Lenders Sought Edge Against U.S. in Student Loans
In a fierce contest to control the student loan market, the nation's banks and lenders have for years waged a successful campaign to limit a federal program that was intended to make borrowing less costly by having the government provide loans directly to students.
The companies have offered money to universities to pull out of the federal direct loan program, which was championed by the Clinton administration. They went to court to keep the direct program from becoming more competitive. And they benefited from oversight so lax that the Education Department's assistant inspector general in 2003 called for tightened regulation of lender dealings with universities.
At Indiana University in 2004, for example, Sallie Mae, the nation's largest student lender, offered $3 million that the university could use for "opportunity loans" to some students if it left the direct loan program. Indiana left the direct loan program but said the $3 million was not the reason; Sallie Mae currently administers their loan program.
Bank of America, which won the University of Virginia's student loan business, said in its 2002 proposal that certain possible incentives had "the potential to violate" federal law. The bank, which said such a discussion was normal in the bidding process, suggested that it discuss the issues with university officials "during the oral presentation phase of the process."
All of this has helped give private lenders clear dominance of the $69 billion federal student loan industry. The lenders, who defend these practices, say they are winning business primarily because they offer lower interest rates than the government and often lower fees.
Advocates of the direct loan program say that it has been held back from offering more competitive rates and benefits, and that a very small percentage of students can take advantage of the private rivals' advertised rates and incentives. They argue that private lenders cost the government vast amounts of money because they are subsidized and guaranteed against default.
President Bush's budget reports that in 2006 for every $100 lent by private lenders, the cost to the government of subsidies, defaults and other items was $13.81, while the same amount lent through the direct loan program cost the government $3.85. The battle for dominance in the loan market has escalated as tuitions have soared and students have borrowed more. This is the context for many of the payments to universities and financial aid officials that have come to light as a result of recent investigations into student loan practices.
"What has happened is unbridled competition meets lack of oversight," said Terry W. Hartle, senior vice president at the American Council on Education.
Part of what is generating the competition is that the government runs two loan programs - and universities usually choose to participate in one or the other.
Until the 1990s, the primary program was the federal guaranteed loan program under which private lenders like Citibank, Sallie Mae or Bank of America made the loans to students. They were given a helping hand from the government, which paid subsidies to the lenders and guaranteed them against default.
Bill Clinton campaigned for president on the notion of expanding the federal government's role as student loan guarantor into a more central position as the direct lender. The idea was that this would prove cheaper and simpler for students and be less costly for taxpayers because borrowers would pay interest to the federal government instead of to the lenders.
The program went into effect in 1994. The Democrats expected it to become dominant. But unwilling to be muscled aside, private lenders began offering schools and students a variety of benefits like scholarship money and lower interest rates and fees.
Tom Joyce, a spokesman for Sallie Mae, said, "The private sector program has better prices, better product selection, better service and better technology."
For a few years after direct lending went into effect, it grew quickly. But as student loan volume has risen, climbing above $85 billion in 2005-6 from just over $30 billion 10 years earlier, the government's share as a direct lender has declined, and now amounts to less than a quarter of the total.
"When direct lending was created, the initial assumption was that the bank-based program would be quickly overwhelmed by the government program," Mr. Hartle said. No one counted on the strength of the reaction from the lending industry, he and others said.
The Education Department fought back. Richard W. Riley, then the secretary of education, tried to make the direct lending program more competitive in 1999 and 2000 by reducing origination fees and interest rates. The private lenders sued, saying Mr. Riley had no authority to do this because these rates were set by Congress under the loan legislation. (Last year, lawmakers set the interest rate on new Stafford loans, one of the most popular federally guaranteed loans, at 6.8 percent; many private lenders offer to reduce that rate for borrowers who make payments on time or meet other goals.)
In response to the lawsuit, the Education Department argued that the public and private loan programs had the power to offer the same terms and conditions, and added that better loan terms would make loans more affordable and thus reduce defaults, benefiting taxpayers.
With the Bush administration more sympathetic to the private market, the lenders withdrew the lawsuit last year, and the direct loan program has offered some of the incentives used by its private rivals.
