Auctions

Congress Blinks in Game of Chicken with Lenders

Ben Miller — Thu, 02 Apr 2009 20:13:00 -0400

On Monday, the U.S. House of Representatives gave in to pressure from the student lending community by agreeing to a one year postponement of the pilot PLUS loan auction that was slated to begin just under two weeks from now. The Senate is expected to follow suit.

Auction opponents are on the verge of winning the delay because they have threatened to not participate and have made claims that the competitive bidding process rests on too much uncertainty for all involved. We understand why these claims would resonate with lawmakers, but the facts of the auction process simply don't bear them out. Instead, the fear and panic raised by the auction's detractors resulted in an unnecessary game of chicken between lenders and Congress. It's clear who blinked first.

The House included the delay as part of legislation it approved on Monday that aims to make mostly technical corrections to legislation it passed last summer reauthorizing the Higher Education Act. The bill is still waiting on Senate action before it can head to President Obama's desk, though little opposition is expected.

Calls for the delay have come mostly from private lenders and the National Association of Student Financial Aid Administrators (NASFAA), parties that have opposed the auction since its inception as part of the 2007 College Cost Reduction and Access Act. While their arguments against the competitive bidding process have varied, most recently they have had four main talking points:

Lenders would not bid, leaving the system with a lot of uncertainty.
The auction would take too long to announce winners, bringing uncertainty for colleges putting together aid packages and families trying to take on loans.
The auction would lower subsidies for lenders, making it unprofitable to make loans.
Financial conditions make it too hard to bid on a long-term contract

While these arguments all make for good talking points, they are not all borne out by the facts of the PLUS loan auction. Let's take a closer look at these claims.

No Bidders Creates Uncertainty

Several big name lenders, including Sallie Mae and Nelnet, have announced over the past several weeks that they would not be participating in the initial round of bidding on April 15. The lenders' refusal to bid raised concerns that the auctions would fail in many states, and a lack of bidders would result in uncertain borrowing conditions for parents.

But this argument lacks merit for two reasons. First, the auction legislation provides for a lender of last resort that would make all PLUS loans in a state where there are no winning bidders. Under this setup borrowers would be guaranteed to receive their loans and would know exactly from whom they are borrowing. Second, states with no winning bidders and no lender of last resort just return to conventional PLUS lending, in which companies compete to make loans with a 97 percent guarantee against default losses and a typical subsidy rate. A complete auction failure across the country would leave the PLUS loan market completely unchanged. In that case, borrowers would be no more or less certain about receiving PLUS loans than they are in the current market.

Long Timeframe

Another common concern raised by auction opponents is that it would take too long to announce the winners, hindering efforts by schools to put together aid packages and parents to begin taking out loans.

But consider the actual timeframe involved. The auction was set to take place on April 15, less than two weeks from today. Winners would be announced nine days later, on April 24. In the meantime, the final round of college admissions letters did not even go out until the end of March or early April. Students then have until roughly the beginning of May to select their school. In other words, the PLUS loan auction winners will be announced before many students commit to an institution, let alone start the process of taking out loans.

Lower Subsidies Make Loans Unprofitable

As we've written previously, claims that the competitive bidding process would drive down lender subsidies to the point where making PLUS loans is unprofitable fail to consider the additional benefits winning lenders receive.

The two lenders with the lowest subsidy bid rates receive a higher guarantee rate against loan default (99 percent versus 97 percent) and do not have to pay the 1 percent federal default fee required of conventional PLUS lenders. Both of these benefits reduce the cost of a loan. As a result, if lenders were to submit subsidy bids at or around the current rate (3-month commercial paper plus 1.79 percentage points), then the auction could very well reduce their costs. And that's without taking into account ancillary benefits, such as the need to no longer employ large marketing and sales staffs to solicit more PLUS loan volume.

Financial Conditions

Unlike the other talking points, we are sympathetic to concerns by lenders that they may not have the financial capability to guarantee that they can make all of a state's parent PLUS loans for the next two cohorts of students. But winning lenders will still have the authority to sell their loans back to the Department of Education as they are currently allowed to under the Ensuring Continued Access to Student Loans Act. This authority expires after the 2009-10 school year, but it provides some cushion for lenders to figure out their financing.

More broadly, however, if lenders do not have the capital to fulfill their duties as an auction winner, then they should not bid. In a sense, the auction rewards those that that are in good enough financial standing to serve as a winning lender. And as we said before, if no one bids, the system reverts back to business as usual and no one is any better or worse off.

Why Delay?

