Guaranty Agencies

By Deanne Loonin

As I argued last week, the growing reliance of the federal government, student loan guaranty agencies, and colleges on private collection agencies not only to collect on student loans but to resolve disputes and provide repayment information to financially distressed borrowers has been a disaster. Debt collectors are not adequately trained to understand and administer the complex borrower rights available under the Higher Education Act, and the government doesn’t provide sufficient oversight over their activities.

I firmly believe that the time has come to eliminate private collection agencies from the federal student loan programs. The Department of Education, for example, should terminate its contracts with these agencies and, like the I.R.S., hire in-house staff to resolve disputes and collect debts.

I fully recognize, however, that these steps will not be accomplished overnight. So today, I am recommending interim steps the government and other loan holders can take to help protect borrowers’ rights during the collection process. Most of the following steps do not require Congressional or regulatory change but rather a commitment to provide respectful and accurate services to borrowers and to oversee the process so that violations are punished at all levels of the organization:

By Deanne Loonin

There is so much potential for positive change in the student loan programs these days. This is great news for borrowers and we hope Congress and the White House will continue to push for critical changes to benefit borrowers. 

As much as things change, however, some things remain the same for the most financially distressed borrowers. There are good repayment options for many of these borrowers, but unfortunately they often do not get the information they need about their choices or if they do get information, it is often inaccurate or misleading.

The main barrier these borrowers face is that they are forced to deal with collection agencies when trying to resolve problems. It is rarely discussed, but it has become “business as usual” for the federal government, student loan guaranty agencies, and schools to contract with private collection agencies not only to collect, but also to resolve disputes and provide information to borrowers. In both the Federal Family Education Loan (FFEL) program and Direct Lending, private collection agencies are given authority to act on behalf of the loan holder in everything from rehabilitation to providing information about discharges to settling accounts. [Editor's Note: In the FFEL program, the government relies on guaranty agencies to try and prevent delinquent borrowers from going into default and collecting on defaulted loans. Guaranty agencies, however, often hire collection agencies to carry out at least some of these functions. To learn more about guaranty agencies, click here.]

This policy has been a disaster for financially distressed borrowers who are desperate for help. Dispute resolution is, obviously, not the primary mission of loan collection agencies. Debt collectors are not adequately trained to understand and administer the complex borrower rights available under the Higher Education Act, and the government does not provide sufficient oversight of their activities.

As we reported on Tuesday, Qorvis Communications, a top public relations firm in Washington, has taken the lead in the student loan industry's efforts to manufacture grassroots student opposition to legislation that would eliminate the Federal Family Education Loan (FFEL) program. But getting students to rally behind an unpopular industry that profits from their indebtedness has not proven to be an easy task. The firm's desperation has become all too evident in recent weeks.

Take, for instance, the case of Patrick McBride. In a press release announcing the launch of its "Protect Student Choice" public relations effort, Qorvis officials listed McBride, a student at Vanderbilt University, as one of four "local campaign members" -- with the others being leaders of non-profit student loan agencies.

But who is McBride? A former colleague of ours, the enterprising Ben Miller of Education Sector, sought to find out. In an interview he conducted with McBride, Miller learned that he was a first-semester freshman who got interested in the issue while doing research on the Internet. McBride, who would not say whether or not he had taken out student loans (although he added that he "did not have a stake" in the issue), was initially "ambivalent" about the student loan reform legislation. But after talking to David Mohning, the university's financial aid director and a longtime supporter of the FFEL program, he was convinced that the bill was a bad idea.

It's no wonder Americans are deeply suspicious of special interest lobbyists in Washington. Take the student loan industry's latest efforts to kill legislation pending in Congress that would end the Federal Family Education Loan program. It's a prime example of special interest lobbying at its worst.

In 2007, shortly after President Bush signed into law a bill cutting government subsidies to lenders and guaranty agencies, the student loan industry bought into a new strategy to thwart any future Congressional action that might reduce its subsidies further: manufactured grass roots opposition (otherwise known as astroturfing). With Democrats firmly in control of Congress and in a good position to take back the White House in the upcoming presidential election, industry officials knew that the FFEL program was in jeopardy.

Enter Qorvis Communications, a prominent Washington-based public relations firm that had gained notoriety earlier in the decade for its work on behalf of the Saudi Arabian government. Eager for the loan industry's business, one of the firm's partners made a pitch for the company at the 2007 legislative conference of the National Council of Higher Education Loan Programs, a trade group that represents guaranty agencies and non-profit lenders. In a power-point presentation entitled "What Just Hit Us?", this Qorvis executive said that the loan industry had lost the loan subsidy battle because it "had no organized constituency" to "counter" its critics.

[Higher Ed Watch concludes its guaranty agency series today by offering recommendations for reforming and fixing many of the most pressing problems we have identified with these agencies.]

Guaranty agencies' subsidies, responsibilities, and relationships are better suited for a different era of federal student aid policy. Their outdated roles and relationships with lenders not only undermine the underlying policy goals of the original student loan program, they lead to inefficient uses of taxpayer dollars and a variety of practices that harm rather than help student borrowers. Today, the New America Foundation is releasing "Rethinking the Middleman," a report that explores the history and policy shortcomings of guaranty agencies and provides reform recommendations to Congress and the U.S. Department of Education.

