Rural Housing Service: Opportunities to Improve Management	 
(19-JUN-03, GAO-03-911T).					 
                                                                 
Federal housing assistance in rural America dates back to the	 
1930s, when most rural residents worked on farms. Without	 
electricity, telephone service, or good roads connecting	 
residents to population centers, residents were comparatively	 
isolated and their access to credit was generally poor. These	 
conditions led Congress to authorize separate housing assistance 
for rural residents, to be administered by USDA. Over time, the  
quality of the housing stock has improved and credit has become  
more readily available in rural areas. Also, advances in	 
transportation, computer technology, and telecommunications have 
diminished many of the distinctions between rural and urban	 
areas. These changes call into question whether rural housing	 
programs still need to be maintained separately from urban	 
housing programs, and whether RHS is adapting to change and	 
managing its resources as efficiently as possible.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-911T					        
    ACCNO:   A07284						        
  TITLE:     Rural Housing Service: Opportunities to Improve	      
Management							 
     DATE:   06/19/2003 
  SUBJECT:   Federal aid for housing				 
	     Rural housing programs				 
	     Internal controls					 
	     Cost control					 

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GAO-03-911T

Testimony Before the Subcommittee on Housing and Community Opportunity,
Committee on Financial Services, House of Representatives

United States General Accounting Office

GAO For Release on Delivery Expected at 2: 00 p. m. EDT Thursday, June 19,
2003 RURAL HOUSING

SERVICE Opportunities to Improve Management

Statement of William B. Shear, Acting Director Financial Markets and
Community Investment

GAO- 03- 911T

Our testimony is based on two reports addressed to this subcommittee* the
September 2000 report on rural housing options and May 2002 report on
multifamily project prepayment and rehabilitation issues. GAO found that
while RHS has helped many rural Americans achieve homeownership and has
improved the rural rental housing stock, it has been slow to adapt to
changes in the rural housing environment. Also, RHS has failed to adopt
the tools that could help it manage its housing portfolio more
efficiently. Specifically:  Dramatic changes in the rural housing
environment since rural housing

programs were first created raise questions as to whether separately
operated rural housing programs are still the best way to ensure the
availability of decent, affordable rural housing. Overlap in products and
services offered by RHS, HUD, and other agencies has created opportunities
for merging the best features of each. Even without merging RHS*s programs
with HUD*s or those of other agencies, RHS could increase its productivity
and lower its overall costs by centralizing its rural delivery structure.

 RHS does not have a mechanism to prioritize the long- term
rehabilitation needs of its multifamily housing portfolio. As a result,
RHS cannot be sure it is spending limited rehabilitation funds as
effectively as possible and cannot tell Congress how much funding it will
need in the future. Federal housing assistance in rural

America dates back to the 1930s, when most rural residents worked on
farms. Without electricity,

telephone service, or good roads connecting residents to population
centers, residents were comparatively isolated and their access to credit
was generally poor. These conditions led Congress to authorize separate
housing assistance for rural residents, to be administered by USDA. Over
time, the quality of the

housing stock has improved and credit has become more readily available in
rural areas. Also, advances in transportation, computer technology, and
telecommunications have

diminished many of the distinctions between rural and urban areas.

These changes call into question whether rural housing programs still need
to be maintained separately from urban housing programs, and whether RHS
is

adapting to change and managing its resources as efficiently as possible.

www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 911T. To view the full product,
click on the link above. For more information, contact William B. Shear at
(202) 512- 4325 or shearw@ gao. gov. Highlights of GAO- 03- 911T, a
testimony

before the Subcommittee on Housing and Community Opportunity, Committee on
Financial Services, U. S. House of Representatives

June 19, 2003

RURAL HOUSING SERVICE

Opportunities to Improve Management

Page 1 GAO- 03- 911T

Mr. Chairman and Members of the Subcommittee: I am pleased to be here
today to discuss the management of Rural Housing Service (RHS) programs.
RHS makes a significant investment in affordable housing for low- income
rural Americans through a variety of direct and

guaranteed loan and grant programs. RHS manages a single- family and
multifamily direct loan portfolio of about $28 billion, oversees a program
that guarantees about $3 billion in single- family mortgages annually, and
administers over $700 million in rental assistance payments each year.

