For-Profit Lenders

News Flash: Student Loan Industry Denies Subsidies Exist

Jason Delisle — Thu, 01 Oct 2009 16:34:00 -0400

In the coming weeks, the Senate is expected to begin consideration of a companion bill to the Student Aid and Fiscal Responsibility Act adopted by the House of Representatives last month. In an effort to derail the legislation, which would expand the Direct Loan program and eliminate the Federal Family Education Loan program (FFEL), the student loan industry has been making some pretty outrageous arguments to Senators and staff. Consider our favorite example below from loan industry talking points -- which Higher Ed Watch has obtained -- that were provided to Senate staff.

MYTH: Forcing all students to borrow Direct Loans will save billions over the next 10 years by eliminating huge subsidies being paid to private lenders.

FACT: Lenders are not being paid subsidies. This year, lenders will pay the government $9 billion in interest that is passed on from borrowers and in fees. (Source: Budget Appendix, page 388)

It is easy to understand why anyone would be confused by such a statement. Why would private lenders care so much about the proposed elimination of FFEL if they weren't getting any government subsidies under the program? If that were the case, lenders would stand to lose nothing when the program is eliminated -- they would be able to continue to make loans to students at the same FFEL borrower terms as before. Nothing in law would prevent them from doing so.

The claim, of course, is absurd. Without a government subsidy, private lenders would not make loans with as favorable borrower terms as those under FFEL. The loans would be unprofitable.

Lenders do indeed receive government subsidies. They receive two separate subsidies that transfer virtually all of the risk and costs of making a FFEL loan to the federal government. The first subsidy is a default guarantee, which means that if a borrower does not repay his or her loan, the government reimburses the lender for 97 percent of the outstanding loan balance. It is a subsidy in the form of insurance.

The other subsidy is less straightforward, and not surprisingly, is the subject of the misleading talking point above. This subsidy, called a Special Allowance Payment, sets in law the interest rate that lenders are guaranteed to receive on a FFEL loan. The rate adjusts automatically every three months to reflect short-term market interest rates plus an arbitrary 1.79 percentage points. The federal government pays this rate on the loan no matter how high (or low) short term interest might be. That guarantee, or insurance, is a significant subsidy. The Special Allowance Payment is intentionally designed so that it bears no relation to the interest rates that borrowers pay. Thus, lenders do not earn interest from the borrower; they earn it from the federal government.

Now, where do the lenders come up with the $9 billion figure above? The government uses borrower payments to cover the costs of the interest it guarantees the lender under the Special Allowance Payment. But because the Special Allowance Payment rate fluctuates and the borrower rate is fixed, sometimes the borrower rate is more than enough to cover the rate the government guarantees the lender and other times it is not. In 2007 and 2008 the borrower rate was not enough, so the federal government paid lenders $7.7 billion and $2.5 billion respectively. This year it is estimated that borrower interest payments will more than cover the rate guaranteed lenders, leaving some $6.2 billion left over. Add in other fees lenders pay the government and the total comes to $9.5 billion.

But, the cash value of these payments in any one year is not the value of the government subsidy lenders receive. Rather, the actual subsidy is the expected value of all the future payments associated with a loan. And it is also the value of the guarantees - the insurance against default risk and interest rate risk - that lenders receive from the federal government under FFEL.

This is one of the main reasons why loans are subject to accrual accounting in the federal budget rather than cash accounting. The student loan industry knows this of course... and budget analysts know it, too, but the student loan industry is hoping Senators and their staff do not.

So, Senator, when the loan industry hands you the talking point above, tell them that if government guarantees aren't a subsidy, then FFEL lenders should have no problem with Congress eliminating these guarantees. Then, tell them that when FFEL is gone, they can continue to make loans to students at 20-year, fixed 6.8 percent interest rates just as they do today and they won't even have to make those pesky $9 billion payments to the government anymore.

