Public Housing Subsidies: Revisions to HUD's Performance Funding System
Could Improve Adequacy of Funding (Letter Report, 06/19/98,
GAO/RCED-98-174).

Pursuant to a legislative requirement, GAO reviewed the Department of
Housing and Urban Development's (HUD) Performance Funding System (PFS)
for allocating appropriated funds to housing agencies as operating
subsidies, focusing on: (1) how PFS allocates the congressionally
appropriated subsidy among public housing agencies; (2) whether PFS
meets the subsidy needs of individual housing agencies; (3) how HUD's
budget estimates of housing agencies' annual need for operating
subsidies are developed and whether the estimates are appropriate; and
(4) some of the possible options that HUD might have for changing PFS to
make it a more effective tool for subsidizing housing agencies.

GAO noted that: (1) PFS allocates the congressional appropriation by
providing an operating subsidy to each housing agency based on that
agency's HUD-approved operating expenses during the base year 1975, less
its income, plus certain annual adjustments; (2) the adjusted base year
cost is known as the allowable expense level; (3) HUD did not develop
its allocation method on the basis of standards of housing needs because
it believed that reaching a consensus on these standards would have been
too difficult; (4) however, twice over the last 23 years, HUD developed
and used cost models based on specific factors directly related to the
operating costs of well-managed housing agencies, including the age and
height of buildings and the prevailing government wage rates; (5) the
operating subsidies that the PFS provides to housing agencies may not be
adequate for agencies with base year expenditures that were low or
agencies with operating circumstances or costs that have undergone
significant change since 1975; (6) although the PFS provides for annual
adjustments to account for inflation and the aging of public housing
stock, these increases might not have been enough for the agencies with
base year spending that did not adequately reflect their needs or those
with expenses that have increased more rapidly than HUD's allowed
adjustments; (7) GAO found that agencies have experienced significant
operational changes since 1975 that have affected their costs; (8) to
develop its budget estimate for the operating subsidies housing agencies
will need in a coming fiscal year, HUD estimates the needs of a
representative sample of housing agencies and projects this estimate to
the population of nearly 3,200 housing agencies; (9) inadequate
subsidies can be a serious problem for housing agencies that are highly
dependent on subsidies and need them to meet current obligations; (10)
HUD has several options for making PFS a more accurate and effective
funding tool; (11) in the past, information on physical housing
conditions, comparative costs, or other data needed to implement a cost
model has not been readily obtainable, and the cost of developing such
information for all agencies was believed to be high; and (12) data that
HUD is currently developing on housing agencies' financial and physical
conditions should be useful to HUD as it considers new ways of
allocating operating subsidies.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  RCED-98-174
     TITLE:  Public Housing Subsidies: Revisions to HUD's Performance 
             Funding System Could Improve Adequacy of Funding
      DATE:  06/19/98
   SUBJECT:  Public housing
             Low income housing
             Housing programs
             Subsidies
             Cost analysis
             Funds management
IDENTIFIER:  HUD Performance Funding System
             HUD Hope IV Program
             HUD Public Housing Drug Elimination Program
             HUD Comprehensive Grant
             
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Cover
================================================================ COVER


Report to the Subcommittee on VA, HUD, and Independent Agencies,
Committee on Appropriations, U.S.  Senate

June 1998

PUBLIC HOUSING SUBSIDIES -
REVISIONS TO HUD'S PERFORMANCE
FUNDING SYSTEM COULD IMPROVE
ADEQUACY OF FUNDING

GAO/RCED-98-174

Public Housing Subsidies

(385697)


Abbreviations
=============================================================== ABBREV

  FMR - fair market rent
  HABC - Housing Authority of Baltimore City
  HACLA - Housing Authority of the City of Los Angeles
  HAKC - Housing Authority of Kansas City
  HUD - Department of Housing and Community Development
  HOPEIV -
  IBS - Integrated Business System
  MDHA - Miami-Dade Housing Agency
  PFS - Performance Funding System
  PHMAP - Public Housing Management Assessment Program
  VA - Department of Veterans Affairs

Letter
=============================================================== LETTER


B-279576

June 19, 1998

The Honorable Christopher S.  Bond
Chairman
The Honorable Barbara A.  Mikulski
Ranking Minority Member
Subcommittee on VA, HUD, and Independent Agencies
Committee on Appropriations
United States Senate

In fiscal year 1998, the Congress appropriated $2.9 billion to
subsidize the operating costs of nearly 3,200 public housing
agencies.  Almost all housing agencies receive subsidies because the
rental income they collect from their residents is not sufficient to
cover the agencies' operating costs.  In a report on fiscal year 1998
appropriations--Departments of Veterans Affairs and Housing and Urban
Development, and Independent Agencies Appropriations Bill (Senate
Report 105-53)--the Senate Committee on Appropriations requested that
we study the Department of Housing and Urban Development's (HUD)
Performance Funding System (PFS) for allocating appropriated funds to
housing agencies as operating subsidies.  Under PFS, HUD determines
the reasonable expenses that it will allow each housing agency to
expend in managing its assets and serving its tenants and provides an
annual subsidy to cover the difference between these expenses and the
housing agency's projected income. 

To provide information to the Congress about HUD's administration of
PFS and to guide the revision of PFS anticipated in legislation
currently pending in the Congress, we agreed with the staff of the
Senate Committee on Appropriations' Subcommittee on VA, HUD, and
Independent Agencies to address the following questions in our study: 

  -- How does PFS allocate the congressionally appropriated subsidy
     among public housing agencies? 

  -- How well does PFS meet the subsidy needs of individual housing
     agencies? 

  -- How does HUD develop budget estimates of housing agencies'
     annual need for operating subsidies and are the estimates
     appropriate? 

  -- What are some of the possible options that HUD might have for
     changing PFS to make it a more effective tool for subsidizing
     housing agencies? 

To answer these questions, we relied on information from HUD; our
visits to four housing agencies in Los Angeles, California;
Baltimore, Maryland; Kansas City, Missouri; and Miami, Florida (see
apps.  I, II, III, and IV for summaries of our work at these housing
agencies); our analysis of HUD's application of its PFS methodology;
a database of public housing operating expenses for fiscal years
ending in 1992 through 1996 (see app.  V for a limited analysis of
several aspects of that database); and work we have completed or have
under way related to other formula-driven federal programs, including
Medicaid, the Older Americans Block Grant, the Law Enforcement Block
Grant, and Highway Grant Formulas. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

The Performance Funding System allocates the congressional
appropriation by providing an operating subsidy to each housing
agency based on that agency's HUD-approved operating expenses during
the base year 1975, less its income, plus certain annual adjustments. 
The adjusted base year cost is known as the "allowable expense
level." HUD did not develop its allocation method on the basis of
standards of housing needs because it believed that reaching a
consensus on these standards would have been too difficult.  However,
twice over the last 23 years, HUD developed and used cost models
based on specific factors directly related to the operating costs of
well-managed housing agencies, including the age and height of
buildings and the prevailing government wage rates.  HUD used a model
in 1975 to cap the allowable expenses of housing agencies that had
high base year expenditures, which would have resulted in the
agencies' being overfunded; in 1992, HUD used an updated model to
increase the expense levels of some agencies that were underfunded. 
In most years, the annual subsidy that HUD provides to most housing
agencies is the difference between an agency's prior year's allowable
expense level--adjusted for inflation, additions or deletions to its
housing stock, and an additional 0.5 percent to account for the aging
of the housing stock\1 --and the projected income from rent and other
sources. 

The operating subsidies that the Performance Funding System provides
to housing agencies may not be adequate for agencies with base year
expenditures that were low or agencies with operating circumstances
or costs that have undergone significant change since 1975.\2
Although the Performance Funding System provides for annual
adjustments to account for inflation and the aging of public housing
stock, these increases might not have been enough for the agencies
with base year spending that did not adequately reflect their needs
or those with expenses that have increased more rapidly than HUD's
allowed adjustments.  Furthermore, because housing agencies generally
have had little opportunity under the Performance Funding System to
appeal their allowable expense levels, those agencies that started
under the Performance Funding System with a low base year expense
level, or that have experienced significant expense growth, might now
be underfunded by the Performance Funding System.  We found that
agencies have experienced significant operational changes since 1975
that have affected their costs.  For example, at the four large
housing agencies we visited in Los Angeles, Baltimore, Kansas City,
and Miami, the Performance Funding System's relatively minor annual
adjustments to expense levels had not addressed greater changes in
operating circumstances. 

To develop its budget estimate for the operating subsidies housing
agencies will need in a coming fiscal year, HUD estimates the needs
of a representative sample of housing agencies and projects this
estimate to the population of nearly 3,200 housing agencies.  HUD
bases the projections on assumptions about income and expense
factors--such as utility rates, the income levels of residents, and
allowable expense levels--that it must make several years before it
allocates the funds appropriated by the Congress to housing agencies. 
In years when HUD's assumptions do not accurately reflect housing
agencies' aggregate income and expenses, inaccuracy in the subsidy
level might result and adjustment through a supplemental funding bill
might be needed.  Inadequate subsidies can be a serious problem for
housing agencies that are highly dependent on subsidies and need them
to meet current obligations.  In years when the congressional
appropriation is less than HUD's budget request, the Performance
Funding System reduces subsidies to all housing agencies by the same
proportional amount, regardless of the extent to which an agency
depends on the subsidy to meet its expenses. 

HUD has several options for making the Performance Funding System a
more accurate and effective funding tool.  Instead of relying on
historical costs that are two decades old, HUD could, as one of its
options, use an established cost model--such as the one it developed
in 1992 that relates operating conditions to expenditures--or a new
model that might base subsidies on what a basket of standard housing
services should cost at a specific housing agency.  A new model might
also be based on a reliable index of needs, such as the poverty rate
in specific census tracts.  In the past, information on physical
housing conditions, comparative costs, or other data needed to
implement a cost model has not been readily obtainable, and the cost
of developing such information for all agencies was believed to be
high.  However, data that HUD is currently developing on housing
agencies' financial and physical conditions should be useful to HUD
as it considers new ways of allocating operating subsidies.  Other
subsidy options include enhancing the current system with an appeals
mechanism whereby housing agencies would have the opportunity to
present significant information to justify increases in their
allowable costs, linking public housing subsidies to the cost of
operating privately owned low-income housing, and creating a block
grant to fund operating expenses.  A block grant would still require
a new formula be developed. 


--------------------
\1 From 1976 through 1986, HUD used a statistical formula to compute
changes in allowable expenses from year to year.  Now, to simplify
the Performance Funding System, it uses an adjustment factor of 0.5
percent in almost all cases. 

\2 HUD officials believe that some agencies could be receiving
subsidies that are more than adequate because their base year costs
were inordinately high; however, HUD officials do not have sufficient
information to determine how many agencies are receiving adequate or
inadequate subsidies. 


   BACKGROUND
------------------------------------------------------------ Letter :2

Under the Housing Act of 1937, as amended, the Congress created the
federal public housing program to assist communities in providing
decent, safe, and sanitary dwellings for low-income families. 
However, it was not until 1975 that HUD established a permanent
system known as the Performance Funding System (PFS) for subsidizing
public housing.  For years, the public housing program was
self-sufficient because it was open only to residents whose incomes
were high enough for them to be able to pay rents that would cover
operating costs.  The program began to move toward serving poorer
households with the Housing Act of 1949, which required incomes of
eligible households to be 20 percent below the income necessary to
rent decent private housing.  Also, during the 1950s and 1960s, the
average income of public housing tenants began to fall as the more
upwardly mobile households found affordable housing elsewhere.  By
1969, public housing had shifted to serving the poorest households,
those who had difficulty paying rents that were high enough to cover
the full costs of public housing operations. 

As a result, the Congress passed the Brooke Amendments, beginning in
1969, which limited the rent that tenants could be charged to 25
percent of their incomes\3 and authorized a program of federal
subsidies to pay for the operating costs that public housing agencies
could no longer meet with rental income alone.  By the mid-1970s,
rising subsidy costs, along with concern in the Office of Management
and Budget and the Congress that the system did not provide an
incentive for good management, led to the 1974 Housing Act mandating
that the Secretary of HUD establish a mechanism for subsidizing the
cost of providing public housing.  As a result, HUD developed PFS in
1975; since then, PFS has come under almost constant review in
efforts by HUD and others to find a more effective mechanism for
allocating congressional appropriations to housing agencies. 
Provisions in pending housing reform legislation would require HUD to
create a block grant to cover operating expenses and to develop a new
formula for allocating that grant. 


--------------------
\3 The Congress raised this to 30 percent in 1981. 


   HUD BASES SUBSIDIES ON 1975
   OPERATING COSTS AND USED COST
   MODELING TO ESTABLISH UPPER AND
   LOWER LIMITS
------------------------------------------------------------ Letter :3

After implementing PFS in 1975, HUD began allotting operating
subsidies to housing agencies on the basis of their costs in the base
year 1975.  Since then, HUD has adjusted the base year costs annually
for inflation and other factors to update the allowable costs of
operating public housing.  The subsidy that HUD provides is the
difference between a housing agency's income and these allowable
costs.  Although HUD did not base housing agencies' allowable
expenses on what it should cost to provide a standard set of housing
services, twice over the program's life the Department has used
quantitative cost models, based on two different sets of cost data,
to better define subsidy levels:  once at the outset to establish an
upper limit for allowable costs and again in 1992 to adjust some
agencies' costs that, according to the second cost model, were less
than 85 percent of their predicted levels.  HUD and its contractors
did not believe that the results of the statistical analysis provided
a standard of what agency expenses should be or need to be to
efficiently provide a commonly understood standard of service in
public housing. 


      HUD ALLOCATES SUBSIDIES ON
      THE BASIS OF 1975
      EXPENDITURES
---------------------------------------------------------- Letter :3.1

HUD implemented its system for subsidizing public housing agencies in
1975, basing it on the HUD-approved operating expense level incurred
by housing agencies that year.  HUD also developed a cost model,
called the "prototype equation," that was based on the costs of a
group of well-managed agencies.  The equation was used to predict
housing agencies' operating costs and to thereby establish a limited
range of costs within which HUD expected housing agencies to operate. 
HUD and the Urban Institute, which developed the model for HUD,
reported that the model did not produce an estimate of what housing
agencies should or need to spend for housing services.  Instead,
based on a set of five cost-related factors,\4 the model produced for
every agency a predicted, or prototype, expense level that could then
be compared with the actual expenditures that formed the subsidy's
basis.  HUD believed that this comparison showed which agencies had
spending that significantly exceeded the comparable expenses derived
from a group of well-managed agencies, after controlling for their
differences in the five factors. 

Without a method to establish what operating expenses are necessary
to provide some standard level of services--nor a method to define
what that standard level of services would consist of--HUD chose to
use each agency's actual operating expenses in 1975 as its standard
baseline amount, not including utility and audit expenses.\5 Since
then, the subsidy a housing agency receives each year is its prior
year's allowable expenses-- adjusted for (1) additions or deletions
to its housing stock, (2) inflation, and (3) an additional 0.5
percent to allow for higher costs associated with an aging housing
stock\6 --less the amount of rental and other income the housing
agency receives.  Thus, the PFS subsidy is the shortfall between an
agency's allowable expenses and its income.  In years when the
congressional appropriation has not been sufficient to cover the
shortfall, HUD has proportionally reduced each agency's subsidy to
conform to the amount appropriated. 


--------------------
\4 The factors described (1) the average number of bedrooms per
housing unit, (2) the age of the project's buildings, (3) the height
of the buildings, (4) the regional cost of operating housing agencies
(by HUD region), and (5) the population of the area served by the
agency. 

\5 HUD also determines an allowable utility expense level to be used
in the final calculation of the housing agency's operating subsidy. 

\6 The use of the 0.5-percent adjustment began in 1986.  Prior to
that, a cost model was used to compute annual changes for each
housing agency. 


      HUD DEVELOPED COST MODELS TO
      LIMIT ALLOWABLE COSTS AND
      LATER TO ADJUST SOME
      AGENCIES' ALLOWABLE COST
      LEVELS
---------------------------------------------------------- Letter :3.2

To develop the prototype equation, a 1975 study by the Urban
Institute identified certain operating characteristics of housing
agencies that were related to the agencies' operating expenditures. 
On the basis of operating performance and responses to
questionnaires, the study identified a group of local agencies
considered to be well managed at the time.  The Urban Institute used
these agencies' costs to identify five characteristics of a local
agency's housing operations that were directly related to operating
expenditures per housing unit, per month, called per unit-month
costs, and determined the relative impact of the characteristics on
the overall cost of operations.  On the basis of the Urban
Institute's study, HUD established an upper limit for expenses and
beginning in 1975 limited the growth in allowable expenses for
housing agencies that had expenses that significantly exceeded the
level predicted for them by the prototype equation.\7

In 1992, HUD implemented the results of a second study in a subsidy
review process mandated by the 1987 Housing and Community Development
Act.  This study's approach was similar to the Urban Institute's
approach.  It also identified five cost factors that were related to
local agencies' operating costs, but it used different factors and
drew on the past expense levels of a much larger sample of housing
agencies.\8 The act required this study, in part, to correct
inequities in the base year expense level, to accurately reflect
changes in operating circumstances, and to reflect the higher cost of
operating in an economically distressed unit of local government.  If
an agency's allowable expense level was less than 85 percent of the
amount calculated by the new PFS formula developed in the 1992 study,
the allowable expense level would be increased to the 85-percent
level.  At that time, this adjustment was expected to effect 868
housing agencies, most of which were small.  HUD believed that its
PFS formula was not sufficiently accurate to change agencies'
allowable costs that differed by less than 15 percent from the value
predicted by the formula.  A lower percentage would have been more
costly because it would have permitted more housing agencies to
increase their allowable costs.  Because the agencies that qualified
for the increase in allowable expenses were comparatively small, this
review added only 1.4 percent to the total federal subsidy for that
year. 

Although HUD's 1992 study related operating costs to certain
characteristics of a housing agency, HUD did not use the new formula
to establish specific allowable expense levels for all housing
agencies.  Instead, for most agencies, the allowable expense level
continued to be based on past actual costs.  HUD officials believed
that the 1992 cost model improved on the prototype equation in
several respects, but they still had concerns about whether the model
reflected all the important circumstances and conditions affecting
housing agencies' costs.  For example, none of the cost factors
accounted for the condition and quality of the housing stock.  In
addition, neither the Urban Institute's nor HUD's analysis controlled
for differences in the effect that varying maintenance practices
would have had on expenditures and on the varying physical condition
of agencies' housing stock.  Consequently, the studies' statistical
analyses simply reflect historical spending patterns rather than
differences in the cost conditions at different locations.  Moreover,
the spending patterns analyzed in 1992 might not have accurately
reflected the true costs of operating public housing because spending
had been limited since 1975 by housing agencies' available
revenue--the sum of the PFS subsidy and rental and other income. 


--------------------
\7 One study of the application of the cost model asserted that
constraining high-cost agencies was preferable to reducing program
costs by spending cuts across the board.  The agencies with the
highest spending after controlling for the five factors could be
viewed as having the greatest opportunity to reduce spending by
improved efficiency rather than by reducing services. 

\8 The five factors in the new study were (1) the number of pre-1940
rental units occupied by poor households in 1980 as a percentage of
the 1980 population of the community; (2) the local government wage
rate; (3) the number of units with two or more bedrooms available in
the housing agency or 15,000, whichever is less; (4) the ratio of
high-rise two or more bedroom units to total units available in the
housing agency; and (5) the ratio of three or more bedroom units to
total units. 


   HUD'S SUBSIDIES MAY NOT REFLECT
   HOUSING AGENCIES' CURRENT NEEDS
------------------------------------------------------------ Letter :4

The operating subsidies that HUD provides through PFS are not
sufficient to adequately supplement some housing agencies' operations
budgets.  Although these agencies' base year costs were limited by
the prototype formula where necessary, adjusted for inflation and
other effects, and converted into their current allowable expense
levels, the expense levels still reflect housing conditions,
management policies, and, most importantly, the spending patterns
that existed almost a quarter of a century ago.  PFS has not adapted
to the housing agencies' changing needs, residents, or operating
circumstances.  Therefore, the housing agencies that either had
inadequate resources in 1975 because they were serving extremely poor
residents or had changes in their operating circumstances over the
years that had a substantial impact on their costs may not be
receiving adequate subsidies today to operate effectively.  For
example, each of the four large housing agencies we visited had
experienced changes in its circumstances since PFS was implemented in
1975.  The significant actions taken by the housing agencies'
managers to address these changes demonstrate that the operating
subsidies they receive from HUD may not be sufficient to meet their
agencies' needs.  These agencies have deferred maintenance expenses,
reduced staffing in critical areas, and supplemented their operating
budgets with funding from other federal grants.  The four agencies
took these and other actions, despite being reasonably well managed
according to HUD's management assessment program.\9 Finally, we found
that 17 percent of the housing agencies had had declining operating
reserves during their fiscal years ending in 1992 through 1996.  In
particular, 4 of the 21 extra large housing agencies (those operating
6,600 or more housing units) had declining reserve levels in 3 of the
last 4 years.  One of the uses that housing agencies make of
operating reserves is to pay for operating expenses.  For example,
officials at the Miami-Dade Housing Agency stated that they use
reserves to pay for maintenance when their operating
income--primarily comprising rent receipts and the PFS subsidy--is
insufficient. 


