The House Always Wins

HIGHEREDWATCH.ORG

Anya Kamenetz | June 6, 2007

"The casino business and the student loan business have something in common: the house can't lose."

Anya Kamenetz
Blogger and author of Generation Debt

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I'm writing this post from beautiful, sunny Las Vegas, Nevada, where I just gave a talk and saved hundreds of dollars by not gambling. It strikes me that the casino business and the student loan business have something in common: the house can't lose.

Casinos offer their customers beautiful surroundings, free food and drinks, as well as the occasional jackpot. Student lenders offer their customers inducements and discounts on fees and interest rates.

In both cases, the businesses can afford to sweeten the pot this way and still turn a very, very healthy profit because they operate at virtually no risk, with the odds heavily weighted in their favor.

But don't take my word for it -- listen to Sallie Mae's former chief financial officer and newly installed chief executive officer, C.E. Andrews.

Last week Higher Ed Watch referred to a letter sent from Andrews to the Federal Reserve and other federal regulatory agencies in January 2006. You can read the letter here: http://www.federalreserve.gov/SECRS/2006/February/20060214/R-1238/R-1238_38_1.pdf.

I wanted to take a closer look. Sallie Mae maintains its cash flow and has an additional revenue stream from trading asset-backed securities (ABS) -- investment products backed by portfolios of student loans. In the letter, Andrews is asking the Fed to bless the student loan ABS with a higher rating, one that reflects what a very, very, very safe asset a student loan is.

Why does ownership of student loans promote such peaceful sleep? Andrews explains, "The high quality of student loan ABS derives primarily from the largely sovereign risk nature of the underlying assets." FYI, "sovereign" means the risk really belongs to the federal government, not to student lenders.

"The U.S. government's guarantee of Guaranteed Student Loans is direct, explicit, irrevocable and effectively unconditional," he continues. If a student defaults on a loan for any reason, the lender just has to file a claim with a state or nonprofit guarantee agency and they get 98 percent of their principal back, courtesy of the taxpayers.

But that's not all. In theory, guarantees may be revoked if a lender fails to perform "due diligence" on a loan, by, for example, sending warning letters when an account becomes delinquent. But Sallie Mae usually finds a way around this basic servicing responsibility: "In fact, the historical data for Sallie Mae student loan ABS reveals that, in practice, virtually all guaranty claims rejected based on noncompliance with the due diligence requirements are eventually cured," Andrews writes.

So let's review. In the Federal Family Education Loan (FFEL) program, student lenders like Sallie Mae collect interest and fees on 100 percent of what they lend out, but their risk is just 2 percent of what they lend. And even as the lenders are arguing publicly that the slightest reduction in subsidies and guarantees will drive lenders out of business and make it harder for students to get the loans they need, they're sending official letters to the government underlining, repeatedly, just what an outrageously sweet deal -- a "de minimus credit risk" -- they have right now.

There must be a way to lower subsidy levels and guarantees to the point where student lenders share an acceptable amount of risk in exchange for their profits. Truly open competition in the student loan program would allow the market to set that subsidy level.

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Comments

Federal Government Guarantee Assures Universal Access by All

Submitted by Henry B. Howard (not verified) on June 8, 2007 - 3:33pm.

Anya:

Please replace the FFELP loan program using the funds of the New America Foundation. Please use the money of the New America Foundation to make a loan to any 17 year old in America regardless of high school GPA, with no credit history, with no creditworthy parental cosigner, and that has a 50% probability of never finishing undergraduate school, i.e., dropping out without paying his/her student loan payments. Please use the money of the New America Foundation to do this without any guarantee whatsoever from the federal government or a guarantee at less than 97%. Ask the New America Foundation board of directors to approve such a loan program. You have focused on excesses of certain mega-lenders in the FFELP program (which need reform) but you have lost sight of the real purpose of the FFELP program; universal access for every American that wishes to attend a trade school, community college, four year college, or graduate school.

Henry B. Howard, President and Chief Executive Officer of U.S. Education Finance Group (a FFELP lender promoting competition for the benefit of student, parent, and consolidation loan borrowers but not a mega-lender).

Borrower Benefits are Real and Not Meaningless

Submitted by Henry B. Howard (not verified) on June 8, 2007 - 4:55pm.

A recent article by Anya on the New America Foundation website attempts to malign the positive effect of borrower benefits (a reduced interest rate less than the maximum interest rate permitted by federal law) offered by FFELP lenders on student, parent, and consolidation loans which reduce the overall cost of such loans to the borrower.

Anya forgets that not all FFELP lenders are bad and some (such as U.S. Education Finance Group) are quite pro-consumer as a result of injecting competition into the student loan business which has been historically dominated by state specific student loan monopolies such as the Vermont Student Assistance Corporation (historically looked after by Senator Jim Jeffords, Republican turned so called Independent), the South Carolina Student Loan Corporation, and the Wyoming Student Loan Corporation (historically looked after by Senator Mike Enzi, Republican) as well as a national oligolopies such as the federal Government Sponsored Enterprise ("GSE") known as Sallie Mae (historically looked after by Senator Judd Gregg and Representative John Boehner, Republicans) and the U.S. Department of Education Direct Loan Program (historically looked after by Senator Edward Kennedy and Representative George Miller; both proponents along with the New America Foundation of a the U.S. Department of Education being the monopoly student loan and consolidation loan lender in the United States).