This statement is based on two reports addressed to this Subcommittee: our
September 2000 report on rural housing options and our May 2002 report on
multifamily project prepayment and rehabilitation issues. 1 I will also
briefly discuss the objectives of our ongoing work on RHS*s rental
assistance program. My principle objective today is to present an overview
of the concerns identified in our previous reports that you may want to
consider as you deliberate on how best to improve housing services for
rural Americans.

In summary, while RHS has significantly improved the quality of the
housing stock in rural America and has helped many rural Americans become
homeowners, it has been slow to adapt to changes in the rural housing
environment. In addition, it has not adopted the managerial tools that are
now available that would help it make better use of its housing portfolio
and limited budgetary resources. Specifically:

 First, dramatic changes in the rural housing environment since rural
housing programs were first created raise the question of whether
separately operated rural housing programs are still needed to best ensure
the availability of decent affordable rural housing. Overlap in the
products and services offered by RHS, the Department of Housing and Urban
Development (HUD), and other agencies opened up opportunities for merging
the best features of each program. But even

without merging the best features of RHS*s programs with the best features
of those of HUD or other agencies, RHS could increase its

1 Rural Housing: Options for Optimizing the Federal Role in Rural Housing
Development

(GAO/ RCED- 00- 241, September 15, 2000) and Multifamily Rural Housing:
Prepayment Potential and Long- Term Rehabilitation Needs for Section 515
Properties (GAO- 02- 397, May 10, 2002).

Page 2 GAO- 03- 911T

productivity and lower its overall costs by centralizing its rural
delivery structure.

 Second, RHS does not have a mechanism for prioritizing the long- term
rehabilitation needs of its multifamily portfolio. As a result, RHS cannot
be that sure that it is spending its limited rehabilitation funds as
effectively as possible and cannot tell Congress how much funding it will
need in the future.

The government has been providing housing assistance in rural areas since
the 1930s. At that time, most rural residents worked on farms, and rural
areas were generally poorer than urban areas. For example, in the 1930s
very few rural homes had electricity or indoor plumbing. Accordingly, the
Congress authorized housing assistance specifically for rural areas and
made USDA responsible for administering it. However, rural demographic and
economic characteristics have greatly changed over time. By the 1970s
virtually all rural homes had electricity and indoor plumbing. Today, less

than 2 percent of the nation*s population lives on farms, and advances in
transportation, technology, and communications have * or have the
potential to * put rural residents in touch with the rest of the nation.
The federal role has also evolved, with HUD, the Department of Veterans
Affairs (VA), and state housing finance agencies becoming significant
players in administering housing programs.

Homeownership in the United States is at an all- time high with 68 percent
of the nation*s households owning their own home. In rural areas, the
homeownership rate is even higher * 76 percent. However, according to the
Housing Assistance Council, affordability is the biggest problem facing
low- income rural households. Rural housing costs have increased and

income has not kept pace, especially for rural renters who generally have
lower incomes than owners. As a result, rural renters are more likely to
have affordability problems and are twice as likely as rural owners to
live in substandard housing.

Although the physical condition of rural housing has greatly improved over
time, it still lags somewhat behind that of urban housing. The most severe
rural housing quality problems are found farthest from the nation*s major
cities, and are concentrated in four areas in particular: the Mississippi
Delta, Appalachia, the Colonias on the Mexican border, and on Indian trust
land. Minorities in these areas are among the poorest and worst housed
groups in the nation, with disproportionately high levels of inadequate
housing conditions. Migrant farm workers in particular have difficulty
finding affordable, livable housing. The higher incidence of Background

Page 3 GAO- 03- 911T

housing quality problems, particularly in these four areas, offsets many
of the advantages of homeownership, including the ability to use homes as
investments or as collateral for credit.

USDA*s Farmers Home Administration managed rural housing programs and farm
credit programs until reorganization legislation split these functions in
1994. 2 Farm credit programs were then shifted to the new Farm Service
Agency. Housing programs were moved to the newly created RHS in the new
Rural Development mission area which was tasked with helping improve the
economies of rural communities. RHS currently employs about 5,500 staff to
administer its single family, multifamily, and community facilities
programs.

