Mortgage Financing: Financial Health of the Federal Housing
Administration's Mutual Mortgage Insurance Fund (Testimony, 09/12/2000,
GAO/T-RCED-00-287).

Pursuant to a congressional request, GAO discussed the financial health
of the Mutual Mortgage Insurance Fund, focusing on: (1) the activities
of the Federal Housing Administration's (FHA) home mortgage insurance
program; (2) how the reserves of the Fund are estimated; (3) GAO's views
on determining an adequate level of reserves; (4) actions that Congress
and the Secretary of the Department of Housing and Urban Development
(HUD) have taken or could take to influence the level of reserves; and
(5) the impact that actions affecting the level of reserves could have
on the federal budget.

GAO noted that: (1) FHA is a major source of financing for the
single-family housing market--overall as well as for specific groups,
particularly low-income and other homebuyers who may not have much cash
for a down payment but are otherwise able to afford a loan; (2) FHA's
home mortgage insurance program has helped people become homeowners
through the use of a mutual insurance fund that until the 1990s,
returned profits to homebuyers; (3) the reserves that FHA is required to
maintain consist of current capital resources--primarily nonmarketable
Treasury securities--plus estimates of the net present value of future
cash flows from the activity of the Fund; (4) deriving estimates of the
value of future cash flows requires professional judgment and, in
practice, relies on complex economic models; (5) determining what
reserve levels would ensure the financial soundness of the Fund requires
additional study; (6) when Congress first established the 2-percent
reserve requirement, the Fund was experiencing unusual losses; (7)
today, the Fund appears to be enjoying its highest level of reserves in
the last 20 years; (8) to help Congress decide on an appropriate level
of reserves for the future, GAO is now conducting analyses that will
model economic scenarios that the Fund should withstand; (9) losses that
FHA experienced in the 1980s following unusually high claims resulting
from foreclosures in the oil-producing states may provide an indication
of the reserve levels that might be needed for the Fund to remain
financially sound; (10) there are a number of actions that Congress and
the Secretary of HUD have taken and could take to influence the level of
reserve; (11) both the Secretary and Congress have changed insurance
premiums; (12) the Secretary has also taken actions to limit losses from
the management of foreclosed properties and to enhance FHA's oversight
of lenders; (13) Congress has set maximum loan-to-value ratios and
required the Secretary to suspend payment of distributive shares; (14)
any of these actions may have affected the value of the Fund; (15)
Congress and the Secretary could take actions in the future that could
reduce the value of the fund, including reducing premiums, changing
underwriting standards to reach more homebuyers, or reinstituting the
payment of distributive shares; (16) actions taken by the Secretary of
HUD or Congress that influence the Fund's reserve levels will also
affect the federal budget; and (17) any proposal that seeks to use
reserves, if not accompanied by a reduction in other spending or an
increase in receipts, will result in a decline in the federal budget
surplus.

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

 REPORTNUM:  T-RCED-00-287
     TITLE:  Mortgage Financing: Financial Health of the Federal
	     Housing Administration's Mutual Mortgage Insurance Fund
      DATE:  09/12/2000
   SUBJECT:  Mortgage protection insurance
	     Government guaranteed loans
	     Mortgage programs
	     Financial management
	     Financial analysis
	     Budget surplus
	     Insurance losses
	     Mortgage loans
	     Budgetary reserves
	     Foreclosures
IDENTIFIER:  Mutual Mortgage Insurance Fund

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GAO/T-RCED-00-287

MORTGAGE FINANCING

Financial Health of the Federal Housing Administration's Mutual Mortgage
Insurance Fund Statement of Stanley J. Czerwinski, Associate Director,
Housing and Community Development Issues, Resources, Community, and Economic
Development Division

United States General Accounting Office

GAO Testimony Subcommittee on Housing and Transportation,

Committee on Banking, Housing and Urban Affairs, U. S. Senate

For Release on Delivery Expected at 9: 30 a. m., EDT Tuesday September 12,
2000

GAO/ T- RCED- 00- 287

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 1

Mr. Chairman and Members of the Subcommittee: We are here today to discuss
the financial health of the Mutual Mortgage Insurance Fund (the Fund) of the
Department of Housing and Urban Development's (HUD) Federal Housing
Administration (FHA). Through the Fund, FHA operates a single- family
insurance program that, since its creation in 1934, has helped millions of
Americans buy a home. Last fiscal year alone, FHA insured 1.3 million
single- family mortgages, totaling $125 billion. By the end of September
1999, FHA had commitments of almost half a trillion dollars in single-
family mortgage insurance. The Fund, which is financed through insurance
premiums, operates without cost to the American taxpayer.

