The Business of Sallie Mae – Political Risk for Investors and Taxpayers
"Sallie Mae says new student loan bank subsidy cuts are ‘de minimis.’ Gee, that’s not what they told me and other Congressional staff drafting the new student loan law."
-Jason Delisle
New America Foundation
Higher Ed Watch
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The group buying Sallie Mae says it wants to renegotiate the deal in light of legislation passed by Congress and signed into law last week that changes the government subsidy level provided to student loan banks. The buyers argue that the new law changes the student loan program to such a degree that Sallie Mae is not worth what they agreed to pay earlier this year.
Politics
It's not surprising that the Sallie Mae buyers are claiming recent political action has changed the company’s value. Sallie Mae’s business model is subject to an unusual amount of political risk and uncertainty. Why? Well, (1) Sallie Mae derives much of its income from running a government program, and (2) Congress arbitrarily decides how much it will pay Sallie Mae to run the program.
Sallie Mae originates, services, and collects loans as per the federal government’s guaranteed student loan program. Over 80 percent of Sallie Mae’s portfolio is made up of federal student loans. In fact, Sallie Mae is by far the single largest participant in the Federal Family Education Loan program.
The goal of the federal student loan program is to ensure that everyone who wants to go to college has access to a minimum level of below-market interest rate loans. The government sets all of the terms of the loans in law, guarantees them against default and interest rate risk, and then pays Sallie Mae and others to originate, service, and collect those loans.
How much should Congress pay banks for this service? Well, Congress has no idea, so it just makes up a number. And of course the banks provide an awful lot of help when Congress gets in the mood to change that number. Right now the number is 2.34 percentage points over the cost of commercial borrowing. With the new law it will be 1.79 percentage points over the cost of commercial borrowing. Where did those numbers come from? A little bit of guesswork and a lot of lobbying. (It’s worth a good laugh that the members of Congress who picked that number out of thin air thought to add that last decimal place to make it look like an exact number with some sort of defensible rationale behind it).
Fortunately, the recently enacted student loan bill will for the first time take Congress out of the business of setting student loan bank subsidy rates arbitrarily. PLUS loans (loans to parents and independent graduate students) will have their lender subsidy rates set at auction. Sallie Mae will have to bid for the right to make the loans. No more political uncertainty there… just a market process setting the subsidy levels. Frankly, the auction concept should be expanded to the rest of the federal student loan program.
And Posturing
Without a market mechanism to set student loan provider subsidy rates, banks will continue to inundate Congress and its staff with papers, meetings and phone calls pleading that a cut in that arbitrary subsidy rate would be "catastrophic" to the lending business and that a lender subsidy reduction means loans will no longer be made available to students.
In fact, when Congress began considering this most recent round of subsidy cuts, Sallie Mae representatives told me and other Congressional staffers that for the company to continue making federal student loans at the proposed lower subsidy rates, Sallie Mae would have to make the loans through its charity organization. In other words, the proposed and now enacted subsidy cut makes the federal student loan business unprofitable.
Hmm. Square that position articulated to Congressional staff with Sallie Mae’s comment last week to the buyout group balking because of the new subsidy cuts. Reports have those close to Sallie Mae saying the subsidy changes in the new law are not material and their effects on the company's earnings will be "de minimis."
Looks like Sallie Mae’s got a different line for buyers and investors than it does for the members of Congress and Congressional staff who set the company’s pay. All the more reason to push ahead with the auction pilot program for PLUS loans and expand the concept to the rest of the student loan program. Get Congress (and Sallie Mae’s lobbyists) out of the business of setting the banks’ subsidy rate on student loans. The current system is arbitrary, inefficient, and subject to a dangerous amount of political influence. It should go.
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The Real Risk
I wonder what about the panacea of the "market-based" auction will not be arbitrary? Have not the creators of the "market-based" auction concept arbitrarily decided that price alone determines who is allowed to "compete" for FFELP business? Who does the "market-based" auction concept favor? Those like Sallie who already have the economies of scale necessary to low-ball less efficient FFELP players out of the business? Will entrepreneurs be willing to invest in new FFELP businesses knowing that if they lose an auction their capital sits idle until they win one? When there is less competition in the auctions does that lead to lower costs for the taxpayer? When the FFELP business inevitably does become less diffuse because of the "market-based" auction who will lobby Congress all the more harder to keep it that way? When there are less FFELP players will it be easier to dump the FFELP program altogether for the Direct Loan Program
When political and economic power are concentrated together Americans lose no matter how you sell it!
Circular Reasoning
The argument that the auction would cause there to be less FFELP players and then it would be easier to dump the Fedeal Family Education Loan (FFEL) program altogether for the Direct Loan Program, was one heard quite a bit on Capitol Hill when the auction pilot was being debated.
I'd like to point out the irony, or circular reasoning, in this argument. Most supporters of the FFEL program (guaranteed loans), including almost all Republican Members of Congress, argue that it is better than the government lending directly, because the FFEL program is a market-based system and direct lending is a big government program. So, in order to protect FFEL and ensure the whole student loan program doesn't become a "big government program" (direct loans) the subsidy in FFEL program should be protected from a competitive, free market process.
