Higher Ed Watch

Loans of Last Resort: A Program Only Rube Goldberg Could Love

Ben Miller — Thu, 15 May 2008 15:58:00 -0400

The Department of Education recently announced modifications to its lender of last resort program as part of its effort to prepare for the possibility of federal student loan shortages as a result of the credit crunch. The net result is a contraption Rube Goldberg would be proud of -- what in effect are direct student loans that are more difficult to administer and more costly for taxpayers than the regular Direct Loan program.

The lender of last resort (LLR) program is designed to ensure all students have access to Federal Family Education Loans (FFEL) by requiring that guaranty agencies provide loans to students that have been turned down by conventional lenders. Though we support guaranteeing access to student loans, the similarities (and costly differences) to the regular Direct Loan program make LLR a significantly inferior option. In fact, Washington appears to be trying to avoid the more obvious and efficient solution -- boosting the regular Direct Loan program.

Here are five similarities between the new but hardly improved LLR program and the regular Direct Loan program:

Federal Guarantee: While the government reimburses lenders for 97 percent of a FFEL loan that goes into default, it is on the hook for 100 percent of an LLR loan. Since Direct Loans are obligations from the U.S. Treasury, they effectively have a 100 percent guarantee.

Funding Source: The Secretary of Education is permitted to advance U.S. Treasury funds to guaranty agencies for the purposes of making LLR loans. The Department disburses Direct Loans using Treasury funds.

Terms and Conditions: According to the Department of Education, borrowers who take out an LLR loan will have "the same rights, benefits, and obligations" as those who receive FFEL loans. Federal law also requires that Direct Loans have the same terms and conditions as those offered through FFEL.

School-wide Eligibility: Currently, student loan applicants become eligible for a LLR loan only after they have been turned down by two FFEL lenders (only one in some states). However, under the recently signed Ensuring Continued Access to Student Loans Act of 2008, the Education Secretary will be able to designate whole institutions as eligible for LLR loans. Schools using Direct Loans also receive institution-wide eligibility.

Loan Ownership: Similar to Direct Loans, LLR loans made with advanced Treasury funds are assets of the U.S. government.

So let's get this straight. Under the LLR program, loans would be made with Treasury funds and have the same terms and conditions as FFEL loans. They would carry a 100 percent guarantee, and could be granted on an institution-wide basis.

If it looks like a Direct Loan and it functions like a Direct Loan...

But the LLR program isn't a carbon copy of the regular Direct Loan program. In fact, the Department has added provisions that make the program more complicated and costly to taxpayers, such as:

Requiring Additional Federal Payments: With the regular Direct Loan program, the government's initial expenditure is equal to the principal of the loan. But under LLR, the Department would provide a fee to a guaranty agency for "originating and servicing LLR loans made with advances." The government would thus provide money to make the loan and then give the guaranty agency MORE money to agree to originate a loan with ZERO default risk.

Designating the Debt as FFEL Loans: As we noted earlier, borrowers have nearly the same terms under the two federal student loan programs, with at least one notable difference: Direct Loans can be partially forgiven for public service. Under the Department's LLR plans, however, the guaranty agency must assign to the Secretary any loans made with federal advances that she requests. These assigned assets will still be considered FFEL loans, meaning a borrower could end up with a loan owned by the government with inferior terms to other Department-held loans.

A K.I.S.S. for the Department

The Department has put a lot of effort into ensuring the LLR program functions properly. But is it worth the trouble? The government has never put LLR to use on a wide scale before. Do schools really want to put their trust in an unproven system? A regular Direct Loan could provide better terms for borrowers, with the same financing source, school-wide eligibility, and guarantee rate -- without having to make additional payments to other agencies.

If this is the general direction the Department wants to pursue in response to the credit crunch scare, it should follow a lesson we all learned in elementary school -- when faced with complex problems, the best solution is to keep it simple, stupid.

Swiped into Debt

Ben Miller — Wed, 14 May 2008 13:39:00 -0400

Increasingly, colleges are forging agreements with credit card companies, whereby schools profit from student borrowing. It may be good business, but persistent credit card marketing on campus and subsequent heavy use by students is putting many on a fast track to debtors' prison.

Credit card company - college deals take a variety of forms. A common deal revolves around what are called "affinity agreements," whereby a colleges' logo is emblazoned on a credit card. In exchange for a college's imprimatur, the relevant credit card company sends back to the school in question, their alumni association, or their athletics department a share of revenue generated from student or alumni purchases.