Ten years ago, following an economic downturn during the 1980s that resulted
in severe losses, particularly on loans made in the oil- producing states,
the Fund was estimated to have a negative economic value, and its future was
in doubt. To help place the Fund on a financially sound basis, the Congress
enacted legislation in November 1990 that required the Secretary of HUD to,
among other things, raise insurance premiums and suspend the rebates, called
distributive shares, that FHA borrowers had been eligible to receive under
certain circumstances. The legislation also required the Secretary to take
steps to achieve a capital ratio of 2 percent by November 2000 1 and to
maintain or exceed that ratio at all times thereafter. In the most recent
actuarial study of the Fund, Deloitte & Touche estimated its economic value
at $16.6 billion at the end of fiscal year 1999. This represents 3.66
percent of the amount of mortgages that FHA insured- well above the required
minimum of 2 percent. However, it is not clear what level of reserves would
be adequate to ensure the financial health of the Fund.

In today's robust economy, the Fund's economic value appears to have reached
its highest level in at least 20 years, and several proposals have been made
to use what some are calling excess reserves or to take other actions that
could result in a change in the value of the Fund. However, the level of
reserves that would be adequate to ensure that the Fund could withstand
losses as severe as those FHA experienced in the 1980s is not clear at this
time. This Subcommittee and the House Subcommittee on Housing and Community
Opportunity have asked us to undertake work that would help determine what
level of reserves would allow the Fund to withstand certain economic
downturns. Our statement today is based on reports we have issued over the
last 5 years. (See app. I for related GAO products.) Specifically, our
statement today will focus on (1) the activities of FHA's home mortgage
insurance program, (2) how the reserves of the Fund are estimated, (3) our
views on determining an adequate level of reserves, (4) actions that the
Congress and the Secretary of HUD have taken or could take to influence the
level of reserves, and (5) the impact that actions affecting the level of
reserves could have on the federal budget.

In summary: 1 The act defined the capital ratio as the ratio of the Fund's
capital, or economic net worth, to its unamortized insurance- in- force.
However, the act defined unamortized insurance- in- force as the remaining
obligation on outstanding mortgages- a definition generally understood to
apply to amortized insurance- in- force. FHA has calculated the 2- percent
capital ratio using unamortized insurance- in- force as it is generally
understood- which is the initial amount of mortgages. All capital ratios
reported here are measured using unamortized insurance- in- force as it is
generally understood.

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 2

ï¿½ FHA is a major source of financing for the single- family housing market-
overall as well as for some specific groups, particularly low- income and
other homebuyers who may not have much cash for a down payment but are
otherwise able to afford a loan. 2 FHA's home mortgage insurance program has
helped people become homeowners through the use of a mutual insurance fund
that, until the 1990s, returned profits (distributive shares) to homebuyers.

ï¿½ The reserves that FHA is required to maintain consist of current capital
resources-- primarily nonmarketable Treasury securities-- plus estimates of
the net present value of future cash flows from the activity of the Fund.
Deriving estimates of the value of future cash flows requires professional
judgment and, in practice, relies on complex economic models.

ï¿½ Determining what reserve levels would ensure the financial soundness of
the Fund requires additional study. When the Congress, in 1990, first
established the 2- percent reserve requirement, the Fund was experiencing
unusual losses. Today, the Fund appears to be enjoying its highest level of
reserves in the last 20 years. To help the Congress decide on an appropriate
level of reserves for the future, we are now conducting analyses that will
model economic scenarios that you may wish the Fund to withstand. For
example, losses that FHA experienced in the 1980s following unusually high
claims resulting from foreclosures in the oil- producing states may provide
an indication of the reserve levels that might be needed for the Fund to
remain financially sound.