Panic is the Enemy

Michael Dannenberg — Thu, 21 Feb 2008 15:00:00 -0500

Repeat after us: There is no federal student loan crisis. There is zero danger that federal Stafford loans will not be available in the foreseeable future. Zero danger. At some point in the future, there may be a squeeze on private student loan availability for some high risk borrowers, particularly those attending proprietary schools of questionable quality and limited track record as opposed to all proprietary schools. Should a large private student loan access issue arise, extending even beyond proprietary schools, there are options for federal action to ensure the availability of capital. But let’s not get ahead of ourselves.

Shaky News Coverage

Breathless and not very nuanced accountsof credit market turmoil affecting student loans have appeared in The Wall Street Journal and elsewhere over the last two weeks. These accounts note two phenomena:

[slideshow]First, various auction rate securitization efforts have failed to attract sufficient bids to make capital available to lenders that they had slated to finance new private student loans. A few of the entities that have failed to raise capital have said they are going to stop making private loans. There are, however, many other private student loan providers that can take their place.

Two, the subprime mortgage mess is making lenders take a more careful look at the risk associated with issuing private student loans, all non-government backed loans really, to high risk borrowers. Because proprietary colleges of questionable quality and limited track records are the most dangerous for high risk borrowers and lenders, the money people who make private loans are requiring those schools to put more of their own skin in the game for their students. Essentially, the lenders are requiring proprietary schools to agree to assume a greater portion of private loan default costs.

Unfortunately, much of the media has conflated the credit market’s potential impact on private student loans and federal student loans. They have created a sense of fear, if not panic. There is a danger that the fear might lead to hasty policy changes. The bigger danger is that the fear, if not panic, could depress college access for students who think they can’t get a loan.

They can. The mainline press should be ashamed for conflating questions of access to private student loans with guaranteed access to federal student loans.

Federal Student Loans are Widely and Safely Available

There are thousands of federal Stafford Federal Family Education Loan (FFEL) providers in addition to the Department of Education’s Direct Loan program. And Stafford loans require no credit check. If 10, 20, even 100 FFEL providers suddenly suspended their Stafford loan originations because of an inability to raise capital, there would still be widespread availability of federal student loans.

The lenders who are having the most trouble raising capital through asset-backed securities are in the secondary market. Regular old banks continue to make federal Stafford loans. In fact, JP Morgan Chase announced it was cutting interest rates and fees on federal and private student loans.

If for some reason a sustained private credit meltdown actually resulted in reduced availability of federal student loans, the Higher Education Act includes a "fail-safe" that ensures federally sponsored guaranty agencies act as "lenders of last resort" with federal capital. If guaranty agencies don’t have capital, they can get an advance payment of capital from the U.S. Department of Education. There is no risk that a student will not be able to access a FFEL Stafford loan.

But if any school is worried that its students will have difficulty obtaining FFEL Stafford loans, that school can always switch to the U.S. Department of Education’s Direct Loan program, which offers the same Stafford loans at the same government-set interest rates. Currently, a little over 20 percent of federal loan volume runs through the Direct Loan program. With the advent of the Common Origination and Disbursement system, any school that participates in the Pell Grant program could easily originate Direct Loans and draw down federal funds from the Department of Education. And despite the fear FFEL industry insiders are spreading, we have been assured by high-level federal officials that the Direct Loan program’s volume could more than double very rapidly, if need be.

Please Take out a Federal PLUS loan Before a Private Loan

Some may object to our take noting that the federal Stafford loan program carries limits on the amount of federal Stafford loan debt that can be borrowed -- $23,000 in the aggregate for an undergraduate. They may ask, what about students who need to borrow more?

Our first response is that the parents of those students should apply for a federally guaranteed PLUS loan. As with federal Stafford loans and for the same reasons, there is zero risk that capital will not be available for PLUS loans. And PLUS loans, unlike Stafford loans, are available in amounts up to the total cost of attendance for a student. Moreover, PLUS loan interest rates are capped at 8.5 percent and have low fees. They beat most private student loans.