The University of Tennessee, for example, used to have a multi-year affinity agreement with First USA worth $16.5 million. It's now in the midst of a similar $10 million contract with Chase. Ohio State University, which enrolls over 60,000 students, has an affinity agreement arrangement with Bank of America, though the terms have not been disclosed.

Other credit card company - college deals involve institutions providing ready access to students and student contact information. Colleges provide credit card companies with personally-identifiable information about their students in exchange for cash payments. The companies then use the data -- which can include permanent addresses, e-mail addresses, and local telephone numbers -- to market credit cards directly to students. Some colleges go even further, providing companies with face-to-face access to students -- allowing salespeople, for example, to set up marketing tents in central campus hubs.

Until recently, the University of Iowa had a deal with Bank of America in which the bank provided the school with $200,000 annually in exchange for students' local mailing address (six times during the year), e-mail address (four times), local telephone number (twice), and current home address (once). Bank of America also was also allowed to market cards on campus 14 days a year. The level of access doubtlessly contributed to added financial strain to University of Iowa students who already carry some of the highest levels of federal and private student loan debt in the nation. [Note: After the Des Moines Register ran a series of articles calling attention to the arrangement, the University of Iowa renegotiated its deal.]

Nationally, big money is involved in these credit card company - college deals. According to BusinessWeek, Bank of America has agreements with roughly 900 colleges across the United States. A credit card industry survey estimates that as of the end of 2006, 320 million college-affiliated credit cards were in use, accounting for $849 billion worth of transactions. Revenue sharing with institutions of higher education resulted in an estimated $1 billion in transfers to the nation's 300 largest colleges.

Debtor Nation

Students pay a heavy price for credit card companies' hefty profits. A recent survey by a federation of public interest groups (U.S. PIRG) found that college seniors who didn't pay off their monthly credit card statement reported carrying an average balance of $2,623. Those with student loans reported even more debt. College seniors with previous defaults carried an average balance of $4,116. But the credit card companies aren't just interested in student borrowing.

Going after students is a long-term play by credit card companies. Investing millions to gain access to campuses may seems like a substantial payment, but students are a captive and inexperienced market likely to generate both short, and more importantly, large, long-term returns.

Over 70 percent of students keep their first credit card for years, meaning companies can attract thousands of potential lifetime customers for what is essentially a pittance given how much customers will rack up in future credit card debt. The average American credit-card holding household owes $9,659 on their cards; that's 226 percent higher than the same figure in 1990. About two million American households owe more than $20,000 on their credit cards.

We've seen the myriad and creative ways schools use revenue deals with private businesses to sell out their students and put them at risk of severe financial difficulties. Maybe the schools should start thinking about long-term plays just as the credit card industry does. It's pretty hard to make alumni donations when a large share of your monthly income is going to pay off the plastic.

Guest Post: Six Principles for Financial Aid Reform

Ed Policy — Tue, 13 May 2008 14:00:00 -0400

By Art Hauptman

There is widespread agreement among financial aid analysts and practitioners that our country's student aid system is not working as effectively as it could be. Many believe that the solution to this problem is to have the federal government substantially increase the amount of money it spends on the existing student aid programs.

I disagree. The federal government currently spends roughly $40 billion for grants, college work study, loan subsidies, and tax breaks for college -- more than enough to achieve the programs' goals if they were operating effectively and efficiently. As I argued last week, the current structure of student financial support in this country needs to be changed in fundamental ways.

Federal aid programs and tax benefits should be molded into a more comprehensive and comprehensible whole. This would entail some program consolidation and a much better coordination of federal programs and policies with each other. The federal government should also strengthen the incentives it provides states, colleges, and the private sector so that these entities complement, rather than complicate, its public policy goals. Such a system should adhere to the following six principles:

It should be much simpler for students and their families to apply for aid and for college officials to administer it. The current application process serves as a huge barrier to access for many students and families, especially those most at-risk.

A modest amount of self help in the form of loans or work should be required of all students, although institutions should be encouraged to cover some or all of this self-help component for students from the most impoverished circumstances.

The largest proportion of assistance should be targeted on the most at-risk students. This greater commitment to targeting of benefits should include federal and state policies, institutional practices, and private sector initiatives.

Tuition tax breaks should be the primary form of non-repayable aid for middle class students and lifelong learners who are already in the work force. Tax benefits are much better suited for these two groups of students than cramming them into the already strained traditional student aid programs.

The federal student loan programs should be restructured to reduce the adverse effects of growing debt burdens and to stem instances of program abuse. The policy focus should shift from the traditional emphasis on when the loan is made to more attention being placed on helping borrowers when they enter repayment.

