leading lady: sallie mae and the origins of today's

EDUCATIONSECTOR REPORTS

Leading Lady:Sallie Mae and the Origins of Today’s Student Loan Controversy

By Erin Dillon

May 2007

ABout thE Author

ERIN DILLON isapolicyanalystatEducationSector.Shecanbereachedatedillon@educationsector.org.

ABout EDuCAtIoN SECtor

EducationSectorisanindependenteducationthinktankbasedinWashington,D.C.Itisanonprofitandnonpartisanorganizationdevotedtodevelopinginnovativesolutionstothenation’smostpressingeducationalproblems.TheorganizationseekstobeadependablesourceofsoundthinkingoneducationpolicyandanhonestbrokerofevidenceinkeyeducationdebatesinWashingtonandnationally.

ACkNowlEDgEMENtS

TheauthorthanksallofhercolleaguesatEducationSectorfortheirsupportandcontributionstothisproject.

© Copyright 2007 Education Sector. All rights reserved.

1201ConnecticutAve.,N.W.,Suite850,Washington,DC20036202.552.2840•www.educationsector.org

�EDUCATION SECTOR REPORTS: Sallie Maewww.educationsector.org

Thelargestandmostinfluentialplayerintheindustry,SLMCorporation,betterknownasSallieMae,hasn’tescapedthecontroversy:InthewakeofCuomo’sinvestigation,thecompanyagreedunderthetermsofasettlementwiththeNewYorkprosecutortoabidebyanew“codeofconduct”andtoput$2millionintoafundtoeducatestudentsaboutfinancialaid.YetdaysaftertheSallieMaesettlement,thepubliclytradedcompanyannouncedthatitwasbeingsoldtoprivateinvestorsfor$25billion—asumthatsuggeststheenormityofthefinancialstakesinthestudentloanindustry.

ThestoryofSallieMae’srisefromagovernment-sponsoredagencycreatedtohelpneedystudentstoaprivatecorporationwitha$142billionloanportfoliogoesalongwaytowardexplaininghowandwhythestudentloanindustryhaslandedatthecenterofcontroversy.

CreatedbyCongressin1972toincreasethesupplyoflendablefundsunderthethen-decade-oldfederalstudentloanprogram,SallieMaeformanyyearsplayedarelativelynarrowroleintheindustryasa“secondarylender,”buyingandmanagingloansfrombanksandotherlendersthatusedtheirproceedsfromSallieMaetomakenewloans.

Butinthemid-1990s,skyrocketingdemandforstudentloanspromptedbyescalatingcollegetuitions,expandingeligibilityforstudentloans,andahostofnewtypesoflendingcombinedtomakethestudentloanindustryinfinitelymorecomplex,larger,andmorelucrative.AndSallieMaeemergedastheindustry’sbiggestplayer.

Aftersheddingitsgovernment-sponsoredstatusandbecomingafullyprivate,for-profitcorporation,SallieMaeembarkedonanaggressiveexpansioncampaign.Itbought,orformedpartnershipswith,companiesworkingineverycornerofthestudentlendingindustry,fromlendingandloancollectiontoenrollmentmanagementandevencollege-tuitionsavingsplansforinfants.

SallieMaehashelpedmillionsofstudentspayforcollege,studentswhowouldnothaveotherwisebeenabletocoverthecost.ButtherelentlessexpansionofSallieMaeandotherlendinggiantsintoeverypartofthestudent-aidenterpriseandintoeveryregionofthecountrycombinedwithanoutmatchedandoftenunmotivatedfederalregulatorybureaucracy,industrypoliticalcloutthatreachesfromthehallsofCongresstocollegecampuses,andlucrativeregulatoryloopholesthatcontributetostudentlending’simmenseprofitpotentialhavecreatedaclimatethat’sripeforthequestionablemarketingtacticsandotherindustrywrongdoingthathaveemergedinrecentmonths.

Itisaclimatethathasempoweredthelendingindustrytoactaggressivelyateveryturn,placingstudentsatriskofpayinginflatedinterestratesandfeesontheirfederalloansandleavingtaxpayerstopickupthetabforwhatmembersofCongresssayarehundredsofmillionsofdollarsinexcessivesubsidiesforthestudentlendingindustry.

AstheSallieMaestorysuggests,pastisprologueinthestudentlendingindustry.Today’sproblemsaretheresultofconditionsintheindustrythathavebeenbuildingforyears.

The $85-billion-a-year student loan industry has been beset by scandal since new york attorney general andrew Cuomo announced on March 15, 2007, that his office was investigating “unholy alliances” between lending companies and college financial aid officers. Revelations of college officials accepting consulting fees from and holding stock in companies on their school’s preferred-lender lists, lenders staffing college’s financial information call centers, and close ties between U.S. Department of Education officials and lenders have been front-page news.

2EDUCATION SECTOR REPORTS: Sallie Maewww.educationsector.org

Opening College Doors

Thesize,complexity,andimmenseprofitpotentialoftoday’sstudentloanindustryisn’twhatCongressenvisionedwhenitcreatedtheGuaranteedStudentLoanProgram(renamedtheFederalFamilyEducationLoanProgramin1992)aspartoftheHigherEducationAct(HEA)of1965.Theprogrambeganasarelativelysmall,targetedefforttoopencollegedoorsforfinanciallyneedystudents.Theoriginalprogramprovidedloansofupto$1,000peryeartoundergraduatestudentsand$1,500ayeartograduatestudentswithfamilyincomesoflessthan$15,000(seesidebaronfederalstudentloans,page7).1

Sincethestudentsintheprogramwere,bydesign,higher-riskborrowers,thefederalgovernmentcreatedincentivesforlenderstoparticipateinthenewfederalinitiative.Itgavestatesfundstoestablish“guaranteeagencies,”whichwouldinsurelendersagainstlossesfromdefaultedloans,therebyreducinglenders’risk.Thefedsalsoguaranteedlendersa6percentinterestrateontheirstudentloans—atthetime,arateslightlyhigherthanratesformoresecurehomemortgageloans.

Theseincentiveswereinsufficienttoencouragestatestotakeontheriskofestablishingguaranteeagencieswithoutsomefederalinsuranceonloans,andthe6percentinterestratewasnothighenoughtoattractprivatelenders.Inresponse,thefederalgovernmentpursuedtwostrategiestoboostparticipationbybanksandstates:shiftingtherisktothefederalgovernmentandincreasingbanks’profitsonloans.

Congressin1968authorizedtheU.S.DepartmentofEducation(thencalledtheOfficeofEducation)topaystateguaranteeagencies80percentoftheamountoftheirlosses.Theyearbefore,theDepartmentofEducationhadestablishedtheFederalInsuredStudentLoanprogramtoreimburselendersinstateswithoutguaranteeagencies.Underthatprogram,thefederalgovernmentreimbursedlenders100percentoftheirdefaultedloans.

Toincreaseprofitstobanks,Congressquicklyraisedtheguaranteedinterestrateonstudentloansto7percent.2Butbymid-1969,interestrateschargedtothemostcredit-worthyborrowerswere8.5percent,makingthe7percentinterestrateonmoreriskystudentloansunappealingtobanks.Inresponse,Congressestablished

in1969subsidiesknownas“SpecialAllowancePayments”toensurelendersreceivedmarket-rateprofitsonloans(seesidebaronspecialallowancepayments,page12).Specialallowancepaymentsweretiedto

Student lending glossary

Government Sponsored Enterprise (GSE):afor-profit,privatelyoperatedcorporationcharteredbythegovernmenttoincreaseinvestmentsinaspecificsectoroftheeconomy.

Federal Family Education Loan Program (FFELP):afederalstudentloanprogramauthorizedintheHigherEducationAct.Loansareprovidedbyprivatelendersandinsuredbythefederalgovernment.LoanprogramsincludeStaffordSubsidizedandUnsubsidizedloans,andPLUSloans.

Federal Direct Loan Program (FDLP):afederalstudentloanprogramauthorizedinthe1992reauthorizationoftheHigherEducationAct.LoansareprovidedbytheDepartmentofEducationdirectlytostudentsthroughtheirschools,withoutprivatelendersorguaranteeagencies.

Guarantee Agency:organizationintheFederalFamilyEducationLoanProgramthatinsureslendersagainstfinanciallossesduetoloandefaults.Guaranteeagenciesarealsoresponsibleforhelpingtoadministertheprogramandoverseelenders.

Default:Defaultoccurswhenaborrowerfailstomaketherequiredmonthlypaymentsonhisorherloan.IntheFederalFamilyEducationLoanProgramandtheFederalDirectLoanProgram,aborrowerisindefaultafter270daysofnon-payment,assumingnoalternativearrangementsforpaymentweremadewiththelender.

Loan Servicing:activitiesperformedtocollectandprocessloanpaymentsduringthelifeofaloan.Theseincludecontactingandcommunicatingwithborrowers,collectingpayments,filingpaperworkwiththeDepartmentofEducation,andprovidingcollectioneffortsondelinquentloans.

Collection Agency:agencyhiredbyalenderorguaranteeagencytolocatedefaultedborrowersandrecoverpaymentsondefaultedloans.

Loan Consolidation:combiningoneormoreloansintooneloanwithasinglelender.Loanconsolidationcanallowborrowerstomakeonemonthlyloanpayment,extendthepaymentperiodontheirloans(therebyreducingmonthlypayments)andlock-ininterestrates.

Secondary Market:anorganizationthatbuysexistingloansfromabankorotherlender.Lenderssellloanstothesecondarymarketinordertoraisemoneytomakenewloans.

Enrollment Management:theprocessofusingpastenrollmentandfinancialaiddatafromaschooltopredictwhichstudentsarelikelytoapplyandenroll.Enrollmentmanagementoftenincludesleveragingfinancialaidawardstorecruitadesirableclassofstudents.

529 Savings Plans:state-sponsoredinvestmentoptionsrunbyprivateinvestmentgroupsandnamedafterSection529ofthetaxcode.In2001,Congressexemptedthesesavingsplans,whichcanbeusedforhighereducationexpenses,fromfederalincometax.


changinginterestratesandpaidlendersasmuchas3percentagepointsabovethe7percentinterestchargedtostudents.Withspecialallowancepayments,thefederalsubsidiesrosealongwithinterestrates,ensuringprofitsforbanksregardlessofinterestratechanges.

Asaresult,lenders’guaranteedinterestearningsonstudentloansjumpedfrom6percentto9percentin1969,whiletheassociatedriskdroppedtonearlyzero,makingstudentlendingaveryattractivebusiness.3

Still,thefederallendingprogramwasrelativelysimpleinthe1960s.Itinvolvedlenders,thefederalgovernment,whichprovidedsubsidiesandloaninsurancetobanksandstateguaranteeagencies,andcollegesandstudents(seeFigure1).

Increasing Cash FlowButCongresssoonexpandeditseffortstoencouragelendingtostudentsbymakingsurebankshadamplelendablecash.In1972,itcreatedtheStudentLoanMarketingAssociation(SLMA),asSallieMaewasoriginallycalled,toprovidea“secondarymarket”forstudentloans.Thenewcompanyboughtstudentloansfrombankstofreeuplendermoneyfornewloans.

CongresscreatedSallieMaeasaGovernmentSponsoredEnterprise(GSE)—afor-profit,privatelyoperatedcorporationcharteredbythegovernmenttoincreaseinvestmentsinaspecificsectoroftheeconomy.Other

well-knownGSEsinclude“FannieMae,”forthehousingindustry,and“FarmerMac,”forthefarmingindustry.SallieMaereceivedvaluablebenefitsasaGSE,includingexemptionfromstateandlocaltaxes,andaccesstolow-costfundsfromtheU.S.DepartmentoftheTreasury.SallieMaepaidonlyafractionofapercentininterestonthefundsitborrowedfromtheU.S.Treasury.SallieMae’searnings—frominterestpaymentsmadebystudentsandsubsidiespaidbythefederalgovernmentonstudentloans—werealsotiedtoTreasurybillrates.Therefore,ifinterestrateswentupSallieMaepaidmoretotheTreasuryforitsfunds,butgotevenmorebackinsubsidiesfromthefederalgovernment,givingSallieMaeaneasypathtoprofits.

CongressfurthersweetenedthepotforstatesandlenderswiththeTaxReformActof1976.Thisactauthorizedstateagenciestoissuetax-exemptbondstopurchasestudentloansinthesecondarymarket.Statesquicklytookadvantageofthisopportunity,whichallowedthemtouselow-cost,tax-exemptmoneytobuyloanswhilereapinginhighfederalinterestsubsidiesonthoseloans.Statesestablishednonprofitcorporationstoactassecondarymarketsandpurchasestudentloansfrombanks.HavingbothstatesecondarymarketsandSallieMaefurtherensuredthattherewouldbeenoughmoneyavailableforbankstokeepmakingloans,anditgavebankssecurity,knowingtheycouldselltheirloansifneeded.Congressalsoincreasedthefederal“reinsurance”ondefaultedstudentloansto100percentforstateguaranteeagencies.Withtherisktostategovernmentslargelyeliminated,thenumberofstateguaranteeagencies,whichneverexceeded26before1976,grewto50by1981.4

WiththeadditionofSallieMaeandothersecondarymarkets,thefederalloanprogrambecamemorecomplexandmorecostlyfortaxpayers.Thefederalgovernmentwasnowguaranteeingallloansat100percent,andpayingbanks,SallieMae,andstatesecondarymarketshighinterestsubsidiesonloans.In1979,AlfredB.Fitt,thegeneralcounselinthenewlyestablishedCongressionalBudgetOfficestated,“the[federalloan]programhasgonethroughpiecemealalterationsthathavetransformeditintoasystemmuchmorecostlythanadirectfederalloanprogram,withthehighercostsnotredoundingtothebenefitofstudentborrowers,butrathertothebenefitofthefinancialinstitutionsthatmaketheloans”(seeFigure2).5

Figure 1. Federal Student loan Program, circa �965

Federal Government

Students

Banks (Lenders)

Colleges and Universities

State Guarantee Agencies


Selling StockLoosenedloaneligibilityrequirements,togetherwithtwonewfederalloanprograms,increasedstudentborrowingfrom$1.8billionin1977to$12billionin1989.6The1978MiddleIncomeStudentAssistanceActeliminatedincomerestrictionsandexpandedfederalloaneligibilitytoallstudents(In1981,theReaganadministrationre-instatedfinancialneedasarequirementforreceivingsubsidizedstudentloans);theAuxiliaryLoantoAssistStudentsprogram(ALAS),approvedbyCongressin1981,extendedeligibilitytostudentswithnoparentalfinancialsupport;andCongresscreatedtheParentLoanforUndergraduateStudentsprogram(PLUS)in1980,toallowparentstotakeoutsupplementalloanstohelpcovertheirchildren’scollegecosts.

