Student Loan Scandals

Greetings from the Financial Aid Office!

Ed Policy — Thu, 19 Nov 2009 16:30:00 -0500

[Last week, we reported (see here and here) on the fact that some of the student loan industry's most fervent supporters in the financial aid world are potentially putting their schools and students at risk by refusing to take even the initial steps to prepare for a possible shift to direct lending next fall. Since then, we've been wondering how these aid directors would explain their inaction to students. So, after hearing the comments that financial aid administrators and lenders made at last week's Lexington Institute event and on the Finaid-L listserv, we decided to write up a fictional account of how these aid officials might explain themselves. We hope you enjoy it.]

Dear Students,

As you may have heard, we have recently taken action that could potentially disrupt your ability to obtain federal student loans next fall. But we want to assure you that there is absolutely nothing to worry about. Our good friends in the student loan industry have a sure-fire strategy in place to stop any efforts in Washington that would force us to change the way we do business. And for that we're very grateful because we can't imagine doing things any other way.

Here's some background. Last month, we received a letter from U.S Secretary of Education Arne Duncan urging us to take at least the initial steps to become "Direct Loan-ready" for the 2010-11 academic year. As you may know, the Obama administration has proposed ending the Federal Family Education Loan (FFEL) program in favor of 100 percent direct lending. Under the plan, tens of billions of dollars in savings from making the switch, and eliminating lender subsidies, would be used to provide a substantial boost in spending on Pell Grants, which go to the most financially needy students. This may sound good but it won't help us much because we don't enroll many of those students. In other words, the upper middle income students we predominantly serve will be left out in the cold!

Now it's not exactly clear where this legislation is headed. As of now the measure appears to be stalled in the Senate, where the never-ending health care debate drags on. But even if this bill doesn't go anywhere, we won't be out of the woods. That's because a federal law that has been propping up the FFEL program over the last year and half -- known as ECASLA -- is set to expire in July and neither the Obama administration nor Congressional Democrats want to extend it. If lenders can't get access to government financing to make federal student loans, the FFEL program will be sunk. At least that's the excuse Secretary Duncan is giving us for why we need to be prepared to flip the switch. But we told him to take a hike. That's a lot of nerve, telling us how to run a federal program that benefits students.

You see we used to be in the Direct Loan program more than a dozen years ago, and the program ran into some administrative difficulties. At the same time, Republican Congressional leaders tried to kill direct lending, and when that failed, they did everything they could to put it at a competitive disadvantage to FFEL, including preventing the U.S Department of Education from being able to market the program to schools and preserving generous subsidies for lenders that they used to woo financial aid offices like ours. So it is not surprising that we had lenders literally banging down our doors each week trying to convince us to switch back to FFEL. Some of the offers they made were just too good to pass up, and they are worth holding out for despite what the Obama administration says! [Enough said about that. We don't want to get into any details just in case that jerk Cuomo gets hold of this letter -- no offense intended, of course, Mr. Attorney General.]

Yes, we know that some of our colleagues in the financial aid world have made the switch to direct lending and say that it went much more smoothly than they had imagined. The problems we experienced a dozen years ago have long since been fixed, they say, and in fact are ancient history. But do we really want to take that risk? Our lender friends -- at least those that in the student loan business because of the help they received as a result of ECASLA -- say we shouldn't. Because after all, what has the government ever done right?

So please don't be worried about your loans because there's really no need for concern. Our friends in the loan industry assure us that they can spread enough fear and confusion on Capitol Hill to convince Congress that a switch to 100 percent direct lending would lead to a catastrophic breakdown. But in order to help them, we must do our part. If enough colleges like us dig in their heels, and refuse to take even the most rudimentary steps to prepare, we may be able to help lenders scare lawmakers away from enacting any real student loan reform and maybe even get them to extend ECASLA for another year.

So have no fear. This is definitely a gamble worth taking. Because if there's anything the loan industry does well, it's spreading fear and confusion. What else do you think they hire those high-priced lobbying and communication firms to do?

Sincerely,

Your trusty financial aid director

Fontana's Follies and the Downfall of the Student Loan Industry

Stephen Burd — Wed, 04 Nov 2009 00:30:00 -0500

The news that Matteo Fontana, a former high-ranking official at the U.S. Department of Education, has pleaded guilty to charges that he lied to the government about his ownership of stock in a student loan company he was in charge of overseeing provides a timely reminder of why the student loan industry is in such hot water now.

During the Bush administration, the loan industry went virtually unregulated. Top officials at the Education Department did not just look the other way while widespread abuses occurred in the Federal Family Education Loan (FFEL) and private student loan programs. They actually helped lenders skirt federal laws and regulations so the companies could maximize their profits -- often at the expense of students and taxpayers.

The government's case against Fontana provides the most glaring example of the type of conflicts of interest that were rife within a Department heavily staffed by former student loan industry officials. As Higher Ed Watch first revealed in April 2007, Fontana, the general manager of the Financial Partners Division of the agency's Federal Student Aid office, held 10,500 cut-rate insider shares of stock, worth over $100,000 in the parent company of Student Loan Xpress for nearly a year after he joined the Education Department in the fall of 2002. At the time, we did not know whether Fontana had fully disclosed his stock holdings to his superiors at the agency.

According to federal prosecutors, Fontana repeatedly lied about his stock holdings on financial disclosure forms -- falsely claiming, for instance, that he had sold his Student Loan Xpress stock in December 2002. In fact, he didn't sell his stock -- including an additional 1,400 shares he purchased while at the Department -- until 2004 and 2005, for a total of around $219,000.

