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A second point which was made in the article dealt with nonprofit sponsors, and this is a very difficult problem. What we look for in nonprofit sponsors are continuity, motivation, knowledge, and interest. One of the problems that faces us is that when we insure a mortgage, we are going to have to abide by that decision for 40 years, because this is the term of the mortgage on these projects. I think that Internal Revenue takes a new look at the nonprofit status of various organizations annually to see that their status continues. You may have some very properly and well-motivated nonprofit sponsors who are led by a particular group who then leave, for one reason or another. They may leave this earth. And with them goes the motivation and the interest in this particular project.

These are not the kind of things that you can foresee with great precision when you are looking at a project that is going to be mortgaged for a period of 40 years. The nonprofit sponsor also operates through the creation of a mortgagor corporation which is created specifically, in most instances, to cover the sponsorship of the particular project. Congress provided 100 percent mortgage assistance for nonprofit sponsors in some of these special purpose programs. It was believed that this is what it would take in order to make these programs available to supply the kind of housing that was aimed at, and this has been done, but the sponsorship may not have a tremendous amount in assets. They are not putting any great amounts of moneys into these because they do not have the money to do it.

What they have is the interest, the desire, the motivation, the continuity. If all of these things occur, then we are willing to go along with that kind of sponsorship and let them take the benefits of 100 percent financing. This was the program that was created by the Congress to achieve this objective and this is how we are trying to administer it.

Now, where we believe that a project has to be subsidized in order to be successful, there we look into the assets of the nonprofit sponsorship and we obtain from that sponsorship a guarantee which gives us the kind of assurance we believe is necessary to subsidize the project. The third point dealt principally with land values, and this is another think that has given us a good deal of concern.

The article seems to equate land values and land costs, and this also fails to take into account the good many things that have to happen before a piece of raw land becomes eligible for a multifamily site. In some of the illustrations, this was what happened, as I have outlined in the point by point analysis.

Senator SPARKMAN. I wonder if you would just mention what some of those things are, Mr. Brownstein.

Mr. BROWNSTEIN. Yes, sir; I intend to, Mr. Chairman.

First, the land may have to be rezoned, and it may be rather expensive to do this.

Secondly, the question of how long this land has been held is quite a factor. If it has been held for a number of years, I think that all of us are quite aware of what has happened to land prices and land values in many residential areas.

Third, what it takes to prepare this land for residential construction can be very costly, and one of the illustrations cited there involved a

very serious drainage problem that cost a good many thousands of dollars to correct before that land was increased in value.

But, on the other hand, we may find that the cost of the land really does not reflect the value in the other direction, and I have seen cases where we have refused to allow the entire cost of the land in our evaluation. Cost and value are not always parallel.

Nevertheless, this was troubling us and in January of 1964 we put out instructions to our offices in which we said that in every multifamily project they would determine the cost of the land in the last arm's-length transaction, and if the value to be included in the mortgage exceeded the cost-and, as I have outlined, for many good reasons this could happen-then there will be full documentation showing the justification for the increase in value.

With the committee's permission, I will introduce into the record a copy of those instructions.

Senator SPARKMAN. Without objection, that will be done.
(FHA's instructions on multifamily land valuations follow.)

FEDERAL HOUSING ADMINISTRATION

UNDERWRITING LETTER NO. 1955-CONTROL NO. F-789

JANUARY 9, 1964.

To: Directors of all field offices.

Subject: Multifamily land valuations.

Field review of insured projects finds a most serious inadequacy or complete lack of documented support of the land valuations used in processing. Land valuations used in arriving at the total replacement cost of the property must be fully supported by complete and detailed evidence in the docket.

In addition to the usual procedures and technique used to estimate available market price of site in fee simple the following steps are mandatory and are effective upon receipt of this letter:

(1) Adequate supporting data for the available market price estimate must be in the file.

(2) Price paid for the site by the sponsor must be ascertained. To do this the appraiser must examine the history of recent transfers of the subject site as well as the history of recent transfers of comparable sites. The pur pose is to uncover all relevant data for use in arriving at a final conclusion of estimated market price of site and fair market value of land in fee simple and "as is" for cost certification purposes.

(3) Form 2401 LV must be completed in all multifamily cases.

In making these determinations the valuator will recognize all of the factors involved which might tend to affect price such as rezoning, assemblage factors, changes in use of surrounding lands, firm trends of economic uses in the area which may increase or decrease the value since acquisition.

