The System is a government-sponsored enterprise consisting of a nationwide network of privately owned cooperative banks and their related associations that provide billions of dollars of credit and services to eligible farmers, ranchers, producers, cooperatives, and others in rural America. The System, like other government-sponsored enterprises, raises funds in the capital markets at a relatively low cost because of the strength of its ties to the federal government. Most System borrowing is done through the issuance of System-wide debt obligations that are the joint and several liabilities of all eight System banks. This means that, in the event one or more banks are unable to repay their respective obligations, the FCA can require the remaining banks to repay the total amount of the obligations. However, the 228 System associations, which are the cooperative owners of the banks in their respective geographical districts, are not liable for the repayment of the banks’ debts. The System nearly collapsed in the mid-1980s, and as a result, investors began to lose confidence in the System’s debt obligations. As we noted in a 1994 report, the System’s problems were partly caused by weak credit standards, ill-advised loan pricing, and excessively risky financing policies that resulted in a costly mismatch in the maturities of its liabilities compared to its assets. Under these circumstances, the System was unable to weather the deflation of commodity and land values and the extreme volatility in market interest rates in the early to mid-1980s. At this point, Congress decided to intervene before the System failed. In 1985, Congress began to devise a long-term plan to rescue the System and prevent recurrence of the problems that led to its near failure. Up to that time, FCA had functioned as a part of the System, with limited powers for dealing with financially troubled institutions. The Farm Credit Amendments Act of 1985 reconstituted FCA as an arm’s-length regulator with enforcement powers that essentially parallel those of regulators of other federally insured financial institutions. Under this legislation, FCA was authorized for the first time to issue cease and desist orders to banks and to remove bank management. FCSIC was established under the Agricultural Credit Act of 1987 (the 1987 Act) as part of a recovery plan involving federal assistance. The initial capitalization of the FCSIC Insurance Fund was provided by a $260 million transfer in 1989 of government funds that were in a revolving fund and thus available to assist the System. Since that time, the reserves of the Insurance Fund have increased through premiums paid by the System banks and by income earned on its own investments. FCSIC is authorized to assist troubled System banks or the direct lender associations. It is also required to act as conservator or receiver if a System institution fails. The Insurance Fund is not the last source of investor and taxpayer protection because of the banks’ joint and several obligation to repay the insured debt. However, that obligation cannot be invoked until the Insurance Fund has first been depleted. As of December 31, 1995, the amount of outstanding insured debt issued by System banks was $58.5 billion. The Insurance Fund equity balance was $902 million, or about 1.6 percent of the insured debt. The System’s financial condition improved significantly between year-ends 1990 and 1995. Total System capital (excluding Insurance Fund equity) increased from $5.4 billion to $8.8 billion during that period. Combined annual System earnings rose from $0.61 billion in 1990 to $1.2 billion in 1995. The growth of net loans outstanding has been gradual: at year-end 1990, loans were $49.7 billion, increasing to $56.9 billion at year-end 1995. FCSIC has experienced no significant losses in its regular insurance operations. FCSIC officials have indicated that none of the eight banks is financially threatened at this time, and therefore the Insurance Fund shows no additional provision for other losses. The Insurance Fund balance, which was $298 million in 1990, rose to $902 million as of December 31, 1995. During this period, the ratio of this balance to insured System debt rose from about 0.6 percent to 1.6 percent. The Insurance Fund’s year-end 1995 financial statement also reflects a special one-time liability to repay debts that were incurred in 1990 in connection with the federal rescue. As of December 1995, this liability was estimated to be $121 million. The 1987 Act requires that FCSIC assess premiums until the Insurance Fund balance exceeds 2 percent of the insured obligations, or such other percentage of the insured obligations as FCSIC in its sole discretion determines is “actuarially sound.” This level is referred to as the Secure Base Amount. When the Fund balance, less estimated expenses for the year, exceeds the Secure Base Amount, FCSIC must reduce premiums to an amount sufficient to maintain the Insurance Fund at the Secure Base Amount. FCSIC has projected that the Insurance Fund will