Federal employees are allowed to own stock in a company but are prohibited from working on issues affecting that company if their holdings exceed $15,000. But that didn't stop Fontana, the prosecutors say. In September 2004, Fontana overruled a decision by a lower-level Education Department employee that would have prevented Student Loan Xpress from expanding its business. Company officials had asked Fontana to intervene, saying in an e-mail that the employee's decision not to bless an arrangement they had forged with the Pennsylvania Higher Education Assistance Authority had left them "at a stand still and losing business by the day." By reversing that decision, Fontana, the prosecutors charged, "did participate personally and substantially as a Government officer and employee" in "a particular matter in which [he] knew he had a financial interest."

While the charges against Fontana are serious, at Higher Ed Watch we know that they are just the tip of the iceberg. Over the last two years, we have learned that under Fontana's leadership, officials in the Financial Partners Division:

Turned a blind eye while student loan providers routinely violated a federal law forbidding lenders from providing "illegal inducements" to colleges and financial aid administrators in exchange for getting the schools to steer borrowers their way. Department officials ignored concerns about these "pay for play" practices, even from the agency's own Inspector General and lenders who complained about their competitors' activities.

Looked the other way and, in some cases, actually provided assistance and encouragement to lenders as they systematically overcharged the federal government hundreds of millions of dollars in improper 9.5 percent loan subsidy payments. As we have previously reported, officials within the division wrote a series of program review reports from 2005 to 2006 in which they signed off on some non-profit lenders' 9.5 billion practices and, in at least several cases, showed the loan agencies how they could take greater advantage of these inflated subsidies.

Allowed lenders specializing in offering consolidation loans to mine the National Student Loan Data System (NSLDS) to collect personal information about borrowers for marketing purposes. While civil service employees at the Department had loudly complained about these practices, the agency's leaders didn't do anything about it until Higher Ed Watch broke the story and the national news media picked up on our coverage.

Emphasized partnerships over compliance in overseeing lenders and guaranty agencies. As a result, the division frequently overrode decisions made by program review specialists that were critical of student loan companies and limited their ability to effectively carry out investigations of these companies' practices.

Meanwhile, Student Loan Xpress was not the only loan company that directly benefited from its ties to the general manager of the Financial Partners division. Prior to joining the Education Department, Fontana worked at Sallie Mae for 11 years. In 2004, that connection paid huge dividends to the student loan giant and its shareholders.

At the time, Sallie Mae's long-sought goal of becoming a fully-privatized corporation was effectively being held up the Department's Inspector General, who had determined that a lucrative arrangement between the company and USA Funds, the country's largest guaranty agency, violated the law and needed to be severed in order to protect borrowers. The IG argued that the arrangement effectively put the guarantor under Sallie Mae's control, creating twisted incentives that allowed the lender to reap huge profits by growing its borrowers' debt to unmanageable levels. Fontana ultimately overruled the IG -- offering the nonsensical opinion that because the Sallie Mae subsidiaries that helped manage USA Funds had separate tax identification numbers from other parts of the company, they were officially separate entities. Why the former Sallie Mae official was allowed to make ruling of such critical importance to the company has never been clear to us.

The revolving door that existed between the student loan industry and the Department of Education under the Bush administration provided license to lenders to pursue their own self interest with little regard for students or taxpayers. The level of corruption that has since been uncovered makes it abundantly clear that a fundamental overhaul of the federal student loan programs is needed. President Obama and Democratic Congressional leaders clearly recognize that a shift to 100 percent Direct Lending would make the federal loan program much less susceptible to the types of abuses that have plagued it in recent years.

So if loan industry officials are looking for someone to blame for their predicament, they need only to look to themselves and their former cronies at the Department of Education, such as Matteo Fontana, who failed to rein them in and, in fact, enabled them.

Breaking News: Criminal Charges Filed Against Matteo Fontana

Ed Policy — Mon, 02 Nov 2009 19:45:00 -0500

In April 2007, Higher Ed Watch revealed that Matteo Fontana, a former high-ranking official in the U.S. Department of Education's Federal Student Aid office, had held at least $100,000 of stock in a student loan company he was in charge of overseeing. Last week, the Justice Department filed criminal charges against Fontana on two counts: lying to federal officials about his ownership of stock in the company Student Loan Xpress and illegally using his position to help the corporation expand its business.

According to the Washington Examiner, which first reported on the Justice Department's action, the charges against Fontana are misdemeanors that each carry a maximum penalty of imprisonment for up to a year. However, The Chronicle of Higher Education reported this afternoon that Fontana has agreed to plead guilty to the charges and to pay a fine of up to $115,000. If the federal judge hearing the case accepts the plea agreement, Fontana will not have to serve any prison time, the Chronicle states.

We will have more details and commentary on this case tomorrow. Stay tuned...

Below is the text of the original April 5, 2007 Higher Ed Watch post:

EXCLUSIVE: Education Department Official Implicated in Widening Student Loan Scandal

Stephen Burd | April 5, 2007

Higher Ed Watch has learned that a top Education Department official held at least $100,000 worth of stock in a student loan company that may have substantially benefited from its ties to him.

According to a Securities and Exchange Commission (SEC) filing by Education Lending Group (see chart on page 18), the Education Department official, Matteo Fontana, held at least 10,500 shares in Student Loan Xpress as of September 2003. Fontana is currently in charge of overseeing lenders and guarantee agencies that participate in the Federal Family Education Loan Program (FFELP). Mr. Fontana's shares were offered for sale at just under $10 per share in September 2003, according to SEC filings. The extent of his total holdings in September 2003 and today is unknown.

Mr. Fontana, who is a good friend of Student Loan Xpress's president Fabrizio "Breeze" Balestri, joined the Education Department in November 2002 and was put in charge of the National Student Loan Data System (NSLDS), a gigantic computer database that keeps track of the student aid awards of tens of millions of students who have received federal financial aid.