--------------------
\9 According to the agencies' scores from HUD's Public Housing
Management Assessment Program, which ranks all housing agencies on
eight performance indicators, two of the four agencies are high
performers, scoring over 90 on HUD's 100-point assessment scale; the
third agency's current score is 85; and the fourth's score is 70.  In
a previous report, we reviewed HUD's management assessment program
and recommended ways that HUD could improve the program's usefulness
and accuracy.  See Public Housing:  HUD Should Improve the Usefulness
and Accuracy of Its Management Assessment Program (GAO/RCED-97-27,
Jan.  20, 1997).  HUD is currently taking actions to adopt our
recommendations. 


      BASE YEAR COST VARIATION AND
      THE INFLATION ADJUSTMENT
      METHOD CONTRIBUTE TO THE
      INADEQUACY OF THE SUBSIDY
---------------------------------------------------------- Letter :4.1

When HUD adopted PFS, housing agencies' expenditure levels varied
significantly according to the rental income they could collect from
their tenants and other factors such as the quality of their housing
stock and neighborhood characteristics.  Annual expenditures were
driven by the level of maintenance needed to keep the housing stock
in good condition, neighborhood and tenant characteristics that
affected both security expenses and the residents' need for social
services, local agencies' policies regarding the volume and types of
social services they made available to residents, and agencies'
criteria for selecting and evicting tenants.  A 1980 Urban Institute
study of 17 large housing agencies reported that comparatively wide
differences existed among housing agencies in expenditures for
operating activities in 1975.\10 The expenditures ranged from a low
of $45.18 per unit-month in Columbus, Ohio, to $95.49 per unit-month
in Los Angeles.  The variations that existed in 1975 have been
perpetuated by PFS until today, even though the operating
circumstances for many agencies are likely to have changed
significantly. 

Although HUD adjusts agencies' allowable costs each year for
inflation, the adjustment may not cover the agencies' total cost
growth.  In determining the inflation adjustment to housing agencies'
allowable cost levels, one of the factors that PFS uses is the Wages
and Salaries Index of the Employer Cost Index published by the
Department of Labor.  However, a similar index, the Total
Compensation Index, also tracked and published by the Labor
Department, may be more comprehensive because it includes the value
of employee benefits, such as health insurance premiums.  Using the
Total Compensation Index instead of the Wages and Salaries Index
would mean a higher subsidy because over the period 1980 through
1997, the Total Compensation Index increased by 6 percent more than
did the Wages and Salaries Index.  Because labor costs are
approximately 60 percent of housing agencies' expenses, estimated
annual funding needs for PFS would more accurately reflect housing
agencies' costs each year if HUD calculated inflation on the basis of
the Total Compensation Index rather than the Wages and Salaries
Index.  However, using the Total Compensation Index would also raise
the annual subsidy by 3 to 4 percent, or approximately $100 million. 


--------------------
\10 Raymond J.  Struyk, A New System of Public Housing:  Salvaging a
National Resource (Washington, D.C.:  The Urban Institute, 1980), pp. 
87-89. 


      CONDITIONS AT FOUR LARGE
      HOUSING AGENCIES INDICATE
      THAT CHANGING CIRCUMSTANCES
      MAKE PFS SUBSIDIES
      INADEQUATE AT SOME AGENCIES
---------------------------------------------------------- Letter :4.2

At each of the four large housing agencies we visited, we found
conditions similar to those described by HUD in its annual
performance plan submitted to the Congress in early 1998.  The
Department noted decades of mistakes in public housing, including
flawed site plans and architecture, buildings that have outlived
their useful lives, and neighborhoods that have changed from healthy
residential settings to isolated pockets of poverty and despair.  We
found that because of these conditions, housing agency managers
believed that PFS significantly underfunds their need for subsidy. 
They attributed inadequate subsidies primarily to PFS' inability to
recognize that changing circumstances over the past 23 years have
increased housing agencies' costs in areas such as crime deterrence,
management information systems, and maintenance.  We observed housing
conditions and spoke with housing managers at many of the agencies'
developments, who were nearly unanimous in their belief that crime,
aging physical stock, and the poor design and layout of the housing
itself were the primary factors causing their costs to rise today. 
They told us that their operating costs are significantly higher
now--even taking inflation into account--than they were when PFS set
their agencies' allowable expense levels in 1975.  Table 1 summarizes
the information we obtained at the four housing agencies. 



                                         Table 1
                         
                             Summary of Information About the
                         Adequacy of PFS Obtained at Four Housing
                                         Agencies

                                                       Management
                   Is PFS                              actions to cope
                   adequately        Chief reasons     with              Comments by HUD
                   funding current   for subsidy not   insufficient      field office
                   expenses?         being adequate    operating funds   staff
-----------------  ----------------  ----------------  ----------------  ----------------
Housing Authority  No                (1) Increasing    Reduced           Allowable
of Baltimore                         and new costs     maintenance       expenses are
City                                 not anticipated   staff and         adequate for
                                     by PFS and (2)    activity;         existing stock
                                     costs of aging    supplemented      but too low to
                                     stock not         operating budget  manage newly
                                     recognized by     with other funds  rehabilitated
                                     PFS                                 housing

Housing Authority  No                (1) Cost of       Reduced           Using drug
of Kansas City                       aging housing     staffing,         elimination and
                                     stock and         deferred          modernization
                                     (2) additional    maintenance, and  grants to
                                     cost of managing  used funds from   supplement
                                     much of the       other accounts    operations
                                     agency's housing  to supplement     enables the
                                     stock that is     the operating     agency to manage
                                     located in high   budget            well
                                     crime areas

Housing Authority  No                Aging housing     Reduced           The agency very
of Los Angeles                       stock and         staffing,         aggressively
                                     deteriorating     deferred          seeks funding
                                     infrastructure    maintenance, and  and appears to
                                     is costing more   used portions of  need all of the
                                     to maintain       other grants to   funding it
                                                       defray operating  obtains
                                                       costs

Miami-Dade         No                (1) Increases in  Reduced           The agency has
Housing Agency                       existing costs    maintenance and   had to provide
                                     that exceed       administrative    additional
                                     inflation, (2)    staff, deferred   services to its
                                     new costs, and    maintenance, and  tenants without
                                     (3) spending on   used operating    the funding to
                                     deteriorating     reserves and      go with the
                                     and poorly        other resources   services (e.g.,
                                     designed units    to fund a         Family Self-
                                                       portion of        Sufficiency
                                                       operations        Program)
-----------------------------------------------------------------------------------------
Although all the housing agency managers we spoke with believed that
PFS was insufficient to meet their agencies' needs, this belief was
not always shared by officials at the local HUD field offices.  For
example, the director of public housing in HUD's Maryland State
Office said that the Housing Authority of Baltimore's allowable
expense levels seemed to be sufficient to operate the agency's
developments; however, he also said that these expense levels would
not be adequate to protect the investment Baltimore is making in its
newly rehabilitated developments.  He added that although other
HUD-assisted properties not owned by the housing agency receive less
revenue to operate than the Baltimore City agency receives, the
housing agency has specific circumstances--such as high-cost family
high-rises, large aged developments, very-low-income tenants, and
higher crime rates--that raise its operating costs above those of
privately owned properties.  In Florida, HUD's director of public
housing said that PFS does not provide housing agencies with
sufficient subsidy, even in years when the Congress funds it at 100
percent of HUD's request.  She said that despite the insufficiency of
the subsidy, housing agencies generally perform satisfactorily and
often add a small amount to their operating reserves at the end of
the year.  She also said, however, that most supplement their
operating budgets with funds from other sources, including HUD's
Comprehensive Grant Program for major housing repairs and
modernization;\11 HUD's Public Housing Drug Elimination Program; and
other federal, state, and local grant programs.  She said that
supplemental funding is necessary because "PFS is an antiquated
system that does not fund the operating costs of new programs that
have come on-line in the public housing industry."


--------------------
\11 Modernization grants are generally targeted for major repairs and
the rehabilitation of deteriorated housing stock.  For fiscal year
1998, the Congress appropriated $2.5 billion for this program--nearly
as much as the $2.9 billion appropriation for operating subsidies. 


      NEW EXPENSE CATEGORIES AND
      INCREASES IN EXISTING
      CATEGORIES MAKE PFS'
      BASELINE COSTS OBSOLETE
---------------------------------------------------------- Letter :4.3

For the most part, officials at the four agencies that we visited
told us that since HUD set their allowable costs in 1975, new cost
categories have emerged and costs in established categories have
risen.  For example, abating lead-based paint has become a
significant cost at some agencies.  And the cost of protective
services--while always necessary--has increased along with the cost
of maintaining ever-aging buildings and the cost over time of poor
geographic locations or physical layouts that facilitate increased
crime.  Conditions at the following housing developments illustrate
some of the factors that increased operating costs in recent years: 

  -- O'Donnell Heights in Baltimore.  Illegal drug activity has
     worsened over the last decade but is difficult to deter because
     of the large size and openness of O'Donnell Heights.  Because of
     the high crime rate--worse than in the surrounding
     neighborhood--residents frequently request to transfer or to
     relocate.  To help control crime, the development uses special
     lighting and two police officers but does not have contract
     security, fencing, security cameras, or controlled entry. 

  -- Claremont Homes in Baltimore.  Claremont's per unit-month
     expenses (before utilities) are about $383, 24 percent more than
     the average for the housing agency.  Claremont's housing manager
     said that renovating vacant units to abate lead hazards and
     replace almost all of the original plumbing fixtures and
     cabinetry has had the most impact on maintenance costs. 
     Claremont's low-rise units are very costly because they have the
     original steam-heated radiators and plaster walls that are damp
     because of poor ventilation and need constant repainting and
     replastering.  This maintenance must be done frequently because
     the paint in the units is lead-based and poses a health hazard
     if it is allowed to peel and crack.  These maintenance costs
     have grown until they have become a significant portion of the
     development's total operating costs.  Housing agency officials
     are concerned about the potential for incurring additional costs
     from litigation if they cannot keep up with the lead abatement
     needed as the paint continues to chip and peel. 

  -- Chouteau Courts in Kansas City.  At this development, both
     residential sewage and rain water feed into the same sewerage
     transfer system.  Heavy rains cause the sewers to back up into
     the basement of one of the buildings, causing damage, creating
     significant health hazards, and resulting in additional costs
     for the housing agency. 

  -- Dana Strand in Los Angeles.  Housing managers cited increasing
     maintenance as having the greatest impact on their operating
     costs, and they attributed the increase to the age of Dana
     Strand's buildings.  Officials cited corroding water and gas
     lines, rotting window sashes, and old electrical conduits as not
     only maintenance problems but also contributing to hazardous
     living conditions.  For example, water leaking from corroded
     plumbing accelerated the corrosion of gas pipes, resulting in a
     gas explosion that injured several tenants and blew off a
     portion of the building's roof and walls.  Housing agency
     officials told us that similar plumbing problems exist at other
     developments. 

  -- Scott Homes in Miami.  Increasing crime and vandalism, the age
     of the development, and the need for grounds keeping and waste
     management all contribute to the increased operating costs at
     Scott Homes.  Crime in the development and its surrounding
     community gives Scott Homes a bad reputation that makes it
     difficult to attract residents, especially working families. 
     Vandals steal copper pipes and security windows from vacant
     units, shoot out lights, and steal street signs.  Physical
     deterioration of the housing is evident in rotting door frames,
     water pipes that break and leak into units, and appliances that
     have outlived their usefulness.  Since fiscal year 1995,
     grounds-keeping costs have nearly tripled because of the
     extensive tree trimming needed to prevent damage to buildings
     and sidewalks.  Meanwhile, Miami's strict dumping requirements
     have caused the housing agency's waste management costs to
     nearly double. 


      TO MEET OPERATING EXPENSES,
      HOUSING AGENCIES USE FUNDS
      FROM OTHER HUD GRANTS AND
      DEFER MAINTENANCE
---------------------------------------------------------- Letter :4.4

To cope with insufficient subsidies, we found that the management
teams at the four housing agencies we visited supplemented their
operating budgets with funding from other HUD programs, including the
Comprehensive Grant Program, the HOPE VI urban revitalization program
for severely distressed housing, the Public Housing Drug Elimination
Program, and any remaining funds from the Major Rehabilitation of
Obsolete Properties program that were awarded several years ago.\12
Some agencies also supplement their public housing operating budgets
with a portion of the administrative fee they receive from HUD in
return for operating Section 8 tenant-based assisted housing
programs. 

We found that a frequently used source of additional funding was the
Comprehensive Grant Program for modernizing and rehabilitating
deteriorated housing stock.  Federal statutes and regulations have
provided two ways for housing agencies to use up to 30 percent of the
grants from this program to address operations needs.  First,
provisions in the HUD appropriations acts for fiscal years 1996 and
1997 permitted housing agencies to use 10 percent of their
Comprehensive Grant Program funding for activities related to
operations.  The Congress did not include this provision in the
fiscal year 1998 act, however.  Second, HUD allows a housing agency
to use up to 20 percent of its Comprehensive Grant for "management
improvements." HUD's regulations state that eligible costs under
general management improvement include those incurred for operating
activities like management and accounting systems, security, rent
collection, and maintenance.  In a survey of over 800 housing
agencies done by the Public Housing Authority Directors Association,
20 percent responded that they use modernization funds to cover
operating expenses.  The Council of Large Public Housing Authorities,
which represents over 100 of the larger agencies, believes that many
of its member agencies use Comprehensive Grant funding to cover
operating expenses, but the extent of the practice is unknown. 
Having maintenance costs eligible under the Comprehensive Grant is
important to housing agencies because maintenance is generally the
single largest expense in their operating budgets. 

The impact on a housing agency's operating budget of using a
significant portion of its Comprehensive Grant to cover the
management and administration of the agency can be substantial.  For
example, officials at the Housing Authority of Baltimore City said
that the agency generally uses the full 20 percent of modernization
funding that it is allowed to cover management improvement costs.  In
fiscal year 1997, this amounted to about $6 million of the agency's
$75 million operating budget. 

An additional source of funding for operations is the Public Housing
Drug Elimination Program that was authorized in the Anti-Drug Abuse
Act of 1988 and implemented by HUD the following year to help housing
agencies combat drug use and drug-related crime.  The program
authorizes many activities, including security and drug education. 
However, because the grants are competitive, agencies that receive a
grant one year are not guaranteed to receive a grant the next year. 
Moreover, the funding has become more of a necessity in recent years. 
A 1994 HUD study of the program noted that all of the agencies
included in the study had suffered from "the upsurge of drug activity
during the 1980s as well as the increasing impoverishment of public
housing resident populations."

Deferred maintenance and staffing cuts also rank high among housing
agencies' tools for coping with funding shortfalls.  In Kansas City,
officials said they reduced administrative and maintenance staff and
deferred maintenance to fund the new or increased operating expenses. 
Deferred maintenance can be costly, however.  For example, although
the Miami-Dade Housing Agency has in the past replaced roofs before
leaks occur, its current practice is to defer replacement until after
leaks are detected.  This practice leads to other costs, including
damaged walls, floors, and electrical systems. 

According to housing agency officials, the long-term consequences of
their coping strategies will be to undermine the viability of the
housing stock and to place an unjustified dependence on grants, such
as the drug elimination and HOPE VI grants, that may not continue
indefinitely.  Housing officials in Baltimore told us that deferring
maintenance items means that they eventually become "extraordinary
maintenance" or emergency items that must be addressed.  The
comptroller of the Baltimore agency said that although he requested
modernization funds for extraordinary maintenance at the O'Donnell
Heights development, so many other demands for this funding exist
that O'Donnell's needs are not yet a priority.  Agency officials in
Baltimore said that in general, the potential result of long-term
underfunding is that many of their units eventually will become
uninhabitable and need to be demolished.  They said that HOPE VI
program grants will help to deal with some of these problems, but
accomplishing adequate maintenance before excessive deterioration
becomes evident is more cost-effective.  They also recognized that
the HOPE VI funding will not continue indefinitely. 


--------------------
\12 Major Rehabilitation of Obsolete Properties is not a currently
funded program, but grants made under it in earlier years are still
being spent by housing agencies. 


   HUD BASES ITS PFS BUDGET
   ESTIMATE ON PROJECTIONS OF
   INCOME, INFLATION, AND EXPENSE
   LEVELS OF A SAMPLE OF HOUSING
   AGENCIES
------------------------------------------------------------ Letter :5

Each year, HUD's Office of Finance and Budget forecasts how much will
be needed to fund PFS' operating subsidies for the fiscal year by
estimating the future costs of a sample of housing agencies and
projecting these costs to the total population of nearly 3,200
agencies.  HUD bases this estimate on expense data from a stratified
sample of housing agencies; factors from the PFS formula; and several
assumptions, including forecasts of tenant income, inflation, and
energy costs.  However, because agencies' expense data may not
accurately reflect their need for subsidy, the budget estimate
likewise does not accurately reflect the costs of adequately
providing public housing.  In addition, in years when HUD's budget
estimate is not fully funded by the congressional appropriation, HUD
prorates the appropriation across all agencies, which results in a
relatively greater hardship for the agencies that are more dependent
on the subsidy to help cover their expenses. 


      HUD'S BUDGET ESTIMATE BUILDS
      ON AGENCIES' ALLOWABLE COSTS
      AND PROJECTIONS OF RENTAL
      INCOME AND EXPENSES
---------------------------------------------------------- Letter :5.1

HUD's process for developing its PFS budget estimate begins with
obtaining data on allowable expense levels, income, and utility
expenses from a sample of 213 public housing agencies.  This sample
includes all of the 146 large agencies (those with 1,250 or more
housing units) and a randomly selected sample of 67 small to
medium-size agencies (those with 100 to 1,249 units).  The 146 large
agencies in the sample account for about 74 percent of total
expenditures by public housing agencies to cover operating costs.  To
prepare the budget estimate for fiscal year 1999, HUD obtained data
from fiscal years 1996 (the last completed fiscal year of the housing
agencies in the sample) and 1997 (to the extent that data were
available).  HUD then adjusted the allowable expense level for each
housing agency in the sample to reflect major changes in
circumstances--such as significant additions or deletions to the
housing stock--from fiscal year 1996 to fiscal year 1999.  For
agencies that reported changes in the PFS formula's predictive cost
factors, such as the number of units built before 1940 and the local
government employee wage rate, HUD used the formula to adjust these
agencies' expense levels. 

After making these adjustments to individual expense levels on the
basis of the most recent changes, HUD computed an overall weighted
average for the sample of 213 housing agencies.  HUD then determined
the percentage change in the sample's new expense level from the
prior year's level.  HUD assumed that the expense levels of all
housing agencies increase in the same proportion as the expense
levels of the agencies in the sample.  Finally, HUD increased the
projected allowable expense levels according to the Office of
Management and Budget's estimate of inflation in fiscal year 1999. 

Other assumptions that HUD makes in preparing its budget estimates
involve utility costs and residents' incomes.  To estimate utility
costs, HUD obtains the value of utility costs in the last year for
which data are complete and adjusts the value for projected changes
in utility prices, using forecasts from the Department of Energy's
Energy Information Administration.  HUD does not attempt to adjust
utility costs for changes in weather or the aging or rehabilitation
of buildings in specific markets or nationwide.  HUD also makes
projections of residents' income.  For several years in the early
1990s, HUD assumed that the income of public housing residents--and
therefore the rental income available to housing agencies--remained
unchanged.  However, budget estimates for fiscal years 1998 and 1999
have assumed a small increase in incomes, based on recent income
trends and the presumed effect of welfare reform. 

For several reasons, HUD's budget estimate for PFS may differ from
actual expenses in the budget year.  As shown in figure 1, to develop
projections for fiscal year 1999, HUD began in mid-1997 and based the
projections on fiscal year 1996 data and some fiscal year 1997 data,
when available.  (The time line represents a typical budget cycle;
specific dates may vary from year to year.) Thus, the data used for
the 1999 budget estimate were generated 2 to 3 years before the
budget year.  Furthermore, because of the time lag between when
housing agencies' expenditures occur and when HUD obtains these data
and uses them in the budget estimate, some estimating inaccuracy is
introduced into this budget estimate.  The inaccuracy could be
further magnified because of the 2-year period between the time HUD
completes its budget estimate and the time the housing agencies spend
their allocations. 

   Figure 1:  Time Line of PFS
   Budget Estimation Process for
   Fiscal Year 1999

   (See figure in printed
   edition.)

Similar estimating errors are made in other agencies' budget
estimates across the federal government; however, housing agencies
are particularly affected by errors that result in underfunding
because they spend almost all their subsidies on salaries for their
staff during the year that they receive the funds, rather than using
the funds for capital expenses, contracting, and other spending over
several years.  Shortages, therefore, generally mean staff layoffs or
other unplanned and immediate cost reductions. 

