Credit Crunch

Guest Post: Another Bold, Radical Proposal for…a Bailout

Ed Policy — Tue, 06 Oct 2009 14:45:00 -0400

By Travis Reindl

We probably should have expected this. Since the Obama Administration declared its intentions to pump nearly $800 billion into the economy and put $12 billion on the table to help regain world leadership in college attainment by 2020, some of our most elite institutions have gone public to plead their case for federal funding. Presidents, chancellors, and board chairs have penned op-eds and signed onto full-page ads in major national newspapers, wrapping themselves in the Morrill Act and the GI Bill to argue that the federal government cannot abandon the world's greatest universities in their hour of need.

The latest entry in this anthology of angst surfaced in The Washington Post a couple of weeks ago. Under the alarming headline "Rescuing Our Public Universities," Robert Birgeneau and Frank Yeary, the chancellor and vice chancellor of the University of California at Berkeley, proposed a "daring scheme" whereby "a limited number of our great public research and teaching universities receive basic operating support from the federal government and their respective state governments." The institutions, selected on the basis of factors such as research achievements, graduation rates, public service, and commitment to diversity, would use the funds to eliminate out-of-state tuition and effectively create a cadre of national universities.

Berkeley would make out quite well under that bold plan, wouldn't it? Why does this sound eerily like what we have heard from the leaders of the Big Three automakers, or the banks that were simply "too big to fail?"

But wait -- there's more. "To ensure stability, the federal government should agree to match, at a rate of 2-to-1, and the state governments, at a rate of 1-to-1, private endowment funds raised by these universities for 10 years." Basically, some of the nation's richest institutions would receive $3 for every $1 they raise from some of the nation's (and world's) wealthiest donors. Not a bad deal, if you already have a cool billion in the bank and annually raise at least $50 million.

Now, of course, it's true that, as in previous recessions, public higher education is being slashed in state budgets, particularly in California. But it is also true that the budget cutter's pen rarely discriminates, which means that there are institutions operating on a much slimmer margin than UC-Berkeley and serving a more diverse student population that are not asking for a federal earmark in The Washington Post and calling it a "daring scheme."

Achieving the President's goal means that the nation will have to do a much better job of educating students who have too often been left behind, including low-income and first-generation students, working adults, and students of color. Reaching that mark is also about more than global bragging rights, as the percentage of jobs requiring education beyond high school and the percentage of Americans believing that college is essential to success in the workforce both continue to climb. The trends are clear -- failing to increase access and success rates for these groups will represent not just a moral failure, but an economic failure as well.

To that end, here's a counterproposal to the one that Berkeley's leaders have offered. Under this plan, which we'll call the Morrill Act for the 21^st Century (MAC21), the federal government would offer assistance to any public institution that:

Improves its performance in enrolling and graduating students from historically underserved populations. Currently, UC-Berkeley has a 90 percent overall six-year graduation rate, but that rate drops to 82 percent for Latino students and 77 percent for African American students. Surely, Berkeley could improve on those numbers.

Reduces average time-to-degree. According to the U.S. Department of Education, just under two-thirds (64 percent) of beginning students in 2002 completed a baccalaureate degree in four years at UC-Berkeley, but 90 percent earned a degree within six years. While there are legitimate reasons (degree requirements, changing majors, unavailable classes) why students take longer than four years to earn a baccalaureate degree, the university should be able to narrow this gap by at least 10 percentage points. And yes, it can be done without diluting quality.

Maintains or increases the share of spending allocated to instruction, academic support, and student services The Delta Cost Project reports that in recent years, there has been a subtle but definite shift away from activities that more directly affect students and toward those that more directly affect institutions (e.g. institutional support, facilities). Universities that wish to be known as outstanding "research and teaching institutions" must demonstrate a serious commitment to teaching to receive dedicated taxpayer funding.

The leaders of some of our most illustrious public colleges and universities are right to point out that we have reached one of those defining moments where we must decide what "the people's universities" will look like moving forward. This is more than an abstract question for thousands of students in California and around the nation who are scrambling just to get a seat in class. What is troubling about the current dialogue, though, is the absence of the student voice. Most of what we have seen and heard recently has been by institutions, about institutions, and for institutions. Despite all the marketing, how "student centered" is our enterprise?

History has shown that this nation is at its best in the face of adversity. The Morrill Act sacrificed treasure to invest in the nation as the future of the nation stood in the balance, and the GI Bill became part of our social contract as our grandparents sacrificed their comforts and their lives to ensure that our democratic ideals would survive. In this moment of adversity, it seems as though the most we have sacrificed is our pride. When we reach the point where the debate focuses on how much each higher education sector gets over what the nation and its students need, we have already lost.

Travis Reindl is the state policy and campaigns director at CommunicationWorks, a public affairs firm that specializes in educational improvement. Prior to joining the firm, he had 15 years of experience in higher education policy and advocacy. Most recently, he served as program director at Jobs for the Future, where he led a national initiative focused on increasing productivity in higher education. Before that, he headed the state policy analysis unit at the American Association of State Colleges and Universities. He has written extensively on issues of college affordability, accountability, and governance. His views are his own and do not necessarily reflect those of the New America Foundation.