Greater reliance should be placed on non-financial aid activities to improve the preparation and increase the aspirations of students most at-risk. Student aid is clearly not enough when it comes to the riskiest students; reaching them in various ways while they are in grade school or middle school is clearly key to greater success.

By taking the following three steps, policymakers can accomplish the kind of reform that is needed without spending any additional money:

Federal student aid programs and tuition tax benefits should be integrated in a systematic way. Many student aid advocates have suggested doing away with the current range of tuition tax benefits and using the savings to increase spending on need-based financial aid. Others have suggested making the tax credits refundable. A better approach is to recognize the need for tax benefits -- both to offset current tuition expenses and stimulate more college savings -- and integrate the tax system with federal student aid programs: before, during, and after college.

The federal government should be more aggressive in seeking to increase the access and success of the students from the lowest income families. Federal policy makers have tended to rely on expanding Pell Grants as the means for helping low-income students. But it is increasingly obvious that other policies are needed to achieve this goal, including more early intervention through GEAR UP and related efforts, and providing incentives for institutions to require less borrowing from these students. It would also be worthwhile to consider establishing college savings accounts for poor but promising students to raise their aspirations.

A student-centered seamless federal student loan structure should be created. Federal student loan policies and practices have been central to postsecondary policy debates for the past several decades, with the primary focus over the past 15 years on whether loans should be financed directly by the federal government or privately financed. But the ‘direct loan' debate has obscured a number of other critical issues related to the provision of student loans, including the complexity of the system and whether federal policies contribute to rapidly mounting student debt burdens. We should consider how the federal student loan structure can be streamlined so that all loans have the same terms and conditions and real relief is provided to borrowers in trouble when they reach repayment.

These three sets of reforms could be paid for largely through changes in the student loan programs that would: restrict the in-school interest payments that the government makes on behalf of students in the subsidized Stafford Loan program to Pell Grant recipients; increase the share of federal student loans provided through the Direct Loan Program; and use auction mechanisms to determine a market rate of return on federally guaranteed loans and thereby drive down federal payments to lenders. In addition, improving coordination between the Pell Grant and tax credit programs would create some savings by making students from middle-income families ineligible for Pell Grants. This change would justify increasing tuition tax benefits for middle-class students and their families through the consolidation of existing tuition tax breaks into a new single expanded tuition tax credit.

Future posts will consider how adopting these reforms could lead to a reinvigorated system of student financial support in this country.

Art Hauptman is an independent consultant on higher education finance issues. His guest blog column will continue to appear each Tuesday in the month of May. The views expressed herein are his own and do not necessarily reflect the positions of the New America Foundation.

Higher Ed Roundup: Week of May 5 - May 9

Ed Policy — Thu, 08 May 2008 17:44:00 -0400

White House, Fed Move on Student Loans

Lawmakers Mobilize to Boost G.I. Education Benefits

Education Department Puts Off Review of ABA as Law School Accreditor

Coalition Offers Help to Schools Considering Switch to Direct Lending

White House, Fed Move on Student Loans

President Bush signed a bill into law on Wednesday that aims to increase federal loan options for students and ease the effects of the credit crunch for lenders that participate in the Federal Family Education Loan (FFEL) program. The measure will increase the annual and aggregate federal unsubsidized Stafford loan limits, allow parents to defer payments on PLUS loans while their children are in school, and establish the Department of Education as a "secondary lender of last resort" with the power to purchase outstanding FFEL loans and service them through the Direct Loan program. On Friday, the Federal Reserve announced that it would provide further help to lenders by allowing them to swap student loan backed securities for Treasury bills through its 28-day term lending facility. The move was designed to inject liquidity into the student loan market. Some loan companies, however, remain unsatisfied and continue to push for an even bigger bailout.

Lawmakers Mobilize to Boost G.I. Education Benefits

Congress is set to debate two competing G.I. bills that would increase education benefits for service members returning from Iraq and Afghanistan. The first bill, S.22, sponsored by Sen. Jim Webb (D-VA), would cover up to the full cost of attendance at the most expensive public college in a veteran's home state for those who served in the military after Sept. 11, 2001. Under the measure, tuition and fees would be paid directly to colleges, averaging about $1,700 a month per veteran, up from the current $1,101. The bill, which may be inserted into the $108 billion emergency Iraq War funding bill to ensure a quick vote, has received bipartisan support. The Bush Administration, however, opposes the bill, saying it would be too costly and difficult to administer, because maximum benefit awards would have to be calculated on a state-by-state basis. Administration officials also fear that the legislation would harm the country's all-volunteer force by enticing soldiers to leave the military to pursue their studies. Instead, they have thrown their support behind S. 2938, sponsored by Sen. Lindsey Graham (R-SC), which would continue the tradition of paying a fixed award directly to veterans, set at $1,500 a month. Sen. John McCain (R-AZ), the presumptive Republican presidential nominee, is backing that bill.

