[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.

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  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.

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  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

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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.

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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.

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

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                                      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

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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

[[Page 83]]

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

[[Page 84]]

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

[[Page 85]]

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.