reach the Secure Base Amount as early as 1998, assuming that no major losses will occur. However, despite the provisions that could reduce premiums, the Fund is expected to continue to grow because of its investment income. Prior to 1996, FCSIC had no authority to limit this growth of the Insurance Fund. The Farm Credit System Reform Act of 1996 (the 1996 Act) will, in effect, constrain the amount of these excess Fund balances by authorizing FCSIC to make partial distributions of the excess balance each year. These distributions can begin at any point beyond 8 years after the Insurance Fund attains the Secure Base Amount, but not before 2005. Section 204 of the 1992 Act mandated our study of two specific aspects of the Farm Credit System and of FCSIC. First, we were to study the impact on the System of a growing trend toward mergers and consolidations of the banks. This trend was described in our 1994 report Farm Credit System: Potential Impacts of FCB Mergers on Farmer and Rancher Borrowers (GAO/GGD-95-19, Dec. 2, 1994). Second, the act required us to study the feasibility and appropriateness of three specific options to increase FCSIC’s powers to (1) directly or indirectly assess association capital, (2) assess supplemental insurance premiums, and (3) establish a risk-based insurance premium system. The primary purpose of this report is to fulfill this second part of the 1992 Act’s mandate. To address these issues, we reviewed the statutes and legislative history of FCSIC, our previous reports, and records of pertinent congressional hearings. We identified and reviewed three of FCA’s 1991 legislative recommendations that were related to the issues in our mandate. We had numerous discussions with FCSIC and FCA staff and reviewed relevant correspondence, memoranda, legal opinions, and financial statements of the System and of the FCSIC Insurance Fund over the past 6 years. We did not audit or verify these financial data, all of which were provided to us by FCSIC and FCA officials. We reviewed the basis for FCA’s 1991 legislative recommendations pertaining to increased powers for FCSIC. We also reviewed a report done by a System task force that presented its response to these FCA recommendations. In addition, we reviewed our previous recommendations from a 1994 report regarding the Insurance Fund to determine whether any that had not yet been adopted should be further considered at this time. We did our work between June 1994 and March 1996 at FCSIC and FCA headquarters, which are both located in McLean, Virginia, in accordance with generally accepted government auditing standards. We obtained written comments from FCSIC, FCA, and the System on a draft of this report. We have reprinted their letters in appendixes I through III. The comments are summarized and evaluated at the end of this report. If the Insurance Fund were to be depleted, the next layer of protection against losses for investors in Systemwide debt and for taxpayers is represented by the capital of the eight Farm Credit Banks. In 1991, FCA was concerned that the association capital did not also stand behind this FCSIC-insured debt. For that reason, FCA recommended to Congress in 1991 that association capital be exposed to this debt by authorizing FCSIC to assess the capital of associations, if needed, in order to restore financial soundness to the Insurance Fund or a troubled bank. FCA’s concern was that, after 1987, banks had no means of requiring associations to contribute capital to the Insurance Fund. FCA cited three additional issues in support of its recommendation. Two of these issues have diminished since 1991. First, uncertainty about the System’s return to financial health, noted by FCA at the time, is no longer a major concern because the System has recovered significantly. Second, the Insurance Fund, which was very small in 1991, is now approaching the Secure Base Amount. The third concern of FCA was that bank capital had been declining as a percentage of total System capital. This issue could be addressed simply by requiring that the banks maintain, as FCA believes they now do, an acceptable level of capital. However, even if these additional issues are no longer of serious concern, this does not settle the basic question of whether drawing upon the associations’ capital is an acceptable way to support the Insurance Fund and the banks, should the need arise. While the concept of assessing associations to support the Insurance Fund, back up the insured debt, and prevent losses to taxpayers may appear reasonable, it could be difficult and perhaps impractical to implement for three reasons. First, the System structure is such that a System bank does not have the power to require financial support from its member associations, because it does not own them. The situation is additionally complicated by the fact that each of the 228 associations is an independent entity. Association stock is owned solely by its member borrowers, and each association is governed by a board of directors elected from its own membership.