Because of the large number of housing agencies and the difficulty of
obtaining current data for each agency, the potential inaccuracy in
HUD's budget estimate for PFS may be unavoidable.  Instead of
reducing the inaccuracy, therefore, accommodating it through a
central supplemental or reserve fund might offer a funding cushion to
absorb the effect of inadequate subsidies.  In addition, encouraging
housing agencies to maintain larger operating reserve funds at the
local level could have a similar effect.  To justify a central
reserve fund, HUD may need to collect data to document the extent of
any estimating inaccuracies. 


      HUD'S METHOD FOR REDUCING
      AGENCIES' SUBSIDIES TO MATCH
      AVAILABLE APPROPRIATIONS MAY
      BE INEQUITABLE
---------------------------------------------------------- Letter :5.2

HUD's procedure for reducing subsidy payments when the budget
appropriation does not fully fund its budget request for PFS
operating subsidies may be inequitable because it does not affect all
housing agencies equally.  When the appropriation is not sufficient
to fully fund agencies' operating subsidies, HUD reduces the amount
of each agency's subsidy by the same percentage.  Although this
represents an evenhanded reduction in the federal PFS subsidy amount
across all housing agencies, it produces unequal reductions in local
agencies' operating budgets because some agencies depend to a higher
degree than others on the PFS subsidy to supplement their operating
budgets.  For example, in response to the fiscal year 1996
appropriation for PFS being below HUD's request by 11 percent, HUD
reduced each agency's subsidy by 11 percent.  At an agency where the
subsidy constituted 20 percent of the total revenues, that reduction
in the subsidy would result in a more than 2-percent decline in total
operating funds.  At an agency where the subsidy constituted 60
percent of the total revenues, however, the same reduction would
result in a more than 6-percent decline in total operating funds. 

As table 2 shows, HUD funding makes up between 20 and 60 percent of
the operating income of 2,176 housing agencies (over 70 percent of
all agencies).  For 360 agencies (or 12 percent of all agencies), at
least 60 percent of their operating income comes from HUD's PFS
subsidy. 



                                Table 2
                
                Percentage of Operating Income Provided
                                 by HUD

Percentage of revenues from      Number of housing       Percentage of
HUD                                       agencies    housing agencies
------------------------------  ------------------  ------------------
0                                               86                 2.8
Over 0 to 20 percent                           459                14.9
Over 20 to 40 percent                        1,020                33.1
Over 40 to 60 percent                        1,156                37.5
Over 60 to 80 percent                          330                10.7
Over 80 to 100 percent                          30                 1.0
======================================================================
Total                                        3,081               100.0
----------------------------------------------------------------------
Source:  GAO's analysis of HUD's Integrated Business System database,
for housing agencies with fiscal years ending in 1996. 

In addition, the larger the housing agency, the greater the reliance
on HUD funding.  For instance, while about 24 percent of the extra
small and small housing agencies received more than half of their
operating income from HUD, almost 41 percent of the medium-size
agencies and nearly 68 percent of large agencies received more than
half of their operating income from HUD.\13 HUD funding represented
more than half of the operating income for all 17 of the extra large
agencies, which managed 31 percent of all public housing units in the
country. 


--------------------
\13 For an explanation of these size categories, see appendix V. 


   SEVERAL OPTIONS AND OTHER
   OPPORTUNITIES ARE AVAILABLE FOR
   REDESIGNING PFS
------------------------------------------------------------ Letter :6

To make PFS a system that more effectively supplements housing
agencies' operating budgets, HUD has several design options,
including basing subsidies on fair market rents, comparing private
and public housing costs to determine a reasonable cost and set of
services, and using the five-factor cost model it developed in 1992. 
In redesigning PFS, HUD also will have the opportunity to better
address questions of whether PFS is adequate to fund public housing
and whether it provides an equitable subsidy to specific housing
agencies, given the varying circumstances that exist across agencies. 
For example, HUD will be able to revisit its policy of not allowing
housing agencies to appeal the subsidy provided to them through PFS. 
Under HUD's Management 2020 Reform initiative, the Department plans
to reorganize its field staff by creating centralized centers for
payments and oversight that may be better able to administer an
appeals process than the current network of field offices.  HUD also
is developing new data on the physical conditions in public housing
that should assist the Department in understanding the magnitude of
the current need for maintenance, which, in turn, should shed light
on the adequacy of the operating subsidy and the Comprehensive Grant
Program to meet that need.  Finally, pending legislation in the
Congress (H.R.  2 and S.  462 have passed the House and Senate,
respectively, and are awaiting the results of a House-Senate
conference expected later this year) would give public housing
agencies greater flexibility in whom they house and greater certainty
in their annual funding through block grants covering capital and
operating expenses.  If the pending legislation is enacted, HUD will
be required to determine new formulas for providing the block grants
to housing agencies. 


      REVISING PFS INVOLVES
      CONSIDERING FUNDING ADEQUACY
      AND EQUITY
---------------------------------------------------------- Letter :6.1

In revising PFS, we believe that HUD will need to address the issues
of both adequate and equitable funding.  Adequacy means determining
whether available funding--both federal subsidies and income from
tenants' rents and other sources--is sufficient to fund a consistent
set of housing services across all housing agencies to enable them to
provide decent, safe, and sanitary housing to low-income people who
cannot find affordable housing in the private market.  Equity is
concerned with distributing the subsidy fairly by accounting for
operating circumstances unique to individual housing agencies.  To
achieve funding adequacy, HUD could define the standard housing
services it expects of a housing agency operating a housing stock
with average characteristics in terms of its age, size, design, and
construction and serving a tenant population with average demographic
characteristics, such as family size and income.  Funding equity
would, in principle, account for the number of units an agency
manages and the unique operating circumstances it faces.  In this
way, PFS could adjust agencies' standard expense levels to account
for differences in housing stock, tenant population, and income
received from rent and other sources. 

This model of funding adequacy and equity is represented
schematically in figure 2.  Funding adequacy is represented by a
national standard expense level and equity by the factors associated
with cost, the number of housing units, and the income of the agency. 

   Figure 2:  Model of Funding
   Adequacy and Equity

   (See figure in printed
   edition.)

Defining funding adequacy and equity is relatively simple compared
with the task of implementing these concepts in designing a new PFS. 
Developing statistical indicators for both the adequacy and equity
factors involves many choices for HUD.  In the following discussion,
we identify the major possibilities and some of the pros and cons of
each approach. 


      SEVERAL APPROACHES COULD BE
      TAKEN TO ADDRESS FUNDING
      ADEQUACY
---------------------------------------------------------- Letter :6.2

The following discussion is based on our prior work and on work that
we have ongoing to review and develop options for other formula-based
funding programs similar to PFS.  In addition to issuing reports on
Medicaid, the Older Americans Block Grant, the Law Enforcement Block
Grant, and the Highway Grant Formulas, we recently worked closely
with congressional staff to develop options for targeting HUD's
Community Development Block Grant.  Thus, we believe that to develop
a national standard for operating public housing, HUD could take
several approaches, including the following: 

  -- HUD could base a national standard on the operating expenses
     necessary to deliver an allowable and expected ï¿½basket of
     servicesï¿½ at a ï¿½well-managedï¿½ housing authority and use data
     from a selected sample to estimate the national average cost of
     providing that mix of services.  Some of these "should-cost"
     data could be based on the cost per unit of services in the
     private market.  HUD considered this option during its formal
     review process in 1992 and decided against it partly because of
     difficulties in reaching a consensus as to what standards to use
     and what type of non-housing agency projects to select for
     [making cost] comparisons.\14 Although this approach would
     provide a comprehensive cost basis for determining funding
     adequacy, HUD officials believe that it would require a
     relatively large commitment of time and resources to develop
     consensus on the standard service basket and its costs.  It
     would, however, preclude the need to determine actual housing
     needs and their costs for each individual housing agency. 

  -- A second approach would be to base a standard on the cost of
     operating private low-income housing by using HUD's data on fair
     market rents across the country.\15

The advantage of this approach is that it would employ existing data
that reflect rents in the private rental market.  However, because
the private rental market does not provide tenant social services but
does consider replacement costs, depreciation, and taxes, it accounts
for its costs much differently from those in public housing.  This
means that some research would be needed to effectively compare
private and public housing environments and costs. 

Regardless of the approach chosen to resolve the adequacy issue, in
redesigning PFS HUD would have the opportunity to revisit the way it
adjusts housing agencies' allowable costs for the aging of the
housing stock and for inflation.  For most agencies, HUD's
application of an 0.5-percent adjustment across the board for aging
stock is appropriate.  The inflation adjustment, however, captures
only the growth in wages and not the cost of employee benefits such
as health care coverage.  But as we have discussed earlier and as
housing agency officials have told us, the cost of employee benefits
has grown more rapidly than wages in general, and this added cost has
not been fully reflected in inflation adjustments for PFS. 


--------------------
\14 Final Rule, The Federal Register, Vol.  57, No.  23 (Feb.  4,
1992), p.  4284. 

\15 A detailed evaluation of a fair market rent option is contained
in Judith D.  Feins, Revised Methods of Providing Federal Funds for
Public Housing Agencies (Washington, D.C.:  Abt Associates, Inc.,
June 1994), ch.  7. 


      OPTIONS ALSO ARE AVAILABLE
      THAT ADDRESS EQUITY ISSUES
---------------------------------------------------------- Letter :6.3

To improve equity by distributing subsidies according to the unique
circumstances of individual housing agencies, HUD has several
options, including the following: 

  -- As an expansion of the option of costing out a standard basket
     of housing services to address the adequacy issue--if HUD were
     to choose to adopt such an option--HUD could collect the
     information relevant to address equity issues and develop an
     appropriate cost adjustment factor for each housing agency. 
     This effort could be excessively time-consuming, expensive, and
     administratively burdensome for both HUD and housing agencies,
     especially where information on relevant factors affecting costs
     is not readily available or of comparable quality.  Limiting the
     types of data collected and the types of agencies that must
     report would help to lessen the burden, though it would also
     lessen the accuracy of funding decisions. 

  -- Another option for developing an adjustment factor based on
     local circumstances would be to apply to every housing agency
     the five-factor cost model from HUD's 1992 review of allowable
     expense levels.  Currently, its use is triggered only when an
     agency gains or loses 5 percent or more of it units or when it
     gains or loses 1,000 or more units.  Use of this model would, on
     average, yield allowable expense levels that more systematically
     reflect circumstances affecting operating costs.  The cost model
     also has the advantage of being readily available and therefore
     would not require additional time and effort to implement.  The
     model is based, however, on housing agencies' expenditures that
     have been constrained by the total of PFS subsidies and tenants'
     rent since 1975, and, therefore, it may not portray an accurate
     picture of operating needs.  Also, the model may not apply
     equally well to all agencies because it may not adequately
     reflect the full range of housing agencies' circumstances and
     may overestimate or underestimate costs for agencies with
     unusual characteristics such as very high security costs or
     other circumstances not reflected in the data. 

  -- Another approach would be to determine whether additional cost
     indicators besides those identified in the 1992 review might
     also be effective in developing a cost-adjustment factor.  For
     example, under the recently implemented Indian Housing Block
     Grant Formula, a combination of historical allowable expense
     levels and geographic differences in fair market rents (FMR) is
     used to adjust a national standard expense level.  Such an
     approach would allow housing agencies with comparatively high
     past expense levels to continue to have those levels reflected
     in the formula, while also allowing agencies that are predicted
     to have costs that exceed their past levels to have those costs
     reflected.  Thus, under this approach, both the FMR in a housing
     agency's metropolitan area and HUD's cost model could be
     considered the basis for estimating an agency's relative
     allowable costs.  The Indian Housing Block Grant program also
     has developed a geographic cost index that reflects labor and
     materials costs associated with developing new housing units. 
     Such an index, or other similar indexes, might also be suitably
     modified to reflect differences in labor costs associated with
     low-income housing maintenance and administrative services. 


      OPPORTUNITY EXISTS TO
      MINIMIZE INEQUITIES WITH AN
      APPEALS PROCESS AND A
      GRADUAL TRANSITION TO ANY
      NEW SUBSIDY SYSTEM
---------------------------------------------------------- Letter :6.4

In any reforms to PFS, HUD is likely to find it difficult to fully
address all the issues associated with developing valid indicators
for all the factors that affect both funding adequacy and equity. 
Consequently, a process to allow housing agencies to appeal their
formula-calculated or allowable expense levels on the basis of their
unique circumstances would enhance the equity of the overall process. 
When multiple factors affect the cost of delivering housing services,
a thorough analysis of detailed information from all housing projects
offers the possibility of accurately gauging the need for financial
assistance.\16 Similar attention to detail may aid the transition to
a new system.  The immediate budgetary impact of losses in funding,
if any, could be tempered by phasing in changes.  If a housing agency
has few supplementary resources and minimal reserves, the impact of a
loss of funds could swiftly result in consequences such as deferred
maintenance, decreased services, and layoffs.  As a result, changes
to PFS would be more effective if implemented gradually, either by
establishing a limit on the magnitude of any reductions in funding
for individual housing agencies or by guaranteeing that funding for
housing agencies does not fall below the amounts they received in the
year prior to implementing the changes to the system. 

HUD considered an appeals mechanism in the past when it responded to
the mandate in the Housing Act of 1987 that offered HUD a choice
between establishing an appeals process or giving housing agencies a
one-time opportunity to raise their allowable expense levels.  At
that time, HUD chose not to allow agencies to appeal their expense
levels because it could not treat agencies in accordance with an
objective standard and such a standard would not be as
administratively feasible as using the existing approach to
establishing subsidies.  However, an objective standard may exist in
the near future because several of HUD's options for redesigning PFS
would involve establishing an objective standard of expected housing
services.  Moreover, HUD's Management 2020 Reform initiatives include
establishing a centralized payment center to administer PFS, and
this, in turn, could facilitate the administration of an appeals
process. 


--------------------
\16 As part of the adoption of the Indian Housing Block Grant
program, local Indian tribes or their designees will conduct census
surveys to more accurately determine the basis for calculating the
amount of their awards. 


      PENDING LEGISLATION PROVIDES
      FOR MIXED INCOME AND BLOCK
      GRANTS FOR PUBLIC HOUSING
      AGENCIES
---------------------------------------------------------- Letter :6.5

The housing reform legislation currently pending in the Congress
contains provisions that would encourage housing agencies to admit a
higher proportion of working families and require HUD to establish a
block grant formula to fund housing agencies' operating costs.  These
provisions could make some housing authorities' funding less
dependent on federal subsidies and more predictable and thereby
assist their financial planning.  For example, higher-income tenants
would contribute more toward rent and reduce housing agencies'
vulnerability to the Congress's not fully funding HUD's budget
request.  HUD estimates that for fiscal year 1999, public housing
tenant income nationwide will rise by 4 percent. 

In addition, as we have discussed earlier, because some housing
agencies perceive a shortfall in PFS funding, they supplement their
operating budgets with funds from other sources, including HUD's
Comprehensive Grant Program for modernizing housing stock and grants
that are competitive but not available each year, such as grants from
the Public Housing Drug Elimination Program.  Under a block grant,
funding that now is available competitively but not with certainty
could be rolled into a single grant and provided with certainty by
way of an appropriate formula.  This would be likely to achieve
administrative cost savings at both the federal and local levels. 

The approaches we have discussed for redesigning PFS' basic funding
formula would continue to be applicable under a block grant. 
Moreover, the approach taken in the Indian Housing Block Grant
program may offer other alternatives to consider that address a more
sweeping approach to funding operations, modernization, and the
development of new housing stock. 


   CONCLUSIONS
------------------------------------------------------------ Letter :7

If legislative reform for public housing is enacted this year, HUD
will be mandated to assess PFS and determine whether a more adequate
and equitable system can be developed.  In doing so, HUD will have
the opportunity to address questions about both the overall adequacy
of PFS to fund public housing and the equity with which it funds
individual housing agencies.  Since HUD implemented PFS in 1975,
public housing agencies' subsidies have been based for the most part
on the actual costs those agencies incurred in the base year 1975,
with annual adjustmentsï¿½primarily for inflation.  In many cases,
these annually adjusted actual costs do not fully reflect housing
agencies' current need for resources to adequately house and serve
low-income families because these agencies' true funding needs have
never been determined.  However, these cost levels are part of HUD's
basis for developing its annual budget estimate for PFS and for
determining subsidies each year for the nearly 3,200 housing
agencies. 

Over the life of PFS, housing agencies have had only one opportunity
to receive an overall correction to their adjusted base year costs to
account for either unduly low initial cost levels or for gradual but
costly changes in operating circumstances, such as the increase in
crime and maintenance costs.  Although we do not know how many
housing agencies' allowable costs are currently insufficient or
excessive to meet their needs, housing conditions at the agencies
that we visited and management actions at these agencies taken to
supplement operating expenses indicate that PFS may be underfunding
these and other agencies.  We recognize that a process to allow
housing agencies to appeal their allowable cost levels would be
administratively burdensome and probably would increase the level of
PFS funding.  However, we believe that this subsidy cost increase
could be mitigated in the near term by the increase in tenant income
projected by HUD in fiscal year 1999 and in the long term by the
gradual influx of more working families to public housing as a result
of the assisted housing reform legislation now pending in the
Congress. 


   RECOMMENDATION
------------------------------------------------------------ Letter :8

In response to pending legislation, HUD is likely to begin efforts in
the near future to revise the way it provides subsidies to public
housing agencies.  As HUD considers its various options for
redesigning the Performance Funding System, we recommend that the
Secretary of HUD also consider establishing a process that (1) allows
housing agencies to appeal their expense levels when they believe
that significant changes have occurred over time in their operating
circumstances that cause their subsidy to be inappropriate and (2)
HUD can use to review housing agencies' expense levels that it
believes may be excessive. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :9

We provided copies of a draft of this report to HUD for its review
and comment.  HUD's written comments and our responses appear in
appendix VI. 

In its comments, HUD disagreed with several specific aspects of our
report and provided detailed comments in these areas.  Although HUD
did not disagree explicitly with the thrust of our recommendations in
the draft, the Department believed that the recommendations should be
stated more clearly and could provide more specific direction for
what we expected it to do.  We agree with HUD and have withdrawn one
recommendation and clarified the other one. 

HUD stated that we confused the issues of the adequacy of the
Performance Funding System and the accuracy of HUD's budget estimates
of the Performance Funding System.  HUD stated that the Performance
Funding System is a formula and is not intended to reconcile funding
with housing agencies' actual expenditures.  We disagree that our
analysis confused the issues.  We concluded that the adequacy of the
Performance Funding System and the accuracy of HUD's budget estimates
for PFS are necessarily interrelated.  Determining allowable expense
levels is not only an integral part of allocating the PFS subsidy to
housing agencies, but as we describe in our report, expense levels
also play a significant role in HUD's process of developing its
annual budget estimate for the Performance Funding System because the
estimate is based on a large sample of these expense levels. 

HUD also said that the draft report relied heavily on four case
studies and that it did not contain sufficient data to draw
conclusions about the overall adequacy of the Performance Funding
System's funding.  We agree and therefore drew no specific
conclusions about the Performance Funding System's adequacy.  On the
basis of our case studies, we conclude that some housing agencies are
underfunded, but we cannot project to the universe of all housing
agencies.  Therefore, we did not draw any overall conclusions about
the adequacy of subsidies nationwide.  Instead, our case studies, a
survey of 800 housing agencies, and discussions with trade group and
HUD officials enabled us to conclude that operating subsidies may not
be adequate for housing agencies that had low base year expenditures
or that had operating circumstances or costs that have undergone
significant changes since 1975.  On this basis, therefore, we do
question the adequacy of the Performance Funding System and believe
that options exist for improving its methodology for allocating
congressional appropriations. 

HUD stated that the draft report did not define what costs subsidies
should be covering.  We assume HUD is referring to the costs of
managing the housing agency and providing housing and other services
to the residents that could be legitimately covered by an operating
subsidy.  The Congress did not ask us, nor did we intend, to define
what specific costs the operating subsidies should be covering. 
Rather, we believe that HUD is responsible for defining the scope of
costs that the Performance Funding System should cover, and one of
the options that we suggest for redesigning the system includes
developing such a definition of covered costs. 

Finally, HUD stated that much of the discussion in the report about
the level of funding dealt with housing agencies' funding needs that
are more appropriately met through capital and grant funding.  We
disagree and believe that just the opposite condition exists.  We
report that some housing agencies are using substantial amounts of
funding from capital and other grants to cover their operating
expenses.  This indicates that these agencies are not receiving
enough funding through the Performance Funding System and rental
income alone to cover these expenses. 

In its more detailed comments attached to its letter, HUD said that a
recommendation in our draft report for revising the way HUD estimates
its budget request was not clear because it did not state explicitly
what changes we believed HUD should adopt.  We agree and believe that
it is premature for HUD to change its budget estimating methodology
until the Department revises the way it provides subsidies to public
housing agencies, as would be required under pending legislation.  We
also believe that given the data and timing constraints under which
HUD must prepare its budget estimate, the estimate is reasonably
accurate.  We have, therefore, withdrawn our recommendation that the
Secretary consider revising the way HUD makes its Performance Funding
System budget estimate, and we have made changes to our report
accordingly. 