So let's review. Worst case scenario, no one submits bids, and by April 24 we know that the market will continue to operate as it had. Parents will still have time to find loans before their children enter school in the fall and lenders' financing will be no different. If lenders and NASFAA are so sure that is what would happen anyway, why not just wait the three weeks and get proven correct instead of raising panic levels unnecessarily?

Weekly Roundup: Week of March 9 - March 13

Ed Policy — Fri, 13 Mar 2009 19:00:00 -0400

Republican Lawmakers Spar with Education Secretary Over Pell Grants

Sallie Mae Says No to Plus Loan Auction

Nevada AG Warns Students to Avoid Unlicensed Trade Schools

Republican Lawmakers Spar with Education Secretary Over Pell Grants

At a U.S. House of Representatives Budget Committee hearing on Thursday, Republican lawmakers took aim at President Obama's proposal to make the Pell Grant program into a true entitlement for low-income students by financing it entirely through mandatory spending. Rep. Paul Ryan of Wisconsin, the budget committee's top Republican, said he was disappointed with the President's plan "to move this program to the mandatory side of the ledger" at a time when the costs of other federal entitlement programs, like Medicare and Social Security, are spiraling out of control. "We should be reforming existing entitlements, not adding new ones to the mix," he stated. Education Secretary Arne Duncan, who testified at the hearing, defended the plan, saying that it would turn the program into "a more reliable" source of funding for low-income students wishing to pursue a higher education. "For the first time ever, Pell Grants will not be subject to the politics of the moment or the whims of the market," Duncan said. "They will be a commitment that Congress is required to uphold each and every year."

Sallie Mae Says No to Plus Loan Auction

Sallie Mae, the country's largest student loan provider, announced in a letter to colleges this week that it will not participate in the U.S. Department of Education's upcoming PLUS Loan Auction, which would use market forces to set student loan subsidy rates for lenders making federal PLUS loans to parents. The loan company's decision comes a week after the U.S. Department of Education signaled its intention to move forward with the auction, despite the continued downturn in the economy and the student loan industry's opposition to the program. Sallie Mae said that taking part in the auction would not be profitable for the company, which currently controls about 40 percent of the PLUS Loan market. The loan giant appears to be confident that other lenders will sit out the auction as well -- noting in its letter that if the auction collapses, the current system would stay in place.

Nevada AG Warns Students to Avoid Unlicensed Trade Schools

The State Attorney General's Office in Nevada issued a press release this week warning students to avoid unlicensed and unaccredited trade schools that do not participate in the federal student aid programs. "History often repeats itself, and this decade is no different when it comes to student loan scams facilitated by private student lenders willing to partner with largely unregulated vocational, trade, and technical schools," the news release states. "Unfortunately the end result often leaves the student borrower on the hook for costly student loans and, too frequently, with little or no education or training to show for it." The AG's office likened these scams to "a Ponzi scheme" with the schools' survival depending entirely on their ability to lure in students, often predicated on false premises. The Nevada AG has been investigating the collapse of Silver State Helicopters, a for-profit chain that shut down unexpectedly on Super Bowl Sunday last year. As we reported this week, the FBI and a group of state attorneys general are investigating the exclusive lending arrangements that KeyBank had with Silver State and TAB Express, a defunct flight school in northern Florida.

Briefly Noted...

Congress completes action on omnibus spending bill for the 2009 fiscal year that increases spending on Pell Grants, GEAR UP, and the TRIO programs for disadvantaged students.
Federal Reserve issues proposals to improve consumer disclosures on private student loans, as required under last year's Higher Education Act reauthorization legislation.
Connecticut nonprofit student loan agency under fire for "questionable expenses."

Getting the Facts Straight on the PLUS Loan Auction

Jason Delisle — Tue, 03 Mar 2009 22:30:00 -0500

At Higher Ed Watch, we hate to see journalists get played by the student loan industry. But that's just what happened last week when two well-respected national publications -- The Wall Street Journal and The Chronicle of Higher Education -- ran articles in which they mischaracterized the upcoming PLUS Loan Auction, a program that private lenders and some groups representing financial aid administrators oppose.

Reporting on efforts by the National Association of Student Financial Aid Administrators to delay implementation of the auction program, the two newspapers claimed that the auction was designed to cut federal subsidies for private lenders ("Schools Seek Delay in Move to Cut Subsidies to Student Lenders," the Wall Street Journal proclaimed). This assertion echoes the loan industry's talking points and is just plain wrong. In fact, the auction allows for a subsidy increase for lenders making PLUS loans.

In 2007, Congress created the new auction program to determine student loan subsidy rates for private lenders making federal PLUS loans to parents. The auction replaces a system that allows Congress to set the subsidy rate through political negotiations. The first auction is set to begin this April, and applies to all parent PLUS loans made in the 2009-10 and 2010-11 academic years.