Duringthesameperiod,CongressexpandedSallieMae’sroleinthelendingindustry.Inthe1980reauthorizationofHEA,CongressauthorizedSallieMaetooffer“loanconsolidation”tostudentswithsignificantdebt,permittingthemtocombinemultiplefederalloansintosingleloanswithlongerrepaymenttermsandlowermonthlypayments.LawmakersalsograntedSallieMaepermissionbothtomakeloansdirectlytostudentsinareasofthe

countrywherestudentscouldnotgetloansfromanotherlenderandtoactasaguarantorinstateswheredemandforloansoutpacedsupply.7

Thesechanges,alongwiththenewloanprogramsandresultingboominloanvolume,meantrisingprofitsforSallieMaeandotherlenders.SallieMae’sassetsgrewfrom$1.6billionin1979to$28.6billionin1988.Inbetween,thecompanyissueditsfirstpublicstockofferingin1983,raising$357millioninprivatecapital.8Withtheinfluxofprivatecapital,SallieMaewasnolongerreliantonlyonfederalfundsforexpansion.

Risinglenderprofitsmeanthigheradministrativecostsforthefederalgovernment.Thepricetagofthefederalloanprogram,includingloansubsidiestostudentsandbanksandfederalpaymentsfordefaultedloans,grewfrom$2.7billionin1981to$4.1billionin1985.9In1986,paymentstolendersfordefaultedloansalonecostthefederalgovernmentover$1billion.

Inanefforttoreducehighdefaultrates,theU.S.DepartmentofEducationimposednewdue-diligencerequirementsonthestudentlendingindustrywhenitreauthorizedtheHigherEducationActin1986.Therequirementsdictatedthatlendersandguaranteeagenciesfollowexactingproceduresinmakingloans,processingpayments,andcollectingondefaultedloans—andrisklosingreimbursementsondefaultedloansiftheyfailedtofollowthem.Inadvertently,thedepartment’snewregulationshelpedfuelthedevelopmentoflending-industrygiantslikeSallieMaebycreatingbarrierstoentrytosmaller,newercompanieswantingtoenterthefield.

Existinglenders,whichwereoftenstateorregionalbanks,sawthenewregulatoryrequirementsasathreattotheirbottomlines.Toprotectthemselves,theybegansellingtheirloanstolargelenders,oroutsourcingloanservicing(processingpaymentsandpaperwork)andcollection(locatingandcontactingdefaultedborrowers).Asaresult,bothlendingandloanservicingbecameconcentratedinfewerandfewercompanies.10Thenumberofactivelendersinthefederalloanprogramhasdroppedfromahighof11,298in1985to3,166in2007(seeFigure3).

Theoutsourcingofloanservicingandcollectingandtheexpansionofloanconsolidation,whichCongressoriginallyonlyofferedtoSallieMaebutsoonextended


Federal Government

Students

Banks (Lenders)


Sallie Mae/Secondary Markets



toothercompanies,createdanevenmorecomplicatedstudentlendingsystem(seeFigure4).

Warning Signs

The1990ssawmoreincreasesinbothstudentlendingvolume(from$14billionin1991to$30billionin1996)andindustryprofits.Risingtuitionsandthe1992reauthorizationoftheHigherEducationAct,whichincreasedfederalloanlimitsandintroducedunsubsidizedloans(loansforwhichthegovernmentdidnotpaytheinterestwhilestudentswerestillincollege)tostudentsatallincomelevels,11fueleddemandforstudentloans.

Butthislatestexpansionofthestudentloanindustrywasaccompaniedbyearlysignsofabusesandalackofgovernmentoversight,muchlikethestoriesmakingheadlinestoday.HearingsbytheSenatePermanentSubcommitteeonInvestigationsin1990revealed

instancesoffraudandabuseamongtradeschools,lenders,andguaranteeagencies.Chargesincludedloanservicersfalsifyingdocumentstocoverupmistakes,lendersnotpayingmandatedfeestotheDepartmentofEducation,and“diplomamill”for-profitschoolsusingtheloanprogramtomakemoneywithoutprovidingaworthwhiledegree.12Congress“didnothearofevenasinglepartoftheguaranteedstudentloanprogramthatisworkingefficientlyoreffectively,”declaredcommitteeChairmanSamNunnofGeorgia.13

Inresponsetotherevelationsofabuseintheprogramandthehighprofitsofsomelenders,CongressintroducedanewFederalDirectLendingProgram(FDLP)in1992.TheFDLPallowedthefederalgovernmenttomakeloansdirectlytostudentsthroughtheirschools,therebycreatingaformidablecompetitortobanksandotherFederalFamilyEducationLoanProgramlenders(FFELP).FDLPsupportersarguedthatbyeliminatingtheFFELPmiddlemen,thedirectlendingprogramwouldbeamoreefficientlendingsystemandlesspronetoabuse.

Figure 3. Number of Active lenders Participating in the FFEl Program, �966–2007

Activ

e Le

nder

s

Fiscal Year

0

2000

1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

4000

6000

8000

10000

12000

Note:Somelendersreportedloansundermultiplenumbers.Intheseinstanceslenderswerecountedmorethanonce.ThesecountsdonotincludelenderswhoparticipatedexclusivelyundertheFederalInsuredStudentLoanProgramwhichexistedfromFY68throughFY84.Source:U.S.DepartmentofEducation,OfficeofPostsecondaryEducation,NationalStudentLoanDataSystem.


Inamovethatsignificantlychangedtheroleofguaranteeagencies,CongressauthorizedlenderstoappealdirectlytotheDepartmentofEducationforloanreimbursement,astepprecipitatedbythecollapseoftheHigherEducationAssistanceFoundation(HEAF),oneofthelargestguaranteeagenciesinthecountry.Themovediminishedtheroleofguaranteeagenciesasguarantors—theywerenolongernecessaryforalendertoreceivereimbursementonaloan,butdidnotchangetheiroversightandadministrativeresponsibilitiesintheloanindustry.Theymuststillverifyloans,ensurethatlendershaveperformedtherequireddue-diligenceontheirloans,andverifythatlenders’defaultclaimsarevalid.

HEAFcollapsedin1990duetohighdefaultratesfromthelargenumberofloansitwasmakingtofor-profitcolleges.Toensurelendersremainedintheprogramandloanscontinuedtobeavailabletostudents,theDepartmentofEducationassumedresponsibilityforHEAF’sloansand,eventually,foralldefaultedfederalloansifalendercouldproveaguaranteeagencywasinsolvent.14

PresidentBillClintonin1993expandedthedirectlendingprogram,withthegoalofmakingallfederalloansthroughtheFDLP.TheFDLP,becauseitgotfundsdirectlyfrom

theTreasuryanddistributedthemdirectlytostudents,eliminatedtheneedforprivatebanks,guaranteeagencies,andSallieMaeasasecondarymarket.ClintonalsoimposedafeeonSallieMaethatessentiallyeliminateditsfundingadvantageasaGovernmentSponsoredEnterpriseandmandatedthatSallieMae,becauseitwasagovernment-charteredentity,actasalenderoflastresortforstudentswhocouldnotobtainloanselsewhere.15SallieMae’soperationsasaGSEwereprimarilylimitedtosecondarymarketactivities,makingitdifficultforSallieMaetorespondtocompetitivethreatsliketheFDLP.Inlightofthesechangesandincreasingnational-levelcompetitionforstudentloans,SallieMaesoughtandwoncongressionalapprovaltoabandonitsGSEstatusandbecomeafullyprivatecompany,freetoexpanditsbusinessoperationsandpursueprofitsmoreaggressively.16

CongresspassedtheStudentLoanMarketingAssociationReorganizationAct(commonlyreferredtoasthe“PrivatizationAct”)in1996.Thelawallowedthecreationofaholdingcompany—acompanythatownsmultiplecorporations—permittedtopursuebusinessopportunitiesoutsidethelimitsofSallieMae’sGSEcharter.SLMHoldingCorporationbecametheparentcompanyofbothaGSEentity—knownasthe


Federal Government

Parents

Students




Lender and GuarantorServicing

Collection AgenciesConsolidation

Loan Companies

Banks (Lenders)

Note:Dashedlinesindicateoutsourcedservices.


“StudentLoanMarketingAssociation”—andanon-GSEcorporation—SallieMae.TheGSEwasallowedtocontinueservingasasecondarymarketforstudentloans,butwasexpectedtoenditsoperationsby2008.(TheGSEentityactuallyendeditsoperationsfouryearsaheadofschedule,inlate2004.)Meanwhile,thenon-

GSEarmoftheholdingcompanycouldpursueotherbusinessactivitiesandbuilditsoperationsintothecompanywenowknowasSallieMae.AftertwodecadesofoperatingunderitsGSEcharter,SallieMaewasfreetoexpanditsdominanceofthestudentloanindustryevenfurther.

Federal Student loans

Therearethreetypesofloansofferedthroughthefederalstudentloanprogram:Staffordloans,whichincludesubsidizedloans,need-basedloansforwhichthefederalgovernmentpaystheinterestduringschool,andunsubsidizedloans,non-need-basedloansforwhichthegovernmentdoesnotpayinterestduringschool;ParentLoanforUndergraduateStudents(PLUS)loans,whichallowparentstosupplementtheirchildren’sfinancialaid;andGradPLUSloans,anewloanforgraduatestudentstosupplementStaffordloans.

Theseloansareadministeredthroughtwoprograms,theFederalFamilyEducationLoanProgram(FFELP)andtheFederalDirectLoanProgram(FDLP).

ThedifferencebetweenthetwoprogramsisthatunderFFELP,banksandotherlendersprovidefederalloanstostudentsviatheircollegeoruniversityfinancialaidoffices,whileunderFDLP,thefederalgovernmentactsasthelender,withtheU.S.DepartmentofEducationmakingloanstostudentsthroughtheircampusaidoffices.Seventy-sevenpercentoffederalstudentloansaremadethroughFFELP,23percentthroughFDLP.

Whiletheinterestratesandtermsforallfederalloansarethesame,theprivateFFELPlendersoftenofferinterest-ratereductionsforon-timeorautomaticpaymentsthatcomedirectlyfromtheborrower’sbankaccount.

StudentsmustcompletetheFreeApplicationforFederalStudentAid(FAFSA)inordertoapplyforStaffordandGradPlusloans.Theapplicationcalculatesastudent’sExpectedFamilyContribution—howmuchstudentsandtheirfamiliesareexpectedtocontributetothecostofcollege—andastudent’seligibilityforneed-basedfederalfinancialaid.

Loan Interest rate Limits Repayment

Stafford Loans Fixed,6.8percent Undergraduatelimit:$23,000

Combinedundergraduateandgraduatelimit:$65,500

Studentsmaydeferpaymentswhileinschoolandfor6monthsafterleavingschool.

Therepaymenttermis10years.

SubsidizedLoans

Thegovernmentpaystheinterestontheseloanswhilethestudentisenrolledinschool.Whilethereisnoincomerequirementtoreceivesubsidizedloans,studentsmustdemonstrateneed,calculatedasthecostofattendance,minusotheraidandminustheExpectedFamilyContribution.

UnsubsidizedLoans

Thegovernmentdoesnotpaytheinterestontheseloanswhilethestudentisenrolled.Therearenoincomelimitsorneedrequirementstoreceiveunsubsidizedloans.

Parent Loan for Undergraduate Students (PLUS)

Fixed,8.5percent Nocumulativelimit.

Parentsmayborrowuptothecostofattendance,minusanyloan,grant,orwork-studyaidreceived.

Repaymentbegins60daysafterfundsaredisbursedandtherepaymenttermis10years.

TherearenoincomeorneedrequirementstoreceivePLUSloans.Parentsmustsubmitaloanapplicationandpassacreditcheck.Parentswithadversecredithistoriesmayhavetheirapplicationsrejected,inwhichcasethestudentiseligibleforincreasedStaffordloanlimits.

GradPLUS Fixed,8.5percent Nocumulativelimit.

Studentsmayborrowuptothecostofattendance,minusanyaidreceived.

Studentsmaydeferpaymentswhileinschool.


TherearenoincomeorneedrequirementstoreceiveGradPLUSloans,butstudentsmustsubmitaFAFSAandmax-outStaffordloanlimitsfirst.Students,likeparentsforthePLUSloan,canbedeniedaloaniftheyhaveanadversecredithistory,howevertheyarenoteligibleforincreasedStaffordloanamountsifthishappens.StudentscanconsolidatetheseloanswiththeStaffordloans.


Breaking FreeAtthesametimeSallieMaewasbreakingfreeofitsgovernmentalshackles,twonewlendingtrendsweretransformingstudentlendingfromprimarilyalocalandregionalbusinesstoanationalindustry,andmakingstudentlendingamorecompetitivemarketplaceintheprocess.

Intheearlystagesofthestudentloanindustry,lendersandguaranteeagenciesprimarilyservedtheirstates.Butasitbecameapparentthathighloanvolumecouldmeanlargeprofits,lendersandguaranteeagenciesmovedacrossstatelinesandbegantocompeteonanationalscale.SallieMae,alarge,nationalcompanywithawell-knownname,wasintheperfectpositiontoprofitfromthistrend.

Thesecondtrendwasthestart,intheearly1990s,ofdirect-to-consumerloanmarketing—wherebylenderswentdirectlytostudentsorparentstoselltheirloans,bypassingfinancialaidoffices.Thismarkedasignificantshiftintherelationshipbetweenschools,lenders,andborrowers.

Asnational-levelcompetitionanddirect-marketinggrew,bothstudentsandschoolswerefacedwithavarietyofchoicesfarbeyondtheirlocalbank.Tohandlethisnewinfluxofloaninformationandtobettercompareandbargainforloandeals,schoolsreliedon“preferred-lenderlists.”Andthelistsofrecommendedlendersgreatlyinfluencedstudents’borrowingdecisions:Thetoplenderonapreferred-lenderlistcangarnerupwardof95percentofaschool’sloanbusiness.17Thisputfinancialaidofficesinthepowerfulpositionofactingasgatekeeperstoloanbusiness.Forlenders,itcreatedasinglelocationoneverycampustomarkettheirproducts.

ForSallieMae,the“preferred-lenderlist”arrangementhasbeenaboon.Inadditiontomarketingdirectlytostudents,SallieMaehasa400-membercampus-basedsalesstaff,whichprovidesservicestoover6,000collegesanduniversities—inessence,nearlyeverycollege,university,andeducationalinstitutionintheUnitedStates.18

Direct-to-consumerconsolidationloancompaniesalsosprungupinthe1990s.Thesecompanies,takingadvantageofhistoriclowinterestrates,offeredlocked-ininterestratestograduatesanddidnotrequireanyfinancialaidofficeinvolvement.