It's unclear whether Mr. Fontana disclosed his stock holdings -- which he held for almost a year while at the Department -- to his superiors at the agency. Mr. Fontana didn't return Higher Ed Watch's calls.

Meanwhile, the Education Department released a statement late on Thursday that didn't address whether Mr. Fontana had made the disclosures. "The Department takes this matter very seriously and our Office of the General Counsel is actively reviewing it," Samara Yudof, a spokesperson for the agency stated.

What is clear is Student Loan Xpress, which started in 2001 primarily as a student loan consolidation company, stood to benefit significantly from having such a close colleague in charge of NSLDS, which includes detailed personal data on individual federal student-loan borrowers.

According to several key sources, civil service employees at the Education Department have long complained that officials in charge of the Federal Student Aid office allowed loan consolidation companies to mine NSLDS records so they could steal away borrowers from the Department's Direct Student Loan Program.

Over the last five years, private lenders have been extremely aggressive in marketing consolidation loans to Direct Loan borrowers, offering them rebates on fees and interest rates that the government does not match, despite the fact Direct Loans are less expensive for taxpayers than the FFELP alternative. According to Education Department data, as reported by The Chronicle of Higher Education, close to 800,000 Direct Loan borrowers, with a total debt of about $17 billion, left the Direct Loan program between 2003 to 2005 to refinance their loans with private loan providers, such as Student Loan Xpress.

The misuse of NSLDS by companies marketing consolidation loans and other entities appears to have been so rampant that the Department's Inspector General sent a memo to Terri Shaw, the Chief Operating Officer of the Federal Student Aid office, in 2005 demanding that the office limit access to the database. As a result of the Inspector General's prodding, Mr. Fontana sent out his own notice to lenders warning them that NSLDS information was not to be used for "the marketing of student loans or other products."

Revelations that Mr. Fontana owned a stake in Student-Loan Xpress come a day after Higher Ed Watch uncovered that financial aid administrators at three major universities had received significant shares of stock from the company. As a result of our investigation, Columbia University placed its aid director, David Charlow, on leave pending a full review by the institution. Columbia also alerted New York Attorney General Andrew Cuomo to our findings. Mr. Cuomo promptly issued a subpoena to Columbia University and sent letters to the other two universities in question -- the University of Southern California and the University of Texas at Austin -- seeking more information about the administrators' stock ownership.

Higher Ed Watch continues to believe that the problem of corruption in America's student loan system stems from excessive taxpayer subsidies going to the student loan banking industry instead of families and needy kids.

This problem has to be addressed at its root.

Michael Dannenberg contributed to this report.

Here are links to other posts we have written about Fontana's management of the Financial Partners Division of the Education Department's Financial Partners Division:

The Revolving Door and the Damage It has Done (April 17, 2007)

Friends in High Places Deliver Big for Sallie Mae Behind the Scenes (May 9, 2007)

Where in the World is Matteo Fontana? (July 8, 2008)

Case Not Closed: Matteo Fontana's Resignation Leaves Unanswered Questions (September 30, 2008)

Exclusive: Some Ed Dept. Officials Encouraged Lenders to Overcharge the Government (May 14, 2009)

Putting an End to the Subprime Student Loan Racket

Ed Policy — Thu, 29 Oct 2009 14:00:00 -0400

[Editor's Note: Yesterday we ran an excerpt from an article that Higher Ed Watch Editor Stephen Burd wrote for The Washington Monthly [cover pictured right] on the subprime student loan crisis at some of the nation's largest chains of for-profit colleges. Today, we're running a second excerpt that provides recommendations for putting an end to predatory lending at these institutions. To read the full article, click here.)

For a while it looked like the meltdown on Wall Street, and the ensuing credit crunch, would put an end to predatory lending at for-profit schools. In 2008 Sallie Mae quit offering subprime private loans to students at for-profit colleges because the astronomical default rates had helped throw its stock price into a nosedive. But the proprietary college industry has found a way around this roadblock, namely making private loans directly to students, much the way used-car lots loan money to buyers rather than going through a third party. For example, in a recent earnings call with investors and analysts, Corinthian said that it plans to dole out roughly $130 million in "institutional loans" this year, while Career Education and ITT Educational Services Inc., another for-profit chain, have reported that they expect to lend a combined total of $125 million.

These loans could prove to be even more toxic than the private ones offered by Sallie Mae. This is because some schools are packaging them as ordinary consumer credit, which has even fewer built-in safeguards than private student loans, especially when it comes to disclosure requirements. This makes it easier for schools to mislead borrowers about the terms of the debt they are taking on. In one class-action lawsuit filed earlier this year, former students of Colorado-based Westwood Colleges allege they were duped into borrowing institutional loans at a staggering 18 percent interest. According to the complaint, the college's corporate bosses advise their admissions officers to sign students up for these loans without revealing how costly they are going to be. Thus borrowers don't learn about the steep interest until after they leave school and receive their first loan bill. Worse, the lawsuit alleges that some students have been signed up for loans without their permission.

Jillian L. Estes, a Florida lawyer who represents the plaintiffs in the case, says she has been approached by two dozen former Westwood admissions representatives who admit that they deliberately avoided telling students about the terms of these loans. "They knew they'd never be able to enroll these students if they were up front with them," Estes explains. (In their written response to the lawsuit, Westwood College officials offered a "categorical rejection" of the allegations brought by Estes and her clients.)

Significantly, many proprietary schools are pushing institutional loans even when they know students won't be able to pay them off; Career Education and Corinthian Colleges only expect to recover roughly half of the money they distribute through their institutional lending programs, according to communications with shareholders. Why would they lend knowing they won't get the money back? Because any loss is more than offset by federal loans and financial aid dollars, which, despite the surge in private educational lending, still fund the bulk of tuition at proprietary schools. Say a student gets a $60,000 federal financial aid package and supplements it with a $20,000 institutional loan. The school comes out $40,000 ahead even if the borrower ultimately defaults. Plus, getting students in the door pumps up enrollment numbers, which makes for happy shareholders.