RHS*s homeownership programs provide heavily subsidized direct loans to
households with very low and low incomes, guaranteed loans to households
with low and moderate incomes, and grants and direct loans to low- income
rural residents for housing repairs. Multifamily programs provide direct
and guaranteed loans to developers and nonprofit organizations for new
rental housing that is affordable to low and moderate income tenants;
grants and loans to public and nonprofit agencies and to individual
farmers to build affordable rental housing for farm workers; housing
preservation grants to local governments, nonprofit organizations, and
Native American tribes; and rental assistance subsidies that are attached
to about half the rental units that RHS has financed. In addition, RHS
administers community facilities programs that provide

direct and guaranteed loans and grants to help finance rural community
centers, health care centers, child care facilities, and other public
structures and services. For fiscal year 2003, RHS received an
appropriation of $1.6 billion. Of this

amount, the largest share, $721 million, is for its rental assistance
program. Congress also authorized about $4.2 billion for making or
guaranteeing loans, primarily for guaranteeing single- family loans. 3 RHS
oversees an

2 Federal Crop Insurance Reform and Department of Agriculture
Reorganization Act of 1994, Pub. L. 103- 354 (1994). 3 Authorized dollar
amounts represent the expected private- sector loan levels guaranteed by
RHS as well as loans made directly by RHS during the year. Actual
appropriations are much lower because they cover the subsidy cost, not the
face value of the loans or guaranteed

loans. The subsidy cost is the estimated long- term cost to the government
of a direct or guaranteed loan calculated on a net present value basis,
excluding administrative costs. In fiscal year 2003, the $4.2 billion in
loan authorizations are estimated to require about $37 million in credit
subsidy costs.

Page 4 GAO- 03- 911T

outstanding single- family and multifamily direct loan portfolio of about
$28 billion. Table 1 lists RHS*s programs, briefly describes them, and
compares the spending for them in fiscal year 1999 with the spending for
them in fiscal years 1979 and 1994. The table also shows that, although
RHS*s single and multifamily guaranteed programs are relatively new, by
1999 RHS had guaranteed more single- and multifamily loans than it made
directly.

Table 1: Data on RHS*s Housing Programs Dollars in millions

RHS housing program Total

dollars spent, fiscal year

1979 Total

dollars spent, fiscal year

1994 Total

dollars spent, fiscal year

1999 Number of

households helped, fiscal

year 1999 Type of assistance

Single- Family Housing Direct Loans (sec. 502) $2,870.0 a $1,656.8 a
$966.9 a 15,600 Loans subsidized as low as 1 percent

interest Single- Family Housing Guaranteed Loans (sec. 502)

$725.9 a $2,980.0 a 38,600 No money down, no monthly mortgage insurance
loans

Single- Family Home Repair Grants and Loans (sec. 504)

$33.7 $52.7 $46.8 9,021 Grants for elderly and loans subsidized as low as
1 percent interest

Single- Family Housing Mutual Self- Help Grants (sec. 523)

$5.6 $12.8 $25.4 1,350 Grants to nonprofit and public entities to provide
technical assistance

Multifamily Direct Rural Rental Housing Loans (sec. 515)

$869.5 a $512.4 a $114.3 a 2,181 Loans to developers subsidized as low as
1 percent interest Multifamily Housing

Guaranteed Loans (sec. 538)

$74.8 a 2,540 Guaranteed loans for developing moderateincome apartments
Multifamily Housing Farm

Labor Grants and Loans (secs. 516/ 514) $68.8 $56.3 $33.2 622 Grants and
loans subsidized at 1 percent

interest Multifamily Housing Preservation Grants (sec. 533)

$23.0 $7.2 1,800 Grants to nonprofit organizations, local governments, and
Native American tribes, usually leveraged with outside funding Multifamily
Housing

Rental Assistance (sec. 521)

$423.0 $446.7 $583.4 42,000 Rental assistance to about one- half the
residents in RHS rental and farm labor units Source: Rural Housing:
Options for Optimizing the Federal Role in Rural Housing Development (GAO/
RCED- 00- 241, September 15, 2000). pp. 15- 16.

a Dollar amounts represents private- sector loan levels guaranteed by RHS
or loans made directly by RHS during the year. Actual federal outlays are
much lower because they cover the subsidy cost, not the face value of the
loans or guaranteed loans. The subsidy cost is the estimated long- term
cost to

the government of a direct or guaranteed loan calculated on a net present
value basis, excluding administrative costs.

