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Guaranty Agencies: A Middleman in College Access Clothing
What do an appendix, plica semilunaris, and student-loan guaranty agency all have in common? They're all vestigial structures whose original purpose is no longer necessary. But unlike the first two examples, guaranty agencies are desperate to show -- despite all evidence to the contrary -- that they are still relevant.
As parts of a system known for its complexity and confusion (the Federal Family Education Loan Program, otherwise known as FFEL), guaranty agencies are the ultimate amorphous entity, branching out into numerous roles that are completely unrelated to their original purposes.
Soon after Congress created the FFEL program in 1965, it authorized the involvement of guaranty agencies (many of which were already in existence in the states), to encourage lenders to offer student loans by providing default insurance. Congress also gave the guarantors important oversight responsibilities, such as ensuring that only eligible students obtain federal loans, and that lenders make a concerted effort to keep delinquent borrowers from defaulting.
While it made sense for guaranty agencies to occupy these roles at a time when technological limitations made it difficult for solely the federal government to oversee FFEL, the program's current setup and recent oversight failures make it clear that guaranty agencies should not be the ones to carry out these functions.
Consider loan guarantees. Currently, all FFEL loans must be certified by one of the 35 guaranty agencies. If a loan defaults, the guaranty agency reimburses the lender for 97 percent of its loss. The agency then takes control of the loan and attempts to either get the borrower to begin making payments or start collection proceedings -- both of which result in compensation for the guarantor. But if neither effort is successful, the guaranty agency is reimbursed for nearly all of its losses by the U.S. Department of Education. Guaranty agencies can thus serve as little more than a pass-through of federal funds from the Department to the lender -- a middleman at its finest.
The oversight role, meanwhile, has been completely undermined by overly close ties between lenders and guaranty agencies. Take the relationship between Sallie Mae and USA Funds, the nation's largest guarantor. As The Chronicle of Higher Education outlined in a recent article, the two companies have a contractual relationship, in which USA Funds pays the lending giant a quarter of a billion dollars each year to handle nearly all of its guarantor functions - essentially putting Sallie Mae in charge of monitoring itself.
This problem of incestuous lender/guarantor relationships is far from novel. In 1993, for instance, the U.S. General Accounting Office (GAO) raised red flags about these types of relationships, warning that "many guarantee agencies have expanded their operations to activities that create serious conflicts of interest with their stewardship responsibilities in the program."
Given the superfluity of their guarantees and the ineffectiveness of their oversight, it's not surprising to see guaranty agencies stretching into other areas to show their relevance. In fact, guaranty agencies successfully lobbied Congress to insert a provision into a 2006 budget reconciliation bill that explicitly required them to take steps to promote college access -- a role completely unrelated to loan guarantees. Under that law, guarantors are to "promote and publicize information" for low-income students and those from traditionally underserved populations "on how to plan, prepare, and pay for college."
Now, guaranty agencies are using these college access activities to justify their continued existence -- and at least some members of Congress seem to be buying it. In June, caucuses representing black, Hispanic, and Asian American lawmakers sponsored a briefing touting guaranty agencies for their role in "enhancing higher education access and success for minority students."
In a letter to lawmakers announcing the briefing, the leaders of these groups praised guarantors for "support[ing] programs that promote higher education preparedness, access and success for students who are members of ethnic minority groups, including scholarships, early awareness programs, symposiums for minority-serving institutions, research to promote college access for minority students and Spanish-language college planning materials."
The real purpose of the event, which was co-hosted by USA Funds and Texas-based guarantor TG, was to show the damage that would occur to college access efforts if the FFEL program was eliminated, as the presumptive Democratic presidential nominee Barack Obama has proposed. Speaking at the briefing, Marshall Grigsby, a USA Funds board member and former top aide to Rep. William Clay (D-MO), warned that if FFEL is abolished, guaranty agencies "will disappear" and take all the positive college access benefits with them.
While we strongly support efforts to increase college access, we aren't convinced that guaranty agencies are the most appropriate entities to fulfill this purpose. For one, there is no accountability for how taxpayer dollars are spent on these efforts. Congress has put in place no standards for measuring success or effectiveness. And, there is no way to gauge how much federal money guaranty agencies are spending on this purpose.
