HUD, through FHA, provides insurance that protects private lenders from financial losses stemming from borrowers’ defaults on mortgage loans for both single-family homes and multifamily rental housing properties for low- and moderate-income households. When a default occurs on an insured loan, a lender may “assign” the mortgage to HUD and receive payment from FHA for an insurance claim. According to the latest data available from HUD, FHA insures mortgage loans for about 15,800 multifamily properties. These properties contain just under 2 million units and have a combined unpaid mortgage principal balance of $46.9 billion.These properties include multifamily apartments and other specialized properties, such as nursing homes, hospitals, student housing, and condominiums. In addition to mortgage insurance, many FHA-insured multifamily properties receive some form of direct assistance or subsidy from HUD, such as below-market interest rates or Section 8 project-based assistance. HUD’s Section 8 program provides rental subsidies for low-income families. These subsidies are linked either to multifamily apartment units (project-based) or to individuals (tenant-based). According to HUD’s latest available data, about 1.4 million units at about 20,400 multifamily properties receive Section 8 project-based subsidies. Under the Section 8 program, residents in subsidized units generally pay 30 percent of their income for rent and HUD pays the balance. According to HUD, its restructuring proposals apply to 8,636 properties that both have mortgages insured by FHA and receive project-based Section 8 rental subsidies for some or all of their units. Data provided by HUD in April 1996 show that, together, these properties have unpaid principal balances totaling $17.8 billion and contain about 859,000 units, of which about 689,000 receive project-based Section 8 subsidies. According to HUD’s data, about 45 percent of the insured Section 8 portfolio (3,859 properties, 303,219 assisted units, and $4.8 billion in unpaid loan balance) consist of what are called the “older assisted” properties. These are properties that were constructed beginning in the late 1960s under a variety of mortgage subsidy programs, to which project-based Section 8 assistance (Loan Management Set Aside) was added later, beginning in the 1970s, to replace other subsidies and to help troubled properties sustain operations. About 55 percent of the insured Section 8 portfolio (4,777 properties, 385,931 assisted units, and $13.0 billion in unpaid loan balance) consists of what are called the “newer assisted” properties. These properties generally were built after 1974 under HUD’s Section 8 New Construction and Substantial Rehabilitation programs and received project-based Section 8 subsidies based on formulas with automatic annual adjustments, which tended to be relatively generous to encourage the production of affordable housing. There is great diversity among the properties in HUD’s insured Section 8 portfolio, as illustrated by the 10 properties that we studied in greater depth as part of our current assignment. These properties differ in a number of important respects, such as the amount of their remaining unpaid mortgage debt; the types and amounts of assistance they receive from HUD; and their financial health, physical condition, rents, types of residents served, and surrounding neighborhoods and rental housing markets. These factors can influence the effect that HUD’s or other reengineering proposals would have on the properties. There is wide variation in the size of the insured mortgages at these properties. The unpaid mortgage balances at our 10 properties (as of Dec. 31, 1995) ranged from about $731,000 to almost $75 million. There is also wide variation in the types and amounts of assistance HUD provides to the properties. For example, HUD provides project-based Section 8 rental subsidies for all 60 apartment units at the smallest of our 10 properties but for only 119 of the 594 units at the largest property. In addition, the rents that HUD subsidizes vary greatly. The rents for a one-bedroom apartment, for instance, ranged from $332 to $1,231. HUD also subsidizes the interest rate at six of the properties, reducing the rate actually paid by the properties to between 1 and 2 percent. The other four properties pay mortgage interest rates ranging from 7.5 percent to 11.9 percent. Furthermore, 3 of our 10 properties also have received low-interest loans from HUD for repairs and maintenance, and 2 of these 3 have received grants from HUD to combat drug-related crime. Finally, the financial and physical conditions of our 10 case study properties also varied substantially. The majority of the residents in our 10 case study properties have low incomes. According to the properties’ records, between 60 percent and 96 percent of the Section 8 units at each property are occupied by households earning less than $10,000 per year. However, the properties tend to serve different types of households. At six of the properties, all or almost all of the Section 8 units are occupied by elderly or disabled persons, while at the other four properties, family and single adult households