Ed Money Watch

Revisiting the 9.5 Percent Student Loan Scandal

Stephen Burd — Tue, 23 Sep 2008 13:13:00 -0400

As the Bush administration nears its end, key questions remain about its role in a scandal that allowed student loan companies to bilk taxpayers out of more than $1 billion by overcharging the government for subsidy payments on loans they made to students. At Higher Ed Watch, we think it's especially vital to get answers to the following questions: what did the political appointees at the Education Department know about the 9.5 percent scandal and when did they know it?

Before delving into these questions, it's important to recall the details of the scandal, which has been largely overshadowed in recent years by higher-profile student loan controversies and the credit crunch.

The roots of the 9.5 scandal date back to the 1980s when poor economic conditions and soaring loan costs prompted Congress to keep nonprofit lenders, which use tax-exempt bonds to finance their loans, in business by guaranteeing them a return of 9.5 percent on loans. Congress rescinded that policy in 1993 but grandfathered in the loans already made, believing that the volume of 9.5 loans would decline as they were paid off.

Instead, a group of lenders devised a strategy to aggressively grow the volume of loans that they claimed were eligible for the inflated payments. They did so by transferring loans that qualified for the 9.5 subsidy payment to other financing vehicles and recycling the proceeds into new loans that they claimed were then eligible for the subsidy. A particularly egregious actor was Nelnet, which was created in 1998 when Nebraska's nonprofit student loan agency converted to for-profit status. By repeating the transfer and recycling process over and over, Nelnet increased the amount of loans for which it sought the 9.5 percent rate from about $550 million in 2003 to nearly $4 billion in 2004.

Profits began to slow after Congress passed bills in 2004 and then again in 2006 to try to prevent lenders from engaging in these type of loan and bond manipulations. At the time, Department officials claimed that they didn't have the authority to stop these practices without Congressional action or a lengthy rulemaking process. Some believed otherwise, and questioned whether the Department's inaction indicated that it was complicit in the scandal.

All told, according to a report last week The Chronicle of Higher Education, the government appears to have lost nearly $1.2 billion in overpayments to lenders over a six-year period.

Still today, the Bush administration officials who run the Education Department bristle at the suggestion they gave a green light to lenders to fleece taxpayers, or knowingly looked the other way while it was happening. But even they have come to acknowledge that they were slow to react to the abuses-- ignoring calls from their own employees, key lawmakers, and the Government Accountability Office to put a stop to it. The political appointees say they didn't fully understand the extent to which Nelnet and other lenders were gaming the system until the Department's Inspector General (IG) released an audit report in September 2006 explaining the illegality of the loan company's actions.

Department of Education officials say that once the picture became more clear, Education Secretary Margaret Spellings took decisive action to cut off the payments. In January 2007, Spellings barred Nelnet and other lenders that refused to submit to independent audits from making any further 9.5 percent claims. This action, department officials say, saved taxpayers more than $800-million in future subsidy payments to Nelnet alone.

But Spellings' decision in the Nelnet case raised more questions than it answered -- because she ultimately let Nelnet off the hook by rejecting the IG's recommendation to require the company to return the $278-million it had received in overpayments. Instead, she reached a settlement agreement that allowed Nelnet to hold onto the funds as long as it didn't submit future 9.5 percent claims. In addition, she extended the terms of the agreement to all other lenders that had taken part in the scheme, assuring them that they would not have to return excess subsidy payments they had improperly obtained.

In explaining this ruling, Education Department officials initially said that they were not requiring Nelnet to return the overpayments because of concerns about putting small non-profit lenders who had made similar claims out of business. "In some parts of the country, these small not-for-profits are the only option we have," Sara Martinez Tucker, the Department's under secretary of education, told reporters at the time. "We were trying to make the best decision for the taxpayer and for students."

But testifying before the House Committee on Education and Labor in May 2007, Spellings backed away from that explanation and offered another more intriguing one. She said she felt it was better to settle with Nelnet than risk losing in court. "We had significant legal exposure," she said, and "significant liability potential."

Spellings expanded on these statements in comments she made to The Washington Post in the fall of 2007. "The department, I believe, had some responsibility with respect to that confusion [over the rules governing the 9.5 subsidy rates.]," she said.

"We had legal risk, in my view, and the prudent course of action was to, once and for all, end this practice and provide certainty in the industry that that was not allowable," Spellings told the newspaper. "While it cost us $278 million to make that final call, it also saved us potentially a billion dollars had we lost the litigation."

To this day, it remains unclear why Spellings was so pessimistic about the Department's chances in a potential Nelnet lawuit. Had the Department confused lenders simply by its inaction? Or had political appointees at the Department given Nelnet and other loan companies the impression that they had approved their actions? Many lenders did not partake in the scheme. Should those that tried to game the system not be held accountable?

At Higher Ed Watch, we believe these are vital questions to ask and we will do our best, in the coming days and weeks, to try to shed light on them. Meanwhile, we hope that Congress will exercise its oversight responsibilities and demand answers to these questions themselves. To start, lawmakers should require the Department to turn over all communications it had with lenders about the 9.5 percent payments since the beginning of the Bush Administration.

