Credit Crunch

By Travis Reindl

We probably should have expected this. Since the Obama Administration declared its intentions to pump nearly $800 billion into the economy and put $12 billion on the table to help regain world leadership in college attainment by 2020, some of our most elite institutions have gone public to plead their case for federal funding.  Presidents, chancellors, and board chairs have penned op-eds and signed onto full-page ads in major national newspapers, wrapping themselves in the Morrill Act and the GI Bill to argue that the federal government cannot abandon the world's greatest universities in their hour of need.

The latest entry in this anthology of angst surfaced in The Washington Post a couple of weeks ago.  Under the alarming headline "Rescuing Our Public Universities," Robert Birgeneau and Frank Yeary, the chancellor and vice chancellor of the University of California at Berkeley, proposed a "daring scheme" whereby "a limited number of our great public research and teaching universities receive basic operating support from the federal government and their respective state governments."  The institutions, selected on the basis of factors such as research achievements, graduation rates, public service, and commitment to diversity, would use the funds to eliminate out-of-state tuition and effectively create a cadre of national universities.

Berkeley would make out quite well under that bold plan, wouldn't it?  Why does this sound eerily like what we have heard from the leaders of the Big Three automakers, or the banks that were simply "too big to fail?"

In January, the Federal Education Budget Project published an issue brief on the student loan purchase programs put in place under the Ensuring Continued Access to Student Loans Act of 2008 (ECASLA). Given the new developments and new information released by the Obama Administration, it's a good time to catch up on the ECASLA programs.

When financial markets began to break down last year, Congress confronted the possibility that private lenders issuing federally-backed student loans (the Federal Family Education Loan Program, FFEL) might not be able to meet student demand. In response, Congress passed legislation (ECASLA) granting the U.S. Department of Education temporary authority to purchase FFEL loans. The new loan purchase authority helps ensure that FFEL lenders have access to adequate and affordable capital and can convert their loan assets into cash to fund new loans. ECASLA gives the Department of Education considerable discretion in designing and implementing loan purchase programs. Using this discretion, the Department designed and implemented four separate loan purchase arrangements: a put option; a short-term purchase program; a financing arrangement; and an asset-backed commercial paper support program. Each option involves different purchase arrangements and targets loans from different years. The ECASLA issue brief, which will be updated in the coming weeks, includes an explanation of each program and is available here.

ECASLA Performance Info Released

Since January, new information has been made available about the ECASLA programs. In March, the Obama Administration reported the volume of loans each private lender made under each program. The reports show that eleven lenders exercised put options on FFEL loans issued during the 2008-09 academic year, selling $701 million in loans back to the Department of Education. Two lenders, Edamerica and Wachovia Education Finance, accounted for about 90 percent of that volume. Subsequently, the Office of Management and Budget (OMB) released estimates in May 2009 showing that $4.8 billion in 2008-09 loans ultimately will be put to the Department (about 8 percent of expected 2008-09 FFEL issuance).

Prospects for President Obama's proposal to eliminate the Federal Family Education Loan (FFEL) program remain uncertain. Democratic leaders in the U.S. House of Representatives and the Senate continue to be divided over whether or not to go forward with a controversial budget procedure known as budget reconciliation, which would make it significantly easier for the President to get the votes he needs to achieve his goal.

But even if the White House fails to persuade Congress to move ahead with its plan this year, the student loan industry will not be able to rest easy. That's because the administration has a trump card up its sleeve. An emergency law that is currently propping up FFEL-- the Ensuring Continued Access to Student Loans Act (ECASLA) -- is set to expire in about a year and a half, and the Obama administration doesn't appear to have any intention of asking Congress to renew it.

Robert Shireman, a senior advisor at the U.S. Department of Education, said as much at an event here last week on "The Future of Federal Student Loans" when he responded to a concern that the administration  was rushing through its plans to overhaul the federal student loan programs. Regardless of whether the proposal to end FFEL goes through, "ECASLA only goes until this next coming year," he said. "A decision has to be made."

The Obama administration on Thursday laid out a bold plan that would turn the Pell Grant program into a true entitlement for low-income students and pay for it in part by eliminating the Federal Family Education Loan (FFEL) program once and for all.

