Student Loan Scandals

Did Sallie Mae officials engage in an elaborate scheme to hide the rapidly deteriorating state of the company’s private student loan portfolio from Wall Street at a time when they were trying to complete a buy-out deal that would have brought them great riches? Were they systematically pushing subprime private loan borrowers at for-profit colleges into forbearance to mask the amount of risk they were taking on by making such high-cost loans to this vulnerable group of borrowers?

Unfortunately, we’ll probably never know the answers to these questions, which are at the center of a class action lawsuit that a group of investors have brought against the company (click here for part 1 of the suit and here for part 2). That’s because a federal district court judge in Manhattan – William H. Pauley of the Federal District Court in Southern New York – has preliminarily approved a $35 million settlement agreement between the parties that would not require Sallie Mae to admit to any wrongdoing. A final ruling on the settlement is expected in August.

While the shareholders will make out well from this deal, the real victims of Sallie Mae’s apparent scheme – the low-income and working-class students who never should have been steered to these risky loans in the first place – will not even get the satisfaction of seeing this case get its day in court. Sallie Mae will essentially get off scot-free ($35 million is hardly even a wrist slap for a company that holds nearly $140 billion of federally guaranteed student loans), many of these borrowers will be stuck with this debt hanging over them for the rest of their lives.

At a time when there is so much concern about a potential student debt bubble, the allegations made in this lawsuit should be getting more attention. With that in mind, I am re-posting a piece I wrote for Higher Ed Watch in October 2010 that lays out the investors’ case and shows why it is so regrettable that the questions posed at the top of this post may never be answered.

The topic of student loans is being debated in the Senate this week, with lawmakers on both sides of the aisle hoping to pass legislation that would curb rising interest rates. Without legislation, interest rates on federal student loans will double from their current rate of 3.4% to 6.8% beginning on July 1st. A recent article in the New York Times provides a good summary of this debate.

By Jon H. Oberg

Reauthorization of the Education Sciences Reform Act, the legislation that governs the federal government’s education research efforts, is three years overdue. On the chance that the current Congress will take up the reauthorization, the American Educational Research Association (AERA) recently offered a set of recommendations for lawmakers to consider.

The trade association provides some sound advice, particularly in urging Congress not to scrap the whole enterprise and start over, as lawmakers have done twice before without achieving the results they were seeking. The approach the association recommends, however, is too steeped in trying to resolve past battles than in addressing the real problems that have plagued the government’s education research efforts: political interference and, at least in the case of its higher education work, inappropriate entanglements with higher education lobbying associations and industries.

To many in higher education, ESRA is a dimly lit corner of federal education law. The National Center for Education Statistics (NCES) is well known, but the other entities authorized by ESRA are more obscure: the Institute of Education Sciences (IES), in which NCES is housed, along with the National Center for Education Research (NCER) and the National Center for Education Evaluation (NCEE). Although the Institute and its centers are components of the Department of Education, the IES director is appointed by the president and confirmed by the Senate to a six-year term overlapping presidential election cycles. The work of the Institute and its centers is, by statute, to be independent of policy and political interference. 

In the upcoming reauthorization, Congress must review the performance of the Institute, which it created in 2002, organizational in-fighting due to the fact that the NCES commissioner is also a presidential appointee, and the perennial struggle for independence from the Education Department and the administration in power. Especially with regard to higher education, Congress must take note that IES has been ineffectual and plagued by dissension with its NCES component. The Institute has not been able to assert its independence or establish necessary credibility as a higher education research and evaluation organization, even as federal spending on higher education has ballooned, scandals have erupted, and America has slipped from its once vaunted position of leading the world in higher education.  

Starting Thursday, there will be, for the first time, a single federal agency in charge of regulating private student loans. The new Consumer Financial Protection Bureau (CFPB) replaces a patchwork of government agencies that for years turned a blind eye to the predatory private loan practices that we at Higher Ed Watch have helped expose since the blog’s start in 2006.

The Dodd-Frank financial overhaul bill that Congress approved last year put the new bureau in charge of writing rules that apply to all private student loans, including those offered by non-banks, such as Sallie Mae and for-profit colleges. It also gave the CFPB full oversight and enforcement authority over non-banks and banks with more than $10 billion in deposits. In addition, the legislation established a new Private Student Loan Ombudsman within the CFPB who will not only assist borrowers but will also analyze complaints that are filed with the bureau against lenders to determine whether there are any clear patterns of abuse -- and make policy recommendations to Congress and the administration to address them.

The bureau, however, will not be at full strength at the start. That’s because the law requires the CFPB to have a permanent director in place before it can carry out many of the consumer protection responsibilities that Congress assigned it. While President Obama on Monday nominated former Ohio Attorney General Richard Cordray to lead the CFPB, Senate Republicans have vowed to block his confirmation until major changes are made to the bureau’s structure that would significantly weaken it.

