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.
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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.
