Rural Housing Service: Overview of Program Issues (10-MAR-05,	 
GAO-05-382T).							 
                                                                 
The rural America of 2005 is far different from the rural America
of the 1930s, when the federal government first began to provide 
housing assistance to rural residents. Advances in		 
transportation, computer technology, and telecommunications,	 
along with the spread of suburbia, have linked many rural areas  
to urban areas. These changes, along with new fiscal and budget  
realities, raise questions about how Rural Housing Service (RHS) 
programs could most effectively and efficiently serve rural	 
America.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-382T					        
    ACCNO:   A19037						        
  TITLE:     Rural Housing Service: Overview of Program Issues	      
     DATE:   03/10/2005 
  SUBJECT:   Eligibility criteria				 
	     Eligibility determinations 			 
	     Federal grants					 
	     Internal controls					 
	     Loans						 
	     Low income housing 				 
	     Population statistics				 
	     Program evaluation 				 
	     Program management 				 
	     Rental housing					 
	     Rural housing programs				 
	     RHS Multifamily Direct Rural Rental		 
	     Housing Loans Program				 
                                                                 
	     RHS Multifamily Housing Farm Labor Loans		 
	     Program						 
                                                                 
	     RHS Section 521 Rental Assistance			 
	     Program						 
                                                                 

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GAO-05-382T

United States Government Accountability Office

GAO Testimony

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

For Release on Delivery

Expected at 2:00 p.m. EST RURAL HOUSING

Thursday, March 10, 2005

                                    SERVICE
                           Overview of Program Issues

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

GAO-05-382T

March 10, 2005

RURAL HOUSING SERVICE

Overview of Program Issues

[IMG]

What GAO Found

This testimony is based on a report on how RHS determines which areas are
eligible for rural housing programs, three reports on RHS's rental
assistance budgeting and distribution processes, and a report we are
releasing today on internal control issues with RHS's loans and grants
databases. GAO found that while RHS has significantly improved the housing
stock in rural America and has made progress in addressing problems,
several issues prevent the agency from making the best use of resources.
Specifically:

o  	Statutory requirements for program eligibility, including those
related to metropolitan statistical areas (MSA), "grandfathering"
communities, and demonstrating a "serious lack of mortgage credit," are of
marginal utility. For example, using density measures rather than MSAs
might allow RHS to better differentiate urban and rural areas, and phasing
out the "grandfathering" of communities could better ensure that RHS makes
more consistent eligibility determinations.

o  	RHS has consistently overestimated its rental assistance budget needs
by using higher inflation rates than recommended by the Office of
Management and Budget and incorrectly applying those rates. Also RHS
lacked sufficient internal controls to adequately monitor the use of
rental assistance funds, particularly for fund transfers and income
verifications. RHS has been taking actions that should correct many of the
rental assistance shortcomings GAO identified.

o  	GAO found incorrect, incomplete, and inconsistent entries in RHS's
loans and grants databases. Until RHS can demonstrate that its system edit
functions or other design features can ensure the accuracy of data in its
databases, second-party review is necessary to meet internal control
standards.

                 Statutory Requirements Can Impede Eligibility

Source: GAO analysis of Census data.

                 United States Government Accountability Office

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss the management of Rural Housing
Service (RHS) programs and our examinations of agency efforts. 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 $500
million in rental assistance payments each year. However, the rural
America of 2005 is different from the rural America of the 1930s, when the
federal government first began to provide housing assistance to rural
residents. Advances in transportation, computer technology, and
telecommunications, along with the spread of suburbia, have linked many
rural to urban areas and blurred distinctions between them. Yet the need
for decent, safe, and affordable low-income housing remains strong in
rural areas. The changing face of rural America, advances in technology
affecting program administration, and new fiscal and budget realities
raise questions about how RHS programs could most effectively and
efficiently serve rural Americans.

Thus, my principle objective today is to present an overview of issues you
may want to consider as you deliberate on how to best improve housing
services for rural Americans.