ï¿½ There are a number of actions that the Congress and the Secretary of HUD
have taken and could take to influence the level of reserves. For example,
both the Secretary and the Congress have changed insurance premiums. The
Secretary has also taken actions to limit losses from the management of
foreclosed properties and to enhance FHA's oversight of lenders. The
Congress has set maximum loan- to- value ratios and required the Secretary
to suspend payment of distributive shares. Any of these actions may have
affected the value of the Fund. In addition, the Congress and the Secretary
could take actions in the future that could reduce the value of the fund,
including reducing premiums, changing underwriting standards to reach more
homebuyers, or reinstituting the payment of distributive shares.

ï¿½ Actions taken by the Secretary of HUD or the Congress that influence the
Fund's reserve levels will also affect the federal budget. In short, any
proposal that seeks to use reserves, if not accompanied by a reduction in
other spending or an increase in receipts, will result in a decline in the
federal budget surplus.

Let me start by briefly explaining the reason for mortgage insurance
programs like FHA's, the concept of mutuality, and the recent history of the
Mutual Mortgage Insurance Fund.

FHA Is a Major Source of Single- Family Mortgage Insurance

FHA was created in 1934 to broaden homeownership, shore up and protect
lending institutions, and stimulate employment in the building industry.
While the mortgage market has changed over time, FHA continues to be a major
source of financing for single- family homes, particularly for minority,
low- income, and first- time homebuyers. HUD reported in March of this year
that it set a record in 1999, insuring an additional 1.3 million mortgages
worth $125 billion and bringing the total number of mortgages it now insures
to about 6.7 million. HUD also reported that

2 A “low- income” borrower is one whose income is no greater
than 80 percent of the median income in the Metropolitan Statistical Area in
which the borrower lives.

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 3

almost 38 percent of the loans insured by FHA in 1999 were made to minority
homebuyers and over 80 percent of new FHA- insured loans were made to first-
time homebuyers. As we reported last year, FHA is more likely than the
Department of Veterans Affairs or private mortgage insurers to insure loans
for minority and first- time homebuyers. 3 FHA is also more likely to insure
loans for low- income homebuyers, many of whom might not qualify for private
mortgage insurance. In line with its original role to shore up lenders and
provide employment, FHA continues to offer insurance in areas suffering from
economic hardship under the same terms that it does in areas with more
robust economies. Private mortgage insurers, by contrast, offer insurance
under more restrictive terms when an area is experiencing economic hardship.
As a result, they are likely to provide less insurance in these areas.

FHA provides most of its single- family insurance through a program
supported by the Mutual Mortgage Insurance Fund. The Fund is a mutual fund
in that any income received in excess of the amounts required to cover
initial insuring costs, operating expenses, and losses due to claims may be
paid to borrowers after they pay their mortgages in full or voluntarily
terminate their FHA insurance. In accordance with this principle, from 1943
to 1990, FHA rebated these so- called excess funds to borrowers as
distributive shares. In 1990, however, the Congress suspended the payment of
these shares after the Fund became weakened by losses resulting from high
foreclosure rates in economically stressed regions, particularly in the oil-
producing states during the 1980s. The decline in the value of the Fund
during the 1980s contrasts with the relative health the Fund has enjoyed for
most of its history. While the economic value of the Fund at the beginning
of the 1980s was estimated to be $3.4 billion, or 5.3 percent of the
insurance- in- force, by 1990, the Fund was estimated to have a negative
economic value of $2.7 billion. In 1990, the Congress not only suspended the
payment of distributive shares but also required the Secretary to raise
premiums and take other actions to build up a reserve to protect the Fund in
case of future downturns.

Reserve Estimates Are Based on Professional Judgment

Estimating the value of the reserves involves extensive professional
judgment. The 1990 reforms defined the reserves or economic value of the
Fund as the current cash available to the Fund plus the net present value of
future cash flows expected to result from mortgages insured under the Fund.
In practice, the Fund has been measured as current capital resources 4 plus
the net present value of future cash flows. Investments in nonmarketable
Treasury securities represent the largest component of FHA's current capital
resources. From the overall perspective of the government, these FHA assets
are offset by corresponding liabilities of the U. S. Treasury.