If, however, guarantors really want to move in this direction, then perhaps it's time to shift the agencies' reimbursement and incentive structure accordingly. Rather than funneling billions of dollars through them as middlemen, Congress should provide guaranty agencies with a simple block grant to help run counseling and education services. In exchange, the Department would take on the reimbursement and oversight roles, functions it already handles or should handle. Collection activities, meanwhile, could be handed over to the same agencies that have already won the competitive bidding on the Direct Student Loan servicing contract. Using a block grant over the current haphazard system would also allow provide a way for overseeing the effectiveness of these efforts.
While these changes might decrease the number of guaranty agencies, that's not a bad thing, particularly for taxpayers. Like the appendix, these agencies have served their purpose, and are unlikely to be missed.
NAF Can't Handle the Truth
It's an uninformed, complete distortion of the role of guaranty agencies to say they "serve as little more than a pass-through of federal funds from the Department to the lender -- a middleman at its finest." If that were true, why then does the New America Foundation-supported Direct Loan Program have HIGHER lifetime default rates in every category of loans, including both Staffords and PLUS loans? Somewhere in there is a value-added that saves taxpayers billions of dollars and students a lot of misery. In addition, what difference does it make that college access may not have been one of its orginal purposes, an assertion I'm not sure is even true? What matters is what is happening today. Guaranty agencies provide a wide range of college access services to low- and middle-income families, besides helping millions of students avoid default. Finally, who needs think tanks supported by tax-deductible donations? We already have the Congressional Research Service, state universities, members of Congress who are really smart and the Military television channel.
Default rates for FFEL vs. Direct Loans
I wanted to ask Alex where his statistics came from for the lower default rates for FFEL vs. Direct Loans. I have not seen them published anywhere.
Default rates
The lifetime default rates are published annually in the Pres.'s FY Budget document. Look at page 363 of appendix to Pres.'s FY 2009 Budget.
Loan origination
Those are politically-determined estimates/projections of how a single year's "new" loans will default over the next few decades. Strange how the same people touting these types of estimates were constantly talking down the previous Administration's estimates as purely political. Here are the ones that count, from CBO, http://www.cbo.gov/budget/factsheets/2008b/education.pdf. Default rates? slightly higher in ffel than in dl, the exception being the defaulted ffel loans that are consolidated into dl — where the borrowers quite frequently default a second occasion. OMB counts those defaults as dl while CBO counts them as ffel (because that’s where the loan capital started out) defaults. If there were an iron wall between the programs, you would expect the exact same default rates, right, because, as the press is always touting, the terms/conditions of the loans are supposed to be the same in dl as in ffel?Just through an accident of history, though, many of the "lower risk" schools happen to be in dl.
The combination of (1) moving "bad" loan paper into dl consolidation and (2) removing dl's good loan paper through consolidation into ffel has probably created a significant disparity between omb and cbo approaches which ordinarily would not arise. In the first example omb counts potential defaults against dl while cbo counts them against ffel. In the second example omb would credit ffel with the good performance while cbo would credit dl (because that's where the loan capital originated). CBO does not consider consolidation to be a separate loan type but rather a repayment option for the underlying Stafford and PLUS loans. CBO scores the prepayment possibility/risk and other consolidation behavior as part of scoring the original Stafford and PLUS loan. CBO only provides cost estimates for Stafford and PLUS loans. There is no separate line for estimating the cost of consolidation loans. Thus, CBO attributes the default of a dl consolidation loan to the original ffel stafford loan in those cases where a defaulted ffel consolidates into DL and then the DL consolidation subsequently defaults. OMB, on the other hand, attributes all those defaults to the dl program. At the same time, under the omb approach, dl gets assigned with high defaults on loan capital it never originated. Defaults are just one of dozens of factors that go into what the taxpayer cost of the loan programs is. Even a significantly-higher dl default rate would not likely close the budgetary gap created by the primary difference: dl borrower payments go to the treasury, while ffel borrower payments go to the loan holder, as they should, because it was originally private capital supplied there. While the ffel loan may have been sold or securitized, the investors’ price included the assumption that private parties would receive payments of principal, interest, special allowance, etc.
