Reining in insurers and expanding health coverage for Americans aren’t the only reforms achieved last week by the White House and Congress. The passage of the health care bill also accomplishes a much-needed if less-noticed goal that, like health care, was last seriously pursued during the early days of grunge rock: The termination of federal subsidies to the scandal-plagued private student loan industry.
Within the pages of the Health Care and Education Reconciliation Act of 2010 is a section that, at long last, stops private lenders from profiting off federally subsidized student loan programs. This means an end to nearly four decades of corporate welfare for the government-created — but now fully privatized — icon of the industry, Sallie Mae. The savings to be had from terminating this subsidy — estimated at between $60 and $70 billion over the next decade — will go toward shoring up the Pell Grant program (which helps low-income Americans attend college), health care programs and deficit reduction. Where the Department of Ed has long paid private loan companies like Sallie Mae and Citigroup to issue and manage government-backed student loans, the department will now make all federal loans directly, without the help of a middleman, through its own Direct Loan program.
Private lenders, meanwhile, will bid for contracts to service, not originate, these loans.
The change is a major setback for a student loan industry grown fat and arrogant, which for decades has racked up huge profits by making government-backed, risk-free loans to students. Since 1965, these taxpayer-subsidized loans came with a double-guarantee: first against default, and another providing a floor on the rate of return. Taxpayers not only guaranteed high interest rates for lenders, they also protected the banks against any losses. The subsidies are a big part of the reason why Sallie Mae CEO Albert Lord was recently able to build a private 18-hole golf course on his 225-acre estate near his company’s headquarters in Reston, Virginia.
Starting in July, those loans will be Sallie Mae’s to lend no more. In acronymic language almost every college grad under the age of 50 can understand, the famous FFEL is dead.
To grasp why Obama’s termination of the FFEL deserves a loud cheer, it helps to call Sallie Mae by its real name. Sallie Mae and Nellie Mae, its sister company, sound like kindly maternal aunts, the sort who not only provide money for college at stable interest rates, but might also bring out a warm plate of raisin cookies to munch on while you fill out the forms. In reality, Sallie and Nellie are cutesy public relations masks for the SLM Corporation, a publicly traded billion-dollar company that long ago lost any resemblance to the public-minded “government-sponsored enterprise” launched by Congress in 1972 to encourage wider involvement in government loan programs created by the Higher Education Act of 1965.
Within a decade of being launched with the mission to help kids afford college, executives at Sallie Mae grew bored. To expand their operations (and increase profits) they began courting Wall Street in the late 1970s. Wall Street was an eager suitor in return, anxious to get in on the endless flow of government-guaranteed action. It seemed too good to be true: Sallie Mae was congressionally chartered and had the promise of the U.S. Treasury behind 97.5 percent of every FFEL loan it originated and serviced. Along with other major lenders that entered the game during the 1970s and ’80s, Sallie Mae’s profits swelled on the back of a booming student loan market racing to keep pace with the upward spiral of tuition costs.
By the time Bill Clinton entered the White House in 1993, there were growing rumblings — by both Democrats and fiscally conservative Republicans — over this taxpayer-sponsored boomlet. During his first year in power, Clinton announced plans to stop funding what had become an anachronistic cash cow for private lenders. The Department of Education, after all, could save a lot of money by issuing the loans directly, and then use the benefits to help educate more Americans at lower cost — which was the whole point of the program to begin with. Building on plans hatched by deficit hawks in the George H.W. Bush administration, Clinton created the Direct Loan program and set a timetable to gradually phase out the FFEL program.
But the loan industry lucked out. When Republicans won control of Congress in 1994, they ran to the fierce defense of the industry that had supported so many of their campaigns.
“After the midterms in 1994, the Republicans did their best to hamstring the Department of Education from effectively promoting the Direct Loan program,” says Edie Irons, of the Berkeley-based advocacy group Institute for College Access & Success. “They also negotiated the survival of the FFEL as part of the deals to pass Clinton’s budgets. So the subsidy lived on.”
Sallie Mae did not waste its second lease on life. With the student loan market breaking records every quarter, and confident with the backing of strong new allies in Congress, the company went on a buying spree. Between 1997 and 2000 the firm purchased roughly a quarter of all the outstanding federally backed FFEL loans, totaling some $40 billion. As Sallie Mae and other lenders serviced ever-greater amounts of taxpayer-backed money, they began peddling — many would say pushing — other high-risk financial products and services.
Sometimes, this involved using the muscle provided by its role as a leading purveyor of federal loans.
“Sallie Mae is the student-loan industry’s Microsoft,” one competing servicer told the Chronicle of Higher Education in 2000. “[It] bundles its services to [banks and financial aid departments]. They say, ‘If you want us to originate and disburse your loans, you have to sell them to us at below-market rates.'”
During this period, the company increased its business in predatory subprime private loans, which it pushed on borrowers as a way to close the student loan “donut hole” created by rising costs. Internal company documents show that Sallie Mae’s strong move into risky, high-interest private loans was underwritten by the guaranteed income Sallie Mae made on FFEL loans. In other words, the United States government was directly financing the slimiest practices of its private partner-competitor.
Under the chairmanship of Albert Lord, Sallie Mae grew increasingly cozy with Republican lawmakers in the Bush era. The relationship was a two-way street: The administration protected Sallie Mae’s steady, no-questions access to FFEL money, and the company generously supported GOP candidates and causes. It was, of course, an outrageously corrupt and inefficient arrangement, with taxpayers subsidizing both political kickbacks and lobbying costs. The relationship was consummated in 2004, when Sallie Mae was allowed to go completely private — with no talk of ending its subsidy or controlling salaries and costs.