This statement is primarily based on reports we did for this Subcommittee
as well as for the Ranking Minority Member of the Subcommittee on
Agriculture, Rural Development, and Related Agencies, Senate Committee on
Appropriations:

o  	a December 2004 report on how RHS determines which areas are eligible
for rural housing programs;1

1GAO, Rural Housing: Changing the Definition of Rural Could Improve
Eligibility Determinations, GAO-05-110 (Washington, D.C.: Dec. 3, 2004).

o  	three previous reports on RHS's rental assistance budgeting and
distribution processes;2 and

o  	a report we are releasing today addressed to the RHS Administrator
that describes errors in, and internal control issues for, RHS's loans and
grants databases.3

Finally, I will provide a few comments addressing the recently completed
Comprehensive Property Assessment, which RHS initiated in response to our
May 2002 study on long-term needs in the Section 515 multifamily housing
program.4

In summary, while RHS has significantly improved the housing stock in
rural America and RHS management has made progress in addressing problems
we have identified in the past, several issues still prevent the agency
from making the best use of its resources.

o  	Statutory requirements for program eligibility may not reflect changes
in rural areas or best determine which areas qualify for RHS housing
programs. Specifically, we found the statutory requirements relating to
metropolitan statistical areas (MSA), the ability to "grandfather"
eligibility, and demonstration of a serious lack of mortgage credit for
low-and moderate-income families to be of marginal utility. Changes to
these requirements, such as using density measures rather than the
currently used MSA criterion, might allow RHS to better differentiate
urban and rural areas. Also, phasing out the "grandfathering" of
communities that experience changes in eligibility because of inclusion in
an MSA could better ensure that RHS more consistently makes eligibility
determinations for rural housing programs. Finally, "lack of credit" does
not appear to be as great a challenge to rural Americans gaining access to
affordable housing as lack of income or the inability to repay loans. RHS
already

2GAO, Rural Housing Service: Updated Guidance and Additional Monitoring
Needed for Rental Assistance Distribution Process, GAO-04-937 (Washington,
D.C.: Sept. 13, 2004); Rural Housing Service: Agency Has Overestimated Its
Rental Assistance Budget Needs over the Life of the Program,GAO-04-752
(Washington, D.C.: May 20, 2004); and Rural Housing Service:
Standardization of Budget Estimation Processes Needed for Rental
Assistance Programs, GAO-04-424 (Washington, D.C.: Mar. 25, 2004).

3GAO, Information Resource Management Internal Control Issues, GAO-05-288R
(Washington, D.C.: Mar. 10, 2005).

4GAO, Multifamily Rural Housing: Prepayment Potential and Long-Term
Rehabilitation Needs for Section 515 Properties, GAO-02-397 (Washington,
D.C.: May 10, 2002).

targets its programs and services, based on income, to areas and
populations of greatest need. As a result, the "lack of credit"
requirement does not appear necessary to appropriately determine program
eligibility.

o  	Weaknesses in RHS's budget estimation and oversight of rental
assistance funds increase the risk that the agency is not efficiently or
appropriately allocating resources. We found that RHS had consistently
overestimated its budget needs for rental assistance contracts in its
Section 521 program by using higher inflation rates than recommended and
incorrectly applying those rates. Using and correctly applying the
inflation rates provided by the Office of Management and Budget (OMB)
would help the agency more accurately estimate its rental assistance
needs. Additionally, RHS lacked sufficient internal controls to adequately
monitor the use of rental assistance funds, particularly in its funds
transfer processes, methodology for supervisory reviews, and tenant income
verification processes. Establishing centralized guidance on transferring
unused rental assistance, improving sampling methods in the tenant file
review process, and improving processes for verifying tenant information
could help ensure that these funds are being effectively administered and
used. Also, making a statutory change to give RHS access to the Department
of Health and Human Services' National Directory of New Hires, which
provides recent nationwide data on wages, could help the agency verify
tenant income information. RHS has recently moved on a number of fronts to
correct the many rental assistance program shortcomings identified in our
reports. While it is too early for us to fully review the impact of these
changes, we believe that changes in how rental assistance budgets are
estimated and the application or strengthening of internal controls,
consistent with our recommendations, would result in greater efficiency
and resource savings in this pivotal program.