Thenewconsolidation-onlyloancompaniesthreatenedtotakeawaytraditionalloancompanies’businessentirely.Withthelowinterestrates,studentswereconsolidatingtheirborrowingatrecordlevels,evenbeforetheygraduatedfromcollege,meaningthatacompanycouldlosealoansoonaftermakingit.FamilyFederalEducationLoanconsolidationsjumpedfrom$9billiontoalmost$54billionbetween2001and2005.19Originally,traditionallenders,includingSallieMae,attemptedtoholdbackthegrowthinconsolidationloansbylobbyingforCongresstoimplementregulationsthatlimitedthecompanieswithwhichstudentscouldconsolidate.Eventually,though,SallieMaeandotherprivatelendersjoinedthecompetitionforconsolidationloans,usingtheirdirect-marketingtechniquestoselltheirloanconsolidationservicestorecentgraduates.

SallieMaealsohasbeenanaggressiveplayerintherise,sincethemid-1990s,inprivatelending—lendingoutsideofthefederalstudentloanprogramatmarketratesandwithoutsubsidiestolendersorstudents.

Theearlyreluctanceoflenderstomakeloanstostudents,whichledtothefederalloanprogram,hadlargelyvanishedbythemid-1990s.After30yearsofexperiencemanagingfederallybackedstudentloans,bankssawprivatestudentloansasaprofitablemarket.Risingtuitionsopenedupdemandforprivateloansamongmiddle-andupper-classfamilies,andthehigherinterestratesbankscouldchargeontheseloansmadethemmoreprofitable.Asaresult,privatelendingtocollegestudentshasincreasedbyanaverageof27percentayearsince2000,fromalmost$4billiontoover$16billionin2006.20SallieMae’sprivatelendingincreasedfromlessthan$2billiontoover$7billionduringthesameperiod.21

Withtheadventofloan-consolidationcompanies,theFederalDirectLoanProgram,directmarketing,andprivateeducationlending,thestudentloanlandscapehasbecomeextraordinarilycomplexandlucrative,andincreasinglydifficultforregulatorstotrack.AccordingtoFederalStudentAid,theU.S.DepartmentofEducationprogramthatoverseesthefederalstudentaidprograms,thedepartmenttodayworkswith3,200lenders,35guaranteeagencies,secondarymarkets,72third-partyloan-serviceorganizations,andwithmanyotherindustryentities.22

ButitisSallieMaethatdominatestheindustry.Nolongerheldbackbyitsstatusasaquasi-governmentalagency,thecompanymovedaggressivelytoestablishacompetitive


presenceineverypartofstudentlending,largelybyacquiringahostofothercompanies(seeFigure5).

SallieMae’searliestpurchasesincludedNellieMaein1999andStudentLoanFundingResourcesin2000,bothnonprofitstudentlendingcorporations.23NellieMaeoriginatedover$300millioninfederalloansatthetimeSallieMaepurchasedit,makingitthe17thlargestloanoriginator.SinceNellieMaewasanonprofitorganization,SallieMaewasrequiredtocompensatethepublicforitsmarketvalue.24TheresultwasthecreationoftheNellieMaeFoundation,whichhad$395millioninassetsaftertheacquisition.25TheacquisitionofStudentLoanFundingResourcesreceivedlessattention,butinvolvedthepurchaseoftheeighthlargestholderoffederalstudentloans.

ThreeotherlenderacquisitionsexpandedSallieMae’sgeographicreach.In2003,thecompanyacquiredtheMassachusetts-basedAcademicManagementServices

Corporation,whichadded$1.4billioninstudentloans.In2004,SallieMaeexpandedtotheSouthwestwiththeacquisitionofnonprofitSouthwestStudentServicesCorporation,atop-30loanoriginator,andthentotheNorthwestwiththepurchaseofthenonprofitlender,StudentLoanFinanceAssociation.

In2000,SallieMaepurchased,for$770million,theUSAGroup,thelargestguaranteeagencyinthecountryandanonprofitlendingconglomeratewithservicesinloanorigination,enrollmentmanagement,loanservicing,anddebtcollection.26WiththeUSAGrouppurchase,SallieMaewentfrom“beingthe800-poundgorillatobeingthe8,000-poundgorilla,”inthestudentlendingindustry,saidHenryB.Howard,presidentofU.S.EducationFinance,aprivateloancompany.27

SallieMae’spurchaseofUSAGroupdidnotincludeUSAFunds,theguaranteeagencyarmofUSAGroupand

Figure 5. Federal Student loan Program, circa 2007, and Sallie Mae’s Presence in the Market*

Federal Government

Students/Parents

Private Loans


Secondary Markets

EnrollmentManagement

529 SavingsPlans

Federal Direct Loan Programs



Collection Agencies ConsolidationLoan Companies

Banks and Lenders

†

Note:Dashedlinesindicateoutsourcedservices.*ShadedboxesindicateareasinwhichSallieMaeoraSallieMaesubsidiaryoperate.†SallieMaeprovideslendingservicestoUSAFundsalongwitheightotherguaranteeagencies.SallieMaedoesnotownaguaranteeagency.

�0EDUCATION SECTOR REPORTS: Sallie Maewww.educationsector.org

itslargestoperation.Becauseguaranteeagenciesarerequiredbylawtobeeitherstateagenciesornonprofitagencies,SallieMae,asafor-profitcompany,couldnotownUSAFunds.Instead,aspartofthedeal,SallieMaerequiredUSAFundstocontractallofitsguaranteeservicestoSallieMae.TheexclusiverelationshipgaveSallieMaecontrolovertheentireloanprocess,allowingittoofferschoolsmoreintegratedservicesandgivingitasizeablecompetitiveadvantage.

ThepurchasealsoallowedSallieMaetodramaticallyexpanditsdebtcollectionanddefaultmanagementservices,nowitssecondlargestbusinesssegmentbehindstudentlending.TheUSAGroupacquisitionadded$6billioninstudentloanstoSallieMae’sportfolioandincreasedrevenuenearly40percentwiththenew,fee-basedservicesSallieMaewasabletooffer.28

SincetheUSAGroupacquisition,SallieMaehaspurchasedfourotherdebtmanagementandcollectioncompanies—GeneralRevenueCorporation,PioneerCreditRecovery,ArrowFinancialServices,andGRPFinancialServicesCorporation—whichhaveexpandeditsdebtmanagementoperationsbeyondstudentloancollectionsintoothertypesofconsumerdebt,includingcreditcardsandmortgages.

Asaresultofthisshoppingspree,SallieMaenowownsacompany,orpartnerswithacompany,ineachofthecriticalareasoflending,frommakingloanstocollectingloans.Itisnowtheindustryleaderinloanorigination,loanholdings,loanservicing,andloancollecting,anditcontractsservicestothelargestguarantorinthecountry.In2006,SallieMaeoriginated,throughitsvariouslendingbrands,nearly$7billioninFFELPandPLUSloans,almost80percentmorethanthenextcompetitor(seeFigure6).Thecompany’sloanscomprised27percent29ofallfederalstudentlending,4percentmorethantheDepartmentofEducation’sentiredirectlendingprogram,and21percentmorethanthenextlargestprivatestudentlender,Citibank.30

March Toward Monopoly?SallieMae’sdramaticexpansionhelpedfuelextraordinaryenthusiasmforthecompanybyWallStreetinvestors.SallieMae’sstockhasrisenby1,900percentsince1995.

But,noteveryoneisasenthusiasticasWallStreetaboutSallieMae’srapidgrowth.IndustryobserversworrythatifSallieMaecontinuestoexpand,itcouldeliminatecompetitioninthestudentloanindustryand,mostimportantly,thebenefitsstudentsseefromcompetition,includingreducedfeesanddiscountedinterestrates.

Figure 6. loan origination Volume Among top Student lenders, �996–2006

1996 1997 1998 1999 2000 2001 2002 2003 2004 20062005

Bank of AmericaWells Fargo BankBank One

Citibank

J.P. Morgan Chase

Sallie Mae

Loan

Vol

ume

(in m

illio

ns)

0

1000

2000

3000

4000

5000

6000

7000

8000

Source:U.S.DepartmentofEducation,OfficeofFederalStudentAid,FinancialPartners“Top100OriginatorsofFFELPLoansHistoricalReports.”

��EDUCATION SECTOR REPORTS: Sallie Maewww.educationsector.org

“SallieMaeisonthemarchtowardmonopolyhere,”chargedBarmakNassirian,associateexecutivedirectoroftheAmericanAssociationofCollegiateRegistrarsandAdmissionsOfficers,ina2006Chronicle of Higher EducationarticleonSallieMae’spurchaseofstatenonprofitloanagencies.31

Nassirian’sconcernsareillustratedbySallieMae’spurchaseofthelendinggiantUSAGroup,whichnotonlyaddedbillionsinstudentloans,butalsoallowedSallieMaetoexpanditsoperationsintoeachpointofthestudentlendingcycle,andbya$1billionunsolicitedbidthatSallieMaemadein2005tobuythePennsylvaniaHigherEducationAssistanceAssociation,thenation’slargestnonprofitstateloanagency.

YetthebiggestpotentialformonopolymaylieinthedeclineoftheFederalDirectLendingProgram,SallieMae’sbiggestcompetitor.Thefederalgovernment’sshareofnewstudentloansthroughitsdirectlendingprogramdropped9percent—from32percentto23percent—between1999and2006,whileSallieMae’smarketsharehasincreasedby12percent—from15percentto27percent—duringthesameperiod.35

Whenthedirectlendingprogramwasintroduced,itofferedanumberofbenefitstostudentsnotavailableamongprivatelenders:faster,onlineloanapplicationandprocessing;reducedloanfees;avarietyofrepaymentplans;andnoconfusionaboutwheretosendtheirchecksbecausethefederalgovernmentwouldn’tselltheirloans.Inresponse,privatelendersimprovedtheirservices,includingofferingmoreflexiblepaymentplansandreduced,orzero,loanfees.

SallieMaecontendsthatdespiteitsexpansion,thestudentloanindustryremainsahealthy,competitivemarketplace,andthatcompetitionhasbenefitedborrowersthroughreducedinterestratesforon-timepayments,zerooriginationfees,improvedservicestoschoolsandstudents,andlowerdefaultratesfromimprovedcollectionpractices.Thecompanyalsoarguesthatitsscalehasallowedittoinvestheavilyinimprovedtechnologyandservicesthathavealsohelpedborrowers.36

Yetthedeclineinthedirectlendingprogram’smarketshare,whichispartlyduetoSallieMae’saggressivemarketingtoschoolstoswitchfromthedirectlending

programtotheprivatelendingprogram,mayeffectivelyeliminateSallieMae’sonlyrealcompetitor.

Relationship BuildingThemostsignificantpurchaseduringSallieMae’sexpansionwasthecompany’sacquisitionofUSAGroupandtheresultingdealwithUSAFunds.Inthedeal,USAFundsagreedtooutsourcethedefault-managementandloan-servicingfunctionsonitsthen-$9billionloanportfoliotoSallieMae,makingUSAFundsoneofSallieMae’sbiggestcustomers.In2006,32percentofSallieMae’sfee-based,debt-managementrevenuecamefromservicingUSAFunds’$27billionloanportfolio.37

WhilethisisagooddealforSallieMae,itmightnotbeagooddealfortaxpayers.Relationshipsbetweenlendersandguaranteeagencies—likeSallieMae’srelationshipwithUSAFunds—maycompromisetheoversightroleofguaranteeagenciesandultimatelyhurtstudentsandtaxpayers.

Guaranteeagencies,inadditiontobeingtheprimaryinsureroffederalloans,areresponsibleforensuringthatlendersperformduediligenceonloans—fulfilltheirlegalobligationstolocateandcollectdelinquentloans—beforefilingaclaimforrepayment.ThishelpspreventfraudintheFFELprogrambyensuringthatlendersdonotfilefalsedefault-reimbursementclaims.

TitleIVoftheHigherEducationActprohibitsguaranteeagenciesfromcontractingwithoutsideentitiestoperformdefaultaversionorcollectionservicesonloans,ifthoseentitiesholdorservicetheloan.38IntheSallieMae/USAFundsarrangement,SallieMae’sguarantorservicingdivisionservicesUSAFunds’loans.BecausethisdivisionistechnicallyseparatefromSallieMae’slendingentities,itdoesnotviolatetheTitleIVprohibition.Butthisdoesnoteliminatethepotentialforconflictofinterest.

TheU.S.DepartmentofEducationInspectorGeneralissuedareportin2002statingthatthisexactarrangementbetweenUSAFundsandSallieMaedid,infact,violatetheTitleIVregulation.39But,USAFundssuccessfullyarguedin2004thatSallieMae’sguaranteeservicingarmanditslendingarmconstitutedtwoseparateentities,andtheU.S.DepartmentofEducationdecidedtolettheUSAFunds/SallieMaearrangementcontinue.Thisdecisiondeviates


fromthefindingsoftwoearlierreportsonrelationshipsbetweenguaranteeagenciesandloancompanies.

A1993reportbytheGovernmentAccountabilityOffice,theinvestigativearmofCongress,highlightedtheproblemofconflictsofinterestbetweenguaranteeagenciesandlenders:“Anenvironmentinwhichaguarantyagency’sfinancialtransactionswithlendersare‘lessthanarms-length’…mayresultinreducedattentionbyguarantyagenciestotheiroversightresponsibilities.”40Another1993report,fromtheU.S.DepartmentofEducationInspectorGeneral,concludedthat“billionsofdollars”ofFFELPloanswereatriskof“mismanagement,waste,andabuse,”becauseofguaranteeagencies’affiliationswithlenders.41Currently,however,onlynineofthe35guaranteeagenciesnationallyarenotassociatedwithalenderorsecondarymarket.42

AlongwithUSAFunds,eightotherguarantorsalsocontractedwithSallieMaetodothesametypeofworkin2006andinall,SallieMaeprocessedguaranteesfor29percentofthefederallyguaranteedstudentloansthatyear.43

Throughitspurchasesofcompaniesateachstageoftheloancycle,SallieMaehassoughttocreatea“seamless”systemforcustomers,andtoprofitfromthefeesandservicesateachpoint.SallieMaehasalsouseditsacquisitionstobuildrelationshipswithcollegefinancialaidofficersandtocross-promoteitsservicestopotentialcustomers—moresignsofitsaggressiveandsuccessfulbusinessstrategies.