Education Department Puts Off Review of ABA as Law School Accreditor

The Department of Education has decided to delay its review of the American Bar Association's status as an accreditor of law schools for six months, so it can take more time to investigate allegations that the association has overstepped its authority by requiring its members to demonstrate that they are taking "concrete action" to diversify their student bodies and faculties. Over the past decade, the ABA has withstood much criticism that its standards are poorly monitored and unrelated to law school quality. But the accreditor has come under intense fire from conservative groups since 2006 when it began requiring schools to meet its "Equal Opportunity and Diversity" standard. These organizations contend that the ABA is requiring law schools to employ racial preferences that are unlawful in some states. The upcoming review, which will now take place in December, could result in the ABA losing its status as the nation's sole accreditor of law schools.

Coalition Offers Help to Schools Considering Switch to Direct Lending

The National Direct Student Loan Coalition has announced that it will step up its efforts to assist colleges considering switching into the Direct Loan program. The announcement comes on the heels of a recent survey that showed as many as 20 percent of colleges, citing instability in the student loan market as a result of the credit crunch, were thinking about transitioning from the Federal Family Education Loan program to Direct Lending. Among other things, the coalition is starting a mentor program in which officials from Direct Loan schools will help provide technical and operational advice to colleagues considering making the move. In addition, the coalition is co-hosting an online event with the National Association of College and University Business Officers on May 20 "to provide an overview of campus operations under the Direct Loan program, the steps involved in switching, and address the many questions being raised" by college officials contemplating the switch. [If interested, register for the event here]

No NCAA Showdown Over Academic Penalties

Lindsey Luebchow — Thu, 08 May 2008 14:00:00 -0400

When the National Collegiate Athletic Association announced its penalties for poor athlete academic performance this week, it let many high-profile Division I college basketball and football teams off the hook.

After four years of collecting data, the organization was set to enact full scholarship penalties for teams that fail to keep their athletes on track to graduate. But because of the NCAA's generous use of waivers for wealthy, high-profile athletic programs, as well as a flawed penalty structure, many teams with poor academic records found themselves in the clear.

Under the NCAA's Academic Progress Rates (APR) system, teams get points each semester for retaining athletes and for keeping them academically eligible. The NCAA has a system of penalties for teams that post low APRs. For the past three years, most teams have not been subject to the penalties, however, because of squad-size adjustments, or exemptions due to insufficient data.

This year, the full penalties came into effect, and any team with an APR below 925 (which corresponds to a 50 percent federal graduation rate) was supposed to be subject to "immediate penalties," or reductions in scholarships. Any team with an APR below 900 was supposed to be subject to "historical penalties," which are more severe and range from reductions in practice time to restrictions on postseason competition and Division I membership.

The APR isn't a rigorous test of academic performance: athletic programs are awarded one point for each athlete who simply remains enrolled in school and another point for each athlete who maintains their academic eligibility. The goal is to make sure that players are actual students, in a very minimal sense of the word.

But many teams are struggling to meet even these low standards. Over 40 percent of men's basketball teams (137 teams) and nearly 34 percent of football teams (81 teams) posted a four-year average APR (2003-07) below 925.

Yet this week the NCAA announced that only 37 college football teams and 53 college basketball teams would be penalized next season—about 40 percent of those with APRs below 925. What gives?

One reason that many teams escaped being hit with scholarship reductions involves the NCAA's penalty structure. If a team posts an APR below 925, it loses scholarships only if a player leaves the college early in poor academic standing (otherwise known as a "0-for-2" players—those who drop out when they are also academically ineligible).

Take, for example, Maryland's basketball team, which recorded a very low APR score of 906. The team did not lose any scholarships because the players who left the school without graduating had already exhausted their academic eligibility (and thus technically weren't "0-for-2" because they didn't drop out early). This is a pretty large loophole, especially for a basketball team with such a low APR—and a most recent graduation rate of zero percent (for players who entered between 1997 and 2000).

In addition, the NCAA granted waivers to some low-performing football and basketball teams at "low resource institutions," including many historically black college and universities. Such waivers are considered appropriate, so long as the NCAA requires the athletic programs at these schools to demonstrate improvement over time.

But the NCAA also granted waivers to wealthy, big-time sports schools that have plenty of money to spend on academic support. Instead of standing up to these universities and penalizing them for their academic failings, the NCAA quietly consented to their waiver requests.