o  	Although RHS has worked to improve its management information systems,
we found incorrect, incomplete, and inconsistent entries in its loans and
grants databases, and the system "edit" functions do not appear to flag or
correct these errors. Further, RHS does not have a process to review these
databases for accuracy. Additional internal control measures could ensure
more accurate data entry and reporting, particularly at the field office
level, and such an effort could ensure that RHS' investment in system
upgrades would provide more meaningful and useful information to the
agency itself, Congress, and the public.

o  	RHS recently contracted for a study called the Comprehensive Property
Assessment. The study was done to develop a baseline for assessing the
portfolio's physical and financial condition. Its principal findings-that
RHS's multifamily housing portfolio is aging rapidly and property reserves

and cash flows do not appear sufficient for basic maintenance or longterm
rehabilitation needs-are consistent with our work in the area. The study
concludes that leveraging market-based solutions with traditional
approaches would provide a more cost-effective alternative to using only
federal dollars. It also concludes that while the solutions proposed will
cost more than current budget levels, delaying actions to address the
physical, fiscal, and market issues documented in the study could result
in even greater budget needs in the future.

                                   Background

The Housing Act of 1949 authorized new rural lending programs to farmers,
which were administered by RHS's predecessor, the Farmers Home
Administration, within the U.S. Department of Agriculture (USDA). RHS now
facilitates homeownership, develops rental housing, and promotes community
development through loan and grant programs in rural communities. Over the
decades, Congress changed the requirements for rural housing
eligibility-for example, by changing population limits- and rural housing
programs have evolved to serve low-and moderateincome people of all
occupations. The current definition of rural considers factors such as
whether an area is contained in an MSA, is "rural in character," and "has
a serious lack of mortgage credit for lower-and moderate-income families."

RHS's Section 521 Rental Assistance Program is the agency's largest
line-item appropriation, with an annual budget of more than $500 million.
The program provides rental subsidies for approximately 250,000 tenants
who pay no more than 30 percent of their income for rent (RHS pays the
balance to the property owner). The units in which the tenants live are
created through RHS's Section 515 Multifamily Direct Rural Rental Housing
Loans and Section 514 Multifamily Housing Farm Labor Loans programs. The
Section 515 and 514 programs provide developers loans subsidized with
interest rates as low as 1 percent to help build affordable rental housing
for rural residents and farm workers.

Some Eligibility Requirements for RHS Programs Can Result in Similar Areas
Receiving Dissimilar Treatment

RHS staff determine which areas are eligible for RHS housing programs by
interpreting statutory requirements and agency guidance; however, their
determinations involve judgment and may be open to question. Additionally,
some eligibility requirements often result in areas with similar
characteristics receiving different designations. For example, the
requirement that an eligible area cannot be part of an MSA often results
in ineligibility for what appears to be a rural area. Also, the "lack of
credit" in rural areas remains an eligibility requirement, even though
USDA has reported that a lack of income and ability to pay the mortgage
appear to be the greater problems than a lack of credit for rural
Americans.

While Statute and Guidance Help RHS Staff, Determinations of Eligibility
Require Judgment and Can Be Problematic

Section 520 of the Housing Act of 1949, as amended, defines rural for most
RHS housing programs. Using the statute and instructions promulgated by
the national office, state and local (together, field) offices determine
the boundaries to delineate eligible areas from ineligible areas-a task
field office officials acknowledged is time-consuming, based on judgment,
and can be problematic.5 The statutory definition generally identifies
eligible rural areas as those with populations up to 20,000 and defines
"rural" and "rural areas" as any open country or any place, town, village,
or city that is not part of or associated with an urban area.

Specifically, there are several population levels at which communities may
be determined eligible, but as a community's population increases, the
statute imposes additional requirements that include being "rural in
character" (a concept that is not defined in the statute), having a
serious lack of mortgage credit, or not being located within an MSA.
Certain communities with populations above 10,000 but not exceeding 25,000
may be "grandfathered in," based on prior eligibility if they still met
the "rural in character" and "lack of credit" criteria. USDA's
instructions give its field offices flexibility in implementing the
statute. Field office officials said that drawing the eligibility
boundaries required an element of judgment because "rural in character" is
open to interpretation-even with the overall national guidance on the
statute and review of census populations, MSA standards, maps, aerial
photographs, and visits to communities.

