A Windfall for a Student Loan Program

[azskeptic]

NY Times

August 27, 2004
A Windfall for a Student Loan Program
By GREG WINTER

ore than a decade ago, Congress decided it was giving away too much to the student loan industry, needlessly guaranteeing big profits at taxpayer expense. So lawmakers put their collective feet down, passing a law that gradually erased hundreds of millions of dollars in subsidies that could have gone directly to students instead.

Or so they thought.

Today, lenders are collecting a record amount of the old subsidies Congress thought it had retired, government data show, and they are busily stepping up the pace. Taking advantage of a loophole in the law, student loan companies have been billing the federal government at the rate of nearly $1 billion a year, at least four times the amount just three years ago - all for a subsidy that was supposed to have largely faded away.

"The banks are obviously making an all-out effort to milk the loophole for as big a subsidy as possible," said Senator Edward M. Kennedy, the Massachusetts Democrat who tried to rein in the lender payments more than a decade ago, only to watch them grow. "Every penny of this unnecessary subsidy should be helping needy students struggling to pay for college."

Even some student loan companies say that the large subsidies they are receiving from the government, guaranteeing them 9.5 percent interest rates at a time when students pay much less than that, are hardly the best way of expanding access to college. But until either Congress or the administration closes the loophole promising them higher profits than the market offers on its own, there is little reason for them to stop using it.

"This is the playing field, and we're just playing on it," said Don R. Bouc, the president of Nelnet, one of the nation's largest student loan companies. According to federal records, provided by members of Congress, Nelnet's quarterly payments from the government at the old subsidy rate have gone from about $4.6 million at the end of 2002 to $48.7 million in June.

"Yeah, it's a great return," Mr. Bouc said of the subsidy. "But there are better ways of using the money."

Virtually all parties in the debate, be they Republican or Democrat, say the loopholes should be closed so that the money can benefit students, not bottom lines, but few can agree on whose responsibility it is.

Democrats accuse the Bush administration of tacitly supporting the loopholes by paying the swelling invoices some lenders send them. The Education Department blames the Clinton administration for setting an early precedent that it is merely following today. Congress has a number of proposals before it from each side of the aisle, but has made little headway on the issue - or on most of the other major higher education questions before it - for the better part of a year.

In the meantime, student loan companies like Nelnet are building up huge loan portfolios that carry the old subsidy rate, and may continue to carry them even if the law is changed. At the close of 2002, for example, there were $12 billion in loans guaranteed at the 9.5 percent interest rate, federal data show. Within 18 months, that figure had grown to $17 billion. Nelnet alone accounts for more than $3 billion of the increase.

"It was widely assumed that these loans would gradually decline and eventually disappear," said Terry W. Hartle, a senior vice president for the American Council on Education who worked on the legislation more than a decade ago. "Apparently, it didn't work out that way."

Government payments to student loan companies are not unusual. In fact, they are a cornerstone of the federal financial aid system, enabling companies to offer students unusually low interest rates while still making their profit margins. But throughout the 1980's, some lenders, particularly states and nonprofits, were granted fixed interest rates of 9.5 percent, guaranteed by the government regardless of what students actually paid.

Congress eliminated the guarantee by 1993, eventually moving to a system that is more closely tied to the market, but it allowed some lenders to keep collecting the higher interest rates on money they had already raised. What Congress did not anticipate was that interest rates would fall so low, making the promise of a 9.5 percent return a potential windfall in a market where students are paying less than 3.4 percent in interest on their loans.

Moreover, some of the lenders who originally qualified for the guarantee have been converted into, or have been subsumed by, for-profit companies, putting greater emphasis on the search for profits. In recent years, lenders have begun employing some creative financing tactics to keep the old guarantees alive on entirely new loans, according to a report by the Government Accountability Office. It found that the guarantees have given lenders at least $1.7 billion more in federal subsidies than they might have received otherwise, and most of that has come in the last few years.

More than three dozen lenders, most of them nonprofits, received the higher interest rates last year, the accounting office found, and almost half of them have managed to expand their loan portfolio in recent years, assuring them bigger subsidies. The Southwest Student Services Corporation, for example, a lender that was bought this month by Sallie Mae, the industry giant, more than doubled its holdings to around $650 million worth of loans in the last two years, federal records show.

"Everyone's rushing in before the door closes," said Matthew J. Snowling, an analyst with Friedman, Billings, Ramsey.

Democrats in Congress contend that the Education Department has stood back and let loan companies exploit loopholes giving them access to old subsidies, in part because of the Bush administration's political connections with lenders. Indeed, Mr. Bouc of Nelnet was appointed by the department to serve on a financial aid advisory committee, but the department points out that it is not in favor of these higher subsidies, and has proposed changes that would save billions in its budget for the next fiscal year.

As for closing the loopholes now, while lenders are hurriedly mounting large portfolios, the department said there was little it could do. "I don't think we would want them to do it," Sally Stroup, an assistant secretary of education, said of the rapid increase in new loans with the old guarantees. "But I don't think we have the legal authority to stop them."

Many experts, including some within the department itself, disagree. "It is the agency's rules that created the loopholes," said Robert Shireman, director of the Institute for College Access and Success, which published a report today with findings similar to the G.A.O.'s. "It is the agency's responsibility to fix them. It is irresponsible not to act."

The department says it is anxious for Congress to rewrite the law, soon. Members of Congress are confident a change will come, eventually, but so far the issue has been just one of many tied up in the reauthorization of the Higher Education Act, which expired last year. The process has been highly partisan, inflamed by intense lobbying from loan companies and educators alike, and is nowhere near completion.

Beyond that, Republicans and Democrats differ on how tightly the loopholes should be closed. While Republicans in the House have proposed cutting off the guarantee on loans made after May 2004, Senate Democrats say the government should refuse paying the high subsidies to any company that has used the loopholes to build large loan portfolios over the last few years, and possibly even before that.

Though rising interest rates will probably decrease the size of the subsidies lenders receive, the delay could still be costly because student loan companies can keep issuing new loans with the old guarantee until the rules are changed, experts say. In its report, for instance, the institute for college access estimates that waiting another year to close the loopholes could cost an extra $2.8 billion in federal subsidies that do not expand college access but siphon away money that could possibly be used for college grants instead.