The PLUS loan auction requires that the quarterly interest rate subsidy guaranteed lenders under the FFEL program structure be no higher than the rate now set in law (3-month commercial paper + 1.79). In other words, lenders may receive the same interest rate subsidy on a PLUS loan under the auction as they do now - they just have to bid at that rate.

At the same time, the auction makes two key changes to current law that would result in lenders receiving larger subsidies than today.

First, loan companies that win the auction will no longer have to pay the U.S. Department of Education a fee equal to one percent of the principal value of the loan upon origination, as PLUS loan providers currently do.

Second, the loans made under the PLUS auction will carry a 99 percent guarantee. Under the current program, PLUS loans carry a 97 percent federal guarantee against default losses for lenders. That's a big increase in the federal subsidy... according to the logic used by lenders. Those who follow the industry closely will recall that when some in Congress proposed reducing the federal guarantee on all FFEL loans in 2007, lenders vehemently opposed such changes, arguing that even small changes in the guarantee rate have big effects on the value of the loan.

Interest Rate Subsidy Cut is Voluntary

If lenders can get the same interest rate subsidy under the PLUS loan auction, but pay less fees to the federal government and are granted a higher (99 versus 97 percent) guarantee against default losses, how on earth can the program be characterized as cutting subsidies? The only way subsidies would be cut under the PLUS loan auction is if lenders submit bids lower than the 1.79 percentage point cap. Perhaps some lenders will, and perhaps some won't. We won't know until the bids are in.

But that's not the story that the loan industry wants you to hear. Unfortunately, reporters at The Wall Street Journal and The Chronicle of Higher Education took the bait. Hopefully, they'll be more careful in the future.

Please Don't Make Us Bid on PLUS Loans!

Jason Delisle — Wed, 25 Feb 2009 21:30:00 -0500

Are private student lenders and their allies in the financial aid world thankful for the credit crunch? If they can use the market turmoil as an excuse to torpedo the PLUS loan auction set to begin this year, they may very well be.

The student loan industry and their friends in the national and state associations representing financial aid administrators are calling on Congress and the Obama Administration to postpone or eliminate the new pilot auction program, arguing that current financial market disruptions would make it unworkable. They also argue that the program, which would use market forces to set student loan subsidy rates for lenders making federal PLUS loans to parents, won't reduce costs for the government.

Policymakers should bear in mind a few key points when considering the loan industry's latest cries.

Credit market disruptions have made the whole Federal Family Education Loan (FFEL) program structure 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 convert them into direct loans, as well as to lend federal money to FFEL lenders. The auction as designed may very well be an awkward fit within this new FFEL paradigm.

Yet, where there is a will, there is a way... to make the auction work. The ECASLA programs are a perfect example of how creative policies have been implemented to ensure the FFEL program continues to function in the face of credit market turmoil. These policies, however, are possible only because of the cooperation and support of the student loan industry, the Congress, and the Administration.

We don't doubt that these groups could find a way to make the auction work under the new FFEL structure and credit market environment. For starters, Congress could enact legislation increasing or removing the arbitrary cap on the subsidy bids lenders are allowed to make under the pilot auction program.

Policymakers should know, however, that such cooperation is unlikely, as the loan industry opposed any auction even before Congress had drafted its first proposal in early 2007. In fact, the lenders' concern about credit market conditions is largely a smokescreen. Lenders fear an auction because they would have to bid for the federal subsidies that they receive for making FFEL loans. This would require that they tip their hand and show the federal government and taxpayers what an appropriate subsidy rate really is. Moreover, the least efficient lenders would be squeezed out of the program. (Gee, imagine that.)

The industry's claims regarding auction costs savings are also a straw man. The auction program isn't so much about reducing costs as it is about getting student loan lobbyists and the Congress out of the business of setting subsidy rates. This model for setting loan subsidies is a terribly inefficient policy and one that we have criticized in a number of posts (available here, here, and here). Bear in mind, even if the auction increases costs for taxpayers, it is still superior to the existing subsidy setting approach.

The FFEL program wasn't designed to work under current credit market conditions. But the loan industry, of course, didn't argue that we should abandon the FFEL program or "postpone" it. Instead, they helped Congress and the Bush Administration design a solution. Why then should the auction be postponed or abandoned?

10 Higher Ed Questions for Arne Duncan

Ed Policy — Mon, 12 Jan 2009 14:29:00 -0500

Education Secretary-Designate Arne Duncan will appear before the Senate Heath, Education, Labor, and Pensions Committee for his confirmation hearing on Tuesday morning. While Higher Ed Watch won't be there to grill Duncan, we do have some tough questions on higher education policy for the Chicago Public Schools chief. Feel free to suggest ones of your own.