TheUSAGrouppurchasemarkedSallieMae’sentryintoenrollment-managementconsultingthroughthe

SpecialAllowancePaymentsareintendedtoensurethatlendersmakeenoughprofitsonstudentloanstocontinueparticipatinginthefederalloanprogram.Thesepaymentsmakeupasignificantamountoftheprogram’sadministrativebudget,costingthefederalgovernment$4.6billioninfiscal2007.32

Congressisresponsibleforestablishingthe“SpecialAllowanceMargin,”—ineffect,theprofit—that’sguaranteedtolenders.But,toreduceprogramcosts,Congresshas,since1986,graduallyreducedthespecialallowancemarginfromahighof3.5percent.Currently,foraStaffordloaninrepayment,thespecialallowancemarginis2.3percent.

This“profit”isaddedtoareferenceinterestrate.Thereferenceinterestrateismeanttoreflectcurrentmarketrates,which,inturn,reflectthecosttolendersofmakingstudentloans.Priorto2000,thisreferenceratewasthe90-dayTreasurybillrate.ForloansmadeafterJanuary2000,theU.S.DepartmentofEducationusestheratefor30-daycommercialpaper.

Inthecurrentformula,thespecialallowancemarginisaddedtothecostof30-daycommercialpaper,andifthistotal(commercialpaper+specialallowancemargin)exceedstheinterestratepaidbytheborrower,theU.S.DepartmentofEducationpayslendersthedifference.LendersbilltheDepartmentofEducationquarterlyforthesespecialallowancepayments.

Thespecialallowancemarginonloanshasdeclinedsteadilyoverthepast10-years,exceptonso-called9.5percentloans,whichhaveprovidedafinancialwindfalltosomelenders.

Duringthedifficulteconomictimesofthe1980s,thefederalgovernmentallowednonprofitlenders,generallystate-sponsoredagenciessuchasthePennsylvaniaHigherEducationAssistanceAssociation,whichfinancedtheirloanswithtax-exemptbonds,tocollectahigherrateofreturnonstudentloans—9.5percent.Thiswasintendedtoencourage

nonprofitlenderstocontinuemakingloanstostudentsandtoprotecttheirfinancialstability.In1993,whentheeconomyhadimproved,Congresstookawaythespecial9.5percentreturnforanynewloans—orsoitthought.

WhileCongressallowedlenderstocontinuecollectingthe9.5percentmarginonexistingloans,aloopholeinthelawallowedbothnonprofitlendersandfor-profitlenderswhohadpurchasedanonprofitstudentloancompany,tomakenew9.5percentloans,throughaprocesslenderstermed“recycling.”Bymakingnew9.5percentloans,thesecompaniescoulddramaticallyincreasetheirrevenues—whileinterestratesonmostloansin2003–04werearound3percent,bankswerecollecting9.5percentintereston“recycled”loans.Thefederalgovernmentmadeupthedifference,payingbanksahugeamountinsubsidiesandgivingthemhugeprofits—profitsthatcamefromtaxpayermoneyviatheDepartmentofEducation.

ASeptember2006InspectorGeneralauditofspecialallowancepaymentson9.5percentloanstoonelarge,for-profitstudentloancompany,NationalEducationLoanNetwork(Nelnet),foundthatNelnetreceivedapproximately$278millioninimproperpaymentsfromtheDepartmentofEducation.By“recycling”existing9.5percentloansinaprogramthatNelnettermed“Project950,”thecompanyincreasedtheamountoftheseloansfrom$551millioninMarch2003to$3.66billioninJune2004.33

InJanuary2007,NelnetsettledwiththeDepartmentofEducation.ThesettlementagreementallowedNelnettokeepthe$278millioninimproperpayments;however,itprohibitedfuturepaymentstoNelnetonthoseloans.TheDepartmentofEducationalsostoppedallfuturepaymentstolendersuntilitcouldverifythattheloanswereeligibleforthe9.5percentsubsidy.Tomany,thesettlementwasinsufficient.DeclaredSenatorEdwardKennedy:“The[Bush]administrationshouldhavesettledfornothinglessthanthefullrecoveryofNelnet’sill-gottenproceedsfromtheseloans.”34

Special Allowances and the ‘9.5 Percent loan’ Controversy


acquisitionofUSAGroupsubsidiaryNoel-Levitz,thenation’slargestenrollment-managementconsultingfirm.Enrollmentmanagementusespastenrollmentandfinancialdatafromaschooltopredictwhichstudentsarelikelytoapplyandenroll,andhowfinancialaidawardscanbeleveragedtoenrollthemostdesirableclassofstudents.Noel-Levitzhasadvised1,800collegesanduniversitiesoverits30-yearhistory,workingwithschoolsonmarketingcampaigns,recruitingmethods,financialaidawards,andstudentretentionandgraduationstrategies.

ThisrelationshipallowsSallieMaetoconsultwithcollegesontheirfinancialaidstrategies,andthuspotentiallyincreasetheamountofSallieMae-providedloansthecollegeoffers.44ItisunlikelythatNoel-Levitz’sconsultingservicesdirectlydrivemuchofSallieMae’slendingbusiness.ButitdoesgiveSallieMaeanimportantrelationship-buildingtool.Evenwithincreasesindirect-to-studentmarketing,collegesanduniversitiesremaingatekeeperstostudentloanbusiness,andNoel-LevitzgivesSallieMaeanopportunitytobuildrelationshipswithfinancialaidoffices.

SallieMae’smostrecentacquisitionhascreatedanotheropportunityforthecompanytocross-promoteitsbusinesses.In2006,SallieMaeenteredintothebusinessofcollegesavingsplans.Toencouragecollegesavings,Congressexemptedso-called529SavingsPlanscontributions(namedafterSection529ofthefederaltaxcode)fromfederalincometax.Theplansarestate-sponsoredinvestmentoptionsrunbyprivateinvestmentcompanies.Thesesavingsplanshavegrownrapidlysincetheincometaxexemptionbeganin2001,and,in2006,SallieMaepurchasedUPromise,oneofthetop529savingsplancompanies.

Thepurchase,whichstockmarketanalystshailedasacoupforSallieMae,notonlyfurtherdiversifiedSallieMae’soperations,itgaveSallieMaeearlyaccesstopotentialcustomers.45Parentswhoopen529savingsplansfortheirchildrenarelikelyalsoparentsthatwillbehelpingtheirchildrendecidewhichloanstotakeoutforcollege,andco-signingprivateloans.UPromise’s7.2millionmembersprovideSallieMaewithmanysuchpotentialborrowers.

An Opportunity for ChangeWhilerevelationsofquestionablemarketingpracticesandotherpotentialwrongdoingbySallieMaeandother

lendingindustrycompaniescontinuetounfold,SallieMae’srecentsalefor$25billiontoaprivateinvestorgroupthatincludesBankofAmerica,J.P.MorganChase,andtwoprivateequityfirms,islikelytoreducepublicscrutinyofthecompanybecauseprivatelyheldcompaniesarenotsubjecttothesamelevelsofpublicdisclosureoffinancialinformationthatthefederalSecuritiesandExchangeCommissionrequiresofpubliclytradedcompanies.

ThisputsevenmorepressureontheU.S.DepartmentofEducationtooverseetheactivitiesofSallieMae,aswellastheentirestudentlendingindustry—somethingithasnotdonewellinrecentyears.“FinancialPartnershadnotimplementedanacceptablelevelofinternalcontroloveritsmonitoringandoversightofFederalFamilyEducationLoanprogramparticipants,”theU.S.DepartmentofEducationinspectorgeneralsaidinaSeptember2006reportonFinancialPartners,thearmofthedepartment’sOfficeofFederalStudentAidresponsibleformonitoringguaranteeagencies,lenders,andservicers.ThereportalsostatedthatFinancialPartners“emphasizedpartnershipovercomplianceindealingwithguaranteeagencies,lenders,andservicers.”46

RecentnewsreportshaverevealedtiesbetweentheDepartmentofEducationandthelendingindustrythatmayfurthercompromisethedepartment’soversightabilities.TheWashington Posthasreported,forexample,that“atleast20formerSallieMaeemployeeshadmovedintothedepartmentundertheBushadministration.”47Thestudentloanindustryalsospendsalotofmoneyoncampaigncontributionsandlobbying.AccordingtoTheNew York Times,Nelnet,alargelenderfoundtohaveimproperlybilledtheDepartmentofEducationformillionsofdollars,wasthe“nation’smostgenerouscorporatedonortotheNationalRepublicanCongressionalCommitteein2006.”48

Theinspectorgeneral’s2006reportnotedthathighturnoverinthegeneralmanagerpositionatFinancialPartnerscontributedtothe“weakcontrolenvironmentformonitoringandoversight.”Since1999,FinancialPartnershasseenfourdifferentgeneralmanagers.Ofthese,threehavecomefromthelendingindustry(andtworeturnedtoitfollowingtheirtimeatFinancialPartners)andonefromtheNationalCouncilofHigherEducationLoanPrograms,aloanindustrytradegroup.Thislistincludesthecurrentgeneralmanager,MatteoFontana,whoworkedatSallieMaepriortotakingthetopjobatFinancialPartners,and


whohasrecentlybeensuspendedbytheU.S.DepartmentofEducationafterdisclosureofhisownershipofstockinastudentloancompany.

Whenitlaunchedthefederalstudentloanprogramfourdecadesago,Congresswasforcedtooffersignificantfinancialincentivestobanksandotherlendersinordertogetthemtoparticipateinthestudentlendingprogram.Sincethen,theprogramhasgrownsteadilylargerandvastlymorelucrativeforlendersandotherplayersintheindustry.Yettheprogramhascontinuedtofavortheindustrythroughlendingratestructuresandgenerous,

taxpayer-fundedfinancialperksthatallbutguaranteeimmenseprofits,andthroughasympatheticregulatoryenvironment.Notsurprisingly,thelendingindustryhasrecognizedtheseopportunitiesforwhattheyareandhasmovedaggressivelytocapitalizeonthem—oftenatsignificantcoststostudentsandtaxpayers.

ButintheupcomingreauthorizationoftheHigherEducationAct,Congresshasanopportunitytostrikeanewbalanceinstudentlending,onethatservestheinterestsofstudents,taxpayers,andtheindustryinmoreequalmeasures.


Endnotes1 RichardGeorge,“ThoughtsontheIndustry’sPastand

Present:AnInsider’sPerspective,”(paperpresentedattheconference,“FootingtheTuitionBill:NewDevelopmentsintheStudent-LoanIndustryandHowTheyAreChangingtheWayWePayforHigherEducation,”AmericanEnterpriseInstitute,Washington,D.C.,September2006).

2 AndrewRudalevige,“IrreconcilableDifferences?ThePoliticalTopographyofFederalStudentLoans,”(paperpresentedattheconference,“FootingtheTuitionBill:NewDevelopmentsintheStudent-LoanIndustryandHowTheyAreChangingtheWayWePayforHigherEducation,”AmericanEnterpriseInstitute,Washington,D.C.,September2006).

3 FredGallowayandHokeWilson,Reframing the Student Loan Costing Debate(Washington,D.C.:EducationalPolicyInstitute,2005).

4 Financial Audit: Guaranteed Student Loan Program’s Internal Controls and Structure Need Improvement, GAO/AFMD-93-20(Washington,D.C.:GovernmentAccountabilityOffice,March1993).

5 StatementofAlfredB.Fitt,GeneralCounsel,CongressionalBudgetOfficebeforetheSubcommitteeonPostsecondaryEducation,CommitteeonEducationandLabor,U.S.HouseofRepresentatives,May30,1979.

6 Trends in Student Aid(Washington,D.C.:CollegeBoard,October2006).

7 Secondary Market Activities of the Student Loan Marketing Association, GAO/HRD-84-51(Washington,D.C.:GovernmentAccountabilityOffice,May1984).

8 Ibid.9 FredGallowayandHokeWilson,Reframing the Student Loan

Costing Debate.10RichardGeorge,Thoughts on the Industry’s Past and Present:

An Insider’s Perspective.11Aggregateloanlimitswereincreasedinthe1992HEA

reauthorizationfrom$17,250to$23,000forundergraduateloansandfrom$54,750to$65,500forcombinedundergraduateandgraduateloans.Inaddition,PLUSloanlimitswereincreasedtocoverthetotalcostofattendance,minusotheraid,andlimitsonPLUSloanswereeliminated.

12ChristopherMyers,“LendersAssailedinSenateProbeofStudent-LoanPrograms,”The Chronicle of Higher Education,October3,1990.

13ThomasJ.DeLoughry,“WillColleges,StudentsBeHelpedorHurt?LongTermEffectofStudent-LoanInvestigationDebated,”The Chronicle of Higher Education,October17,1990.

14Guaranty Agency Solvency: Can the Government Recover HEAF’s First-Year Liquidation Cost of $212 Million?, GAO/HRD-93-12BR (Washington,D.C.:GovernmentAccountabilityOffice,November1992).

15MichaelJ.Lea,Privatizing a Government Sponsored Enterprise: Lessons from the Sallie Mae Experience,(IndianaStateUniversity:NetworksFinancialInstitute,April2006).

16MarkG.Overend,“ThePrivatizationofSallieMae,”(ThirdConferenceonGovernmentSponsoredEnterprises,AmericanEnterpriseInstitute,Washington,D.C.,May23,2000).

17FinAid,“IllegalInducementsandPreferredLenderLists,”availableonlineat:http://www.finaid.org/educators/illegalinducements.phtml.

18SLM Corporation Annual Report 2005(Reston,Va.:SLMCorporation).

19U.S.DepartmentofEducation,Federal Family Education Loans Net Volume by Fiscal Year, FY 2008 President’s Budget,availableat:http://www.ed.gov/about/overview/budget/studentloantables/index.html.

20Trends in Student Aid(Washington,D.C.:CollegeBoard,October2006).

21SLMCorporation,Report to the United States Securities and Exchange Commission, Form 10-K,2006.

22U.S.DepartmentofEducation,Federal Student Aid Annual Report, 2006.

23 In1996,anamendmentwasaddedtoataxbillthatmadeiteasierfornonprofitsecondarymarketstoconverttofor-profitsecondarymarkets.ThisallowedSallieMaetopurchasenonprofitssuchasNellieMaeandSLFR.

24How Nonprofit Student Loan Officials Get Rich (briefingpaper,TheInstituteforCollegeAccessandSuccess,May26,2005).

25“SLMHoldingCorp.(SallieMae)toAcquireNellieMaeCorp.,”SLMHoldingCorporationPressRelease,May26,1999.