   SCOPE AND METHODOLOGY
----------------------------------------------------------- Letter :10

To determine how PFS estimates the amount of operating subsidy
housing agencies' require on an annual basis, we interviewed HUD
officials and evaluated the model HUD uses to make its annual
estimates.  Also, we reviewed the literature describing HUD's
methodology for establishing housing agencies' allowable cost levels
and reviewed how HUD uses these cost levels and other data in an
estimating model for the annual PFS budget submission.  To determine
how well PFS distributes the subsidy funding, we analyzed financial
data for fiscal years ending 1992 through 1996 from housing agencies'
Statements of Operating Receipts and Expenditures in HUD's Integrated
Business System database.  We also interviewed HUD officials at
headquarters and field offices and visited four housing agencies in
different regions of the country to develop case studies of how they
cope with insufficient operating funds.  To develop options for HUD
in revising its PFS, we relied on the extensive experience we have
had in reviewing other formula-funded programs and in consulting with
the Congress on options for funding these programs.  A more detailed
discussion of our objectives, scope, and methodology is in appendix
VII. 


--------------------------------------------------------- Letter :10.1

We are sending copies of this report to the appropriate congressional
committees; the Secretary of Housing and Urban Development; and the
Director, Office of Management and Budget.  Copies are available to
other interested parties upon request. 

If you or your staff have any questions, please call me at (202)
512-7631.  Major contributors to this report are listed in appendix
VIII. 

Judy A.  England-Joseph
Director, Housing and Community
 Development Issues


HOUSING AUTHORITY OF THE CITY OF
LOS ANGELES
=========================================================== Appendix I

The Housing Authority of the City of Los Angeles' (HACLA) total
conventional public housing operating budget for 1997 was over $45
million (55 percent of which HUD subsidized).  HACLA owns and manages
over 8,000 conventional public housing units, almost half of which
are over 50 years old.  Despite the large number of units that are
old, 99.5 percent are occupied.  However, the increasing costs of
maintaining the aging housing stock and the high crime rate
associated with the developments have reduced the agency's ability to
provide services and have forced HACLA officials to defer maintenance
and reduce their maintenance staff.  Agency officials believe that
the operating subsidy provided by the Department of Housing and Urban
Development (HUD) is not sufficient to operate the housing agency
effectively.  To supplement their operating budget, HACLA officials
have used--in accordance with HUD's regulations--a part of their
grant for capital improvements to defray operating expenses. 


   BACKGROUND
--------------------------------------------------------- Appendix I:1

HACLA owns and maintains 8,367 public housing units in 63
developments dispersed throughout the city of Los Angeles.  The
developments range in size from 2 to over 1,000 units and include
many "scattered site" locations; 50 percent of HACLA's units were
built before the mid-1950s.  The housing agency provides homes to
over 32,000 residents, over 1,000 of whom are elderly.  According to
HUD officials, HACLA has an occupancy rate of approximately 98
percent.  This high occupancy rate has helped the agency maintain a
management assessment score in the high 90s over the last 3
years--making it a high performer in HUD's Public Housing Management
Assessment Program.  Approximately 338 people work in HACLA's
conventional public housing program.  Almost all of the maintenance
positions are funded out of the conventional public housing funds. 
Between fiscal years 1994 and 1997, HACLA reduced its number of
employees from 421 to 338, or by almost 20 percent. 

HACLA's direct operating expenses for administration and maintenance
of the public housing developments are estimated at $354 per
unit-month; however, HACLA officials told us that total operating
expenses for the full range of activities pertaining to public
housing are even higher.  A 1995 study of actual operating costs
reflected per unit -month expenses for all services and activities
(i.e., protective services, social services, and central office
administration plus direct operating expenses) of $508.  In that same
year, the operating subsidy ($231) and rental income ($187) brought
total revenue to $419 per unit-month.  Other sources of federal funds
include grants or portions of grants--from such programs as the
Public Housing Drug Elimination Program and the Comprehensive Grant
Program for modernizing the housing stock--make up the shortfall. 

The top five factors influencing operating expenses at HACLA, in
order of importance, are the age of the developments, design
features,\1 crime, joblessness, and the percentage of working
families in residence.  HACLA officials ranked the age of the
developments as the factor having the most impact on operating costs. 
They also said that overhead levels that are not sufficient to
support field operations and the cost of employee benefit packages
influence operating expenses. 


--------------------
\1 Design features include common areas and building types (i.e.,
low-rise or high-rise). 


   AGENCY OFFICIALS BELIEVE THAT
   THE OPERATING SUBSIDY IS
   INADEQUATE
--------------------------------------------------------- Appendix I:2

Officials in HUD's Los Angeles Field Office believe that HACLA makes
maximum use of the operating subsidy HUD provides and diligently
takes advantage of the other funding sources available to it. 
Nevertheless, HACLA officials told us that the operating subsidy is
inadequate.  They attributed the inadequacy to HUD's Performance
Funding System (PFS) being based on 1975 expenses.  The inflation
adjustments over the last 23 years have not been sufficient to
account for increasing maintenance costs, they said.  These costs
include those to repair the aging housing stock and infrastructure,
such as broken water distribution lines or leaking gas distribution
lines.  According to HACLA officials, the allowable expense levels
under PFS also do not adequately cover expenses for administration or
for additional activities that did not exist when HUD set HACLA's
expense levels in 1975.  To supplement its operating subsidy, the
agency has reduced staff, deferred maintenance, and drawn on funding
from other federal grants. 

HACLA's allowable costs under PFS were based on maintaining buildings
that were then 30 years old and had systems that were approaching the
end of their useful lives and needed modernizing in 1975, HACLA
officials said.  However, even in 1975, the operating subsidy was not
high enough to cover the modernization needs.  Those same buildings
are now 50 years old, and many years of inadequate PFS funding have
caused an intractable amount of deferred routine maintenance that
must now be funded utilizing modernization funds from HUD's
Comprehensive Grant Program that should be used instead for major
repairs. 

Aging housing stock requires increased routine maintenance and is
more prone to require extra maintenance, HACLA officials said. 
Adding to the expense are the replacement costs of fixtures that
become irreparable when materials in the fixtures exceed their useful
life or fixtures simply become obsolete and go out of production. 
For example, many units in older developments have wooden window
sashes that have dry-rotted or metal windows that require repair
parts made from "scratch" because the manufacturer is no longer in
business or does not make the part.  As housing stock ages and
infrastructure--such as gas lines and water distribution lines--
ages, unplanned maintenance expenses increase.  Agency officials said
that at several of HACLA' s 50-year-old developments, deteriorating
gas and water lines may cause potentially dangerous living
circumstances.  They estimate that $1 million will be needed to
replace the lines.  We observed the conditions the HACLA officials
told us about at two developments--Aliso Village and Dana Strand. 

Aliso Village, built in 1942, is a low-rise development comprising 33
buildings and 685 units on 34 acres in East Los Angeles.  It is a
family development and home to 2,524 tenants.  (The development's
housing managers estimate that an additional 1,000 tenants live
unofficially in the development.) Aliso Village is in an area that
has experienced over 60 years of gang activity.  The managers said
that crime in the area is a moderately serious problem, with
gang-related vandalism and graffiti the crimes most frequently
committed in the development.  Still, the development's occupancy
rate is 99 percent. 

The architectural design and the age of the development are the
uncontrollable factors that have the greatest impact on operating
costs at Aliso Village.  The design feature with the most impact on
operating costs is the underground electrical and plumbing lines that
have corroded over time.  In addition, wooden window frames have
rotted over time, and cracks in walls from the settling of the
foundation cause water leaks that lead to leaking and rusty pipes in
the walls.  The age of the fixtures is also a maintenance
problem--the original free-standing heaters in the units cannot be
repaired at a reasonable cost because the manufacturer no longer
makes the heaters and cannot support their maintenance. 

The Dana Strand development, built in 1942 near the Los Angeles
harbor area, provides housing for families and the elderly.  It is a
low-rise development in fair condition on a 21-acre site and consists
of 384 units with an occupancy level of approximately 99 percent. 
The area has a moderate crime rate, but the development itself is
subject to gang-related crimes, such as graffiti on buildings.  HACLA
has installed bullet-resistant lights at Dana Strand at a cost of
$800,000 to increase the level of security.\2 Before the
bullet-resistant lights were installed, criminals would shoot out
lights to reduce visibility and give cover for criminal activity at
the development. 

Highest on the list of factors contributing to maintenance
expenditures at Dana Strand is the age of the development.  Dana
Strand officials cite deteriorating plumbing, rotting window sashes,
and old underground electrical lines as problems at the development. 
For example, the plumbing in the walls of the units is corroding and,
in one recent instance, leaking water from corroded plumbing
accelerated the corrosion of gas pipes, resulting in an explosion in
one unit.\3 Several tenants suffered minor injuries in the explosion
that blew off a portion of the building's roof and blew the walls out
of two units. 

Dana Strand officials listed three operating expenses that have
increased:  waste management, routine maintenance, and grounds
keeping.  Officials attributed the development's increasing expenses
for routine maintenance to its age.  Environmental regulations have
also contributed to increasing maintenance costs.  Because of the new
city requirements for waste management, for example, HACLA had to
install a clarifying pit at each of its developments to separate
caustic agents--used for cleaning stoves and appliances--from waste
water before the water is discharged into the city's sewer system. 
About once or twice per year, the pits have to be pumped out by an
authorized waste handler at a cost of $2,500 per visit.  Over the
last 5 years, HACLA has reduced Dana Strand's maintenance staff from
10 to 7 people--a loss of a painter, a gardener, and janitor. 
Without the painter, the staff had difficulty meeting the maintenance
standard that calls for each unit's interior to be painted every 5
years. 


--------------------
\2 Each light cost $1,000, including installation. 

\3 Dana Strand and two other developments, Ramona and Rancho San
Pedro, were built during the same period and have similar
construction (i.e., raised foundation).  Two problems occur with this
type of construction in the Los Angeles area:  Humidity condenses
under the buildings and, over time, the metal pipes deteriorate. 
Pipes also deteriorate at the points where they come out of the
ground and where the vertical risers enter a building's foundation. 
After the explosion at Dana Strand, inspections showed that similar
deterioration was occurring at the two other developments.  The black
malleable iron pipe used at the developments is standard and still
used; however, since those developments were built, it has become the
practice to wrap underground gas pipes and, where the pipes enter the
foundation on raised-foundation buildings, they are fitted into
protective sleeves (to eliminate the electrolysis that leads to the
deterioration of the pipes).  HACLA is replacing the deteriorated
pipes but needs funds from the modernization program to address the
problem. 


      USING HUD GRANTS HELPS HACLA
      COPE WITH FUNDING SHORTFALLS
------------------------------------------------------- Appendix I:2.1

HACLA officials said that the insufficient operating subsidy and the
Congress's periodic underfunding of the PFS appropriation are
responsible for the agency's inability to attract and retain
qualified staff, the increased time for making vacated units
available to new tenants, the deterioration of the housing stock, the
difficulty with funding employee benefits, and the difficulties with
providing adequate security.  To address the funding shortfalls, the
HACLA officials said they had reduced administrative and maintenance
staff, deferred maintenance, and transferred funds from the
Comprehensive Grant and Section 8 programs to cover operating costs. 
HUD's director of public housing in the Los Angeles Field Office told
us that HACLA is very aggressive in seeking funding and taking
advantage of available funding sources.  For example, HACLA has a
large Section 8 assisted housing program and receives an
administrative fee of over $25 million for administering it.  In
1997, HACLA allocated $2 million of its Section 8 administrative fee
to its public housing program.  HACLA also used the largest part of
its funding from HUD's drug elimination program to pay for its
security force in fiscal year 1996 and, as allowed under
appropriation law provisions, used 10 percent of the funds it
received for modernization to supplement its public housing program's
operating fund. 

Also, HACLA used funds from its Comprehensive Grant Program grants to
pay for management improvements in its public housing program, such
as the acquisition of its management information system.  According
to HACLA's director of planning, when HUD established PFS 23 years
ago, HACLA did not have an automated management information system. 
Thus, the agency's allowable costs under PFS do not include the costs
of developing and maintaining an information system.  No process
exists under PFS to change the allowable expense levels to cover new
technology.  Hence, HACLA used the Comprehensive Grant Program's
Management Improvement Program to fund the initial development of its
system.  However, using a portion of the Comprehensive Grant Program
allocation that way resulted in delaying much-needed physical
improvements to the housing stock; moreover, the ongoing operating
costs of the automated system are not included in the PFS
calculation. 

As table I.1 shows, aside from the spike created by the HOPE VI grant
in 1996, total HUD grants to HACLA peaked in 1995 (not adjusted for
inflation).\4 One reason for the recent decline is the downward trend
for modernization funding.  The modernization awards declined during
the period that the Congress did not fully fund HUD's budget request
for PFS.  Hence, any movement of grant funds to the operating fund
effectively resulted in a net reduction of modernization funds. 



                               Table I.1
                
                  HUD Grants Awarded to HACLA, Fiscal
                          Years Ending 1993-97

                         (Dollars in millions)

                          1993      1994      1995      1996      1997
--------------------  --------  --------  --------  --------  --------
Modernization            $29.0     $30.2     $28.5     $23.3     $22.9
 program
HOPE VI                    0.0       0.0       0.0      50.0       0.0
Resident services          1.5       0.0       2.3       0.0       1.0
 programs
Drug elimination           1.3       2.0       2.2       2.2       2.2
 program
======================================================================
Total                    $31.9     $32.2     $33.0     $75.5     $26.0
----------------------------------------------------------------------
Source:  HACLA grant data. 


--------------------
\4 HOPE VI is an urban revitalization program for severely distressed
housing. 


      INCREASING EXPENSES
------------------------------------------------------- Appendix I:2.2

Waste disposal, employee benefits, and security are expenditures that
HACLA officials said increased.  Litigation has raised HACLA's
insurance premiums, self-insurance payments, and legal expenses. 
Despite a one-time adjustment to the allowable expense level to
offset higher insurance costs,\5 HACLA had to take other steps to
fund its higher insurance costs.  It engaged in partnerships with
community groups to provide resident services, reduced its
administrative and maintenance staffs, and reduced the amount of
maintenance being done. 

HACLA officials told us that the cost of employee benefits has grown
more rapidly than wages in general and that the PFS inflation
adjustments have not fully reflected the additional cost.  They
singled out two areas in which the agency's employee benefit expenses
increased:  health care plans and retirement and disability.  The
officials told us that health care premiums have skyrocketed since
1975, and HACLA cannot afford to cover a full family or even a single
dependent under some health care plans.  However, the agency attempts
to provide a competitive health care benefit package to retain
qualified professional staff. 

HACLA officials said that if the operating subsidy is not increased
in the near future, it is likely that the housing agency will engage
in more partnerships with community groups, reduce its administrative
staff even more, and continue to defer maintenance. 

Figure I.1 shows that for the most part, the proportions of the
operating subsidy that HACLA used for most categories has remained
flat except for the general expenses category, which has been
erratic, and the ordinary maintenance category, which, since 1995,
has trended downward.  HACLA officials told us that maintenance
expenditures charged to the conventional public housing budget might
have declined, but that the overall maintenance expenditure is much
greater.  HACLA has shifted a sizeable portion of its routine
maintenance budget to the nonroutine category, but funded it by using
modernization funds. 

   Figure I.1:  HACLA Operating
   Expenditures Per Unit-Month,
   Fiscal Years Ending 1993-97

   (See figure in printed
   edition.)

Note:  Adjusted to constant 1996 dollars. 

Source:  HACLA's Statement of Operating Receipts and Expenditures for
fiscal years ending 1993 through 1997. 


--------------------
\5 In response to a congressional mandate to permanently compensate
housing agencies for increased insurance costs, HUD adjusted the
allowable expense level by $8.45 in 1989. 


   INCENTIVES AND DISINCENTIVES
   BUILT INTO PFS HAVE LITTLE
   IMPACT ON MANAGEMENT ACTIONS
--------------------------------------------------------- Appendix I:3

The disincentives built into PFS outnumber the incentives for HACLA
to operate efficiently.  HACLA's management has had to produce the
same or greater number of outputs (decent, safe, sanitary housing
units) with a lesser amount of inputs (dollars).  However, some PFS
rules discourage efficiency because many revenue-generating or
cost-saving actions result in the housing agency losing part of its
subsidy.  In some respects, the housing agency is better off doing
nothing and receiving a full subsidy allocation.  For example,
present rules penalize housing agencies for good financial management
in at least two areas:  First, under the rules governing interest
income, the Target Investment Income formula equation establishes a
framework where interest earned cannot wholly be retained.  Second,
if a housing agency receives discounts from vendors in return for
paying its bills within 30 days, the discounts must be recorded as
income for the housing agency, and the operating subsidy is reduced
by that amount.  Therefore, a housing agency can only partially
retain the interest on its investments and cannot benefit from
efficient purchasing procedures. 

HACLA officials believe that HUD recognized some of the disincentives
to efficient management in its notice PIH 96-24 (HA), "Performance
Funding System Policy Revision to Encourage Public and Indian Housing
Authorities to Facilitate Resident Employment and Undertake
Entrepreneurial Initiatives." They told us that the notice
temporarily helped correct some of the problems inherent in the PFS
logic, which does not recognize that efficiencies cannot be maximized
by legislative mandate alone.  Policies are needed that do not
penalize a housing agency for operating in its own self-interest when
to do so is good business, they said.  HACLA officials noted that PIH
96-24 expires in 1998. 


HOUSING AUTHORITY OF BALTIMORE
CITY
========================================================== Appendix II

The Housing Authority of Baltimore City (HABC) in Maryland is among
the nation's largest housing agencies.  With an annual operating
budget of over $75 million (70 percent of which is subsidized by
HUD), it manages over 16,000 units of public housing.  Of this total,
about 14,000, or 84 percent, are occupied.  HABC officials attribute
the relatively low occupancy rate (the industry average is 92
percent) to the poor physical condition of much of the housing
stock--some is uninhabitable and almost half is 35 years old or
older--and to the high crime rate near the developments that results
in costly vandalism, property destruction, and a lack of demand for
the units.  Limitations on HABC's funding have prevented it from
addressing either problem.  To the extent that the agency has
attempted to address the crime problem, it has covered the costs by
forgoing routine maintenance.  HABC officials believe that PFS
underfunds the agency, and their management of the housing agency
reflects this belief.  They have reduced maintenance by one-third
over 5 years, used funding from federal grants from the capital
modernization program to support operations, frozen administrative
expenses, and deferred ordinary maintenance to the point that it has,
in some cases, become emergency maintenance.  Officials believe that
these actions jeopardize the long-term viability of their housing
stock. 

The director of public housing at HUD's Maryland State Office had
mixed opinions about the sufficiency of HABC's operating subsidy.  He
said that HABC's cost base was sufficient when PFS was implemented
and that the current allowable expense level seems to be adequate. 
But he also said that expense levels need to be revised to better
protect the investment HABC is making in its newly rehabilitated HOPE
VI developments.  He added that although other HUD-assisted
properties in the area receive less revenue to operate than HABC
does, HABC has specific circumstances--such as high-cost family
high-rises; large, older developments; very low-income tenants; and
higher crime rates--that raise its operating costs above that of
privately owned properties. 


   BACKGROUND
-------------------------------------------------------- Appendix II:1

HABC's 16,558 housing units are located in 42 conventional
developments and 18 "scattered site" developments that are mostly
vacant houses.  These developments are home to 30,414 people.  Of the
42 conventional developments, the agency rates 24 as being in fair to
very good condition and 10 as being in poor to uninhabitable
condition; 8 are unrated.  HABC officials said that the poor
condition of some of its developments and crime account for its high
vacancy rate--currently at 16 percent, twice the national average. 
Some housing units are vacant because HABC does not have the funds to
modernize the units.  HABC officials would like to sell some of the
3,000 scattered site units, where many of the vacancies exist, but it
cannot afford the repairs needed to make the dwellings salable.  The
director of public housing in HUD's Maryland State Office said that
HABC could do a better job of managing and, if necessary, of
disposing of these properties.  A number of other vacancies are in
developments that HABC plans to demolish.  The large number of
vacancies reduces HABC's Public Housing Management Assessment Program
score, which is currently in the range of about 70.  But only a
couple of years ago, HABC's score was in the low 60s.  Falling below
60 would have earned HABC a "troubled agency" designation. 

HABC's operating budget for its fiscal year ending June 30, 1997, was
approximately $75.6 million, of which HUD contributed $52.6 million,
or about 70 percent; $28.3 million came from rental income.  For that
fiscal year, HUD also awarded significant grants to HABC to fund
other types of activities.  (See table II.1.)