The proposal, which was included in President Obama's 2010 fiscal year budget overview, is sure to create a firestorm of controversy on Capitol Hill, where the student loan industry has many friends in both political parties. Ultimately, the budget blueprint recognizes a couple of hard truths about the federal student aid system that Higher Ed Watch and our sister blog Ed Money Watch have helped expose.

First, the way the federal government is currently financing Pell Grants is a huge mess, as Jason Delisle, the research director of New America's Education Policy Program, recently wrote. Congressional appropriators currently set the maximum Pell Grant each year based on estimates of expected demand for the grants made by federal budget officials. Because the estimates are made far in advance, they are generally off the mark. As a result, the Pell program has often been plagued by large budget shortfalls. To make up for the gaps, the Department of Education often dips into future program funds, pushing the shortfall off to the future.

The global credit crunch is not denying access to federal student loans, but it is making life difficult for thousands of borrowers who are trying to get out of default. As several higher education trade publications have reported, continuing financial market turbulence has made it nearly impossible for defaulted borrowers to rehabilitate their loans -- leaving them with tarnished credit records and denying them the benefits of being in repayment. Fortunately, there are easy steps Congress can take to fix this problem. Lawmakers just have to be sure not to devise a solution that creates a new cash cow for student loan guaranty agencies.

Here's how loan rehabilitation works in the Federal Family Education Loan (FFEL) program. When a borrower defaults on a loan, its title is transferred to the guaranty agency that administered the loan. Guarantors then work with the borrower to create a repayment plan. Once an agreement is reached, borrowers are expected to make nine payments on the loan over a 10-month period. Once this requirement is met, the loan is considered ready to be rehabilitated. The only remaining hurdle is that the guarantor must sell the loan to an eligible lender.

This is where the credit crunch is gumming up the process. Guaranty agencies cannot find any lenders to purchase loan titles. And without a sale the defaulted loan cannot re-enter repayment.

The inability to sell these loans means borrowers are denied rehabilitation benefits. For example, rehabilitated borrowers have their default history expunged from their credit records -- improving their chances of buying or renting a house or obtaining other types of loans that have credit checks. Rehabilitating a loan also makes borrowers eligible for additional federal student assistance -- a benefit not available to anyone holding defaulted federal debt. Finally, rehabilitated borrowers become eligible for benefits available in the FFEL program like loan forgiveness.

At Higher Ed Watch, we have long opposed the idea of the government bailing out private lenders who have engaged in predatory private student loan practices. Our view, as we have said before, is that student loan companies should have to bear responsibility for the consequences of pushing high cost private loan debt on high-risk borrowers. After all, for years, they gladly raked in profits from these loans.

Over the past six months, we have heard from scores of financially distressed borrowers who are outraged that the government would rush to the aid of private student loan providers without offering any relief to them. With U.S. Treasury Department officials preparing to start carrying out this month their plans for reviving the credit markets to help provide capital and liquidity to lenders so they can continue making high-cost private loans, we feel that it is our duty to make sure these voices are heard.

Typically in our mailbags, we provide a sample of comments that have been submitted on a given subject. But as we sifted through the dozens of comments we have received in recent months, one particularly caught our eye because it perfectly illustrates the human costs of a system that has left so many students vulnerable to abuse from predatory lenders and unscrupulous trade schools.

In yet another example of how politicians are overreacting to the panic over the credit crunch, officials in New York are considering spending $50 million in the coming fiscal year to create a new state-sponsored private student loan program.

The proposal, included in Gov. David Paterson's 2009-10 fiscal year budget request, aims to keep up a steady flow of private loans to New York State students. It is also designed to provide a lower cost alternative loan product than is generally available from commercial lenders.

Under the program, credit-worthy undergraduates would be eligible to receive up to $10,000 in private loans annually, and $50,000 cumulatively, after they have exhausted their federal student loan eligibility (not counting PLUS loans). Students would have the option of taking out either fixed-rate or variable rate loans. The plan calls for the state to issue $350 million in tax-free bonds to finance the fixed rate loans -- and the interest rate on these loans would reflect the interest rates paid on these bonds. State officials say they expect the rate to be around 8 percent in the program's first year.

