Scandal

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

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 Congress rescinded that policy in 1993 but grandfathered in the loans already made, believing that the volume of 9.5 loans would decline as they were paid off.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.

What do an appendix, plica semilunaris, and student-loan guaranty agency all have in common? They're all vestigial structures whose original purpose is no longer necessary. But unlike the first two examples, guaranty agencies are desperate to show -- despite all evidence to the contrary -- that they are still relevant.

As parts of a system known for its complexity and confusion (the Federal Family Education Loan Program, otherwise known as FFEL), guaranty agencies are the ultimate amorphous entity, branching out into numerous roles that are completely unrelated to their original purposes.

Soon after Congress created the FFEL program in 1965, it authorized the involvement of guaranty agencies (many of which were already in existence in the states), to encourage lenders to offer student loans by providing default insurance. Congress also gave the guarantors important oversight responsibilities, such as ensuring that only eligible students obtain federal loans, and that lenders make a concerted effort to keep delinquent borrowers from defaulting.

While it made sense for guaranty agencies to occupy these roles at a time when technological limitations made it difficult for solely the federal government to oversee FFEL, the program's current setup and recent oversight failures make it clear that guaranty agencies should not be the ones to carry out these functions.

If the events of the last two years have taught us anything, it's that the U.S. Department of Education's oversight of the Federal Family Education Loan (FFEL) program has been unconscionably lax. The recent revelations that the Department had inadvertently allowed convicted felons to become eligible FFEL lenders is just the latest example of the agency's negligence.

Why then, despite all evidence to the contrary, does the Government Accountability Office (GAO) no longer consider the FFEL program to be at a "High Risk" for waste, fraud, and abuse?

Every two years the GAO, the investigative arm of Congress, puts together the "High Risk" list, an official compilation of federal programs it considers to be the most vulnerable to exploitation. Started in 1990, the goal of the list is to help set the oversight agenda for each new Congress. For 15 years, the federal student aid programs stood at the top of the list, along with other notorious trouble areas such as the Defense Department's contracting practices, and the IRS's efforts to police tax law violations.

Among the government's financial-aid programs, the GAO expressed the most serious reservations about the FFEL program. For instance, a January 1999 update to the report noted that the guaranteed loan program was "particularly vulnerable because of its size, the large number of participants, and the federal guarantee under which the federal government bears most of the risk when students default on their loans."

We hope you all enjoyed your Fourth of July vacation. While it’s nice to have the occasional hard-earned day off, we know someone else who has been on a very long paid break.

It has been 459 days since Matteo Fontana, the then-general manager of Financial Partners Division of the U.S. Department of Education’s Federal Student Aid office, was placed on administrative leave. The Department took this action after Higher Ed Watch revealed that he held at least $100,000 worth of insider stock in the student-loan company Student Loan Xpress. At the time, Education Secretary Margaret Spellings promised that she was taking the matter “very seriously.” But as far as we can tell, the Department hasn’t done anything beyond giving Fontana his regular paycheck and telling him to disappear.

It is clear that Fontana’s purchase and subsequent sale of the stock represented a substantial conflict of interest -- he was, after all, responsible for overseeing the lenders and guaranty agencies that participate in the Federal Family Education Loan (FFEL) program. In addition, at the time he received the stock he was in charge of the National Student Loan Data System (NSLDS), a national database that keeps track of the student aid awards of tens of millions of students. Last year, the Department was forced to shut it down temporarily because, as Higher Ed Watch also revealed, student-loan companies had been mining it to collect personal information about borrowers for marketing purposes.

At Higher Ed Watch, we have written much about the U.S. Department of Education's lax oversight over the lenders and guarantee agencies that participate in the Federal Family Education Loan (FFEL) program. But until we read a recent investigative report in the St. Petersburg Times, we didn't fully grasp just how lax that oversight has been.

As that report revealed, the Education Department does not conduct criminal background checks on individuals who are seeking to become eligible FFEL lenders. The agency leaves it to student-loan guarantee agencies to verify eligibility for participation. But apparently most guarantors often don't even bother to ask about past criminal records of those who apply to become federal student loan providers.

As a result, the St. Pete Times reports, some convicted felons and others with criminal records have gained entry into the guaranteed-loan program and taken advantage of the rich rewards the government bestows on lenders that participate in the FFEL program.

Up until now, we've been willing to give Philip Day the benefit of the doubt.

In March, Day, the former chancellor at the City College of San Francisco, became the president of the National Association of Student Financial Aid Administrators (NASFAA), a group with such strong ties to the student loan industry that in recent years its policy positions have closely mirrored those of the Consumer Bankers Association and Sallie Mae.

At Higher Ed Watch, we have been critical of NASFAA in the past. We were hopeful, however, that the organization's first presidential change in its 32 year history -- coming on the heels of reforms imposed on NASFAA by New York State Attorney General Andrew Cuomo that cut into the financial support the group receives from loan providers -- would set the association on a new track.

We were especially encouraged by statements Day made shortly after accepting the job. In January, he told The Chronicle of Higher Education that NASFAA needed to "reassess" its relationship with lenders. "It's something I don't feel 100 percent comfortable with," he stated. Amen to that.

By now anyone with access to a television, radio, newspaper, or internet connection knows that New York Governor Eliot Spitzer has become ensnared in a federal investigation into an interestate prostitution ring. It's a major disappointment for both his family and the people of the state of New York. The internets are abuzz with speculation about the salacious details and whether or not Spitzer will step down as governor. As a family blog, we'll eschew the tawdry aspects of this story to ask a substantive question: What does this mean for early education in New York State?

House Approves Bill to Reauthorize Higher Education Act

[slideshow]In an overwhelming 354 to 58 vote, the House approved legislation on Thursday that would reauthorize the Higher Education Act for the next five years. The College Opportunity and Affordability Act (H.R. 4137) would impose new restrictions on the relationships between student loan providers and colleges, increase transparency in the private student loan market, simplify the process of applying for financial aid, keep textbook costs down, increase aid for veterans and military families, and tackle rising tuition costs. The legislation would also significantly weaken a provision in the law that protects students from unscrupulous for-profit trade schools.

Economic Woes Hit Sallie Mae, Nelnet

Tightening credit markets and the slowing economy appear to be spreading into the student loan industry, as two major lenders announced recently that they will be cutting jobs and shying away from riskier loans. Last Friday, Virginia-based Sallie Mae said it would be trimming 350 jobs across the country, roughly 3 percent of its workforce. Nelnet, located in Nebraska, announced it would cut 300 jobs, about 10 percent of its workforce — its second round of major layoffs since September. Both companies also announced changes to the loan services they would be offering. Sallie Mae said it would be more selective about offering private loans to students with low credit scores and those enrolled at schools with low graduation rates. Nelnet, meanwhile, announced it would stop offering loan consolidation services and would be more selective with the loans it offered.

9.5% Program Cost Taxpayers $3.5 Billion Since 2001

From 2001 to 2006 the Department of Education paid out $3.5 billion under a subsidy program designed to guarantee nonprofit student loan providers a 9.5 percent rate of return, the

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