One of the missions of our office, beyond reviewing thegovernor's budget plan each year, is to periodically examine state programs to see if they are administered effectively and are still serving the needs of the public.

In January, we completed just such a fundamental examination of the Cal-Vet home loan program and recommended that the Legislature rethink the state's approach to assisting California's war veterans. What we have in mind are changes that would be a "win-win" situation both for the veterans who need services as well as for the taxpayers who deserve to have state funds used as cost-effectively as possible.

The Cal-Vet program has been in business since 1921 and over its life has provided more than 400,000 California veterans the opportunity to buy a farm or home through state assistance.

The program is funded primarily through general obligation bond issues approved by the voters and now has about $3 billion in outstanding debt. Throughout its operation, the money borrowed to provide the loans has been repaid with the monthly mortgage payments made by veterans without a subsidy from the state's general fund.

For many years, the program flourished, especially in the early 1980s when the 8 percent interest rate offered to Cal-Vet borrowers was far below the prevailing double-digit interest rates for getting a conventional loan from a private lender. The program was consistently in the black, with the result that the state's equity in the Cal-Vet operating fund (what remains after all program debts are subtracted from all program assets) reached $458 million in 1986.

Much has changed since that time. Our January report to the Legislature documents that the number of outstanding Cal-Vet loans is 39,000, or less than a third of the number of loans in the portfolio in the early 1980s. About 1,000 new loans per year are being issued, compared to the 8,000 per year the program used to issue.

Cal-Vet loan activity has declined sharply for several reasons.

California's war veterans are aging and, just like other older Californians, relatively few of them are buying new homes. The federal tax code has restrictions on the use of tax-free bonds that is shrinking the pool of veterans eligible for Cal-Vet assistance. In addition, Cal-Vet faces stiff competition from other public and private lenders, such as the federal VA loan program that provides zero downpayment home loans specifically for veterans.

Meanwhile, the Cal-Vet program has not fared well financially, losing money in eight of the last 11 years and for five years in a row. The state's equity in the Cal-Vet operating fund - once at $458 million - was down to $258 million as of last year.

The losses stem from past mismanagement of Cal-Vet operations. Almost every major element in the program - including bond sales, investment of cash, handling of delinquent accounts, insurance programs - suffered because longstanding problems were allowed to continue without corrective action and proper oversight for many years.

The Department of Veterans Affairs has been making some commendable improvements in the Cal-Vet program. Some old, high-cost debt is being refinanced with less-costly new bonds. Program operations are being revamped so they are more in line with loan industry practices. The interest rate for Cal-Vet loans is being cut to 6.95 percent to get more veterans interested in participating in the program and to provide a substantial benefit to existing borrowers.

Elizabeth G. Hill directs the Legislative Analyst's Office, a nonpartisan office which provides fiscal and policy information and advice to the Legislature. If you would like to read the Legislative Analyst's Office report yourself and have access to the Internet, it can be found on the LAO web page (www.lao.ca.gov).

We believe these steps, while warranted, are not enough. We believe it is time to rethink the basic direction that was set for the program in 1921 and establish a fundamentally new state approach to veterans' assistance that reflects the realities of the new millennium. We recommend changes in both the short-term and long-term direction of the program.

In the short term, we suggest strengthening oversight of the program to ensure that the state's equity in it is preserved. For example, the state treasurer and state director of finance should be represented on the California Veterans Board, along with veterans with expertise in such areas as mortgage lending and financial investments. Also, the board should have a bigger say in how the program is run and more information should be provided to lawmakers about how it is performing.

We also recommend a change that would give the department the flexibility to change Cal-Vet interest rates for new loans up or down, in line with its borrowing costs, just like every other lender. Current law requires that virtually all Cal-Vet loans carry the same interest rate regardless of how much it costs the state to borrow the money.

In the long run, the issuance of new Cal-Vet loans should be phased out by the year 2007. By that time, federal tax code restrictions will no longer permit use of general obligation bonds for large numbers of veterans. The aging of the veteran population will sharply reduce the demand for Cal-Vet loans. At the same time, private- and public-sector programs will remain available to help the relatively smaller group of young veterans who will need home loans.

The phase-out of new lending, as we propose, would allow the state to use the monies in the Cal-Vet fund to meet the growing needs of the veteran population. These needs are potentially wide-ranging, from medical care for Alzheimer's disease and dementia that are afflicting our aging war veterans to homeless assistance and employment services. Given that the federal government appears unlikely to fully address these needs, we have proposed seeking state voter approval to shift surplus Cal-Vet money to a veterans trust fund for such purposes.

Under our proposed approach, the changing needs of California's veterans would be met without creating additional fiscal demands on state government - a "win-win" situation for veterans and taxpayers that we believe warrants consideration by the Legislature.