The valuator will support his findings for permanent record in the docket. Where he finds that the land valuation ascribed in processing is at a higher figure than that paid by the sponsor, or in the latest arm's-length transaction, he will, under all circumstances, fully explain and document his reasons for the higher valuations.

Mr. BROWNSTEIN. I would like to supplement what I have said to you, Mr. Chairman, with more specifics.

As far as FHA reserves are concerned, we still have $1,100 million in our reserves, and this is after we have paid all our losses and administrative expenses, and we continue to add to that reserve annually. I do not believe that any of our insured mortgagees need be concerned about the safety of their investment.

Senator SPARKMAN. Let me be sure I have that figure correctly. $1,100 million in reserves.

Mr. BROWNSTEIN. Yes, sir.

Senator SPARKMAN. That represents what has been accumulated over the years since FHA has been operating, is that right?

Mr. BROWNSTEIN. Yes.

Senator SPARKMAN. That really represents a net earning after paying all expenses during the years.

Mr. BROWNSTEIN. Including the amount that was advanced to FHA initially by the Treasury.

Senator SPARKMAN. All right, go ahead. You feel that is an adequate reserve?

Mr. BROWNSTEIN. Yes. Not only I, but all of our actuaries and the actuaries from outside the agency believe this.

Senator SPARKMAN. Let me ask you this: Has it been steadily increasing throughout the years? Have you ever had a year when there was a deficit in operation?

Mr. BROWNSTEIN. There was an adjustment made last year based on the valuation of the properties that we had on hand. This resulted in a reduction. That was the first time in my memory. Senator SPARKMAN. All right. Is there anything else you want to add?

Mr. BROWNSTEIN. I will give you more detail in the record, Mr. Chairman, as I indicated earlier.

Senator SPARKMAN. I have a series of questions here that I would ask if we had sufficient time for it, but what I would like to do would be to give them to you and let you answer them specifically in connection with your extension of your remarks.

Mr. BROWNSTEIN. I will be happy to, Mr. Chairman.

Senator SPARKMAN. Senator Bennett, do you have any questions? Senator BENNETT. Since I will submit questions, too, I will hold them.

Senator SPARKMAN. Senator Williams?

Senator WILLIAMS. Just one: This Reader's Digest magazine analysis, is that yours?

Mr. BROWNSTEIN. Yes.

Senator SPARKMAN. What you have was supplied to the members of the subcommittee.

Mr. BROWNSTEIN. We have made a point-by-point analysis.
Senator SPARKMAN. It is his point-by-point analysis of it.

Senator WILLIAMS. And your observations come under the title "Comment."

Mr. BROWNSTEIN. Yes, sir.

Mr. WEAVER. Might I say two things I think the record should show?

Senator SPARKMAN. Yes.

Mr. WEAVER. The first is that this whole area of getting into nonprofit groups, particularly first in senior citizen housing and more recently in housing for moderate incomes, and now with rent supplement housing for low income families is a fairly new area. Certainly for FHA and it is a pretty new area in this country in general. This has troubled us from the very beginning. We have watched it and in 1963, as a result of some of the problems to which the article of the Reader's Digest refers, and which were before this committee 2 years

ago, because these are practically the same cases rehashed again, I appointed Mr. Baughman, who is the President of FNMA, and Mr. Semer, who was then the General Counsel of HHFA, to make a detailed study of this subject, and out of this came a report made to me which had certain administrative recommendations for change. When Mr. Brownstein came in, these were transmitted to him, and administrative changes were made.

In addition, in 1964 Mr. Brownstein issued a whole new set of regulations relating to the nonprofit sponsors and has constantly augmented these changes in his regulations.

The point I am trying to make is that we have not been sitting by, waiting for these things to develop, but we have, on our own initiative, taken steps to make reforms, and we are continuing to do so in a very, very unprecedented and untrod area of activity.

Senator SPARKMAN. Thank you. May I say that we try to keep up with those matters, and one thing that is a little discouraging is to see a lot of this stuff raked over 2 years after it had been freely reported by this subcommittee.

I may say that the staff of this subcommittee has standing instructions to stay right on top of all of these programs as far as we can, and when any part of our housing program, the overall housing program, goes sour or shows indications of doing so, we want to know about it and we want to get in and see what is the trouble, and if action is required in the way of legislation, we will move to bring it and get it, and we are eager to cooperate with your agency, your Department, and to do everything that we can to see that things are running right. We want to see a good program, we want to see one that is economically sound, and my own feeling has been that the general housing program has been a tremendous success in this country in furnishing homes for American families and doing it without net loss to the Federal Government. I think it is a great tribute to all of those connected with housing that we have been able to do that, and of course, Mr. Brownstein, whatever you can do to clear this up and to let us have accurate, correct, dependable information, we shall appreciate it.