Estimating the net present value of future cash flows is a complex actuarial
exercise that requires extensive professional judgment. Cash flows into the
Fund from premiums and the sale of foreclosed properties; cash flows out of
the Fund to pay claims on foreclosed mortgages, premium refunds, and
administrative expenses. See figure 1. The future cash flows are

3 Homeownership: Results of and Challenges Faced by FHA's Single- Family
Mortgage Insurance Program (GAO/ T- RCED- 99- 133, Mar. 25, 1999). 4
According to HUD, the Fund's capital resources for 1999 were $14.3 billion
including fund balances with the U. S. Treasury of $3.6

billion, investments in U. S. Treasury securities of $14.7 billion, net
credit program receivables and related foreclosed property of $2.8 billion,
interest receivable from U. S. government securities of $0.2 billion, and
other assets of $0.2 billion, minus net receivables and payables including
borrowings from the U. S. Treasury, other liabilities, claims payable,
premium refunds payable, and debentures issued to claimants of $ 7.1
billion.

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 4

estimates based on a number of assumptions about the future, including
predictions of mortgage defaults and the likelihood that those holding FHA-
insured mortgages will prepay their loans. These predictions are based on
elaborate models that use past relationships between defaults and
prepayments and certain economic variables, such as changes in house prices.
To the extent that these relationships are different in the future, the
actual defaults and prepayments will differ from the estimates. Moreover,
the estimating procedures make many other assumptions. For example, the
estimates usually assume that no changes will take place in FHA's program
and that future economic variables-- specifically, changes in house prices,
unemployment rates, or mortgage rates-- will take on certain values. If HUD
changes its program or these economic values are different from those
forecasted, then the actual default and prepayment experience is also likely
to be different from that used in estimating the reserves.

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 5

Figure 1: Cash Flows of the Mutual Mortgage Insurance Fund

Refinancedor sold! Refunds of

up- front premiums if

mortgage terminated voluntarily within 7 years

Sold! FHA

Administrative expenses

HUD- owned house Previously foreclosed

Proceeds from sale of foreclosed

property FHA- insured

mortgage Insurance

premiums (up- front and annual)

Lender Claims on

foreclosed properties MMI

Fund

The 1990 reforms required the Secretary of HUD to take steps to ensure that
by November 2000 the Fund would build a reserve or increase its economic
value– or capital-- to at least 2 percent of the insurance- in- force
and that this capital ratio would remain at 2 percent or more thereafter. In
addition, an independent actuarial review is required annually to estimate
the economic value of the Fund and the capital ratio. This review was
performed by Price Waterhouse-- now PricewaterhouseCoopers- for fiscal years
1989 5 through 1998 and by Deloitte & Touche in 1999. For fiscal years 1993
and 1994, we estimated capital ratios that were similar to those calculated
by Price Waterhouse. 6 The independent actuarial reviews show that the
estimated capital ratio has risen from a low of –0.9 percent of the
insurance- in- force in 1990-- a time when the economic

5 Price Waterhouse estimated the value of the fund for fiscal year 1989 at
HUD's request. 6 Mortgage Financing: Financial Health of FHA's Home Mortgage
Insurance Program Has Improved( GAO/ RCED- 95- 20, Oct. 18,

1994) and Mortgage Financing: FHA Has Achieved Its Home Mortgage Capital
Reserve Target( GAO/ RCED- 96- 50, Apr. 12, 1996).

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 6

value of the Fund was negative-- to a high in 1999 of 3.66 percent of the
insurance- in- force. As figure 2 shows, in the early 1990s, estimated
reserves were lower- sometimes far lower- than the level of reserves that
would have been needed to meet a 2- percent capital ratio. In 1990, for
example, estimated reserves were almost $9 billion lower than needed to meet
a 2- percent capital ratio. However, the graph tells a very different story
for the second half of the 1990s. Beginning in 1995, the estimated reserves
exceeded the level needed to meet a 2- percent capital ratio. As the decade
progressed, FHA insured a larger volume of loans, but the annual estimated
reserves grew well beyond the levels needed to meet a 2- percent capital
ratio. As a result, in 1999, Deloitte & Touche estimated that the Fund had
reserves of $16.6 billion- a level more than 80 percent higher than the $9
billion level needed to meet a 2- percent capital ratio. While the increase
in the reserves throughout most of the 1990s was due, in part, to
legislative and other changes to FHA's single- family mortgage insurance
program, the favorable prevailing and forecasted economic conditions were
primarily responsible for the improvement.