Ohio State University's basketball team is a perfect example: with an APR of 909, and a most recent federal graduation rate of 27 percent, the program should have been subject to scholarship reductions for next year. But Ohio State submitted an "APR Improvement Plan" to the NCAA, with promises of more tutoring and monitoring of athletes, and thus avoided the penalty.

Other high-profile teams that were granted waivers include the University of South Carolina's football team, Purdue University's football team, and Indiana University's basketball team. The NCAA granted waivers to 11 percent of teams of teams with APRs below 925 in this category.

If the NCAA is serious about academic reform, it should make an example of these high-profile sports schools. And if it wants to force real change, it needs to strengthen its penalty system. Little will change if fewer than half of the men's basketball and football teams with scores below 925 are actually punished.

In announcing the recent penalties, Myles Brand, the president of the NCAA, passed the ball. It might make sense, he said, for schools "to put money into the development of academic resources than into the development of new [football stadium] suites."

We hate to break it to you Mr. Brand, but no big-time sports school is going to shift money to academics by choice. You need to force them to by implementing and enforcing academic penalties with teeth.

Bernanke Says Auction

Jason Delisle — Wed, 07 May 2008 13:42:00 -0400

Federal Reserve Chairman Ben Bernanke says the government’s biggest student loan program, the Federal Family Education Loan (FFEL) program, is poorly designed. His suggested solution sounds a lot like an endorsement for an auction. In a letter to Sen. Chris Dodd (D-CT) on Federal Reserve action to help student lenders weather credit market turmoil, Bernanke notes that the structure of the FFEL program is problematic. He writes:

The other side of the profitability equation--the reimbursement spread paid to lenders under this program--is under the control of the Congress and the executive branch. In particular, Congress may well wish to revisit the question of whether setting a fixed spread over the commercial paper rate is the best approach. You may decide that a more market-sensitive approach--flexible enough to provide a wider spread during times of market stress and a narrower one during normal times--could provide a more robust structure.

Here is what’s behind Bernanke’s assessment of the FFEL program and his suggestion for a "more market sensitive approach."

Two Parts to the FFEL Profit Equation

Turmoil in the credit markets has markedly increased the cost of capital for FFEL lenders, capital that they use to make student loans. Even though the loans are virtually risk free (they are guaranteed and subsidized by the federal government) the credit markets currently are demanding a hefty premium for capital compared to what was charged in the past. But while financing costs for student loan providers are problematic, they are only one side of the equation when it comes to the profitability of a FFEL loan. The other side is the subsidy paid by the federal government.

The federal government guarantees lenders an interest rate on all FFEL loans that is equal to a variable short-term market interest rate (three month commercial paper) plus a premium of 1.79 percentage points. Right now that rate equals about 4.5 percent, but fluctuates each quarter based on commercial paper interest rates. More information on this subsidy is available here.

In the past, the interest rate subsidy was sufficient to induce FFEL lenders to make loans. The cost of raising capital was low enough that the guaranteed interest rate paid on the loan produced a spread. For example, in the past a lender could borrow at 5.5 percent to make a loan, and then collect a guaranteed 7.5 percent rate by the federal government. The 2.0 percentage point spread was enough to cover the lender’s costs of origination, marketing, and leave a nice profit after taxes.

Today, however, the lenders’ cost of raising money has reduced the spread, and some lenders say it has eliminated it. As a result, lenders say that they may not make loans this fall.

FFEL Design is Risky and Wasteful

No one should be surprised. Congress has designed the FFEL program in a way that makes it susceptible to such disruptions. The guaranteed interest rate paid on the loans is arbitrary, made up by Members of Congress, and fixed in law. Some years that rate is too generous, heaping windfall profits on lenders and wasting taxpayer money. Other years, it may not be high enough to induce any lender to make loans.

What’s the solution? Well right now lenders and Members of Congress are coming up with all sorts of schemes to allow lenders to raise funds at lower, taxpayer-subsidized rates, which is intended to increase the spread lenders earn on a FFEL loan.

Use an Auction a la Ben Bernanke

Why not take Bernanke’s approach instead? Let a market set the guaranteed interest rate that the federal government pays lenders. If financing costs spike, as they have now, then the subsidy paid to lenders would adjust accordingly, ensuring a profitable spread. In less volatile years, the rate could adjust lower to ensure taxpayers weren’t paying more than they needed to fund the FFEL program.

The PLUS auction pilot set to begin next year is one model for such a system, provided one flaw is corrected. The auction sets a reserve price for bids made on the subsidy rate, capping bids at an arbitrary, fixed rate. The reserve price should be raised, and the Secretary of Education should be given the flexibility to adjust it in each auction when special circumstances arise. Details on the PLUS auction are available here.