I will give you this list of questions that I ask you to answer specifically.

I shall request that you submit for the record other up-to-date regulations referring to this matter.

(The material follows:)

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT,

Hon. JOHN SPARKMAN,

FEDERAL HOUSING ADMINISTRATION,
Washington, D.C., May 5, 1966.

Chairman, Subcommittee on Housing,
Committee on Banking and Currency,
U.S. Senate, Washington, D.C.

DEAR MR. CHAIRMAN: As requested in the hearings of the Housing Subcommittee on April 19, 1966, I am submitting statements for inclusion in the record on each of the six points referred to as the basis for FHA failures in the April Reader's Digest article. These points are covered in the enclosed exhibits 1-6. I am also enclosing exhibits 7-15 in answer to your questions on our analysis of the Reader's Digest article.

Much of the criticism of FHA operations is made without due consideration for the fact that we are engaged in the business of taking insurance risks. It is impossible to foresee all hazards and possible failures in any

underwriting process, and the payment of claims is a normal part of insurance operations. These claims are paid by the FHA out of insurance reserves which have been accumulated from fees and premium income and from the resale of acquired properties. Our programs have been self-sustaining and the payment of all losses as well as expenses of administration have been absorbed without the use of appropriated funds.

The FHA default and foreclosure situation was thoroughly discussed and analyzed during the hearings before your subcommittee on January 27 and 28, 1964. At that time our percentage of foreclosures was about one percent of the total number of the mortgages insured. Our present foreclosure rate is substantially the same as that in 1964. These foreclosures continue to be concentrated, as in 1964, in areas that have experienced economic setbacks. However, the overall foreclosure rate is within the range developed by FHA actuarial calculations for a period of normal business activity. Our reserves of $1,100,000,000 are adequate to meet future contingencies.

I appreciate this opportunity to clarify the record and to explain how in recent years we have steadily strengthened procedures in our programs, some of which are still relatively new.

Sincerely yours,

P. N. BROWNSTEIN, Assistant Secretary-Commissioner.

EXHIBIT 1

NONPROFIT SPONSORS AND MORTGAGORS

A. Requirements for approval

1. The FHA publishes a form of corporate charter for the use of nonprofit mortgagors and its use is mandatory. The form may be modified only by technical changes required by state law. The guide form of charter has been examined and cleared by officials of the Internal Revenue Service who are concerned with tax exemption of nonprofit organizations.

In January 1965, the guide form of charter was amended to require that the membership and directors of the mortgagor corporation must be persons who have the approval of the directors of the nonprofit sponsoring organization. This change assures continuity of interest and responsibility by the sponsoring organization. It eliminates possible friction between the mortgagor and sponsor by permitting the sponsor to remove from the mortgagor corporation those persons who are no longer working in the interests of the nonprofit project.

2. On July 7, 1961, after the enactment of section 221(d)(3), the below market interest rate program, the FHA regulations were amended to define nonprofit mortgagors as those which the Commissioner finds are in no manner controlled by or under the direction of persons or firms seeking to derive profit or gain from the operation of the project.

3. On August 10, 1962, the FHA established a new procedure under which the sponsors of nonprofit organizations are examined in greater depth. The objective of the examining procedure is to make certain that, on the basis of the evidence presented, there will be no relationship which will subject the mortgagor to control by any person or firm seeking profit or gain. These procedures require a careful review and approval of the submitted data by field office directors and multifamily regional offices. With certain specified exceptions, Washington office review was also required.

4. Beginning in August 1963, sponsors of subsidized nonprofit elderly housing projects were required to execute Form 3436, Guaranty Agreement. Under this procedure, if the FHA finds that the anticipated income of a nonprofit elderly housing project will not support a mortgage based on 100 percent of FHA's estimate of replacement cost, then one or the other of two courses of action must be followed. Either the mortgage must be reduced to an amount which the project income will support, or a Guaranty Agreement must be obtained from the sponsor.

Under the Guaranty Agreement, the sponsor is legally bound in the case of default to make a subsidy differential payment to prepay the mortgage to an amount which the FHA has predetermined can be supported by project income. The Guaranty Agreement is executed by the sponsor with the mortgagee and is assignable to the FHA. The FHA thus acquires a right to collect the prepayment from the sponsor after a mortgage has been as

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