Even when local supervisors fully understand the local conditions and
rural character of an area, finding a way to equitably decide on a
boundary

5The definition of rural applies to most RHS housing programs. However,
two programs- farm labor housing loans and grants-do not require that
applicants live in rural areas.

is sometimes problematic. For instance, field staff in Maryland told us
that in response to December 2002 national guidance, they stopped using
natural features such as rivers or mountains as eligibility boundaries for
communities. Maryland now uses only roads. Figure 1 shows a new boundary,
a road that divides the eligible area on the left from the ineligible area
on the right. RHS local office officials told us that the "road only"
criteria forced them to find the nearest public road to a populated
section of Hagerstown, which happens to go through farmland. The result is
that apparently similar rural areas received different designations.

Figure 1: Road Serving as Eligible Area Boundary outside Hagerstown,
Maryland

Source: GAO.

Figure 2 shows an area in Brookside, Ohio, where the city line divides the
eligible from the ineligible area. The Maryland example illustrates that
using the only physical boundary available resulted in one piece of
farmland receiving a rural designation and the other not. The Brookside
example shows that using a political boundary also did not necessarily
result in a readily discernible urban-rural difference.

 Figure 2: City Line of Brookside, Ohio, Divides Eligible from Ineligible Area

                                  Source: GAO.

Eligibility Interpretations of Associations with Urban Areas May Be
Questionable

Our analysis of RHS eligible areas nationwide, compared with census data,
found approximately 1,300 examples where communities with populations at
or below 10,000 were within or contiguous with urban areas that had
populations of 50,000 or more. The statute states that eligible
communities cannot be a part of or associated with an urban area. Some
field staff determinations of eligibility in these cases might be
questionable as some of these communities, despite their low populations,
might not be considered rural, and thus, eligible.

For example, field staff told us that Belpre, Ohio, is eligible for RHS
programs because it meets both the population and "rural in character"
requirements. However, Belpre is contiguous with Parkersburg, West
Virginia, which has a population of more than 33,000 (see fig. 3).6 In
addition, the 2000 census considers Belpre, along with Parkersburg and
Vienna, West Virginia, as part of an urbanized area because its total
population exceeds 50,000. Although it is across the Ohio River from
Parkersburg, bridges have connected Belpre and Parkersburg for decades
and, according to a Belpre city employee, many people from Belpre work in
Parkersburg. Furthermore, most of Belpre has a population density of

6Parkersburg, West Virginia, is not an eligible area.

1,000 people or more per square mile, which the Census Bureau considers
"densely settled" and a measure of urbanization. For these reasons, it is
unclear whether Belpre meets the eligibility requirements.

Figure 3: Belpre, Ohio, Is Part of the Parkersburg, West Virginia-Ohio,
Urbanized Area

Sources: RHS and Census data.

Note: Area density levels are shown by census tract. Census tracts are
small, relatively permanent statistical subdivisions of a county or
statistically equivalent entity used to provide a stable set of
geographical units for presenting decennial census data.

Changing Some Eligibility Requirements Could Better Delineate Boundaries
for Urban-Rural Areas and Address Inconsistent Treatment of Similar
Communities

Changes to the way eligibility is defined might allow RHS to better
designate "rural" areas and treat communities with similar characteristics
more consistently. For instance, eliminating the MSA requirement and
"grandfathering" might help RHS better serve its clients. To illustrate,
we found rural communities with populations exceeding 10,000 that were
directly impacted by the MSA and "grandfather" restrictions. Because MSAs
are county-based and may contain both urban and rural areas, the MSA
restriction and the grandfathering of certain communities resulted in some
communities being eligible while others with similar demographic profiles
were ineligible.

