 79 percent of
    eligible acres participated in the crop insurance program.
      RMA offers both yield and revenue-based insurance products. Revenue
    insurance programs protect against loss of revenue stemming from low
    prices, poor yields, or a combination of both. These programs extend
    traditional multi-peril or yield crop insurance by adding price
    variability to production history.
      RMA is continuously trying to develop new products or expand existing
    products in order to cover more types of crops. Two new Group Risk
    Protection risk management tools for pasture, rangeland and forage (PRF)
    protection were approved for the 2007 crop year. These innovative pilot
    programs are based on vegetation greenness and rainfall indices and were
    developed to provide livestock producers the ability to purchase
    insurance protection for losses of forage produced for grazing or
    harvested for hay. The pilots proved to be more popular than anticipated
    and both programs are being expanded to new areas for the 2008 crop
    year. Also new for the 2008 crop year is the Biotech Yield Endorsement
    (BYE) for non-irrigated corn. The BYE is being pilot tested in four
    states and will provide producers a premium rate reduction if they plant
    non-irrigated corn that is intended to be harvested for grain and has
    three specific biotech traits. The premium reduction is based on data
    showing that non-irrigated corn containing these specific traits has a
    lower risk of yield loss than non-traited corn. RMA continues to pursue
    a number of avenues to increase program participation among underserved
    States and commodities by working on declining yield issues and looking
    at discount programs for good experienced producers who pose less risk.
      For more information and additional crop insurance program details,
    please reference RMA's web site: (www.rma.usda.gov).

                    Insurance Against Security-Related Risks

    Terrorism Risk Insurance

      On November 26, 2002, President Bush signed into law the Terrorism
    Risk Insurance Act (TRIA) of 2002 (P.L. 107-297), which was intended to
    help stabilize the insurance industry during a time of significant
    transition that followed the terrorist attacks of September 11, 2001.
    The Act established a temporary, three-year Federal program that
    provided a system of shared public and private compensation for insured
    commercial property and casualty losses arising from acts of foreign
    terrorism (as defined by the Act). In 2005, Congress passed a two-year
    extension (P.L.109-144), that narrowed the Government's role by
    increasing private sector retentions, reducing lines of insurance
    covered by the program, and adding an event trigger amount for Federal
    payments. In December 2007, Congress passed a seven-year extension
    (P.L.110-318). The 2007 extension of TRIA added a requirement for
    commercial property and casualty insurance companies to offer insurance
    for losses from domestic as well as foreign acts of terrorism. The 2007
    extension maintains for all seven extension years an insurer deductible
    of 20 percent of the prior year's direct earned premiums, an insurer co-
    payment of 15 percent of insured losses above the deductible, and a $100
    million event trigger amount for Federal payments. The 2007 extension
    changes mandatory recoupment provisions, requiring Treasury to collect
    133 percent of the Federal payments made under the program, and
    accelerates time horizons for recoupment of any payments made before
    September 30, 2017.
      The President's Working Group on Financial Markets (PWG) reported in
    September 2006 that the Terrorism Risk Insurance Program had achieved
    its goals of supporting the insurance industry post September 11, 2001.
    In terms of insurance availability, the PWG and successive industry
    analyses found record take-up rates

    [[Page 92]]

    in 2006 of nearly 60 percent, compared with 27 percent in 2002. In
    addition, the PWG found significant improvements in affordability
    demonstrated by median terrorism insurance premiums falling from $37,700
    in 2005 to $16,750 in 2006. These trends are also present in high risk
    commercial areas like New York City. Furthermore, the estimated $450
    billion in industry-wide surplus currently held by property and casualty
    insurers exceeds pre-September 2001 levels.
      The Administration believes that TRIA should not be a permanent
    program, that private sector retentions under it should be increased,
    and that over time, the private market is the best provider of
    reinsurance. Over the coming year the Administration will examine
    possible changes to current law that could further develop the private
    terrorism reinsurance market.
      The Budget, for the first time, includes the estimated Federal cost of
    providing terrorism risk insurance, reflecting the 2007 TRIA extension.
    The growth in the private insurance market for this coverage provides
    data in the form of insurance premiums that show how private insurers
    estimate the likelihood of attack and price their projected losses.
    Using this market driven data, the Government can project annual outlays
    and recoupment under TRIA. These estimates represent the weighted
    average of TRIA payments over a full range of scenarios, most of which
    include no terrorist attacks (and therefore no TRIA payments), and some
    of which include terrorist attacks of varying magnitudes. The Budget
    projections, however, are in no way an official forecast of future
    attacks.
      On this basis, the Budget projects the 2007 TRIA extension will have a
    net deficit impact (spending less receipts from premium surcharges) of
    $1.78 billion over the 2009-2013 period and $3.85 billion over the 2009-
    2018 period.

    Airline War Risk Insurance

      After the September 11, 2001 attacks, private insurers cancelled
    third-party liability war risk coverage for airlines and dramatically
    increased the cost of other war risk insurance. In addition to a number
    of short term responses, the Congress also passed the Homeland Security
    Act of 2002 (P.L. 107-296). Among other provisions, this Act required
    the Secretary to provide additional war risk insurance coverage for hull
    losses and passenger liability to air carriers insured for third-party
    war risk liability as of June 19, 2002. The Department of Transportation
    Appropriations Act for 2008 (P.L. 110-161) further extended the
    requirement to provide insurance coverage through August 31, 2008.
    Acting on behalf of the Secretary, the FAA has made available insurance
    coverage for (i) hull losses at agreed value; (ii) death, injury, or
    property loss liability to passengers or crew, the limit being the same
    as that of the air carrier's commercial coverage before September 11,
    2001; and (iii) third party liability, the limit generally being twice
    that of such coverage. The Secretary is also authorized to limit an air
    carrier's third party liability to $100 million, when the Secretary
    certifies that the loss is from an act of terrorism.
      This program provides airlines with financial protection from war risk
    occurrences, and thus allows airlines to meet the basic requirement for
    adequate hull loss and liability coverage found in most aircraft
    mortgage covenants, leases and in government regulation. Without such
    coverage, many airlines might be grounded. Currently, aviation war risk
    insurance coverage is generally available from private insurers, but
    premiums are significantly higher in the private market. Also, private
    insurance coverage for occurrences involving weapons of mass destruction
    is more limited.
      Currently 75 air carriers are insured by Department of Transportation.
    Coverage for individual carriers ranges from $80 million to $4 billion
    per carrier, with the median insurance coverage at approximately $1.8
    billion per occurrence. Premiums collected by the Government for these
    policies are deposited into the Aviation Insurance Revolving Fund. In
    2007, the Fund earned approximately $170 million in premiums for
    insurance provided by DOT, and it is anticipated that an additional $157
    million in premiums will be earned in 2008. At the end of 2007, the
    balance in the Aviation Insurance Revolving Fund available for payment
    of future claims was $951 million. Although no claims have been paid by
    the Fund since 2001, the balance in the Fund would be inadequate to meet
    either the coverage limits of the largest policies in force ($4 billion)
    or to meet a series of large claims in succession. The Federal
    Government would pay any claims by the airlines that exceed the balance
    in the Aviation Insurance Revolving Fund.
      Aviation insurance program authority expires on March 30, 2008. The
    Administration does not support a straight extension of this program and
    instead favors a return to private sector mechanisms for managing risk.
    As part of the Federal Aviation Administration (FAA) reauthorization,
    the Administration has proposed reforms that would gradually transition
    airlines from government provided insurance to privately provided
    insurance. Current law caps the premium rates that FAA may charge.
    Continuation of insurance coverage, if any, should allow FAA to set
    deductible levels as the first step in moving airlines to the private
    insurance market and reducing the indirect subsidy that the government
    currently provides. The Administration is committed to working with the
    Congress to reform this program, and to ensure that air carriers more
    equitably share in the risks associated with this program.