26Disclosure:SallieMae’smergerwithUSAGroupresultedin$1billionfortheLuminaFoundation.EducationSectorreceivesfundingfromtheLuminaFoundationforitsworkonundergraduateeducation.TheLuminaFoundationdidnotfundthisproject.

27StephenBurd,“InaMergerofStudent-LoanGiants,SallieMaeWillBuyMuchofUSAGroup,”The Chronicle of Higher Education,June23,2000.

28Summary Annual Report2000(Reston,Va.:USAEducation,Inc.“SallieMae”).

29ThisnumberincludesbothloansmadethroughSallieMae’sinternallendingbrands—brandsthatareownedbySallieMae—andloansmadethrough“forwardpurchaseagreements”withoutsidebanks.

30SLMCorporation,Report to the United States Securities and Exchange Commission, Form 10-K,2006,p.15.

31StephenBurd,“SallieMaeMovestoBuyStateAgencies,ScaringCritics,”The Chronicle of Higher Education,March31,2006.

32Budget of the United States Government, Fiscal Year 2008(OfficeofManagementandBudget,February2007).

33Final Audit Report: Special Allowance Payments to Nelnet for Loans Funded by Tax-Exempt Obligations, ED-OIG/A07F0017(Washington,D.C.:OfficeofInspectorGeneral,DepartmentofEducation,September2006).

34KellyField,“LenderAllowedtoKeepFederalOverpaymentsof$278-million,”TheChronicle of Higher Education,February2,2007.


35SLMCorporation,“DebtInvestorPresentation,FirstQuarterendedMarch31,2006,”(Reston,Va.:April21,2006).

36BasedoncommentsfromPaulCarey,formerExecutiveVicePresidentformarketingandbusinessservicesatSallieMae.OnlinechatwithStephenBurd,“SallieMaeandtheFutureoftheStudent-LoanIndustry,”The Chronicle of Higher Education,August9,2000,availableonlineat:http://chronicle.com/colloquylive/transcripts/2000/08/20000809carey.htm.


38U.S.DepartmentofEducation,Compilation of Student Aid Regulations,34SFR682.404(k)(4).

39Final Audit Report: United Student Aid Funds, Inc.’s Administration of the Federal Family Education Loan Program Federal and Operating Funds, ED-OIG/A05-B0033(Washington,D.C.:OfficeofInspectorGeneral,UnitedStatesDepartmentofEducation,April2002).

40Financial Audit: Guaranteed Student Loan Program’s Internal Controls and Structure Need Improvement, GAO/AFMD-93-20(Washington,D.C.:GovernmentAccountabilityOffice,March1993).

41RegionalInspectorGeneralforAuditRegionIX,“EdShouldProhibitConflictsofInterestbetweenGuarantyAgenciesandAffiliatedOrganizations,”ManagementImprovementReportNo.93-02,March15,1993.

42RichardGeorge,Thoughts on the Industry’s Past and Present: An Insider’s Perspective.

43SLMCorporation, Report to the United States Securities and Exchange Commission, Form 10-K,2006,pp.16–17.

44For Students or For-Profit?NewAmericaFoundation,HigherEdWatchBlog,October27,2006,availableonlineat:http://www.newamerica.net/blogs/2006/10/for_students_or_for_profit.

45NathanParmelee,“SallieMaeSnagsUpromise,”The Motley Fool, June2,2006,availableonlineathttp://www.fool.com/investing/small-cap/2006/06/02/sallie-mae-snags-upromise.aspx.

46Final Audit Report: Review of Financial Partners’ Monitoring and Oversight of Guaranty Agencies, Lenders, and Servicers, ED-OIG/A04E0009(Washington,D.C.:OfficeofInspectorGeneral,DepartmentofEducation,September2006).

47JonathanD.GlaterandKarenW.Arenson,“QuestionsonOfficials’TiestoLenders,”The New York Times,April25,2007.

48SamDillon,“Whistle-BloweronStudentAidIsVindicated,”The New York Times,May7,2007.

EDUCATIONSECTOR REPORTS

Leading Lady:Sallie Mae and the Origins of Today’s Student Loan Controversy

By Erin Dillon

May 2007

ABout thE Author

ERIN DILLON isapolicyanalystatEducationSector.Shecanbereachedatedillon@educationsector.org.

ABout EDuCAtIoN SECtor

EducationSectorisanindependenteducationthinktankbasedinWashington,D.C.Itisanonprofitandnonpartisanorganizationdevotedtodevelopinginnovativesolutionstothenation’smostpressingeducationalproblems.TheorganizationseekstobeadependablesourceofsoundthinkingoneducationpolicyandanhonestbrokerofevidenceinkeyeducationdebatesinWashingtonandnationally.

ACkNowlEDgEMENtS

TheauthorthanksallofhercolleaguesatEducationSectorfortheirsupportandcontributionstothisproject.

© Copyright 2007 Education Sector. All rights reserved.

1201ConnecticutAve.,N.W.,Suite850,Washington,DC20036202.552.2840•www.educationsector.org


Thelargestandmostinfluentialplayerintheindustry,SLMCorporation,betterknownasSallieMae,hasn’tescapedthecontroversy:InthewakeofCuomo’sinvestigation,thecompanyagreedunderthetermsofasettlementwiththeNewYorkprosecutortoabidebyanew“codeofconduct”andtoput$2millionintoafundtoeducatestudentsaboutfinancialaid.YetdaysaftertheSallieMaesettlement,thepubliclytradedcompanyannouncedthatitwasbeingsoldtoprivateinvestorsfor$25billion—asumthatsuggeststheenormityofthefinancialstakesinthestudentloanindustry.

ThestoryofSallieMae’srisefromagovernment-sponsoredagencycreatedtohelpneedystudentstoaprivatecorporationwitha$142billionloanportfoliogoesalongwaytowardexplaininghowandwhythestudentloanindustryhaslandedatthecenterofcontroversy.

CreatedbyCongressin1972toincreasethesupplyoflendablefundsunderthethen-decade-oldfederalstudentloanprogram,SallieMaeformanyyearsplayedarelativelynarrowroleintheindustryasa“secondarylender,”buyingandmanagingloansfrombanksandotherlendersthatusedtheirproceedsfromSallieMaetomakenewloans.

Butinthemid-1990s,skyrocketingdemandforstudentloanspromptedbyescalatingcollegetuitions,expandingeligibilityforstudentloans,andahostofnewtypesoflendingcombinedtomakethestudentloanindustryinfinitelymorecomplex,larger,andmorelucrative.AndSallieMaeemergedastheindustry’sbiggestplayer.

Aftersheddingitsgovernment-sponsoredstatusandbecomingafullyprivate,for-profitcorporation,SallieMaeembarkedonanaggressiveexpansioncampaign.Itbought,orformedpartnershipswith,companiesworkingineverycornerofthestudentlendingindustry,fromlendingandloancollectiontoenrollmentmanagementandevencollege-tuitionsavingsplansforinfants.

SallieMaehashelpedmillionsofstudentspayforcollege,studentswhowouldnothaveotherwisebeenabletocoverthecost.ButtherelentlessexpansionofSallieMaeandotherlendinggiantsintoeverypartofthestudent-aidenterpriseandintoeveryregionofthecountrycombinedwithanoutmatchedandoftenunmotivatedfederalregulatorybureaucracy,industrypoliticalcloutthatreachesfromthehallsofCongresstocollegecampuses,andlucrativeregulatoryloopholesthatcontributetostudentlending’simmenseprofitpotentialhavecreatedaclimatethat’sripeforthequestionablemarketingtacticsandotherindustrywrongdoingthathaveemergedinrecentmonths.

Itisaclimatethathasempoweredthelendingindustrytoactaggressivelyateveryturn,placingstudentsatriskofpayinginflatedinterestratesandfeesontheirfederalloansandleavingtaxpayerstopickupthetabforwhatmembersofCongresssayarehundredsofmillionsofdollarsinexcessivesubsidiesforthestudentlendingindustry.

AstheSallieMaestorysuggests,pastisprologueinthestudentlendingindustry.Today’sproblemsaretheresultofconditionsintheindustrythathavebeenbuildingforyears.

The $85-billion-a-year student loan industry has been beset by scandal since new york attorney general andrew Cuomo announced on March 15, 2007, that his office was investigating “unholy alliances” between lending companies and college financial aid officers. Revelations of college officials accepting consulting fees from and holding stock in companies on their school’s preferred-lender lists, lenders staffing college’s financial information call centers, and close ties between U.S. Department of Education officials and lenders have been front-page news.


Opening College Doors

Thesize,complexity,andimmenseprofitpotentialoftoday’sstudentloanindustryisn’twhatCongressenvisionedwhenitcreatedtheGuaranteedStudentLoanProgram(renamedtheFederalFamilyEducationLoanProgramin1992)aspartoftheHigherEducationAct(HEA)of1965.Theprogrambeganasarelativelysmall,targetedefforttoopencollegedoorsforfinanciallyneedystudents.Theoriginalprogramprovidedloansofupto$1,000peryeartoundergraduatestudentsand$1,500ayeartograduatestudentswithfamilyincomesoflessthan$15,000(seesidebaronfederalstudentloans,page7).1

Sincethestudentsintheprogramwere,bydesign,higher-riskborrowers,thefederalgovernmentcreatedincentivesforlenderstoparticipateinthenewfederalinitiative.Itgavestatesfundstoestablish“guaranteeagencies,”whichwouldinsurelendersagainstlossesfromdefaultedloans,therebyreducinglenders’risk.Thefedsalsoguaranteedlendersa6percentinterestrateontheirstudentloans—atthetime,arateslightlyhigherthanratesformoresecurehomemortgageloans.

Theseincentiveswereinsufficienttoencouragestatestotakeontheriskofestablishingguaranteeagencieswithoutsomefederalinsuranceonloans,andthe6percentinterestratewasnothighenoughtoattractprivatelenders.Inresponse,thefederalgovernmentpursuedtwostrategiestoboostparticipationbybanksandstates:shiftingtherisktothefederalgovernmentandincreasingbanks’profitsonloans.

Congressin1968authorizedtheU.S.DepartmentofEducation(thencalledtheOfficeofEducation)topaystateguaranteeagencies80percentoftheamountoftheirlosses.Theyearbefore,theDepartmentofEducationhadestablishedtheFederalInsuredStudentLoanprogramtoreimburselendersinstateswithoutguaranteeagencies.Underthatprogram,thefederalgovernmentreimbursedlenders100percentoftheirdefaultedloans.

Toincreaseprofitstobanks,Congressquicklyraisedtheguaranteedinterestrateonstudentloansto7percent.2Butbymid-1969,interestrateschargedtothemostcredit-worthyborrowerswere8.5percent,makingthe7percentinterestrateonmoreriskystudentloansunappealingtobanks.Inresponse,Congressestablished

in1969subsidiesknownas“SpecialAllowancePayments”toensurelendersreceivedmarket-rateprofitsonloans(seesidebaronspecialallowancepayments,page12).Specialallowancepaymentsweretiedto

Student lending glossary

Government Sponsored Enterprise (GSE):afor-profit,privatelyoperatedcorporationcharteredbythegovernmenttoincreaseinvestmentsinaspecificsectoroftheeconomy.

Federal Family Education Loan Program (FFELP):afederalstudentloanprogramauthorizedintheHigherEducationAct.Loansareprovidedbyprivatelendersandinsuredbythefederalgovernment.LoanprogramsincludeStaffordSubsidizedandUnsubsidizedloans,andPLUSloans.

Federal Direct Loan Program (FDLP):afederalstudentloanprogramauthorizedinthe1992reauthorizationoftheHigherEducationAct.LoansareprovidedbytheDepartmentofEducationdirectlytostudentsthroughtheirschools,withoutprivatelendersorguaranteeagencies.

Guarantee Agency:organizationintheFederalFamilyEducationLoanProgramthatinsureslendersagainstfinanciallossesduetoloandefaults.Guaranteeagenciesarealsoresponsibleforhelpingtoadministertheprogramandoverseelenders.

Default:Defaultoccurswhenaborrowerfailstomaketherequiredmonthlypaymentsonhisorherloan.IntheFederalFamilyEducationLoanProgramandtheFederalDirectLoanProgram,aborrowerisindefaultafter270daysofnon-payment,assumingnoalternativearrangementsforpaymentweremadewiththelender.

Loan Servicing:activitiesperformedtocollectandprocessloanpaymentsduringthelifeofaloan.Theseincludecontactingandcommunicatingwithborrowers,collectingpayments,filingpaperworkwiththeDepartmentofEducation,andprovidingcollectioneffortsondelinquentloans.

Collection Agency:agencyhiredbyalenderorguaranteeagencytolocatedefaultedborrowersandrecoverpaymentsondefaultedloans.

Loan Consolidation:combiningoneormoreloansintooneloanwithasinglelender.Loanconsolidationcanallowborrowerstomakeonemonthlyloanpayment,extendthepaymentperiodontheirloans(therebyreducingmonthlypayments)andlock-ininterestrates.

Secondary Market:anorganizationthatbuysexistingloansfromabankorotherlender.Lenderssellloanstothesecondarymarketinordertoraisemoneytomakenewloans.

Enrollment Management:theprocessofusingpastenrollmentandfinancialaiddatafromaschooltopredictwhichstudentsarelikelytoapplyandenroll.Enrollmentmanagementoftenincludesleveragingfinancialaidawardstorecruitadesirableclassofstudents.

529 Savings Plans:state-sponsoredinvestmentoptionsrunbyprivateinvestmentgroupsandnamedafterSection529ofthetaxcode.In2001,Congressexemptedthesesavingsplans,whichcanbeusedforhighereducationexpenses,fromfederalincometax.


changinginterestratesandpaidlendersasmuchas3percentagepointsabovethe7percentinterestchargedtostudents.Withspecialallowancepayments,thefederalsubsidiesrosealongwithinterestrates,ensuringprofitsforbanksregardlessofinterestratechanges.

Asaresult,lenders’guaranteedinterestearningsonstudentloansjumpedfrom6percentto9percentin1969,whiletheassociatedriskdroppedtonearlyzero,makingstudentlendingaveryattractivebusiness.3

Still,thefederallendingprogramwasrelativelysimpleinthe1960s.Itinvolvedlenders,thefederalgovernment,whichprovidedsubsidiesandloaninsurancetobanksandstateguaranteeagencies,andcollegesandstudents(seeFigure1).

Increasing Cash FlowButCongresssoonexpandeditseffortstoencouragelendingtostudentsbymakingsurebankshadamplelendablecash.In1972,itcreatedtheStudentLoanMarketingAssociation(SLMA),asSallieMaewasoriginallycalled,toprovidea“secondarymarket”forstudentloans.Thenewcompanyboughtstudentloansfrombankstofreeuplendermoneyfornewloans.