We looked at two communities within the Bakersfield, California, MSA,
which is basically rural outside the environs of Bakersfield (see fig. 4).
Lamont was grandfathered because it lost eligibility when its population
went above 10,000 at the 1980 census. Taft's population was already over
10,000 prior to the 1980 census, so Taft was not eligible for
grandfathering. The right side of the figure shows what would happen if
MSAs and grandfathered eligibility were removed from the equation and a
densitybased system such as the Census Bureau's urbanized areas/urban
clusters were used to indicate changes in population.7 Taft would be in
its own urban cluster outside of the Bakersfield urbanized area, which
happens to include Lamont. Based on our visit, we believe this scenario,
where the more rural community would be the one eligible, is more in line
with the overall purpose of the legislation than the current situation.

7Census defines an urbanized area as a continuously built-up area with a
population of at least 50,000, comprising one or more places and adjacent
densely settled areas. An urban cluster consists of densely settled
territory that has at least 2,500 people but fewer than 50,000 people.

Figure 4: Taft, California, Could Be Eligible Under Density-based Criteria

Source: GAO analysis of Census data.

In another example, by eliminating the MSA criterion, RHS could review the
eligibility of Washington Court House and Circleville, Ohio, based on
population and rural character criteria. Additionally, using density-based
mapping could help RHS draw boundaries around these communities, which
although Census-designated as "urban clusters," still meet rural housing
program population requirements (see fig. 5).

Figure 5: Eliminating MSA Criterion Could Allow Circleville to Be
Considered for Eligibility

The statute imposes a requirement to demonstrate a serious lack of
mortgage credit for lower- and moderate-income families in communities
with populations of 10,001 to 25,000. RHS has a policy stating that a
serious lack of mortgage credit at rates and terms comparable with those
offered by the agency exists in all rural areas. However, a study by
USDA's Economic Research Service concluded that credit problems in rural
areas are primarily limited to sparsely populated or remote rural areas;
such communities generally do not fall into the population range specified
above. Many of the RHS officials and industry experts with whom we spoke
also saw the primary "credit" problem as lack of income rather than lack
of credit.

Additionally, eligibility requirements for RHS programs are based on
income levels. The agency uses funding set asides, funding allocations,
application reviews, and state-level strategic plans to determine areas
and populations of greatest need. As a result, RHS program activity
already is

                      Source: GAO analysis of Census data.

"Lack of Credit" Requirement Does Not Appear Central to Determining
Eligibility

Opportunities to Improve RHS Rental Assistance Budgeting and Allocation
Processes Exist

focused on income issues, and given RHS's blanket policy, the "lack of
credit" requirement is not central to determining participant eligibility.

We reported that weaknesses in RHS's budget estimation and oversight of
rental assistance funds had resulted in largely overestimated budget
levels and increased the risk that the agency was not efficiently or
appropriately budgeting and allocating resources. Additionally, RHS lacked
sufficient internal control to adequately monitor the disbursement of
rental assistance funds.

RHS Overestimated Budgets for Section 521 Program

In March 2004, we reported that since 1990, RHS had consistently
overestimated its budget needs for the rental assistance program. Concern
had arisen about this issue because in early 2003 RHS reported hundreds of
millions of dollars in unexpended balances tied to its rental assistance
contracts. Specifically, in estimating needs for its rental assistance
contracts, RHS used higher inflation factors than recommended, did not
apply the inflation rates correctly to each year of the contract, and
based estimates of future spending on recent high usage rather than
average rates.

First, the agency used inflation factors that were higher than those
recommended by OMB for use in the budget process. Second, RHS did not
apply its inflation rate separately to each year of a 5-year contract, but
instead compounded the rate to reflect the price level in the fifth year
and applied that rate to each contract year. The result was an inflation
rate that was more than five times the rate for the first year. For
example, using these two methods, RHS overestimated its 2003 budget needs
by $51 million or 6.5 percent. Third, RHS based its estimates of future
expenditure rates on recent maximum expenditures, rather than on the
average rates at which rental assistance funds were being expended.