Katherine McLane, a spokeswoman for Education Secretary Margaret Spellings, said both federal loan programs were "a vital source of funds for student aid." Ms. McLane said that "through these two programs we have improved students' and families' choices by increasing competition, upgrading customer service and lowering costs."
The Bush administration took virtually no action as lenders offered special pools of money if universities would leave the direct loan program. Lenders, by law, are barred from offering inducements to gain loan applications. But what is an inducement is not entirely clear.
A review by the Education Department's office of the inspector general in 2003 - prompted by an accusation that Sallie Mae was offering illegal inducements - found that the department had brought only one public action, a case involving Sallie Mae and a college of podiatric medicine in 1995, which an administrative law judge later struck down.
The assistant inspector general, Cathy H. Lewis, who conducted the examination, also noted that the Education Department had not given any updated opinions about what kind of inducements were barred since 1995, even though the competition for loan business had escalated sharply since then. Ms. Lewis expressed concern about "bargaining practices between schools and lenders." She referred to both the guaranteed loan program and private loans, which like any consumer loan lack government backing. Students increasingly rely on private loans because of limits on borrowing through the federal program.
She wrote that the practices "should be addressed through statutory and regulatory changes or further department guidance."
Ms. McLane said in an e-mail message that the department had offered no guidance to lenders because it believed it had "no authority over the private loan instruments and market and therefore no guidance could be provided."
She said the department had begun examining whether there should be new regulations in December.
Republicans in Congress have issued a continuing stream of criticisms about the direct lending program and tried to restrict it in a variety of ways.
Just last year, they voted to give lawmakers the power to cut the budget of the Education Department office that oversees the student loan program - a looming if indirect threat to direct lending. They also made it more difficult for many borrowers with multiple loans to combine them into a single, larger direct loan, effectively making it harder for students to refinance their debts.
"The federal government should be in the business of student loans as the lender of last resort when private lenders can't offer competitive opportunities," said Senator Michael B. Enzi, a Wyoming Republican who is the former chairman of the Education Committee.
In the absence of any crackdown on inducements, banks and other lenders showered universities with incentives to leave the direct lending program.
Sallie Mae, for example, offered Pace University in New York City $4 million in loans for students who would not have otherwise qualified if it left the direct loan program, the university said. Pace turned the offer down, a spokesman said. But it did eventually leave the program.
Colleges in the direct lending program were increasingly concerned about its future in the face of growing Republican opposition.
Yvonne Hubbard, director of Student Financial Services at the University of Virginia, said that was one factor that prompted the school to leave the program, along with the better deals being offered by the private lenders.
The university invited lender proposals in 2002 and chose Bank of America for a five-year term. It was in this process that the bank warned that some services under discussion had "the potential to violate" regulations against inducements.
Ms. Hubbard said she had no memory of what that language might have referred to, and a Bank of America spokesman, Joe Miller, said that it was not unusual to use this language in responding to a request to bid for a contract.
Bank of America is the only lender the University of Virginia recommends. The bank handles about 95 percent of the federal student loans at the university. Under the agreement, students who take out subsidized loans through the bank pay no origination or guarantor fees.
Ms. Hubbard said that the university tried to make clear to families that they were free to borrow from anyone but that it also offered this advice: "Take the terms we have negotiated with Bank of America and use this as your baseline, and try get your vendor to at least match it. It's a good deal."
Along with the partisan battle over the lending programs has come a fierce argument over their relative costs to taxpayers. Lenders vehemently argue that the direct loan program is in fact more expensive.
With Democrats now in control of Congress, Senator Edward M. Kennedy, Democrat of Massachusetts, and Representative George Miller, Democrat of California, with some bipartisan support, are pushing legislation intended to bolster the direct loan program.
Many Republicans are determined to defend private lenders. "I don't want a few problems to be the excuse for the Democrats to put the federal government in charge of all student lending in the United States," said Representative Ric Keller of Florida, the ranking Republican on the higher education subcommittee.
Copyright 2007 The New York Times Company