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 7

Figure 2: Comparison of Reserves Equaling 2 Percent of Insurance- in- Force
and Estimated Reserves: 1989- 99

Source: GAO's analysis of PricewaterhouseCoopers and Deloitte & Touche data.

What Constitutes Adequate Reserve Levels Has Not Received Enough Study

Determining what constitutes an adequate reserve level is essentially a
question of what kinds of adverse economic conditions-- moderately severe or
catastrophic-- the reserve should be able to withstand, and this issue has
not received much attention recently. By statute, the Fund is supposed to be
actuarially sound; however, the legislation does not define actuarial
soundness. In the actuarial review of the Fund conducted by Price Waterhouse
for fiscal year 1989, the researchers concluded that actuarial soundness
would be consistent with a reserve that could withstand adverse, but not
catastrophic, economic downturns. They further concluded that the Treasury
implicitly covers catastrophic risk. In other words, they concluded that
policyholders should pay premiums high enough to cover some moderate level
of adverse experience, but that taxpayers should shoulder the additional
risk imposed by such severe conditions as the oilproducing states
experienced in the 1980s. By contrast, rating agencies have taken the
position, when evaluating private mortgage insurers, that they should have
enough capital to withstand

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 8

catastrophic risk. These agencies have, therefore, measured the capital
adequacy of these firms against their ability to withstand downturns such as
the oil- producing states encountered in the 1980s. While the Fund can
ultimately rely on the taxpayer, in many ways the Fund faces more risk than
private mortgage insurers. Generally, compared with private insurers, the
Fund insures more low- income borrowers, provides insurance for mortgages
with lower down payments, and insures essentially 100 percent of the
mortgage amount, whereas private insurers generally cover only about 20
percent of the mortgage amount. Finally, private insurers tend to cease
insuring new business when mortgage markets go bad, whereas FHA remains in
the market, helping to cushion the downturn. However, requiring FHA to hold
capital equivalent to that held by private mortgage insurers would likely
impair FHA's public purpose.

Because little analysis has been done to determine the level of protection
provided by the 2- percent reserve requirement, we believe that further
study is needed on whether that requirement or some other requirement is
adequate. As we mentioned earlier, we are undertaking work that would help
determine what level of reserves would allow the Fund to withstand certain
economic downturns. As part of this work, we are in the process of
estimating the Fund's reserve and expect to report our findings in 2001. At
that time, we also plan to report on the degree of protection provided by
the 2- percent minimum reserve ratio. For example, we plan to assess whether
a 2- percent reserve ratio would be adequate to protect the Fund from a
downturn comparable to the one in the 1980s. We understand that the Office
of Management and Budget (OMB) and the Congressional Budget Office (CBO) are
also conducting analyses that will shed light on the current size of the
reserves and on the level of adversity the Fund could withstand.

The Congress and HUD Have Taken Actions That Affect the Value of the Fund's
Reserves

The Congress has taken actions in the past that are likely to have changed
the economic value of the Fund and might take additional actions in the
future that could have an effect on the value of the Fund. The 1990 reforms,
which were designed to improve the actuarial soundness of the Fund, made
significant changes in the way premiums were set. The reforms reinstituted
annual premiums and required that premiums vary with the riskiness of the
loan. This legislation also called for phased- in reductions of the maximum
allowable up- front premium in the ensuing years. Subsequently, the Congress
has taken action to

ï¿½ lower the maximum up- front premium from 2.25 percent to 2 percent for
first- time homebuyers who receive home ownership counseling before
purchasing a home,

ï¿½ raise the maximum limits on the size of the loans FHA can insure–
for high- cost areas this limit was raised to almost $220,000 in January
2000-- and

ï¿½ have FHA implement a new loss mitigation program that encourages lenders
to take actions to lower defaults on FHA- insured mortgages.