Page 5 GAO- 03- 911T

While RHS administers its programs in rural areas, HUD, VA, and state
housing finance agencies provide similar programs nationwide, including
assistance to households that may be eligible for RHS programs in rural

areas. For example, RHS*s single- family loan guarantee program serves
moderate- income homebuyers as does the Federal Housing Administration*s
(FHA) much larger single- family insurance program. VA and most state
housing finance agencies also offer single- family loan programs. In the
multifamily area, HUD*s multifamily portfolio is similar to RHS*s
multifamily portfolio and HUD*s project- based section 8 program

operations parallel RHS*s rental assistance program. Further, in contrast
to RHS, HUD has more established systems for assessing the quality of its
multifamily portfolio through its Real Estate Assessment Center (REAC) and
for restructuring financing and rental assistance for individual
properties through its Office of Multifamily Housing Assistance
Restructuring (OMHAR). Given the diminished distinctions between rural and
urban areas today,

improvements in rural housing quality and access to credit, and RHS*s
increasing reliance on guaranteed lending and public/ private
partnerships, our September 2000 report found the federal role in rural
housing is at a crossroads. We listed arguments for and against
fundamentally changing the programs* targeting, subsidy levels, and
delivery systems, as well as merging RHS*s programs with HUD*s or other
agencies* comparable programs.

A number of arguments have been presented to support continuing RHS*s
housing programs separately from HUD and other agencies or for maintaining
a separate system for delivering these programs, including the following:

 Some rural residents need the close supervision offered by RHS local
offices because they do not have access to modern telecommunications or
other means of obtaining information on affordable housing opportunities;

 Rural borrowers often need a local service office familiar with their
situation in the first year of a loan; Changes in the Rural

Housing Environment Raise Questions About the Need to Maintain Separately
Operated Rural Housing Programs

Arguments For and Against Separately Operated Programs

Page 6 GAO- 03- 911T

 Rural areas could lose their federal voice in housing matters;  Rural
areas could lose the benefits of the lower rates and terms RHS*s

direct and guaranteed loan programs currently offer; and  HUD and other
potential partners have not focused on rural areas. Proponents of
arguments for merging RHS*s housing programs with other housing programs
or not maintaining a separate system for delivering housing programs in
rural areas present a different set of arguments:

 RHS*s field role has changed from primarily originating and servicing
direct loans to leveraging deals with partner organizations;

 In some states, local banks, nonprofit organizations, social workers,
and other local organizations are doing much of the front- line work with
rural households that was previously done by RHS staff;

 The thousands of RHS staff with local contacts could provide a field
presence for HUD, and other public partners, applying their leveraging and
partnering skills to all communities; and

 RHS and HUD could combine management functions for their multifamily
portfolios that are now provided under separate systems.

We also noted that without some prodding, the agencies are not likely to
examine the benefits and costs of merging as an option. As a first step
toward achieving greater efficiency, we suggested that the Congress
consider requiring RHS and HUD to explore the potential benefits of
merging similar programs, such as the single- family insured lending
programs and the multifamily portfolio management programs, taking
advantage of the best practices of each and ensuring that targeted
populations are not adversely affected.

Since we issued our report in September 2000, it appears that RHS and FHA
have shared some mutually beneficial practices. First, RHS*s singlefamily
guaranteed program plans to introduce its automated underwriting
capabilities through technology that FHA has already developed and has

agreed to share with RHS. Second, RHS, FHA, and VA have collaborated in
developing common reporting standards for tracking minority and firsttime
homeownership statistics. Third, we understand that there have been
discussions between RHS and HUD staff on developing a model to Actions
Taken to Share

Resources and Expertise

Page 7 GAO- 03- 911T

restructure RHS section 515 mortgages using techniques that HUD has
learned through restructuring similar HUD section 236 mortgages.

Our September 2000 report also identified a number of actions that RHS
officials and others have identified that could increase the efficiency of
existing rural housing programs, whether or not they are merged. I will
limit my discussion today to two issues that deal with RHS*s field
structure.

