Secretary Cuomo's Statement before the
Senate Committee on Banking, Housing, and Urban Affairs
Subcommittee on Housing Opportunity and Community Development
June 17, 1997
Mr. Chairman and Members of the Committee: Thank you for
inviting me to testify on the very important matter of reforms to
the multifamily housing programs and specifically on S. 513 and
the Administration's bill, which was introduced by Chairman
D'Amato as S. 853. I request that my entire statement be
included in the record.
I am pleased to accept this opportunity to testify on
legislation regarding the nation's stock of federally assisted,
privately owned housing. I believe that solving the systemic
problems facing the FHA-insured and subsidized portfolio is one
of the highest priorities for the Department. We must work in a
bi-partisan fashion to address the long-standing problems facing
the multifamily housing inventory.
If we work together, we can enact historic legislation this
year. We need a strong bill that preserves affordable housing
for the benefit of low- and moderate-income residents, treats
project owners fairly, and protects the taxpayers. Failure to
design appropriate and responsible mechanisms for how these
reforms are carried out could cost the taxpayers billions of
dollars and expose residents and communities to the loss of
vitally needed affordable housing.
Let me begin by reviewing the status of and lessons learned
under the FY 1996 and 1997 mark-to-market Demonstration Programs
and then proceed to a discussion of proposed new legislation.
The lessons learned from implementing the two
Congressionally authorized demonstrations should be applied
to any bill that addresses this complex problem.
The HUD FY 1996 Appropriations Act authorized HUD to conduct
a Demonstration Program with respect to no more than 15,000 units
and appropriated $30 million in funding. The Appropriations Act
of 1997 authorized HUD to carry out a Demonstration Program with
respect to no more than 50,000 units and appropriated $10 million
in addition to the $30 million appropriated in FY 1996.
Substantial progress has been made during the past year with
regard to the 1996 and 1997 Demonstration Programs.
Of the 35 projects accepted into the 1996 Demonstration
- 5 projects have closed;
- 6 owners are no longer interested;
- 12 projects are in active negotiations; and
- 12 projects are on hold because the owners must seek
approval of the local and state agencies that financed
the FHA-insured mortgages.
To date, owners of 75 eligible projects have chosen to
participate in the FY 1997 Demonstration Program -- a
participation rate of about 50 percent. Due diligence is under
way for all of these projects and preliminary restructuring
negotiations are in progress for many of these. Additional
projects will be added to the 1997 Demonstration Program over the
next four months as contracts expire.
With regard to the FY 1997 Demonstration Program, we have
developed or completed the following:
- Published eligibility guidelines for projects entering
- Developed a financial model to quantify the savings or
cost of potential loan restructure scenarios;
- Implemented a field tracking system for all project,
credit subsidy and loan-related information to evaluate
and control the program;
- Developed industry-benchmarked due diligence
procedures for analyzing market and property conditions.
- Trained personnel from 10 field offices who will be
assisting HUD headquarters in the Demonstration Program
- Selected 43 local and state Housing Finance Agencies
- Issued guidance for State and local housing finance
agencies regarding their roles as designees on a fee
for service basis.
Working with local and state housing finance agencies and
nonprofits is a key part of the Demonstration program.
The Demonstration legislation provides the Department with
the authority to enter into agreements with local and state
housing finance agencies, nonprofits, and for-profits to carry
out project restructurings on behalf of the Department. We
focused first on local and state housing finance agencies. After
a number of discussions with interested agencies, we published a
notice requesting that interested agencies indicate their
interest and qualifications by February 15, 1997. Forty-five
days later we selected 43 local and state housing finance
agencies for participation. We asked those agencies to provide
us with management plans detailing how they would carry out
To date, we have received management plans from the States
of Ohio, Virginia, and Massachusetts, and from the City of
Chicago. We have concluded discussions with Ohio and
Massachusetts on their management plans, and have requested
additional information from the other two public agencies and are
waiting for responses. The State of Ohio has the largest number
of projects eligible for the demonstration this year.
In addition to local or state housing finance agencies, HUD
is seeking partnership arrangements with non-profit
organizations, in which designees assume some or all of HUD's
risk of restructuring. In exchange, designees will receive a
share of the savings to the FHA insurance fund resulting from
restructuring. The objective of this approach is to explore ways
to significantly reduce HUD's administrative role while reducing
claims to the FHA insurance fund.
Lessons learned from the Demonstration include the need to
address the owners' concerns about timing, the tax
consequences of restructuring, and the safe harbor provided
by rents maintained at 120 percent of FMR.