    [[Page 93]]

                        Table 7-1.  ESTIMATED FUTURE COST OF OUTSTANDING FEDERAL CREDIT PROGRAMS
                                                (In billions of dollars)
    ----------------------------------------------------------------------------------------------------------------
                                                                       Estimated                        Estimated
                                                      Outstanding   Future Costs of    Outstanding   Future Costs of
                        Program                          2006             2006            2007             2007
                                                                    Outstanding \1\                  Outstanding \1\
    ----------------------------------------------------------------------------------------------------------------
    Direct Loans: \2\
      Federal Student Loans.......................             116               16             124               15
      Farm Service Agency (excl. CCC), Rural                    43               10              44               10
       Development, Rural Housing.................
      Rural Utilities Service and Rural Telephone               38                2              40                1
       Bank.......................................
      Housing and Urban Development...............              11                3              10                3
      P.L. 480....................................               8                4               8                4
      Disaster Assistance.........................               7                2              10                2
      Export-Import Bank..........................               7                2               6                2
      Agency for International Development........               7                3               6                2
      Commodity Credit Corporation................               2                1               1  ...............
      VA Mortgage.................................               1  ...............               1               -1
      Other Direct Loan Programs..................              12                4              11                5
                                                   -----------------------------------------------------------------
        Total Direct Loans........................             251               47             260               44
                                                   -----------------------------------------------------------------
    Guaranteed Loans: \2\
      Federal Student Loans.......................             325               52             363               51
      FHA-Mutual Mortgage Insurance Fund..........             317                3             322                7
      VA Mortgage.................................             211                3             232                4
      FHA-General and Special Risk Insurance Fund.              98                1             108  ...............
      Small Business \3\..........................              67                2              72                2
      Export-Import Bank..........................              36                2              39                1
      Farm Service Agency (excl. CCC), Rural                    31  ...............              32  ...............
       Development, Rural Housing.................
      International Assistance....................              22                2              22                2
      Commodity Credit Corporation................               3  ...............               3  ...............
      Maritime Administration.....................               3  ...............               3  ...............

    [[Page 94]]

      Government National Mortgage Association      ..............                *  ..............                *
       (GNMA) \3\.................................
      Other Guaranteed Loan Programs..............               7                1               6                2
                                                   -----------------------------------------------------------------
        Total Guaranteed Loans....................           1,120               66           1,202               69
                                                   -----------------------------------------------------------------
    Total Federal Credit..........................           1,371              113           1,461              113
    ----------------------------------------------------------------------------------------------------------------
    * Less than $500 million.
    \1\ Direct loan future costs are the financing account allowance for subsidy cost and the liquidating account
      allowance for estimated uncollectible principal and interest. Loan guarantee future costs are estimated
      liabilities for loan guarantees.
    \2\ Excludes loans and guarantees by deposit insurance agencies and programs not included under credit reform,
      such as CCC commodity price supports. Defaulted guaranteed loans which become loans receivable are accounted
      for as direct loans.
    \3\ Certain SBA data are excluded from the totals because they are secondary guarantees on SBA's own guaranteed
      loans. GNMA data are excluded from the totals because they are secondary guarantees on loans guaranteed by
      FHA, VA and RHS.

    [[Page 95]]

                                      Table 7-2.  REESTIMATES OF CREDIT SUBSIDIES ON LOANS DISBURSED BETWEEN 1992-2007 \1\
                                                     (Budget authority and outlays, in millions of dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                       Program                      1997     1998     1999     2000     2001     2002     2003     2004     2005     2006     2007     2008
    --------------------------------------------------------------------------------------------------------------------------------------------------------

                    DIRECT LOANS:

    Agriculture:
      Agriculture Credit Insurance Fund.........      -31       23  .......      331     -656      921       10     -701     -147       -2      -14     -251
      Farm Storage Facility Loans...............  .......  .......  .......  .......  .......       -1       -7       -8        7       -1  .......       51
      Apple Loans...............................  .......  .......  .......  .......  .......       -2        1  .......        *        *        *        *
      Emergency Boll Weevil Loan................  .......  .......  .......  .......  .......  .......        1        *        *        3  .......        *
      Distance Learning and Telemedicine........  .......  .......  .......  .......  .......        1       -1       -1        1        7        1        3
      Rural Electrification and                        84  .......      -39  .......      -17      -42      101      265      143     -197     -108      -36
       Telecommunications Loans.................
      Rural Telephone Bank......................       10  .......       -9  .......       -1  .......       -3       -7       -6      -17      -48      -22
      Rural Housing Insurance Fund..............      -73  .......       71  .......       19      -29     -435      -64     -200      109  .......        4
      Rural Economic Development Loans..........        1  .......       -1        *  .......       -1       -1  .......       -2        *       -3        3
      Rural Development Loan Program............  .......  .......       -6  .......  .......       -1       -3  .......       -3       -2       -7        *
      Rural Community Advancement Program \2\...        8  .......        5  .......       37        3       -1      -84      -34      -73      -77       -8
      P.L. 480..................................       -1  .......  .......  .......      -23       65     -348       33      -43     -239      -26       44
      P.L. 480 Title I Food for Progress Credits  .......  .......  .......  .......  .......  .......     -112      -44  .......  .......  .......  .......