An Update on ECASLA

Jason Delisle — Tue, 26 May 2009 18:30:00 -0400

In January, the Federal Education Budget Project published an issue brief on the student loan purchase programs put in place under the Ensuring Continued Access to Student Loans Act of 2008 (ECASLA). Given the new developments and new information released by the Obama Administration, it's a good time to catch up on the ECASLA programs.

When financial markets began to break down last year, Congress confronted the possibility that private lenders issuing federally-backed student loans (the Federal Family Education Loan Program, FFEL) might not be able to meet student demand. In response, Congress passed legislation (ECASLA) granting the U.S. Department of Education temporary authority to purchase FFEL loans. The new loan purchase authority helps ensure that FFEL lenders have access to adequate and affordable capital and can convert their loan assets into cash to fund new loans. ECASLA gives the Department of Education considerable discretion in designing and implementing loan purchase programs. Using this discretion, the Department designed and implemented four separate loan purchase arrangements: a put option; a short-term purchase program; a financing arrangement; and an asset-backed commercial paper support program. Each option involves different purchase arrangements and targets loans from different years. The ECASLA issue brief, which will be updated in the coming weeks, includes an explanation of each program and is available here.

ECASLA Performance Info Released

Since January, new information has been made available about the ECASLA programs. In March, the Obama Administration reported the volume of loans each private lender made under each program. The reports show that eleven lenders exercised put options on FFEL loans issued during the 2008-09 academic year, selling $701 million in loans back to the Department of Education. Two lenders, Edamerica and Wachovia Education Finance, accounted for about 90 percent of that volume. Subsequently, the Office of Management and Budget (OMB) released estimates in May 2009 showing that $4.8 billion in 2008-09 loans ultimately will be put to the Department (about 8 percent of expected 2008-09 FFEL issuance).

The Obama Administration also released information in March regarding the short-term purchase program that the Department operated from December 2008 through February 2009. The program applied to 2007-08 academic year leans. In total, six lenders sold $998 million in loans under the program. One lender, the SLM Education Finance Corp (Sallie Mae), accounted for $952 million of that amount.

As of March 18, 2009, the Department had provided $23.2 billion in financing to 23 lenders through the ECASLA participation interest program. The program effectively allows private lenders to borrow from the Department of Education to make FFEL loans to students. SLM Education Finance Corp (Sallie Mae) had used the program to fund $13.8 billion in 2008-09 academic year loans, the most of any one lender. The Student Loan Corporation (Citibank) made $2.1 billion in loans, the second most of any lender using the program. More recent information released by OMB in May 2009 shows that an estimated $33.8 billion in 2008-09 loans will be made through the participation interest program, representing 55 percent of FFEL program loans to be issued that year.

Conduit Program Now In Place

Finally, the ECASLA asset-backed commercial paper conduit program first announced by the Department last November is now up and running. The program was expected to begin in February 2009, but was delayed until May. Under the program, the Department of Education is acting as buyer-of-last-resort for FFEL loans financed through private conduits. The Department has committed to purchase the underlying FFEL loans in the event that a conduit cannot refinance maturing commercial paper. (For more on what an asset backed commercial paper conduit is, read the ECASLA issue brief.)

Under the arrangement, the Department will purchase FFEL loans issued after May 1, 2008, for 100 percent of outstanding principal and accrued interest. Loans issued earlier will be paid out at 97 percent of unpaid principal and accrued interest. The conduit must pay the Department two separate fees, one based on the value of the outstanding commercial paper it has issued to finance FFEL loans, and another based on market interest rates. The conduit will be backed by the put option until January 20, 2014, but no loans may be placed into it after June 30, 2010.

To date, one conduit has been approved by the Department of Education: Straight-A Funding, LLC, which was set up by Citibank and Morgan Stanley and is run by Bank of New York Mellon. In addition to the put option provisions provided by the Department of Education, the federal government will also provide a five-year, $60 billion line of credit to the conduit through the Federal Financing Bank (FFB). The FFB is an existing government corporation within the U.S. Treasury Department that centralizes federal and federally-assisted borrowing. The line of credit will be used to provide short-term (90 day) loans to the conduit if it experiences difficulty refinancing maturing commercial paper. Thus, the Straight-A Funding conduit has two federal supports to ensure liquidity: the FFB line of credit and the Department of Education put option on the underlying FFEL loans. As of May 26, 2009, several large private lenders had announced placement of FFEL loans into the conduit or approval from the Department to begin placing loans into it.

Be sure to read the updated ECASLA issue brief when it is released in the coming weeks.