We have learned a good deal from the Demonstration:
With regard to the FY 1996 Demonstration, we have learned
that, as negotiations progress, some owners find the tax
consequences too onerous when weighed against the gains of the
restructuring. They therefore choose to wait until more
favorable conditions prevail. The fact that Section 8 contracts
for properties in the FY 1996 Demonstration have not yet expired
may have added to the propensity to delay.
- We have found that owners typically have chosen to
move slowly at all stages of potential restructuring;
- The restructurings take longer to consummate than
- About half of eligible properties in FY 1997 have
chosen to accept rents at 120 percent of the Fair
Market Rents rather than participate in the
Demonstration -- indicating a preference to wait for
legislative initiatives that Congress may consider
relative to future expiring Section 8 contracts and tax
relief for the impact of debt restructuring;
- Some owners also have opted to wait based on their
expectation that local market rents will rise;
- Because owners have been reluctant to participate
without fully understanding all aspects of their
exposure, we find that 180 days is not sufficient time
for the entire restructuring process; and
- The due diligence procedures of appraisal, market
analysis and physical needs inspection are time
consuming, and account for approximately 60 of the 180
The universe of properties eligible to participate in FY
1997 includes insured properties with contract rents above 120
percent of the Fair Market Rent. At the beginning of the fiscal
year, we believed that this universe would number approximately
330 contracts. In fact, we found that owners of properties with
rents below 130 percent of the FMRs often found little incentive
to participate in the demonstration. They were able, instead, to
tighten their belts and accept the rent reduction, while waiting
to see what the rules would be next year.
It is clear from the experience we have gained from the
Demonstration Program so far that many owners are waiting and
watching to see what will ultimately happen with regard to the
proposals that are now before the Congress.
The Administration's bill builds upon the lessons learned
from the demonstration as well as on the provisions in S.
I would now like to turn to the Mark-to-Market provisions of
the Administration's Housing 2020: The Multifamily Housing
Reform, Consolidation, and Enforcement Act of 1997. This bill
was introduced in the Senate by Chairman D'Amato as S. and in
the House by Chairman Lazio and Congressman Kennedy as H.R. 1433.
In an era of shrinking governmental resources, we cannot
afford to continue to subsidize projects with rents in excess of
market rents. Yet, as those over-market rental subsidies are
reduced, many projects with FHA-insured mortgages supported by
above-market rents will default, sending the bill for those
defaults to the American taxpayer. Both the Administration's
bill and S. 513 address this fundamental problem. Both bills
also address the fact that the impact for tenants and communities
could also be severe, as those projects able to survive in market
conditions may be lost as affordable housing, while others will
be abandoned and will blight communities.
The Administration's bill provides authority to HUD to
operate a mark-to-market program to protect the financial
interest of the taxpayer by simultaneously reducing over-
subsidized Section 8 contracts and writing down the FHA-insured
debt. The legislation would allow HUD to act quickly to reduce
over-market subsidies, restructure project financing, provide
funds for rehabilitation needs and protect tenants -- rather than
wait passively while costs mount and conditions worsen.
The bill includes tax legislation to ensure that adverse tax
consequences do not deter owners from participating in mark-to-
market. In exchange for favorable tax treatment, owners would
preserve units at rents affordable to low-income families.
The Administration's bill and S. 513 share a number of key
elements designed to protect residents and communities while also
reducing budget costs.
The Administration's proposal differs in a number of
important respects from previous proposals advanced by the
Administration over the last several years.
- reducing over-subsidized rents to market levels
- using designees to assist HUD in restructuring
- addressing the need to also rehabilitate deteriorated
properties in the process of debt restructuring.
- facilitating the voluntary transfer of ownership of a
portion of this stock to resident organizations and
Both HUD's bill and S. 513 would exclude owners who have not
carried out their obligations to the federal government from
participating in any mark-to-market program.
- The new bill is a more balanced approach. The bill
now includes the authority to provide project based
assistance in special cases, such as where tenant based
assistance would be difficult to use or where the
project houses predominantly or primarily elderly
and/or disabled families.
- The bill reflects historic cooperation between
Treasury and HUD. The bill contains a well-targeted tax
proposal to encourage proactive restructuring, which we
believe is the key to making the process feasible.
- The bill is more flexible. All types of financing,
including insured financing, are permitted. In
addition, the bill provides a number of ways to
rehabilitate projects where needed.
Contracts should be renewed at current levels on projects
that are financially vulnerable.