The paper recommends that policymakers take the following steps to correct many of the problems with guaranty agencies we have previously identified:

Eliminate the Guaranty Agency Insurance Role

The initial purpose of guaranty agencies was to cover the costs incurred by student lenders when a borrower defaults on a loan, with some assistance from the federal government. Today, guaranty agencies perform that role by making payments to lenders entirely with federal funds held in trust. The vast majority of these funds are reimbursed by the U.S. Department of Education, making guaranty agencies a middleman with minimal stake in the FFEL Program.

[In recent months we have cast a critical eye on federal student loan guaranty agencies by taking a closer look at a few specific agencies to show how concerns about conflicts of interests and misaligned financial incentives operate in practice. Previous entries can be found here, here, here, here, and here. Today, our series continues with a look at the actual amount of subsidies and payments provided to these agencies.]

Guaranty agencies are paid to perform three basic functions within the Federal Family Education Loan (FFEL) Program: provide default insurance for lenders; work with delinquent borrowers to help them avoid default; and collect on or rehabilitate defaulted student loans. Though each individual purpose is important; entrusting a single agency to carry out all of these functions creates opportunities for conflicts of interest. Even worse, the financial payment structure provides guaranty agencies with the greatest compensation for letting a student loan default -- the worst possible outcome for borrowers and taxpayers.

According to the U.S. Department of Education, guaranty agencies received $1.57 billion from the federal government in fiscal year 2008 for dealing with defaulted student loans and working with borrowers. Guaranty agencies also ended the 2008 fiscal year with an additional $1.63 billion worth of federal assets held in trust to reimburse lenders for losses on defaulted loans.

A breakdown of the distribution of federal payments to guaranty agencies reveals why taxpayers and policymakers should be concerned about these companies' financial incentives. As the table below shows, 60.5 percent, or $948.8 million, of the federal payments guaranty agencies received in the 2008 fiscal year were for the collection and rehabilitation of defaulted student loans. (The Department of Education does not separate these payments out so we don't know how much agencies got for each function.) By contrast, they received only $177.3 million for helping keep borrowers out of default. In addition, guaranty agencies received $203.9 million to cover the cost of processing and issuing the initial default guarantee on new loans and another $237.9 million for maintaining existing loan accounts.

On May 21, René Drouin, the president and chief executive officer of the New Hampshire Higher Education Assistance Foundation (NHHEAF) Network Organizations, appeared before the House of Representatives Committee on Education and Labor to discuss reforms to the federal student aid programs.

Higher Ed Watch continues its series that takes a closer look at individual federal student loan guaranty agencies. The introductory post can be found here. The first two posts looking at the guaranty agencies for Georgia, Washington, and Idaho can be found here and here. Today, the series continues with an examination of TG.

TG, or the Texas Guaranteed Student Loan Corporation, is the designated guaranty agency for the Lone Star State. A public, nonprofit company, TG was the third largest guaranty agency in 2008, providing insurance for a total of 1,468,078 loans worth a total of $7,277,747,627.

Unlike the first two agencies we looked at, TG does not have any explicit connections to any particular lenders. Instead, TG has two aspects that are particularly worth discussing: the way it balances its roles within the state and nationally, and its past attempts to change the way it is compensated and structured.

State Ties

So far in our series we have looked at one guaranty agency that is part of the state government and one that has absolutely no ties to the governments in the states in which it operates. TG falls somewhere in between these extremes: An agency that has ties to the state, but is also not constrained by them.

Something fishy appears to be going on in South Carolina.

Financial reporting documents that Higher Ed Watch obtained from the U.S. Department of Education suggest that the state student loan agency in South Carolina may be exploiting its ties to a closely affiliated guaranty agency to receive excessive taxpayer subsidies from the federal government. At issue is the guarantor's apparent abuse of an emergency program that the government has in place to ensure that all eligible students are able to obtain federal student loans.

The federal lender-of-last-resort program is administered by the designated guaranty agency in each state to provide government-backed loans to students whose applications have been denied by other lenders. Since the agency must give qualified borrowers a loan-of-last-resort, the federal government agrees to take on all the risk associated with the debt. This means that holders of these loans are reimbursed for 100 percent (page 8) of any losses sustained due to borrower default, as opposed to ordinary loans made through the Federal Family Education Loans program (FFEL) that are reimbursed at only a 97 percent rate.

Higher Ed Watch continues its series that takes a closer look at individual federal student loan guaranty agencies. The introductory post can be found here. The first post, on the Georgia Student Finance Commission can be found here. Today, the series continues with the Northwest Education Loan Agency.

The Northwest Education Loan Association (NELA) is a nonprofit guaranty agency based in Seattle, Washington that serves as the designated guaranty agency for both Washington and Idaho.

In operation since 1978, NELA was the 13th largest guarantor (out of 35) in the 2008 federal fiscal year, overseeing 176,773 loans worth $799.1 million. It was, however, the smallest guaranty agency to act as a designated guarantor for multiple states.

Unlike the Georgia Student Finance Commission (GSFC), which is basically a state agency, NELA is a private, nonprofit guarantor. It is, however, anything but independent. In late 2004, Sallie Mae, the country's largest student loan provider, essentially took over the guaranty agency's operations. This arrangement raises serious conflict of interest concerns, calling into question how a guarantor can carry out its federal oversight responsibilities over a lender that effectively controls it. As we have seen in similar cases, these types of close-knit relationships between lenders and guarantors can leave borrowers vulnerable to abuse.