(1) Do you believe that the federal student aid programs, as currently designed, are appropriately targeted and work both efficiently and effectively in expanding college access, or do you believe that the programs need to be overhauled to ensure that the doors of college remain open for low-income and working-class students?

(2) Do you expect the administration to continue supporting both the Direct and Guaranteed Student Loan Programs or instead push for a 100 percent Direct Lending model given research that shows this program is less costly to run?

(3) As currently designed, federal higher education tax credits disproportionately favor middle- and upper-income families and are largely unavailable to low-income families due to the fact that they are nonrefundable and have limitations on the costs that they cover (tuition and fees versus cost of attendance). Given that the federal student aid system was created to increase the enrollment rates of those who could not otherwise afford to attend, are tax credits an efficient way to deliver limited student aid resources? Has the administration given any thought to revamping the current tax credits so they are available to lower-income families? What steps do you anticipate taking to ensure that the President-elect's proposed American Opportunity Tax Credit is available to low-income students who may have trouble meeting the 100 hour service requirement due to family and work responsibilities?

(4) Over the last several years, the federal government has increasingly asked and expected families to save more for their children's college education, and more and more are doing so in 529 college savings plans. As currently designed, 529s disproportionately benefit higher-income families who can afford to save and who reap enormous tax benefits for doing so. Potentially building on some innovations in various states, what would you do to make 529s more progressive or more attractive to the millions of moderate- and middle-income families who find it hard to save for their children's education but very much want to?

(5) The College Cost Reduction and Access Act, signed into law in September 2007, included a new auction program to determine taxpayer subsidy levels paid to private lenders that make federal student loans. The auction program will apply to all federal Parent PLUS loans made in the 2009-2010 academic year and thereafter. Does the administration plan to implement the program as required under law, or will it seek changes to the program, or argue that it be postponed as some stakeholder interest groups have suggested?

(6) Studies have shown that a large percentage of students taking out private loans do not first exhaust their eligibility for cheaper federal student loan options. This can be extremely harmful to students, since private student loans almost always have much higher interest rates than federal loans and rarely provide repayment options that take into account income or public service. What do you think can be done to ensure that students first exhaust their cheaper federal student loan options before turning to private student loans?

(7) Private student loans currently enjoy a level of protection in bankruptcy court akin to unpaid taxes, child support, and government fines. In reality, they are more similar to a car or home loan, which is dischargeable during bankruptcy proceedings. This disparity in treatment creates an enormous burden for students who find themselves stuck with high-cost debt during tough financial times. Do you believe that more should be done to equalize the bankruptcy treatment of private student loans so that they are closer to other conventional types of consumer debt?

(8) Ever-increasing college prices are a major concern of American families. Some experts fear that college will be absolutely unaffordable for all but the most affluent within the next 25 years. Do you envision a proactive way for the federal government to do more to control college costs?

(9) According to budget officials at the Department, the Pell Grant program is facing a $4 to 5 billion shortfall in the coming year. Will attempting to close that gap prevent the administration from being able to fulfill its campaign promise to significantly increase the maximum Pell Grant?

(10) The Bush administration has been accused of turning a blind eye to allegations of corruption in the student loan industry. Will the Department of Education, under your leadership, make enforcement of student loan law and regulations a higher priority than it has been? How would you accomplish that?

Image used under a creative commons license from flickr user Obama-Biden Transition Project

Back Room Deal on Student Loan Subsidies?

Jason Delisle — Thu, 04 Dec 2008 15:45:00 -0500

Last month Secretary of Education Margaret Spellings wrote to Sen. Edward Kennedy (D-MA) asking that Congress retroactively change the way the federal government sets lenders subsidies in the guaranteed student loan program. This request has received little attention from the press given its arcane nature.

At issue is the index the government uses to set subsidy payments to lenders. Currently, subsidy payments are indexed to commercial paper interest rates, but securitization markets prefer to operate on LIBOR, a different index. In her letter, Secretary Spellings says that "volatility in the financial markets" has caused a major mismatch between the two indexes that could "have a severe impact on lenders' ability to make loans." She urges Kennedy to change the index "as quickly as possible."

While we appreciate the Secretary's concerns, this is not a matter that should be rushed or handled through behind-the-scenes policy negotiation. What Spellings has proposed is unprecedented, could be costly to taxpayers, and again highlights the desperate need for long-term reforms in the Federal Family Education Loan (FFEL) program.

