The Financial Aid Fiasco
Colleges and lenders settle in New York, but probes continue
When an investigation by New York Attorney General Andrew Cuomo revealed last week that financial aid officers at several of the country's top colleges received stock or consulting fees and other perks from a company that provides student loans, it seemed it might be merely a case of a few individuals' disregard for conflicts of interest.
Then came the inquiry's revelation that the schools themselves had an altogether too cozy relationship with the lenders to whom they funneled student business. The results were swift. Two of the country's largest lenders, Citibank and Sallie Mae, each paid $2 million to settle Cuomo's probe and agreed to follow a new set of guidelines restricting their relationships with financial aid offices. Several universities voluntarily revised their "preferred lender" lists and dropped revenue-sharing agreements with private lenders; six schools already have agreed to pay the money they made off those deals back to students.
The rapid increases in college tuition costs-and a corresponding increase in student borrowing-have created an $85 billion per year student loan industry that has transformed many college financial aid offices into businesslike operations designed to maximize a university's net revenue. That switch challenges the conventional belief that aid officers exist to help students determine their best options. "Financial aid offices are utilizing the perception that they are fiduciaries, but they are really in a conflict of interest," says Raza Khan, cofounder of upstart lender MyRichUncle, which set off the investigations by complaining about unfair competition last year.
At issue in the Cuomo probe and a pair of ongoing congressional investigations are the loans that students secure to bridge the gap between the sticker price of their school and the funds they receive in grants, scholarships, and federally subsidized loans. Increases in federal loans have not kept pace with rising tuition costs, and students have made ends meet by turning to private lenders.
Scrutiny. Private student loans totaled some $17.3 billion in 2005-06 and have grown at an annual average rate of 27 percent in the past five years, according to the College Board. They represented 20 percent of all educational borrowing in 2005-06, compared with 4 percent a decade earlier. "Schools could not have gone the high-tuition/high-financial aid road they decided to travel without the availability of loans," says Arthur Hauptman, a researcher who studies higher education financing.
The relationships between schools and lenders are under scrutiny now; so is the role of college financial aid officers. "Students and parents may assume that a college's financial aid officer may be biased towards their college, but it doesn't occur to them that they might have financial interests in the companies that provide private loans," says Robert Shireman, executive director of the Project on Student Debt.
Incentives. Others contend that while the revelations look bad for schools, arrangements like listing lenders as preferred are not inherently bad for students. "Schools have incentives to partner with a loan provider in exactly the same way that a baseball stadium has an incentive to partner with either Coke or Pepsi," says Rick Hess of Education Policy Studies at the American Enterprise Institute. Deals can yield lower interest rates, eliminate fees, and offer more responsive customer service, says Kevin Bruns of America's Student Loan Providers. In exchange, companies listed as preferred lenders reap the lion's share of a school's private loan business.
Colleges saw the benefits, too. Syracuse University had a revenue-sharing arrangement with Citibank from 2003 to 2006, covering some $32.6 million in loans. The school received $164,000 in referral fees, which they now must disburse to students as part of a settlement with Cuomo. David Smith, vice president for enrollment management at Syracuse, says Citibank was offering lower rates than the competition. "Our assumption was Citibank took lower profits" on the loans. While such arrangements are illegal for federally subsidized loans, "there is a very conspicuous lack of guidance in the matter" of private loans, says Smith.
Already under fire for high tuition, disappointing graduation rates, lack of access for poor and minority students, and ruthlessly competitive admissions, the last thing higher education needs is a scandal over student loan processes. Some education watchers worry that poor students now will be even more reluctant to seek loans in light of the investigations. "For many poor families, the whole process is a witch's brew that they don't well understand, and this is only going to make people more suspect," says Sean Callaway of Pace University.
The government is suspicious, too. Cuomo is continuing his investigation into several lenders and multiple universities, and Congress also is beginning to ask questions about the relationships. Sen. Ted Kennedy's Education Committee is looking into stock deals between a lending company and four officials-one from the U.S. Department of Education plus the university aid directors at Columbia University, the University of Southern California, and the University of Texas-Austin. Cuomo, meanwhile, will testify at hearings before the House Education and Labor Committee, which is investigating the loan industry, at the end of this month.
With Kim Clark and Elizabeth Weiss Green
This story appears in the April 23, 2007 print edition of U.S. News & World Report.