constitute a much larger percentage (in three cases, a majority) of the assisted households. Our 10 case study properties are located in various types of communities: 6 in urban communities, 3 in suburban communities, and 1 in a rural community. The properties’ neighborhoods also vary in terms of their economic and social conditions, ranging from areas with declining physical conditions, high crime rates, high unemployment, abandoned buildings, and/or frequent drug activity, to areas with economic growth, lower crime rates, and high income levels. Some properties are in neighborhoods dominated by multifamily, government-subsidized housing, while others are in neighborhoods dominated by unsubsidized housing, and in some cases single-family residences. The rental housing markets in the neighborhoods also vary, with occupancy rates ranging from about 88 percent to 100 percent. The insured Section 8 portfolio suffers from three basic problems—high subsidy costs, high exposure to insurance loss, and in the case of some properties, poor physical condition. A substantial number of the properties in the insured Section 8 portfolio now receive subsidized rents above market levels, many substantially above the rents charged for comparable unsubsidized units. This problem is most prevalent in (but not confined to) the “newer assisted” segment of the portfolio, where it stems from the design of the Section 8 New Construction and Substantial Rehabilitation programs. The government paid for the initial development or rehabilitation of these properties under these programs by initially establishing rents above market levels and then raising them regularly through the application of set formulas that tended to be generous to encourage the production of new affordable housing. The overall high cost of Section 8 subsidies is reflected in the cost of renewing the existing project-based contracts for the properties in the insured Section 8 portfolio as they expire. For example, HUD is requesting $863 million in budget authority in fiscal year 1997 to renew expiring contracts covering almost 293,000 units in the insured Section 8 portfolio. As long-term Section 8 contracts expire and 1-year contract renewals continue to roll over annually, HUD’s estimated annual renewal costs will increase steadily in each of the following 9 fiscal years. A second key problem affecting the portfolio is the high risk of insurance loss. Under FHA’s insurance program, HUD bears virtually all the risk in the event of loan defaults. A third, closely related problem is the poor physical condition of many properties in the portfolio. A 1993 study of multifamily rental properties with FHA-insured or HUD-held mortgages found that almost one-fourth of the properties were “distressed.” Properties were considered to be distressed if they failed to provide sound housing and lacked the resources to correct deficiencies or if they were likely to fail financially. As we noted in testimony last year, the problems affecting HUD’s insured Section 8 portfolio stem from several causes. These include (1) program design flaws that have contributed to high subsidies and put virtually all the insurance risk on HUD; (2) HUD’s dual role as mortgage insurer and rental subsidy provider, which has resulted in the federal government averting claims against the FHA insurance fund by supporting a subsidy and regulatory structure that has masked the true market value of the properties; and (3) weaknesses in HUD’s oversight and management of the insured portfolio, which have allowed physical and financial problems at a number of HUD-insured multifamily properties to go undetected or uncorrected. The basic concept behind HUD’s May 1995 mark-to-market proposal was to address the three key problems and their causes by decoupling HUD’s mortgage insurance and project-based rental subsidies and subjecting the properties to the forces and disciplines of the commercial market. HUD proposed to do this by (1) eliminating the project-based Section 8 subsidies as existing contracts expired (or sooner if owners agreed), (2) allowing owners to rent apartments for whatever amount the marketplace would bear, (3) facilitating the refinancing of the existing FHA-insured mortgage with a smaller mortgage if needed for the property to operate at the new rents, (4) terminating the FHA insurance on the mortgage, and (5) providing the residents of assisted units with portable Section 8 rental subsidies that they could use to either stay in their current apartment or move to another one if they wanted to or if they no longer could afford to stay in their current apartment. Recognizing that many properties could not cover their expenses and might eventually default on their mortgages if forced to compete in the commercial market without their project-based Section 8 subsidies, the mark-to-market proposal set forth several alternatives for restructuring the FHA-insured mortgages in order to bring income and expenses in line. These alternatives included selling mortgages, engaging third parties to work out restructuring arrangements, and paying full or partial FHA insurance claims to reduce mortgage debt and monthly payments.