                               Table II.1
                
                    Significant Federal Grants HABC
                 Received, Fiscal Years Ending 1993-97

                         (Dollars in millions)

                          1993      1994      1995      1996      1997
--------------------  --------  --------  --------  --------  --------
Modernization            $41.8     $39.7     $38.4     $30.7     $30.1
 program
HOPE VI                    0.0      49.7      22.7      20.0      31.3
Resident services
 programs
Resident initiatives       0.0       0.0       0.0       0.0       1.1
Family support             0.0       0.0       0.0       0.0     4.5\a
 services
Drug elimination           0.0       4.4       4.5       0.0       4.3
 program
======================================================================
Total                    $41.8     $93.8     $65.6     $50.7     $71.3
----------------------------------------------------------------------
\a The sources for this grant were the modernization program, $1.2
million; earned income, $1.1 million; congregate housing, $120,000;
state congregate housing, $500,000; drug elimination grant, $1.2
million; other private funds, $380,000. 

Source:  HABC's Office of the Executive Director. 


   HABC OFFICIALS BELIEVE THAT THE
   OPERATING SUBSIDY IS INADEQUATE
-------------------------------------------------------- Appendix II:2

Officials of HABC's top management, housing operations, and
comptroller's office told us that the agency is not receiving a
sufficient subsidy under PFS.  They said that increasing costs not
anticipated or recognized by PFS, coupled with aging, poorly
designed, and vacant housing stock, have created significant
shortfalls in the funds provided to operate the housing agency
effectively.  Of the actions that HABC has taken to address this
shortfall, the most striking is its substantial reduction in ordinary
maintenance over the last few years.  The maintenance cost category
has declined from $32 million in fiscal year 1993 to $22 million in
fiscal year 1997.  As a result of the cost-cutting, fewer staff are
available to prepare vacated housing units for new tenants.  Because
more units are being vacated than can be prepared for re-leasing,
unnecessary vacancies, lower rental income, and a greater dependency
on subsidies result. 


      SEVERAL NEW COSTS AND THE
      INCREASING NEED FOR
      MAINTENANCE CREATE A BUDGET
      DILEMMA FOR HABC
------------------------------------------------------ Appendix II:2.1

HABC has several new or increasing expense categories that PFS does
not recognize adequately.  These categories include the costs of
security, litigation, and employee health benefits.  At the time that
HABC's expense levels were set by PFS, the agency was not incurring
significant security costs.  HABC established a security force in
1987 and converted it to a sworn police force in 1991.  It now has 88
police officers and a total security staff of 100.  HABC's deputy
executive director said that HUD's Public Housing Drug Elimination
Program helps to defray the costs of this force (funding 30 to 40 of
the officer positions at any one time) but that the costs of the
force generally fall under other budgets, such as the Management
Improvement Program portion of the Comprehensive Grant Program, which
normally funds capital expenses for modernizing the housing stock and
improving its management.  By using these funds for security, HABC
has less for modernization and risks continued deterioration and
vacancies.  In years when no drug elimination funding is available,
HABC must find other funds to cover the security costs.  The payment
in lieu of taxes that HABC makes to Baltimore City is generally in
the range of $300,000 to $400,000, which does not fund many City of
Baltimore policemen to patrol and deter crime in HABC's housing
developments. 

Another cost that HABC's allowable expense level does not adequately
cover is that of health insurance benefits for employees.  Although
the agency's operating budget now covers the costs of the benefits,
these costs increased more since 1975 than the inflation rate HUD
allows under PFS.  To pay the higher benefit costs today, HABC must
forgo some other expenditures such as routine maintenance.  In
addition, HABC officials told us that litigation costs have doubled
from 1993 to 1997, primarily because of lawsuits filed to reduce the
concentration of poor and minority households in public housing. 

HABC also faces rising costs from its aging housing stock and the
combined effects of the poor housing design, conditions, and crime. 
We observed examples of these conditions at two of HABC's
developments--O'Donnell Heights and Claremont Homes. 

O'Donnell Heights is one of HABC's largest developments, comprising
900 densely packed units with little curb appeal or open space but a
great deal of access to surrounding city streets.  Most heads of
households are young, single women.  Built in the early 1940s,
O'Donnell Heights had significant modernization work in the early
1980s but none in the last 5 years, and none is planned in the next 5
years.  Housing managers at O'Donnell said that the age of the
housing contributes to the cost of maintaining it because of its
general deterioration.  The director of public housing at HUD's
Maryland State Office said that HABC is not allocating sufficient
resources to O'Donnell Heights, but he could not determine whether
the housing agency had enough maintenance funding in its budget to
adequately address the development's problems. 

O'Donnell's housing managers said illegal drug activity is difficult
to deter because of the size, openness, and demographics of the
development.  Because of the high rate of crime--worse than in the
surrounding neighborhood--residents often request transfers,
relocate, or move completely out of O'Donnell.  To control crime at
O'Donnell Heights, the development uses special lighting and two
policemen, one from the City of Baltimore and one from HABC's police
force.  However, O'Donnell has no contract security, fencing,
security cameras, or controlled entry to the development--all of
which can deter crime in housing developments.  The development's
wide-open layout contributes to the prevalence of the gang-related
drug activity that intimidates the residents, according to O'Donnell
housing managers.  They also said that the seriousness of the crime
has grown significantly during the last decade. 

O'Donnell Heights' design also contributes to the increasing
maintenance costs.  For example, hardwood floors, sheet-rock walls,
and separate hot water heaters and furnaces for each unit increase
costs.  Each unit has two doors, front and back, and two screen
doors, the maintenance of which increases costs; and the aluminum
siding has been hard to maintain because of the wear and tear from
the children living in the development.  The many gutters and
downspouts on O'Donnell's units are also difficult to maintain, and
officials described instances of water in the ground-floor units,
flooding and drainage problems, and foundation leaks. 

At Claremont Homes, the most significant cost factors are the
development's architectural design, lead-based paint, and its
46-year-old buildings.  Claremont's low-rise units are very costly
because they have the original steam-heated radiators that, in
combination with the old plaster walls that are damp because of poor
ventilation, create an almost constant need to repaint and replaster. 
The paint in all of the units is lead-based and needs frequent
attention to keep it from being hazardous.  The cost of addressing
the problems caused by the steam heating system, damp walls, and
lead-based paint has gradually grown over time so that it is now a
significant portion of the development's total operating costs. 

Because of Claremont's generally stable, older population of tenants,
its strong resident council, and its effective layout, crime--except
for some minor vandalism--is not a serious problem and does not
contribute significantly to the operating costs.  Nevertheless,
Claremont's per unit-month expenses (before utilities) are about
$383, 24 percent more than the average for HABC.  Claremont's housing
manager said that routine maintenance, grounds keeping, and vacancy
renovations were three costs that had increased over the years.  Of
these, the highest cost was for renovating vacated units to abate the
lead-base paint hazard and replace almost all of the original
plumbing fixtures and cabinetry.  HABC officials are concerned about
the potential for additional costs related to lead-paint litigation
if they cannot keep up with the lead abatement needed as the paint
continues to chip and peel. 


      HABC HAS TAKEN MANY ACTIONS
      TO COVER NECESSARY EXPENSES
------------------------------------------------------ Appendix II:2.2

HABC's housing operations officials told us that crime and poor
physical conditions are the two most chronic problems at the housing
agency.  Nevertheless, two of the actions that HABC officials have
taken to address perceived shortfalls in funding for operations
include deferring maintenance and reducing maintenance staff.  HABC
has reduced its maintenance expenditures from $32 million to $22
million over the past 5 years, from fiscal years 1993 to 1997, a
reduction of nearly one-third. 

At the same time, as figure II.1 shows, the cost of protective
services has increased dramatically--nearly doubling from $16 per
unit-month in fiscal year 1993 to $30 per unit-month in fiscal year
1997, totaling $5.9 million for fiscal year 1997.  Because HABC's
operating subsidy increases each year only to offset inflation, the
agency has been unable to address the mounting need to protect its
residents while at the same time maintaining a constant expenditure
for maintenance.  HABC's comptroller projects that the agency's
security costs will be about $9 million next yearï¿½$6 million in the
security line item plus about 34 percent in fringe benefitsï¿½or about
50 percent more than the cost in 1997.  He told us that the need for
protective services is more immediate and is, therefore, a higher
priority than routine maintenance. 

   Figure II.1:  HABC Operating
   Expenditures Per Unit-Month,
   Fiscal Years Ending 1993-97

   (See figure in printed
   edition.)

Note:  Adjusted to constant 1996 dollars. 

Source:  HABC's Statement of Operating Receipts and Expenditures for
fiscal years ending in 1993 through 1997. 

Other actions that HABC has taken to address shortfalls in funding
for operations include reducing administrative staff, an action that
officials said was the most effective in allowing HABC to operate
within funding limitations; transferring funds from other programs,
such as the modernization program, the second most effective action;
deferring maintenance; reducing operating reserves in some years; and
reducing maintenance staff, which officials said was the least
effective. 

In addition, HABC's HOPE VI director said that she thought that
funding for the agency's six HOPE VI projects contributed to
defraying the agency's operating costs in several ways.  She cited
the following as evidence of this effect: 

  -- Because HOPE VI pays for site preparation for the redevelopment,
     it is likely to cover costs that the operating budget would
     ordinarily have had to cover, including abatement of lead-based
     paint hazards created by demolition and other costs not directly
     related to the redevelopment and revitalization of the immediate
     area. 

  -- Expending HOPE VI funds often relieves the pressure on funding
     from other grant programs, such as the Comprehensive Grant
     Program for modernizing public housing stock, and various social
     service grants.  Because a HOPE VI project--and its associated
     HUD grants, matching community funding, and other human and
     community service funding--is expected to address most of the
     redevelopment needs of a qualified housing development, HABC's
     other grant and subsidy funding can be more focused on the
     remaining needs of the agency. 

  -- The greater cost efficiencies inherent in a newly rehabilitated
     housing development--such as more efficient heating systems,
     more effectively insulated construction, and fewer routine
     maintenance work orders--lower the development's operating
     costs, at least in the near term, and therefore tend to relieve
     the agency's operating budget. 

In the future, to cope with reduced operating funds or funding
shortfalls, HABC officials told us that the agency most likely would
exercise management options such as those listed below, ranked by the
relative ease with which they can be achieved: 

  -- asking the City of Baltimore for a waiver of the payment in lieu
     of taxes,

  -- reducing maintenance staff,

  -- reducing operating reserves,

  -- reducing administrative staff,\1

  -- reducing or deferring maintenance, and

  -- entering into partnerships with community or private sector
     groups. 


--------------------
\1 HABC's administrative expenses have been frozen at about $13.50
per unit-month for the past 5 years. 


      INSUFFICIENT OPERATING FUNDS
      RESULT IN VACANCIES AND THE
      POTENTIAL FOR LOSS OF
      HOUSING STOCK
------------------------------------------------------ Appendix II:2.3

One of the clear effects at HABC of not having sufficient operating
funds is the necessity of laying off maintenance staff, which, in
turn, leads to an increase in the time required to "turn around"
vacant housing units after they have been vacated and return them to
a rentable condition for new tenants.  At HABC, approximately 150
units (out of nearly 14,000 under lease) are vacated each month
(slightly more than a 1-percent turnover per month).  However, with
limited maintenance staff, only about 120 to 130 can be reconditioned
for leasing to new tenants each month.  A high vacancy rate means
that rental income is below expectations, thus creating more of a
dependency on the operating subsidy provided by HUD. 

As the agency has performed less and less preventive or ordinary
maintenance over the years to cope with inadequate operating funds,
more items have eventually become "extraordinary maintenance" or
emergency items.  In some cases, these items are aggregated into a
request to HABC's modernization committee to be done under the
capital grant program.  But the officials said that the reality is
that much maintenance is not done because modernization funding also
is not sufficient to meet HABC's needs.  For example, HABC's
comptroller said that he requested modernization funds for
extraordinary maintenance at the O'Donnell Heights development, but
so many other demands for this funding exist that O'Donnell's needs
are not yet a priority.  HABC officials said that in general, the
potential result is that many of HABC's units will eventually become
uninhabitable and need to be demolished.  They said that HABC's HOPE
VI program awards will help deal with some of these problems, but
that it would be more cost-effective if HABC had the money to do
adequate maintenance before excessive deterioration became evident. 
They also recognized that eventually the HOPE VI money will not be
available. 


   IMPACT ON OPERATIONS AS A
   RESULT OF INCENTIVES OR
   DISINCENTIVES BUILT INTO PFS
-------------------------------------------------------- Appendix II:3

Both the director of public housing at HUD's Maryland State Office
and HABC officials told us of ways that PFS currently affects
operations and ways that it could better influence management
decisions.  For example, HUD's director of public housing in Maryland
said that combining funds for capital improvement and operating costs
would give housing agencies a more predictable stream of income.  And
HABC's deputy director said that HUD should establish some incentive
for housing agencies to earn other income.  Currently, earning other
income reduces an agency's subsidy on a dollar-for-dollar basis. 


      HUD OFFICIAL FAVORS
      INCENTIVES TO PERFORM NEEDED
      MAINTENANCE
------------------------------------------------------ Appendix II:3.1

HUD's director of public housing in the Maryland State Office said
that he would favor an incentive built into PFS that would encourage
a housing agency to invest in maintaining its stock.  He said that
the reaction of HABC and many other housing agencies to budget cuts
is to reduce their expenditures on maintenance.  He would like to see
a single formula that would provide both operating and capital funds
so that a housing agency can predict its total income and make more
informed decisions about how best to meet both operating and capital
needs.  Eventually, if the housing agencies do not adequately fund
maintenance, the quality of their housing stock declines.  He also
said that several disincentives are inherent in the current formula. 
For example, an automatic annual inflation adjustment creates a
disincentive for efficiency.  In addition, a housing agency has
little incentive to maximize its rental income over a several-year
period because if income declines, the subsidy will rise the next
year to compensate.  On the other hand, if rental income increases
unexpectedly during the current year, the housing agency can keep the
rental windfall for that year.  Finally, according to PFS rules, a
housing agency's fiscal audit costs are not limited, and no incentive
exists to seek the most cost-effective contract for such audits. 

The director said he favored setting new allowable expense levels for
developments that have been revitalized and rehabilitated with HOPE
VI grants.  He believes that it is important to fund maintenance at a
high enough level to ensure that the investment in the property is
protected.  In addition, he believed that performance indicators
needed to be better linked.  For example, he said that establishing a
high operating reserve account makes the financial performance
indicator look good, but creating this high reserve at the expense of
performing needed maintenance would be wrong and should not be
rewarded.  Combining the two indicators for physical and financial
conditions would offer a means of better performance measurement, in
his opinion. 


      HABC OFFICIALS SAID PFS HAS
      SOME IMPACT ON MANAGEMENT
      ACTIONS
------------------------------------------------------ Appendix II:3.2

In years when PFS is funded at 100 percent of HUD's forecast of
housing agencies' needs, additions that a housing agency makes to the
ï¿½other incomeï¿½ line item cause a dollar-for-dollar reduction in the
agency's PFS subsidy, according to HABC's deputy director.  This
provides no incentive for housing agencies to earn income from such
activities as renting space on building roofs for radio or other
broadcasting antennas or to operate services for tenants such as
laundromats or day care.  He also said that in 1993, HABC incurred
significant operating expenses to reduce vacancies.  To cover this
expense, however, HABC needed to use funds from its operating
reserve.  Using this source of funding reduced the reserve to a level
that resulted in a lower management assessment score under HUD's
Public Housing Management Assessment Program.  Now, to increase the
assessment score, HABC is building up its operating reserve levels at
the expense of performing some needed maintenance, according to the
deputy director. 

Although such incentives and disincentives exist, HABC's deputy
director told us that PFS is not a needs-based system that can
provide a subsidy to a particular housing agency on the basis of what
it needs to operate because HUD's policy has been to use a generic
system to address the needs of all housing agencies.  He said that
HABC makes most of its management decisions based not on PFS, but
rather on the viability of the projects and on the long-term survival
of the agency.  Furthermore, small adjustments to PFS are not likely
to affect HABC's operating behavior or to "incentivize" better
management, he said. 


   INCENTIVES FOR INCREASING
   OPERATING EFFICIENCY
-------------------------------------------------------- Appendix II:4

HABC officials said that among the actions allowable or potentially
allowable under PFS that they believe are most useful as incentives
for increasing operational efficiency, are the ability to

  -- expeditiously evict difficult-to-manage tenants;

  -- lease to easy-to-house tenants or to working tenants;

  -- perform preventive maintenance;

  -- form partnerships with the local community, nonprofits, and the
     city to obtain funding for resident services or to obtain the
     services themselves;

  -- implement the income disregard options and ceiling rents; and

  -- implement minimum rents. 

HABC's comptroller told us that as housing agencies begin to improve
their stock through demolition and rehabilitation, they tend to lose
their most costly-to-house tenants--those who do not work
consistently, violate housing agency rules, or do not pay rent on
time--and keep their best or most affluent tenants.  He said that
this could explain the trends of increasing rental income and
employment of public housing tenants nationally.  Therefore, it would
make sense for HUD to allow agencies to keep at least half of the
rent increases that result from higher-income residents for a given
year, similar to the incentive that HUD allows for utility cost
savings.  As for utility cost savings, he suggested that HUD allow a
housing agency to keep the savings beyond the current year if the
agency was instrumental in negotiating the savings with the provider. 


HOUSING AUTHORITY OF KANSAS CITY
========================================================= Appendix III

Since being placed on HUD's list of troubled housing agencies, the
Housing Authority of Kansas City (HAKC), Missouri, has been operating
under court-ordered receivership for about 3 years.  The agency
provides a full range of housing services for over 1,000 households. 
By using portions of other federal grants, particularly its
modernization grant, to pay for some of its operating costs, HAKC is
supplementing its operating budget and providing day-to-day
maintenance of its housing stock.  The availability of other funding
sources has allowed HAKC to fund most operating areas while still
increasing its operating reserve--which grew from $1.3 million at the
end of fiscal year 1994 to $2.8 million at the end of fiscal year
1997--to a level that the receiver believes is more prudent to meet
working capital and emergency repair needs of a capital nature. 
However, HAKC's housing stock is almost all more than 35 years
old--most of it located within a 5-mile radius in a high crime area. 
The costs of repairing an aging stock and coping with changing
circumstances, such as the expense of deterring worsening crime, have
grown significantly over the 23 years since HUD set HAKC's allowable
level of operating costs in 1975.  In recent years, HAKC has
attempted to address the problem of its relatively fixed operating
subsidy from HUD by reducing spending in other areas, such as the
salaries paid for the administration of the housing agency, although
HAKC officials believe that this has threatened their ability to
retain competent staff and management. 


   BACKGROUND
------------------------------------------------------- Appendix III:1

In receivership for 3 years, HAKC is plagued with deteriorated
housing stock and the high vacancies that accompany such conditions. 
It is a large housing agency that manages approximately 1,824 housing
units; only 1,053 households occupy its conventional public housing. 
Its vacancy rate under receivership has been between 3 and 5 percent,
however.\1 Of those households, 680 (or 65 percent) are in family
developments, with the rest living in developments for the elderly. 
Single heads of households constitute almost 90 percent of HAKC's
households.  Two of HAKC's developments are high-rises, both in good
condition and having low vacancy rates but experiencing high
operating expenses.  One of the high-rises primarily houses elderly
tenants and has high operating costs for security and support
services for this population that were not contemplated when PFS was
established.  The other high-rise, which houses frail elderly and
disabled households, has even higher operating expenses.  Half of
HAKC's mid-rise units are uninhabitable, and just 13 percent of the
livable half are in better-than-fair condition.  Partly because of
the poor housing conditions and high vacancy rate, HAKC has had a low
Public Housing Management Assessment Program (PHMAP) score for many
years.  Its PHMAP score is currently 85, which classifies it a
standard performer.\2

HAKC's total expenditures for fiscal year 1997 were $5.3 million, of
which the operating subsidy funded $5.1 million or 97 percent.  In
addition, HAKC used over $3 million, or an additional amount equal to
slightly more than 60 percent of its operating subsidy, from various
grants and the administrative fees from its Section 8 tenant-based
assisted housing program to supplement its operating funds.  The
grants included its Comprehensive Grant Program and Comprehensive
Improvement Assistance Program grants for modernization, its Public
Housing Drug Elimination Grant, its Public Housing Apprenticeship
Grant, and its Vacancy Reduction grant.  HAKC used these grants to
pay for salaries, receivership administration, and software upgrades. 
HAKC is implementing three HOPE VI projects to substantially replace
existing developments, which should improve the quality of HAKC's
housing stock.  HAKC officials expect the new developments to be
ready for occupancy over a 3-year period ending in 2000. 


--------------------
\1 HAKC's adjusted vacancy rate excludes units covered by programs
under the Comprehensive Improvement Assistance Program, the
Comprehensive Grant Program, the Major Rehabilitation of Obsolete
Properties program, and the HOPE VI program. 

\2 The PHMAP score required for a housing agency to be removed from
receivership varies from receiver to receiver.  Essentially, HAKC is
in a management and compliance receivership, and thus, regardless of
the PHMAP score it receives, it will not be removed until the judge
in the case is satisfied that housing conditions have improved.  The
receiver intends to initiate discussions in 1999 on the future of
HAKC's governance with the plaintiffs to the receivership action and
the interested parties in the case. 