Yes, the credit markets are partly to blame for possible disruptions in the FFEL program. But Congress is also at fault. Congress makes up the subsidies for lenders in the FFEL program and isn’t very good at getting them right. Let lenders bid for the subsidies instead. That’s how Ben Bernanke would do it.

(Image used under a Creative Commons license from flickr user trackrecord )

Guest Post: A System of Student Financial Support

Ed Policy — Tue, 06 May 2008 16:22:00 -0400

By Art Hauptman

Current arrangements for providing financial support to college students and their families in this country are not meeting many of the objectives for which they were intended. The Spellings Commission summed it up well in its final report: "The entire financial aid system - including federal, state, institutional, and private programs - is confusing, complex, inefficient, duplicative, and frequently does not direct aid to students who truly need it." As a result, the Commission and a number of other groups with wide ranging political agendas have recommended that "the entire student financial system be restructured". But what would that entail?

Since first established in the 1960s, the federal student aid programs of grants, loans, and work-study - in concert with state, institutional, and private efforts - have provided access to a postsecondary education for millions of Americans who otherwise might not have had enough funds to attend. More recently, federal tax offsets against current tuition expenses and tax-preferred incentives for college savings serve as an important source of financial relief for hard-pressed taxpayers from a range of incomes who worry that they will be unable to pay the constantly mounting bill for tuition and other expenses.

But there is good reason to believe that the financing system also has been a factor in some of the most nagging difficulties associated with American postsecondary education:

The growing number of students who require remedial coursework because they are not fully prepared to do college level work when they enroll

The fact that degree completion rates in the United States are below average among industrialized countries

Tuitions and other charges at both public and private colleges increasing at twice the rate of inflation for a quarter century, raising concerns about college affordability.

Student aid and tuition tax policies are certainly not solely or even primarily to blame for these concerns and trends. Many other factors are much more important in explaining the lack of student readiness, low completion rates, and mounting tuition bills. But the student aid system is not blameless.

The basic underlying problem is that the current system of providing financial support to college students and their families is not a system at all. Rather it is a loose conglomeration of policies and practices at the federal, state, institutional, and private levels that often conflict with each other, with the result that efforts by one governmental unit or group often cancel out efforts by others.

Moreover, federal policies are often in conflict with each other - student aid programs intended to promote greater access may be detracting from better student readiness and success as measured by degree completion. Increasing reliance on tax policies to help families pay for college is often at odds with the more access-oriented policies contained in the traditional federal and state student aid programs. As a result of poor design and lack of policy coordination, there are many problems with the current structure of providing financial support to college students and their families, including:

The system of applying for aid and administering it is far too complex which in itself becomes a large barrier to greater access.

Aid often is not well targeted to students from the lowest income families making it that much harder to achieve the goal of providing greater equity of access.

Student debt burdens are growing rapidly and there is far too little relief for the growing number of borrowers who are having trouble making their payments.

The existing financing structure places too much emphasis on getting students into college and there is not nearly enough focus on whether students are prepared to do the work or whether they will complete their educational program.

There is reason to suspect that the growing availability of aid, particularly loans, have been a factor in tuition and other charges growing at twice the rate of inflation for the past quarter century, suggesting a price effect of student aid.

The provision of government aid may encourage institutions that package aid to move their discounts up the income scale, suggesting that some forms of student aid, particularly government grants, may have an adverse substitution effect.

These and very real problems that indicate the current structure of student financial support needs to be changed in fundamental ways.

A subsequent post or two, if Higher Ed Watch doesn't tire of me, will describe a set of principles that should guide future reforms with specific suggestions for moving forward on this agenda. Big changes are needed to make current levels of government support work better for students and their families. Patchwork won't do.

Art Hauptman is an independent consultant on higher education finance issues. The views expressed herein are his own and do not necessarily reflect the positions of the New America Foundation.

Higher Ed Roundup: Week of April 28 - May 2

Ed Policy — Fri, 02 May 2008 21:49:00 -0400

Student Loan Credit Crunch Bill Sent to President

One in Five Colleges Considering Switch to Direct Lending

Tuition On the Rise, but Spending for Instruction is Not

Report Calls for Revised Pell Grant Formula

Student Loan Credit Crunch Bill Sent to President

The U.S. House of Representatives moved quickly on Thursday to give final approval to H.R. 5715, which would increase the annual and aggregate federal unsubsidized Stafford loan limits, allow parents to defer payments on PLUS loans while their children are in school, and establish the Department of Education as a "secondary lender of last resort" (one of our ideas) with the power to purchase outstanding FFEL loans and service them through the Direct Loan program. Congress put the legislation on the fast track after President Bush used his weekly radio address to highlight the need for quick action to address tight liquidity for student loan providers. The final measure includes amendments that the Senate added to the bill before approving it on Wednesday. Among other things, the bill will now sunset the Education Secretary's authority to designate entire colleges for the "lender of last resort program" at the end of the 2008-09 academic year and direct all savings derived from the legislation to increase funding for the Academic Competitiveness and SMART grant programs. The President is expected to sign the bill shortly.

