Student Loan Scandals

[This is the fourth in a Higher Ed Watch series "Revisiting the 9.5 Student Loan Scandal." The series takes a closer look at the origins of the scandal with the purpose of trying to resolve unanswered questions and dispel lingering myths surrounding it. Links to earlier parts of the series are available here, here, and here and are included in the post.]

More than four years since the 9.5 percent student loan scandal was first exposed, a stubborn myth persists that lenders were engaged in perfectly legal activities. According to this myth, which was promoted by the student loan industry and unwittingly spread by journalists (including the author of this post when he was a senior writer at The Chronicle of Higher Education), a group of lenders gained windfall profits from the federal government by exploiting a legal loophole in federal student aid law.

In fact, there never was any loophole. As the U.S. Department of Education's Inspector General concluded in 2006, the lenders' scheme to aggressively grow the volume of loans they claimed to be eligible for 9.5 percent subsidy payments was "not in compliance with the HEA [the federal Higher Education Act], regulations, and other guidance issued by the Department." In January 2007, Education Secretary Margaret Spellings concurred with this opinion and barred the student loan company Nelnet and other lenders that refused to submit to independent audits from receiving any further 9.5 payments.

Last week, we described how Key Bank has partnered with dozens of unlicensed and unaccredited trade schools to help thousands of students take on high-cost private student loans, and then refused to cancel them when the institutions shut down. Key Bank has apparently been able to avoid forgiving borrower debt at these defunct schools by engaging in a coordinated strategy that legally knocks out existing federal regulations and consumer protections for borrowers.

As we noted last week, a large part of Key Bank's strategy to avoid discharging borrowers' debt has been to intentionally disregard the U.S. Federal Trade Commission's Preservation of Claims and Defense Rule. Otherwise known as the FTC Holder Rule, this regulation requires schools and lenders that have "a referring relationship" to notify students that they have the right to discharge their private loans if the schools close unexpectedly.

Key Bank has refused to include the required notice in the private loan master promissory notes it provides students. The lender argues that it is not subject to the rule because it is not regulated by the FTC but by the Treasury Department's Office of the Comptroller of the Currency (OCC), which oversees national banks and does not have a similar requirement in place. Despite pleas from consumer advocates, FTC and other federal officials have so far failed to challenge the bank's interpretation of the law.

Yesterday at Higher Ed Watch, we wrote about how Key Bank has partnered with dozens of unlicensed and unaccredited trade schools to provide expensive private loans to the high-risk students these institutions tend to attract. Many of these schools then shut down before delivering on the education that was promised.

Ordinarily, students who attended these fly-by-night institutions would be held harmless, due to an existing federal consumer protection that gives students the right to discharge their loans if a school closes. However, Key Bank's intentional disregard for this protection has left these students in a precarious position -- heavily indebted with expensive private loans and no practical training.

At issue is a federal law Congress enacted in the late 1970s that was designed, in part, to protect students from sham trade schools. Lawmakers created the Federal Trade Commission Preservation of Claims and Defenses Rule, otherwise known as the FTC Holder Rule, to regulate private, nongovernment loans. The rule essentially requires schools and lenders that have "a referring relationship" to notify students that they have the right to have their private loans canceled if a school closes down without warning, or engages in fraud.

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 Key Bank -- 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 Key Bank. Over the last decade, Key Bank 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 Key Bank. 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.

A recent report by Iowa's attorney general about misdeeds at the Iowa Student Loan Liquidity Corporation has one major shortcoming: it essentially lets the leadership of the state-affiliated nonprofit lender off the hook.

Don't get us wrong -- the report is not a whitewash. As we noted previously, it provides an illuminating account of how the Iowa loan agency, also known as ISL and Iowa SLLC, pursued a concerted strategy to steer students to its most expensive private student loan products. Among other things, the report found that the agency made improper payments to colleges that recommended its private "Iowa Partnership Loans" to their students; falsely advertised its private loan products as the "lowest cost" options available; and routinely failed to advise students and their families to exhaust their federal student loan eligibility before taking out private loans.

"The future of many Iowa students is burdened by a mountain of student loan debt," Iowa Attorney General Tom Miller (pictured left) wrote in the report. "It appears that ISL unduly elevated the goals of increasing its competitive advantage, market share, and loan portfolio size over its mission of always striving to do the best for its student borrowers."