[Update: The ECASLA issue brief was updated June 1 and is available here]

Obama’s Trump Card

Stephen Burd — Tue, 07 Apr 2009 15:00:00 -0400

Prospects for President Obama's proposal to eliminate the Federal Family Education Loan (FFEL) program remain uncertain. Democratic leaders in the U.S. House of Representatives and the Senate continue to be divided over whether or not to go forward with a controversial budget procedure known as budget reconciliation, which would make it significantly easier for the President to get the votes he needs to achieve his goal.

But even if the White House fails to persuade Congress to move ahead with its plan this year, the student loan industry will not be able to rest easy. That's because the administration has a trump card up its sleeve. An emergency law that is currently propping up FFEL-- the Ensuring Continued Access to Student Loans Act (ECASLA) -- is set to expire in about a year and a half, and the Obama administration doesn't appear to have any intention of asking Congress to renew it.

Robert Shireman, a senior advisor at the U.S. Department of Education, said as much at an event here last week on "The Future of Federal Student Loans" when he responded to a concern that the administration was rushing through its plans to overhaul the federal student loan programs. Regardless of whether the proposal to end FFEL goes through, "ECASLA only goes until this next coming year," he said. "A decision has to be made."

Last spring, Congress effectively shored up the system by allowing the Education Department to buy FFEL loans and lend federal money to lenders. In other words, the bank-based program's survival now increasingly depends on the government providing federal capital to lenders to make the loans.

ECASLA covers loans only through the 2009-10 school year and officially expires in September 2010. Some loan industry officials have floated the idea of making the emergency law permanent. But the Obama administration doesn't see the need for the government to run what has become essentially a second Direct Loan program -- particularly when the existing one is working so well. "The Direct Loan Program, which uses market process to determine subsidy payments to servicers, has suffered no disruptions and continues to function at lower cost to taxpayers," the President's budget overview states. "The Administration's goal is to continue to tap low-cost, stable sources of capital so students are ensured access to loans."

So the loan industry pretty much has to decide between taking the types of consolation prizes that the White House is offering now (Note to guaranty agencies: $500 million in mandatory spending a year for your college access work is surely better than nothing!); coming up with an alternative reform plan that may or may not be acceptable to the administration and Congress; or hoping against hope that the financial markets improve enough that they are not at all dependent on federal financing to make government-backed loans.

Although they may not fully realize it, colleges and students have a lot riding on the outcome of this debate. Under the President's plan, money saved from ending FFEL would be used to turn the Pell Grant program into a true entitlement for low-income students by financing it entirely through mandatory funding. Achieving a Pell entitlement has long been a dream of student aid advocates, including, incidentally, the National Association of Student Financial Aid Administrators, which opposes Obama's plan.

But if the Obama administration loses the battle this year, and simply allows ECASLA to expire, there's no guarantee that the savings would go anywhere but to deficit reduction -- and that would truly be a wasted opportunity.

Obama's Bold Proposal

Stephen Burd — Thu, 26 Feb 2009 20:58:00 -0500

The Obama administration on Thursday laid out a bold plan that would turn the Pell Grant program into a true entitlement for low-income students and pay for it in part by eliminating the Federal Family Education Loan (FFEL) program once and for all.

The proposal, which was included in President Obama's 2010 fiscal year budget overview, is sure to create a firestorm of controversy on Capitol Hill, where the student loan industry has many friends in both political parties. Ultimately, the budget blueprint recognizes a couple of hard truths about the federal student aid system that Higher Ed Watch and our sister blog Ed Money Watch have helped expose.

First, the way the federal government is currently financing Pell Grants is a huge mess, as Jason Delisle, the research director of New America's Education Policy Program, recently wrote. Congressional appropriators currently set the maximum Pell Grant each year based on estimates of expected demand for the grants made by federal budget officials. Because the estimates are made far in advance, they are generally off the mark. As a result, the Pell program has often been plagued by large budget shortfalls. To make up for the gaps, the Department of Education often dips into future program funds, pushing the shortfall off to the future.

In recent years, Congress has created new funding streams (through the College Cost Reduction and Access Act of 2007 and the giant stimulus package that Congress recently approved) to boost spending on Pell and increase the maximum award. These new funding sources, however, are only temporary. When they run out, policymakers will again face the tough choice of either substantially decreasing the Pell Grant (by more than $1,200) or shelling out billions of dollars more just to keep the maximum award constant.

President Obama's budget blueprint seeks to put an end to this budgeting nightmare by financing the program entirely through mandatory funding, meaning that spending for the program would no longer be determined through the annual appropriations process. The president proposes raising the maximum Pell Grant to $5,550 for the 2010-11 academic year, and then indexing future increases to the Consumer Price Index plus 1 percentage point so that it will keep up with inflation. "To make sure that we have a highly-educated workforce and that the opportunity to go to college is not determined by how much money you have, we need to put the Pell Grant program on sure footing," the budget overview states.