Nevertheless, the increased oversight that the new entity promises to bring to non-federal student loans is extremely welcome, particularly at a time when the private student loan marketplace appears to be on the rebound.

Yesterday, The Chronicle of Higher Education ran a story about the sorry state of the student loan industry. Throughout the article, we are told that the demise of the Federal Family Education Loan (FFEL) program last year has led student loan companies and guaranty agencies to lay off thousands of workers and eliminate college access programs they managed. While some lenders and guarantors are coming up with “innovative ideas for helping people pay for college” in order to survive, “many of the ideas may not work out, which could lead to a further shrinking of the industry,” the article states.

After reading the story, even we at Higher Ed Watch felt a lump in our throats. That is until we remembered an essential point that the article neglected to mention: the one and only purpose of the federal student loan program is, and has always been, to ensure that all college students have access to affordable loans for any school they wish to attend without delay or disruption. By all accounts, the U.S. Department of Education’s Direct Student Loan program is carrying out this job quite well -- and at a much lower cost to taxpayers.

Earlier this week, we wrote about a class action shareholder lawsuit that accuses Sallie Mae executives of having engaged in an elaborate scheme to hide the rapidly deteriorating state of the company's private student loan portfolio at a time when they were trying to complete a buy-out deal that would have brought them great riches.

At Higher Ed Watch, we find these allegations compelling. It was, after all, only a week after Sallie Mae's deal with J.C. Flowers & Co. collapsed that the company began to come clean about the huge amount of losses it was about to incur on the extremely risky private loans it had made to sub-prime borrowers at some of the largest chains of for-profit college companies in the country.

Unsurprisingly, Sallie Mae's lawyers tell a different story. Far from being conspirators, the student loan giant's leaders, they say, were "unsuspecting victims" of the financial turmoil that overtook the country during that period of time. "Although not recognized at the time, the second half of 2007 marked the start of what became the largest credit crisis since the Great Depression, described by former Federal Reserve Chairman, Alan Greenspan (who did not predict it), as a "once-in-a-century credit tsunami," the company's counsel wrote in their unsuccessful motion to get the case dismissed. "During this period SLM Corporation experienced unprecedented defaults by its student borrowers and its stock price declined substantially, on virtually the same downward trajectory as other consumer credit providers."

They concluded the motion by saying, "In sum, plaintiffs offer no contemporaneous, reliable evidence sufficient to support any inference other than that defendants were unsuspecting victims of a consumer credit tsunami that cause unprecedented numbers of its student borrowers to default."

This explanation could be convincing -- but only if you ignore the numerous statements that Sallie Mae officials have made since that time acknowledging the part they played in creating the mess in which they find themselves. At Higher Ed Watch, we thought we'd provide the following chronology to remind our readers of what Sallie Mae executives had to say as the true condition of  the company's private loan portfolio became known:

On December 12, 2007, Sallie Mae announced that the extremely lucrative buy-out deal that it had reached earlier in the year with an investor group led by the private equity firm J.C. Flowers & Co. had gone up in smoke. A week later, Sallie Mae executives began to acknowledge the rapidly deteriorating state of the company's private loan portfolio, particularly among those high-risk loans it had made to sub-prime borrowers at some of the largest chains of for-profit colleges in the country.

Was the timing a coincidence? Or had the student loan giant's leaders engaged in a deliberate scheme to mask the company’s true financial condition to make sure the deal -- which promised to bring great riches to its board members, including chairman Al Lord, who was set to rake in $225 million -- was consummated?

Those questions are at the center of a class action shareholder lawsuit (click here for part 1 of the complaint and here for part 2) that a federal judge in Manhattan has allowed to proceed against Sallie Mae [SLM]. Late last month, William Pauley of the Federal District Court in Southern New York rejected a motion by Sallie Mae to dismiss the lawsuit, saying that the investors suing the company had provided sufficient evidence of possible wrongdoing to allow the litigation to move forward.

The case dates back to the fall of 2006 when Sallie Mae put itself up for sale. In the immediate years preceding, the loan company had forged sweetheart deals with some of the largest chains of for-profit colleges in the country, including Career Education Corporation, Corinthian Colleges, and ITT Educational Services, as Higher Ed Watch has previously reported. Under these arrangements, Sallie Mae agreed to provide funds for private student loans, with interest rates and fees totaling more than 20 percent per year, to low-income and working class students at these schools who normally wouldn’t qualify for them because of their poor credit records. Sallie Mae apparently viewed these loans as “loss leaders,” meaning that the company was willing to make these loans, many of which were likely to go into default, in exchange for becoming the exclusive provider of federal loans to the hundreds of thousands of students these huge chains collectively serve.