For mark-to-market projects, rents on restructured projects
would not exceed market rents. For all other projects that are
not eligible for mark-to-market, contract renewals in FY 1998 in
general would be consistent with FY 1997 provisions. That is,
they would be renewed at current rents, not to exceed 120 percent
of FMR, except that projects can be renewed at current rents
above 120 percent of FMR if:
- the project's primary financing or mortgage insurance
is provided by a state government and the mortgage is
not insured by FHA;
- the project is a Section 202 or a Section 515, Rural
Housing Service project; or
- the project is eligible for mark-to-market but would
not be financially viable at market rents, even with a
complete write-off of the FHA-insured debt.
HUD's bill would protect the most financially fragile
projects--those that cannot survive at market rents, even if all
debt is written off--until we learn more about the best ways to
protect those projects. These projects are found in rural
communities where market rents are lower than the rents needed to
operate these projects. They are also found in inner-city
neighborhoods where, because of the need to pay higher operating
costs for increased security and because of the characteristics
of their tenants, projects have operating costs higher than
market rents for unsubsidized projects. S.513 does not protect
these projects, but instead would require that they be included
in a restructuring program.
Section 8 assistance must provide for resident choice and
while also protecting the most vulnerable residents.
HUD's bill would continue project-based assistance where the
project is more than 90 percent occupied by elderly and/or
disabled families. Project-based contracts would also be
continued where the use of tenant-based assistance would be
difficult because of tight market conditions, for example,
communities with low vacancy rates.
We estimate that over 50 percent of projects would continue
with project-based assistance. Residents of the other projects
would be provided tenant-based assistance as a level that would
allow residents to remain in their current units.
The Senate bill would provide for project-based assistance
on all projects that are restructured, regardless of whether it
was needed or not. We believe that tenant-based assistance must
be part of any proposal that addresses this problem. The
Administration's bill protects vulnerable tenants, but allows
other residents the right to exercise choice in where they live.
Coupled with the requirements for tax amortization in our bill,
this approach would expand the supply of affordable housing at a
time when it is badly needed.
Efficient tax provisions must be included, so that owner
concerns are addressed while protecting taxpayers and
providing for long-term affordability.
As you are aware, owners whose debt is restructured face
significant tax consequences as a result. These tax consequences
are a formidable barrier to the voluntary participation of owners
in a mortgage restructuring program prior to the expiration of
their over-market Section 8 contracts. HUD and Treasury have
worked together to craft a tax proposal that addresses the
legitimate concerns of owners about the impact of debt
restructuring while also protecting the taxpayers.
In the Administration's bill, taxes owed as a result of a
restructuring transaction -- that is, from debt forgiveness --
would be amortized over a period of up to 10 years, rather than
being due immediately. Incentives would also be provided to
owners who sell projects to nonprofits.
In exchange for favorable tax treatment, owners would agree
to maintain 40 percent of the project's units at rents affordable
to families who earn 60 percent of the median income or less.
These affordability restrictions match the eligibility
requirements for the Low Income Housing Tax Credit. In order to
ensure that the owner can provide these affordable units without
endangering the project's financial stability, FHA will write-off
or forgive sufficient debt to reflect the reduced income from
The Senate bill lacks a similar comprehensive tax provision,
but instead provides for the bifurcation of the FHA-insured
mortgage into a performing, first mortgage, and a nonperforming
second mortgage repaid only after the first mortgage is repaid.
The nonperforming second mortgage would accrue interest at the
Applicable Federal Rate. Over time, the second mortgage would
balloon in size to double, triple, quadruple its original amount,
because of the accrual of interest.
The second-mortgage provision of S. 513 poses a significant
risk to the future viability of restructured projects. Accruing
second mortgages would grow so large that the owner has no hope
of repaying it, and would consume all of the project's equity.
The owner would then have no financial inventive to maintain the
property, exposing the taxpayers and residents to the dangers of
severely dilapidated properties.
In addition, the Department of Treasury notes that the
second-mortgage provision of S. 513 poses a very serious problem
for the owners from a tax perspective. The bifurcation of the
mortgage will result in an immediate tax liability for the owners
if the second mortgage is not respected as valid indebtedness for
tax purposes. In light of the terms of the second mortgage and
the expectation that the owners would have no hope of repaying
it, the second mortgage would most likely not be respected as
valid indebtedness. As a result, the restructuring provision of
S. 513 would effectively create immediate taxable income for the
owners in an amount equal to the second mortgage. In short,
while this provision purports to address owners' tax problems, it
is unworkable--thus defeating the larger purpose of the
Restructuring must be done with a range of tools, so that it
can be accomplished in a way that protects taxpayers and
The Administration's bill would authorize a range of tools
to restructure a project so that it would be financially viable,
including the complete or partial write-off of the FHA-insured
mortgage. The owner could choose whether or not to retain FHA
insurance on the restructured mortgage.