After all, doesn't the public have a right to know whether public officials were complicit in a scheme to fleece taxpayers?

Layers of Inequity

Jennifer Cohen — Thu, 22 May 2008 20:04:00 -0400

Poor states, communities, and children persistently get the short end of the stick in school funding. Education spending policies at all levels-federal, state, and local-layer on inequities that disproportionately benefit high-wealth school districts and lead to large funding disparities between high- and low-poverty communities. A new report from Education Sector and the Center on Reinventing Public Education seeks to quantify the cumulative impacts of these inequities on local schools. The results are striking. Addressing these inequities should be a key priority for federal and state policymakers.

The Education Sector/Center on Reinventing Public Education report examines two elementary schools in neighboring states that serve similar populations but receive very different levels of federal, state, and local funding. Cameron Elementary in Fairfax County, Va., receives more than twice the per pupil funding Ponderosa Elementary in Cumberland County, N.C., receives even though both schools serve predominantly low-income populations in poorer sections of their respective counties. These funding disparities are the result of funding distribution structures that disproportionately benefit wealthier states, districts, and schools over poorer states, districts, and schools.

The federal government distributes Title I funds to states based on the number of poor children in each state to improve the quality of the services they receive. However, the specific amount allotted per student depends on how much money a state and its localities spend on education. Because state and local spending is more a function of the wealth of the state and locality than a function of the cost of providing that education, wealthy states like Virginia receive more Title I funds per poor child than poorer states like North Carolina.

While federal funding disparities are significant, 90 percent of the funding schools receive comes from state and local sources. State policies determine both the amount and distribution of these funds, and are a major source of inequities. In Virginia, state funds provide a minimum foundation for education funding-40 percent-that each locality must match out of local funds. Localities can also choose to supplement school funding with additional local tax revenues. North Carolina, in contrast, uses a district funding formula based on student enrollment and cost of hiring teachers and staff that benefits wealthier districts and has no local matching requirement. As a result, local funding constitutes 31 percent of education funding in North Carolina and more than 53 percent in Virginia. Less flush districts like Cumberland County, N.C., are unable to supplement education spending as much as wealthier districts like Fairfax County, Va., and have no incentive to do so.

Finally, district-level funding distribution practices benefit wealthier, easier to staff schools over schools with poorer, more challenging populations. Seniority staffing rules and experience-based salary schedules mean that higher poverty schools are generally staffed by cheaper, less experienced teachers.

We've written previously about how the No Child Left Behind Act's funding comparability requirements contribute to this problem, by allowing districts to overlook these experience-based salary differences when determining whether teacher salary funds are allocated equitably between Title I (read: more poor) and non-Title I (read: more affluent) schools. As a result, poorer schools spend less money on teacher salaries and therefore have fewer resources overall.

The impact of these differences is striking: Despite its high poverty population, Cameron is succeeding at retaining qualified and experienced teachers, while Ponderosa has a constantly cycling staff of inexperienced teachers. As a result, the average teacher at Cameron makes $62,533, compared to $35,610 for the average Ponderosa teacher. Whatever Cameron is doing right to maintain its teachers is worth thousands in increased spending on teacher salaries at the school.

The ES/CRPE report provides a series of policy recommendations to mend the funding disparities at the federal, state and district level. Among these is eliminating the section of the federal comparability requirement which allows districts to ignore experienced-based salary differences when determining whether funding is equal across schools. This change would force districts to recognize the mal-distribution of experienced teachers in their schools and act accordingly to fix it.

The report also suggests that districts give schools a standard amount of funding per student for paying teacher salaries rather than basing funding on the salaries of the actual teachers each school hires. This way schools will be able to prioritize between hiring many inexperienced teachers or a few experienced teachers and consider offering incentives to highly desirable teachers. Both of these changes would be important steps toward improving the equity of school funding and would give poorer schools a real chance to attract and retain qualified and experienced teachers. Other policy recommendations include:

Basing Title I funding on national average per student funding (adjusted for both state wealth and actual cost of education in that state), rather than state and local funding;
Encouraging states to provide minimum floors and maximum ceilings for state and local education funding contributions; and
Distributing state education funding in inverse proportion to district wealth, in order to mitigate disparities in spending due to differences in the amount of property tax revenue districts can raise.

Each of these proposals is likely to face political opposition-especially those that seek to lessen the role of property taxes, and therefore local control, in education funding. However, they would be significant strides towards equalizing both inter- and intra-state education funding disparities across the country and giving low-income students the education they need and deserve.

(Funding) Formula for Success in Pre-K

Sara Mead — Tue, 26 Feb 2008 18:06:00 -0500

A new Pre-k Now report on pre-k finance highlights the increasing use of state school funding formulas as a vehicle for pre-k funding. When Pre-K Now produced a similar report in 2006, it identified only 6 states that funded pre-k through their state school funding formulas. The 2008 report identifies 11 states that do so, including some national leaders on pre-k.