As the credit crunch eases, traditional lenders may well go back to making private loans to proprietary school students, especially given the changes afoot in the industry. President Obama aims to get rid of the program that allows lending companies to collect lucrative fees and interest for serving as the middleman on federal student loans and instead have the government offer the loans directly. Once forced out of the federal student loan program, traditional lenders will have a powerful incentive to seek profits by wading deeper into the private student loan market, and for-profit schools, with their exponential growth, could once again be an appealing target

The good news is that the Obama administration seems more inclined than its predecessor to stand up against the abuses of proprietary schools. In May, the Department of Education revealed that it was considering reversing changes the Bush administration made to weaken the law that prohibits colleges from compensating recruiters based on the number of students they enroll. It is also thinking about adding teeth to the rules requiring proprietary colleges to show that graduates are finding "gainful employment" in their field and cracking down on schools that willfully mislead prospective students. "Our overall goal at the Department of Education in post-secondary education is to make sure that students ... have the information they need to make good choices," Robert Shireman, the deputy undersecretary of education, told financial analysts and investors during a conference call earlier this year.

These proposals are a good start, but more steps will be needed. For starters, the Department of Education should publish the data that it already collects on the number of students at each school who default over the lifetime of their loans. At the moment, it only releases the number who default during the first two years after leaving college, which is of limited value, not only because this is such a short time span, but also because the rates can be easily manipulated by schools.

Just publishing lifetime default rates would give prospective students a clearer picture of the risks of enrolling in a particular school. But the impact would be far greater if Congress used this data, along with graduation rates, to weed out abusive institutions; ideally, any school that failed to meet a certain threshold should be kicked out of the federal financial aid programs.

At the same time, Congress should require companies that offer private student loans to give the same kinds of flexible repayment options and consumer protections as are available through the federal student loan program, including allowing borrowers to repay their loans as a percentage of their income. Lawmakers also need to revisit changes Congress made to the bankruptcy code in 2005, which make it exceedingly difficult for financially distressed borrowers, including those with private student loans, to discharge their debt in bankruptcy.

These changes would go a long way toward helping people like Martine Leveque escape their mountains of debt and ensuring that future students don't wind up in the same situation. It would also guarantee that taxpayers don't go on bankrolling giant companies that profit by exploiting those who are struggling to build better lives.

Attention Congress: Don’t Reward Non-Profit Student Loan Wrongdoing

Stephen Burd — Wed, 14 Oct 2009 21:00:00 -0400

At Higher Ed Watch, we have made clear our opposition to a provision in the pending student loan reform legislation that would provide a set aside for all existing non-profit student loan agencies to service up to 100,000 borrowers in their home states. But we have also said that if Democratic Congressional leaders insist on keeping the provision in the bill -- because they believe that they can't pass a bill without it -- they should at least bar from participation non-profit lenders that have broken the law or acted in ways that are harmful to students.

Case in point: the Iowa Student Loan Liquidity Corporation (ISL), the state-affiliated non-profit student loan provider. As both federal and state investigations have shown, ISL's aggressive pursuit of market share and financial rewards over the last decade has been damaging to students and taxpayers alike. According to these investigations, the loan agency has done the following:

Pursued a Concerted Strategy to Steer Borrowers to its Most Expensive Private Loan Products

In a report released a year ago, Iowa Attorney General Thomas Miller found that the agency's aggressive marketing practices and its cozy relationships with area colleges pushed students to take on unnecessarily high levels of expensive private student loan debt. According to the report, ISL provided kickbacks to colleges that recommended its private "Iowa Partnership Loans" to their students. The agency said that the payments, which totaled about $1.5 million to 50 colleges over five years, were meant to reimburse schools for the cost of administering the private loan program. But as the report points out, the types of activities for which the colleges were reimbursed -- such as "counseling borrowers, certifying loan applications, disbursing loans" -- are "all functions that are "normally considered part of a college's administrative capabilities."

The report also found that the loan agency gave financial rewards to their employees based on the number of private loan borrowers they secured; paid bonuses to staff members at the college access centers they managed based on the number of borrowers they brought in; falsely advertised its private loan products as the "lowest cost" options available; and routinely failed to advise students and their families to exhaust their federal student loan eligibility before taking out private loans.

The attorney general said that his findings were particularly disturbing because Iowa college students graduate with the highest level of debt in the nation. "The future of many Iowa students is burdened by a mountain of student loan debt," Miller wrote. "It appears that ISL unduly elevated the goals of increasing its competitive advantage, market share, and loan portfolio size over its mission of always striving to do the best for its student borrowers.

Provided Cash Inducements to Colleges to Win Federal Student Loan Consolidation Business

As we wrote yesterday, the Department of Education recently ordered ISL to repay the federal government nearly $16 million after finding that it had violated a federal law that prohibits lenders from providing "illegal inducements" to colleges to win federal student loan business on the campuses.

At issue is an "affinity agreement" that ISL officials forged with Iowa State University's alumni association in June 2006 in order to get it to exclusively market their federal consolidation loan product to its members. Under the deal, ISL agreed to pay the association $35,000 a year, and to make additional payments based on the number of completed consolidation loan applications generated through the group's promotional efforts. For example, if the association was able to bring in 300 and 399 completed applications a year, it would be paid $25 per application. But if it was able to bring in 600 or more, it would get $75 per application.