    Commerce:
      Fisheries Finance.........................  .......  .......  .......  .......      -19       -1       -3  .......        1      -15      -12       11

    Defense:
      Military Housing Improvement Fund.........  .......  .......  .......  .......  .......  .......  .......  .......        *       -4       -1       -8

    Education:
      Federal Direct Student Loan Program: \3\
        Volume Reestimate.......................  .......  .......       22  .......       -6  .......       43  .......  .......  .......  .......  .......
        Other Technical Reestimate..............      -83      172     -383   -2,158      560  .......    3,678    1,999      855    2,827    2,674      408
      College Housing and Academic Facilities     .......  .......  .......  .......       -1  .......  .......  .......  .......  .......        *        *
       Loans....................................
      Historically Black Colleges and             .......  .......  .......  .......  .......  .......  .......  .......  .......  .......       11      -16
       Universities.............................

    Homeland Security:
      Disaster Assistance.......................  .......  .......  .......       47       36       -7       -6        *        4        *        *        *

    Interior:
      Bureau of Reclamation Loans...............  .......  .......  .......        3        3       -9      -14  .......       17        1        1        5
      Bureau of Indian Affairs Direct Loans.....  .......  .......        1        5       -1       -1        2        *        *        *        1       -1
      Assistance to American Samoa..............  .......  .......  .......  .......  .......  .......  .......        *        *  .......        2       -1

    Transportation:
      High Priority Corridor Loans..............  .......       -3  .......  .......  .......  .......  .......  .......  .......  .......  .......  .......
      Alameda Corridor Loan.....................  .......  .......  .......      -58  .......  .......  .......      -12  .......  .......  .......  .......
      Transportation Infrastructure Finance and   .......  .......  .......  .......       18  .......  .......  .......        3      -11        7       11
       Innovation...............................
      Railroad Rehabilitation and Improvement     .......  .......  .......  .......  .......  .......  .......       -5      -14      -11       -1       15
       Program..................................

    Treasury:
      Community Development Financial             .......  .......  .......        1  .......  .......        *       -1        *       -1        1        *
       Institutions Fund........................

    Veterans Affairs:
      Veterans Housing Benefit Program Fund.....      -72      465     -111      -52     -107     -697       17     -178      987      -44      -76     -402
      Native American Veteran Housing...........  .......  .......  .......  .......  .......  .......       -3        *        *        *        1        1
      Vocational Rehabilitation Loans...........  .......  .......  .......  .......  .......  .......        *        *        *       -1        1       -1

    Environmental Protection Agency:
      Abatement, Control and Compliance.........  .......  .......  .......  .......        3       -1        *       -3        *        *        *        *

    International Assistance Programs:
      Foreign Military Financing................       13        4        1      152     -166      119     -397      -64      -41       -7       -6      -30
      U.S. Agency for International Development:
        Micro and Small Enterprise Development..  .......  .......  .......  .......  .......        *  .......        *  .......  .......  .......  .......
      Overseas Private Investment Corporation:
        OPIC Direct Loans.......................  .......  .......  .......  .......  .......  .......       -4      -21        3       -7       72       31
      Debt Reduction............................  .......  .......  .......       36       -4  .......        *      -47     -104       54       -3  .......

    Small Business Administration:
      Business Loans............................  .......  .......  .......  .......        1       -2        1       25  .......      -16       -4        4
      Disaster Loans............................  .......     -193      246     -398     -282      -14      266      589      196       61      258     -109

    Other Independent Agencies:
      Export-Import Bank Direct Loans...........  .......  .......  .......     -177      157      117     -640     -305      111     -257     -227     -120
      Federal Communications Commission.........  .......    4,592      980   -1,501     -804       92      346      380      732      -24       11  .......

                  LOAN GUARANTEES:

    Agriculture:
      Agriculture Credit Insurance Fund.........      -51       96  .......      -31      205       40      -36      -33      -22     -162       20      -36
      Agriculture Resource Conservation           .......  .......  .......  .......        2  .......        1       -1        *        *  .......  .......
       Demonstration............................
      Commodity Credit Corporation Export             343  .......  .......  .......   -1,410  .......      -13     -230     -205     -366     -232     -225
       Guarantees...............................
      Rural Development Insurance Fund..........       -3  .......  .......  .......  .......  .......  .......  .......  .......  .......  .......  .......

    [[Page 96]]

      Rural Housing Insurance Fund..............      -10  .......      109  .......      152      -56       32       50       66       44  .......      -19
      Rural Community Advancement Program \2\...      -10  .......       41  .......       63       17       91       15       29      -64      -16      -10
      Renewable Energy..........................  .......  .......  .......  .......  .......  .......  .......  .......  .......  .......        *        *

    Commerce:
      Fisheries Finance.........................  .......       -2  .......  .......       -3       -1        3        *        1        *        1        *
      Emergency Steel Guaranteed Loans..........  .......  .......  .......  .......  .......  .......       50        *        3      -75      -13        1
      Emergency Oil and Gas Guaranteed Loans....  .......  .......  .......  .......        *        *        *        *        *       -1        *        *

    Defense:
      Military Housing Improvement Fund.........  .......  .......  .......  .......  .......  .......  .......       -3       -1       -3       -5       -1
      Defense Export Loan Guarantee.............  .......  .......  .......  .......  .......  .......  .......  .......       -5  .......  .......  .......
      Arms Initiative Guaranteed Loan Program...  .......  .......  .......  .......  .......  .......  .......  .......  .......  .......  .......       20

    Education:
      Federal Family Education Loan Program: \3\
      Volume Reestimate.........................       99  .......      -13      -60      -42  .......      277  .......  .......  .......  .......  .......
      Other Technical Reestimate................  .......  .......     -140      667   -3,484  .......   -2,483   -3,278    1,348    6,837   -3,399     -189

    Health and Human Services:
      Heath Center Loan Guarantees..............  .......  .......  .......        3  .......        *        *  .......        1        *        *       -1
      Health Education Assistance Loans.........  .......  .......  .......  .......  .......  .......       -5      -37      -33      -18      -20        *