The Subsidy And Its History

The federal government provides an interest rate subsidy to private lenders making FFEL loans (and a guarantee against 97 percent of default losses). The subsidy ensures lenders are paid a quarterly short term market interest rate plus a somewhat arbitrary mark up (currently 1.79 percentage points) for the life of the loan. This "Special Allowance Payment" (SAP) has been a key part of the loan program for decades. It compensates lenders for the cost of capital used to make the loans and the costs that they incur servicing them.

For decades the quarterly SAP was based on the interest rate on 91-day Treasury bonds, plus 2.5 to 3.5 percentage points. But in the late 1990s lenders rightly argued that the SAP should be based on a market index for short term interest rates, not risk-free rates at which only the federal government borrows. Indeed, a market rate better aligns the federal subsidy to lenders' capital costs. But which market index should be used?

Lenders financing loans through securitization usually need to pay investors rates based on 1-month or 3-month LIBOR, making it an ideal index for the subsidy. During the deliberations, lenders acknowledged that LIBOR was the best choice but argued instead for a different market index. They told the Department of Education and the GAO that, "... the FFELP Group recommends that the Congress adopt the 90-day Commercial Paper (CP) rate plus 2.40% as the reference rate used to determine lender yield on FFELP loans."

Why not LIBOR?

At the time, temporarily switching the subsidy index from 91-day Treasury rates to CP on new loans showed $20 million in savings from 2000 to 2003, while LIBOR was projected to increase costs. Thus, lenders backed the index that appeared to generate savings since it was more likely to be adopted. In 1999 Congress enacted the CP change for new loans made through 2003, and then in 2002 made the rate permanent at a considerable cost to taxpayers.

Credit Crunch

Since 2000 lenders have been borrowing at LIBOR rates to finance loans that pay slightly lower CP rates. The arrangement worked because LIBOR and CP rates were roughly the same over that time period, but there was always a small chance that the rates could diverge enough to make the financing source problematic.

And that is exactly what has happened.

Credit market disruptions have thrown the two interest rate indices into fits. In October, LIBOR spiked some 2.00 percentage points above CP (compared to an average 0.12 percentage points), and though it has settled lower recently, the spread is still well above historical averages.

Unprecedented, Costly... And All Behind the Scenes

In response to the market disruptions, Secretary Spellings and the lending industry want to temporarily change the CP index to LIBOR for existing guaranteed loans. That means outstanding loans made in past years would suddenly start paying a different subsidy rate to lenders. The move would be unprecedented. Subsidy rate changes have always been done prospectively - that is, they have applied to newly issued loans, not loans made earlier. What's more, the change could cost taxpayers hundreds of millions of dollars each financial quarter in higher subsidies to lenders.

For these reasons, Congress and the Secretary must have an open debate on the index change, rather than negotiate through private correspondence and backroom deals with student loan companies. At a minimum, a Congressional hearing should be held before any action is taken. Important policy changes are too often slipped into larger must-pass legislation without thorough vetting... and are subsequently made permanent by the same process. The LIBOR change is ripe for such pell-mell policy making.

Long Term Reform Needed

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, 200-page study group reports and lobbying bonanzas.

Read the latest post on this issue here.

Election 2008: Our Wish List for the President-Elect

Ed Policy — Wed, 05 Nov 2008 18:15:00 -0500

Barack Obama's historic victory last night ensures that a change in direction is coming to the U.S. Department of Education and hopefully to federal higher education policy.

Starting tomorrow, we will take a closer look at Obama's signature higher education proposals. (Got to give him at least a one day honeymoon, right?) Today, we will present our wish list for the incoming administration. Here are some changes we would like to see:

Emphasize Oversight and Enforcement at the Department of Education: Over the last eight years, the Bush administration officials in charge of the Department looked the other way as widespread abuses occurred in the Federal Family Education Loan (FFEL) program. To this day, the Department has not disciplined a single lender for violating a federal law that prohibits loan providers from offering inducements to secure student loan business. At the same time, the education secretary allowed lenders to keep more than $1 billion they illegally obtained in improper subsidy payments. Federal leadership is sorely needed to protect the integrity of the federal student loan programs, for the sake of both the students who depend on them and the taxpayers who finance them. For starters, the new administration should take a close look at the conflict-ridden relationship between Sallie Mae and USA Funds, the guarantee agency it effectively controls. As we have noted, there is compelling evidence that the loan giant has exploited this arrangement to take advantage of borrowers who are having difficulty repaying their federal loans. A thorough investigation is needed.