On its own, this proposal would not be too controversial. While fiscal hawks may object to creating a new federal entitlement program that will ultimately cost tens of billions of dollars a year, groups representing students and colleges have long embraced the idea. The plan, however, is certain to cause a furor in Congress because President Obama plans to pay for it in large part by eliminating the FFEL program and providing government-backed student loans entirely through the Direct Lending program. Under the proposal, the Department of Education would stop providing subsidies to FFEL lenders on new federal loans as of July 1, 2010. Lenders would continue to receive subsidies on existing loans.

That brings us to the second hard truth: credit market disruptions have made the FFEL program untenable. Only an emergency law -- the Ensuring Continued Access to Student Loans Act (ECASLA) -- saved the system by allowing the U.S. Department of Education to buy FFEL loans and lend federal money to lenders. In other words, the bank-based program's survival depends almost entirely on the government providing federal capital to lenders to make the loans. Sounds a lot like Direct Lending, doesn't it?

The federal government has gone to extraordinary efforts to help the student loan industry cope with the turmoil in the financial markets. But how long will it continue to have to do so? There appears to be no end in sight for the credit crunch, and some lenders have even floated the idea of making ECASLA permanent.

The Obama administration doesn't see the need to keep propping up FFEL when there is a less costly, more stable alternative in place. "The Direct Loan program, which uses market processes to determine subsidy payments to servicers, has suffered no disruptions and continues to function at lower cost to taxpayers," the budget overview states. "The Administration's goal is to continue to tap low-cost, stable sources of capital so students are ensured access to loans."

At Higher Ed Watch, we applaud the administration's gutsy proposal. Now let's just see if Congress has the guts to recognize these hard truths too.

For more details on President Obama's 2010 fiscal year budget overview, check out this post on Ed Money Watch.

Get Rehabilitated Loans Back on Track

Ben Miller — Wed, 18 Feb 2009 20:07:00 -0500

The global credit crunch is not denying access to federal student loans, but it is making life difficult for thousands of borrowers who are trying to get out of default. As several higher education trade publications have reported, continuing financial market turbulence has made it nearly impossible for defaulted borrowers to rehabilitate their loans -- leaving them with tarnished credit records and denying them the benefits of being in repayment. Fortunately, there are easy steps Congress can take to fix this problem. Lawmakers just have to be sure not to devise a solution that creates a new cash cow for student loan guaranty agencies.

Here's how loan rehabilitation works in the Federal Family Education Loan (FFEL) program. When a borrower defaults on a loan, its title is transferred to the guaranty agency that administered the loan. Guarantors then work with the borrower to create a repayment plan. Once an agreement is reached, borrowers are expected to make nine payments on the loan over a 10-month period. Once this requirement is met, the loan is considered ready to be rehabilitated. The only remaining hurdle is that the guarantor must sell the loan to an eligible lender.

This is where the credit crunch is gumming up the process. Guaranty agencies cannot find any lenders to purchase loan titles. And without a sale the defaulted loan cannot re-enter repayment.

The inability to sell these loans means borrowers are denied rehabilitation benefits. For example, rehabilitated borrowers have their default history expunged from their credit records -- improving their chances of buying or renting a house or obtaining other types of loans that have credit checks. Rehabilitating a loan also makes borrowers eligible for additional federal student assistance -- a benefit not available to anyone holding defaulted federal debt. Finally, rehabilitated borrowers become eligible for benefits available in the FFEL program like loan forgiveness.

There is an obvious candidate to purchase these loans: the U.S. Department of Education. Ever since Congress approved the Ensuring Continued Access to Student Loans Act (ECASLA) last spring, the Department has been forging agreements with lenders to purchase outright or backstop groups of student loans. While none of these ECASLA programs involve a direct arrangement with guaranty agencies, it makes sense to expand these programs to include them.

Allowing the Department to purchase rehabilitated loans, however, has legal and policy roadblocks. ECASLA authorizes the Department to purchase only loans disbursed on or after Oct. 1, 2003 -- excluding all rehabilitation-eligible borrowers with older loans. Moreover, loan purchase authority applies when "there is an inadequate availability of loan capital to meet the demands for loans." The programs are thus used to ensure new borrowers have access to loans, not provide help to existing borrowers. This suggests the Department would need a legislative change to expand its purchasing authority.

(While Congress works on that change, we recommend that states follow the lead of Illinois' General Assembly, which introduced legislation in both chambers to offer new bonds that would be used to buy rehabilitation-ready loans. We would also urge guarantors to inform borrowers who are trying to get out of default that they can do so by refinancing their loans in the Direct Loan program, allowing them to take advantage of the income-contingent repayment program. This isn't a perfect solution because it does not clear up a borrower's past credit record, but that may be an acceptable trade-off for at least some borrowers who are stuck in limbo).

But any legislative fix should raise two policy questions: how should guaranty agencies be compensated, and what should be done about borrower collection costs?

Making the Department a buyer of rehabilitation-eligible loans without changing how guarantors are compensated could lead to a windfall for guaranty agencies. Currently, these agencies keep at least 22.5 percent of a rehabilitated loan's sale price (the rest is returned to the Department).[1] Presumably this is done to reward the guarantor both for the work it did in getting the borrower to make on-time payments and also for the difficulty of finding a buyer for the loan.