    Housing and Urban Development:
      Indian Housing Loan Guarantee.............  .......  .......  .......  .......       -6        *       -1        *       -3       -1        *       -5
      Title VI Indian Guarantees................  .......  .......  .......  .......  .......  .......       -1        1        4        *       -4       -3
      Community Development Loan Guarantees.....  .......  .......  .......  .......  .......  .......  .......       19      -10       -2        4        1
      FHA-Mutual Mortgage Insurance.............     -340  .......    3,789  .......    2,413   -1,308    1,100    5,947    1,979    2,842      636    3,923
      FHA-General and Special Risk..............      -25      743       79  .......     -217     -403       77      352      507      238   -1,254     -362

    Interior:
      Bureau of Indian Affairs Guaranteed Loans.       31  .......  .......  .......      -14       -1       -2       -2        *       15        5      -30

    Transportation:
      Maritime Guaranteed Loans (Title XI)......  .......  .......      -71       30      -15      187       27      -16        4      -76      -11      -51
      Minority Business Resource Center.........  .......  .......  .......  .......  .......        1  .......        *        *  .......        *        *

    Treasury:
      Air Transportation Stabilization Program..  .......  .......  .......  .......  .......  .......      113     -199      292     -109      -95  .......

    Veterans Affairs:
      Veterans Housing Benefit Fund Program.....     -706       38      492      229     -770     -163     -184   -1,515     -462     -842     -525      183

    International Assistance Programs:
      U.S. Agency for International Development:
        Development Credit Authority............  .......  .......  .......  .......  .......       -1  .......        1       -3       -2        2       11
        Micro and Small Enterprise Development..  .......  .......  .......  .......  .......  .......  .......        2       -2  .......       -3        *
        Urban and Environmental Credit..........  .......      -14  .......  .......  .......       -4      -15       48       -2       -5      -11      -22
        Assistance to the New Independent States  .......  .......  .......  .......  .......      -34  .......  .......  .......  .......  .......  .......
         of the Former Soviet Union.............
        Loan Guarantees to Israel...............  .......  .......  .......  .......  .......  .......  .......      -76     -111      188       34      -16
        Loan Guarantees to Egypt................  .......  .......  .......  .......  .......  .......  .......  .......  .......        7       14      -12
      Overseas Private Investment Corporation:
        OPIC Guaranteed Loans...................  .......  .......  .......  .......  .......        5       77       60     -212      -21     -149     -268

    Small Business Administration:
      Business Loans............................      -16     -279     -545     -235     -528     -226      304    1,750    1,034     -390     -268     -140

    Other Independent Agencies:
      Export-Import Bank Guarantees.............  .......  .......  .......     -191   -1,520     -417   -2,042   -1,133     -655   -1,164     -579     -174

                                                 -----------------------------------------------------------------------------------------------------------
    Total.......................................     -832    5,642    4,518   -3,357   -6,427   -1,854     -142    3,468    6,008    9,003   -3,441    2,161
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    * Less than $500,000.
    \1\Excludes interest on reestimates. Additional information on credit reform subsidy rates is contained in the Federal Credit Supplement.
    \2\Includes Rural Water and Waste Disposal, Rural Community Facilities, and Rural Business and Industry programs.
    \3\Volume reestimates in mandatory programs represent a change in volume of loans disbursed in the prior years.

    [[Page 97]]

                                       Table 7-3.  DIRECT LOAN SUBSIDY RATES, BUDGET AUTHORITY, AND LOAN LEVELS, 2007-2009
                                                                    (In millions of dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                          2007 Actual                    2008 Enacted                  2009 Proposed
                                                                --------------------------------------------------------------------------------------------
                         Agency and Program                                 Subsidy                        Subsidy                        Subsidy
                                                                  Subsidy    budget     Loan     Subsidy    budget     Loan     Subsidy    budget     Loan
                                                                 rate \1\  authority   levels   rate \1\  authority   levels   rate \1\  authority   levels
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Agriculture:
      Agricultural Credit Insurance Fund Program Account.......      9.32         92       985      9.28         88       948      9.37         88       944
      Farm Storage Facility Loans Program Account..............      0.38          1       174      1.01          2       153      6.11          9       153
      Rural Community Advancement Program \2\..................      9.09        132     1,451  ........  .........  ........  ........  .........  ........
      Rural Electrification and Telecommunications Loans            -0.67        -29     4,267     -0.57        -41     7,284     -2.05        -98     4,790
       Program Account.........................................
      Distance Learning, Telemedicine, and Broadband Program...      1.98          5       283      2.15         12       523      3.90         12       298
      Rural Water and Waste Disposal Program Account...........  ........  .........  ........      6.81         70     1,025      3.77         48     1,269
      Rural Community Facilities Program Account...............  ........  .........  ........      5.55         22       404      5.72         17       302
      Rural Housing Assistance Grants..........................     47.82          1         2  ........  .........  ........  ........  .........  ........
      Farm Labor Program Account...............................     47.95         16        33     43.26         13        31  ........  .........  ........
      Multifamily Housing Revitalization Program Account.......  ........  .........  ........     46.39          6        14  ........  .........  ........
      Rural Housing Insurance Fund Program Account.............     13.42        181     1,354     11.85        156     1,313     12.93          6        38
      Rural Development Loan Fund Program Account..............     44.07         15        34     42.89         14        34     41.85         14        34
      Rural Economic Development Loans Program Account.........     21.84          6        26     22.59          7        33  ........  .........  ........

    Commerce:
      Fisheries Finance Program Account........................     -8.02         -4        48     -3.72         -4        90    -12.78         -1         8

    Defense--Military:
      Defense Family Housing Improvement Fund..................     14.57         59       406     23.86        109       457     43.50         47       107

    Education:
      College Housing and Academic Facilities Loans Program         65.22        304       467  ........  .........  ........     16.31         10        61
       Account.................................................
      TEACH Grant Program Account..............................  ........  .........  ........     13.03          7        57     13.05         14       105
      Loans for Short-Term Training Program Account............  ........  .........  ........  ........  .........  ........     -0.27  .........        46
      Federal Direct Student Loan Program Program Account......      1.37        258    18,850      0.76        169    19,891      1.13        250    21,048

    Homeland Security:
      Disaster Assistance Direct Loan Program Account..........  ........  .........  ........      1.73  .........        25      1.04  .........        25

    Housing and Urban Development:
      FHA-Mutual Mortgage Insurance Program Account............  ........  .........         3  ........  .........        50  ........  .........        50

    State:
      Repatriation Loans Program Account.......................     60.14          1         1     60.22          1         1     59.77          1         1

    Transportation:
      Federal-aid Highways.....................................      3.92         30       766     10.00        232     2,320     10.00        100       998
      Railroad Rehabilitation and Improvement Program..........  ........  .........       103  ........  .........       600  ........  .........       600

    Treasury:
      Community Development Financial Institutions Fund Program     37.47  .........         1     37.52          3         8     37.88          1         2
       Account.................................................