What in Washington isn’t politically driven?
Consider the “politics” that prompted NAF to remove the following quote and other information from its Web site only days after the latest President’s budget was released showing that FFELP is cheaper than Direct Loans on a subsidy rate basis.
“Budget experts agree that the most appropriate way to assess the cost of a loan commitment -- whether a guarantee or a direct loan -- is to use ‘present value’ or ‘subsidy rate’ accounting. The Government Accountability Office (GAO) says that this approach ‘puts direct loans and loan guarantees on an equal footing.’ According to the White House Office of Management and Budget (OMB), this cost estimation process ‘takes the best information available at a given point in time to measure the budget impact of Federal loan programs. It uses the actual historical cash transactions of loan programs to compare the net present value of payments and receipts.”
Now NAF and other DL advocates argue that Direct Loan Consolidation Loans should be treated separately when computing overall program costs.
There’s no better example of politically-driven policy than the Direct Loan Consolidation Program. Politicians have used the Direct Loan Consolidation Program to provide exclusive and specific features to attract recent graduates. For many years, the Direct Loan Consolidation Program has been used opportunistically to grow Direct Loan volume (primarily because 80% of schools remained committed to FFELP). For example, Income Contingent Repayment (ICR), which is only available in Direct Loans, was heavily promoted as a means to allow people to pick low-paying careers like teaching.
The recently approved College Cost Reduction and Access Act extends public service loan forgiveness to Direct Loan borrowers only. The only way for 80 percent of student loan borrowers to take advantage of the program is if they consolidate their FFELP loans into the Direct Loan Consolidation Loan Program.
There are other examples of how the loan consolidation program has been used to grow the Direct Loan program.
Loan rehabilitation is one of the most effective ways to resolve loan default. Rehabilitation, however, requires 9 consecutive monthly payments and is not an option for many borrowers in default because many cannot afford a single full payment.
One of the next best options for a borrower in default is loan consolidation. But in FFELP a borrower must make 3 consecutive payments before being eligible for a FFELP Consolidation Loan. This exact same borrower, however, is not required to make a single payment to be eligible to consolidate into the Direct Loan program. Often, this means that the BEST option for defaulted borrowers is to consolidate into the Direct Loan program (which interestingly is labeled as “dumping” bad loans into the program).
NAF and other “budget experts” including GAO said OMB subsidy rates are the best indicator of program costs. But now that the political goals of Direct Loan advocates have been accomplished through using the Direct Loan Consolidation Program as a key feature in growing loan volume in the program, they want to run away from the numbers.
The reason: it’s only going to get worse. Direct Loan costs are going to explode in the coming years as volume increases and the makeup of the colleges in the program changes dramatically. On top of it all, nearly every federal consolidation loan this year is going to be made in the Direct Loan program as lenders have been forced out of the program due to extreme subsidy cuts.
One has to ask: what pages on the NAF Web site will quickly be altered when Direct Loan Consolidation costs continue to rise?
And what excuses will be made by the Direct Loan advocates?
Higher Ed Watch Response
The text you’ve referenced was on our Federal Education Budget Project page titled “Student Loan Cost Estimates.”
The text was not removed for any “political” reason. In fact, we believe the text you reference is still 100% accurate and agree with every point it makes.
The pages on our Federal Education Budget Project website are regularly updated to improve the quality and timeliness of information we provide on the federal education budget. To that end, the modifications you are referencing were done to provide a more detailed explanation of the student loan cost estimate process than what was previously shown on that page. That current page is available here.
Separately, with respect to the treatment of consolidation loans in cost estimates, we believe that OMB’s decision to treat consolidation loans as “new loans” has important implications for the relative costs of an average direct loan versus an average FFEL loan. Specifically, OMB’s treatment reflects that high default risk FFEL loans are consolidated into the direct loan program, which increases the default rate of direct loans on average. But such budget treatment spuriously suggests that some aspect of the direct loan program makes students more likely to default.
The CBO treats consolidation loans as one of many repayment options “imbedded” within the loan when it is originated. The CBO method “controls” for the effects of high risk FFEL loans consolidated as direct loans. As such, we believe the CBO method provides a more accurate reflection of both FFEL and direct loan costs.