This is good news. There are lots of benefits to using state school funding formulas to pay for pre-k. For starters, it's simple: States simply allow school districts and charter schools to receive state per-pupil funds for four-year-olds, as they already do for older students. Because state school funding formulas and the bureacratic systems to operate them already exist, this approach requires little in the way of additional bureacracy. That's particularly important as more states start thinking about scaling up relatively modest existing targeted pre-k programs: A grant program that works well when you're serving less than 10% of children--as more than half of states currently do--becomes a lot more unwieldy when you're trying to serve all 3- and 4-year-olds in a state. That's borne out by the fact that, of the top 10 states serving the most 4-year-olds in pre-k, 6 use the state school fudning formula to do so.

More importantly, funding pre-k through the state school funding formula sends a clear message that pre-k is education--not childcare. Routing pre-k funding through districts and charter schools also gives them resources and leverage to ensure that pre-k programs are aligned with early elementary offerings. Funding pre-k through the state funding formula, rather than keeping it in a separate pot of money, also helps insulate pre-k funding against cuts in difficult economic times, since legislators are loathe to make unpopular cuts in school funding levels.

Some pre-k supporters are understandably reluctant to embrace an approach that directs pre-k funding through the public school system, because they fear community-based pre-k providers will be excluded. But the emergence of charter schools, contract management, and other approaches for integrating diverse providers into the public education system at the K-12 level should offer a solution to these concerns. Pre-k Now notes that all the states that currently use school funding formulas for pre-k include community-based providers in their pre-k systems.

Early Ed Watch is pleased to see a trend towards using state school funding formulas for pre-k. As more states seek to expand existing pre-k programs or create new ones, this is a strategy they should immitate. By the same token, when states consider reforms to their school funding formulas, including pre-k funding in these formulas should be an important part of the agenda.

Photo by flickr user theritters, used under a Creative Commons license.

FY2008 Budget Cuts Early Education Funding

Sara Mead — Wed, 09 Jan 2008 00:00:00 -0500

Early education programs fared poorly under the fiscal year 2008 omnibus appropriations bill signed by President Bush in late December. Of 9 federal programs that provide support for early education, only one—Title I—received a significant funding increase—$1 billion, bringing Title I funding to $13.9 billion for 2008. But, because Title I funds are used to improve education for disadvantaged students from preschool through high school, only a fraction of this increase will go to early education.

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The legislation significantly cuts funding for three early education programs:

Cuts Reading First, which supports scientifically based literacy programs in kindergarten through third grade, by two-thirds, or $636 million;
Cuts Even Start, which supports family literacy, parenting classes, and early education, cut by 20 percent, or $16 million;
Eliminates the Early Childhood Educator Professional Development program.

Several other programs received level funding—a cut in real terms—or small cuts due to a 1.74% across the board recission for all programs. As a result, total funding for early education programs other than Title I fell by $677 million. These cuts exceed any likely increase in school districts’ early education spending as a result of Title I increases.

Would early education programs have faired better under a Labor-HHS-Education appropriations bill that the President vetoed earlier this fall? That bill would have provided a larger, nearly $1.5 billion, increase in Title funding, and would have increased funding for Head Start and the Child Care and Development Block Grant (which can be used to fund pre-k) by about $185 million. But it also made large cuts—totaling more than $650 million—to Reading First, Even Start, and the Early Childhood Educator Professional Development Program.

Congress’ and the President’s tightfistedness with early education programs stands in stark contrast to the states, 36 of which increased early education by a total of more than $500 million for fiscal year 2008, as well as rhetoric on the presidential campaign trail, where leading Democratic candidates have proposed billions in new early education investments.

Why such a disconnect? The biggest reason is politics around the Reading First program, which accounted for the bulk of funding cuts to early education. The Reading First initiative is strongly identified with President Bush, who made it a signature campaign proposal in 2000, and has been
embroiled in a controversy over efforts by some former Department of Education staff to steer state grantees toward particular reading programs. Appropriators saw cuts in Reading First funding as a way to hold the Department accountable for these problems.

That’s unfortunate, because cutting Reading First doesn’t just hurt the Department; it hurts children by undermining state efforts to improve literacy instruction. These cuts are particularly disappointing because early evidence suggests that, despite the problems with the Department’s implementation, Reading First is having positive impacts on students’ reading skills. Even the organizations that first complained about how the Department was implementing Reading First don’t want to see its funding cut.

More fundamentally, Members of Congress and the President don’t seem to see early education as a priority the way state elected officials are. That’s hardly surprising: Early education advocates, pessimistic about the chances of enacting new early education investments under a Republican
President and Congress, have spent much of the past 7 years focused on state-level advocacy. The significant expansion in state pre-k funding is the result of that advocacy. But it’s not progress if states expand early education funding while the federal government cuts it.

If the rhetoric on the presidential campaign trail is any guide, early education issues are going to be getting more attention at the federal level. Supporters of high-quality, aligned systems of early education must educate members of Congress—on both sides of the aisle—about the benefits
of investing in PK-3 early education.