The Administration's bill recognizes the constraints on
HUD's existing staff by authorizing the use of designees to act
for the Department in restructuring cases. HUD proposes to enter
into arrangements with designees to carry out restructuring
activities and to rely on expertise available outside of the
Department to accomplish its mission during a time of diminished
- HUD would establish procedures to ensure that local
governments, tenants, and the holder of the insured
mortgage receive timely notice of the owner's
participation in the restructuring process.
- Third parties would be authorized to carry out the
restructuring and HUD could use designees by
delegation, contract, cooperative agreement, or other
arrangement. The designees could be state and local
housing agencies and non-profit or for-profit entities.
- The Secretary would establish procedures to encourage
the sale or transfer of a project, or the transfer of
the management of a project, to tenant organizations,
community-based nonprofits, and public agencies.
The Administration's bill authorizes State and local housing
agencies and non-profit and for-profit groups to be designees.
The designees may be reimbursed and may work separately or in
conjunction with one another. These designees will be
accountable to the Secretary of HUD and will be selected based on
S. 513 provides HUD with the authority to contract with
designees, but would limit HUD to using only designees that are
local and state housing finance agencies and would constrain
HUD's ability to choose qualified designees. It would also
severely constrain HUD's ability to provide adequate oversight to
ensure that taxpayers are protected as local and state agencies
act on HUD's behalf.
I would like to quote from a letter written by HUD's
Inspector General on this issue. She wrote on June 25, 1996 to
the Subcommittee to convey her comments on a Senate discussion
paper on a strategy for addressing this portfolio, including the
primary reliance on local and state housing finance agencies to
carry out restructurings. The Inspector General wrote: "While
there are many well performing SHFA's [state housing finance
agencies] and other similar public and non-profit entities, there
is reason to doubt whether there would be sufficient such
entities that are qualified, able, or interested in taking on the
responsibility of restructuring HUD's portfolio. There is also
reason to doubt whether these entities would ensure that the best
financial choices are made on behalf of the Federal government,
without close oversight."
This portfolio has significant repair needs, which, if left
untended, pose an enormous liability for taxpayers,
residents, and communities.
With regard to rehabilitation, the Administration's bill
would finance needed repairs through a number of means. Owners
would have to apply project reserves and residual receipts to
rehabilitation. Rehabilitation costs could also be funded as
part of restructuring, through refinancing or write-down of the
existing debt or, when required, grants from the FHA insurance
fund. In addition, Interest Reduction Payments could be
continued on restructured or refinanced 236 projects to pay for
The Senate bill recognizes the need for rehabilitation of
this portfolio, but does not include the use of Interest
Reduction Payments to fund rehabilitation, a worthwhile use of
that funding when it is no longer needed to support the
restructured mortgage. S. 513 limits rehabilitation to $5,000
per unit, a number which will be too low for many projects.
Although we support the need to exercise prudence and cost
control over any decisions about rehabilitation, we believe that
a higher rehab cost cap might be considered in light of the
actual physical condition of this portfolio.
Any legislation must be implemented quickly.
The Senate's bill would require the use of negotiated
rulemaking to develop regulations for the program. Negotiated
rulemaking could potentially lead to gridlock on the development
and implementation of regulations. Projects will expire while
HUD attempts to reach consensus with affected parties. We
believe that the Department should use notice-and-comment
rulemaking to develop regulations for the program, which will
provide all interested parties with the opportunity to comment on
the program regulations.
Bankruptcy reform is an important part of efforts to
restructure multifamily housing.
Both the Administration's bill and S. 513 include provisions
that would strengthen the Department's ability to take actions
against bad owners. S. 513 does not include an important
provision, however, that would amend the Bankruptcy Code
governing the powers of a bankruptcy court.
These changes would allow HUD to proceed in a timely manner
with foreclosure actions and to take all necessary and
appropriate measures to protect the property, the FHA insurance
fund, or the residents of HUD-insured or HUD-assisted multifamily
housing projects from the potentially adverse impact of mortgagor
bankruptcies. Bankruptcy reform will help the portfolio
restructuring process by minimizing delaying tactics by negligent
owners of assisted housing.
It is time to work together to pass a bill.
The Administration's bill and S. 513 are in many respects
very close; but, clearly, substantial work remains for us to
produce a successful bill. Let us make a commitment to resolve
the remaining issues in a way that protects taxpayers, residents,
and communities. With bipartisan effort, we can pass a bill that
will put a significant portion of the FHA-insured and Section-8-
subsidized portfolio on a much sounder footing for the difficult
years ahead. I invite you to work with me to achieve that.
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