Reference no: EM131624859

Question: Auditing the Effectiveness of a Loan Program. The following problem is based on an actual program and situation. The Office of Economic Opportunity (OEO) designed special programs to have a major impact on unemployment, dependency, and community tensions in urban areas with large concentrations of low-income residents or in rural areas having substantial migration to such urban areas. The purpose of these experimental programs-combining business, community, and personnel development-is to offer poor people an opportunity to become self-supporting through the free enterprise system. The programs are intended to create training and job opportunities, improve the living environment, and encourage development of local entrepreneurial skills. Assume that the OEO has identified Mayville as a participant in the special impact program. The Mayville program received more than $50 million in federal funds and obtained another $10 million from private foundations.

Problems: Mayville is a three-square-mile section of Mega City with a population of approximately 200,000. This area has serious problems of unemployment and underemployment and inadequate housing. Mayville's problems are deeply seated and have resisted rapid solution. They stem primarily from the fact that local residents, to a considerable degree, lack the education and training required for the jobs available elsewhere in the city and from the lack of jobs in the area. Unemployment and underemployment, in turn, reduce buying power, which has a depressing effect on the area's economy. The magnitude of the Mayville problems is indicated by the following data disclosed by the U.S. census:

1. Of the total civilian labor force, 8.9 percent was unemployed compared with unemployment rates of 7.1 percent for Mega City and 6.8 percent for the standard metropolitan statistical area (SMSA).

2. Per capita income was $14,106, compared with $22,720 for New York City and $29,909 for the SMSA.

3. Families below the poverty level made up 27.8 percent of the population, compared with 12.4 percent in New York and 9.2 percent in the SMSA.

4. Families receiving public assistance made up 25.4 percent of the population compared with 9.6 percent in New York and 7.5 percent in the SMSA. A number of factors aggravate the area's economic problems and make them more difficult to solve. Some of these are

• A reluctance of industry to move into Mega City.

• A net outflow of industry from Mega City.

• High city taxes and a high crime rate.

• A dearth of local residents possessing business managerial experience. The area's housing problems resulted from the widespread deterioration of existing housing and are, in part, a by-product of below-average income levels resulting from unemployment and underemployment. These problems were aggravated by a shortage of mortgage capital for residential housing associated with a lack of confidence in the area on the part of financial institutions, which, as discussed later, seems to have been somewhat overcome. Mayville was the target of several special impact programs. Included were programs designed to stimulate private business, to improve housing, to establish community facilities, and to train residents in marketable skills. There were two programs to stimulate private business: a program to loan funds to local businesses and a program to attract outside businesses to the area. Under the business loan program begun five years ago, the sponsors proposed to create jobs and stimulate business ownership by local residents. At first, investments in local businesses were made only in the form of loans. Later, the sponsors adopted a policy of making equity investments in selected companies to obtain the sponsors' voice in management. Equity investments totaling about $159,000 were made in four companies. Loans were to be repaid in installments over periods of up to 10 years, usually with a moratorium on repayment for six months or longer. Repayment was to be made in cash or by applying subsidies allowed by the sponsors for providing on-the-job training to unskilled workers. Loans made during the first two years of the program were interest free. Later, the sponsors revised the policy to one of charging below-market interest rates. Rates charged were from 2 to 5 percent. This policy change was made to (1) emphasize to borrowers their obligations to repay the loan and

(2) help the sponsors monitor borrowers' progress toward profitability. Prospective borrowers learned of the loan program through (1) information disseminated at neighborhood centers, (2) advertisements on radio and television and in a local newspaper, and (3) word of mouth. Those who wished to apply for loans were required to complete application forms providing information relating to their education, business and work experience, and personal financial statements and references. The sponsors set up a management assistance division, which employed consultants to supplement its internal marketing assistance efforts and to provide management, accounting, marketing, legal, and other assistance to borrowers. The sponsors proposed to create at least 1,700 jobs during the first four years of the loan program by making loans to some 73 new and existing businesses.

Required: Put yourself in the position of the GAO manager in charge of all audits pertaining to the Office of Economic Opportunity. The Mega City field office has been assigned to conduct a detailed review of the special impact program described here. Prepare a memo to the Mega City field office in which you indicate, in as much detail as is possible from the information provided, the specific steps the field office should perform in evaluating the effectiveness of the special impact loan program.