CongresscreatedSallieMaeasaGovernmentSponsoredEnterprise(GSE)—afor-profit,privatelyoperatedcorporationcharteredbythegovernmenttoincreaseinvestmentsinaspecificsectoroftheeconomy.Other

well-knownGSEsinclude“FannieMae,”forthehousingindustry,and“FarmerMac,”forthefarmingindustry.SallieMaereceivedvaluablebenefitsasaGSE,includingexemptionfromstateandlocaltaxes,andaccesstolow-costfundsfromtheU.S.DepartmentoftheTreasury.SallieMaepaidonlyafractionofapercentininterestonthefundsitborrowedfromtheU.S.Treasury.SallieMae’searnings—frominterestpaymentsmadebystudentsandsubsidiespaidbythefederalgovernmentonstudentloans—werealsotiedtoTreasurybillrates.Therefore,ifinterestrateswentupSallieMaepaidmoretotheTreasuryforitsfunds,butgotevenmorebackinsubsidiesfromthefederalgovernment,givingSallieMaeaneasypathtoprofits.

CongressfurthersweetenedthepotforstatesandlenderswiththeTaxReformActof1976.Thisactauthorizedstateagenciestoissuetax-exemptbondstopurchasestudentloansinthesecondarymarket.Statesquicklytookadvantageofthisopportunity,whichallowedthemtouselow-cost,tax-exemptmoneytobuyloanswhilereapinginhighfederalinterestsubsidiesonthoseloans.Statesestablishednonprofitcorporationstoactassecondarymarketsandpurchasestudentloansfrombanks.HavingbothstatesecondarymarketsandSallieMaefurtherensuredthattherewouldbeenoughmoneyavailableforbankstokeepmakingloans,anditgavebankssecurity,knowingtheycouldselltheirloansifneeded.Congressalsoincreasedthefederal“reinsurance”ondefaultedstudentloansto100percentforstateguaranteeagencies.Withtherisktostategovernmentslargelyeliminated,thenumberofstateguaranteeagencies,whichneverexceeded26before1976,grewto50by1981.4

WiththeadditionofSallieMaeandothersecondarymarkets,thefederalloanprogrambecamemorecomplexandmorecostlyfortaxpayers.Thefederalgovernmentwasnowguaranteeingallloansat100percent,andpayingbanks,SallieMae,andstatesecondarymarketshighinterestsubsidiesonloans.In1979,AlfredB.Fitt,thegeneralcounselinthenewlyestablishedCongressionalBudgetOfficestated,“the[federalloan]programhasgonethroughpiecemealalterationsthathavetransformeditintoasystemmuchmorecostlythanadirectfederalloanprogram,withthehighercostsnotredoundingtothebenefitofstudentborrowers,butrathertothebenefitofthefinancialinstitutionsthatmaketheloans”(seeFigure2).5


Federal Government

Students

Banks (Lenders)




Selling StockLoosenedloaneligibilityrequirements,togetherwithtwonewfederalloanprograms,increasedstudentborrowingfrom$1.8billionin1977to$12billionin1989.6The1978MiddleIncomeStudentAssistanceActeliminatedincomerestrictionsandexpandedfederalloaneligibilitytoallstudents(In1981,theReaganadministrationre-instatedfinancialneedasarequirementforreceivingsubsidizedstudentloans);theAuxiliaryLoantoAssistStudentsprogram(ALAS),approvedbyCongressin1981,extendedeligibilitytostudentswithnoparentalfinancialsupport;andCongresscreatedtheParentLoanforUndergraduateStudentsprogram(PLUS)in1980,toallowparentstotakeoutsupplementalloanstohelpcovertheirchildren’scollegecosts.

Duringthesameperiod,CongressexpandedSallieMae’sroleinthelendingindustry.Inthe1980reauthorizationofHEA,CongressauthorizedSallieMaetooffer“loanconsolidation”tostudentswithsignificantdebt,permittingthemtocombinemultiplefederalloansintosingleloanswithlongerrepaymenttermsandlowermonthlypayments.LawmakersalsograntedSallieMaepermissionbothtomakeloansdirectlytostudentsinareasofthe

countrywherestudentscouldnotgetloansfromanotherlenderandtoactasaguarantorinstateswheredemandforloansoutpacedsupply.7

Thesechanges,alongwiththenewloanprogramsandresultingboominloanvolume,meantrisingprofitsforSallieMaeandotherlenders.SallieMae’sassetsgrewfrom$1.6billionin1979to$28.6billionin1988.Inbetween,thecompanyissueditsfirstpublicstockofferingin1983,raising$357millioninprivatecapital.8Withtheinfluxofprivatecapital,SallieMaewasnolongerreliantonlyonfederalfundsforexpansion.

Risinglenderprofitsmeanthigheradministrativecostsforthefederalgovernment.Thepricetagofthefederalloanprogram,includingloansubsidiestostudentsandbanksandfederalpaymentsfordefaultedloans,grewfrom$2.7billionin1981to$4.1billionin1985.9In1986,paymentstolendersfordefaultedloansalonecostthefederalgovernmentover$1billion.

Inanefforttoreducehighdefaultrates,theU.S.DepartmentofEducationimposednewdue-diligencerequirementsonthestudentlendingindustrywhenitreauthorizedtheHigherEducationActin1986.Therequirementsdictatedthatlendersandguaranteeagenciesfollowexactingproceduresinmakingloans,processingpayments,andcollectingondefaultedloans—andrisklosingreimbursementsondefaultedloansiftheyfailedtofollowthem.Inadvertently,thedepartment’snewregulationshelpedfuelthedevelopmentoflending-industrygiantslikeSallieMaebycreatingbarrierstoentrytosmaller,newercompanieswantingtoenterthefield.

Existinglenders,whichwereoftenstateorregionalbanks,sawthenewregulatoryrequirementsasathreattotheirbottomlines.Toprotectthemselves,theybegansellingtheirloanstolargelenders,oroutsourcingloanservicing(processingpaymentsandpaperwork)andcollection(locatingandcontactingdefaultedborrowers).Asaresult,bothlendingandloanservicingbecameconcentratedinfewerandfewercompanies.10Thenumberofactivelendersinthefederalloanprogramhasdroppedfromahighof11,298in1985to3,166in2007(seeFigure3).

Theoutsourcingofloanservicingandcollectingandtheexpansionofloanconsolidation,whichCongressoriginallyonlyofferedtoSallieMaebutsoonextended


Federal Government

Students

Banks (Lenders)





toothercompanies,createdanevenmorecomplicatedstudentlendingsystem(seeFigure4).

Warning Signs

The1990ssawmoreincreasesinbothstudentlendingvolume(from$14billionin1991to$30billionin1996)andindustryprofits.Risingtuitionsandthe1992reauthorizationoftheHigherEducationAct,whichincreasedfederalloanlimitsandintroducedunsubsidizedloans(loansforwhichthegovernmentdidnotpaytheinterestwhilestudentswerestillincollege)tostudentsatallincomelevels,11fueleddemandforstudentloans.

Butthislatestexpansionofthestudentloanindustrywasaccompaniedbyearlysignsofabusesandalackofgovernmentoversight,muchlikethestoriesmakingheadlinestoday.HearingsbytheSenatePermanentSubcommitteeonInvestigationsin1990revealed

instancesoffraudandabuseamongtradeschools,lenders,andguaranteeagencies.Chargesincludedloanservicersfalsifyingdocumentstocoverupmistakes,lendersnotpayingmandatedfeestotheDepartmentofEducation,and“diplomamill”for-profitschoolsusingtheloanprogramtomakemoneywithoutprovidingaworthwhiledegree.12Congress“didnothearofevenasinglepartoftheguaranteedstudentloanprogramthatisworkingefficientlyoreffectively,”declaredcommitteeChairmanSamNunnofGeorgia.13

Inresponsetotherevelationsofabuseintheprogramandthehighprofitsofsomelenders,CongressintroducedanewFederalDirectLendingProgram(FDLP)in1992.TheFDLPallowedthefederalgovernmenttomakeloansdirectlytostudentsthroughtheirschools,therebycreatingaformidablecompetitortobanksandotherFederalFamilyEducationLoanProgramlenders(FFELP).FDLPsupportersarguedthatbyeliminatingtheFFELPmiddlemen,thedirectlendingprogramwouldbeamoreefficientlendingsystemandlesspronetoabuse.

Figure 3. Number of Active lenders Participating in the FFEl Program, �966–2007

Activ

e Le

nder

s

Fiscal Year

0

2000

1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

4000

6000

8000

10000

12000

Note:Somelendersreportedloansundermultiplenumbers.Intheseinstanceslenderswerecountedmorethanonce.ThesecountsdonotincludelenderswhoparticipatedexclusivelyundertheFederalInsuredStudentLoanProgramwhichexistedfromFY68throughFY84.Source:U.S.DepartmentofEducation,OfficeofPostsecondaryEducation,NationalStudentLoanDataSystem.


Inamovethatsignificantlychangedtheroleofguaranteeagencies,CongressauthorizedlenderstoappealdirectlytotheDepartmentofEducationforloanreimbursement,astepprecipitatedbythecollapseoftheHigherEducationAssistanceFoundation(HEAF),oneofthelargestguaranteeagenciesinthecountry.Themovediminishedtheroleofguaranteeagenciesasguarantors—theywerenolongernecessaryforalendertoreceivereimbursementonaloan,butdidnotchangetheiroversightandadministrativeresponsibilitiesintheloanindustry.Theymuststillverifyloans,ensurethatlendershaveperformedtherequireddue-diligenceontheirloans,andverifythatlenders’defaultclaimsarevalid.

HEAFcollapsedin1990duetohighdefaultratesfromthelargenumberofloansitwasmakingtofor-profitcolleges.Toensurelendersremainedintheprogramandloanscontinuedtobeavailabletostudents,theDepartmentofEducationassumedresponsibilityforHEAF’sloansand,eventually,foralldefaultedfederalloansifalendercouldproveaguaranteeagencywasinsolvent.14

PresidentBillClintonin1993expandedthedirectlendingprogram,withthegoalofmakingallfederalloansthroughtheFDLP.TheFDLP,becauseitgotfundsdirectlyfrom

theTreasuryanddistributedthemdirectlytostudents,eliminatedtheneedforprivatebanks,guaranteeagencies,andSallieMaeasasecondarymarket.ClintonalsoimposedafeeonSallieMaethatessentiallyeliminateditsfundingadvantageasaGovernmentSponsoredEnterpriseandmandatedthatSallieMae,becauseitwasagovernment-charteredentity,actasalenderoflastresortforstudentswhocouldnotobtainloanselsewhere.15SallieMae’soperationsasaGSEwereprimarilylimitedtosecondarymarketactivities,makingitdifficultforSallieMaetorespondtocompetitivethreatsliketheFDLP.Inlightofthesechangesandincreasingnational-levelcompetitionforstudentloans,SallieMaesoughtandwoncongressionalapprovaltoabandonitsGSEstatusandbecomeafullyprivatecompany,freetoexpanditsbusinessoperationsandpursueprofitsmoreaggressively.16

CongresspassedtheStudentLoanMarketingAssociationReorganizationAct(commonlyreferredtoasthe“PrivatizationAct”)in1996.Thelawallowedthecreationofaholdingcompany—acompanythatownsmultiplecorporations—permittedtopursuebusinessopportunitiesoutsidethelimitsofSallieMae’sGSEcharter.SLMHoldingCorporationbecametheparentcompanyofbothaGSEentity—knownasthe


Federal Government

Parents

Students





Collection AgenciesConsolidation

Loan Companies

Banks (Lenders)

Note:Dashedlinesindicateoutsourcedservices.


“StudentLoanMarketingAssociation”—andanon-GSEcorporation—SallieMae.TheGSEwasallowedtocontinueservingasasecondarymarketforstudentloans,butwasexpectedtoenditsoperationsby2008.(TheGSEentityactuallyendeditsoperationsfouryearsaheadofschedule,inlate2004.)Meanwhile,thenon-

GSEarmoftheholdingcompanycouldpursueotherbusinessactivitiesandbuilditsoperationsintothecompanywenowknowasSallieMae.AftertwodecadesofoperatingunderitsGSEcharter,SallieMaewasfreetoexpanditsdominanceofthestudentloanindustryevenfurther.

Federal Student loans

Therearethreetypesofloansofferedthroughthefederalstudentloanprogram:Staffordloans,whichincludesubsidizedloans,need-basedloansforwhichthefederalgovernmentpaystheinterestduringschool,andunsubsidizedloans,non-need-basedloansforwhichthegovernmentdoesnotpayinterestduringschool;ParentLoanforUndergraduateStudents(PLUS)loans,whichallowparentstosupplementtheirchildren’sfinancialaid;andGradPLUSloans,anewloanforgraduatestudentstosupplementStaffordloans.

Theseloansareadministeredthroughtwoprograms,theFederalFamilyEducationLoanProgram(FFELP)andtheFederalDirectLoanProgram(FDLP).

ThedifferencebetweenthetwoprogramsisthatunderFFELP,banksandotherlendersprovidefederalloanstostudentsviatheircollegeoruniversityfinancialaidoffices,whileunderFDLP,thefederalgovernmentactsasthelender,withtheU.S.DepartmentofEducationmakingloanstostudentsthroughtheircampusaidoffices.Seventy-sevenpercentoffederalstudentloansaremadethroughFFELP,23percentthroughFDLP.

Whiletheinterestratesandtermsforallfederalloansarethesame,theprivateFFELPlendersoftenofferinterest-ratereductionsforon-timeorautomaticpaymentsthatcomedirectlyfromtheborrower’sbankaccount.

StudentsmustcompletetheFreeApplicationforFederalStudentAid(FAFSA)inordertoapplyforStaffordandGradPlusloans.Theapplicationcalculatesastudent’sExpectedFamilyContribution—howmuchstudentsandtheirfamiliesareexpectedtocontributetothecostofcollege—andastudent’seligibilityforneed-basedfederalfinancialaid.

Loan Interest rate Limits Repayment

Stafford Loans Fixed,6.8percent Undergraduatelimit:$23,000

Combinedundergraduateandgraduatelimit:$65,500

Studentsmaydeferpaymentswhileinschoolandfor6monthsafterleavingschool.

Therepaymenttermis10years.

SubsidizedLoans

Thegovernmentpaystheinterestontheseloanswhilethestudentisenrolledinschool.Whilethereisnoincomerequirementtoreceivesubsidizedloans,studentsmustdemonstrateneed,calculatedasthecostofattendance,minusotheraidandminustheExpectedFamilyContribution.