    Veterans Affairs:
      Housing Program Account..................................      5.08          6       122      0.55          2       337     -0.16  .........       328
      Native American Veteran Housing Loan Program Account.....    -13.46         -1         8    -14.48         -2        12    -10.07         -1        13
      General Operating Expenses...............................      2.00  .........         3      2.16  .........         3      1.93  .........         3

    International Assistance Programs:
      Debt Restructuring.......................................  ........         31  ........  ........        107  ........  ........         34  ........
      Overseas Private Investment Corporation Program Account..      4.42         13       291      3.22         11       342      2.34         11       450

    Small Business Administration:
      Disaster Loans Program Account...........................     17.73        267     1,506     16.27        156       959     14.92        158     1,061
      Business Loans Program Account...........................     10.21          2        19     10.12          2        20  ........  .........        25

    Export-Import Bank of the United States:
      Export-Import Bank Loans Program Account.................  ........  .........  ........     33.01         17        50     33.01         17        50
                                                                --------------------------------------------------------------------------------------------
        Total..................................................       N/A      1,386    31,203       N/A      1,159    36,984       N/A        737    32,809
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    \1\  Additional information on credit subsidy rates is contained in the Federal Credit Supplement.
    \2\  2007 data include Rural Water and Waste Disposal and Rural Community Facilities loan programs.
    N/A = Not applicable.

    [[Page 98]]

                                      Table 7-4. LOAN GUARANTEE SUBSIDY RATES, BUDGET AUTHORITY, AND LOAN LEVELS, 2007-2009
                                                                    (In millions of dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                          2007 Actual                    2008 Enacted                  2009 Proposed
                                                                --------------------------------------------------------------------------------------------
                         Agency and Program                                 Subsidy                        Subsidy                        Subsidy
                                                                  Subsidy    budget     Loan     Subsidy    budget     Loan     Subsidy    budget     Loan
                                                                 rate \1\  authority   levels   rate \1\  authority   levels   rate \1\  authority   levels
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Agriculture:
      Agricultural Credit Insurance Fund Program Account.......      2.58         56     2,155      2.58         67     2,607      2.61         65     2,497
      Commodity Credit Corporation Export Loans Program Account      2.92         39     1,334      2.33         53     2,274      0.96         26     2,675
      Rural Community Advancement Program \2\..................      4.09         45     1,090  ........  .........  ........  ........  .........  ........
      Rural Water and Waste Disposal Program Account...........  ........  .........  ........     -0.82         -1        75     -0.82         -1        75
      Rural Community Facilities Program Account...............  ........  .........  ........      3.68          8       210      3.08          6       210
      Rural Housing Insurance Fund Program Account.............      1.37         51     3,754      1.37         84     6,141      0.30         16     5,149
      Rural Business Program Account...........................  ........  .........  ........      4.33         63     1,463      4.35         30       700
      Renewable Energy Program Account.........................      6.49          4        57      9.69         18       184  ........  .........  ........

    Education:
      Loans for Short-Term Training Program Account............  ........  .........  ........  ........  .........  ........      1.02          3       316
      Federal Family Education Loan Program Account............      6.29      6,850   108,873      1.07      1,077   100,559      2.21      2,407   109,117

    Energy:
      Title 17 Innovative Technology Loan Guarantee Program....  ........  .........  ........  ........         90       600  ........  .........     2,220

    Health and Human Services:
      Health Resources and Services............................      3.42          1        28      3.41  .........         8  ........  .........  ........

    Housing and Urban Development:
      Indian Housing Loan Guarantee Fund Program Account.......      2.35          5       235      2.42          9       367      2.52         11       420
      Native Hawaiian Housing Loan Guarantee Fund Program            2.35          1        43      2.42          1        41      2.52          1        41
       Account.................................................
      Native American Housing Block Grant......................     11.99          1        12     12.12          2        17     12.34          2        17
      Community Development Loan Guarantees Program Account....      2.17          4       201      2.25          5       200  ........  .........  ........
      FHA-Mutual Mortgage Insurance Program Account............     -0.37       -209    56,519     -0.51       -368    72,172     -0.49       -749   151,280
      FHA-General and Special Risk Program Account.............     -2.46       -813    32,927     -1.76       -693    39,346     -2.20       -143     6,530

    Interior:
      Indian Guaranteed Loan Program Account...................      6.45          6        87      6.53          6        86      7.73          7        85

    Transportation:
      Minority Business Resource Center Program................      1.82  .........         3      2.03  .........        18      1.86  .........        18
      Federal-aid Highways.....................................  ........  .........  ........     10.00         20       200     10.00         20       200
      Railroad Rehabilitation and Improvement Program..........  ........  .........  ........  ........  .........       100  ........  .........       100
      Maritime Guaranteed Loan (Title XI) Program Account......  ........  .........  ........      4.35          5       115  ........  .........  ........