It was thus a dual celebration when the SLM Corporation donated $250,000 — the maximum amount allowed by law — to the 2004 Bush Inauguration. Sallie Mae CEO Albert Lord developed a particularly close relationship with Ohio Republican John Boehner, a frequent guest on SLM’s corporate jet who cosponsored a party the company threw during the 2004 Republican National Convention. That same year, Lord ranked first in a Washington Post survey of D.C.-area executives, pulling in $41.8 million in salary and stock. By 2007, Karl Rove was pushing to get Republican lawmakers lucrative seats on SLM’s board of directors.
But the return of Democrats to congressional power in 2006 returned focus to the wasteful student loan subsidy. The question was given added urgency by a string of scandals resulting from the industry’s years running amok under Bush. In February 2007, New York Attorney General Andrew Cuomo launched an investigation into allegations of deceptive lending practices by major student loan providers, including Citibank and Sallie Mae. Later that year, the same companies were the subject of a federal investigation focused on the kickbacks it they were providing colleges to get the schools to steer borrowers their way. Over the course of the investigation, documents surfaced showing that Sallie Mae tried to use the Freedom of Information Act to force the State University of New York to turn over students’ personal information.
Around the same time, Sallie Mae faced a lawsuit that it was intentionally ballooning students’ debt by pushing delinquent students into forbearance (and thus adding interest). Then there was the class action lawsuit brought against Sallie Mae alleging that the company discriminates against African American and Hispanic private student loan applicants by charging them higher interest rates and fees. Echoing concerns voiced by Cuomo’s earlier investigation, the lawsuit also alleged Sallie Mae gave misleading information on private loan terms to prospective borrowers.
Sallie Mae has settled some of these suits; others are ongoing.
The financial crisis of 2008 finally delivered the knockout blow to the FFEL cash cow. “The credit crunch put the loan industry in the precarious position of having to rely on the government to finance its loans,” says Stephen Burd, writer of the Higher Ed Watch blog at the New America Foundation. “As a result, for the last two years, the government has essentially been running two direct loan programs. That was not a sustainable model.”
After Obama’s election, the industry had a flashback to 1993 and began to mobilize to stop the termination of its subsidy. With Democrats in power, private lenders turned to the same for help. The Hill reports that Sallie Mae’s $3.48 million rearguard lobbying effort last year included the hiring of several prominent Democratic lobbyists, including former deputy attorney general Jamie Goralick and several Democrats working for the Podesta Group. According to Jane Hamsher, who has the inside scoop on the last-minute politics behind the legislation, the efforts of these lobbyists can only be described as bungling; despite being paid millions to protect the subsidy, they completely failed to see the reconciliation bill barreling down the pipe.
Throughout the battle over the FFEL program, the loan industry’s K Street army and its conservative media allies took a peculiar line of attack: removing the industry’s right to service federal loans, they argued, amounted to a “government takeover.” The talking point was distributed in a September 2009 memo circulated by the House Republican Conference that urged House Republicans to oppose a move to 100 percent direct lending because it “kills jobs and greatly expands the federal government’s control of the education loan market.”
Needless to say, this laughable argument failed to catch much traction with the public. How could a government program be “socialized” by streamlining it? The subsidies were nothing but a way to socialize risk for private servicers and lenders using taxpayer money — the precise opposite of their free market ideology. The irony and hypocrisy of the industry’s opposition did not escape the notice of principled small-government conservatives who follow education issues.
“In their support for the FFEL program, it appears that House Republicans want big government too — they just want to dress it up as private enterprise,” Jason Delisle, a former Republican Congressional aide who is now the director of the New America Foundation’s Federal Education Budget Project, wrote recently on Higher Ed Watch:
Under FFEL, the federal government sets the terms of the loans while taxpayers insure private lenders against 100 percent of the interest rate risk, subsidize administrative costs, and cover all but a sliver of default losses on loans. How exactly does that arrangement make for smaller government than if the same loan were made directly from the Treasury? When private entities are paid under no-bid formulas to run a government entitlement program as they are in the FFEL program, it’s quite a stretch to claim the jobs entailed are “private sector” jobs.
But since Republicans still want to talk about these jobs, it’s worth emphasizing again exactly what the employees of these lenders were doing. In an article for the Washington Monthly last winter, Stephen Burd described the worst of the Bush-era abuses: offering buckets of private loan money to financial aid departments in exchange for the exclusive right to issue federal loans. The result was Sallie Mae misleading more students into taking out high-risk, high-interest, high-default predatory loans that students could not shake off in bankruptcy — thanks to the loan industry supported Bankruptcy Act of 2005 — all the while recovering costs with the lock it had on federally guaranteed loans.
“In 2007, Senate investigators uncovered internal company documents showing that executives expected a staggering 70 percent of its private [mostly subprime] student loans at one for-profit school to end in default,” reported Burd. “Investigators concluded that Sallie Mae viewed these loans as a ‘marketing expense’ — a token sum to be paid in exchange for the chance to gorge on federal funds.”
Thanks to Obama and Congress, those days are over. But work remains to be done in the area of student loan reform. Most urgently, the double standard that allows private loan creditors to claim bankruptcy protection, but denies their student borrowers the same right, must end. Considering that Barack Obama was one of only 25 Democratic senators to vote against this law when it passed in 2005, there is reason for optimism that the loan industry is in for another losing fight.
Alexander Zaitchik is a Brooklyn-based freelance journalist and AlterNet contributing writer. His book, Common Nonsense: Glenn Beck and the Triumph of Ignorance, will be published by Wiley in June.