Established in 1965, HUD is the principal federal agency responsible for the programs dealing with housing and community development and fair housing opportunities. Among other things, HUD’s programs provide (1) mortgage insurance to help families become homeowners and to help provide affordable multifamily rental housing for low- and moderate-income families, (2) rental subsidies for lower-income families and individuals, and (3) grants and loans to states and communities for community development and neighborhood revitalization activities. HUD’s fiscal year 1997 budget proposal requests about $22 billion in discretionary budget authority and plans about $33 billion in discretionary outlays. Compared with HUD’s fiscal year 1996 appropriation, this request represents about a 7-percent increase in budget authority and 10 percent increase in outlays. HUD believes that this increase in outlays between fiscal years 1996 and 1997 is somewhat misleading. For example, 1996 outlays were unusually low because HUD expended $1.2 billion—which normally would have been disbursed early in fiscal year 1996—in late fiscal year 1995 because of the government shutdown. In addition, reforms in the mortgage assignment program generated a significant one-time savings of over $1 billion in fiscal year 1996 (under credit reform as scored by the Congressional Budget Office). HUD’s March 1995 blueprint, HUD Reinvention: From Blueprint to Action, proposed to merge 60 of its 240 separate programs into three performance-based funds that would be allocated directly to the states and localities. HUD’s objectives were to provide communities with greater flexibility and instill a level of accountability in its programs through the use of performance measures and a series of rewards and incentives. As of March of this year, few of the proposals in this reinvention document have been adopted. HUD’s second reinvention proposal, Renewing America’s Communities from the Ground Up: The Plan to Continue the Transformation of HUD, also known as Blueprint II, would supersede the first proposal but continue the move toward accountability by fiscal year 1998 by (1) consolidating over 20 community development programs into three performance funds where high-performing grant recipients would be awarded bonuses, (2) replacing 15 separate public housing programs with two performance funds, and (3) consolidating the 14 existing voucher and certificate funds. Appendix II summarizes HUD’s plans to fund the proposals in Blueprint II through its fiscal year 1997 budget request. HUD’s fiscal year 1997 budget request discusses how a planned, major restructuring of the multifamily housing program is likely to affect its budget over the next 6 years and beyond. The restructuring is aimed at addressing serious and longstanding problems affecting properties with HUD-insured mortgages that also receive rental subsidies tied to units in the properties (project-based assistance). HUD deserves credit for attempting to address these complex problems. However, HUD’s assumptions about its ability to quickly restructure properties with high subsidy costs appear overly optimistic and could be responsible for HUD underestimating its request for rental assistance for low-income families. According to HUD’s latest data, 8,636 properties with about 859,000 apartments would be subject to the restructuring proposal; the unpaid loan balances for these properties total about $17. 8 billion. In many cases, HUD pays higher amounts to subsidize properties than are needed to provide the households living in them with decent, affordable housing. In other cases, rents set by HUD are lower than required to maintain the properties’ physical condition, contributing to poor living conditions for families with low incomes. Initially termed “mark to market” in last year’s budget request, and now referred to as “multifamily portfolio reengineering,” the goal and general framework of HUD’s proposal remain the same: eliminate excess subsidy costs and improve the poor physical condition of some of the properties by relying primarily on market forces. Specifically, for properties with mortgages insured by FHA that also receive project-based assistance, HUD has been proposing to let the market set the property rents to market levels and reduce mortgage debt if necessary to permit a positive cash flow. In addition, HUD has proposed replacing project-based rental subsidies with portable tenant-based subsidies, thereby requiring the properties to compete in the marketplace for residents. While maintaining this general framework, HUD made several changes to its proposal this year. For example, under the initial proposal all rents would have been reset to market levels whether the market rents were above or below the subsidized rents. The current proposal gives priority attention initially to properties with subsidized rents above market. In addition, HUD plans to let state and local governments decide whether to continue with project-based rent subsidies after mortgages are restructured or to switch to tenant-based assistance. HUD has also indicated that it will allow owners to apply for FHA insurance on the new, restructured mortgage loans, whereas last year the proposal expressly disallowed FHA insurance on restructured loans. We are currently evaluating a study by Ernst & Young LLP released on May 2, 1996, that