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

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

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

By Deanne Loonin

As most readers of Higher Ed Watch know, current bankruptcy law treats students who face financial distress the same severe way as people who are trying to discharge child support debts, alimony, overdue taxes and criminal fines. It's difficult to separate fact from fiction when trying to understand the logic behind this policy, but one thing is clear -- the restrictions came about without any empirical evidence that students were more likely to "abuse" the bankruptcy system.

Unfortunately, the legislative history of the student loan bankruptcy provision sheds little light.

The bare facts are that in 1976, Congress made student loans generally non-dischargeable except five years after default or if the borrower could prove "undue hardship." Since then, there have been three significant legislative changes. First, in 1990, the five year period was extended to seven years. In 1998, Congress eliminated the seven-year floor primarily as a budget savings gimmick to pay for student loan changes it made when it reauthorized the Higher Education Act that year. Finally, in 2005, lawmakers included private loans in the non-dischargeability category as part of comprehensive bankruptcy amendments (the change primarily affected for-profit lenders because private loans made by nonprofit providers were already exempt). If there were reasons to consider restricting bankruptcy for federal loans, there was absolutely no such basis for extending the policy to high-cost private loans.

With Thanksgiving behind us, it is officially the start of the gift-giving season. Unfortunately, students at public colleges and universities across the country can already expect an unwanted present from their governors -- tuition and fee increases. At least coal could have been used for heat.

Students are going to face increased tuition burdens, both for next semester and the following academic year, because governors and state legislators often turn to higher education when they need to make budget cuts. But increasing tuition could lead more students to drop out or delay enrollment -- lowering graduation rates and stranding students with debt. To prevent these negative outcomes, we urge states to make a sustained commitment to higher education, while asking schools to reexamine their financial aid and revenue allocation policies.

The coming months are going to be gloomy for higher education funding. Several states have already announced plans for postsecondary education cuts, and many more are sure to follow suit. The governors of New York and California -- the two states with the largest public higher education systems in the country -- recently proposed a new round of budget cuts on top of ones that these colleges endured earlier this year.

Higher Ed Watch is about to take the week off to celebrate Thanksgiving, and help ourselves to plenty of turkey, cranberry sauce, stuffing, and pumpkin pie. But before we do, here is a brief list of some things that we are especially thankful for:

• New leadership coming to the U.S. Department of Education that will hopefully close the revolving door between the agency and the student loan industry.

• Growing interest in redesigning the federal student aid programs to make them less complicated and more equitable. Over the last several months, both the College Board's Rethinking Student Aid Study Group and the U.S. Department of Education have unveiled proposals for overhauling the system. While we don't entirely agree with the details of either plan, we hope these efforts will spur policymakers to consider broad-scale reforms. The aim should be to design a coherent system that is efficient and targets aid to those students who need it most.

Bush Administration Announces More Relief for FFEL Lenders

Opposition to Private Student Loan Bailout Mounts

Department of Ed Data Project Sparks Controversy

High Costs Keep Thousands of Qualified Students Out of College, Survey Finds

The National Association of Student Financial Aid Administrators (NASFAA) is at it again -- raising panic levels to pressure policymakers to provide a massive bailout of the student loan industry. This time, the group's focus is on ensuring that lenders and colleges can continue to offer expensive private loans to high-risk borrowers.

On Monday, NASFAA President and CEO Phillip Day (pictured) sent a letter to both Treasury Secretary Henry Paulson and Education Secretary Margaret Spellings asking for their assurances that they will use a portion of the $700 billion bailout package to provide liquidity to companies that make private student loans. Praising the efforts Congress and the Bush administration have made to assist lenders that participate in the Federal Family Education Loan (FFEL) program, Day urged Paulson and Spellings to take "similar effective actions to ensure credit financing is available for those private educational loan borrowers that need it in order to pay postsecondary education expenses."

"Surely," he continued, "private education loans must be considered ‘troubled loan assets' and action is needed to correct this marketplace dysfunction." [The bailout package Congress approved in October gives the Treasury Secretary the authority to purchase "troubled assets."]