As they started to shop the company around, Sallie Mae executives, the lawsuit says, decided to double down on this risky strategy. "Defendents sought to increase short-term profits in an effort to negotiate a sale to the Flowers group (or another buyer) at an attractive premium and convince investors that an acquisition on favorable terms was likely,” the complaint states. “The scheme consisted of writing billions of dollars in private loans to high-risk borrowers, recording increased income from these loans (as a result of increased loan volume and higher rates of interest SLM was entitled to receive on the loans" as compared to federal loans), and "underreporting expected losses.” From June 2006 to December 2007, Sallie Mae’s private loan portfolio “more than doubled,” from $7 billion to $15.8 billion.

To make the strategy work, Sallie Mae officials needed to find a way to mask the amount of risk the company was taking on. Their aim was to keep delinquency and default rates on these high-cost loans artificially low while the buy-out deal was pending, the lawsuit says. Otherwise, they would have had to significantly raise the amount of money they held in reserve to cover possible losses on these loans -- which would have “reduced reported income and earnings” and ultimately the company’s value. 

According to the lawsuit, Sallie Mae officials found an easy solution: pretend that the problems with the portfolio didn't exist by pushing delinquent borrowers into forbearance. By manipulating the company's forbearance, they could ensure that delinquent borrowers would not default on their loans until after the buy-out deal was completed and ownership had changed hands.

The student loan company Nelnet announced late Friday afternoon that it has reached "an agreement in principle" to settle a Federal False Claims lawsuit filed against the corporation and five other lenders that engaged in a scheme to bilk taxpayers by systematically overcharging the government for subsidy payments on federal loans they made to students. The lawsuit, brought by by Jon Oberg, the former Department of Education researcher who uncovered the 9.5 student loan scandal, has sought the return of approximately $1 billion to the government in overpayments these lenders improperly received.

According to a news release Nelnet put out at around 4:30 p.m. on Friday, the Nebraska-based lender has agreed to pay $55 million to settle the case. The bulk of the money will go back to the federal government. The company said that it was pleased with the deal, as it will not be admitting any wrongdoing.

It appears that Oberg has also reached tentative agreements with the other lenders in the case as well. About an hour before Nelnet issued its release, John F. Anderson, the federal judge presiding over the case, issued an order canceling the trial, which was scheduled to get under way in the U.S. District Court for the Eastern District of Virginia on Tuesday.

Higher Ed Watch will be off for the next two weeks for summer break. But when we get back, we will dig deeper into the court documents to try and resolve at least some of the remaining unanswered questions surrounding the scandal.

One way or another, the whistle-blower lawsuit filed by Jon Oberg, the U.S. Department of Education researcher who uncovered the 9.5 student loan scandal, against six student loan companies that participated in the scheme should be resolved shortly.

The parties are currently in the third-day of court-ordered settlement talks to resolve the lawsuit, which seeks the return of approximately $1 billion to the government in overpayments these lenders improperly received. If the negotiations break down, the case is scheduled to go to a jury trial in the U.S. District Court for the Eastern District of Virginia on Tuesday.

The defendant with the most to lose in the case is Nelnet, the Nebraska-based loan company that was the most aggressive participant in the scheme, reaping about $300 million in excess federal subsidy payments from the government. The other defendants are: Brazos Higher Education Services Corporation (Texas), Education Loans Inc. (South Dakota), Panhandle Plains Higher Education Authority (Texas), Sallie Mae, and Southwest Student Services Corporation (Arizona). Brazos and Oberg have tentatively reached a settlement, the terms of which are now under review by the Justice Department.

As we have repeatedly said, this case should finally resolve many of the unanswered questions surrounding the scandal -- a goal we have been pursuing at Higher Ed Watch over the last couple of years. After doing a careful review of court documents publicly available on PACER (Public Access to Court Electronic Records), here are some of the truths that we believe have been revealed:

The U.S. Department of Justice dealt a powerful blow this week to efforts by the student loan company Nelnet to derail a Federal False Claims lawsuit filed against the corporation and five other lenders that engaged in a scheme to bilk taxpayers by systematically overcharging the government for subsidy payments on federal loans they made to students. The lawsuit, brought by by Jon Oberg, the former Department of Education researcher who uncovered the 9.5 student loan scandal, seeks the return of approximately $1 billion to the government in overpayments these lenders improperly received.

On Monday, the Justice Department (DOJ) filed a brief with the U.S. District Court for the Eastern District of Virginia urging the court to reject a central argument that Nelnet has repeatedly made to try and get the judge to throw out the lawsuit -- namely that Oberg can't sue the company on behalf of the government because federal officials have already resolved the case.

At issue is the settlement agreement that the Department of Education [ED] reached with Nelnet in January 2007. Concurring at the time with the Department's Inspector General that the Nebraska-based loan company and other lenders had illegally grown the volume of loans that they claimed were eligible for the 9.5 subsidy rate, then-Education Secretary Margaret Spellings barred Nelnet from receiving any further 9.5 payments. She did not, however, require the loan company to return the overpayments it had already received. In addition, she included a statement in the settlement saying that "Nelnet and the Department agree that bona fide, good faith disputes and controversies exist between them concerning the matters described."