Higher Ed Watch has uncovered the Bond Market Association's stealth defense of student loan giant Nelnet’s grossly inflated taxpayer subsidy claims. 

As Higher Ed Watch readers will recall,  the Department of Education’s Inspector General recently called upon the Secretary of Education to take back $278 million in improperly claimed taxpayer subsidy payments to Nelnet and halt another $882 million in pending payments. A decision from the Secretary of Education on the $1.2 billion total is expected any day.

At issue are subsidy payments for loans purportedly entitled to a taxpayer-guaranteed 9.5% rate of return that Congress phased out in 1993. For an explanation of how Nelnet engaged in a reverse money laundering scheme and actually grew its claimed 9.5% loan volume by 900% between 2001 and 2004, see Higher Ed Watch’s blog posts here and here on the Department of Education Inspector General’s audit.

The Bond Market Association (BMA) took its defense of Nelnet to Terri Shaw, head of the Education Department’s Federal Student Aid office and a former Vice President at Sallie Mae, who seems to be just fine with the idea of escalating 9.5% loan payments since she didn't stop them between 2001 and 2004. That, however, is the subject of another blog post.

BMA makes three arguments in Nelnet's defense.  Each is spurious. 

First, BMA argues that because recycling was approved by the Education Department in the past, Nelnet should get to keep 100% of its $1.2 billion in inflated taxpayer subsidies.

In fact, less than 10% of Nelnet’s loan claims are due to recycling, according to the Government Accountability Office.  Approximately 90% of are a product of Nelnet’s controversial growth scheme.

Second, BMA warns that, if accepted, "the Inspector General’s conclusions in the Nelnet audit would disrupt the student loan finance market and unfairly penalize investors while eroding the market fundamental of legal certainty."

Hogwash. The Department of Education has not passed judgment on the legality of Nelnet’s growth scheme and attendant taxpayer subsidy claims. There’s no retroactive policy change in the offing. As the Bush Administration has made clear, "The Department did not approve or disapprove of the methods that Nelnet and other lenders were using."

Finally, BMA suggests that a decision by the Secretary of Education in accord with the Inspector General’s recommendation to reclaim that $1.2 billion in taxpayer money could upset "efficient capital markets."

Wall Street's Fitch Ratings seems to disagree. Fitch told investors in 2004 that its lawyers suspected Nelnet’s scheme to increase its holdings of 9.5 % guaranteed loans might not be legal. Fitch analysts noted at the time that Nelnet’s own accountants recommended holding the questionable income in escrow so that it could be paid back against the day that federal auditors would come knocking (as they eventually did).

Is it efficient to let wrongdoers retain improperly seized property because some in the bond market may have relied on the seizure when those same folks had notice from Nelnet and others that the property was of questionable title? Higher Ed Watch has a bit of legal training, and we think an attorney would be laughed out of court with that argument.

Shouldn’t the Department of Education focus first and foremost on the efficient use of taxpayer dollars? And does the bond market really have a worry?

According to Bloomberg News, student loan bonds currently have higher rates of return than other asset-backed securities. Student loan bonds "are attractive relative to high quality uninsured corporate" debt, according to Dan Ivascyn, who oversees $30 billion in asset-backed securities at Pacific Investment Management. Why? As Scott Kirby, a manager of asset-backed bonds for River Source Investments says, "the credit risk is minimal." 

The substance of the 9.5% loan scandal has been laid out very effectively by the Department of Education’s Inspector General. Tomorrow, Higher Ed Watch will sketch out the political implications of Secretary of Education’s pending $1.2 billion Nelnet decision and make our prediction as to the outcome.

In the meantime, we have one final note for BMA: When you cc your letter to the Department of Education’s "General Council," it may or may not wind up with the General Counsel.  Losers.

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