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Lenders' Last-Ditch Gambit

July 8, 2009

For all their talk about how damaging and risky the Obama administration's student loan proposal could be for students and the country, leaders in the student loan industry appear to be willing to live with the plan in its broad outlines -- or at least to have concluded that they can't do too much to derail it.

On Tuesday, a broad array of companies and loan agencies (with some notable exceptions) offered an alternative to the Obama plan that departs in a few key ways -- continuing to allow lenders to originate loans, and to let state and nonprofit lenders "service" loans in their regions -- but endorses the administration's overall goals of having the government own all federal loans and redirecting tens of billions of dollars in lender subsidies to increase aid to students ($87 billion by the latest estimate).

The lenders are banking on the prospect that the members of Congress who will ultimately decide the fate of the student loan programs will be swayed by the idea of keeping jobs in their districts (by sustaining the ability of state loan agencies to compete to collect loans) and/or by skittishness over creating a government-run program without any alternatives in the event of a meltdown. Lawmakers from both parties have expressed enough reservations about those and other potential effects of the administration's proposal that an alternative could win enough support.

But perhaps the most remarkable aspect of the lenders' alternative is just how far it goes in conceding the underlying transformation that the administration's proposal would represent. The student loan community's plan abandons the idea -- long a staple of the guaranteed student loan program -- that it is essential to keep private capital in the mix for financing federal student loans. (That view has been significantly undercut in the 18 months by the reality that many loans made by lenders since the enactment of the 2007 Ensuring Continued Access to Student Loans Act have actually been financed by the government.) It gives up on challenging the argument that the administration's approach will produce scores of billions of dollars in budgetary savings. And it accepts the notion, which lenders fought for many years, that government subsidies to lenders are both excessive and unnecessary.

"We ... acknowledge that the time has come for a significant change in the way student loans are financed," the loan groups said in a letter to lawmakers about their new proposal. "The Administration has proposed the framework for meeting these goals. Our plan merely enhances that framework to ensure they are met as seamlessly -- and efficiently -- as possible."

The strongest proponents of the administration's plan were not won over by the lenders' alternative. “Thus far, President Obama’s proposal is the only plan that will meet both our goals of generating tens of billions of dollars in savings to help students pay for college while creating a reliable, effective and cost-efficient federal student loan program for families and taxpayers,” said Rachel Racusen, a spokeswoman for Rep. George Miller, the California Democrat who heads the House Education and Labor Committee and is a close ally of the president. Thirty-one Democrats, however, signed a letter this week urging Congressional leaders to consider alternatives to the administration's plan.

The 'Consensus' Plan

Though its sponsors billed the lenders' proposal as a "consensus view" from "all sectors of the student loan industry, including nonprofit state agencies, stand alone lenders and loan servicers, consumer banks and non-profit, state-based guaranty agencies," the proposal unveiled Tuesday does not represent a full coming together of the loan industry, which has been fracturing in recent months as various players struggled to figure out their most advantageous approach to the Obama administration's bold proposal to end the guaranteed loan program. ("Like rats on a sinking ship" was a descriptor applied privately by more than one analyst of the loan industry in recent weeks.)

The Education Finance Council, for instance, which represents nonprofit and state-based entities that originate loans or serve as "secondary markets," has been quietly pushing a proposal that would abandon any role for lenders in originating loans but lock in a role for state secondary markets in servicing loans. Sallie Mae, the country's biggest student loan provider, had promoted its own plan to essentially extend the ECASLA program, while several guarantee agencies have been floating proposals that would lock in a stream of funds for them in exchange for counseling and other services they would provide to borrowers.

It's not surprising, then, that the "consensus" proposal contains elements of all those ideas (and more). Ron Gambill, chairman and CEO of EdSouth, a nonprofit lender, said the proposal "builds on" Obama's plan to use savings from the loan programs to significantly bolster spending on Pell Grants, but does so without the "significant transition risk that comes with the administration's proposed takeover of $60 billion in private sector loans."

Education Department officials have trumpeted the fact that the federal government's direct loan program has smoothly absorbed the growth it has seen in the number of colleges and borrowers it serves since the freeze of the credit markets 18 months ago. But some observers have questioned how things might go if thousands of colleges were forced (by the Obama proposal) to abandon the guaranteed loan program by next summer, when the current setup for the loan programs (under ECASLA) is due to expire.

Under the lenders' alternative:

  • Individual colleges could select to have their students' loans originated by at least two lenders of their own choosing, based on the lenders' delivery technology, customer service and quality (all loans, whether originated by the government or lenders, would have the same terms, so there would be no competition on that front). The government would pay lenders a loan administration fee (0.69 percentage points times the principal of the loan) and a $75 origination fee for each loan, and the lenders would be required to sell the loans to the government within 120 days of disbursement.
  • The entities that originated loans would have the right to continue to service the loans if colleges chose them as their servicers. State agencies and nonprofit lenders, which would be largely left out of loan servicing under the Obama plan, would continue to be able to compete to service loans on a fee-for-service basis under the alternative.
  • Companies or agencies that service loans would agree to absorb some of the risk of borrowers' defaults by paying the government 3 percent of the unpaid principal, generating additional savings for the plan and, the lenders argue, giving them added incentive to keep borrowers out of default.
  • The government would allocate at least a third of the $2.5 billion the Obama administration plans to distribute from its proposed College Access and Completion Fund to states for financial literacy education, money that would, under the lenders' alternative, flow to loan guarantee agencies; the agencies and state or nonprofit lenders would gain additional funds for "outreach services" to students and families to increase college going.

Analysts at the New America Foundation, which takes a generally skeptical view of the student loan industry and has editorialized in favor of the Obama plan, questioned some of the principles underlying the lenders' alternative proposal. Jason Delisle, who directs the Federal Education Budget Project at the foundation's Education Policy Program, wondered whether colleges rather than the government should be the ones who paid the lenders' fees for loan origination, since they would be the ones choosing (and benefiting from) the improved customer service. "If the argument is that there's a benefit here, let consumers, in this case the colleges, decide for themselves if it is worth it to pay, instead of shoving it down the taxpayers' throats," Delisle said.

He also said he hoped that members of Congress did not decide whether to support the lenders' alternative based on how many jobs it saved in their districts. "The jobs argument is a terrible, terrible way to make student loan policy," he said. "We should be administering the federal loan program with as few employees as possible."

 

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