ISL officials have denied any wrongdoing. They say that federal regulations that were in place at the time allowed them to pay colleges a reasonable fee for administering their loans. But in its program review report on the case, the Education Department rejected that argument out of hand. "Based on the documentation reviewed, ISL's payments exceeded reasonable compensation for costs and were based on loan volume in violation" of federal law, the Department's investigators wrote. Because the violations were so "serious," the report says, further penalties to the loan agency are being considered, including its possible termination from the student loan program.

Engaged in a Scheme to Bilk Taxpayers by Overcharging the Federal Government

ISL was one of a small group of nonprofit lenders (and some for-profit ones too) that took part in a strategy to improperly grow the volume of federal student loans that they claimed were eligible for the 9.5 percent subsidy rate available from the government on loans financed through tax-exempt bonds issued before 1993. This was a goldmine for lenders in the existing low interest rate environment (at the time, the borrower interest rate on regular loans hovered around 3.5 percent). They accomplished this scheme by transferring loans that qualified for the 9.5 subsidy payment to other financing vehicles and recycling the proceeds into new loans that they claimed were then eligible for the subsidy. These lenders then repeated this process over and over again.

Between 2001 and 2004, the Iowa student loan agency grew its 9.5 student loan holdings by 81 percent to $684 million. A 2007 audit of the agency, conducted on behalf of the U.S. Department of Education, revealed that in 2006 ISL claimed the 9.5 rate on over $300 million of loans not eligible for the subsidies.

What's more, ISL officials continued to pursue this scheme of growing its 9.5 loan holdings even after Congress in 2004 expressly prohibited loan companies from doing so. The cavalier efforts earned an unusually strong rebuke in January 2008 from Bush Administration appointees at the U.S. Department of Education, who rejected the agency's arguments that they had acted legally because the new law was not clear enough. "By failing to seek and obtain clarification, [ISL] abdicated its responsibilities and cannot now be excused from the consequences," David Dunn, the education secretary's chief of staff at the time, wrote to the agency in January 2008.

ISL officials continued to fight the matter until last month, when the Department of Education ordered the agency to return $2.4 million in overpayments it received on 9.5 loans between 2004 and 2006. According to The Des Moines Register, officials with the Iowa loan agency have agreed to repay the money.

Conclusion

In an internal agency e-mail obtained by the Des Moines newspaper in 2007, Steve McCullough, ISL's chief executive officer, wrote that his aim was to achieve "hypergrowth" by pursuing "an aggressive, offensive strategy to bring in new loan volume." In carrying out that mission, the agency lost track of its tax exempt public purpose mission, and instead put students and taxpayers in harm's way.

Does an agency that has operated in this manner deserve a no-bid servicing contract? We certainly don't think so.

Sweeping the Student Loan Scandal Under the Rug

Stephen Burd — Tue, 13 Oct 2009 15:45:00 -0400

The student loan industry must think we all have very short memories. As part of their effort to derail legislation that would eliminate the Federal Family Education Loan (FFEL) program, lenders have been sharing talking points with Senators and staff arguing that the “pay for play” scandals that engulfed the student loan industry in 2007 were much ado about nothing.

“After thorough investigations by Congress and various state Attorneys General, there were no findings that any employee or a lending institution or school broke any laws, nor were there any criminal penalties levied,” lenders wrote in talking points -- which Higher Ed Watch has obtained -- that were distributed to Senate staff.

While that statement may have been technically true at the time it was first made, it’s a brazen sweeping under the rug of a scandal that outraged the American public, particularly college students and their parents. New York Attorney General Andrew Cuomo did charge about a dozen colleges and lenders, such as loan giants Sallie Mae and Nelnet, with violating federal and state laws, and filed lawsuits against them. But instead of fighting Cuomo, the student loan companies and schools quickly reached settlement agreements with his office that required them to change their conduct. In other words, they were not confident enough about the legality of their practices to defend them in court.

The lenders’ claim is particularly cavalier given that they were only able to avoid being penalized because of who was guarding the henhouse. Bush Administration appointees at the U.S. Department of Education with strong ties to the student loan industry simply looked the other way while lenders and college financial aid offices engaged in kickback schemes.

Despite all the evidence that lenders were routinely violating federal law by providing illegal inducements to colleges to win student loan business, the Education Department refused to discipline even a single one of these companies. The Department did not even consider penalizing Student Loan Xpress, which, as we discovered, gave insider stock to leading college officials, not to mention a senior Education Department employee, in order to curry favor.

However, with new leadership at the Education Department, the loan industry can no longer rely on the lax enforcement that allowed it to deny the significance of the “pay for play” scandal in its talking points. Case in point: late last month, the Department ordered the Iowa Student Loan Liquidity Corporation (ISL) to repay the federal government nearly $16 million after finding that officials with the non-profit student loan agency paid off the alumni association at one of the state’s flagship universities to steer borrowers their way.

At issue is an “affinity agreement” that ISL officials forged with Iowa State University’s alumni association in June 2006 in order to get it to exclusively market their federal consolidation loan product to its members. Under the deal, ISL agreed to pay the association $35,000 a year, and to make additional payments based on the number of completed consolidation loan applications generated through the group’s promotional efforts. For example, if the association was able to bring in 300 and 399 completed applications a year, it would be paid $25 per application. But if it was able to bring in 600 or more, it would get $75 per application.

The loan agency and the alumni association terminated the deal in May 2007, about two weeks after The Des Moines Register first reported on it. At the time, media attention on the student loan scandal was at its height, with revelations about sweetheart deals between lenders and schools coming out on almost a daily basis.