   HUD OFFICIALS AND THE RECEIVER
   AGREED THE OPERATING SUBSIDY IS
   INSUFFICIENT
------------------------------------------------------- Appendix III:2

Officials at HUD's Kansas City Field Office and HAKC's receiver
stated that the operating subsidy is inadequate for HAKC to
reasonably meet its expenses.  The receiver said that the funding
provided by PFS does not adequately supplement rental and other
income because of the flawed composition of the formula that HUD uses
to determine the amount of operating subsidy.  He said that routine
maintenance--HAKC's highest expense category--and extraordinary
maintenance are not adequately recognized under the PFS formula
because factors affecting maintenance, such as building age and
vandalism, have changed drastically since PFS's implementation in
1975.  Because of the inadequate operating subsidy, HAKC continues to
face a wide range of operating problems, he said.  The problems cited
included the inability to attract and maintain qualified staff, the
inability to fund employee benefits, the increased time required to
prepare vacated units for new tenants, the deterioration of housing
stock, and the inability to provide adequate security.  To address
funding shortfalls, HAKC has reduced administrative and maintenance
staff, reduced employee training, and used funds from other programs
when allowed under HUD's regulations.  Under the receivership, HAKC
has been successful in obtaining special grant funds that have
enabled the agency to make management improvements.  The receiver is
concerned that many of the grant funds are essentially nonrecurring,
special purpose capital and social services funding.  HAKC cannot
rely on these funds to cover ongoing operations. 


      CRIME, AGING STOCK, AND
      OTHER FACTORS CREATE BUDGET
      DIFFICULTIES
----------------------------------------------------- Appendix III:2.1

Having developments located near high-crime areas increases the cost
of preparing units for new households after previous tenants have
departed.  In HAKC's developments, the primary crime problem is
vandalism by drug users who break into unoccupied units, damaging
screens, windows, and doors.  After breaking in, drug users deface
walls and floors or set fires and, once units have been broken into,
children enter and cause further damage.  Damage to a unit already
prepared for new tenants means additional work for maintenance crews
at a cost that could exceed the initial cost of preparing the unit. 
HAKC's housing stock is also expensive to maintain because of its age
and because of the quality of public housing design and construction
in the era in which it was built.  We observed some of the effects of
these conditions at HAKC's Chouteau Courts and West Bluff
developments. 

Chouteau Courts, built in 1958, is a 140-unit mid-rise development
that is home to 124 families.  It is located in a high-crime area. 
The site manager estimated that more than half of Chouteau Courts'
units were in good to excellent condition.  Within the last 5 years,
the heating and air conditioning systems were modernized, and plans
call for additional modernization within the next 5 years.  The site
manager told us that the selling of narcotics in and around the
development is the criminal offense that is the most detrimental to
the housing stock. 

The site manager described the continuing maintenance required by the
way the development was built and said that utility costs at Chouteau
Courts could be lower if the units were better insulated.  Building
specifications at the time the development was constructed did not
require exterior walls to be insulated.  Because the walls have a
cement block core, insulating them now would be expensive.  When it
rains heavily, drainage problems cause sewer backups into the
basement of one of the buildings because the basement is lower than
the sewer line.  Many units have doors that are difficult or
impossible to open because the doorjambs are metal and have rusted to
the point that the doors do not hang straight.  HAKC is directing a
substantial amount of modernization funds for repairs at this
development through its comprehensive 5-year plan for Comprehensive
Grant Program funds.  The per unit-month expense for Chouteau Courts
is $266, which contrasts with $189 for West Bluff, a newer
development located in an area with a lower crime rate. 

West Bluff, built in 1964, consists of 100 townhome units and is home
to 89 families.  The site manager told us that all of the units were
in excellent condition.  Modernization work has been done on the
roofs, windows, plumbing, and air conditioning systems within the
last 5 years.  Within in the next 5 years, HAKC plans to modernize
the exterior water and sewer lines.  HAKC officials rate crime at
West Bluff as a moderately serious problem. 

HAKC officials said the following crimes and design features have an
impact on the operating costs at West Bluff: 

  -- Drug users breaking into vacant units cause 25 percent of the
     damage done to units at West Bluff. 

  -- Prior to 1997, gang-related vandalism and damage to units from
     gang incidents also had an impact on the high operating costs at
     this development. 

  -- Prior modernization efforts were partial and did not address all
     physical deficiencies.  The lack of insulation in exterior walls
     has resulted in isolated incidents of frozen pipes. 

  -- The pitched roof design, with valleys where the townhouses
     connect at a common wall between units, results in leaks in the
     units because, over time, the sheet metal that serves as the
     base for the valleys has separated between many units. 

In addition, HAKC officials told us that their costs for waste
disposal and security had grown significantly and that HUD's
allowable expense levels for these costs are no longer adequate.  Of
the two cost categories, security is the greater; but together, these
increasing costs are having a moderate to severe impact on HAKC's
operating expenditures. 


      OTHER INCOME SOURCES AND
      COST REDUCTIONS ARE USED TO
      COVER EXPENSES
----------------------------------------------------- Appendix III:2.2

HAKC's receiver told us that because the operating subsidy from HUD
is insufficient, the housing agency has had to supplement its
operating budget with funds from other sources.  These sources
include its grants from the Comprehensive Grant Program and
Comprehensive Improvement Assistance Program established to modernize
developments, the HOPE VI program established to rehabilitate
distressed properties, the Public Housing Drug Elimination Program,
remaining funds from grants received several years ago under the
Major Rehabilitation of Obsolete Properties program,\3 and a portion
of the administrative fee reserve received from HUD in return for
operating a large Section 8 tenant-based assisted housing program. 
In addition, HAKC has formed partnerships with local government and
community groups, reduced administrative and maintenance staff, and
deferred maintenance.  Of these measures, the staff reductions were
the most effective in freeing up operating funds to pay for
increasing operating expenses.  To address budget shortfalls in the
future, HAKC officials said they would continue the partnerships and
would use operating reserves rather than continue to reduce staff and
maintenance.  Table III.1 shows the grants HAKC received from HUD in
fiscal years 1993 through 1997. 



                              Table III.1
                
                Total HUD Grants Awarded to HAKC, Fiscal
                          Years Ending 1993-97

                         (Dollars in millions)

                          1993      1994      1995      1996      1997
--------------------  --------  --------  --------  --------  --------
Modernization            $11.2      $3.4     $10.3      $2.9      $2.9
 program
HOPE VI                   47.6       0.0       0.0       0.0      13.0
Resident services          0.0       1.0       0.4       0.0       0.1
 programs
Drug elimination           0.0       0.0       0.0       1.5       0.5
 program
Total                    $58.8      $4.4     $10.7      $4.4     $16.5
----------------------------------------------------------------------
Source:  HAKC grant documents. 


--------------------
\3 The Major Rehabilitation of Obsolete Properties program is not a
currently funded program, but grants made under it in earlier years
are still being spent by housing agencies. 


      INSUFFICIENT OPERATING FUNDS
      RESULT IN THE INABILITY TO
      ATTRACT QUALIFIED STAFF AND
      PERFORM NECESSARY
      MAINTENANCE
----------------------------------------------------- Appendix III:2.3

Although HAKC's pay scales are comparable to those of other
government entities in the region, the pay scales are significantly
lower than the those in private industry.  HAKC's financial analyst,
for example, left the agency for a higher paying position in the
private sector.  Also, HAKC's pay scale for its maintenance staff is
low when compared to the private sector; its entry-level wage for a
maintenance worker is about $6.80 per hour, while the wage for a
comparable worker in the private sector is between $8.00 and $9.00
per hour. 

Figure III.1 shows that over the last 5 fiscal years, except for
ordinary maintenance and operations, HAKC's expenses have remained
relatively flat when adjusted for inflation. 

   Figure III.1:  HAKC Operating
   Expenditures Per Unit-Month,
   Fiscal Years Ending 1993-97

   (See figure in printed
   edition.)

Note:  Adjusted to constant 1996 dollars. 

Source:  HAKC's Statement of Operating Receipts and Expenditures for
fiscal years ending in 1993 through 1997. 


   PFS OFFERS FEW INCENTIVES FOR
   GOOD MANAGEMENT PRACTICES
------------------------------------------------------- Appendix III:3

HAKC's receiver believes that PFS provides few incentives for good
management.  He offered the following observations on PFS: 

  -- The artificial cost structure that PFS imposes on the housing
     agency places it in the position of constantly seeking funds
     because, under PFS, HUD has not defined the actual group of
     services the housing agency should provide and PFS does not
     address changing needs.  Thus, the only incentive the housing
     agency has is to always look for ways to supplement an operating
     subsidy that is inadequate for the needs and services it
     provides. 

  -- No incentive exists for a housing agency to maximize rental
     income, as would be the case in the private sector, because
     increased rental income results in the subsidy being reduced by
     an equal amount. 

  -- PFS does not correctly address the expenses of newer
     developments that replace older developments.  Units in newer
     developments are not brought back on line at an amount that is
     incrementally equal to the developments that they replace.  When
     developments are modernized, they are sometimes reconfigured to
     decrease density.  Less dense developments nurture more positive
     behaviors among tenants.  Although the new development might
     have fewer units, the reduction in units is not commensurate
     with the loss in subsidy.  When density is decreased, fixed
     costs are not necessarily reduced as a result. 


MIAMI-DADE HOUSING AGENCY
========================================================== Appendix IV

The Miami-Dade Housing Agency (MDHA) in Florida is one of the largest
housing agencies in the country.  In fiscal year 1997, it had an
operating budget for public housing of over $38 million and a total
agency budget of over $216 million.  MDHA manages over 10,000 units
of public housing and administers over 15,000 Section 8 certificates
and vouchers.  Over 4,400 of MDHA's public housing units are at least
30 years old, with some units over 60 years old.  MDHA officials said
that much of their housing stock is in dire need of continual
maintenance and major modernization and rehabilitation.  They
attributed a significant portion of that need to their allowable
expense level under PFS not having kept pace with the agency's
increasing costs for such activities as security and employee
benefits.  As a result, MDHA has not been able to do all needed
routine and preventive maintenance and has reduced maintenance staff. 
Moreover, because of the deferred maintenance, MDHA officials believe
that the problems with the physical condition of their housing stock
will worsen as the properties continue to age.  To supplement its
operating expenses, MDHA has relied on other sources of funding,
including the Comprehensive Grant and the Public Housing Drug
Elimination programs. 


   BACKGROUND
-------------------------------------------------------- Appendix IV:1

MDHA maintains 10,100 conventional public housing units in 87
developments and serves over 33,000 individuals.  MDHA also has 596
Section 8 project-based units and 506 units that are mixed income
properties.\1 MDHA contracts with four private companies to manage
approximately 1,772 of its conventional public housing units.  MDHA's
conventional public housing stock consists primarily of low-rise
developments, with the high-rise developments occupied by elderly
residents.  A substantial number of the public housing units are over
30 years old, with some as old as 60.  MDHA's most recent occupancy
rate was 93 percent.  Its Public Housing Management Assessment
Program (PHMAP) score was 91 percent for fiscal year 1996 and 95.5
percent for fiscal year 1997, making it a high performer. 

MDHA's operating budget for public housing totaled over $38 million
in fiscal year 1997, with over $25 million, or 66 percent, coming
from the PFS operating subsidy and nearly $12 million from rental
income.  Other major sources of income in fiscal year 1997 that were
used to supplement MDHA's operating budget for public housing
included nearly $13 million in Comprehensive Grant Program
modernization funds and $2.7 million in Public Housing Drug
Elimination Program funds.  MDHA relies entirely on rents, grants,
and subsidies from HUD to operate its public housing.  The agency
employs a staff of 708, 360 of whom are assigned as public housing
support personnel.  The employees are part of the Dade County system
of government and also belong to the state's retirement system; 97
percent of them belong to employee unions that represent supervisory
employees, general employees, and professional employees. 

Most MDHA residents (79 percent) are unemployed, and 61 percent of
the residents receive welfare.  Heads of households are mostly female
(93 percent), with 40 percent of the households headed by residents
who are 20 to 30 years old. 


--------------------
\1 MDHA acquired three properties from HUD and the Resolution Trust
Corporation under their affordable housing disposition programs.  At
these properties, a percentage of the units is reserved for low and
very low-income residents, with the remaining units housing residents
paying market rate rents.  No federal assistance is provided to
operate these properties, and their units for low-income residents
are cross-subsidized by the market rate units. 


   HOUSING AGENCY OFFICIALS
   BELIEVE THAT THE OPERATING
   SUBSIDY IS NOT ADEQUATE
-------------------------------------------------------- Appendix IV:2

Officials from MDHA's top management, housing operations, and finance
and administration office told us that PFS does not provide an
adequate subsidy.  They said that increasing existing costs, combined
with new costs not anticipated or recognized by PFS and deteriorating
and poorly designed units, have created significant shortfalls in the
funds needed to operate the housing agency effectively.  The most
significant impact of the insufficient funding has been on the
physical condition of the housing stock because of the practice of
deferring preventive maintenance to conserve funding.  MDHA performs
what preventive maintenance is possible under its budget, but each
year it defers a substantial amount.  Inadequate funding has also
required MDHA to reduce staff, services to residents, and operating
reserves.  To cope with inadequate subsidies, MDHA officials told us
that they supplement their operating budget with funding from other
federal sources such as modernization and drug elimination grants,
portions of which can be used to cover operating costs. 

The director of public housing at HUD's Florida State Office stated
that the PFS operating subsidy is inadequate for MDHA.  She said that
since PFS was established, MDHA has been required to provide
additional services to its tenants, such as the Family
Self-Sufficiency Program, without being given the funding to
administer these programs.  Moreover, MDHA, like other housing
agencies, has not received its full subsidy in recent years when the
Congress did not appropriate 100 percent of the funds HUD requested. 


      SEVERAL NEW AND EXISTING
      COSTS AND THE INCREASING
      NEED FOR MAINTENANCE CREATE
      BUDGET DILEMMA FOR MDHA
------------------------------------------------------ Appendix IV:2.1

MDHA has experienced several new or increasing expense categories
that PFS does not adequately recognize.  These include the costs of
employee benefits, insurance, and security.  Employee benefits are a
major cost category at MDHA because housing agency employees are
county employees, and their pay is based on county wage rates.  MDHA
employees also belong to the Florida State Retirement System.  MDHA
officials said that their employees' benefits package is equal to 42
percent of salaries, which is significantly higher than the
28-percent average at housing agencies nationwide. 

Property-related insurance rates for MDHA have increased dramatically
in recent years.  From fiscal year 1993 through fiscal year 1997,
MDHA's property insurance costs have risen by 166 percent.  The
primary reason for this increase is the damage done by Hurricane
Andrew in 1992.  MDHA officials also said that insurers are reluctant
to insure MDHA properties, partly because of their deteriorating
condition. 

In 1975, when MDHA's allowable expense levels were set by under PFS,
the housing agency was not incurring significant security costs. 
Since then, however, MDHA has had to hire Dade County police officers
to provide additional protection to its developments outside
municipalities and to hire security guards for its housing
developments for the elderly.  MDHA initially used part of a subsidy
it received from the county government to cover these costs.\2 When
the county discontinued the subsidy in fiscal year 1996, the housing
agency used its grants from HUD's drug elimination program to pay for
security services at its developments for the elderly instead of at
developments in other parts of the county.  MDHA also used the county
funds to provide some resident services and to help pay for employee
benefits.  In fiscal year 1995, for example, MDHA supplemented each
development's budget by $6 per unit-month to help pay for employee
benefits.  When the county discontinued funding in fiscal year 1996,
developments had to absorb the reduction into their budgets. 

Ever-increasing city code requirements have also increased MDHA's
costs for maintenance.  For example, the city code requires MDHA to
have removable security screens in its units' windows.  Residents
continually open and close the security screens, which causes the
screens to need more maintenance because of the additional wear and
tear. 

MDHA's operating costs are rising because its housing stock is aging
and poor housing design, conditions, and crime combine to drive costs
up.  We observed examples of these conditions at two of MDHA's
developments--Liberty Square and Scott Homes. 

The Liberty Square Housing Development was constructed in 1937, with
additional buildings completed in the late 1940s.  It is one of
MDHA's largest developments, comprising 753 units in one- and
two-story buildings in a predominantly residential neighborhood. 
Liberty Square is a family development that is 93-percent occupied. 
Approximately 95 percent of the households are headed by single
females.  Liberty Square employs 17 full-time staff:  7
administrative staff and 10 maintenance staff.  Security features at
Liberty Square include city police patrols, fencing along the
perimeter of the property, lighting, and security screens in the
residents' windows. 

Liberty Square officials attributed the development's increased
operating costs to crime, vandalism, the location and age of the
development, its architectural design, and the type of residents. 
The officials said that crime was a very serious problem, with
drug-related crimes occurring most frequently.  Replacing the lights
that are shot out by drug dealers and practically anything of value
that vandals can steal from vacant units raises the development's
costs.  Appliances are not stolen because the maintenance staff
removes them immediately after a resident vacates a unit, but the
time spent moving the appliances in and out of the units is costly. 
Painters spend 25 percent of their time covering graffiti. 

Housing management officials at Liberty Square said that the property
is so old that the concrete walls are disintegrating, plaster is
falling off the walls, pipes are rusting and leaking, and bathtubs
are deteriorating.  Because appliances have gone past their useful
life, the staff receives approximately 20 calls a day from tenants
asking to have refrigerators repaired.  Design features of the
buildings contribute to higher costs because the buildings are not
insulated and the front doors have mail slots that criminals use to
break into units and through which vandals insert water hoses and
flood the units. 

The Scott Homes Housing Development was constructed in 1954 and
consists of 754 units in two-story buildings.  It is managed by a
private management company.  Primarily a family development, Scott
Homes has a 97-percent occupancy rate, and employs 19 full-time
staff.  The development is in a neighborhood with a mixture of
residences and commercial businesses.  Over the past 5 years,
approximately 290 units have had some modernization work done, and
within the next 5 years, MDHA's plans are to completely rebuild Scott
Homes if the development receives a HOPE VI grant; however, MDHA's
application for such a grant has failed twice to receive HUD
approval.  Overall, officials at Scott Homes said approximately 40
percent of the units are in fair to poor condition.  Eight units are
in such bad condition that MDHA does not plan to rent or repair them
because it would be too costly to bring the units up to standard. 
Security features at Scott Homes include county police patrols,
fencing along the outside perimeter of the property, lighting, and
security screens in the residents' windows.  Scott Homes provides the
space, utilities, and furnishings for a police substation at the
development. 

Despite the security measures and the police substation on site,
Scott Homes officials attributed some of the development's increasing
costs to crime and vandalism.  They attributed other increasing
operating costs to the age of the development, its architectural
design, and the residents.  Crime is a serious problem at Scott Homes
with drug-related crimes being the most serious.  Because of the
crime, the development and its surrounding community have a bad
reputation that makes it difficult for the development to generate
rental income, especially by attracting higher-income residents. 
Vandalism is also costly.  Vandals rip out copper pipes from vacant
units, steal security windows and street signs, and shoot out lights. 
The units' age contributes to the cost of their maintenance because
door frames are deteriorating, water pipes break and leak into units,
and screen doors and appliances have outlived their useful life and
are constantly in need of repair.  Housing management officials
attributed other increasing costs to the development's architectural
design:  Porches and sidewalks have no underlying support, and the
building pilings are sinking or leaning, becoming safety hazards to
residents.  Finally, officials at Scott Homes told us that residents
contribute to higher operating costs because families with children
cause a great deal of wear and tear on units and also use more
utilities. 

Scott Homes officials also pointed to increased costs for such
activities as grounds keeping and waste management, noting that since
fiscal year 1995, grounds-keeping costs at Scott Homes have increased
nearly 300 percent because staff have to trim tree limbs and roots to
keep them from damaging the buildings and sidewalks.  In addition,
ground erosion has become a major problem at Scott Homes, and Miami's
strict dumping requirements have caused waste management costs to
nearly double since fiscal year 1995. 

Officials at Scott Homes said the increased costs and inadequate
operating subsidy have resulted in seven maintenance staff and one
administrative person being laid off, primarily because of a
reduction in the operating subsidy of $400,000 in 1996.  Because of
the reduction in the maintenance staff, the deferral of maintenance
has increased further.  The buildings are not being painted nearly as
often as they should be, for example. 


--------------------
\2 From fiscal year 1986 through fiscal year 1995, Dade County
subsidized MDHA.  In the first year, MDHA received $10 million from
the county, but in subsequent years, the subsidy declined until, in
the final year, MDHA received $3.3 million.  Of the $3.3 million it
received in fiscal year 1995, MDHA used $1.2 million to pay for
security guards at housing developments for the elderly. 