But having the Department buy rehabilitation-eligible loans reduces the work needed by guaranty agencies. As a result, the agencies should receive less compensation. To address this, Congress could institute a "buyer of last resort" provision that pays guaranty agencies a flat-rate rehabilitation fee for loans purchased by the Department. In contrast to the current percentage-based one, this new fee could be modeled on the Lender of Last Resort program that guaranty agencies currently administer for students who cannot obtain federal loans from conventional lenders.

Here's how it would work: If a guaranty agency is denied twice by lenders when trying to sell a rehabilitated loan, it would have to sell the loan to the Department. In return, the guarantor would receive a flat per-loan fee that reflects the costs of getting borrowers to make on-time payments. A flat fee ensures that guaranty agencies have no incentive to inflate the loan sale price because their compensation is the same regardless.

Congress would also have to decide what to do with the collection costs charged to borrowers if guaranty agencies sell the rehabilitation-eligible loans to the Department. Currently guarantors are allowed to charge borrowers a collection fee of up to 18.5 percent of the unpaid principal and interest at the time of the loan sale. This money is then capitalized and added to a borrower's principal balance. These collection costs cover expenses incurred by the guarantor when it rehabilitates and sells the loan. But if the Department acts as a guaranteed loan purchaser, why should the Department increase the balance owed on its newly acquired loans, when doing so increases the likelihood borrowers will default again? Instead, when a rehabilitated loan is purchased by the Department, the guarantor should be reimbursed for an amount that reflects the collection costs involved with returning the loan to repayment. That cost should be passed on to borrowers, but in such a way that it is kept separate from their unpaid principal, meaning it does not compound with interest.

Congress has willingly taken quick action to buttress lenders to guarantee access to federal student loans. Financial conditions now require it do the same for the struggling borrowers who are trying to repay their defaulted loans, while fiscal prudence demands that it do so in such a way that does not result in unnecessary payments to guaranty agencies or excessive charges to borrowers. It's time to end the rehabilitation treadmill so borrowers can get themselves back on the right track.

[1] The actual percentage amount retained is equal to 100 minus (81.5 multiplied by the guaranty agency's reinsurance rate). Since most guaranty agencies are reinsured at a rate of 95 percent, this works out to 100 - (81.5 * 0.95), or 22.5 percent. If their reinsurance rate is 85 percent, then guarantors would keep 30.1 percent, while a 75 percent reinsurance rate would result in the agency retaining 38.9 percent of a loan sale.

Mailbag: Borrowers in Desperate Straits

Ed Policy — Thu, 05 Feb 2009 17:15:00 -0500

At Higher Ed Watch, we have long opposed the idea of the government bailing out private lenders who have engaged in predatory private student loan practices. Our view, as we have said before, is that student loan companies should have to bear responsibility for the consequences of pushing high cost private loan debt on high-risk borrowers. After all, for years, they gladly raked in profits from these loans.

Over the past six months, we have heard from scores of financially distressed borrowers who are outraged that the government would rush to the aid of private student loan providers without offering any relief to them. With U.S. Treasury Department officials preparing to start carrying out this month their plans for reviving the credit markets to help provide capital and liquidity to lenders so they can continue making high-cost private loans, we feel that it is our duty to make sure these voices are heard.

Typically in our mailbags, we provide a sample of comments that have been submitted on a given subject. But as we sifted through the dozens of comments we have received in recent months, one particularly caught our eye because it perfectly illustrates the human costs of a system that has left so many students vulnerable to abuse from predatory lenders and unscrupulous trade schools.

Like many of the distressed borrowers we hear from, this commenter says that he was duped into taking out high-interest private loans by aggressive trade school recruiters who misled him about the terms and conditions on these loans, as well as the quality of the academic programs their schools were offering:

I have attended two schools -- ITT and Westwood. When signing up they told me that I would need a Sallie Mae loan to cover what my grants didn't and that once I completed school that I would be making payments of around $50 a month for each loan.

After attending I didn't feel like I was receiving the education that I was paying for in these loans. The reason why I say this is because my 4th grade son was bringing home assignments that mirrored the ones I was receiving from ITT and Westwood. I was getting A's on all my assignments without any studying because it was so easy my son could do it. If you are going to pay over $75,000+ in loans when you complete a school shouldn't it actually teach you something??

After withdrawing from these schools, he says that these loans have become an inescapable burden for him and his family. The loan giant Sallie Mae, he says, has been inflexible and unwilling to help him find ways to make repayment easier.

Ultimately, this commenter has paid a heavy price for his decision to go back to school to try and better his life. His situation, he says, has become increasingly desperate:

Until we started going to receive food from the church last winter, my family had to all live in one room in the back of our trailer with no water, gas, or phone (can only pay electric on $120 a month). For heat we had a space heater that could only heat one room. My wife was late term high risk pregnancy at the time. We lived on ramen noodles and what the local church was able to help supply with their food assistance.