Lead the Way on Federal Student Loan Reform: The time has come for the government to reassess the way we provide low-cost federal loans to students. Do we still need two competing federal student loan programs to fulfill this function? If so, we need to focus on finding the most efficient ways to run these programs. Currently, the way the government sets subsidy rates in FFEL is arbitrary, wasteful, and subject to political manipulation. In addition, the program's complexity makes it ripe for abuse and makes good oversight by both the Department and Congress more difficult. Hopefully, Obama and his Democratic colleagues in Congress won't let the lenders' scare tactics frighten them away from pursuing reform. If anything, the credit crunch provides even further evidence that policymakers need to fundamentally change the way the government compensates student loan providers.

Provide Relief to Student Loan Borrowers in Desperate Straits: In 2005, Congress tucked a provision into bankruptcy reform making it extremely difficult for financially distressed borrowers to discharge private student loans. As we have said before, we don't see any good reason for private loans to be accorded the harshest bankruptcy status. Individuals who borrow private loans are trying to better their lives. They certainly shouldn't be treated more harshly than those with excessive credit card debt. This summer, Obama unveiled a plan to rewrite federal bankruptcy law to make it easier for financially strapped senior citizens, military families, and individuals suffering from medical emergencies to get relief from debilitating debt. We would like to see Obama extend this relief to struggling private student loan borrowers as well.

Strengthen Consumer Protections for Students Against Unscrupulous Trade Schools: Over the last decade, some of the largest publicly traded for-profit higher education companies have come under intense scrutiny from federal and state regulators and have faced numerous lawsuits by former employees, shareholders, and students over allegations that they have engaged in deceptive recruiting and admissions tactics to inflate their enrollment numbers. Yet at the same time, the Bush administration and Congress, under both Republican and Democratic control, have weakened provisions in the Higher Education Act that aim to protect students from questionable schools. If Obama and the Democratic-led Congress are serious about changing Washington, they need to put the interests of students before those of deep-pocketed trade school lobbyists. The new administration can get off to a fast start on this front -- by using the Department of Education's upcoming negotiated rulemaking sessions to overturn regulatory changes the Bush administration made in 2002 that made it easier for unscrupulous trade schools to take advantage of low-income and working-class students.

Concentrate on Redesigning and Simplifying Federal Student Aid, Rather than Adding New Programs: The federal student financial aid system is not working as well as it should. Financially needy students are taking on too much debt and working an excessive amount of hours at jobs outside of school to pay for college. The last two Congresses have seen new additions to the federal student aid programs, including the introduction of new grant and loan forgiveness programs aimed at increasing the academic preparation of low-income students and encouraging students to go into low-paying, public-service careers such as teaching. While well-intentioned, lawmakers have created a mish mash of programs that are redundant and don't always interact well together. We would suggest that the new administration step back and consolidate, coordinate and simplify financial aid in ways that make it clear where students can get the best deal as it relates to paying for college and paying student loans back. The federal government doesn't need new programs, it needs a coherent system. It's also time for a president who is willing to take institutions of higher education head on in the debate over rising college prices.

That's our wish list. How about yours? Please send us any higher education recommendations you may have for the next president. We look forward to reading them.

Election 2008: Student Aid Hurdles for the Next President

Ed Policy — Tue, 04 Nov 2008 16:00:00 -0500

No matter whether Sen. Barack Obama (D-IL) or Sen. John McCain (R-AZ) wins today's election, the next president is going to face major challenges on the higher education front.

While neither candidate has made education a centerpiece of his campaign, each has offered proposals that may be difficult to carry out given the hurdles that lie ahead. Not the least of which is the federal budget deficit, which is likely to far exceed the $482 billion the Congressional Budget Office projected in July. Obama may be particularly frustrated in his plans, as he has called for significantly increased spending on federal student aid. McCain, on the other hand, has proposed consolidating the government's aid programs.

Here is a brief description of some of the other student aid challenges awaiting the next president:

The Continuing Credit Crunch

Over the last year, the federal government has made extraordinary efforts to help the student loan industry cope with the turmoil in the financial markets. As a result of these efforts, and the revitalization of the Direct Student Loan program, students haven't experienced any difficulty obtaining federal loans.

Still, there's little evidence that the credit crunch is likely to subside anytime soon. With more and more colleges considering switching to Direct Lending, lenders and their allies at groups like the National Association of Student Financial Aid Administrators will continue to raise panic levels and demand greater federal intervention to prop up the ailing Federal Family Education Loan (FFEL) program further (including a renewed effort to get Congress to rescind the cuts it made to lender subsidies last year). In the face of these entreaties, it will be important for the new president to remember that the point of the federal student loan programs is not to protect the well-being of each and every lender, but to make sure that low-cost loans are available to college students.