One in Five Colleges Considering Switch to Direct Lending

Citing instability in the student loan market, 19 percent of colleges surveyed last week by Student Lending Analytics say that they are considering switching from the Federal Family Education Loan program to the Direct Loan program, in which the Department of Education provides loans directly to students through their college. Nearly six percent of institutions surveyed have already made the switch. So far, the largest institutions to make the move have been Indiana University at Bloomington, Michigan State, Northeastern, and Pennsylvania State Universities. Those expressing the most interest in switching programs, however, are community colleges (about 7 percent are planning to make the switch, and another 29 percent are considering doing so) and for-profit trade schools (14 percent are planning to make the switch, and another 43 percent are considering doing so.) These results are hardly surprising as several banks in recent weeks have said they plan to be more selective in making federal loans to financially-needy students attending these types of institutions.

Tuition On the Rise, but Spending for Instruction is Not

Annual tuition hikes are becoming a fact of life at pubic and private colleges around the country, but little of that additional money is going towards student instruction. A new report from The Delta Cost Project, "A Growing Imbalance: Recent Trends in U.S. Postsecondary Education Finance," finds that the percentage of institution revenue dedicated to faculty salaries and other instructional costs at private colleges increased by just 1 percent between 1998 and 2005, down from a 2.2 percent increase between 1987 and 1996. In particular, tuition revenue at public colleges, though on the rise, often did not translate into increased spending because it was used to offset decreases in state appropriations. Since 1998, student tuition has covered a larger percentage of the costs of a student education, up from 37 percent to 47 percent at public schools and up to 31 percent from 24 percent at private institutions.

Report Calls for Revised Pell Grant Formula

Planned increases to the maximum Pell Grant award are important for helping low-income students, but a new report argues that additional modifications should be made to the program to ensure that funds are better targeted to the poorest individuals. "Window of Opportunity: Targeting Federal Grant Aid to Students with the Lowest Incomes," released Monday by the Institute for Higher Education Policy, argues for changes in the Pell Grant award formula, which is determined by taking the difference between the maximum award and the student's expected family contribution (EFC). The report recommends that students be allowed to have a negative EFC of up to $750 (the current minimum is zero), in turn allowing the poorest students to receive a Pell Grant award of up to $750 beyond the maximum limit. The report also recommends increasing both the minimum and maximum Pell Grant awards.

Fueling Sham Trade Schools

Stephen Burd — Thu, 01 May 2008 06:20:00 -0400

We have written a lot recently about Silver State Helicopters, a Nevada-based company that left the 2,500 students who attended its flight academies in the lurch when it shut its doors without warning on Super Bowl Sunday and filed for bankruptcy liquidation.

As we noted yesterday, Silver States' entire existence depended on the willingness of loan companies -- in this case, the infamous Student Loan Xpress and the Pennsylvania Higher Education Assistance Agency (PHEAA) through its national brand American Education Services -- to make and service high-cost private loans to help students cover the $70,000 cost that they were required to pay up front to attend the unlicensed and unaccredited flight schools. Unfortunately, Silver State students are now stuck repaying these private loans for training they did not ultimately receive.

Silver State is hardly an isolated case.

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

Reviving Trade School Scams

These practices first came to light several years ago when dozens of unaccredited computer training schools unexpectedly shut down, leaving their students without training and with heavy private loan debt. Just like Silver State, these schools (owned by now-defunct chains such as Ameritrain, Solid Computer Decisions, and The Academy Schools, among others) had forged sweetheart deals with the loan giants Sallie Mae and Key Bank to provide their students with tens of thousands of dollars of private loans to cover the full cost of tuition upfront before any classes were provided.

Consumer lawyer Tom Domonoske exposed these deals in an article entitled "The Finance Industry Fuels Revival of Trade School Scams," which ran in late 2003 in the trade journal The Consumer Advocate but received little attention at the time. In the article, Domonoske explained how the easy availability of private loans helped disreputable schools thrive by allowing them to attract students without having to worry about being regulated by the federal government.