It's bad when a government-protected institution puts money ahead of the welfare of its citizens. After the winter was over Sallie Mae collected around $3000+ of family assistance and it sure hasn't shown up as credit on my loans.

As policymakers move forward with their plans to help private loan providers, we believe that it is absolutely essential that they look for ways to help private loan borrowers who find themselves in dire straits. Borrowers with unmanageable debt loads may not be able to hire high-priced lobbyists or lavish lawmakers with generous PAC contributions, but that doesn't mean that they should be left out of the discussions.

As always, we appreciate the comments we have received on this topic and others. Please keep them coming.

Skewed Priorities in New York

Stephen Burd — Thu, 22 Jan 2009 21:30:00 -0500

In yet another example of how politicians are overreacting to the panic over the credit crunch, officials in New York are considering spending $50 million in the coming fiscal year to create a new state-sponsored private student loan program.

The proposal, included in Gov. David Paterson's 2009-10 fiscal year budget request, aims to keep up a steady flow of private loans to New York State students. It is also designed to provide a lower cost alternative loan product than is generally available from commercial lenders.

Under the program, credit-worthy undergraduates would be eligible to receive up to $10,000 in private loans annually, and $50,000 cumulatively, after they have exhausted their federal student loan eligibility (not counting PLUS loans). Students would have the option of taking out either fixed-rate or variable rate loans. The plan calls for the state to issue $350 million in tax-free bonds to finance the fixed rate loans -- and the interest rate on these loans would reflect the interest rates paid on these bonds. State officials say they expect the rate to be around 8 percent in the program's first year.

The rate on the variable loan product would be tied to the prime rate with a mark up to be determined by the New York State Higher Education Services Corporation (HESC), the state student loan guarantee agency, which would be running the program. HESC would also determine the amount of fees it would charge students for taking out these loans.

"In a time of rising borrowing costs and tightening lending by private banks, this new lower-interest student loan program I have proposed will help ensure New Yorkers have access to the funds they need to finance their college educations," Governor Paterson said in December, when he unveiled the proposal.

James Ross, the president of HESC, has also been busy promoting the program. "As the nation works through the financial crisis, such innovative programs are needed to help keep the doors of higher education open to all New Yorkers and maintain a highly educated workforce," he stated in testimony he delivered last week at a state legislative hearing.

But state legislators, don't believe the hype. While the program would undoubtedly provide some students with cheaper private loans than they would be able to obtain otherwise, and has some other positive features, the benefits of the loans are not nearly as generous as advertised. The authorizing legislation creating the program leaves it up to HESC to set most of the terms and conditions on the loans. In fact, the proposal explicitly exempts the program from state usury laws and declares that "there shall be no limitation on the rate or amount of interest or fees payable on education loans made under this program."

Moreover, we are not entirely clear on the overriding public purpose that this program is designed to serve. As of yet, we at Higher Ed Watch have not seen any solid evidence that credit-worthy students - those that this program would serve - are having difficulty obtaining the financing they need (through the federal or private loans programs) to go to college. Remember that that the parents of most students attending high-cost colleges are eligible to receive federal PLUS loans, which cover the full cost of attendance. For families who get turned down for PLUS loans because of credit worthiness, Stafford loan limits double making them eligible for $57,500 in aggregate federal loans.

Granted this still may not be enough to pay the price of particularly expensive institutions. Several newspaper accounts have drawn attention to the phenomena of parents and students spending more time "shopping around" this year before committing to a university. But, as we've asked before, is shopping around so bad? Shouldn't we encourage families to spend more time thinking about the levels of debt they and their children can incur and reasonably expect to pay back?

At a time when New York State officials are considering making substantial budget cuts to the state university and community college systems, raising the tuition and fees students at these schools pay, and tightening eligibility for the state's need-based grant program, surely there are better ways to spend scarce resources than to push students further into debt.

Next week, we will take a more-detailed look at the proposal to point out the best and worst features of the program. Stay tuned.

Hidden in the Stimulus Bill

Jason Delisle — Thu, 15 Jan 2009 22:43:00 -0500

Last December Higher Ed Watch caught wind of back-room maneuvering on Capitol Hill to retroactively change the way the federal government sets lender subsidies in the guaranteed student loan program. Education Secretary Margaret Spellings sent a letter to key members of Congress asking them to quickly enact legislation to change the index used to determine the quarterly interest rate subsidy paid to lenders. The change would calculate the subsidy based on LIBOR instead of commercial paper

No action was taken...until now. The stimulus bill released today by the U.S House of Representatives Appropriations Committee would make the change. Specifically, it would recalculate the subsidy for last financial quarter (October through December 2008) owed to private lenders. And the change would also apply to all loans issued since 2000.

According to our estimates, the change would retroactively increase the subsidy paid to lenders by about 0.50 percentage points. Multiply that across hundreds of billions of dollars in outstanding loans and the extra payments could reach into hundreds of millions. Strangely, the Appropriations Committee reports that the cost will be only $10 million.

