Taming the Student Loan 'Wild West'

The market for private student loans has exploded in recent years, fueled by the growing gap between the price of attending college and the availability of federal grant and subsidized loan funds. And the competition among student loan companies to provide those non-federal loans, occurring at a time of little or no federal regulation, created an environment in which some questionable (if not illegal) marketing practices flourished.

June 7, 2007

The market for private student loans has exploded in recent years, fueled by the growing gap between the price of attending college and the availability of federal grant and subsidized loan funds. And the competition among student loan companies to provide those non-federal loans, occurring at a time of little or no federal regulation, created an environment in which some questionable (if not illegal) marketing practices flourished.

That has been one of the starkest conclusions of the student loan controversy that has unfolded over the last three months. And at a U.S. Senate hearing Wednesday, a slew of witnesses -- led by New York Attorney General Andrew M. Cuomo, whose own investigation has spurred inquiries in Congress and elsewhere -- discussed the private loan market and what if anything Congress should do to increase oversight of it. Among the issues debated: Looking back, is there more the federal government should have done to regulate the private loan industry? And going forward, should federal laws or rules be changed to give federal agencies more authority to regulate the market?

Wednesday's hearing was the third in Congress in recent weeks about the cascading student loan scandal, and it had a decidedly different cant from the earlier ones, both of which took place before the House Education and Labor Committee. In late April, Cuomo testified and, egged on by the panel's Democratic leaders, cast significant blame on the U.S. Education Department for having done too little to regulate the student loan industry generally. In mid-May, before the same House panel, Secretary Margaret Spellings gamely defended the department’s actions and insisted that the agency had regulated as much as it could given limitations in federal law on its authority -- most notably in the realm of private loans.

The venue and themes of Wednesday’s hearing represented a significant shift. First, the setting was the Senate Banking Committee, which generally has not had a role in overseeing the student loan programs. And the topic focused not on student loan practices in general but specifically the private loan industry, which has seen its share of student borrowing grow to nearly 20 percent over the last decade, up from 4 percent. The loans are controversial in part because they tend to have higher rates and less appealing terms than federally backed loans.

There was very little of the partisan bickering that characterized the House hearings. That was partly because of the nature of the Senate, where gentility (at least feigned, if not real) usually wins out. But it was also because while discussion of the federal student loan programs almost inevitably treads onto the partisan subject of the government’s two competing programs – the Democratic-favored direct loan program and the Republican-preferred guaranteed loan program (to risk oversimplifying greatly) -- there is very little disagreement that private loans are problematic.

The overarching theme of the hearing, which was called by its chairman, Sen. Christopher Dodd (D-Conn.), was that while private loans play a role in meeting that growing gap between college students’ costs and the other kinds of aid available to them (and are therefore probably inevitable if not necessarily desirable), the federal government has not sufficiently regulated borrowers’ use of them, and must do so more.

That argument was made by the day’s star witness, Cuomo, who once again received the equivalent of a hero’s welcome by the Democrats who control the panel (for what it’s worth, he earned a lot of praise from the committee’s Republicans, too). He recounted practices (“rampant,” Cuomo said) uncovered by his investigation that he said showed that loan providers had offered incentives to college financial aid officials that made them less-than-honest brokers in advising the students who come to them for advice about which lenders to choose. And he argued that the federal government had enabled those practices by failing to police the private loan industry.

Cuomo, who had lambasted the Education Department in his last visit to Capitol Hill, responded in this one to Spellings’s argument that her agency had its hands tied (metaphorically) in its ability to crack down on private lenders. If that’s the case, the New York official said, the department still botched the job because it failed to refer concerns its officials may have had to federal banking or consumer protection agencies that, he asserted, definitely did have regulatory authority.

“The Education Department said it cannot extend the government’s supervision [over federally guaranteed loans] to the private loan sector. Then why not refer these actions to the appropriate banking and consumer protection regulators?” Cuomo asked rhetorically. “It’s clear that the left hand didn’t know what the right hand wasn’t doing.”

Cuomo insisted that “all of the actions” his office has brought or threatened to bring against lenders and college officials “could have been brought” under existing federal laws and rules by regulators like the Federal Trade Commission, the Federal Deposit Insurance Corp., or the Office of the Comptroller of the Currency. (Bank officials disagree with that assertion, saying there is no evidence that many of the practices Cuomo has criticized – revenue sharing agreements between lenders and colleges, for instance -- are illegal under any federal law. But consumer advocates say that colleges’ failure to tell student borrowers about deals that might influence their referrals to a lender would violate federal consumer fraud laws.)

Dodd embraced Cuomo’s suggestion that the Senate panel have “some of the regulators come in and talk about what they feel they have the authority to do,” and “pursue them aggressively to get them to do what they have the authority to do.” But the Connecticut senator and others also pressed Cuomo on whether he believed the government needed to toughen its laws and rules to ensure better oversight of the private loan market. “The question for us is, can you do it under existing regulations and statutes, or does this Congress need to act to give the agencies additional authority that they claim not to have?” Dodd said.

Cuomo reiterated his belief that the government already had the authority to regulate private loans, but he endorsed applying to the private loan sector toughened standards that Congress and the Education Department have proposed imposing on lenders and college officials in the federal loan programs.

The New York attorney general also revealed that his office was widening its investigation into private loans by looking at whether the criteria lenders use to award private loans discriminate against students attending less-wealthy institutions, much as mortgage lenders are sometimes accused of refusing to give loans to, or gouging, borrowers in poor neighborhoods. "There are civil rights and legal ramifications," Mr. Cuomo said.

The other panelists who spoke Wednesday – including student advocates and officials from Sallie Mae, Bank of America and First Marblehead, three dominant players in the private loan industry – took varying stances on how much new regulation or legislation they thought was necessary. Bank officials generally said they thought that the changes being considered by Congress now, and included in the code of conduct that Cuomo has promulgated, were more than sufficient, and that greater transparency and public information about loan rates and terms would go a long way toward protecting borrowers.

But Luke Swarthout, higher education advocate for the U.S. Public Interest Research Group, called for much more extensive changes, including changing personal bankruptcy laws so that private loans are discharged when a borrower enters bankruptcy.

In a related development Wednesday, two more college financial aid directors lost their jobs stemming from charges made against them in the loan investigation.

Capella University released a statement saying that Tim Lehmann, its director of financial aid, "will be leaving Capella." Lehmann is among the financial aid officials who received had received stock or payments from a lender, Student Loan Xpress, who had appeared on its list of preferred lenders. Capella had placed him on leave in April.

And Widener University acknowledged that its aid director, Walter Cathie, had retired, the Wall Street Journal reported. Student Loan XPress had paid tens of thousands of dollars to a consulting company Cathie runs, and he had been seen as a central figure in the spread of private loans.


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