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New Future for Loan Guarantors

June 1, 2011

WASHINGTON -- When Education Department officials took stock last fall of how successfully the government and college officials had made the much-ballyhooed transition to a single system for originating federal student loans, they expressed satisfaction with virtually all aspects of the process -- save one.

Their major concern was that the department did not seem to have a plan in place yet for providing or replicating the services for default prevention and financial literacy efforts for which colleges had traditionally turned to guarantee agencies, lenders and other parties that faced uncertain futures under the new system.

Those worries were exacerbated by last week's release of data showing a sharp increase in student loan defaults. While that outcome is largely due to borrowers' financial woes in a down economy, some student aid experts attributed the upturn in part to the diminished availability of financial aid counseling and other services aimed at helping students and borrowers avoid repayment problems.

Tuesday, the Obama administration turned to an initiative abandoned by its predecessor -- and to a group of entities that had been among the targets of the 2010 restructuring of the loan programs, guarantee agencies -- to try to address that problem. In a news release and a notice in the Federal Register, Education Department officials invited state and nonprofit guarantors to propose new (and more cost-effective) methods of providing the default prevention and other services for government-made student loans that they have historically offered for lender-originated federal loans.

The department said it would utilize authority it gained under a 1998 change in the Higher Education Act to enter into "voluntary flexible agreements" with guarantee agencies -- agreements that were designed to alter how the agencies were rewarded financially, with the goal of encouraging them to come up with new ways to reduce and prevent loan defaults and delinquencies. The voluntary program was widely seen as successful, but the Bush administration ended it in 2007, citing its expense.

Guarantee agencies were often seen by critics as part of the problem of the guaranteed loan program, given that they derived (sizable) federal payments both from collecting on defaulted loans and from preventing defaults -- a potential conflict of interest that troubled advocates for students. By phasing out the guaranteed loan program and its billions of dollars of subsidies to lenders and guarantors, the Obama administration's 2010 restructuring of the loan programs was seen as threatening the future of some of the guarantors, though many of the state-based agencies retain other roles such as operating their states' grant programs and college savings plans.

But even as they took steps that hurt the guarantors, Education Department officials seemed to recognize that the agencies had a lot to offer.

Last fall, William J. Taggart, who heads the department's Federal Student Aid office and has overseen the loan program transition, said he recognized that colleges were worried about how they would handle the default management and prevention and financial literacy education that guarantors historically provided -- and that he knew it would be unwise for the department to "try to duplicate many of those [existing] competencies that exist in [guarantee] agencies." The agency, Taggart said at the time, would seek to "leverage what [the guarantors] already had" and "help them to recalibrate [their services] so they can bring that value to the direct loan program."

Tuesday's announcement appeared to present a path forward for the guarantors. Although details are sketchy at this point, the department's statement invites the agencies, individually or as groups, to come forward with proposals under which they would provide various default prevention and financial literacy services to colleges and borrowers in a cost-effective way that avoids "conflicts of interest that may potentially exist when a guaranty agency is responsible for both default prevention and default collections."

Shelly Repp, general counsel and, as of July 1, incoming president of the National Council of Higher Education Loan Programs, which represents guarantors, said he read the announcement to say that the department would not approve any voluntary flexible agreement under which a guarantor both collected on defaulted loans and sought to prevent them.

Repp and Brett Lief, the council's retiring president, said it was too early to say exactly what kinds of arrangements the department is hoping will emerge from its invitation to guarantors. But "every guarantee agency has an opportunity to develop a basket of services and a fee structure," and "there is an awful lot of daylight for organizations to think out of the box," Lief said, and to come up with new ways to serve colleges in their states or regions.

Justin Draeger, president of the National Association of Student Financial Aid Administrators, said he was heartened by the department's invitation to guarantors, which he said offered the promise of much-needed help for institutions.

"Schools are looking for assistance with their default prevention efforts," Draeger said in an e-mail message. "Default rates are on the rise and financial aid operating budgets have been strained." A NASFAA survey this spring found that "some of the first services to be cut by schools facing resource shortages are loan counseling and other services that help students stay out of default."

He added: "Schools will welcome default prevention assistance from these agencies – particularly since conflicts of interest possibly associated with the [guaranteed loan] program no longer exist."

 

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