In the late 1980's and the early 1990's, the federal government was forced to take emergency actions to crack down on an explosion of fly-by-night trade schools set up solely for the purpose of reaping profits from the federal student aid programs. To avoid another student loan-proprietary school debacle, policymakers began requiring schools that participate in the federal student loan program to demonstrate, among other things, that they are financially stable. The schools must show that they do not pose a danger of closing precipitously.

But disreputable trade school owners found a way to around these rules -- by staying out of the federal aid programs and pushing private loans to their students. Meanwhile, lenders, Domonoske wrote, have proved more than willing to provide "liquidity" to these sham schools. "[T]he current problem of school closures in the computer training field would not exist if entities like Sallie Mae and Key Bank were applying similar restrictions" to those of the government, Domonoske wrote at the time.

The Loan Industry's Complicity

Under pressure from consumer advocates, Sallie Mae eventually agreed to stop serving unlicensed schools. But Key Bank apparently continues to do so. And, in light of the Silver State Helicopters case, other lenders, like Student Loan Xpress and the non-profit state agency, PHEAA, appear to have picked up the slack.

Why would lenders ever agree to make such risky loans in the first place? Don't loan providers pay a price for making loans to students attending sham schools? Not if they securitize the loans and get them off their books. As Domonoske puts it:

"Key Bank's willingness to fund bad loans seems at first glance to be counterproductive for its own bottom line. However, Key Bank does not intend to hold all the loans during their repayment period; instead it pools and sells the loans to investors. Through a process called "asset-backed securitization," Key Bank obtains full value for the loans by selling them to an investment trust. It sells the loans as if they were honest and legitimate transactions solicited by schools that were acting properly...Consequently, the investors pay full value without a disclosure of the inherent defects in the loan."

In other words, by providing huge private loans to students attending unlicensed, unaccredited schools and then securitizing the debt, the lenders have not only caused great harm to students but have also deliberately misled investors.

As policymakers consider a bail out the student loan industry from the credit crunch beyond legislation passed in the Senate yesterday, they need to remember that lenders have brought a good part of these problems onto themselves. Lenders have dumped lots of bad private student loans onto the marketplace, knowing full well that much of this debt was likely to go into default. Is it any wonder that investors are now wary of student loans?

Predatory Lending Biting Back

Stephen Burd — Wed, 30 Apr 2008 14:52:00 -0400

With calls from student loan providers for a bailout growing louder every day, it's worth remembering that the lenders have brought a good part of these problems onto themselves. Investors are wary of purchasing student loan asset back securities, and, and least when it comes to those made up of private loans, they have good reason. Lenders have dumped lots of bad loans made to subprime borrowers going to dubious schools onto the marketplace, knowing full well that much of this debt was likely to go into default.

Case in point: as we noted last week, there has been in recent years a proliferation of unlicensed, unaccredited trade schools that do not participate in the federal student aid programs and therefore go largely unregulated. The growth of these schools of dubious quality has been fueled by student loan companies that have willingly and irresponsibly "partnered" with these institutions to provide high-cost private loans to often at-risk students that these schools tend to attract. The lenders have then turned around and, like subprime mortgage lenders, securitized the loans, shifting the risk of the loans onto unsuspecting investors.

Low-income and working class students who enroll in these schools have paid a high price for these policies.

Take Silver State Helicopters for instance. On Super Bowl Sunday, the Nevada-based company, which owned unaccredited flight academies across the country, shut its doors without warning and filed for bankruptcy liquidation. As recounted by The San Diego Union-Tribune, the 2,500 students enrolled in the flight academies were "left in the lurch." Because the schools did not have the proper accreditation to qualify to participate in the federal student aid programs, the company directed students to take out expensive private loans to cover the $70,000 tuition that they were required to pay up front. Unfortunately, Silver State students are now stuck repaying these loans for training they did not ultimately receive.

But Silver States' entire existence depended on the willingness of loan companies -- in this case, the infamous Student Loan Xpress and the Pennsylvania Higher Education Assistance Agency (PHEAA) through its national brand American Education Services -- to make and service private loans to students lured into unlicensed, unaccredited, and ultimately "fly-by-night" schools (forgive the pun). In fact, the company appears to have gone immediately belly up the minute the lenders revealed that they would no longer provide private loans to its students because the lenders would not be able to securitize them as a result of the credit crunch.

The student loan industry is desperately seeking a bailout and offering neither borrowers nor taxpayers anything in return. Don't Silver States' students deserve a bailout too? Don't taxpayers deserve protection against another student loan - proprietary school debacle, as we had in the late 1980s and early 1990s? We at Higher Ed Watch think both student borrowers and taxpayers deserve better.