The new administration will also have to resist efforts by the loan industry to use the credit crunch to kill key student loan reforms, such as the new pilot PLUS auction program that is scheduled to go into effect next fall. If anything, the credit squeeze provides even further evidence that policymakers need to fundamentally change the way that the government compensates student loan providers.

Budget Shortfall in the Pell Grant Program

A surge in demand for Pell Grants -- caused by the downturn in the economy and a major expansion in student eligibility for the awards by Congress -- has left the program in a deep hole. According to the Department of Education's budget chief, Congress will need to find an additional $4 to $5 billion to keep the maximum Pell Grant award at its current level of $4,731. Given the political stakes, the next president and Congress will likely find the money to keep the program whole. But spending such an exorbitant amount just to maintain the status quo will leave them with few, if any, additional resources to raise the Pell Grant further or to finance other student-aid priorities.

This could be especially problematic for Obama because he would be under substantial pressure from Democratic-leaning interest groups to substantially increase spending on student aid. Ironically, if elected, he could find himself in the same position as former Democratic President Bill Clinton was early in his presidency. During his first several years in office, Clinton and the Democratic Congress grappled with a $2 billion Pell Grant shortfall and were able to provide only a tiny increase in the maximum grant. College leaders and lobbyists complained bitterly. This is "what we are used to seeing from Reagan and Bush. But a kick in the teeth hurts a lot more from a friend," Julianne Still Thrift, then-president of Salem College and a strong supporter of Clinton, told The Chronicle of Higher Education in 1993.

Expiring Student Aid Programs and Benefits

The next president is also going to have a very difficult decision to make regarding student loans toward the end of his first term. The interest rate reduction that Congress approved for subsidized federal student loans is due to expire at the end of the 2011-12 academic year. In other words, under current law, loans issued that year will have a fixed interest rate of 3.4 percent for the life of the loan, but loans issued the following year will carry a fixed rate of 6.8 percent. The new president will have to decide whether he supports extending the 3.4 percent interest rate. Doing so could cost as much as $3 billion a year. Of course, allowing student loan interest rates to double could be politically risky, no matter the costs or public policy implications. [At Higher Ed Watch, we believe that policymakers should consider expanding the existing student loan interest rate reduction instead. That proposal would be less costly and better targeted on recent college graduates with burdensome levels of debt.]

Also expiring during the next president's term will be two relatively new grant programs that provide additional support to Pell Grant eligible students who meet certain academic standards. Both programs were created in 2006 by the Republican-led Congress and funded through 2010. The first, Academic Competitiveness Grants (ACG), are given to low-income freshmen and sophomores who complete a "recognized rigorous secondary school program of study" and maintain a 3.0 grade point average in college. The other, SMART Grants, are available to low-income juniors and seniors majoring in mathematics and science. The new president will have to decide whether to extend these programs, at a cost of $1 billion a year.

For a number of reasons, these programs have not been particularly well received by financial aid administrators and college lobbyists, and they have been underutilized by students. In fact, Congress has had to rescind a significant amount of the money it has provided for these programs, citing low participation rates. Still, these programs do provide generous benefits to financially-needy students. So deciding whether or not to continue financing them will not be an easy call to make.

Despite these hurdles, we remain hopeful that the next president will take higher education policy making in a new direction. Tomorrow, we will highlight some of the changes we would like to see the next administration make. Stay tuned.

Guaranteeing Complexity

Ben Miller — Wed, 15 Oct 2008 20:30:00 -0400

They're the middlemen of the Federal Family Education Loan (FFEL) program, they engage in some ill-defined activities outside their purview, and in many cases are closely linked to loan companies. Now, thanks to the reauthorization of the Higher Education Act, guaranty agencies will also be playing a key role in the pilot PLUS loan auction program.

As we've written previously, the pilot PLUS loan auction is an opportunity to harness market forces (credit market emergencies notwithstanding) to determine the ideal subsidy lenders should receive in exchange for originating student loans. Lenders will bid for one of two spots to exclusively originate PLUS loans in a state, and will keep that authority for two years. [More on the student loan auction can be found on our Federal Education Budget Project Web site.]

The reauthorization of the Higher Education Act improved upon this program by introducing penalties for lenders who win an auction but fail to follow up on their commitment by not making all PLUS loans in a state. These disciplinary measures include reducing the subsidies lenders receive on other loans, banning them from participating in future auctions, or kicking them out of the FFEL program altogether. These measures should ensure that only serious lenders submit a bid.

Oddly, the reauthorization also added a role for guarantors in the PLUS auction, by requiring that all loans made by winning lenders receive a 99 percent guarantee from these agencies. It remains unclear to us why lawmakers chose to add guarantors into the pilot program, as there were no public hearings on this matter. The initial legislation assumed that the federal government would directly administer the guarantee, as it does quite successfully in the Direct Loan program. Not to mention the fact that the government is the ultimate guarantor of all federal loans since it reimburses guaranty agencies for default losses.