But, at the same time, the report opens up the possibility that the agency's leaders will not be held accountable for their actions.

It hasn't taken long for media and bloggers everywhere to shift their attention to potential candidates for the next education secretary. But rather than indulging in games of name-dropping, we have one piece of advice for the transition team in choosing a secretary as well as candidates for other high-level positions: End the revolving door between the Department of Education and student loan companies.

For the past eight years, the Bush administration has employed the revolving door as a common method of filling its most important higher education posts in the Department of Education. According to the Wall Street Journal, at least eight top Department officials came from the student loan industry, including a deputy education secretary, an assistant secretary of postsecondary education, and a chief operating officer of the Federal Student Aid office (FSA).

With so many foxes watching the hen house, is it any surprise that the Department consistently looked the other way as widespread abuses occurred in the Federal Family Education Loan (FFEL) program? While some simply turned a blind eye, there is compelling evidence to suggest that others used their powerful positions to benefit their former employers far more than taxpayers and students

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Barack Obama's historic victory last night ensures that a change in direction is coming to the U.S. Department of Education and hopefully to federal higher education policy.

Starting tomorrow, we will take a closer look at Obama's signature higher education proposals. (Got to give him at least a one day honeymoon, right?) Today, we will present our wish list for the incoming administration. Here are some changes we would like to see:

• Emphasize Oversight and Enforcement at the Department of Education: Over the last eight years, the Bush administration officials in charge of the Department looked the other way as widespread abuses occurred in the Federal Family Education Loan (FFEL) program. To this day, the Department has not disciplined a single lender for violating a federal law that prohibits loan providers from offering inducements to secure student loan business. At the same time, the education secretary allowed lenders to keep more than $1 billion they illegally obtained in improper subsidy payments. Federal leadership is sorely needed to protect the integrity of the federal student loan programs, for the sake of both the students who depend on them and the taxpayers who finance them. For starters, the new administration should take a close look at the conflict-ridden relationship between Sallie Mae and USA Funds, the guarantee agency it effectively controls. As we have noted, there is compelling evidence that the loan giant has exploited this arrangement to take advantage of borrowers who are having difficulty repaying their federal loans. A thorough investigation is needed.

Officials at the Iowa Student Loan Liquidity Corporation, the state-affiliated nonprofit student loan provider, have never been shy in their quest to expand their market share and reap financial rewards. In internal company e-mails obtained by The Des Moines Register last year, agency officials said their aim was to achieve "hypergrowth," by pursuing "an aggressive, offensive strategy to bring in new loan volume."

A new report released last week by Iowa Attorney General Thomas Miller provides an illuminating - if somewhat incomplete - account of how Iowa Student Loan, also known as ISL, put this strategy into motion. The document shows that the loan agency consistently steered borrowers to its most expensive private student loan products. These revelations are particularly disturbing because Iowa college students graduate with the highest level of debt in the nation.

"The future of many Iowa students is burdened by a mountain of student loan debt," Miller wrote in his report. "It appears that ISL unduly elevated the goals of increasing its competitive advantage, market share, and loan portfolio size over its mission of always striving to do the best for its student borrowers."

Over the last two years, as we have investigated and reported on the "pay for play" student loan scandals, we have heard from some skeptical loan industry officials and college leaders and lobbyists who question whether any students have actually been hurt by the unethical practices that have been revealed.

Well, if lenders and college officials are truly assessing the damage, then they need look no further than two new reports last week showing how predatory lending practices have put students in harm's way.

These must-read reports --one from The Chronicle of Higher Education and the other from Iowa's Attorney General -- focus respectively on the operations of Sallie Mae, the nation's largest student loan provider, and the nonprofit lender Iowa Student Loan Liquidity Corporation.

Both reports demonstrate how the loan companies' drive for profits and market share have at least allegedly led them to engage in improper and possibly illegal activities that have left students with larger debt loads than they should have had.

The reports also underscore how the U.S. Department of Education's appalling lack of oversight over the student loan industry has left financially needy students vulnerable to abuse. Apparently the only people interested in enforcing the law and protecting students-- judging by these reports -- are state attorneys general and whistleblowers who bring false claims lawsuits against unscrupulous companies on behalf of the government. In the absence of federal leadership, is it any wonder that student loan providers have been so willing to push the envelope?