The first issue involves state delivery systems. When state Rural
Development offices were given the authority to develop their own program
delivery systems as part of the 1994 reorganization, some states did not
change, believing that they needed to maintain a county- based structure
with a fixed local presence to deliver one- on- one services to potential
homeowners. Other states tried innovative, less costly approaches to
delivering services, such as consolidating local offices to form district
offices and using traveling loan originators for single- family programs.
However, RHS has undergone a major shift in mission during the past few
years. RHS is still a lending agency like its predecessor, the Farmers
Home Administration, but it now emphasizes community development, and uses
its federal funding for rural communities to leverage more resources to
develop housing, community centers, schools, fire stations, health care
centers, child care facilities, and other community service buildings.
Some state Rural Development officials we spoke with

questioned the efficiency and cost- effectiveness of maintaining a
countybased field structure in a streamlined environment where leveraging,
rather than one- on- one lending, has become the focus of the work.

For example, the shift in emphasis from direct to guaranteed single-
family lending moved RHS from relying on a labor intensive loan generation
process to one that relies on private lenders to underwrite loans. When we
performed our audit work in 2000 we found that Mississippi, which
maintains a county- based Rural Development field structure, had more
staff and field offices than any other state but the next to lowest
productivity as measured by dollar program activity per staff member.
Ohio, however, which ranked fifth in overall productivity, operated at
less than one- fifth of Mississippi*s cost per staff member. We recognize
that it is more difficult to underwrite single- family loans in the
Mississippi Delta and other economically depressed areas than in rural
areas generally, and Mississippi does have a substantial multifamily
portfolio. Nevertheless, the number of field staff in Mississippi far
exceeded that in most other states. Ohio, whose loan originators were
based in four offices and traveled across the state with laptop computers,
ranked seventh in the dollar value Opportunities Exist to

Improve RHS Program Efficiencies

Page 8 GAO- 03- 911T

of single- family guaranteed loans made and fifth in the dollar amount per
staff member of direct loans made. Ohio had also done a good job of
serving all of its counties, while Mississippi had experienced a drop in
business in the counties where it had closed local offices. Ohio*s travel
and equipment costs had increased with the use of traveling loan
originators.

The Maine Rural Development office had also fundamentally changed its
operational structure, moving from 28 offices before the reorganization to
15 afterwards, and in 2000 it operated out of 3 district offices. The
state

director at the time, who had also headed the Farmers Home Administration
state office in the 1970s, said that he had headed the agency under both
models and believed the centralized system to be much more effective. He
added that under the new structure, staff could no longer sit in the
office waiting for clients to come to them but had to go to the clients.
He also maintained that a centralized structure was better suited to
building the partnerships with real estate agents, banks, and other
financial institutions that had become the core element of RHS*s work.

The second issue involves the location of field offices. Consistent with
its 1994 reorganization legislation, USDA closed or consolidated hundreds
of county offices and established *USDA service centers* with staff
representing farm services, conservation, and rural development programs.
However, the primary goal of the task team that designed the service
centers was to place all the county- based agencies together,

particularly those that dealt directly with farmers and ranchers, to
reduce personnel and overhead expenses by sharing resources. But while the
farm finance functions from the old Farmers Home Administration fit well
into the new county- based Farm Service Agency, the housing finance

functions that moved to the new state Rural Development offices were never
a natural fit in the centers. The decision to collocate Rural Development
and Farm Service offices was based on the fact that Rural Development had
a similar county- based field structure and the Department needed to fill
space in the new service centers. Collocating Rural Development and Farm
Service offices designed to serve farmers and ranchers makes less sense
today, especially in states where Rural Development operations have been
centralized.

Page 9 GAO- 03- 911T

How to deal with the long- term needs of an aging portfolio is the
overriding issue for section 515 properties. In the program*s early years,
it was expected that the original loans would be refinanced before major
rehabilitation was needed. However, with prepayment and funding
restricted, this original expectation has not been realized, and RHS does
not know the full cost of the long- term rehabilitation needs of the
properties it has financed. RHS field staffs perform annual and triennial
property inspections that identify only current deficiencies rather than
the long- term rehabilitation needs of the individual properties. As a
result, RHS does not know whether reserve accounts will cover long- term
rehabilitation needs. Without a mechanism to prioritize the portfolio*s
rehabilitation needs, including a process for ensuring the adequacy of
individual property reserve accounts, RHS cannot be sure it is spending
its limited rehabilitation funds as effectively as possible and cannot
tell Congress how much funding it will need to cover the portfolio*s long-
term rehabilitation costs.

