So Far, So Good

Predictions of calamity in transition to government-based student lending have not come to pass. But U.S. faces another daunting task: helping colleges help borrowers avoid default.

October 25, 2010

WASHINGTON -- The student loan world was supposed to have been in chaos by now, if you believed the hype from last spring. Hundreds of college financial aid offices failing to make the transition to the federal government's direct loan program from the competing Federal Family Education Loan Program. Students at those colleges left without loans, their educational progress disrupted. The U.S. Education Department in a freefall, databases and employees unable to handle the volume of colleges shifting to direct lending.

Three and a half months after legislation took effect that ended the origination of student loans by banks, and several weeks into the first fall semester of the New World Order in student lending, even many who opposed what they saw as the Obama administration's heavy-handed push to kill the lender-based guaranteed student loan program acknowledge that the transition has gone smoothly.

"They've done a good job," says John Dean, the longtime counsel to the Consumer Bankers Association, which fought the Obama proposal. "I'm not aware of a single student whose educational plan was disrupted because of the transition.... [Department officials] should be proud of what they did."

Dean and others give much of the credit for the transition to William J. Taggart, who heads the Education Department's Federal Student Aid office, the "performance-based organization" that administers the government's financial aid programs. In an interview in his office here this month, Taggart expressed satisfaction that the shift has gone as smoothly as it has so far, especially given what he acknowledges was the significant political fallout that would have resulted from a failure. (He also expresses gratitude to his staff and to college financial aid officers, whom he calls "the real heroes here").

But Taggart acknowledges the big "but" that accompanies the praise that Dean and most other financial aid experts interviewed for this article offer for the department's efforts thus far: the reality that many parts of the transition remain incomplete, most notably in providing or replicating the default aversion and financial literacy efforts to which colleges often have turned in the past to guarantee agencies, lenders and others.

"A lot of those services have winnowed away" as lenders have left the student loan market, says Tim Ranzetta, founder of Student Lending Analytics and a careful observer of the lending landscape. If default rates soar because of the declining economy and changes in how the federal government reports the rates, as is likely, the government could be held responsible more than ever before if it does not give colleges the tools to help borrowers prevent defaults, Ranzetta and others say.

"If a lot of borrowers find themselves in trouble, and schools can't rely on borrowers and [loan] servicers [for those programs] as much as they used to, the default rate becomes the government's problem," he says. "You own it now."

Taggart says the idea that the pitfalls of high default rates are deeper for the government now than they were before makes him "scratch my head," since the direct loan program has been responsible for a significant portion of the federal student loan portfolio for years. (Colleges in the direct loan program have historically had a somewhat lower default rate than those in the lender-based program, but the comparisons don't mean much because the mix of institutions differed significantly.) But he concedes that the Federal Student Aid office still has a big job to do, and insists that the government will still look to the other parts of what he calls the "student loan ecosystem" to contribute.

"The default rate is something we care a heck of a lot about, and we're working as closely as we possibly can with all the relevant players to determine the best way, and the most efficient way, to do things like default aversion as we head into this future state," Taggart says. "It's obviously important that we don't go into some kind of catatonic state" just because the loan origination process has gone smoothly this fall.

Calm Amid the Storm

Catatonic, no -- but zen, perhaps.

In an interview in his office not far from Capitol Hill, Taggart is the picture of calm. With his extensive experience in high-level corporate positions that put him in the hot seat during major mergers and the Y2K frenzy, he is nonchalant (externally, at least: "You know the phrase, 'Don't let 'em see you sweat?' " he says. "I get anxious all right; I'm human.") about an operation that might have scared off a lot of people.

Given the intense political battling that unfolded over the Obama administration's 2009 plan to stop banks and other lenders from making federally guaranteed student loans -- battles that this article is very much not about -- many lenders and many Republicans in Congress were watching closely and perhaps hoping for administration officials to fall on their face in carrying out the shift.

Taggart is no politician; the Federal Student Aid office that he oversees was set up, during the "reinventing government" phase of the Clinton administration, to be a "performance-based organization" with clearly measurable goals, operating with less red tape and led by a nonpolitical appointee. Those facts aside, Taggart says with a smile that he was "sensitized to the political environment" and that he recognized that the stakes for a smooth transition were high for President Obama, Education Secretary Arne Duncan and others.

"You can look at projects like this from a risk or reward perspective," he says. "If someone looked at this project purely on risk, they probably would have run the other way.... But how many times in your career do you get an opportunity to lead an effort of this size and magnitude for the benefit of American students and their families and the taxpayers?"

While some critics decried what they characterized as the federal "takeover" of student loans for philosophical reasons, others wondered whether the government had the technological and administrative capacity to handle a huge influx of colleges into the direct loan program.

Those questions, for now, have been answered. While skeptics will complain that the Obama administration got a head start by scaring colleges into switching into direct lending long before Congress formally wrote the changeover into law in March, the Education Department has succeeded in getting all but 2 percent of postsecondary institutions in a position to originate loans through the government's Common Origination and Disbursement system in time for this fall's semester.