In our earlier post, we did not oppose the change, especially given the break down in the commercial paper markets. However, we expressed concern that the change sought by the Secretary (and the student loan industry) was being debated out of the public eye. For example, while the Department of Education regularly publishes on its website important policy letters the Secretary sends to lawmakers, this particular letter is suspiciously absent from the site. We also noted that the proposed changes would be unprecedented, as loan subsidy changes have always applied to new loans, not previously issued loans. We argued that such a proposed change should be thoroughly and publicly debated by Congress, not buried in a huge omnibus, must-pass bill.

Well, it looks like our concerns were warranted, as the change is tucked away in a 258-page stimulus bill. Readers will note that the subsidy change is not touted in any of the press materials released by the House Appropriations Committee.

As we wrote in our earlier post, the index issue and proposed changes are a dangerous symptom of the guaranteed student loan program disease. To get private lenders to make loans under the program, Congress must adequately compensate them. Yet Congress is not skilled at setting a payment rate that is neither too high nor too low, or that encourages the optimal number of lenders to make loans to all students. Worse yet, Congressional subsidy setting is subject to dangerous amounts of influence by student loan company lobbyists. This is particularly true when the issues are steeped in financial complexity, such as yield spreads between commercial paper and LIBOR, or interest rate swaps and asset backed securities.

The index issue should serve as an important reminder to Congress and the incoming Obama administration that they must adopt a system for setting lender subsidies that does not rely on continuous, ad-hoc legislative tinkering and loan industry lobbying. An auction where lenders bid for loan volume or subsidy payments is the best way to avert loan subsidy inefficiencies, crises, and lobbying bonanzas.

Just the Facts on ECASLA

Ed Policy — Thu, 15 Jan 2009 17:45:00 -0500

Over the past year, Congress and the Bush administration have taken some dramatic steps to make sure that student loans through the Federal Family Education Loan (FFEL) program remain widely available despite severe credit market disruptions. At Higher Ed Watch, we have been supportive of some of these efforts and critical of others.

However, one thing is absolutely clear -- the loan purchase programs that Congress and the U.S. Department of Education designed under the Ensuring Continued Student Loan Availability Act of 2008 (ECASLA) are complicated. They were enacted quickly and with little public discussion. As a result, few people outside of the Education Department and the student loan industry have any idea of how these plans are supposed to work.

Jason Delisle, the research director of the New America Foundation's Education Policy Program, has written an issue brief that aims to bring clarity to the debate by providing a detailed explanation of the purchase programs and the role they are designed to play in improving access to student loans.

The report includes information on the effects of credit market disruptions on federal student loan availability and the adoption of ECASLA; a detailed description and explanation of each of the four loan purchase programs designed and implemented by the Department of Education under ECASLA; and tables and graphics depicting each of the programs.

We hope that this report, which will be updated as new information on these programs becomes available, will be a valuable tool for policymakers, the news media, and the public to better understand this new and evolving approach to student loan policy.

A “Key” Reason Not to Bail Out Private Student Loan Providers

Stephen Burd — Wed, 10 Dec 2008 18:00:00 -0500

Readers of this blog will know that we think it would be a major mistake for the U.S. Treasury and Congress to provide bailout funds for private student loan providers -- especially without giving the borrowers of these high-cost loans better consumer protections. To better understand why we think that way, consider the case of KeyBank -- which arguably has engaged in some of the most questionable private student loan practices of any company. Is it really in the best interest of the government and taxpayers to help companies whose lending practices have put students in such harm's way?

As we have reported previously, there has been in recent years a proliferation of unlicensed and unaccredited trade schools that do not participate in the federal student aid programs and therefore go largely unregulated. Their growth has been fueled by lenders that have "partnered" with these institutions to provide expensive private loans to the at-risk students these schools tend to attract. The lenders have then turned around and, like subprime mortgage providers, securitized the loans, shifting these high-risk loans onto unsuspecting investors.

One of the most aggressive players in this arena has been KeyBank. Over the last decade, KeyBank has formed exclusive arrangements with dozens of unlicensed trade schools -- particularly ones that focus on computer training and flight training. These unregulated schools have required their students to pay for the full cost of their training up front, with tens of thousands of dollars of private loans from KeyBank. Unfortunately, many of these schools, like the Nevada-based Silver State Helicopters (SSH), failed to deliver the education promised and then shut down without warning, leaving their students in the lurch -- heavily indebted with expensive private loans and no practical training.

In case after case, KeyBank has fought vigorously (and often successfully) to force students to pay back these high-cost loans, despite the fact that the schools closed before the low-income and working class students these institutions tend to attract could receive the training they were promised. In doing so, the corporation has denied borrowers basic protections that are in federal law to protect borrowers from being scammed by unscrupulous schools and loan providers. For example, the bank has routinely omitted from the promissory notes for its private loans a required notice that asserts the borrowers' right to have their loans canceled if a school with which it has "a referring relationship" closes down, is not licensed, or engages in fraud. [Higher Ed Watch will explore this issue in greater detail in a post tomorrow.]

