Big Money On Campus
In the multibillion-dollar world of student loans, big lenders are finding new ways to drain Uncle Sam's coffers
Perhaps the biggest blow to the direct- loan program came when Michigan State University left the plan last spring. The school was the second-largest participant in direct lending, with $183 million in loans a year. It was lured away by a lucrative deal assembled by three banks and a state agency, the Michigan Higher Education Student Loan Authority. The group offered students a rebate on fees, and it even guaranteed the school a profit of at least $2 million.
The deal raised eyebrows throughout the industry; competitors wondered how the loan authority and its banking partners could afford to be so generous. The answer lies in an obscure loophole in federal law. The provision allows certain lenders to reap windfall profits. The state authority in Michigan, for example, earned $12 million last year from this special federal subsidy. It used that money to bankroll the deal with Michigan State. There was a side effect, however. Michigan State's decision to drop direct loans and switch to the FFEL program will cost taxpayers at least $23.5 million annually, according to a U.S. News analysis. "Essentially, the federal government is paying an excessive fee to drive its own, less expensive program out of business," says one Education Department official. "As a taxpayer, that makes no sense."
Where does the windfall come from? The subsidy guarantees lenders a return of 9.5 percent on certain loans; that's quite a bonus at a time when most students are paying only about 3.5 percent in interest. Lawmakers thought they had done away with the subsidy a decade ago, but some lenders discovered that by exploiting an Education Department ruling and using creative refinancing, they could issue a nearly infinite number of subsidized loans.
The subsidy was originally designed to help nonprofit groups that issued special bonds to finance student loans. But today, the biggest holders include Sallie Mae ($2.1 billion in loans that qualified for the subsidy in 2002) and Nelnet ($495 million in 2002). Both companies acquired nonprofits that qualify for the subsidy. "It's a windfall that has no benefit to taxpayers or students," says Thomas Wolanin of the Institute for Higher Education Policy, a Washington think tank. The bill to taxpayers for the subsidy is likely to exceed $3 billion over the next decade, according to Education Department officials. Nelnet president Bouc acknowledges that critics consider the payments a waste of taxpayer money. "I don't want to argue," he says. "I am not sure I would say anything different." Still, his company is aggressively trying to win more of the special subsidies. Education Department officials told U.S. News that they are now reviewing the loophole but caution against any quick fix.
In the end, there is good reason the lending industry has come up with one scheme after another, cultivated so many friends in Washington, and sought to gut the taxpayer-friendly direct-loan program. College is getting ever more expensive. On average, a four-year education means graduates with loans will be writing checks to pay off nearly $17,000 in debt. Private lenders want those checks made out to them, not to the government.