UnsubsidizedLoans

Thegovernmentdoesnotpaytheinterestontheseloanswhilethestudentisenrolled.Therearenoincomelimitsorneedrequirementstoreceiveunsubsidizedloans.

Parent Loan for Undergraduate Students (PLUS)

Fixed,8.5percent Nocumulativelimit.

Parentsmayborrowuptothecostofattendance,minusanyloan,grant,orwork-studyaidreceived.


TherearenoincomeorneedrequirementstoreceivePLUSloans.Parentsmustsubmitaloanapplicationandpassacreditcheck.Parentswithadversecredithistoriesmayhavetheirapplicationsrejected,inwhichcasethestudentiseligibleforincreasedStaffordloanlimits.

GradPLUS Fixed,8.5percent Nocumulativelimit.

Studentsmayborrowuptothecostofattendance,minusanyaidreceived.

Studentsmaydeferpaymentswhileinschool.


TherearenoincomeorneedrequirementstoreceiveGradPLUSloans,butstudentsmustsubmitaFAFSAandmax-outStaffordloanlimitsfirst.Students,likeparentsforthePLUSloan,canbedeniedaloaniftheyhaveanadversecredithistory,howevertheyarenoteligibleforincreasedStaffordloanamountsifthishappens.StudentscanconsolidatetheseloanswiththeStaffordloans.


Breaking FreeAtthesametimeSallieMaewasbreakingfreeofitsgovernmentalshackles,twonewlendingtrendsweretransformingstudentlendingfromprimarilyalocalandregionalbusinesstoanationalindustry,andmakingstudentlendingamorecompetitivemarketplaceintheprocess.

Intheearlystagesofthestudentloanindustry,lendersandguaranteeagenciesprimarilyservedtheirstates.Butasitbecameapparentthathighloanvolumecouldmeanlargeprofits,lendersandguaranteeagenciesmovedacrossstatelinesandbegantocompeteonanationalscale.SallieMae,alarge,nationalcompanywithawell-knownname,wasintheperfectpositiontoprofitfromthistrend.

Thesecondtrendwasthestart,intheearly1990s,ofdirect-to-consumerloanmarketing—wherebylenderswentdirectlytostudentsorparentstoselltheirloans,bypassingfinancialaidoffices.Thismarkedasignificantshiftintherelationshipbetweenschools,lenders,andborrowers.

Asnational-levelcompetitionanddirect-marketinggrew,bothstudentsandschoolswerefacedwithavarietyofchoicesfarbeyondtheirlocalbank.Tohandlethisnewinfluxofloaninformationandtobettercompareandbargainforloandeals,schoolsreliedon“preferred-lenderlists.”Andthelistsofrecommendedlendersgreatlyinfluencedstudents’borrowingdecisions:Thetoplenderonapreferred-lenderlistcangarnerupwardof95percentofaschool’sloanbusiness.17Thisputfinancialaidofficesinthepowerfulpositionofactingasgatekeeperstoloanbusiness.Forlenders,itcreatedasinglelocationoneverycampustomarkettheirproducts.

ForSallieMae,the“preferred-lenderlist”arrangementhasbeenaboon.Inadditiontomarketingdirectlytostudents,SallieMaehasa400-membercampus-basedsalesstaff,whichprovidesservicestoover6,000collegesanduniversities—inessence,nearlyeverycollege,university,andeducationalinstitutionintheUnitedStates.18

Direct-to-consumerconsolidationloancompaniesalsosprungupinthe1990s.Thesecompanies,takingadvantageofhistoriclowinterestrates,offeredlocked-ininterestratestograduatesanddidnotrequireanyfinancialaidofficeinvolvement.

Thenewconsolidation-onlyloancompaniesthreatenedtotakeawaytraditionalloancompanies’businessentirely.Withthelowinterestrates,studentswereconsolidatingtheirborrowingatrecordlevels,evenbeforetheygraduatedfromcollege,meaningthatacompanycouldlosealoansoonaftermakingit.FamilyFederalEducationLoanconsolidationsjumpedfrom$9billiontoalmost$54billionbetween2001and2005.19Originally,traditionallenders,includingSallieMae,attemptedtoholdbackthegrowthinconsolidationloansbylobbyingforCongresstoimplementregulationsthatlimitedthecompanieswithwhichstudentscouldconsolidate.Eventually,though,SallieMaeandotherprivatelendersjoinedthecompetitionforconsolidationloans,usingtheirdirect-marketingtechniquestoselltheirloanconsolidationservicestorecentgraduates.

SallieMaealsohasbeenanaggressiveplayerintherise,sincethemid-1990s,inprivatelending—lendingoutsideofthefederalstudentloanprogramatmarketratesandwithoutsubsidiestolendersorstudents.

Theearlyreluctanceoflenderstomakeloanstostudents,whichledtothefederalloanprogram,hadlargelyvanishedbythemid-1990s.After30yearsofexperiencemanagingfederallybackedstudentloans,bankssawprivatestudentloansasaprofitablemarket.Risingtuitionsopenedupdemandforprivateloansamongmiddle-andupper-classfamilies,andthehigherinterestratesbankscouldchargeontheseloansmadethemmoreprofitable.Asaresult,privatelendingtocollegestudentshasincreasedbyanaverageof27percentayearsince2000,fromalmost$4billiontoover$16billionin2006.20SallieMae’sprivatelendingincreasedfromlessthan$2billiontoover$7billionduringthesameperiod.21

Withtheadventofloan-consolidationcompanies,theFederalDirectLoanProgram,directmarketing,andprivateeducationlending,thestudentloanlandscapehasbecomeextraordinarilycomplexandlucrative,andincreasinglydifficultforregulatorstotrack.AccordingtoFederalStudentAid,theU.S.DepartmentofEducationprogramthatoverseesthefederalstudentaidprograms,thedepartmenttodayworkswith3,200lenders,35guaranteeagencies,secondarymarkets,72third-partyloan-serviceorganizations,andwithmanyotherindustryentities.22

ButitisSallieMaethatdominatestheindustry.Nolongerheldbackbyitsstatusasaquasi-governmentalagency,thecompanymovedaggressivelytoestablishacompetitive


presenceineverypartofstudentlending,largelybyacquiringahostofothercompanies(seeFigure5).

SallieMae’searliestpurchasesincludedNellieMaein1999andStudentLoanFundingResourcesin2000,bothnonprofitstudentlendingcorporations.23NellieMaeoriginatedover$300millioninfederalloansatthetimeSallieMaepurchasedit,makingitthe17thlargestloanoriginator.SinceNellieMaewasanonprofitorganization,SallieMaewasrequiredtocompensatethepublicforitsmarketvalue.24TheresultwasthecreationoftheNellieMaeFoundation,whichhad$395millioninassetsaftertheacquisition.25TheacquisitionofStudentLoanFundingResourcesreceivedlessattention,butinvolvedthepurchaseoftheeighthlargestholderoffederalstudentloans.

ThreeotherlenderacquisitionsexpandedSallieMae’sgeographicreach.In2003,thecompanyacquiredtheMassachusetts-basedAcademicManagementServices

Corporation,whichadded$1.4billioninstudentloans.In2004,SallieMaeexpandedtotheSouthwestwiththeacquisitionofnonprofitSouthwestStudentServicesCorporation,atop-30loanoriginator,andthentotheNorthwestwiththepurchaseofthenonprofitlender,StudentLoanFinanceAssociation.

In2000,SallieMaepurchased,for$770million,theUSAGroup,thelargestguaranteeagencyinthecountryandanonprofitlendingconglomeratewithservicesinloanorigination,enrollmentmanagement,loanservicing,anddebtcollection.26WiththeUSAGrouppurchase,SallieMaewentfrom“beingthe800-poundgorillatobeingthe8,000-poundgorilla,”inthestudentlendingindustry,saidHenryB.Howard,presidentofU.S.EducationFinance,aprivateloancompany.27

SallieMae’spurchaseofUSAGroupdidnotincludeUSAFunds,theguaranteeagencyarmofUSAGroupand

Figure 5. Federal Student loan Program, circa 2007, and Sallie Mae’s Presence in the Market*

Federal Government

Students/Parents

Private Loans


Secondary Markets

EnrollmentManagement

529 SavingsPlans

Federal Direct Loan Programs



Collection Agencies ConsolidationLoan Companies

Banks and Lenders

†

Note:Dashedlinesindicateoutsourcedservices.*ShadedboxesindicateareasinwhichSallieMaeoraSallieMaesubsidiaryoperate.†SallieMaeprovideslendingservicestoUSAFundsalongwitheightotherguaranteeagencies.SallieMaedoesnotownaguaranteeagency.


itslargestoperation.Becauseguaranteeagenciesarerequiredbylawtobeeitherstateagenciesornonprofitagencies,SallieMae,asafor-profitcompany,couldnotownUSAFunds.Instead,aspartofthedeal,SallieMaerequiredUSAFundstocontractallofitsguaranteeservicestoSallieMae.TheexclusiverelationshipgaveSallieMaecontrolovertheentireloanprocess,allowingittoofferschoolsmoreintegratedservicesandgivingitasizeablecompetitiveadvantage.

ThepurchasealsoallowedSallieMaetodramaticallyexpanditsdebtcollectionanddefaultmanagementservices,nowitssecondlargestbusinesssegmentbehindstudentlending.TheUSAGroupacquisitionadded$6billioninstudentloanstoSallieMae’sportfolioandincreasedrevenuenearly40percentwiththenew,fee-basedservicesSallieMaewasabletooffer.28

SincetheUSAGroupacquisition,SallieMaehaspurchasedfourotherdebtmanagementandcollectioncompanies—GeneralRevenueCorporation,PioneerCreditRecovery,ArrowFinancialServices,andGRPFinancialServicesCorporation—whichhaveexpandeditsdebtmanagementoperationsbeyondstudentloancollectionsintoothertypesofconsumerdebt,includingcreditcardsandmortgages.

Asaresultofthisshoppingspree,SallieMaenowownsacompany,orpartnerswithacompany,ineachofthecriticalareasoflending,frommakingloanstocollectingloans.Itisnowtheindustryleaderinloanorigination,loanholdings,loanservicing,andloancollecting,anditcontractsservicestothelargestguarantorinthecountry.In2006,SallieMaeoriginated,throughitsvariouslendingbrands,nearly$7billioninFFELPandPLUSloans,almost80percentmorethanthenextcompetitor(seeFigure6).Thecompany’sloanscomprised27percent29ofallfederalstudentlending,4percentmorethantheDepartmentofEducation’sentiredirectlendingprogram,and21percentmorethanthenextlargestprivatestudentlender,Citibank.30

March Toward Monopoly?SallieMae’sdramaticexpansionhelpedfuelextraordinaryenthusiasmforthecompanybyWallStreetinvestors.SallieMae’sstockhasrisenby1,900percentsince1995.

But,noteveryoneisasenthusiasticasWallStreetaboutSallieMae’srapidgrowth.IndustryobserversworrythatifSallieMaecontinuestoexpand,itcouldeliminatecompetitioninthestudentloanindustryand,mostimportantly,thebenefitsstudentsseefromcompetition,includingreducedfeesanddiscountedinterestrates.

Figure 6. loan origination Volume Among top Student lenders, �996–2006

1996 1997 1998 1999 2000 2001 2002 2003 2004 20062005

Bank of AmericaWells Fargo BankBank One

Citibank

J.P. Morgan Chase

Sallie Mae

Loan

Vol

ume

(in m

illio

ns)

0

1000

2000

3000

4000

5000

6000

7000

8000

Source:U.S.DepartmentofEducation,OfficeofFederalStudentAid,FinancialPartners“Top100OriginatorsofFFELPLoansHistoricalReports.”


“SallieMaeisonthemarchtowardmonopolyhere,”chargedBarmakNassirian,associateexecutivedirectoroftheAmericanAssociationofCollegiateRegistrarsandAdmissionsOfficers,ina2006Chronicle of Higher EducationarticleonSallieMae’spurchaseofstatenonprofitloanagencies.31

Nassirian’sconcernsareillustratedbySallieMae’spurchaseofthelendinggiantUSAGroup,whichnotonlyaddedbillionsinstudentloans,butalsoallowedSallieMaetoexpanditsoperationsintoeachpointofthestudentlendingcycle,andbya$1billionunsolicitedbidthatSallieMaemadein2005tobuythePennsylvaniaHigherEducationAssistanceAssociation,thenation’slargestnonprofitstateloanagency.

YetthebiggestpotentialformonopolymaylieinthedeclineoftheFederalDirectLendingProgram,SallieMae’sbiggestcompetitor.Thefederalgovernment’sshareofnewstudentloansthroughitsdirectlendingprogramdropped9percent—from32percentto23percent—between1999and2006,whileSallieMae’smarketsharehasincreasedby12percent—from15percentto27percent—duringthesameperiod.35

Whenthedirectlendingprogramwasintroduced,itofferedanumberofbenefitstostudentsnotavailableamongprivatelenders:faster,onlineloanapplicationandprocessing;reducedloanfees;avarietyofrepaymentplans;andnoconfusionaboutwheretosendtheirchecksbecausethefederalgovernmentwouldn’tselltheirloans.Inresponse,privatelendersimprovedtheirservices,includingofferingmoreflexiblepaymentplansandreduced,orzero,loanfees.

SallieMaecontendsthatdespiteitsexpansion,thestudentloanindustryremainsahealthy,competitivemarketplace,andthatcompetitionhasbenefitedborrowersthroughreducedinterestratesforon-timepayments,zerooriginationfees,improvedservicestoschoolsandstudents,andlowerdefaultratesfromimprovedcollectionpractices.Thecompanyalsoarguesthatitsscalehasallowedittoinvestheavilyinimprovedtechnologyandservicesthathavealsohelpedborrowers.36

Yetthedeclineinthedirectlendingprogram’smarketshare,whichispartlyduetoSallieMae’saggressivemarketingtoschoolstoswitchfromthedirectlending

programtotheprivatelendingprogram,mayeffectivelyeliminateSallieMae’sonlyrealcompetitor.

Relationship BuildingThemostsignificantpurchaseduringSallieMae’sexpansionwasthecompany’sacquisitionofUSAGroupandtheresultingdealwithUSAFunds.Inthedeal,USAFundsagreedtooutsourcethedefault-managementandloan-servicingfunctionsonitsthen-$9billionloanportfoliotoSallieMae,makingUSAFundsoneofSallieMae’sbiggestcustomers.In2006,32percentofSallieMae’sfee-based,debt-managementrevenuecamefromservicingUSAFunds’$27billionloanportfolio.37

WhilethisisagooddealforSallieMae,itmightnotbeagooddealfortaxpayers.Relationshipsbetweenlendersandguaranteeagencies—likeSallieMae’srelationshipwithUSAFunds—maycompromisetheoversightroleofguaranteeagenciesandultimatelyhurtstudentsandtaxpayers.