There’s a catch to federal PLUS loans in that they require credit worthiness. In the current credit market environment there is a fear that PLUS loans won’t be as easily available, because lenders fear risk.

But let’s keep in mind that PLUS loan borrowers total about 525,000 each yearas compared to about 7 million new FFEL Stafford borrowers. That’s less than 10 percent and most of those borrowers will continue to not have a problem accessing PLUS loans. For those borrowers that do get turned down for a PLUS loan because of credit worthiness, Stafford loan limits double to $46,000 in the aggregate. And Stafford loans have even lower interest rates than PLUS loans.

Private Loans

Up to $46,000 a year in universally available federal student loan debt generally is enough for undergraduates. It is more than twice average undergraduate debt. But there are outliers and there are cases when for family reasons PLUS loans are not an option. Those borrowers may well have to turn to private loans.

Still the fact is private loans affect a much smaller number of people than federal loans. Private loans are taken out by 10 percent of undergraduates. At least half of those are to or for students with excellent credit, and those students will continue to have no problem accessing a private student loan. Their interest rates may be 50 to 100 basis points higher than before the credit crunch, but they will continue to have access to private student loan capital. At least half of remaining private loan borrowers have access to guaranteed low cost, federal Stafford student loans, but don’t exhause their eligibility. So in terms of access to capital, what we’re looking at is maybe two or three percent of undergraduate students who may in the future confront a private loan availability issue based on circumstances reflected in the current credit market.

For now, Higher Ed Watch recommends that policymakers keep their powder dry. Panic is the enemy. Next week, we’ll discuss further the relationship between the credit crunch and student loan capital, and we intend to float a policy response should a problem that seriously affects actual students arise. As of now, despite the headlines, we’re unconvinced.

Stay tuned, and stay cool.

Four Steps to a Better Student Loan Program

Ed Policy — Wed, 16 Jan 2008 00:00:00 -0500

Yesterday's blog post on Higher Ed Watch argued that legislation under consideration by both the U.S. House of Representatives and the Senate does not go far enough in confronting conflicts of interest between colleges and lenders. …

Note: This post pre-dates Higher Ed Watch's shift to a new publishing system. For the complete original post, including any comments, please click here.

Who Will be Fired First: Al Lord or Isiah Thomas?

Ed Policy — Thu, 10 Jan 2008 00:00:00 -0500

They may share little more in common than the name Lord, but Isiah Lord Thomas (his given name), the much-maligned general manager and coach of the New York Knicks, and Al Lord, the oft-criticized Chief Executive Officer and former Chairman of Sallie Mae, are sitting on seats hot enough to…

Note: This post pre-dates Higher Ed Watch's shift to a new publishing system. For the complete original post, including any comments, please click here.

Sallie Mae's Blame Game

Ed Policy — Wed, 09 Jan 2008 00:00:00 -0500

When student loan giant Sallie Mae announced on Monday that it was removing Al Lord, the company's Chief Executive Officer (CEO), from his position as Executive Chairman of the board a little more than a month after he took the job, it went to great lengths…

Note: This post pre-dates Higher Ed Watch's shift to a new publishing system. For the complete original post, including any comments, please click here.

Naughty and Nice

Ed Policy — Thu, 20 Dec 2007 00:00:00 -0500

Santa has some tough decisions to make this Christmas. We've decided to help him out with our own list of who's been naughty and who's been nice this year in higher education.

Let us know who, if anyone, you think should be added to the list…

Note: This post pre-dates Higher Ed Watch's shift to a new publishing system. For the complete original post, including any comments, please click here.

Handcuffing States

Ed Policy — Wed, 12 Dec 2007 00:00:00 -0500

Yesterday, we wrote that officials in Iowa are investigating whether aggressive marketing practices by the largest student loan provider in the state, and the cozy relationships it has developed with area colleges, have pushed students to take on unnecessarily high levels of expensive private student-loan debt. Specifically, Iowa's…

Note: This post pre-dates Higher Ed Watch's shift to a new publishing system. For the complete original post, including any comments, please click here.