Here the circle begins for my fellow Republicans: I don't want a big government program (direct loans) so I should try to prevent Congress from requiring lenders to compete in an auction for the right to make loans...but wait, if I don't want big government, I should actually support an auction, because letting Congress make up subsidy rates is big government...so let the market set the rate in an auction, but then the auction will lead to all direct loans, which is big government... and round and round we go.
While watching my fellow Republicans race around this circle in debate, one colleague actually got so frustrated and said, "why can't CBO or someone else just tell us the right subsidy rate instead of the auction idea." Sorry. That's still big government setting the price...
-Jason Delisle
What can students do?
What can the students who are affected by the "preferred lender" practice do?
What if the university changed my loans to a different lender without my permission and this is resulting in me paying 6.8% instead of the 0% offered by my state?
Do your homework Cat
Sallie Mae Response
Dear Mr. Delisle:
I respectfully request that you take the responsible step of clarifying your misrepresentation of a recent public statement by Sallie Mae concerning the impact of H.R. 2669, the College Cost Reduction and Access Act of 2007 (“The Business of Sallie Mae – Political Risk for Investors and Taxpayers”). Your characterization of Sallie Mae’s public statement is inaccurate and misleading. It is clear to those who read our statement and the related section of our company’s SEC Form 10-K, that H.R. 2669 would impact our “core earnings” net income by 1.8 percent and 2.1 percent above and beyond similar legislation disclosed in our 10-K.
To help clarify the issue moving forward, I hope you will encourage your readers to refer directly to our statement, which was not included in your posting.Sallie Mae’s Sept. 26, 2007 news release states: “In response to Congress’ passage of the College Cost Reduction and Access Act of 2007 (the “Act”) and President Bush’s expected signing of the Act tomorrow, Sallie Mae has measured the Act’s adverse changes versus the impact of similar legislation described in the company’s SEC Form 10-K [emphasis added] and concluded such changes would reduce “core earnings” net income, between 1.8 percent and 2.1 percent annually over the next 5 years, using business assumptions it has shared with the buyer group.” http://www.salliemae.com/about/news_info/newsreleases/SLMstatement092607.htm
Tom Joyce
Senior Vice President
Sallie Mae
Incremental Changes, Yes - But Still Two Stories
Mr. Joyce's point, as I understand it, is that the "de minimis" quote we cite in our post here refers to the incremental effect on Sallie Mae's earnings that the enacted student loan subsidy cuts will have compared to proposed legislation that Congress considered before ultimately passing H.R. 2669. That's a fair clarification.
But Sallie Mae lobbyists still expressed to Congressional staff (including myself) that the original proposed legislation (by the President in his 2008 budget request, and draft legislation considered by Members of Congress and staff) would cut federal subsidies to such a degree that Sallie Mae would have to make the loans from its charity organization, rather than as a for-profit business.
In other words, Sallie Mae's line to Congressional staff was the same for all proposed subsidy cuts (both the initial subsidy cut and the incremental cut) considered this year by Congress: the subsidy cuts would make the federal student loan business unprofitable, and the incremental increase above those previously proposed would make the loans even more unprofitable.
When Sallie Mae got word that Congress might go further than the President's proposed cuts, they did not characterized that incremental change as "de minimis" to Congressional Staff. They characterized it as eliminating the profitability of federal student loans. Those are two very different stories to describe the same incremental subsidy cut.
-Jason Delisle
Borrower Benefits?
Jason, when you mention the “papers” that banks inundate Congress and its staff with predicting borrower benefit cuts as a result of the new legislation, are you referring to the study by Mark Kantrowitz of FinAid.org?Kantrowitz concluded that subsidy cuts would likely force lenders to cut borrower benefits, and I've seen him quoted a few places lately saying as much. Do you have reason to believe that Kantrowitz’s analysis was flawed or that student lenders had something to do with his study? The guy is as respected a source as there is in the financial aid game, and his independent data and analyses have been cited by your own organization, New America Foundation, in the past.
Circular Is Right
I left the door wide open to change the point didn't I? Should never have muddied the waters with the DLP vs. FFELP comment. There won't be anything competitive about the two winners take all auction. It favors those with scale like Sallie. This lender subsidy backlash started with the mind-boggling profits of Sallie Mae. But Sallie Mae isn't really a market creation-it's a government one. Congress gave Sallie Mae the scale to dominate the FFELP business. Now it will potentially compound the mistake with the "market" auction that favors those with scale. Herein lies the circularity, Sallie Mae keeps making the big bucks.
The FFELP business and the Direct Loan Program are both big-government pet projects. They continue to exist today so that politicians can curry favor with Americans with 3.4% interest rates (that the G can't afford long-term as you pointed-out) and the like. Economic + political power (not always a good thing). If you believe the figures tabulated by the College Board, the earnings premiums for college graduates are substantial ($800,000 for undergraduates, $1,000,000 for graduates). There's no reason why college grads. can't pay more interest for a real free market in lending. Abolishing the government programs won't cut-off access to school, or make school more expensive (contrary to our liberal media, private lenders haven't driven-up the cost of higher education, the schools have done a fine job of that themselves). The more accountable Americans are for the cost of their educations, the more they will make schools accountable for the cost of providing that education.
Students Taking the Real Hit
http://online.wsj.com/article/SB119128234857945763.html?mod=money_page_left_hs
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