Students who attended these unregulated fly-by-night trade schools are fighting back. At least two major lawsuits are moving forward against KeyBank, accusing the company of colluding with disreputable schools to defraud students. They say that KeyBank officials were well aware of problems at these schools but chose to ignore them in order to continue marketing loans to the institutions' students.

KeyBank officials deny any wrongdoing, saying that they cannot be held responsible for mismanagement at the schools with which they work.

Left in the Lurch at Silver State

In May, students in California who attended flight schools run by Silver State Helicopters, a Nevada-based chain that shut down suddenly on Super Bowl Sunday, filed a class action lawsuit against KeyBank and several other lenders, seeking to get their private loans discharged.

According to the lawsuit, KeyBank was Silver State's exclusive private student loan provider from 2002 to 2005, a time when the flight school chain grew by "an astounding 2,786 percent." The lawsuit states that the school directed prospective students to apply for private loans from KeyBank to cover the full cost of attendance -- nearly $70,000 per student -- that they were required to pay upfront before classes started. "The school targeted second career, limited income individuals who, but for the Defendant's loan, lacked the personal financial wherewithal to pay the tuition," the lawsuit states. The willingness of KeyBank to waive its credit requirements to provide these high-cost loans to mostly subprime borrowers served "as a fundamental catalyst for SSH's exponential growth," the document says.

Soon after the students enrolled, however, they realized that the school was ill-equipped to deliver the training that was promised. "SSH was unable to provide the equipment, instructors or maintenance necessary to enable the students to attain their pilot ratings,' the lawsuit says. KeyBank was made aware of these problems, the lawsuit states, but continued to help market the school. [In 2005, KeyBank severed its ties to Silver State, forcing the school to find other lending partners to make and service its loans. The flight school chain then forged an exclusive arrangement with Student Loan Xpress and Pennsylvania Higher Education Assistance Agency (PHEAA).]

The lawsuit argues that KeyBank's relationship with Silver State is not an isolated case. Instead it points to similar arrangements the bank has forged with other unaccredited trade schools that also shut down to assert that "KeyBank's involvement with SSH and its treatment of the SSH students is part of a pattern and practice of fraudulent conduct ." The lawsuit accuses the bank of violating the federal Racketeer Influenced and Organizations (RICO) Act by engaging "in a deliberate pattern and practice of aiding and abetting fraudulent vocational schools that aggressively induce students into obtaining loans with KeyBank."

KeyBank officials deny any wrongdoing, saying that they had little involvement with the schools except to provide financing to their students.

TAB Express International Students Fight Back

A second lawsuit -- filed by more than 50 former students from TAB Express International, a now-defunct flight school in northern Florida -- presents a remarkably similar case to that of the Silver State students.

In June 2005, TAB shut its doors without notice, after KeyBank ended its three-year relationship with the school. Prior to that, the lawsuit states, KeyBank and TAB had "a mutually advantageous relationship" in which the school required students to take out private loans from that lender to attend the institution, according to the lawsuit. "In fact," the lawsuit states, "TAB would not accept cash installments or other loans on behalf of students for their training, and insisted the students instead obtain a loan or loans from KeyBank exclusively."

Just as at Silver State, students wishing to attend TAB had to take out private loans from KeyBank covering the full cost of attendance -- sometimes as much as $100,000 -- before classes even started. The bank sent the money directly to the school. According to the lawsuit, students were told that their loans would be forgiven after they completed the training and worked for TAB's airline for a period of time.

But soon after enrolling, students became suspicious. "The students became aware of a lack of available instructors, simulators, and aircraft at the flight school as the school continued to increase the number of enrollees," the lawsuit states. Eventually, they realized that "TAB had no airline." The lawsuit says that the students repeatedly brought their concerns to KeyBank officials but were rebuffed, and the lender continued to help market the school to prospective students.

When the deal finally collapsed, the lawsuit says, KeyBank officials tried to convince the students to take advantage of a "train out option" that would have required them to take on more debt and to waive their right to pursue legal action. Most of the students were not persuaded. Now the case is scheduled to go to trial in a state circuit court in March.

Be Careful with Bailout Money

As a result of the credit crunch, KeyBank stopped making private student loans this summer. With Treasury Secretary Henry Paulson intent on bailing out the private loan industry, we fear that the government will rush to the aid of KeyBank, and others like it, without being aware of the provider's questionable past practices.

At the very least, the government should withhold any liquidity aid from KeyBank until it launches a thorough investigation of the serious allegations that have been made by students from dozens of unlicensed schools. We would hope that the bank would be required to discharge the private loans of students from Silver State and TAB International, as well as others who were victims of sham schools with which the lender partnered.

To be clear, we oppose a private loan bailout. But if one is to occur, the government needs to insure that it is not adding fuel to the fire, and encouraging private loan providers to continue harming students and borrowers. It's time to put an end to these types of predatory lending practices, not encourage them.