was designed to provide the Department with current information on HUD’s multifamily portfolio. This information could form the basis for the improvement of key assumptions needed to estimate the net savings or costs associated with the reengineering proposal. In this regard, HUD’s contract with Ernst & Young LLP requires that the firm update HUD’s information on (1) market rents versus the project-based rents that the agency subsidizes and (2) the physical condition of the properties.These two variables strongly influence whether a property can operate at market rents without debt reduction or what amount of debt reduction is needed to cover the property’s expenses. Having good data on these variables will allow FHA to better develop claims estimates which will be based on the amount of debt write-down. In addition, the rent data are integral to estimating the change in subsidy costs if the project-based rents are replaced with market rents and the residents receive tenant-based assistance. HUD also tasked Ernst & Young with developing a financial model that would show the likely result of reengineering the portfolio and identify the related subsidy costs and claims costs. The results of the Ernst & Young study were not available when the fiscal year 1997 budget was being developed. Because HUD lacked the project-specific data contained in the Ernst & Young study, HUD used assumptions in some cases that represent the Department’s “best guess” as to outcome. These assumptions can affect the budgetary savings HUD expects to result from reengineering the portfolio. Ernst & Young’s May 2, 1996, report presents information on projects that are expected to be affected by this reengineering. While the report did not directly discuss subsidy and claims costs, we are currently reviewing the results of this study and its cost implications. We plan to issue our report on the Ernst & Young study this summer. On the basis of our ongoing work, we believe that some of the assumptions HUD used may overstate the projected savings associated with reengineering the portfolio. We cannot, however, determine the extent of that overstatement at this time. One of HUD’s assumptions is that a substantial number of mortgages with excess subsidy costs will be restructured well ahead of the dates that their rental assistance contracts expire. Although the extent to which HUD will be able to accomplish this remains unclear, this assumption appears optimistic and HUD’s budget request may understate its need for funding to renew section 8 rental assistance contracts for fiscal year 1997 and beyond. In its fiscal year 1997 budget, HUD requested $845 million in bonus funding for high-performing grantees in four of its six new block grants. HUD calls the block grants “performance funds.” HUD believes that these grants will provide communities with greater flexibility to design local solutions to local problems. HUD plans to competitively award bonuses to grantees who exceed the established performance measures and who submit project proposals. (App. III summarizes the details of the proposed bonus pools.) We generally support performance measurement as a method of building accountability into block grants because it would allow grantees to achieve objectives while also vesting them with responsibility for their choices. Moreover, HUD’s development of block grants and performance measures would be consistent with the underlying principles of the Government Performance and Results Act and recommendations for program consolidation made by the National Performance Review. However, the characteristics of the block grants themselves—their program breadth and the flexibility allowed the grantees—will greatly complicate and add significant time to HUD’s development of uniform performance measures. HUD is still in the early stages of developing such measures, however, and without them grantees will have difficulty understanding HUD’s objectives and performance measurement process. Moreover, because of inadequate information systems to support performance measurement, we question whether HUD’s request for bonus funding can be effectively used during fiscal year 1997. Some features inherent to block grants will complicate the implementation of a performance measurement system in fiscal year 1997. These complications would result in extending beyond fiscal year 1997 the time HUD needs to develop adequate measures. We have reported in the past, for instance, that the flexibility and wide latitude allowed grantees make common and comparative measurement very difficult. HUD will need to collaborate with the states to develop performance measures and establish reporting requirements. These entities’ interests could vary markedly because HUD would be looking to meet national objectives, while the states are trying to meet local needs. Not only do the federal and state interests differ, but it will take time for both to develop data collection systems and reporting capacities once the initial decisions are made. In addition, measurement is complicated because all observed outcomes cannot be assumed to result from the programs and activities under scrutiny. Some outcomes, such as job creation, will be affected by factors outside of the control of program participants, while other desired outcomes, such as enhanced quality of life for residents, may not be quantifiable.