    Veterans Affairs:
      Housing Program Account..................................     -0.36        -87    24,186     -0.34       -120    35,197     -0.66       -236    35,817

    International Assistance Programs:
      Loan Guarantees to Israel Program Account................  ........  .........  ........  ........  .........       700  ........  .........       700
      Development Credit Authority Program Account.............      1.99          7       350      6.00         21       348      3.05         15       475
      Overseas Private Investment Corporation Program Account..     -0.59         -8     1,333     -1.75        -23     1,338     -0.84        -11     1,400

    Small Business Administration:
      Business Loans Program Account...........................  ........  .........    20,506  ........  .........    28,000     -0.01         -5    28,000

    Export-Import Bank of the United States:
      Export-Import Bank Loans Program Account.................     -0.15        -18    12,569     -1.74       -238    13,710     -1.79       -248    13,807
                                                                --------------------------------------------------------------------------------------------
        Total..................................................       N/A      5,935   266,262       N/A         86   306,076       N/A      1,216   361,849
                                                                --------------------------------------------------------------------------------------------
          ADDENDUM: SECONDARY GUARANTEED LOAN COMMITMENTS

    GNMA:
      Guarantees of Mortgage-backed Securities Loan Guarantee       -0.21       -193    85,071     -0.21       -163    77,400     -0.21       -163    77,400
       Program Account.........................................
    SBA:
      Secondary Market Guarantee Program.......................  ........  .........     3,678  ........  .........    12,000  ........  .........    12,000
                                                                --------------------------------------------------------------------------------------------
        Total, secondary guaranteed loan commitments...........       N/A       -193    88,749       N/A       -163    89,400       N/A       -163    89,400
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    \1\  Additional information on credit subsidy rates is contained in the Federal Credit Supplement.
    \2\  2007 data include Rural Water and Waste Disposal, Rural Community Facilities, and Rural Business and Industry loan guarantee programs.
    N/A = Not applicable.

    [[Page 99]]

                                                 Table 7-5.  SUMMARY OF FEDERAL DIRECT LOANS AND LOAN GUARANTEES
                                                                    (In billions of dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                        Actual                                                Estimate
                                               -------------------------------------------------------------------------------------------------------------
                                                   2000       2001       2002       2003       2004       2005       2006       2007       2008       2009
    --------------------------------------------------------------------------------------------------------------------------------------------------------

    Direct Loans:
      Obligations.............................       37.1       39.1       43.7       45.4       42.0       56.3       57.8       42.5       44.7       39.9
      Disbursements...........................       35.5       37.1       39.6       39.7       38.7       50.6       46.6       41.7       42.1       40.5
      New subsidy budget authority............       -0.4        0.3          *        0.7        0.4        2.1        4.7        1.7        5.3        0.7
      Reestimated subsidy budget authority \1\       -4.4       -1.8        0.5        2.9        2.6        3.8        3.1        3.4       -0.6  .........
      Total subsidy budget authority..........       -4.8       -1.5        0.5        3.5        3.0        6.0        7.8        5.1        4.7        0.7

    Loan Guarantees:
      Commitments \2\.........................      192.6      256.4      303.7      345.9      300.6      248.5      280.7      266.5      306.1      361.9
      Lender disbursements \2\................      180.8      212.9      271.4      331.3      279.9      221.6      256.0      251.2      270.3      340.6
      New subsidy budget authority............        3.6        2.3        2.9        3.8        7.3       10.1       17.2        5.7       -2.6        1.1
      Reestimated subsidy budget authority \1\        0.3       -7.1       -2.4       -3.5        2.0        3.5        7.0       -6.8        3.6  .........
      Total subsidy budget authority..........        3.9       -4.8        0.5        0.3        9.3       13.6       24.2       -1.1        1.0        1.1
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    * Less than $50 million.
    \1\ Includes interest on reestimate.
    \2\ To avoid double-counting, totals exclude GNMA secondary guarantees of loans that are guaranteed by FHA, VA, and RHS, and SBA's guarantee of 7(a)
      loans sold in the secondary market.

    [[Page 100]]

                    Table 7-6.  DIRECT LOAN WRITE-OFFS AND GUARANTEED LOAN TERMINATIONS FOR DEFAULTS
    ----------------------------------------------------------------------------------------------------------------
                                                             In millions of dollars          As a percentage of
                                                         ------------------------------     outstanding loans \1\
                    Agency and Program                                                 -----------------------------
                                                            2007      2008      2009      2007      2008      2009
                                                           Actual   Estimate  Estimate   Actual   Estimate  Estimate
    ----------------------------------------------------------------------------------------------------------------
                    DIRECT LOAN WRITEOFFS

    Agriculture:
      Agricultural Credit Insurance Fund................        98        70        70      1.55      1.13      1.15
      Rural Community Facility..........................         1  ........  ........      0.05  ........  ........
      Rural Electrification and Telecommunications Loans         1  ........  ........      0.00  ........  ........
      Rural Business Investment Program.................        14         4         4     22.95      8.51     10.26
      Rural Housing Insurance Fund......................       168        97       100      0.68      0.40      0.42
      Rural Development Loan Fund.......................         1         1         1      0.06      0.06      0.07

    Commerce:
      Economic Development Revolving Fund...............         1  ........  ........     16.67  ........  ........

    Education:
      Student Financial Assistance......................        14        13        13      4.40      4.21      4.33
      Perkins Loan Assets...............................  ........  ........        54  ........  ........      1.46

    Housing and Urban Development:
      Revolving Fund (Liquidating Programs).............         1         1         1     16.67     25.00     50.00
      Guarantees of Mortgage-backed Securities..........         1        12        13     12.50     85.71     56.52

    Interior:
      Revolving Fund for Loans..........................         3         1         1     21.43     10.00     12.50

    Treasury:
      Community Development Financial Institutions Fund.         1  ........  ........      1.54  ........  ........

    Veterans Affairs:
      Veterans Housing Benefit Program..................        40        78        49      4.72     10.68      6.51

    International Assistance Programs:
      Debt Restructuring................................  ........        29  ........  ........     12.89  ........
      Overseas Private Investment Corporation...........         2        15        15      0.26      1.73      1.48

    Small Business Administration:
      Disaster Loans....................................       107       136       157      1.34      1.51      1.81
      Business Loans....................................         7         5         4      4.05      3.27      2.96

    Other Independent Agencies:
      Debt Reduction (Export-Import Bank)...............         7        65  ........      2.33     24.62  ........
      Export-Import Bank................................        16        10        10      0.28      0.26      0.32
      Spectrum Auction Program..........................         1       172       111      0.25     59.11     74.00
      Tennessee Valley Authority Fund...................         1         1         1      1.89      1.79      1.67
                                                         -----------------------------------------------------------
        Total, direct loan writeoffs....................       485       710       604      0.21      0.30      0.25
                                                         -----------------------------------------------------------

          GUARANTEED LOAN TERMINATIONS FOR DEFAULT

    Agriculture:
      Agricultural Credit Insurance Fund................         8        48        48      0.08      0.46      0.42
      Commodity Credit Corporation Export Loans.........        16        26        17      0.50      0.67      0.35
      Rural Business and Industry Loans.................        95       112       132      2.52      2.98      3.35
      Rural Community Facility Loans....................         4         4         4      0.66      0.54      0.45
      Rural Housing Insurance Fund......................       239       271       312      1.46      1.46      1.49

    Defense--Military:
      Procurement of Ammunition, Army...................        15  ........  ........    125.00  ........  ........
      Family Housing Improvement Fund...................  ........         7         7  ........      1.43      1.46

    Education:
      Loans for Short-Term Training.....................  ........  ........         3  ........  ........      3.85
      Federal Family Education Loans....................     7,416     7,004     7,924      2.16      1.83      1.88

    Energy:
      Title 17 Innovative Technology Guarantees.........  ........         1         3  ........      0.67      0.39

    Health and Human Services:
      Health Education Assistance Loans.................        18        19        19      1.44      1.78      2.04
      Health Center Loan Guarantees.....................  ........         1  ........  ........      1.64  ........