      MDHA HAS ATTEMPTED TO
      ADDRESS THE FUNDING
      SHORTFALL THROUGH SEVERAL
      ACTIONS
------------------------------------------------------ Appendix IV:2.2

To address the shortfall in its funding for operations, MDHA has
reduced administrative and maintenance staff, used reserves for
current expenses, and sought other sources of funding to supplement
its operating budget, according to officials.  The immediate effect
of reducing the maintenance staff by 10 percent in 1996 was to delay
preventive maintenance.  For example, although MDHA previously
replaced roofs before leaks occurred, the current practice is to
defer replacement until after leaks are noticed.  This results in
damaged walls, floors, and electrical systems and other problems. 
MDHA officials also said that they have reduced the level of the
operating reserve to maintain operations.  For example, in fiscal
year 1993, MDHA maintained 57 percent of the maximum amount that HUD
allows in its operating reserve; in 1997, MDHA reduced that level to
39 percent. 

The other funding sources that MDHA uses include the Comprehensive
Grant Program for modernization projects and the Public Housing Drug
Elimination Program grant.  An MDHA official estimated that the
agency will use approximately $1.6 million, or 13 percent of $12.5
million in Comprehensive Grant Program funds for fiscal year 1998, to
help pay the salaries of agency staff involved in resident services,
accounting, housing operations, and the reinspection of units to
ensure they meet HUD's Housing Quality Standards.  MDHA also uses the
drug elimination grants to cover its security costs.  This funding
strategy is risky, however, because a housing agency cannot always
count on receiving these competitive grants.  Because MDHA did not
receive a drug elimination grant in fiscal year 1998, and if an
appeal does not result in an award of a grant, MDHA might be forced
to discontinue its security services. 

Figure IV.1 shows that MDHA's ordinary maintenance expenditures
initially rose after 1993, but by fiscal year 1997, they had
decreased 10 percent below the fiscal year 1993 level.  It also shows
that administrative expenditures increased 48 percent and general
expenses increased 11 percent, while tenant services expenditures
decreased 75 percent and protective services expenses decreased 89
percent.  Protective services as a component of operating costs
decreased because MDHA has begun using drug elimination funding to
pay for this activity.  In fiscal year 1996, MDHA used $1.1 million
of its drug elimination funding and $312,000 of its operating funds
to pay for security.  In contrast, in fiscal year 1993, MDHA used
$1.2 million of its operating funds for security. 

   Figure IV.1:  MDHA Operating
   Expenditures Per Unit-Month,
   Fiscal Years Ending 1993-97

   (See figure in printed
   edition.)

Note:  Adjusted to constant 1996 dollars. 

Source:  MDHA's Statement of Operating Receipts and Expenditures for
fiscal years ending in 1993 through 1997. 


   CHANGING HUD REGULATIONS COULD
   IMPROVE OPERATING EFFICIENCY
-------------------------------------------------------- Appendix IV:3

Although MDHA officials provided little information about incentives
that they believed exist under PFS or that should be added, they did
have some opinions about other regulatory incentives or changes that
could be made that would permit more efficient operations: 

  -- Housing agencies should be allowed to evict residents under
     state eviction guidelines rather than federal eviction
     requirements.  Operating under state guidelines would greatly
     reduce the time needed to remove residents.  Judges are familiar
     with state eviction guidelines because they continually review
     them for private landlords seeking to evict residents.  Judges
     are much less knowledgeable about federal eviction guidelines
     and, therefore, take much longer and are more reluctant to evict
     public housing residents.  Accelerating the eviction process
     would allow MDHA to more quickly house residents on its waiting
     list. 

  -- MDHA needs a great deal more flexibility in the rents that are
     set for residents.  The current HUD allowance to set minimum
     rents needs to be made permanent.  MDHA also needs more
     discretion in the amount of the minimum rent and in the
     selection criteria for residents.  More flexibility in
     rent-setting and resident selection would allow MDHA to increase
     its rental income and become less dependent on the PFS subsidy. 

  -- HUD needs to change the regulations on project-based waiting
     lists.  Currently, the household at the top of the list has to
     accept the first apartment that is available regardless of
     location.  If the household does not want the available housing
     unit, the household is placed at the bottom of the waiting list
     and can decline only twice.  Because MDHA's housing developments
     are up to 69 miles apart, the first apartment available to a
     household on the waiting list is often not where they want to
     live.  For working families, the regulation creates even more of
     an inconvenience and an added burden for MDHA because the agency
     is attempting to encourage residents to work.  If residents
     accept units they truly do not want, they then can develop
     justification to transfer to other units.  For example, a
     doctor's opinion that a resident is not in good enough physical
     condition for a long commute is enough justification for a
     resident to receive a transfer.  Every transfer increases MDHA's
     maintenance costs. 

Finally, MDHA officials stated that although they have had excellent
working relationships with the four private management companies that
manage 1,772 of the agency's housing units, they have seen no direct
cost savings from the private management companies operating their
properties.  The officials did say, however, that they have learned a
great deal from these companies and that they are operating their
other developments more efficiently as a result. 

MDHA officials also told us that basing the operating subsidy on
HUD's fair market rent (FMR) would be the most efficient way of
distributing the funds.  A system based on FMR would more accurately
reflect what the rents should be for public housing in a given
municipality, they said.  Even if the subsidy was based only on a
percentage of FMR, at least the measuring would be based on a
market-generated indicator that is independent and is based on
current information.  The amount of subsidy to be awarded to housing
agencies could easily be calculated by subtracting the rental income
and utility allowance from FMR. 


PUBLIC HOUSING AGENCY OPERATING
RECEIPTS AND EXPENDITURES
=========================================================== Appendix V

The annual data HUD collects from approximately 3,200 housing
agencies nationwide show that average rental income is generally
declining, while operating expenses are increasing.  As a result,
HUD's contributions in the form of subsidies have increased.  The
data also show that, possibly as the result of outside influences and
funding from sources other than HUD's operating subsidies, many
housing agencies have increased their operating reserves.  HUD's
performance measurement program, for instance, might have influenced
some agencies to increase their operating reserves to gain higher
performance scores.  Also, some housing agencies might have used
grant funding from other sources to finance a portion of their
administrative costs, routine maintenance, or protective services,
allowing them to use a larger portion of their HUD-funded operating
subsidies to cover increases in their operating reserves. 


   BACKGROUND
--------------------------------------------------------- Appendix V:1

Data used in this analysis are from HUD's Integrated Business System
(IBS), which contains financial data provided by public housing
agencies on HUD's Form 52599.  On HUD's Form 52599, housing agencies
report their operating receipts and expenses for their public housing
properties.  The data, however, may not be indicative of the
financial condition of a housing agency or the sufficiency of PFS
funding because the data do not include all sources of income. 
Additional HUD funds are provided by the Comprehensive Grant Program,
the HOPE VI Grant Program, and the Public Housing Drug Elimination
Program.  The IBS data do not include such supplemental income. 
Thus, our analyses, based solely on IBS data, are limited in their
presentation of the overall financial picture of housing agencies. 
In addition, factors outside the housing agencies may influence their
financial decisions. 

To even out its workload, HUD established four ending dates for the
fiscal years of the local housing agencies it funds--the last day of
March, June, September, and December.  In doing our analyses, we
annualized the IBS financial data reported in this appendix based on
each housing agency's fiscal year ending date.  In addition, we
adjusted all financial data to constant 1996 dollars.  Finally, we
categorized the housing agencies by size according to the number of
their dwelling units, as follows: 

  -- Extra small housing agencies have 1 to 99 dwelling units. 

  -- Small housing agencies have 100 to 499 dwelling units. 

  -- Medium housing agencies have 500 to 1,249 dwelling units. 

  -- Large housing agencies have 1,250 to 6,599 dwelling units. 

  -- Extra large housing agencies have more than 6,599 dwelling
     units. 


   SOURCES OF HOUSING AGENCIES'
   OPERATING RECEIPTS
--------------------------------------------------------- Appendix V:2

As reported on HUD's Form 52599, housing agencies have three basic
sources of operating receipts:  (1) HUD's contributions in the form
of operating subsidies; (2) dwelling rental incomes; and (3) other
operating income. 


      HUD'S CONTRIBUTIONS
------------------------------------------------------- Appendix V:2.1

HUD's contributions were a major source of income for housing
agencies in the fiscal years ending in 1992 through 1996; in fact,
for large and extra large housing agencies, HUD's contributions
represented more than half of their total income for the fiscal year
ending in 1996.  As figure V.1 shows, the average housing agency's
per unit-month HUD contribution, when adjusted to constant 1996
dollars, generally increased between 1992 and 1996. 

   Figure V.1:  Average HUD
   Contributions Per Unit-Month by
   Housing Agency Size Grouping,
   Fiscal Years Ending 1992-96

   (See figure in printed
   edition.)

Note:  Adjusted to constant 1996 dollars. 

Source:  GAO analysis of HUD's IBS data for housing agencies
reporting in fiscal years ending in 1992 through 1996. 

In the fiscal year ending in 1996, HUD's average per unit-month
contribution increased for each successively larger size of housing
agency, from an average of nearly $77 per unit for extra small
housing agencies to a per unit average of almost $261 for extra large
housing agencies.  In addition, for each successively larger size of
housing agency, HUD's contributions represented a larger portion of
the housing agency's income in the same period.  This portion ranged
from an average of 35 percent of extra small housing agencies' total
income, including dwelling rental, to 61 percent for extra large
housing agencies, while small, medium, and large housing agencies
received, on average, 41, 47, and 56 percent of their total income
from HUD's contributions, respectively.  Additionally, HUD's average
contribution, in constant 1996 dollars, increased in each size
category when comparing the fiscal year ending in 1992 with 1996. 
However, while the average HUD contribution for large and extra large
housing agencies increased by 12 and 10 percent when comparing the
fiscal year ending in 1992 to 1996, for that same period the average
HUD contribution increased by between 18 and 21 percent in all other
sized housing agencies. 

Almost three-quarters of housing agencies submitting HUD Form 52599
data in the fiscal year ending in 1996 reported having received over
20 percent, but not more than 60 percent, of their income from HUD's
contributions.  As table V.1 shows, 28 percent of the housing
agencies received more than half their income from HUD's
contributions. 



                               Table V.1
                
                  Number of Housing Agencies With HUD
                Contributions Within Selected Percentage
                 Ranges of Receipts, Fiscal Year Ending
                                  1996

 Portion of total income provided by
                 HUD
--------------------------------------
                                             Number of   Percentage of
                              Not more         housing     all housing
More than                         than        agencies        agencies
------------------------  ------------  --------------  --------------
                                    0%              86            2.8%
0%                                  10             203             6.6
10                                  20             256             8.3
20                                  30             464            15.1
30                                  40             556            18.0
40                                  50             663            21.5
50                                  60             493            16.0
60                                  70             251             8.1
70                                  80              79             2.6
80                                  90              26             0.8
90                                                   4             0.1
----------------------------------------------------------------------
Source:  GAO analysis of HUD's IBS data for housing agencies
reporting in fiscal year ending 1996. 

For the fiscal year ending in 1996, for each successively larger size
of housing agency, the percentage receiving at least half of their
income from HUD's contributions increased.  About one-quarter of the
extra small and small housing agencies received over 50 percent of
their income from HUD contributions.  About 41 and 68 percent of
medium and large housing agencies, respectively, received over 50
percent of their income from HUD's contributions.  HUD's
contributions represented more than half of the income of all extra
large housing agencies. 


      DWELLING RENTAL RECEIPTS
------------------------------------------------------- Appendix V:2.2

In the fiscal year ending in 1996, dwelling rental receipts
constituted over 90 percent of housing agencies' average operating
receipts, exclusive of HUD's contributions in the form of subsidies. 
Figure V.2 shows that, comparing the fiscal year ending in 1992 with
1996, the average per unit-month dwelling rental income declined,
except for housing agencies with fewer than 100 units. 

   Figure V.2:  Average Dwelling
   Rental Receipts Per Unit-Month
   by Housing Agency Size Range,
   Fiscal Years Ending 1992-96

   (See figure in printed
   edition.)

Note:  Adjusted to constant 1996 dollars. 

Source:  GAO analysis of HUD's IBS data for housing agencies
reporting in fiscal years ending in 1992 through 1996. 

Comparing the fiscal year ending in 1992 with 1996, the average
monthly dwelling rental income per unit declined by over 9 percent
for small and extra large housing agencies and by 8 percent for large
housing agencies.  Medium-sized housing agencies saw their rental
income decline by 6 percent.  Only extra small housing agencies
maintained a consistent level of rental income.  However, while extra
small housing agencies maintained their rental income in constant
1996 dollars, possibly because they had large increases in their
operating expenses relative to housing agencies of other sizes, HUD
made larger increases in its contributions to smaller housing
agencies than it did for housing agencies in all other size
categories. 


      OTHER OPERATING INCOME
------------------------------------------------------- Appendix V:2.3

Other operating income represented about 9 percent of a housing
agencies' income in the fiscal year ending in 1996, exclusive of
HUD's contributions.  Other sources of operating income reported in
this category include nondwelling rental (e.g., from renting rooftop
space for signs or broadcasting antennas), interest they earn on
general fund investments, and receipts from other sources (e.g., from
operating services for tenants, such as laundromats or day care
centers). 


   HOUSING AGENCIES' OPERATING
   EXPENDITURES
--------------------------------------------------------- Appendix V:3

Operating expenses, as reported on the HUD Form 52599 consist of six
major categories:  (1) utilities, (2) ordinary maintenance and
operations, (3) administration, (4) general expenses, (5) tenant
services, and (6) protective services. 

As can be seen in figure V.3, a definite diseconomy of scale exists
in the average per unit-month operating expenses of a housing agency. 
For each successively larger size of housing agency, the average
total routine expense per unit increased. 

   Figure V.3:  Average Routine
   Expenses Per Unit-Month by
   Housing Agency Size Range,
   Fiscal Years Ending 1992-96

   (See figure in printed
   edition.)

Note:  Adjusted to constant 1996 dollars. 

Source:  GAO analysis of HUD's IBS data for housing agencies
reporting in fiscal years ending between 1992 and 1996. 


      UTILITIES
------------------------------------------------------- Appendix V:3.1

Utilities, including water, electricity, gas, fuel, and related labor
expense, constituted approximately one-fourth of housing agencies'
routine expenses.  In the fiscal year ending in 1996, utility
expenses ranged from a low of 22 percent of the average routine
expenses for an extra small housing agency up to 27 percent for large
and extra large housing agencies.  However, unlike other routine
expenses, HUD calculates utilities on a 3-year rolling base system,
so we could not analyze utilities in conjunction with the other
routine expense categories.  Thus, any references to total routine
expenses are exclusive of utilities. 


      ORDINARY MAINTENANCE AND
      OPERATIONS
------------------------------------------------------- Appendix V:3.2

Ordinary maintenance and operations consist of expenses for labor,
materials, contracts, and garbage fees.  On average, this category of
routine expenses comprised the largest portion of a housing agency's
operating expenses in their reports for the fiscal year ending in
1996.  Regardless of a housing agency's size, on average over 40
percent of its per unit-month expenses were for ordinary maintenance
and operations.  The average per unit-month costs for this expense
category were about $59 for extra small housing agencies, ranging up
to an average per unit-month expense of $134 for extra large housing
agencies.  Small, medium, and large housing agencies reported average
ordinary maintenance and operation expenses of approximately $62,
$78, and $93, respectively. 

Although they did not have the largest increase in constant 1996
dollars, extra small housing agencies experienced the largest
percentage change in their ordinary maintenance and operation
expenses, when the fiscal year ending in 1992 is compared with 1996. 
While extra small housing agencies had an increase of over 9 percent
(over $5 per unit) during that period, small and medium housing
agencies had increases of 0.2 and 3 percent (about $0.15 and $2 per
unit), respectively.  Although, at about $8 per unit, the dollar
amounts of the increases in large and extra large housing agencies
were greater than those in other size housing agencies, they
represented a smaller percentage change (9 and 6 percent,
respectively) than that of the extra small housing agencies. 


      ADMINISTRATION
------------------------------------------------------- Appendix V:3.3

Administration includes administrative salaries, legal expenses,
staff training, travel, accounting fees, auditing fees, sundry, and
outside management costs.  In the fiscal year ending in 1996, the
average per unit-month expense for administration represented between
one-quarter and one-third of the housing agencies' total routine
expenses.  Except for small agencies, for successively larger sizes
of housing agencies, the average per unit administration expense
increased.  With the exception of large agencies, these expenses
represented an increasingly smaller percentage of the housing
agencies' total expenses for successively larger sizes of agencies. 

In the fiscal year ending in 1996, extra small housing agencies spent
an average of $48 or nearly one-third of their total routine expenses
for administration, whereas extra large housing agencies spent an
average of $78 per unit-month, or one-quarter of their total routine
expenses on administration.  Small, medium, and large housing
agencies spent an average of $41, $48, and $58 per unit-month,
respectively, for their administration, which represented about 27
percent of their total routine expenses. 

With the exception of extra small housing agencies, for successively
smaller sizes of housing agencies, both the amount of their
administration expenses per unit, in constant 1996 dollars, and the
percentage change in those expenses, decreased when comparing the
fiscal years ending in 1992 and 1996.  The over $4 (10 percent)
increase extra small housing agencies experienced in their
administration expenses was greater than the nearly $1 and $3 (2 and
6 percent) increases for small and medium sized housing agencies,
respectively, but less than the approximate $6 and $10 (12 and 15
percent) increases experienced by large and extra large housing
agencies. 


      GENERAL EXPENSES
------------------------------------------------------- Appendix V:3.4

General expenses include insurance, payments made to local
governments in lieu of taxes, terminal leave payments, employee
benefit contributions, collection losses, interest on administrative
and sundry notes, and other general expenses.  For the fiscal year
ending in 1996, housing agencies reported that they spent, on
average, between 24 and 28 percent of their total per unit-month
expenses in this category.  The lowest average per unit-month expense
was about $37 by extra small housing agencies and the highest was
nearly $80 by extra large housing agencies.  Small housing agencies
spent an average of more than $41, while medium and large housing
agencies each spent about $50. 

When comparing the fiscal year ending in 1992 with 1996, extra small
housing agencies had almost a $3 increase in general expenses, the
largest of any size group.  In contrast, small and extra large
housing agencies had reductions in their expenses in this category of
less than $1 each.  As a percentage change, the 8-percent increase
incurred by extra small housing agencies between the fiscal years
ending in 1992 and 1996 was greater than that for all other sizes. 
While small and extra large housing agencies had decreases, the
change for medium and large housing agencies was 3 and 4 percent, or
about $1 and $2, respectively. 


      TENANT SERVICES
------------------------------------------------------- Appendix V:3.5

Tenant services cover salaries, recreation, publications, contract
costs, training, and other expenses.  In the fiscal year ending in
1996, the average per unit-month expense for tenant services ranged
from about $1.50, or less than 1 percent of their average routine
expenses, for extra small housing agencies to $6 for extra large
housing agencies, which represented 2 percent of their total routine
expenses.  The largest increase (in constant 1996 dollars) and
percentage change in this expense category were experienced by extra
small and small housing agencies.  While medium, large, and extra
large housing agencies had increases of 7, 1, and 11 percent (about
$0.30, $0.05, and $0.60), respectively, when comparing the fiscal
years ending in 1992 and 1996, extra small and small housing agencies
had increases of 65 and 29 percent (nearly $0.60 each). 


      PROTECTIVE SERVICES
------------------------------------------------------- Appendix V:3.6

Protective services include expenses for labor, materials, and
contract costs.  In the fiscal year ending in 1996, except for extra
large housing agencies, the average per unit-month amount expended on
protective services ranged from nearly $1 in extra small housing
agencies to almost $4 in large housing agencies, which represented
between 0.4 and 1.7 percent of their average per unit-month routine
expenses, respectively.  For extra large housing agencies, the
average per unit-month expense for protective services was $21, or 6
percent of their average per unit-month total routine expenses. 
However, extra small housing agencies had the largest percentage
change increase in this category.  In fact, their 139-percent
increase was the largest increase for any size housing agency and in
any expense category.  However, in constant 1996 dollars, the extra
small housing agencies' average increase of $0.40 was less than that
of either medium ($0.45) or extra large ($0.50) housing agencies
which, when comparing fiscal year ending 1992 to 1996, had increases
of 21 and 2.5 percent, respectively. 


   NONROUTINE MAINTENANCE
--------------------------------------------------------- Appendix V:4

In general, the average per unit-month expenditures for nonroutine
maintenance declined, in constant 1996 dollars, between the fiscal
years ending in 1992 and 1996.  The exception was extra large housing
agencies, which had a net increase of about $0.10 per unit-month
during that period.  However, as table V.2 shows, the housing
agencies did not experience a consistent decline in nonroutine
maintenance expenses.  All housing agency size groups had increases
in the expenses in this category before showing decreases in the
fiscal years ending in 1995 and 1996. 