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 9

The Secretary of HUD has also taken actions in the past that are likely to
have affected the level of reserves and, even without additional
legislation, could make further changes in the program such as the
following:

ï¿½ The Secretary could authorize the payment of distributive shares. In 1990,
after the Fund began experiencing substantial losses, the Congress required
FHA to stop paying distributive shares until the Fund had accumulated
adequate reserves. While the Fund has attained the required minimum reserves
since the end of fiscal year 1995, an adequate level of reserves has not yet
been defined.

ï¿½ The Secretary could use his discretion to reduce premiums below the
maximum levels set by the Congress. In 1997, HUD reduced the up- front
premium from the maximum of 2 percent to 1.75 percent for first- time
homebuyers who receive home ownership counseling; however, the annual
premium, paid monthly, has not changed since the end of fiscal year 1992.

ï¿½ The Secretary could also adjust underwriting standards, and in January
1998, he directed lenders to tighten the underwriting standards for
adjustable- rate mortgages.

ï¿½ The Secretary could take action to better manage HUD's portfolio of
foreclosed properties and improve its oversight of lenders. For example, HUD
has gone from managing foreclosed properties internally to contracting for
most of the management and sales functions of its property disposition
program.

Changes such as these, whether made by the Secretary of HUD or the Congress,
would be likely to affect the future economic value of the Fund. Recent
actuarial reviews of the Fund have cited the rise in the loan limit, the
loss mitigation program, and the changes in underwriting standards for
adjustable- rate mortgages as actions that are likely to increase the value
of the Fund. These reviews have also cited the reduction in premiums for
first- time homebuyers as an action that may reduce the revenue flowing into
the Fund and thus its value.

Actions That Affect the Reserves Have an Impact on the Federal Budget

Under 1990 credit reform legislation, FHA's budget is required to reflect
the subsidy cost to the government of FHA's loan insurance activities for
that year. 7 Credit reform was intended to ensure that the full cost of
credit activities for the current budget year would be reflected in the
federal budget so that the executive branch and the Congress could consider
these costs when making annual budget decisions. To accommodate the
differing statutory requirements of budgeting for the subsidy cost of
insuring the loans and maintaining a 2- percent reserve, OMB and FHA have
allowed reserves to accumulate in the Fund in the form of interest- bearing
Treasury securities. At the end of fiscal year 1999, FHA held nearly $15
billion in Treasury securities. These securities represent a claim on the U.
S. Treasury to cover future losses to the Fund. From the perspective of the
U. S. Treasury, these securities represent a liability. From the

7 The subsidy cost is the estimated net cost to the government, in present
value terms, of FHA- insured loans over the entire period the loans are
outstanding.

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 10

standpoint of the government as a whole, the securities represent a debt
owed by one part of the federal government to another. By investing in
nonmarketable Treasury securities, FHA makes funds available to other
federal programs. Each year that the Fund runs a surplus, the budget surplus
for the federal government, as a whole, is higher than it would otherwise
have been if FHA had not been insuring profitable loans. When the total
federal budget was in a deficit (as it was for most of the 1990s), that
deficit was lower than it would have been if the Fund had not been realizing
a surplus at the same time.

If the Congress or the Secretary of HUD adopts policies, such as lowering
premiums, paying distributive shares, or loosening underwriting standards,
that reduce the profitability of the Fund, the negative subsidy 8 amount
reported in FHA's budget submission and the Fund's reserve will both be
lower. 9 Some of these policies- lowering premiums and paying distributive
shares- would affect FHA's cash flows immediately. Thus, the amount of money
available for FHA to invest in Treasury securities would be lower. The
Treasury in turn would have less money available for other purposes, and the
overall surplus would decline. If the amounts of cash flowing out of the
Fund exceeded current receipts, FHA would be required to redeem its
investments in Treasury securities to make the required payments. The
Treasury, then, would be required to either increase borrowing from the
public or use general tax revenues to meet its financial obligations to FHA.
In either case, the annual budget surplus would be lower.