    Housing and Urban Development:
      Indian Housing Loan Guarantee.....................         1         1         1      0.21      0.13      0.09
      Native American Housing Block Grant...............  ........         2         2  ........      2.15      1.98
      FHA-Mutual Mortgage Insurance.....................     5,152     8,476    10,290      1.61      2.52      2.56
      FHA-General and Special Risk Insurance............     1,009     1,737     2,176      0.98      1.56      1.89

    [[Page 101]]

    Interior:
      Indian Guaranteed Loans...........................         2         2         3      0.60      0.56      0.84

    Veterans Affairs:
      Veterans Housing Benefit Program..................       855     1,881     1,806      0.39      0.77      0.66

    International Assistance Programs:
      Micro and Small Enterprise Development............         1         1         1     14.29     25.00     50.00
      Urban and Environmental Credit Program............         3         5         5      1.53      1.15      1.32
      Housing and Other Credit Guaranty Programs........        15         7        12     14.29     25.00     50.00
      Development Credit Authority......................         3         2         2      1.31      0.66      0.51
      Overseas Private Investment Corporation...........       172       100       150      4.01      2.08      2.79

    Small Business Administration:
      Business Loans....................................     1,083     1,254     1,620      1.56      1.70      2.04

    Other Independent Agencies:
      Export-Import Bank................................       237       225       225      0.64      0.57      0.54
                                                         -----------------------------------------------------------
        Total, guaranteed loan terminations for default.    16,344    21,186    24,762      1.03      1.25      1.33
                                                         -----------------------------------------------------------
        Total, direct loan writeoffs and guaranteed loan    16,829    21,896    25,366      0.93      1.14      1.20
         terminations...................................
                                                         ===========================================================

    ADDENDUM: WRITEOFFS OF DEFAULTED GUARANTEED LOANS
     THAT RESULT IN LOANS RECEIVABLE

    Agriculture:
      Agricultural Credit Insurance Fund................         5         7         7      9.80     11.67     10.94

    Education:
      Federal Family Education Loan.....................     1,091     1,228     1,308      5.38      5.71      6.05

    Housing and Urban Development:
      FHA-Mutual Mortgage Insurance.....................  ........        20         4  ........      0.74      0.16
      FHA-General and Special Risk Insurance............       299        27        22      8.42      0.66      0.41

    Interior:
      Indian Guaranteed Loans...........................         6         2  ........     60.00     33.33  ........

    International Assistance Programs:
      Overseas Private Investment Corporation...........        22        13        20     18.97     12.15     11.76

    Small Business Administration:
      Business loans....................................       546       279       279     13.75      6.88      6.66
                                                         -----------------------------------------------------------
        Total, writeoffs of loans receivable............     1,969     1,576     1,640      6.30      4.86      4.83
    ----------------------------------------------------------------------------------------------------------------
    \1\ Average of loans outstanding for the year.

    [[Page 102]]

                          Table 7-7. APPROPRIATIONS ACTS LIMITATIONS ON CREDIT LOAN LEVELS \1\
                                                (In millions of dollars)
    ----------------------------------------------------------------------------------------------------------------
                                                                                    2007        2008         2009
                                 Agency and Program                               Actual      Actual      Estimate
    ----------------------------------------------------------------------------------------------------------------
                              DIRECT LOAN OBLIGATIONS

    Agriculture:
      Agricultural Credit Insurance Fund Direct Loan Financing Account.........         910         899          944

    Commerce:
      Fisheries Finance Direct Loan Financing Account..........................          48          90            8

    Education:
      Historically Black College and University Capital Financing Direct Loan           216  ..........          100
       Financing Account.......................................................
      Loans for Short-Term Training Direct Loan Financing Account..............  ..........  ..........           46

    Homeland Security:
      Disaster Assistance Direct Loan Financing Account........................          25          25           25

    Housing and Urban Development:
      FHA-General and Special Risk Direct Loan Financing Account...............          50          50           50
      FHA-Mutual Mortgage Insurance Direct Loan Financing Account..............          50          50           50

    State:
      Repatriation Loans Financing Account.....................................           1           1            1

    Transportation:
      Railroad Rehabilitation and Improvement Direct Loan Financing Account....  ..........  ..........          600

    Treasury:
      Community Development Financial Institutions Fund Direct Loan Financing             8          16            6
       Account.................................................................

    Veterans Affairs:
      Vocational Rehabilitation Direct Loan Financing Account..................           2           3            3

    Small Business Administration:
      Business Direct Loan Financing Account...................................          19          20           25
                                                                                ------------------------------------
        Total, limitations on direct loan obligations..........................       1,329       1,154        1,858
                                                                                ------------------------------------

                             LOAN GUARANTEE COMMITMENTS

    Agriculture:
      Agricultural Credit Insurance Fund Guaranteed Loan Financing Account.....       2,153       2,526        2,497

    Education:
      Loans for Short-Term Training Guaranteed Loan Financing Account..........  ..........  ..........          316

    Energy:
      Title 17 Innovative Technology Guaranteed Loan Financing Account.........       4,000  ..........       38,500

    Housing and Urban Development:
      Indian Housing Loan Guarantee Fund Financing Account.....................         251         367          350
      Title VI Indian Federal Guarantees Financing Account.....................          18          12           17
      Native Hawaiian Housing Loan Guarantee Fund Financing Account............          36          41  ...........
      Community Development Loan Guarantees Financing Account..................         131         200  ...........
      FHA-General and Special Risk Guaranteed Loan Financing Account...........      45,000      45,000       35,000
      FHA-Mutual Mortgage Insurance Guaranteed Loan Financing Account..........     185,000     185,000      185,000