We agree with Day that private student loans are troubled loan assets -- for many of the financially needy borrowers who take them out. As we've written repeatedly, private loans are the most toxic form of student debt available with their high variable interest rates and lack of basic consumer protections. As with subprime mortgages, the lowest income borrowers are often stuck with the highest rates and the worst terms on these loans. And borrowers who have difficulty repaying the loans often have no way out - as private student loan providers have been uniformly inflexible in offering repayment relief. In addition, federal law makes it extremely difficult for financially distressed borrowers to discharge private loans in bankruptcy.

A recent report by Iowa's attorney general about misdeeds at the Iowa Student Loan Liquidity Corporation has one major shortcoming: it essentially lets the leadership of the state-affiliated nonprofit lender off the hook.

Don't get us wrong -- the report is not a whitewash. As we noted previously, it provides an illuminating account of how the Iowa loan agency, also known as ISL and Iowa SLLC, pursued a concerted strategy to steer students to its most expensive private student loan products. Among other things, the report found that the agency made improper payments to colleges that recommended its private "Iowa Partnership Loans" to their students; falsely advertised its private loan products as the "lowest cost" options available; and routinely failed to advise students and their families to exhaust their federal student loan eligibility before taking out private loans.

"The future of many Iowa students is burdened by a mountain of student loan debt," Iowa Attorney General Tom Miller (pictured left) wrote in the report. "It appears that ISL unduly elevated the goals of increasing its competitive advantage, market share, and loan portfolio size over its mission of always striving to do the best for its student borrowers."

But, at the same time, the report opens up the possibility that the agency's leaders will not be held accountable for their actions.

[Editor's Note: Last week, Treasury Secretary Henry Paulson said that he planned to expand the $700 billion bailout plan to aid private student loan providers. But what about the alarming number of financially distressed private loan borrowers who have fallen behind on their payments or are in default? Is there any help for them? In this post, consumer advocate Deanne Loonin takes a critical eye to lenders' arguments for why they have been so unwilling to provide relief to these borrowers.]

By Deanne Loonin

Oscar, a 26 year old college graduate living in the Bronx, called our Student Loan Borrower Assistance phone line the other day. The first member of his extended family to pursue a higher education, Oscar took out both federal and private loans to pay for college. Earlier this year, he was laid off from one of two jobs he works to make ends meet. Since then, he has run intro trouble making payments on his private loans. He wants to avoid default, but is afraid he will have no choice, as his loan holder has repeatedly refused to work with him to ease his monthly payments.

"The loans were so easy to get," he says. "So why is it so hard to get some help?"

Oscar is not alone. Defaults and delinquencies on private student loans are growing at alarming rates. This is hardly surprising given the predatory terms of many of these loans and the current state of the economy. So why are student loan providers so unwilling to offer financially distressed borrowers like Oscar the help they need to dig themselves out of trouble and avoid defaulting?

Paulson Says Student Loans to Benefit from Bailout

New York Governor Announces Spending Cuts for Higher Ed

Bush Administration Unveils Blueprint for Revised Financial Aid System

Transfer Students are Disengaged, Survey Finds

Here's something that we never could have predicted: President Bush is leaving the federal Direct Student Loan program in a stronger position than he found it.

Back in January 2001 few student-aid observers thought that Direct Lending, which had been championed by the Clinton administration and Congressional Democrats, would survive the Bush presidency. Some loan industry lobbyists were so confident of the program's demise that they actually advised the administration to show restraint. "It would be foolish for the Bush administration to try to eliminate direct lending," Jeff Andrade, an advocate of the Federal Family Education Loan (FFEL) program, told The Chronicle of Higher Education shortly before Bush was sworn in. "The program is withering on the vine on its own." [Andrade soon after received a plum assignment at the U.S. Department of Education.]

Now, nearly eight years later, the Direct Loan program's fortunes are on the rise. In the wake of the credit crunch, the program's volume has increased by nearly 50 percent this year, according to the Education Department. Roughly 400 schools have switched to Direct Lending from the competing Federal Family Education Loan (FFEL) program over the last 12 months, bringing the total number of schools offering Direct Loans to about 1,370. If the program's growth continues at its current pace, Direct Lending will overtake the FFEL program for the first time in the program's history. [An additional irony is that, as a result of the credit crunch, the FFEL program is looking more and more like direct lending -- with the federal government providing federal capital and liquidity to struggling lenders to make federal loans.]