Budgetary scoring for budget control purposes under the 1990 Budget
Enforcement Act 10 is required only when a law is enacted; actions taken by
the Secretary under existing authorities are not scored for budget control
purposes, even though they may affect the budget surplus or deficit. Under
the Budget Enforcement Act, if a new law is enacted that creates additional
mandatory spending or reduces receipts, its costs must be offset by
reductions in other mandatory programs, increases in revenues, or a
combination of the two. Whether and how the proposals under discussion would
be scored depends on the exact wording of the new law and is determined by
OMB for Budget Enforcement Act purposes. However, any action taken by the
administration or the Congress to reduce FHA's reserves, if not accompanied
by a similar reduction in other government spending or by an increase in
receipts, will result in either a reduction in the surplus or an increase in
any existing deficit.

In closing, Mr. Chairman, the Fund has accumulated significant reserves over
the last 10 years. These reserves were built up from premiums paid by
borrowers that exceeded the Fund's costs, proceeds from the sale of
foreclosed properties, and interest earned on Treasury securities. The
borrowers who paid these premiums-- many of whom had lower incomes or used
their FHAinsured mortgage to buy their first homes-- have not only paid for
their insurance but have also contributed to the budget surplus we are
enjoying today. We believe that before actions are taken that could affect
the reserve levels, the first question that needs to be addressed is whether
the levels that the Fund is enjoying today, during economically prosperous
times, are sufficient to withstand certain levels of future loan performance
that may be worse than expected. Thus, we urge caution about taking any
action in these surprisingly strong economic

8 Negative subsidies mean subsidy costs are less than zero, i. e., the
program is operating at a profit. 9 If the Congress were to use the Fund's
reserves to fund other programs, the reserves would be lower, but there
would be no effect

on the negative subsidy amount reported in FHA's budget submissions. 10 As
part of the effort to control federal budget results, the Budget Enforcement
Act of 1990, as amended, created controls over laws

changing or creating mandatory spending (basically entitlements) and
receipts.

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 11

times that could not easily be reversed if the actual default and prepayment
experience turned out to be worse than forecasted.

---- Mr. Chairman, this concludes my statement. We would be pleased to
respond to any questions that you or Members of the Subcommittee may have.

Appendix I

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 12

Related GAO Products

Mortgage Financing: Level of Annual Premiums That Place a Ceiling on
Distributions to FHA Policyholders( GAO/ RCED- 00- 280R, Sept. 8, 2000).

Single- Family Housing: Stronger Measures Needed to Encourage Better
Performance by Management and Marketing Contractors( GAO/ T- RCED- 00- 180,
May 16, 2000, and GAO/ RCED00- 117, May 12, 2000).

Single Family Housing: Stronger Oversight of FHA Lenders Could Reduce HUD's
Insurance Risk (GAO/ RCED- 00- 112, Apr. 28, 2000).

Homeownership: Information on Single- Family Loans Sold by HUD( GAO/ RCED-
99- 145, June 15, 1999).

Homeownership: Achievements of and Challenges Faced by FHA's Single- Family
Mortgage Insurance Program( GAO/ T- RCED- 98- 217, June 2, 1998).

Homeownership: Results of and Challenges Faced by FHA's Single- Family
Mortgage Insurance Program( GAO/ T- RCED- 99- 133, Mar. 25, 1999).

Homeownership: Management Challenges Facing FHA's Single- Family Housing
Operations (GAO/ T- RCED- 98- 121, Apr. 1, 1998).

Homeownership: Information on Foreclosed FHA- Insured Loans and HUD- Owned
Properties in Six Cities( GAO/ RCED- 98- 2, Oct. 8, 1997).

Homeownership: Potential Effects of Reducing FHA's Insurance Coverage for
Home Mortgages (GAO/ RCED- 97- 93, May 1, 1997).

Homeownership: FHA's Role in Helping People Obtain Home Mortgages( GAO/
RCED- 96- 123, Aug. 13, 1996).

Mortgage Financing: FHA Has Achieved Its Home Mortgage Capital Reserve
Target (GAO/ RCED- 96- 50, Apr. 12, 1996).

Homeownership: Mixed Results and High Costs Raise Concerns about HUD's
Mortgage Assignment Program( GAO/ RCED- 96- 2, Oct. 18, 1995).

Appendix I

GAO/ T- RCED- 00- 287 Adequacy of FHA's Reserves 13

Mortgage Financing: Financial Health of FHA's Home Mortgage Insurance
Program Has Improved( GAO/ RCED- 95- 20, Oct. 18, 1994.

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