That said, if there is any robust evidence that direct loans make students more likely to default than FFEL, when controlling for factors such as school type, student cohort, borrower ethnicity and income background, region, or anything else that might matter more than loan type, we would be interested in seeing it.
--Higher Ed Watch editors
Guarantors should help students manage higher ed debt
This article highlights the real need for student loan reform. But it overlooks the true value-add of a guarantor: helping student loan borrowers manage their debt and avoid repayment problems. In fact, American Student Assistance and several other forward-thinking guarantors have already shifted their federal funding and incentives to align with this public purpose. In just the first few years of this shift, they’ve delivered proven results in positively affecting student loan repayment and saving taxpayer dollars.
Delinquency prevention needs to be the cornerstone of our federal student loan program. Today, the federal government uses mainly loans, not grants, to provide access to higher education. Student loans have created an obligation not only on the borrower’s part, but also on the government’s part to help students manage their debt. This is where guarantors can have the most impact and relevance. The role of the guarantor should no longer be to insure the lenders, but instead to help guarantee the borrowers’ success. Guarantors should be refocused onto early awareness and information, debt management and default prevention, and loan collection. Ultimately, guarantors should be made accountable for and measured on their ability to prevent student loan repayment disruption. They are in the best position to help government carry out its obligation of not just higher education access, but long-lasting success. For more discussion on the guarantor role, visit www.amsa.com/blogs.
The Role of Guaranty Agencies
In the interest of full disclosure, I am employed by Texas Guaranteed. The views expressed here are my own. At the outset, some of the views expressed in this article are factual. Oversight of FFELP has been and continues to be an issue. But it is being corrected. However, the history cited in the article to back up the facts is, at best incomplete. Sometimes it seems that the NAF's definition of "fair & balanced" when comparing the FFELP & FDLP mirrors that of FOX News when carrying out its responsibility in reporting the news.
In 1965, Congress and President Lyndon B. Johnson realized, in enacting the Higher Education Act (HEA), that many students and their families faced a significant financial barrier to achieving their postsecondary education goals and required assistance in understanding the requirements of and completing the process to obtain federal loans. To provide assistance in overcoming this barrier, Congress, a few years later later, created the role of the guarantor, a non-profit entity, to administer the largest of the federal student financial aid programs and provide support services.
Today, guarantors continue to play a critical role in the delivery of student financial aid. Guarantors approve and process every one of the 12 million FFEL program student loans (totaling $55 billion in Fiscal Year 2006), standing behind these funds to protect the federal government’s investment in our students. An estimated 68% of the federal student aid for college consists of federal student loans. Moreover, (and this is the critical piece of history missing from the article) guarantors enhance access to and success in postsecondary education through early awareness, pre-collegiate outreach, financial literacy, debt management, and avoidance of student loan delinquency and default. This is a part of the guarantor's mission that has evolved over decades - not over the past several months as the article implies.
Guarantors have historically had as part of their mission to play a role in ensuring, as best they are able, that President Johnson’s expressed goal that no high school graduate will be turned away from admission to any college or university in this country “because his family is poor” is achieved through the delivery of federal student loans and the necessary support services and programs. We know that minority students will make up a growing segment of the college-going population in the coming years and that many of these prospective students will need financial aid to pay for college. Guarantors have been especially attentive to helping these students overcome barriers to higher education. We support programs that promote higher education preparedness, access and success for students who are members of ethnic minority groups, including scholarships, early awareness programs, symposiums for minority-serving institutions, research to advance college access and retention, and Spanish-language college-planning materials.
Furthermore, we assist students and families to learn how to avoid the adverse consequences of student loan delinquency and default. Due in significant measure to guarantors’ emphasis on delinquency and default prevention, the national default rate has fallen to 4.6 percent, down from 22.4 percent in 1990 and at a time when the dollar volume of new loans has more than doubled. A few specific examples are provided below, for your review:
Guarantors are not "johnnies come lately", or opportunists, or suddenly motivated by the current environment to "justify their existence" to supporting access to postsecondary education as the article implies. Guarantors simply have not been aggressive in publicizing this crucial role. Maybe now they will.
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