Give Money to Students, Not Lenders

A new Education Department report could have dramatic implications for the Pennsylvania Higher Education Assistance Authority (PHEAA).

The report, from the department’s inspector general’s office, calls on the National Education Loan Network, known as Nelnet, to give up $278 million in improperly claimed taxpayer subsidies. An additional $882 million could still be counted as overpayment, according to the report. Nelnet disagrees with the findings, and it’s now up to the Department of Education secretary to accept or reject the report.

About two-thirds of PHEAA’s earnings in 2004 came from the same subsidy, and the nonprofit lender is now being audited.

How did Nelnet and PHEAA get here and what should be done about it?

When Pennsylvania students borrow money for college, typically their financial aid office funnels them to PHEAA or a private, for-profit lender like Nelnet or Sallie Mae. The government guarantees student loans against default and provides the lender with a subsidy on top of the student’s interest payments. Congress legislates the amount of that subsidy.

In the high-interest-rate 1980s, Congress’ subsidy guaranteed lenders a 9.5 percent rate of return. By 1993, with interest rates lower, Congress ended the 9.5 percent guarantee.

Or so it thought.

Lenders recycled payments from pre-1993 student loans and used the money to make new, post-1993 loans. The lenders then claimed that the old 9.5 percent guarantee applied to new loans, and the government paid accordingly.

Between 2002 and 2004, Nelnet and PHEAA dramatically increased -- by more than $1 billion -- the amount in new loans they claimed were entitled to the 9.5 percent rate of return, according to the report and PHEAA’s annual financial statements.

Given that some student loans went for as little as 3.5 percent in 2004, the 9.5 percent guarantee resulted in significant profits.

A whistleblower brought the problem to the attention of Sen. Edward M. Kennedy (D., Mass.), my former boss, and the inspector general. In response, Congress changed the method for loans issued after 2004 and an investigation was begun. Last month, the inspector general called on Nelnet to give back subsidy money claimed from January 2003 through June 2005.

PHEAA’s nonprofit status is unlikely to spare it from Nelnet’s fate. First, PHEAA hasn’t been a particularly good nonprofit actor of late. Recently, it awarded seven executives almost $900,000 in year-end bonuses. Second, the federal Higher Education Act doesn’t differentiate between for-profit and nonprofit lenders.

While the audit continues, here’s what Congress should do:

Turn off the spigot for all 9.5 percent loans and instead send that money directly to students in the form of grants or lower loan payments.

Stop subsidizing for-profit lenders like Nelnet and Sallie Mae. Guaranteeing their student loans against default is enough. In part, it’s fear of being overwhelmed by these companies that leads nonprofits like PHEAA to act inappropriately.

Stop writing into law subsidy payments for nonprofit lenders. Congress should make lenders compete at auction for government-backed loan business. That’s the only way taxpayers can be sure subsidy payments will be as low and well-directed as possible. As one of the country’s largest student loan lenders, PHEAA would probably do quite well in an auction.

Savings associated with these recommendations could go directly to students or be returned to state governments for increased student aid.

As lawmakers work on this issue, they should keep one thing in mind: Lenders don’t need financial aid. Students do.