Additionally, our analysis of rental assistance payment data showed that
the agency had overestimated its budget needs almost every year since
1990, the earliest year for which we gathered data. Where we were able to
obtain sufficient data from RHS, our analysis showed that if RHS had used
and correctly applied OMB inflation rates to its base per-unit rates, its
estimates would have been closer to actual expenditures (see fig. 6).

Figure 6: Actual and Estimated Rental Assistance Expenditures, Per-Unit,
Per-Year, 1990-2003 Dollar expenditure per-unit per-year

3,500

3,000

2,500

2,000

1,500

1,000

     1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

OMB-based estimate of RHS expenditure

RHS estimate of RHS expenditure

Actual RHS expenditure Source: GAO analysis of RHS data.

RHS Rental Assistance Program Was Not Adhering to Internal Control
Standards

We also reported that RHS was not adhering to internal control standards
regarding segregation of duties, rental assistance transfers, and tenant
income verification reviews.

A single employee within the agency was largely responsible for both the
budget estimation and allocation processes for the rental assistance
program. According to GAO internal control standards, key duties and
responsibilities need to be divided or segregated among different people
to

                                       8

reduce the risk of error or fraud.

8GAO, Standards for Internal Control in the Federal Government,
GAO-AIMD-00-21.3.1 (Washington, D.C.: November 1999).

Internal Control Issues Contribute to Errors in Loan and Grants Databases

Moreover, RHS did not have a comprehensive policy for transferring rental
assistance. As a result, insufficient guidance on the transfer process
limited RHS's ability to move unused rental assistance to properties that
had tenants with the greatest need.

Finally, because RHS conducts reviews infrequently and covers a small
percentage of tenant files, the agency cannot reasonably ensure that
tenants' income and assets, and ultimately rental assistance payments, are
adequately verified. RHS's national, state, and local offices share
responsibility for monitoring the rental assistance program, with the
local offices performing the primary supervisory review every 3 years.
These triennial supervisiory reviews are RHS's primary tool for detecting
misreporting of tenant income, which may result in unauthorized rental
assistance payments. But the shortcomings in the review process increase
the risk that RHS will provide rental assistance to tenants that may not
be eligible. Alternate methods of verifying tenant information, such as
internal database checks and wage matching, also have limited
effectiveness but could help improve internal control if properly designed
or implemented.

Today we are releasing a report addressed to the RHS Administrator on
internal control issues in the Information Resource Management (IRM)
databases. We issued the report as a follow-up to our work addressing the
definition of rural used for rural housing programs. During the earlier
review, we identified several issues that raised concerns about the
accuracy of the information in the IRM databases. For example, while we
originally intended to geocode (match) 5 years of the national RHS housing
loan and grant portfolio to specific communities, the time needed to
ensure the reliability of the data required us to limit much of our
analysis to five states.

In reviewing 29,000 records for five states we found incorrect,
incomplete, and inconsistent entries. For example, over 8 percent of the
community names or zip codes were incorrect. Additionally, inconsistent
spellings of community names distorted the number of unique communities in
the database. More than 400 entries lacked sufficient information (street
addresses, community names, and zip codes) needed to identify the
community to which the loan or grant had been made. As a result, some
communities served by RHS were double counted, others could not be
counted, and the ability to analyze the characteristics of communities
served was compromised.

Comprehensive Property Assessment Advocates Leveraged Solutions

Since these data form the basis of information used to inform Congress
(and the public) about the effectiveness of RHS programs, data accuracy is
central to RHS program management and the ability of Congress and other
oversight bodies to evaluate the agency and its programs. While the agency
has worked to improve its management information systems (for example,
since 2002, the agency has spent $10.3 million to improve its management
information systems including developing single and multifamily program
data warehouses which were designed to improve its reporting
capabilities), the system still relies upon information collected and
entered from field offices.

However, RHS does not have procedures for second-party review of the data
in IRM systems. Moreover, while the IRM databases have edit functions in
place that are intended to prevent the entry of nonconforming data (such
as the entry of a community name in a street address field), the functions
are not preventing incorrect or incomplete entries. Until RHS can
demonstrate that its edit functions or other data entry design features
can ensure the accuracy and completeness of the data in the IRM databases,
second-party review would be necessary.