ISL officials have denied any wrongdoing. They say that federal regulations that were in place at the time allowed them to pay colleges a reasonable fee for administering their loans. But in its program review report on the case, the Education Department rejected that argument out of hand. “Based on the documentation reviewed, ISL’s payments exceeded reasonable compensation for costs and were based on loan volume in violation” of federal law, the Department’s investigators wrote. Because the violations were so “serious,” the report says, further penalties to the loan agency are being considered, including limiting, suspending, or terminating its future participation in the federal student loan program.

ISL is not the only loan company that is coming under scrutiny. In August, Nelnet revealed that the Education Department was investigating its past loan practices, and had, in an early draft program review report, found the Nebraska-based lender out of compliance “with the Higher Education Act’s prohibited inducement provisions.” It’s unclear when a final report will be released.

Nelnet was particularly aggressive in making exclusive deals with university alumni associations to recommend its consolidation loans to their members. In 2007, the Nebraska-based lender canceled the “affinity” arrangements it had with 120 alumni associations, as part of a settlement agreement with Attorney General Cuomo’s office. So it would not come as much of a surprise if this is one of the areas of “noncompliance” on which the Education Department is focused.

Given the Department’s recent actions and renewed interest in enforcement, the student loan industry would be well advised to drop this particular talking point if it wants to maintain any credibility on Capitol Hill.

Getting to the Truth

Stephen Burd — Wed, 02 Sep 2009 21:30:00 -0400

If nothing else, the False Claims lawsuit that Jon Oberg has filed against the main perpetrators of the 9.5 student loan scheme should help resolve at least some of the unanswered questions surrounding the scandal -- a goal we have been pursuing at Higher Ed Watch over the last year.

While the lawsuit seeks the return to the federal government of $1 billion in excess student loan subsidies these lenders improperly obtained, it also sheds more light on the origins of the lenders' strategy to gain windfall profits at the government's and taxpayers' expense, and the unwillingness of the U.S. Department of Education's political leaders at the time to put a stop to it.

Here are some of the most interesting tidbits included in the complaint:

The lawsuit identifies the Pennsylvania Higher Education Assistance Agency (PHEAA) as having been the "first, or among the first, to employ the 9.5 scheme," and estimates that it received approximately $92 million in overpayments.

PHEAA's success employing the strategy had a domino effect, encouraging other loan companies, like Nelnet, to "emulate what it was doing." Nelnet, which was created in 1998 when Nebraska's non-profit student loan agency converted to for-profit status, became the most active participant in the scheme, making about $407 million in improper 9.5 student loan subsidy claims, the complaint states. In turn, the Kentucky Higher Education Student Loan Corporation (KHESLC) "observed Nelnet's activity" and decided "to increase its own 9.5 claims." According to a recent Inspector General's report, KHESLC engaged in a massive loan and bond refinancing and recycling project over the course of four days in January 2004 so that it could claim 9.5 subsidy payments on "nearly all of its loan portfolio."

The lawsuit suggests that both PHEAA and KHESLC relied on the authority of the Education Finance Council (EFC), the national trade group for non-profit lenders, to justify their practices. While the complaint doesn't state this explicitly, it hints that EFC played a central role in devising the strategy that allowed some of its members to raid the federal treasury. If true, this would be very significant, as officials with close ties to the group held prominent positions at the Education Department and on the Republican staff of the House committee with jurisdiction over student loan policy while the 9.5 scandal was occurring. For example, Bill Hansen was the president and chief executive officer of EFC from 1993 to 2001 before becoming the Deputy Secretary of Education during President Bush's first term. Meanwhile, Kathleen Smith served as the chief of staff and director of corporate communications at EFC before becoming a top aide on the House education committee under Rep. John Boehner, the Ohio Republican. As head of the panel, Boehner vigorously opposed efforts to require lenders to return the overpayments. Smith returned to EFC in 2005 to become its president. She stayed until November 2008, when she took a civil service job at the Department.

The lawsuit undercuts a central argument that the Education Department's former political leaders have made to explain why they were slow to react to the abuses. They have said they were unaware of the extent to which Nelnet and other lenders were gaming the system until the Department's Inspector General (IG) released an audit report in September 2006 explaining the illegality of the loan company's actions. The complaint makes clear, however, that as early as 2003, Oberg had warned his superiors about the lenders' scheme -- providing them with detailed memos explaining how the loan companies were engaging in loan and bond manipulations to improperly grow their 9.5 student loan holdings. This suggests that the Department's leaders had other motives for failing to act expeditiously to stop the lenders from bilking taxpayers.

The lawsuit reveals that an Education Department official provided his or her tacit approval for Nelnet's scheme to overcharge the federal government. According to the complaint, "Nelnet was advised by the Department employee, according to two separate accounts shared with Dr. Oberg contemporaneously, that the Department of Education would never put approval in writing but that Nelnet could take its chances that the Department would never ask for the money back." The complaint does not identify who the employee was, but it is believed to be a former high ranking official in the Department's Office for Postsecondary Education.

At Higher Ed Watch, we applaud Jon Oberg for his tenacity in trying to get to the bottom of the scandal and to recover the government's money. But it's outrageous that our political leaders have left this job to a private citizen.

In June, Rep. Tom Petri (R-WI) sent a letter to Education Secretary Arne Duncan recommending that the Department "explore all options" to recover "these illegal subsidies" that these lenders obtained. "To my knowledge, no funds have been recovered regarding illegal subsidies claimed by lenders and no disciplinary action has been taken against Department of Education officials who allowed this abuse to occur," Petri wrote. "I strongly believe the current Administration should work to restore the integrity of this program by getting to the bottom of this scandal."

Congressman Petri is right. We hope that Secretary Duncan was listening.