Let me tell your the story of consolidation loans and borrower benefits. Consolidation loans are fixed interest rate loans which pay off variable interest rate student loans. Student borrowers are benefited by paying off variable rate student loans with a fixed interest rate consolidation loan that has a fixed interest rate lower than the maximum variable rate under the student loan program.

From 1965 to 1973 there were no consolidation loans made by any lender.

From 1973 to 1983, only one lender, Sallie Mae, was allowed to make consolidation loans under the Higher Education Act. Sallie Mae, by law, was the de jure monopoly consolidation loan lender in the entire country and made 100% of all consolidation loans during the period from 1973 to 1983. No other lender was allowed to make consolidation loans. Sallie Mae made consolidation loans at the MAXIMUM interest rate permitted by the Higher Education Act during the period 1973 to 1983 due to fact competitive FFELP lenders were legally preventing from making consolidation loans.

From 1983 to 1986, there were no consolidation loans made by any lender.

From 1986 to 1998, in what I call the Sallie Mae student loan portfolio protection amendment to the Higher Education Act, a student loan borrower was only allowed to obtain a consolidation loan from one of his/her student loan lenders. Since Sallie Mae was more likely than not to own a student loan of anyone that ever obtained a student loan in the history of the planet Earth, Sallie Mae was a de facto monopoly and made 99% of all FFELP consolidation loans during the period 1986 to 1996. Sallie Mae made consolidation loans at the MAXIMUM interest rate permitted by the Higher Education Act during the period 1986 to 1998 due to provisions in the 1986 amendment to the Higher Education Act that effectively made Sallie Mae a monopoly and stifled competition from other FFELP lenders.

In 1998, this writer, fed up by this monopoly, overcharging of borrowers, and uncompetitive situation, moved an amendment to the Higher Education Act through the House Education committee, the full House, the Senate education committe, and the full Senate to allow any student loan borrower to obtain a consolidation loan from any student loan lender. In the House/Senate conference committee, Senator Jim Jeffords and his then assistant, Mark Powden (who would later become the chief of the Education Finance Council, an lobbying group for state level student loan monopolies) indicated he would kill this highly competitive amendment designed to save student loan borrowers money via lower interest rates in order to protect the student loan monopoly of the Vermont Student Assistance Corporation, an entity that would not exist in a purely competitive environment. A very sub-optimal compromise ensued that allowed only student loan borrowers with two (2) or more FFELP student loan lenders to obtain a consolidation loan from the FFELP lender of their choice. Therefore, if a student loan borrower had all of his/her student loans from one lender, as was the overwhelming case in Vermont, such single student loan lender borrower was prohibited by the Higher Education Act from obtaining a consolidation loan from any other lender.

Nevertheless, this simple 1998 amendment to the Higher Education Act resulted in competition between FFELP lenders, the emergence of new competitive FFELP lenders offering lower borrower interest rates such as U.S. Education Finance Group, and overall lower borrower interest rates where none previously existed. From 1998 to 2006, millions of student loan borrowers that did not have a single FFELP student loan lender were able to shop around and obtain a consolidation loan at an interest rate LESS THAN THE MAXIMUM INTEREST RATE permitted by the Higher Education Act. Millions of students were saved millions of dollars in interest via competition and borrower benefits.

Senators Mike Enzi and Edward Kennedy for different reasons, as described above, are attempting to move a Higher Education Act Reauthorization Bill and Budget Reconciliation Bill this week that would make deep cuts in the FFELP program resulting in the withdrawal from the program of competitive lenders other than the Department of Education, Sallie Mae, and the state specific student loan monopolies. Instead of going after these immediately aforementioned oligopolists, Enzi and Kennedy are going after the only existing competitors to such oligopolies.

Even school children in America know monopolies and oligopolies are inherently bad and competition is inherently good for consumers.

Henry B. Howard, President and Chief Executive, U.S. Education Finance Group (a competitive FFELP lender).

Higher Education Funding is Inherently Governmental

Submitted by JPasko (not verified) on June 9, 2007 - 8:33pm.

Higher Education funding is an inherently governmental function which needs to be taken back from profiteers, including most notably SLM Corporation. In the absence of full, outright grants for higher education (such as those in many civilized societies), the Direct Loan Program is the next best thing. Four times cheaper to run and significantly cheaper for students, it's a win-win.

Spin it any way you want. The fact of the matter is that the past 6 years in particular have been a gilded age for student loan profiteers. The Higher Education Act was not envisioned with SLM Corporation Chairman Albert L. Lord having a private luxury golf course or being able to place bona fide bids to purchase a major league baseball team.

One point Mr. Howard makes and with which I agree is that the current system enables any 17-year-old, regardless of GPA, to get a student loan. The dumbing-down of higher education, which includes the proliferation of online blog correspondence courses holding themselves out as "universities," and the decay of admissions standards at legitimate schools, is not only undermining the integrity of higher education but also is fueling explosive profit growth for the student loan industry.