The rate on the variable loan product would be tied to the prime rate with a mark up to be determined by the New York State Higher Education Services Corporation (HESC), the state student loan guarantee agency, which would be running the program. HESC would also determine the amount of fees it would charge students for taking out these loans.

Last December Higher Ed Watch caught wind of back-room maneuvering on Capitol Hill to retroactively change the way the federal government sets lender subsidies in the guaranteed student loan program. Education Secretary Margaret Spellings sent a letter to key members of Congress asking them to quickly enact legislation to change the index used to determine the quarterly interest rate subsidy paid to lenders. The change would calculate the subsidy based on LIBOR instead of commercial paper

No action was taken...until now. The stimulus bill released today by the U.S House of Representatives Appropriations Committee would make the change. Specifically, it would recalculate the subsidy for last financial quarter (October through December 2008) owed to private lenders. And the change would also apply to all loans issued since 2000.

According to our estimates, the change would retroactively increase the subsidy paid to lenders by about 0.50 percentage points. Multiply that across hundreds of billions of dollars in outstanding loans and the extra payments could reach into hundreds of millions. Strangely, the Appropriations Committee reports that the cost will be only $10 million.

In our earlier post, we did not oppose the change, especially given the break down in the commercial paper markets. However, we expressed concern that the change sought by the Secretary (and the student loan industry) was being debated out of the public eye. For example,  while the Department of Education regularly publishes on its website important policy letters the Secretary sends to lawmakers, this particular letter is suspiciously absent from the site. We also noted that the proposed changes would be unprecedented, as loan subsidy changes have always applied to new loans, not previously issued loans. We argued that such a proposed change should be thoroughly and publicly debated by Congress, not buried in a huge omnibus, must-pass bill.

Over the past year, Congress and the Bush administration have taken some dramatic steps to make sure that student loans through the Federal Family Education Loan (FFEL) program remain widely available despite severe credit market disruptions. At Higher Ed Watch, we have been supportive of some of these efforts and critical of others.

However, one thing is absolutely clear -- the loan purchase programs that Congress and the U.S. Department of Education designed under the Ensuring Continued Student Loan Availability Act of 2008 (ECASLA) are complicated. They were enacted quickly and with little public discussion. As a result, few people outside of the Education Department and the student loan industry have any idea of how these plans are supposed to work.

Jason Delisle, the research director of the New America Foundation's Education Policy Program, has written an issue brief that aims to bring clarity to the debate by providing a detailed explanation of the purchase programs and the role they are designed to play in improving access to student loans.

The report includes information on the effects of credit market disruptions on federal student loan availability and the adoption of ECASLA; a detailed description and explanation of each of the four loan purchase programs designed and implemented by the Department of Education under ECASLA; and tables and graphics depicting each of the programs.

We hope that this report, which will be updated as new information on these programs becomes available, will be a valuable tool for policymakers, the news media, and the public to better understand this new and evolving approach to student loan policy.

Readers of this blog will know that we think it would be a major mistake for the U.S. Treasury and Congress to provide bailout funds for private student loan providers -- especially without giving the borrowers of these high-cost loans better consumer protections. To better understand why we think that way, consider the case of KeyBank -- which arguably has engaged in some of the most questionable private student loan practices of any company. Is it really in the best interest of the government and taxpayers to help companies whose lending practices have put students in such harm's way?

As we have reported previously, there has been in recent years a proliferation of unlicensed and unaccredited trade schools that do not participate in the federal student aid programs and therefore go largely unregulated. Their growth has been fueled by lenders that have "partnered" with these institutions to provide expensive private loans to the at-risk students these schools tend to attract. The lenders have then turned around and, like subprime mortgage providers, securitized the loans, shifting these high-risk loans onto unsuspecting investors.

One of the most aggressive players in this arena has been KeyBank. Over the last decade, KeyBank has formed exclusive arrangements with dozens of unlicensed trade schools -- particularly ones that focus on computer training and flight training. These unregulated schools have required their students to pay for the full cost of their training up front, with tens of thousands of dollars of private loans from KeyBank. Unfortunately, many of these schools, like the Nevada-based Silver State Helicopters (SSH), failed to deliver the education promised and then shut down without warning, leaving their students in the lurch -- heavily indebted with expensive private loans and no practical training.