                               Table V.2
                
                Average Nonroutine Maintenance Expenses
                 Per Unit-Month by Housing Agency Size
                   Range, Fiscal Years Ending 1992-96

                          1992      1993      1994      1995      1996
--------------------  --------  --------  --------  --------  --------
Extra small              $6.08     $6.58     $6.48     $5.68     $4.17
Small                     6.14      5.86      5.99      4.94      3.61
Medium                    5.36      5.21      4.47      4.88      3.59
Large                     8.21      6.66      5.70      6.01      5.06
Extra large               4.85      5.35      5.88      5.09      4.97
----------------------------------------------------------------------
Note:  Adjusted to constant 1996 dollars. 

Source:  GAO analysis of HUD's IBS data for housing agencies
reporting in fiscal years ending between 1992 and 1996. 

The decline in average per unit-month nonroutine maintenance expenses
ranged between nearly $2 to just over $3.  Except for extra large
housing agencies, which had a 3-percent increase in their nonroutine
maintenance, all other housing agency sizes showed a decrease when
comparing fiscal year ending in 1992 to 1996.  The largest decrease
was 41 percent for small housing agencies, and the least was 31
percent for extra small housing agencies.  Medium and large housing
agencies had decreases in their expenses in this category of 33 and
38 percent, respectively. 


   CAPITAL EXPENDITURES
--------------------------------------------------------- Appendix V:5

Table V.3 shows that in at least 1 year, capital expenditures
increased in each housing agency size group.  However, in every size
group, reductions occurred in expenditures in this line item between
the fiscal years ending in 1992 and 1996.  In addition, every size
group had a net decrease in its average per unit-month capital
expenditures when comparing the fiscal year ending in 1992 with 1996. 



                               Table V.3
                
                 Average Capital Expenditures Per Unit-
                  Month by Housing Agency Size Range,
                      Fiscal Years Ending 1992-96

                          1992      1993      1994      1995      1996
--------------------  --------  --------  --------  --------  --------
Extra small              $6.60     $6.55     $7.14     $6.79     $6.50
Small                     7.67      7.63      8.16      7.19      5.73
Medium                    6.05      5.81      7.12      5.60      3.79
Large                     5.74      6.18      6.07      5.89      4.23
Extra large               6.01      6.09      5.55      6.00      4.53
----------------------------------------------------------------------
Note:  Adjusted to constant 1996 dollars. 

Source:  GAO analysis of HUD's IBS data for housing agencies
reporting in fiscal years ending between 1992 and 1996. 

In constant 1996 dollars, the range of the average per unit-month
decrease was $0.10 for extra small housing agencies to almost $2.30
for medium housing agencies, with decreases of almost $2 for small
agencies and about $1.50 for both large and extra large housing
agencies.  The decrease in capital expenditures for extra small
housing agencies was almost negligible, representing a decrease of
less than 2 percent.  However, the average per unit-month expenses
decreased about one-quarter in small, large, and extra large housing
agencies and about 37 percent in medium-sized housing agencies. 


   OPERATING RESERVES
--------------------------------------------------------- Appendix V:6

HUD requires housing agencies to maintain an operating reserve to
cover emergency expenses and deficits in their operating budgets. 
Figure V.4 shows that, in constant 1996 dollars, the average per
unit-month operating reserve amounts increased in all sizes of public
housing agencies when comparing the fiscal year ending in 1992 with
1996. 

   Figure V.4:  Average Operating
   Reserves Per Unit-Month by
   Housing Agency Size Range,
   Fiscal Years Ending 1992-96

   (See figure in printed
   edition.)

Note:  Adjusted to constant 1996 dollars. 

Source:  GAO analysis of HUD's IBS data for housing agencies
reporting in fiscal years ending between 1992 and 1996. 

When adjusted to constant 1996 dollars, the increase in average per
unit-month operating reserves ranged from $20 (25 percent) for small
housing agencies to just over $28 (34 percent) for both medium and
large housing agencies, when comparing fiscal year ending in 1992 to
1996.  While the extra large housing agencies' $25 increase in their
per unit-month operating reserve was the second smallest, at 39
percent, it represented the largest percentage change increase of all
housing agency size groups, when comparing fiscal year ending in 1992
with 1996. 

HUD administratively established a maximum allowable operating
reserve that, until the fiscal year ending in 1995, limited the
amount a housing agency could accumulate to 50 percent of its
approved operating budget's total routine expenses or $100,000,
whichever was greater.  During that period, HUD could reduce the
amount of a housing agency's operating subsidy if the housing
agency's estimated year-end operating reserve balance exceeded its
established maximum allowable operating reserve.  In February 1995,
HUD removed this requirement and replaced it with the operating
reserve measure used in its Public Housing Management Assessment
Program.  The revised 1997 Public Housing Management Assessment
Program measure gave its highest score to housing agencies with cash
reserves greater than 15 percent of their total actual routine
expenditures.  As a housing agency's cash reserves--as a percentage
of its routine expenditures--decreased, the housing agency's score
also decreased. 

Figure V.5 shows operating reserves as a percentage of estimated
maximum allowable operating reserves, using pre-1996 criteria, for
the fiscal years ending in 1992 through 1996.  This analysis uses
actual routine expenses as a surrogate for the HUD-approved budgeted
routine expenditure. 

   Figure V.5:  Operating Reserves
   as a Percentage of Maximum
   Allowable Operating Reserves by
   Housing Agency Size Range,
   Fiscal Years Ending 1992-96

   (See figure in printed
   edition.)

Source:  GAO analysis of HUD's IBS data for housing agencies
reporting in fiscal years ending between 1992 and 1996. 

In general, housing agencies showed consistent increases in their
operating reserves.  Almost half (1,558) of the housing agencies
reported increases in their operating reserves in at least 3 of the 4
fiscal years we analyzed, and 15 percent (485) had increases in all 4
years.  However, 17 percent (530) of the housing agencies reported
declines in their operating reserves for at least 3 of the 4 analyzed
fiscal years and 2 percent (66) showed declines in all 4 fiscal
years. 

Comparing the fiscal years ending in 1992 and 1996, for all housing
agency size groups, on average, operating reserves in constant 1996
dollars got closer to the maximum allowed.  Because the average per
unit-month operating reserve for an extra small housing agency was
about $111 in the fiscal year ending in 1996, and extra small housing
agencies have less than 100 units, their average operating reserve
would almost always be less than the $100,000 maximum allowed. 
Therefore, extra small housing agencies were allowed to maintain
operating reserves in excess of 50 percent of their routine expenses
without suffering a reduction in their subsidy. 




(See figure in printed edition.)Appendix VI
COMMENTS FROM THE DEPARTMENT OF
HOUSING AND URBAN DEVELOPMENT AND
OUR EVALUATION
=========================================================== Appendix V



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)


The following are GAO's comments on the Department of Housing and
Urban Development's letter dated June 5, 1998.  The comments are
organized in the order of the major sections of the attachment to
HUD's letter. 


   GAO COMMENTS
--------------------------------------------------------- Appendix V:7

1.  Although we report the statements of officials at four housing
agencies and the conditions we found there, we have not drawn any
overall conclusions about the adequacy of PFS funding nationwide. 
Instead, on the basis of our case studies, a survey of 800 housing
agencies done by a trade group representing housing agencies,
discussions with officials of trade groups and HUD, we conclude that
operating subsidies may not be adequate for housing agencies whose
base year expenditures were low or whose operating circumstances or
costs have undergone significant change since 1975. 

We provide income and expense trends in an appendix to our report. 
Our analyses focused on HUD's database of housing agencies'
statements of operating receipts and expenses.  The analyses are
limited and we draw few conclusions because the underlying data do
not fully reflect housing agencies' incomes and because their
expenditures are limited by the income available to cover them.  We
were unable to obtain complete information on housing agencies'
incomes--including income from states and other federal grants--even
from the four agencies we visited.  Nevertheless, we believe that the
analyses we present will provide other analysts with insights not
available previously. 

The Congress did not ask us nor did we intend to define what costs
the operating subsidies should be covering.  Rather, it is HUD's
responsibility to define the scope of costs that the PFS subsidies
should cover, and one of the options that we suggest HUD might
consider for redesigning PFS includes developing such a definition of
covered costs. 

Finally, we disagree that much of the discussion in the report deals
with needs that are more appropriately met through capital and grant
funding instead of operating subsidies.  Our analysis shows that just
the opposite is true.  We report that some housing agencies are using
substantial amounts of funding from capital and other grants to fund
their operating expenses.  This indicates that these agencies are not
receiving enough funding through PFS and rental income alone to cover
these expenses. 

2.  We disagree that we confuse the issues of PFS adequacy and the
accuracy of HUD's budget estimate.  In fact, we conclude that the
adequacy of PFS for individual housing agencies, which is determined
by their HUD-approved allowable expense levels, and the accuracy of
HUD's budget estimates for PFS are interrelated.  We show that
determining allowable expense levels is an integral part of the PFS
methodology, and we explain that these expense levels also play a
large role in developing the annual PFS budget estimate.  We conclude
that to the extent that expense levels are too low for agencies whose
base year expenditures were low or whose operating circumstances or
costs have undergone significant change since 1975, HUD's budget
estimate may also be too low. 

3.  We agree with HUD's comment on our recommendation for revising
the way HUD estimates its PFS budget request.  It is premature for
HUD to change its budget estimating methodology until the Department
revises the way it provides subsidies to public housing agencies, as
would be required under pending legislation.  We also believe that
given the data and timing constraints under which HUD must prepare
its budget estimate, the estimate is reasonably accurate.  We have,
therefore, withdrawn our recommendation that the Secretary consider
revising the way HUD makes its PFS estimate, and we have made changes
to our report accordingly. 

4.  HUD raises several concerns about the draft report's
recommendation that the Department consider an appeals process.  In
recommending such an appeals process, we intended that HUD could
address both overfunded and underfunded housing agencies, and our
recommendation now reflects this intent.  Whether HUD designs a
process that entails a labor-intensive, subjective review of all
housing agencies or an analysis-based, formula-driven review would be
HUD's decision. 

5.  We agree with HUD that the best way of knowing whether housing
agencies are adequately funded is to establish a set of core services
that should be provided and to determine what the cost of those
services should be in each case.  In our report, we offer this as one
of the options available to HUD as it plans to revise PFS.  However,
we believe that HUD should be able to recognize whether some agencies
are underfunded even if it does not precisely know the best
composition of the set of core services.  Our report shows that
symptoms of inadequate funding are clear at certain housing agencies,
and that if left to worsen, the condition of the housing stock is
threatened. 

6.  HUD states that its approach to dealing with housing stock
deterioration and social problems in public housing is to address the
root causes of such problems with supplementary and competitive
grants to provide protective services, maintenance, and resident
services rather than to increase the subsidy.  However, these
activities are also covered under long-standing public housing
operating expense categories that are designed to be funded with
rental income or, if necessary, the operating subsidy.  We conclude,
therefore, that the supplementary grants are necessary because the
operating subsidy has been insufficient to adequately fund these
activities. 

7.  Our draft report noted examples of housing agencies' using
funding from their operating budgets to temporarily repair their
housing stock--as in painting over peeling lead-based paint--instead
of performing necessary modernization work.  However, this practice
results in unexpected uses of the operating subsidy and inadequate
funding in other areas. 

8.  HUD's letter to us lists several changes adopted by the PFS,
including add-ons for legislative changes to social security,
unemployment compensation, and flood insurance.  HUD states that the
draft report did not recognize these and other changes showing that
PFS has adapted to housing agencies' changing needs.  We recognize
that over the years, several changes have been adopted by PFS for
application across the board.  However, the changes that HUD notes in
its comments have little relation to the cost increases--including
the costs of deteriorating housing stock and increasing crime and
poverty--that agencies told us accounted for most of the increases in
their operating costs. 

9.  HUD's letter disagrees with our conclusion that employee benefits
have not been adequately factored into the PFS wage inflation factor
increases.  HUD states that we incorrectly assumed that the cost of
employee benefits has grown more rapidly than the increases in the
PFS wage inflation factor.  In response, we contacted HUD to obtain
further elaboration on HUD's inflation adjustment factor.  A HUD
official in its Policy Development and Research office explained that
HUD's methodology for adjusting its budget estimate from 1975 to 1988
used wage survey data but excluded observations which showed a
decrease in wages.  As a result, HUD's inflation adjustments were too
high.  On this basis, we agree with HUD's comment that its wage
inflation methodology kept up with actual changes in wages and
benefits, albeit for the wrong reasons.  Although HUD no longer
adjusts the wage data in this manner, it still uses wages as its
measure of labor cost change.  Because housing agencies pay both
wages and benefits, we still believe that a broader measure of
compensation would provide a more accurate basis for making
adjustments for inflation. 

10.  We chose not to include the issue of utilities in our report
because utility expenses are relatively straightforward compared to
other issues we report on.  Changes in utility rates are covered by
HUD, and the utility expense level is adjusted at the end of the year
to reflect changes in estimated consumption.  Housing agencies and
HUD share on a 50-50 basis the savings or additional costs because of
reductions or increases in energy consumption. 

11.  We have changed the text of our report accordingly. 

12.  We disagree with HUD and believe that at some housing agencies
the overall level of income in the base year and earlier did have an
impact on the initial allowable expense level and, therefore, on
whether the housing agency is currently adequately funded.  HUD
states that before PFS was implemented, operating subsidies were
based on a HUD-approved operating budget that was subsidized to cover
the gap between rental income and approved expenditures.  However,
during the interim period from 1972 to 1974, HUD placed a cap on
operating expenditures, which meant that even these HUD-approved and
subsidized budgets could have been inadequate.  Moreover, the amount
of HUD's subsidy was based on what was available from the Congress in
the first few years of subsidizing public housing--an amount that
grew quickly from $233 million in 1972 to over $700 million by 1979. 

13.  We have reconciled these points with the relevant housing
agencies and made changes to our report where necessary. 

14.  We stand by our conclusion that for a housing agency to make
extensive use of modernization and other supplementary funding to
cover operating expenses is evidence of an inadequate operating
subsidy.  In addition, we neither state nor imply that housing
agencies were using their operating subsidies for capital replacement
needs, and we disagree with HUD's statement that the operating
subsidy should not accommodate increases in an established operating
cost category such as protective services.  Moreover, by using
significant portions of their modernization funding to cover
operating costs, housing agencies are jeopardizing the viability of
the housing stock that is in need of major repair. 

We also disagree with HUD's conclusion that housing agencies that use
their supplementary funding to maintain or increase their operating
reserves are doing very well.  Some housing agencies might add to
their operating reserves in order to score better in HUD's Public
Housing Management Assessment Program, and increasing operating
reserves might reflect this motivation and mask underfunding. 

15.  HUD correctly points out that we have reported in the past that
wide differences in costs exist among public housing developments. 
Within a single housing agency, in fact, high-cost and low-cost
developments can exist.  However, cost differences among developments
do not mean that housing agencies themselves are receiving sufficient
subsidies.  Furthermore, knowing whether public housing costs are
higher or lower than the cost to house families under the Section 8
Certificate and Voucher Program does not in itself determine whether
housing agencies are receiving enough subsidy to cover their
expenses.  Therefore, we conclude that those housing agencies with
operating circumstances that have changed significantly or whose
initial base year expenses might have been too low might be currently
underfunded. 

16.  We are aware of both of the studies mentioned by HUD and
reviewed them closely as part of our background research.  These
studies for the most part compare expenditures of public housing with
those of alternative housing programs or funding options and do not
draw conclusions regarding the adequacy of PFS funding to meet public
housing needs.  As a result, we believe that these studies do not
provide data showing that housing agencies are adequately funded. 


OBJECTIVES, SCOPE, AND METHODOLOGY
========================================================= Appendix VII


   OBJECTIVES
------------------------------------------------------- Appendix VII:1

In Senate Report 105-53 in support of the Departments of Veterans
Affairs, Housing and Urban Development, and Independent Agencies
Appropriations Bill, 1998, the Senate Committee on Appropriations
requested that we study HUD's Performance Funding System (PFS) for
allocating appropriated funds to housing agencies as operating
subsidies.  To provide information to the Congress about HUD's
administration of PFS and to guide the revision of PFS so that it
better accommodates changing operational costs and circumstances in
public housing and permits greater local flexibility in managing
public housing, we agreed with the staff of the Committee on
Appropriations' Subcommittee on VA, HUD, and Independent Agencies to
address the following questions in our study: 

  -- How does PFS allocate the congressionally appropriated subsidy
     among public housing agencies? 

  -- How well does PFS meet the subsidy needs of individual housing
     agencies? 

  -- How does HUD develop budget estimates of housing agencies'
     annual need for operating subsidies and are the estimates
     appropriate? 

  -- What are some of the possible options that HUD might have for
     changing PFS to make it a more effective tool for subsidizing
     housing agencies? 


   SCOPE AND METHODOLOGY
------------------------------------------------------- Appendix VII:2

To determine how PFS allocates the congressionally appropriated
subsidy among public housing agencies, we reviewed and evaluated the
history and documentation of the PFS prototype formula.  We also
reviewed the studies done by HUD and its contractors on the
development of PFS, its shortcomings, and the various implications of
PFS for the effective funding and functioning of public housing.  We
also interviewed HUD officials to obtain their views on the
historical development and strengths and weaknesses of PFS. 

To determine how well PFS meets the subsidy needs of housing
agencies, we visited four housing agencies and developed case studies
of their use of funds based on our review of their financial data and
interviews with housing agency officials.  To obtain information on
PFS' adequacy to fund operations at these housing agencies and to
discuss the impact of potential underfunding, we visited two
developments owned by each housing agency.  We discussed with housing
managers at these developments the impact that various factors, such
as location and crime, have on the operating costs of those
developments.  To ensure that we asked officials at the housing
agencies the same questions, we developed and used a standardized
interview guide. 

In addition to our visits to the housing agencies, we reviewed and
analyzed housing agency data from HUD's Integrated Business System
(IBS) for fiscal years ending in 1992 through 1996.  These data
comprised 15,705 records and contained detailed information on each
housing agency's Statement of Operating Receipts and Expenditures. 
IBS data represent only data collected on HUD's Form 52599.  Many
housing agencies supplement their income with funding from other HUD
grants and their local governments.  This funding is not captured in
the IBS data, and obtaining information on it was beyond the scope of
this report.  Our analyses were limited to the data housing agencies
report on their Statement of Operating Receipts and Expenditures.  We
adjusted all financial data in the IBS records to constant 1996
dollars, using the Consumer Price Index for all items as reported in
the February 1998 Economic Report of the President.  We also reviewed
documents describing the development and implementation of IBS,
tested the edit criteria specified in the system documents, and
checked the data's internal validity. 

We discussed the reliability of IBS with its developers and users at
HUD, and we selected a random sample of 300 records from the IBS data
spanning fiscal years ending in 1992 through 1996.  HUD officials
asked the public housing directors in HUD field offices to send us
copies of the original forms provided to HUD by the housing agencies. 
We received 222 usable forms of the 300 requested and checked the
data on them against the data in IBS.  On the basis of our sample, we
estimated that the error rate for the IBS amount field was between
0.2 and 0.6 percent.  This estimate applies to about 75 percent of
the records in the database.  On the basis of the response rate to
our request and the limited number of data errors we found in our
data verification process, we are satisfied that the IBS data are of
sufficient accuracy to be useful in our analyses. 

To determine how HUD develops budget estimates of housing agencies'
annual need for operating subsidy, we interviewed HUD officials and
reviewed and analyzed HUD's methodology for developing its estimates. 
Our review included the time frames involved in the process and the
steps involved in the process.  In addition, we reviewed the
documentation for the model HUD uses to calculate the budget estimate
and the assumptions used in the model.  Also, we discussed with HUD
officials the sampling process HUD uses as part of the estimating
process. 

To determine what options HUD has for changing PFS to make it a more
effective tool for subsidizing housing agencies, we reviewed relevant
literature and interviewed HUD officials and representatives of
industry professional groups.  We relied on our prior experience and
ongoing work to develop options for other formula-based funding
programs, including the Indian Housing Block Grant, Medicaid, the
Older Americans Block Grant, Law Enforcement Block Grant, the Chapter
I Education Grant, Highway Grant formulas, and technical assistance
to the Congress for options in targeting HUD's Community Development
Block Grant. 

To advise us on all aspects of our work, we retained Mr.  Wayne S. 
Sherwood, a consultant with extensive knowledge of the history and
functioning of PFS and expertise in the operations of public housing
agencies. 

We performed our work from August 1997 through May 1998 in accordance
with generally accepted government auditing standards. 


MAJOR CONTRIBUTORS TO THIS REPORT
======================================================== Appendix VIII

RESOURCES, COMMUNITY, AND ECONOMIC
DEVELOPMENT DIVISION

Leslie D.  Albin, Writing and Editing Group
Thomas W.  Barger, Jr., Dallas Regional Office
Andy C.  Clinton, Dallas Regional Office
Austin J.  Kelly, Economic Analysis Group
Eric A.  Marts, Assistant Director
Judy K.  Pagano, Design, Methodology, and Technical Assistance Group
Willie D.  Watson, Dallas Regional Office

HEALTH, EDUCATION, AND HUMAN
SERVICES DIVISION

Robert J.  Dinkelmeyer, Economist
Jerry C.  Fastrup, Assistant Director


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