A New Chapter in the 9.5 Scandal

Stephen Burd — Tue, 01 Sep 2009 19:00:00 -0400

On Monday, a federal court in Virginia unsealed a whistleblower lawsuit filed by Jon Oberg, the U.S. Department of Education researcher who uncovered the 9.5 student loan scandal, against 10 student loan companies that participated in the scheme. The lawsuit, which Oberg filed in 2007 under the federal False Claims Act, seeks the return to the federal government of $1 billion in excess student loan subsidies these lenders improperly obtained.

The roots of the 9.5 student loan case go back to the 1980s when Congress guaranteed non-profit lenders, which use tax-exempt bonds to finance their loans, a minimum rate of return of 9.5 percent on federal student loans made with these bonds. As interest rates on all other student loans fell in the 1990s, policymakers became concerned that these nonprofit student loan providers were making a killing. So in 1993, Congress rescinded that policy, but grandfathered in loans made from the old bonds, believing that the volume of 9.5 loans would decline as they were paid off and the bonds retired.

Instead, beginning in 2002, a small group of lenders devised a strategy to aggressively grow the volume of loans that they claimed were eligible for the 9.5 guarantee. This was a goldmine for lenders in the existing low interest rate environment (at the time, the borrower interest rate on regular loans hovered around 3.5 percent.) They accomplished this scheme by transferring loans that qualified for the 9.5 subsidy payment to other financing vehicles and recycling the proceeds into new loans that they claimed were then eligible for the subsidy. The lenders repeated this process over and over again.

As a researcher in the Education Department's Institute for Education Sciences, Oberg discovered the scheme in 2003 while reviewing internal agency spreadsheets that showed that the total volume of outstanding 9.5 loans was growing rather than shrinking. He brought his concerns to his superiors at the Department but they brushed them off. His supervisor, Grover Whitehurst, ordered him to stop pursuing the issue, and instead to focus solely on his responsibilities as a research administrator in the final 18 months before his scheduled retirement.

But Oberg had also reported his findings to the Department's Inspector General, which launched its own investigation into the 9.5 scandal. His work paid off in September 2006 when the Inspector General declared the lenders' loan and bond manipulations to be illegal. In January 2007, Education Secretary Margaret Spelling concurred with the Inspector General's opinion and barred the student loan company Nelnet and other lenders that refused to submit to independent audits from receiving any further 9.5 payments. But she did not require the lenders to return the overpayments they had already received.

Unhappy with this resolution, Oberg (who first revealed himself to be the whistleblower on the 9.5 scandal at an event hosted by the Education Policy program here at the New America Foundation in 2006) decided to file his own false claims lawsuit on behalf of the government, his lawyers stated. The lawsuit has been under government seal for the last two years, as the U.S. Justice Department weighed whether or not to join it. The federal district court lifted the seal last week after DOJ decided against joining the lawsuit. By law, Oberg has to right to continue to pursue recovery on behalf of the United States, with the Justice Department retaining the right to intervene at a later time.

Among the main targets in the case is Nelnet, which was created in 1998 when Nebraska's nonprofit student loan agency converted to for-profit status. The most active participant in the scheme, Nelnet increased the amount of loans for which it sought the 9.5 percent rate from $393 million in 2001 to more than $3.3 billion in 2004. The lawsuit estimates that Nelnet made approximately $407 million in unlawful 9.5 claims.

Other student loan companies named in the suit are the following:

The Pennsylvania Higher Education Assistance Agency
The Kentucky Higher Education Student Loan Corporation
Panhandle Plains Higher Education Authority (Texas)
Sallie Mae
Southwest Student Services Corporation (Arizona)
Vermont Student Assistance Corporation
Education Loans Inc.(South Dakota)
Brazos Higher Education Services Corporation (Texas)
Arkansas Student Loan Authority

Here is a link to the news release that his lawyers distributed yesterday. To read some of our recent coverage of the 9.5 scandal, read here, here, here, and here.

Tomorrow we will provide further analysis of this important lawsuit. Stay tuned.

Not So Innocent After All

Stephen Burd — Wed, 05 Aug 2009 18:45:00 -0400

[This is the eighth in the Higher Ed Watch series "Revisiting the 9.5 Student Loan Scandal." The series takes a closer look at the origins of the scandal with the purpose of trying to resolve unanswered questions and dispel lingering myths surrounding it. Links to earlier parts of the series are available here, here, here, here, here, here, and here]

Sallie Mae has long boasted that it did not take part in the 9.5 percent student loan scheme. But a new report from the U.S. Department of Education's Inspector General (IG) refutes that claim.

According to the report, which was released on Monday, Sallie Mae improperly obtained $22.3 million in excess student loan subsidies from the federal government between Oct. 1, 2003 and Sept. 30, 2006. The actual amount that the company over-billed the government is probably substantially higher -- as the IG looked only at how the student loan giant handled the 9.5 loans it obtained through its purchase of Nellie Mae [NLMA], the Massachusetts non-profit student loan agency. Between 2000 and the end of 2004, Sallie Mae bought three other non-profit lenders, including the Arizona-based Southwest Student Services Corporation, which had increased the volume of federal loans that it claimed eligible for the 9.5 percent guarantee by 135 percent in the years immediately preceding the sale.

To be clear, Sallie Mae does not appear to have engaged in the type of loan and bond manipulations that other companies, like Nelnet and the Kentucky Higher Education Student Loan Corporation, did to massively grow their 9.5 loan holdings. Instead, the loan company violated the law by submitting 9.5 claims on loans financed by tax-exempt bonds that had matured and been retired, the IG report states.

In the 1980s, Congress guaranteed non-profit lenders a minimum rate of return of 9.5 percent on federal student loans made with tax-exempt bonds. As interest rates fell in the 1990s, policymakers became concerned that these non-profit student loan providers were making a killing. So in 1993, Congress rescinded that policy, but grandfathered in loans made from bonds that had been issued before the new law went into effect. By making that change, lawmakers believed that the volume of 9.5 loans would decline as they were paid off and the bonds retired.