Our 2002 report to this subcommittee on RHS's Section 515 multifamily
program concluded that with little new construction and limited prepayment
at that time, maintaining the long-term quality of the aging housing stock
in the program portfolio had become the overriding issue for the program.
We found that RHS did not have a process to determine and quantify the
portfolio's long-term rehabilitation needs. As a result, RHS could not
ensure that it was spending its limited funds as costeffectively as
possible, providing Congress with a reliable or wellsupported estimate of
what was needed to ensure the physical and fiscal "health" of the
multifamily portfolio, and prioritizing those needs relative to the
individual housing markets. We recommended that USDA undertake a
comprehensive assessment of long-term capital and rehabilitation needs for
the Section 515 portfolio. We also recommended that USDA use the results
of the assessment to set priorities for immediate rehabilitation needs and
develop an estimate for Congress on the amounts and types of funding
needed to deal with long-term needs.

In response to our recommendation, RHS commissioned a consulting firm to
assess the condition and rehabilitation needs of its multifamily
portfolio. RHS released the study in November 2004. The principal
findings-that the housing stock represented in the portfolio is aging
rapidly and that property reserves and cash flows are not sufficient for

Conclusions

basic maintenance or long-term rehabilitation needs-are in line with our
findings in 2002. The study concludes that continuing the status quo would
put undue stress on the rental assistance budget and proposes leveraged
solutions that combine market-based solutions with private-sector funding
as a more cost-effective alternative to using only federal dollars. In
addition, the study concludes that while its proposed solutions will cost
more than current budget levels, delaying actions to address the
portfolio's physical, fiscal, and market issues will result in even
greater budget needs in the future.

RHS has made progress in improving program management over the past few
years. For example, when we began our work on the multifamily loan program
in June 2001, agency officials could not provide us with the number of
properties in the portfolio or a list of where properties were located.
Today, with the exception of some database errors we pointed out that RHS
officials have committed to correct, RHS knows where its multifamily
properties are located and has developed a revitalization strategy to deal
with the physical, fiscal, and market issues identified. However, the
agency still faces challenges in areas that include the basic question of
how best to determine what areas are rural, how to best manage rental
assistance (the largest budget item in RHS), and how to ensure that data
entered into management information systems are accurate. Despite these
challenges, opportunities exist to provide more flexibility and improve
existing processes that could better help RHS serve its clients while
responding to the challenges of current fiscal and budget realities.

For example, while determining what areas are eligible for rural housing
programs will always require an element of judgment, several changes to
the current eligibility requirements could help RHS make more consistent
eligibility determinations. If MSAs were removed from the eligibility
criteria, RHS officials could make determinations for more communities
based on population data and "rural character." And, using an alternative
measure such as the Census Bureau's urbanized areas and urban cluster
classifications as a guide could help RHS better draw boundaries around
rural areas, because the density-based measures provide finer-scale
information. Additionally, eligible communities within MSAs would not need
to be "grandfathered" based on previous eligibility, a provision which
essentially gives these communities an advantage over similar though
ineligible towns located in MSAs. Finally, the "lack of credit"
requirement could be removed with no detriment to RHS housing programs.

We noted further opportunities for improvement in RHS's largest
program-the rental assistance program, which has an annual budget of over
$500 million and provides rental subsidies to about 250,000 rural tenants.
Problems with its budget estimating processes caused the agency to
consistently overstate its spending needs, resulting in hundreds of
millions of dollars in unexpended balances. Consistently overstating
funding needs for one program also undermines the congressional budget
process by making funds unavailable for other programs. In addition, RHS's
internal controls had not provided reasonable assurance that rental
assistance resources were being used effectively. We questioned whether
internal control weaknesses were preventing rental assistance funds from
going to properties with the neediest tenants. RHS has recently moved on a
number of fronts to correct the many rental assistance program
shortcomings identified in our reports. For example, RHS has told us that
it will follow OMB budget estimation guidance, that it is correcting the
program's segregation of duty issues, has issued standardized guidelines
on rental assistance transfers, and is revamping its supervisory review
process. While it is too early for us to fully review the impact of these
changes, we believe that changes in how rental assistance budgets are
estimated and the application or strengthening of internal controls,
consistent with our recommendations, would result in greater efficiency
and resource savings in this pivotal program.