    Interior:
      Indian Guaranteed Loan Financing Account.................................          87          86           85

    Transportation:
      Minority Business Resource Center Guaranteed Loan Financing Account......          18          18           18
      RRIF Guaranteed Loan Financing Account...................................  ..........  ..........          100

    International Assistance Programs:
      Development Credit Authority Guaranteed Loan Financing Account...........         700         700          700

    Small Business Administration:
      Business Guaranteed Loan Financing Account...............................      20,506      28,000       28,000
                                                                                ------------------------------------
        Total, limitations on loan guarantee commitments.......................     257,900     261,950      290,583
                                                                                ====================================

             ADDENDUM: SECONDARY GUARANTEED LOAN COMMITMENT LIMITATIONS

    Housing and Urban Development:
      Guarantees of Mortgage-backed Securities Financing Account...............     200,000     200,000      200,000
    Small Business Administration:
      Secondary Market Guarantees..............................................      12,000      12,000       12,000
                                                                                ------------------------------------
        Total, limitations on secondary guaranteed loan commitments............     212,000     212,000      212,000
    ----------------------------------------------------------------------------------------------------------------
    \1\ Data represent loan level limitations enacted or proposed to be enacted in appropriation acts. For
      information on actual and estimated loan levels supportable by new subsidy budget authority requested, see
      Tables 7-3 and 7-4.

    [[Page 103]]

           Table 7-8.  FACE VALUE OF GOVERNMENT-SPONSORED LENDING \1\
                            (In billions of dollars)
    ------------------------------------------------------------------------
                                                               Outstanding
                                                           -----------------
                                                              2006     2007
    ------------------------------------------------------------------------

               Government Sponsored Enterprises

    Fannie Mae \2\........................................    2,528      N/A
    Freddie Mac \3\.......................................    1,543      N/A
    Federal Home Loan Banks...............................      621      824
    Farm Credit System....................................      105      111
    ------------------------------------------------------------------------
    Total.................................................    4,797      N/A
    ------------------------------------------------------------------------
    N/A = Not available.
    \1\ Net of purchases of federally guaranteed loans.
    \2\ 2007 financial data for Fannie Mae are not presented here because
      Fannie Mae audited financial results for 2007 have not been released.
    \3\ 2007 financial data for Freddie Mac are not presented here because
      Freddie Mac audited financial results for 2007 have not been released.

    [[Page 104]]

      Table 7-9.  LENDING AND BORROWING BY GOVERNMENT-SPONSORED ENTERPRISES
                                   (GSEs) \1\
                            (In millions of dollars)
    ------------------------------------------------------------------------
                             Enterprise                              2007
    ------------------------------------------------------------------------

                               LENDING

    Federal National Mortgage Association: \2\
      Portfolio programs:
        Net change..............................................         N/A
        Outstandings............................................         N/A
      Mortgage-backed securities:
        Net change..............................................         N/A
        Outstandings............................................         N/A

    Federal Home Loan Mortgage Corporation: \3\
      Portfolio programs:
        Net change..............................................         N/A
        Outstandings............................................         N/A
      Mortgage-backed securities:
        Net change..............................................         N/A
        Outstandings............................................         N/A

    Farm Credit System:
      Agricultural credit bank:
        Net change..............................................       1,712
        Outstandings............................................      30,475
      Farm credit banks:
        Net change..............................................       4,764
        Outstandings............................................      80,949
      Federal Agricultural Mortgage Corporation:
        Net change..............................................       1,303
        Outstandings............................................       8,362

    Federal Home Loan Banks: \4\
      Net change................................................     173,108
      Outstandings..............................................     916,963

    Less guaranteed loans purchased by:
      Federal National Mortgage Association: \2\
        Net change..............................................         N/A
        Outstandings............................................         N/A
      Other:
        Net change..............................................         N/A
        Outstandings............................................         N/A

                              BORROWING

    Federal National Mortgage Association: \2\
      Portfolio programs:
        Net change..............................................         N/A
        Outstandings............................................         N/A
      Mortgage-backed securities:
        Net change..............................................         N/A
        Outstandings............................................         N/A

    Federal Home Loan Mortgage Corporation: \3\
      Portfolio programs:
        Net change..............................................         N/A
        Outstandings............................................         N/A
      Mortgage-backed securities:
        Net change..............................................         N/A
        Outstandings............................................         N/A

    Farm Credit System:
      Agricultural credit bank:
        Net change..............................................       1,889
        Outstandings............................................      34,736
      Farm credit banks:
        Net change..............................................       5,828
        Outstandings............................................     100,204
      Federal Agricultural Mortgage Corporation:
        Net change..............................................         490
        Outstandings............................................       5,044
    Federal Home Loan Banks: \4\
      Net change................................................     192,621
      Outstandings..............................................   1,136,660

    [[Page 105]]

                           DEDUCTIONS \5\

    Less borrowing from other GSEs:
      Net change................................................         N/A
      Outstandings..............................................         N/A

    Less purchase of Federal debt securities:
      Net change................................................         N/A
      Outstandings..............................................         N/A

    Federal National Mortgage Association:
      Net change................................................         N/A
      Outstandings..............................................         N/A

    Other:
      Net change................................................         N/A
      Outstandings..............................................         N/A
    ------------------------------------------------------------------------
    N/A = Not available.

    \1\ The estimates of borrowing and lending were developed by the GSEs
      based on certain assumptions that are subject to periodic review and
      revision and do not represent official GSE forecasts of future
      activity, nor are they reviewed by the President. The data for all
      years include programs of mortgage-backed securities. In cases where a
      GSE owns securities issued by the same GSE, including mortgage-backed
      securities, the borrowing and lending data for that GSE are adjusted
      to remove double-counting.

    \2\ Financial data for Fannie Mae are not presented here because audited
      financial results for 2007 have not been released.

    \3\ Financial data for Freddie Mac are not presented here because
      audited financial statements for 2007 have not been released.

    \4\ The net change in borrowings is derived from the difference in
      borrowings between 2007 and the Federal Home Loan Banks' audited
      financial statements of 2006.

    \5\ Totals and subtotals have not been calculated because a substantial
      portion of the total is unavailable as described above.