According to the IG, Sallie Mae submitted 9.5 claims for, and received payments on, federal loans funded by bonds that had expired several years before the claims were made. Sallie Mae officials defended their practices, saying that it was entirely lawful for them to continue billing loans under the 9.5 percent floor until the last bond associated with an "indenture" -- "a formal agreement between the issuer of bonds and a trustee bank," according to the report -- was retired. In other words, the loan company argued that as long as one bond included in this type of trust agreement remained active, all loans financed by bonds included in the agreement were still eligible for the inflated subsidy rate.

The IG rejected this argument. "We do not agree that SLMA's position is a reasonable interpretation of the HEA [Higher Education Act] or regulations," the report states. As a result, Sallie Mae's "billing activities for its NLMA subsidiary did not comply with laws, regulations, and guidance for the 9.5 percent floor calculation."

Interestingly, Nellie Mae had been in full compliance with the law before the purchase. Sallie Mae "took the position that NLMA was mistaken when it ceased billing on a particular bond prior to the maturity of the particular bond indenture," the IG said.

Sallie Mae was certainly not the worst player in the 9.5 scandal. But like the other loan companies involved, it did exploit the law to gain windfall profits at the taxpayer's expense. Unfortunately, this type of waste and abuse appears to have become endemic to the Federal Family Education Loan (FFEL) program. Is it any wonder that the program is on the brink of extinction?

More Scare Tactics from the Student Loan Industry and Friends

Stephen Burd — Tue, 28 Jul 2009 15:30:00 -0400

Now that legislation is moving forward that would carry out President Obama's plan to eliminate the Federal Family Education Loan (FFEL) program, the student loan industry and its most hard-line supporters in the financial aid world are doing what they do best: spreading fear about proposed changes to the student loan programs that would be harmful to their interests.

Take, for example, the Consumer Bankers Association (CBA). In a press release last week, the group wrote that the House Education and Labor Committee's approval of the bill was "a setback for students."

Come again? The legislation would use savings from ending FFEL to boost spending on Pell Grants by $40 billion (yes, you read that right -- 40 BILLION DOLLARS) and significantly expand the low-interest Perkins Loan program so that financially needy students can avoid taking out high-cost private student loans.

So how exactly would the bill's passage harm students?

According to the CBA, if the legislation is enacted and student loans are made entirely through the U.S. Department of Education's Direct Loan (DL) program, "students and parents would no longer have a choice of lenders, a right they've had since 1965."

A group of financial aid directors -- who appropriately call themselves "the Friday the 13th Group" -- made the same point in a letter they sent to lawmakers in April opposing President Obama's proposal. "By eliminating the FFEL program, we essentially remove the ability for borrowers to choose a lender," the group wrote. "This inherent freedom has been available for more than 40 years." ("Inherent freedom? Are you kidding me?" a financial aid administrator who supports the continuation of FFEL but is critical of the group's approach wrote recently on a listserv for aid officers. "Now freedom of the press, freedom of speech, freedom of religion - those are inherent freedoms.")

At Higher Ed Watch, we understand the appeal of this argument. But we also know that it is nothing more than a red herring.

If there is anything that we learned from the "pay for play" student loan scandal, it is how little choice borrowers in the FFEL program actually have. Don't forget that in 2007, the Education Department found that one lender made at least 80 percent of students' federal loans at 921 participating colleges. That same year, the research firm Student Marketmeasure reported that 1,412 FFEL schools had one loan provider that made 80 percent of their students' federal loans, with 531 of those colleges recommending only a single lender to their students. What kind of a choice is that?

Now we know that Congress took steps last year, as part of the Higher Education Act reauthorization legislation it approved, to give students at least a modicum of choice. Under the measure, colleges that have "preferred lender lists" will be required to recommend at least three lenders to their students. That provision has not yet gone into effect, as the U.S. Department of Education has only today released proposed rules to carry it out. Regardless, nothing in these regulations will prevent colleges from continuing to steer the vast majority of their students to a favored lender.

The truth is that students don't really have much of a choice in the FFEL Program. Most financial aid administrators provide a preferred lender list -- which in and of itself narrows down their students' choices. The vast majority of students stick to their aid administrators' recommendations. Notice that most lenders who have tried to buck this trend -- like MyRichUncle -- have ultimately failed.

Perhaps the most hollow part of the “borrower choice” argument is the fact that a lender making FFEL loans is not allowed under program rules to significantly differentiate its product from other FFEL lenders. This is because all lenders must disperse Stafford loans and PLUS loans that have the same terms for borrowers, with only some room to offer slightly more generous interest rates than those required by law. Given that the loans are the same, why is borrower choice so important? It's really only important if you’re a student loan company.

At a House Committee on Education and Labor hearing in May, Rep. Tim Bishop (D-NY) said that the lenders' claim that students would lose choice under the President's proposal was "a seductive argument." However, having been a college administrator for 29 years before coming to Congress, he said it just didn't ring true.

"I never once heard a student say, ‘Gosh, I wish I had a choice,'" Bishop said. "They were grateful to know that that there was a source of money available to them."

The financial aid administrator who wrote into the financial aid listserv criticizing the Friday the 13^th group's letter agreed.

"Most students don't even know who their lender is. With the main point being -- they don't really care," he wrote. "Students are just interested in getting their money. They are not concerned about who is providing it to them."

He added, "I am supportive of maintaining both the DL and FFEL programs." But if ensuring student choice "is our biggest argument for saving FFELP (and I have to assume it is because it was listed first in the letter), then FFELP is in big trouble," he stated.

We couldn't have said it better ourselves.

Jason Delisle contributed to this post.