The transition did not come without its difficulties; the FINAID-L listserv was dotted with occasional gripes early this fall about financial aid officers' difficulties in gaining access to various department websites, and the department did have to provide "additional technical assistance" to 37 institutions, including nine that required site visits from agency employees. (Taggart declines to identify the institutions, but says that special circumstances tended to cause their troubles, such as having recently lost a chief financial officer or having a large proprietary technology system that did not play well with the government's system.)

But Taggart says that those situations were few and far between, an outcome he attributes, modestly, to the "maturity" of the direct loan program, the hard work of his "talented" employees, and the fact that campus financial aid officers "came to the training we offered, rose to the occasion, and met the task.... They were the real heroes."

Some of those student aid officials were not positively disposed toward the change. Dave Cecil, who heads Transylvania University's financial aid office, told Inside Higher Ed last fall that the Kentucky institution, happily ensconced in the guaranteed student loan program, was disinclined to make the switch until it had no other choice. “We’re going to have to get help from IT and other people on our campus, and a lot of schools like us don’t want to go down that road until we absolutely have to,” he said at the time.

When the time came, Cecil said in an interview last week, Transylvania did make the transition -- "not without a lot of heartache and frustration," but with "not as many problems as I might have expected." That's partly because "my staff is even better than I thought it was," but also because of the mindset of financial aid officers. "When given a task, we get it done," Cecil said. "You don't last long in financial aid if you don't have that sort of attitude."

Joseph Russo, director of student financial strategies at the University of Notre Dame, a stalwart of the guaranteed loan program, offers a roughly similar assessment. The university spent months planning for the eventual switch, and when it became clear that the move to 100 percent direct lending was a foregone conclusion, Notre Dame dove in. Department officials responded well to problems the university encountered, and while responsiveness to calls has occasionally lagged, on balance, it's been "so far, so good," Russo says.

Challenges Ahead

For Russo and many other campus officials, though, the big unanswered question lies ahead, regarding the systems that the Education Department has (and will) put in place to provide the various services related to the collection and repayment of student loans. The lender-based system used an array of corporations, and nonprofit and state entities not only to originate loans, but to offer services such as default management and prevention and financial literacy education, which the companies and guarantee agencies (like USA Funds and American Student Assistance) often provided to colleges at no cost on top of the fees they charge to collect and guarantee the loans.

"Schools are concerned about having enough resources to actively manage their default rate," says Justin Draeger, president of the National Association of Student Financial Aid Administrators. "From the people on the ground, they are concerned about their default rate and are looking for resource help, tools they can use to actively manage their default rates. So far, the whole financial literacy/default aversion conversation has been very vague."

That existing student loan infrastructure will continue to service loans that were previously originated by lenders, but under the new system, in which all federal loans are made through the Direct Loan Program, the Education Department has contracted with four major companies to service those loans. It is also developing guidelines under which nonprofit agencies can service those loans -- a plan whose early outlines have come in for criticism because they would require the agencies to operate nationally, instead of in regions where they already have strong relationships with colleges. (John Kane, the Federal Student Aid office's deputy chief business operations officer, insists that that approach is not written in stone, and that the department is open to alternative approaches.)

Taggart says that he understands college officials' concerns about default rates, and that the department shares them, especially given the state of the economy. "We will make sure that whoever's in charge of servicing loans is doing a good job" in terms of default aversion, he says. "Our four new servicers are world-class, and their performance is assessed using a scorecard that is based largely on their ability to keep defaults down." And future distributions of loan volume to banks or other entities that might service federal loans will be based on their "ability to do a darned good job" in that realm, Taggart says.

The administration also has yet to announce exactly how it plans to work going forward with guarantee agencies, which have been primary providers of default aversion and financial literacy services. The same law that brought about the switch to 100 percent direct lending also set aside potentially hundreds of millions of dollars over five years for financial literacy and default management services, through an expansion of the College Access Challenge Grant Program.

Taggart says he knows that it would be unwise for the Education Department to "try to duplicate many of those [existing] competencies that exist in [guarantee] agencies," and that it hopes instead to "leverage what they already had" and "help them to recalibrate [their services] so they can bring that value to the direct loan program."

"It's not a crisis at the moment," he says. "We have some time to continue to work with them in a very collaborative manner."

Just how many guarantee agencies will be able and willing to provide default prevention and other services that used to be add-ons to their very profitable student lending businesses -- and to do so at a price the government is willing to pay -- remains an open question. Several such agencies are openly angling for such arrangements, including American Student Assistance, whose president and CEO, Paul Combe, says that effective default prevention is more necessary than ever, given that "salaries are dropping" for many Americans and "higher education debt is growing faster than health care costs."

Given the government's financial situation, Combe says, it's clear that whatever arrangements the Education Department strikes with providers of default aversion and financial literacy services are going to have to look much different than they used to -- rewarding entities that prevent defaults rather than collect on them, and are willing to provide the services "from a public purpose point of view," rather than to make a profit. "There's just no new money [for the government] -- that's just a reality," he says.


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