RHS*s state personnel annually inspect the exterior condition of each
property financed under the section 515 program and conduct more detailed
inspections every 3 years. However, according to RHS guidelines, the
inspections are intended to identify current deficiencies, such as cracks
in exterior walls or plumbing problems. Our review of selected inspection
documents in state offices we visited confirmed that the inspections are
limited to current deficiencies. RHS headquarters and state officials
confirmed that the inspection process is not designed to determine and
quantify the long- term rehabilitation needs of the individual properties.

RHS has not determined to what extent properties* reserve accounts will be
adequate to meet long- term needs. According to RHS representatives,
privately owned multifamily rental properties often turn over after just 7
to 12 years, and such a change in ownership usually results in
rehabilitation

by the new owner. However, given the limited turnover and funding
constraints, RHS properties primarily rely on reserve accounts for their
capital and rehabilitation needs. RHS officials are concerned that the
section 515 reserve accounts often are not adequate to fund needed
rehabilitation.

RHS and industry representatives agree that the overriding issue for
section 515 properties is how to deal with the long- term needs of an
aging portfolio. About 70 percent of the portfolio is more than 15 years
old and

in need of repair. Since 1999, RHS has allocated about $55 million in
rehabilitation funds annually, but owners* requests for funds to meet RHS
Does Not Have a

Mechanism to Prioritize the LongTerm Rehabilitation Needs of Its
Multifamily Portfolio

Page 10 GAO- 03- 911T

safety and sanitary standards alone have totaled $130 million or more for
each of the past few years. RHS headquarters has encouraged its state
offices to support individual property owners interested in undertaking
capital needs assessments and has amended loan agreements to increase
their rental assistance payments as necessary to cover the future capital
and rehabilitation needs identified in the assessments. However, with

varying emphasis by RHS state offices and limited rental assistance
funding targeted for rehabilitation, the assessments have proceeded on an
ad hoc basis. As a result, RHS cannot be sure that it is spending these
funds as cost- effectively as possible.

To better ensure that limited funds are being spent as cost- effectively
as possible, we recommended that USDA undertake a comprehensive assessment
of the section 515 portfolio*s long- term capital and rehabilitation
needs, use the results of the assessment to set priorities for the
portfolio*s immediate rehabilitation needs, and develop an estimate for
Congress on the amount and types of funding required to deal with the
portfolio*s long- term rehabilitation needs. USDA agreed with the
recommendation and requested $2 million in the President*s 2003 budget to
conduct a comprehensive study. RHS staff drafted a request for

proposal that would have contracted out the study, but the Undersecretary
for Rural Development chose to lead the study himself. Plans are to
develop an inspection and rehabilitation protocol by February 2004 on the
basis of an evaluation of a sample of properties.

Finally, I would like to mention some work we have begun on the Section
521 rental assistance program. With an annual budget of over $700 million,
the rental assistance program is the largest line item appropriation to
the Rural Housing Service. This is a property- based subsidy that provides
additional support to units created through the Section 515 multifamily
and farm labor housing programs. RHS provides this subsidy to property
owners through 5- year contracts. The objectives for our current work are
to review (1) how RHS estimates the current and future funding needs of
its Section 521 rental assistance program; (2) how RHS allocates the
rental assistance; and (3) what internal controls RHS has established to
monitor the administration of the rental assistance program. We anticipate
releasing a report on our findings in February of 2004. GAO Is Examining

Rental Assistance Program Issues

Page 11 GAO- 03- 911T

Mr. Chairman, this concludes my prepared remarks. I would be pleased to
answer any questions you or any other members of the Committee may have.

For questions regarding this testimony, please contact William B. Shear on
(202) 512- 4325 or at shearw@ gao. gov, or Andy Finkel on (202) 512- 6765
or at finkela@ gao. gov. Individuals making key contributions to this
testimony included Emily Chalmers, Rafe Ellison, and Katherine Trimble.
Contact and

Acknowledgements

(250148)

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