Legal Loophole Inflates Profits In Student Loans
By GREG WINTER
The New York Times
September 22, 2004
The federal government is paying hundreds of millions of dollars in unnecessary subsidies to student loan companies even though the Bush administration has the authority to cut them off immediately, according to a report by the Government Accountability Office.
For the last two years, student loan companies have been taking vigorous advantage of a loophole in federal law to receive big subsidies that Congress tried to retire more than a decade ago. As lenders have stepped up the practice, billing the government for more than three times as much as they did just three years ago, the Education Department has maintained that there is little it can do to stop them soon.
But the department has significantly more authority than it has chosen to use, the accountability office said yesterday, prompting members of Congress to accuse education officials of a costly neglect. This year alone, the subsidies could cost the government nearly $1 billion that many lawmakers, Democrats and Republicans alike, say should go directly to students.
''The report makes it clear that the department is sitting on its hands while billions of dollars are being diverted away from higher education programs to the banks,'' said Representative Chris Van Hollen, the Maryland Democrat who requested the study with Representative Dale E. Kildee, a Democrat from Michigan. ''Every day that goes by more taxpayer dollars get drained.''
In a rebuttal to the report, the department agreed that the subsidies, guaranteeing student loan companies a 9.5 interest rate when students pay less than 3.4 percent, should be ''scaled back considerably.'' But it continued to dispute the findings that it could move immediately to close the loopholes, saying that any rules it put forward would take years to put in place.
''Do we have a situation here that falls into a situation of a national emergency?'' said Brian W. Jones, the department's general counsel, referring to what he described as the legal standard that must be met before it can change a regulation without a lengthy public process. ''We just didn't think that that's warranted. There are not the kind of calamitous circumstances the courts have required.''
The department said that Congress could solve the problem far more quickly. But Congress is far from doing so. Though the House overwhelmingly passed an amendment two weeks ago to halt the subsidies for a year, the Senate is still wrestling with one of its own. The president's budget also includes a proposal to curtail future payments, but lenders have been amassing huge loan portfolios over the last three years with little interference from the federal government, and their actions could ensure them the 9.5 percent guarantee for years to come.
In fact, these subsidies have already begun consuming a disproportionate share of the nation's financial aid dollars. Although loans carrying the 9.5 subsidy rate account for no more than 8 percent of the Federal Family Education Loan Program, they have soaked up 78 percent of all subsidies paid to lenders under the program in the current fiscal year, the report found.
What is more, much of the growth in these subsidized loans has come from a single lender, Nelnet. At the close of 2002, for example, Nelnet, one of the nation's largest student loan companies, held a little more than $375 million in loans carrying the 9.5 percent guarantee that Congress had tried to eliminate more than a decade ago, federal records show. Through some creative financing techniques, Nelnet had managed to increase its holdings to nearly $3.5 billion by June of this year, leading some members of Congress to question whether the companies' actions were legal.
Senator Edward M. Kennedy, the Massachusetts Democrat who sought to cut back on lender payments more than a decade ago, called upon the Securities and Exchange Commission yesterday to investigate Nelnet for using the subsidies to mislead its investors, manipulate the market and profit from insider trading.
The accusation stems from a brief exchange of letters between Nelnet and the department. In May 2003, Nelnet essentially alerted the department that it intended to expand its portfolio of loans carrying the subsidy rate Congress had intended to retire. More than a year passed before the department responded with a terse, two-paragraph letter that merely seemed to refer Nelnet back to the regulations on which it had sought guidance.
Within days, Nelnet put out a press release, saying that it had received a satisfactory resolution of its questions and would start counting the subsidies as income. Almost immediately, the company's stock started to rise, from a one-year low of about $17 on July 2, 2004, the day it put out the release, to more than $23 in late August and September. As the company's fortunes rose, many of its highest ranking executives and board members, including Don R. Bouc, its president, sold off millions of dollars in stock.
What the company did not disclose, however, was that the department said it never specifically approved of Nelnet's strategy of amassing more loans carrying the 9.5 percent guarantee.
The department does not say that Nelnet's actions were improper. Indeed, it says that because of a precedent set under the Clinton administration that it continues to follow today, lenders can generally expand their holdings of loans carrying a 9.5 percent guarantee. But, the department points out, that does not mean that it gave Nelnet a nod of approval, either.
''We don't just tend to bless an action on the basis of someone else's self-interested characterization of the facts,'' said Mr. Jones of the department, referring to the correspondence with Nelnet.
In Nelnet's defense, Mr. Bouc said that the company had been ''a leader in asking for a change in the provision'' that guarantees a 9.5 percent return, ''with the resulting savings used to expand available student aid.''
As for the call for an investigation, he said ''we do not know what if anything Senator Kennedy has requested the S.E.C. to look into, and we have no comment.''
Government payments to student loan companies are a cornerstone of the federal financial aid system, enabling companies to offer students unusually low interest rates while still making their profit margins. But the subsidies at issue began in 1980's when some lenders, particularly states and nonprofits, were granted fixed interest rates of 9.5 percent, guaranteed by the government regardless of what students paid.
Congress eliminated the guarantee by 1993, eventually moving to a system that is more closely tied to the market, but it allowed some lenders to keep collecting the higher interest rates on money they had already raised. What Congress did not anticipate was that interest rates would fall so low, making the promise of a 9.5 percent return a potential windfall in a market where students are paying less than 3.4 percent in interest on their loans.
Moreover, some of the lenders who originally qualified for the guarantee have been converted into, or have been subsumed by, profit-making companies like Nelnet, putting greater emphasis on the search for profits. According to the report, the guarantees have given lenders at least $1.7 billion more in federal subsidies than they might have received otherwise, and most of that has come in the last few years.