Including guarantee agencies in the auction pilot adds unnecessary complexity to the program. It also could compromise the integrity of the auction because of the close ties that exist between guarantee agencies and lenders.

While the guarantor and lender ties are a substantial problem in the FFEL program, they could cause even worse problems in the PLUS auction, where each winner is given a near-monopoly. Guaranty agencies often have existing relationships with colleges by virtue of providing counseling services, financial literacy information, and other instructional materials. If one winning lender is tied to a guaranty agency with substantial connections in the state, the guarantor could potentially exploit its college-level connections to give their affiliated lender an advantage in making a disproportionate share of the new PLUS loans. Moreover, including guarantors could also discourage these agencies, eager to gain loan volume, from engaging in the types of oversight activities over lenders that they are required to perform.

These ties are especially concerning given that the largest lender, Sallie Mae, has a lucrative contract with the largest guarantor, USA Funds. This contract allows USA Funds to sell all of its guarantor functions to the loan giant, a relationship that has been mutually beneficial for the two entities, sometimes at the expense of students.

But USA Funds is not the only guaranty agency where such conflicts exist. Some guarantors, like the Pennsylvania Higher Education Assistance Authority (PHEAA) double as both a guaranty agency and nonprofit lender. Even smaller guarantors, such as the South Carolina Student State Education Assistance Authority, are closely affiliated with lenders, such as the South Carolina Student Loan Corporation. In fact, in South Carolina the guarantor and lender share the same website, and occupy spots in the same office building. It's hard to expect guarantor employees to properly exercise their oversight role over someone sitting in the next cubicle over.

Unfortunately, legislative constraints mean that the Department likely cannot do much to prevent guarantors from dealing with PLUS loans held by their affiliated lenders. Congress, however, could take action by giving the Secretary of Education the authority to force lenders to choose a new guarantor if there are conflict of interest concerns. This would not remove the unnecessary middleman in the auction program, but would at least lessen the chance of exploiting local connections to gain a complete monopoly over one state's PLUS loan volume.

The pilot PLUS auction is an exciting opportunity to use market forces to achieve greater efficiency in the federal student loan program. Congress and the Department, however, must be vigilant to ensure that those efficiencies aren't lost by introducing an unnecessary and conflicted middleman into the process.

Sallie Mae Seeks Competitive Bidding

Ed Policy — Thu, 18 Sep 2008 21:48:00 -0400

By Jason Delisle and Stephen Burd

The Wall Street Journal reported yesterday that Sallie Mae is in a contract dispute with the U.S. Department of Education over the agency's plan to purchase federal loans from private lenders that are struggling with liquidity as a result of the credit crunch.

According to the newspaper, Sallie Mae has filed a formal protest with the Government Accountability Office over the Department's decision to put its current Direct Loan servicer, Affiliated Computer Services Inc., in charge of collecting on these loans for the government without putting the contract out for bid. In other words, Sallie Mae is saying that the Department should have held an auction for the contract to service those loans.

Oh, the irony is rich here. Sallie Mae is making the case that a government program run by private businesses should be subject to competitive bidding, so that the lowest cost and best equipped company for the job is ultimately hired. Surely Sallie Mae is arguing that this competitive approach saves money for taxpayers. Too bad the student loan giant has rejected this same argument when policymakers proposed using a competitive bidding process to determine the rates at which the government subsidizes lenders in the Federal Family Education Loan (FFEL) program.

Sallie Mae and other lenders prefer to have Congress set the subsidy rate arbitrarily through the political process. They favor this approach because it makes it easier for them to influence Congress when it sets the subsidy.

Here at Higher Ed Watch, we have argued that federal officials should use an auction mechanism to set the subsidy rate paid to FFEL lenders making student loans. Whether the best approach would be to hold an auction for the right to make federal loans in the first place, such as the PLUS loan auction pilot program will do, remains to be determined.

So is Sallie Mae finally coming around to our side on this issue? Might they now support competitive bidding for both servicing and subsidies in the federal loan program?

It's more likely that they want their cake and to eat it too. With their size and economy of scale, they'd likely be the favorite to win the servicing contract from the Department. As a result, they'd be able to unload their loans on the Department when they have difficulty selling them to anyone else, and still profit by servicing these loans on behalf of the government.

But policymakers should not let Sallie Mae speak out of both sides of its mouth. If competitive bidding would bring great benefits to loan servicing, then imagine the improvements it would bring to the federal student loan program overall.