Finally, in reviewing RHS property data for selected states, we identified
various errors that raise questions about the accuracy of agency's data.
Although the agency is making efforts to improve its data systems, our
findings suggest additional measures could ensure more accurate data entry
and reporting, particularly at the field level. In addition to improving
the accuracy of the information, such an effort could ensure that RHS's
investment in system upgrades would provide more meaningful and useful
information to the agency itself, Congress, and the public.

Matters for To improve eligibility determinations in rural housing
programs, we

suggested that Congress may wish to consider eliminating the MSA
Congressional criterion, recommending that RHS use density measures as a
basis for its Consideration eligibility decisions, phasing out the
practice of "grandfathering"

communities, and eliminating the "lack of credit" requirement.

To help the agency verify tenant information, we also suggested that the
Congress consider giving RHS access to the Department of Health and Human
Services' National Directory of New Hires (New Hires), which includes
centralized sources of state wage, unemployment insurance, and

Recommendations for Executive Action

Agency Comments

new hires data for all 50 states, and it would provide nationwide data for
wage matching. Congress already granted HUD the authority to request and
obtain data from New Hires in January 2004, and as part of its initiative
to reduce improper rent subsidies for its rental assistance program, HUD
is making New Hires information available to public housing authorities
who are responsible for, among other things, verifying tenant income and
calculating rent subsidies correctly. HUD plans to make the data from the
new hires database available to property owners by fiscal year 2006.

To more accurately estimate rental assistance budget needs, we recommended
that the Secretary of Agriculture require program officials to use and
correctly apply the inflation rates provided by OMB in its annual budget
estimation processes.

To ensure that rental assistance funds are effectively distributed to
properties that have tenants with the greatest need, we recommended that
the Secretary of Agriculture require program officials to establish
centralized guidance on transferring unused rental assistance, improve
sampling methods to ensure a sufficient number of tenant households are
selected for supervisory reviews, and improve tenant verification of
information, including more effective use of alternate methods of income
verification.

To improve data entry and accuracy, we recommend that RHS formally advise
field staff to establish a second-party review of data in the IRM
databases are accurate and complete, require correction of errors in
existing information, and ensure that system edit functions are properly
functioning.

USDA generally agreed with our matters for congressional consideration,
stating that our report on eligibility articulates how the use of MSAs has
resulted in disparate treatment of some communities. USDA added that
applying a density-based measure might have merit but that further study
would be needed to properly define such a measure for nationwide
application. We concur with this position. In addition, USDA stated that
the "lack of credit" requirement could be removed with no detriment to RHS
housing programs. USDA initially disagreed with our finding that its
rental assistance budget estimates were too high, questioning whether we
demonstrated that using inflation rate projections from the President's
Budget would provide a more accurate budget estimate. However, USDA

has now reported that it will adopt OMB estimates, and it appears that RHS
now agrees with our report findings. USDA also generally agreed with most
of our recommendations on monitoring and internal controls. RHS has
recently issued regulations and an asset management handbook on
transferring unused rental assistance and expanded guidance on income
verification. Also, it appears that RHS is acting on our recommendation to
improve sampling methods to ensure a sufficient number of tenant
households are selected for supervisory reviews; that is, the agency has
informed us that it is revamping that process. Finally, the RHS
Administrator has generally agreed to implement our recommendations on the
IRM databases.

Contacts and Acknowledgements

(250241)

Mr. Chairman, this concludes my statement. I would be pleased to respond
to any questions you or members of the Subcommittee may have.

For more information regarding this testimony, please contact William B.
Shear at (202) 512-4325 or [email protected] or Andy Finkel at (202) 5126765
or [email protected]. Individuals making key contributions to this testimony
also included Martha Chow, Katherine Trimble, and Barbara Roesmann.

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