Guaranteeagencies,inadditiontobeingtheprimaryinsureroffederalloans,areresponsibleforensuringthatlendersperformduediligenceonloans—fulfilltheirlegalobligationstolocateandcollectdelinquentloans—beforefilingaclaimforrepayment.ThishelpspreventfraudintheFFELprogrambyensuringthatlendersdonotfilefalsedefault-reimbursementclaims.

TitleIVoftheHigherEducationActprohibitsguaranteeagenciesfromcontractingwithoutsideentitiestoperformdefaultaversionorcollectionservicesonloans,ifthoseentitiesholdorservicetheloan.38IntheSallieMae/USAFundsarrangement,SallieMae’sguarantorservicingdivisionservicesUSAFunds’loans.BecausethisdivisionistechnicallyseparatefromSallieMae’slendingentities,itdoesnotviolatetheTitleIVprohibition.Butthisdoesnoteliminatethepotentialforconflictofinterest.

TheU.S.DepartmentofEducationInspectorGeneralissuedareportin2002statingthatthisexactarrangementbetweenUSAFundsandSallieMaedid,infact,violatetheTitleIVregulation.39But,USAFundssuccessfullyarguedin2004thatSallieMae’sguaranteeservicingarmanditslendingarmconstitutedtwoseparateentities,andtheU.S.DepartmentofEducationdecidedtolettheUSAFunds/SallieMaearrangementcontinue.Thisdecisiondeviates


fromthefindingsoftwoearlierreportsonrelationshipsbetweenguaranteeagenciesandloancompanies.

A1993reportbytheGovernmentAccountabilityOffice,theinvestigativearmofCongress,highlightedtheproblemofconflictsofinterestbetweenguaranteeagenciesandlenders:“Anenvironmentinwhichaguarantyagency’sfinancialtransactionswithlendersare‘lessthanarms-length’…mayresultinreducedattentionbyguarantyagenciestotheiroversightresponsibilities.”40Another1993report,fromtheU.S.DepartmentofEducationInspectorGeneral,concludedthat“billionsofdollars”ofFFELPloanswereatriskof“mismanagement,waste,andabuse,”becauseofguaranteeagencies’affiliationswithlenders.41Currently,however,onlynineofthe35guaranteeagenciesnationallyarenotassociatedwithalenderorsecondarymarket.42

AlongwithUSAFunds,eightotherguarantorsalsocontractedwithSallieMaetodothesametypeofworkin2006andinall,SallieMaeprocessedguaranteesfor29percentofthefederallyguaranteedstudentloansthatyear.43

Throughitspurchasesofcompaniesateachstageoftheloancycle,SallieMaehassoughttocreatea“seamless”systemforcustomers,andtoprofitfromthefeesandservicesateachpoint.SallieMaehasalsouseditsacquisitionstobuildrelationshipswithcollegefinancialaidofficersandtocross-promoteitsservicestopotentialcustomers—moresignsofitsaggressiveandsuccessfulbusinessstrategies.

TheUSAGrouppurchasemarkedSallieMae’sentryintoenrollment-managementconsultingthroughthe

SpecialAllowancePaymentsareintendedtoensurethatlendersmakeenoughprofitsonstudentloanstocontinueparticipatinginthefederalloanprogram.Thesepaymentsmakeupasignificantamountoftheprogram’sadministrativebudget,costingthefederalgovernment$4.6billioninfiscal2007.32

Congressisresponsibleforestablishingthe“SpecialAllowanceMargin,”—ineffect,theprofit—that’sguaranteedtolenders.But,toreduceprogramcosts,Congresshas,since1986,graduallyreducedthespecialallowancemarginfromahighof3.5percent.Currently,foraStaffordloaninrepayment,thespecialallowancemarginis2.3percent.

This“profit”isaddedtoareferenceinterestrate.Thereferenceinterestrateismeanttoreflectcurrentmarketrates,which,inturn,reflectthecosttolendersofmakingstudentloans.Priorto2000,thisreferenceratewasthe90-dayTreasurybillrate.ForloansmadeafterJanuary2000,theU.S.DepartmentofEducationusestheratefor30-daycommercialpaper.

Inthecurrentformula,thespecialallowancemarginisaddedtothecostof30-daycommercialpaper,andifthistotal(commercialpaper+specialallowancemargin)exceedstheinterestratepaidbytheborrower,theU.S.DepartmentofEducationpayslendersthedifference.LendersbilltheDepartmentofEducationquarterlyforthesespecialallowancepayments.

Thespecialallowancemarginonloanshasdeclinedsteadilyoverthepast10-years,exceptonso-called9.5percentloans,whichhaveprovidedafinancialwindfalltosomelenders.

Duringthedifficulteconomictimesofthe1980s,thefederalgovernmentallowednonprofitlenders,generallystate-sponsoredagenciessuchasthePennsylvaniaHigherEducationAssistanceAssociation,whichfinancedtheirloanswithtax-exemptbonds,tocollectahigherrateofreturnonstudentloans—9.5percent.Thiswasintendedtoencourage

nonprofitlenderstocontinuemakingloanstostudentsandtoprotecttheirfinancialstability.In1993,whentheeconomyhadimproved,Congresstookawaythespecial9.5percentreturnforanynewloans—orsoitthought.

WhileCongressallowedlenderstocontinuecollectingthe9.5percentmarginonexistingloans,aloopholeinthelawallowedbothnonprofitlendersandfor-profitlenderswhohadpurchasedanonprofitstudentloancompany,tomakenew9.5percentloans,throughaprocesslenderstermed“recycling.”Bymakingnew9.5percentloans,thesecompaniescoulddramaticallyincreasetheirrevenues—whileinterestratesonmostloansin2003–04werearound3percent,bankswerecollecting9.5percentintereston“recycled”loans.Thefederalgovernmentmadeupthedifference,payingbanksahugeamountinsubsidiesandgivingthemhugeprofits—profitsthatcamefromtaxpayermoneyviatheDepartmentofEducation.

ASeptember2006InspectorGeneralauditofspecialallowancepaymentson9.5percentloanstoonelarge,for-profitstudentloancompany,NationalEducationLoanNetwork(Nelnet),foundthatNelnetreceivedapproximately$278millioninimproperpaymentsfromtheDepartmentofEducation.By“recycling”existing9.5percentloansinaprogramthatNelnettermed“Project950,”thecompanyincreasedtheamountoftheseloansfrom$551millioninMarch2003to$3.66billioninJune2004.33

InJanuary2007,NelnetsettledwiththeDepartmentofEducation.ThesettlementagreementallowedNelnettokeepthe$278millioninimproperpayments;however,itprohibitedfuturepaymentstoNelnetonthoseloans.TheDepartmentofEducationalsostoppedallfuturepaymentstolendersuntilitcouldverifythattheloanswereeligibleforthe9.5percentsubsidy.Tomany,thesettlementwasinsufficient.DeclaredSenatorEdwardKennedy:“The[Bush]administrationshouldhavesettledfornothinglessthanthefullrecoveryofNelnet’sill-gottenproceedsfromtheseloans.”34

Special Allowances and the ‘9.5 Percent loan’ Controversy


acquisitionofUSAGroupsubsidiaryNoel-Levitz,thenation’slargestenrollment-managementconsultingfirm.Enrollmentmanagementusespastenrollmentandfinancialdatafromaschooltopredictwhichstudentsarelikelytoapplyandenroll,andhowfinancialaidawardscanbeleveragedtoenrollthemostdesirableclassofstudents.Noel-Levitzhasadvised1,800collegesanduniversitiesoverits30-yearhistory,workingwithschoolsonmarketingcampaigns,recruitingmethods,financialaidawards,andstudentretentionandgraduationstrategies.

ThisrelationshipallowsSallieMaetoconsultwithcollegesontheirfinancialaidstrategies,andthuspotentiallyincreasetheamountofSallieMae-providedloansthecollegeoffers.44ItisunlikelythatNoel-Levitz’sconsultingservicesdirectlydrivemuchofSallieMae’slendingbusiness.ButitdoesgiveSallieMaeanimportantrelationship-buildingtool.Evenwithincreasesindirect-to-studentmarketing,collegesanduniversitiesremaingatekeeperstostudentloanbusiness,andNoel-LevitzgivesSallieMaeanopportunitytobuildrelationshipswithfinancialaidoffices.

SallieMae’smostrecentacquisitionhascreatedanotheropportunityforthecompanytocross-promoteitsbusinesses.In2006,SallieMaeenteredintothebusinessofcollegesavingsplans.Toencouragecollegesavings,Congressexemptedso-called529SavingsPlanscontributions(namedafterSection529ofthefederaltaxcode)fromfederalincometax.Theplansarestate-sponsoredinvestmentoptionsrunbyprivateinvestmentcompanies.Thesesavingsplanshavegrownrapidlysincetheincometaxexemptionbeganin2001,and,in2006,SallieMaepurchasedUPromise,oneofthetop529savingsplancompanies.

Thepurchase,whichstockmarketanalystshailedasacoupforSallieMae,notonlyfurtherdiversifiedSallieMae’soperations,itgaveSallieMaeearlyaccesstopotentialcustomers.45Parentswhoopen529savingsplansfortheirchildrenarelikelyalsoparentsthatwillbehelpingtheirchildrendecidewhichloanstotakeoutforcollege,andco-signingprivateloans.UPromise’s7.2millionmembersprovideSallieMaewithmanysuchpotentialborrowers.

An Opportunity for ChangeWhilerevelationsofquestionablemarketingpracticesandotherpotentialwrongdoingbySallieMaeandother

lendingindustrycompaniescontinuetounfold,SallieMae’srecentsalefor$25billiontoaprivateinvestorgroupthatincludesBankofAmerica,J.P.MorganChase,andtwoprivateequityfirms,islikelytoreducepublicscrutinyofthecompanybecauseprivatelyheldcompaniesarenotsubjecttothesamelevelsofpublicdisclosureoffinancialinformationthatthefederalSecuritiesandExchangeCommissionrequiresofpubliclytradedcompanies.

ThisputsevenmorepressureontheU.S.DepartmentofEducationtooverseetheactivitiesofSallieMae,aswellastheentirestudentlendingindustry—somethingithasnotdonewellinrecentyears.“FinancialPartnershadnotimplementedanacceptablelevelofinternalcontroloveritsmonitoringandoversightofFederalFamilyEducationLoanprogramparticipants,”theU.S.DepartmentofEducationinspectorgeneralsaidinaSeptember2006reportonFinancialPartners,thearmofthedepartment’sOfficeofFederalStudentAidresponsibleformonitoringguaranteeagencies,lenders,andservicers.ThereportalsostatedthatFinancialPartners“emphasizedpartnershipovercomplianceindealingwithguaranteeagencies,lenders,andservicers.”46

RecentnewsreportshaverevealedtiesbetweentheDepartmentofEducationandthelendingindustrythatmayfurthercompromisethedepartment’soversightabilities.TheWashington Posthasreported,forexample,that“atleast20formerSallieMaeemployeeshadmovedintothedepartmentundertheBushadministration.”47Thestudentloanindustryalsospendsalotofmoneyoncampaigncontributionsandlobbying.AccordingtoTheNew York Times,Nelnet,alargelenderfoundtohaveimproperlybilledtheDepartmentofEducationformillionsofdollars,wasthe“nation’smostgenerouscorporatedonortotheNationalRepublicanCongressionalCommitteein2006.”48

Theinspectorgeneral’s2006reportnotedthathighturnoverinthegeneralmanagerpositionatFinancialPartnerscontributedtothe“weakcontrolenvironmentformonitoringandoversight.”Since1999,FinancialPartnershasseenfourdifferentgeneralmanagers.Ofthese,threehavecomefromthelendingindustry(andtworeturnedtoitfollowingtheirtimeatFinancialPartners)andonefromtheNationalCouncilofHigherEducationLoanPrograms,aloanindustrytradegroup.Thislistincludesthecurrentgeneralmanager,MatteoFontana,whoworkedatSallieMaepriortotakingthetopjobatFinancialPartners,and


whohasrecentlybeensuspendedbytheU.S.DepartmentofEducationafterdisclosureofhisownershipofstockinastudentloancompany.

Whenitlaunchedthefederalstudentloanprogramfourdecadesago,Congresswasforcedtooffersignificantfinancialincentivestobanksandotherlendersinordertogetthemtoparticipateinthestudentlendingprogram.Sincethen,theprogramhasgrownsteadilylargerandvastlymorelucrativeforlendersandotherplayersintheindustry.Yettheprogramhascontinuedtofavortheindustrythroughlendingratestructuresandgenerous,

taxpayer-fundedfinancialperksthatallbutguaranteeimmenseprofits,andthroughasympatheticregulatoryenvironment.Notsurprisingly,thelendingindustryhasrecognizedtheseopportunitiesforwhattheyareandhasmovedaggressivelytocapitalizeonthem—oftenatsignificantcoststostudentsandtaxpayers.

ButintheupcomingreauthorizationoftheHigherEducationAct,Congresshasanopportunitytostrikeanewbalanceinstudentlending,onethatservestheinterestsofstudents,taxpayers,andtheindustryinmoreequalmeasures.


Endnotes1 RichardGeorge,“ThoughtsontheIndustry’sPastand

Present:AnInsider’sPerspective,”(paperpresentedattheconference,“FootingtheTuitionBill:NewDevelopmentsintheStudent-LoanIndustryandHowTheyAreChangingtheWayWePayforHigherEducation,”AmericanEnterpriseInstitute,Washington,D.C.,September2006).

2 AndrewRudalevige,“IrreconcilableDifferences?ThePoliticalTopographyofFederalStudentLoans,”(paperpresentedattheconference,“FootingtheTuitionBill:NewDevelopmentsintheStudent-LoanIndustryandHowTheyAreChangingtheWayWePayforHigherEducation,”AmericanEnterpriseInstitute,Washington,D.C.,September2006).

3 FredGallowayandHokeWilson,Reframing the Student Loan Costing Debate(Washington,D.C.:EducationalPolicyInstitute,2005).

4 Financial Audit: Guaranteed Student Loan Program’s Internal Controls and Structure Need Improvement, GAO/AFMD-93-20(Washington,D.C.:GovernmentAccountabilityOffice,March1993).

5 StatementofAlfredB.Fitt,GeneralCounsel,CongressionalBudgetOfficebeforetheSubcommitteeonPostsecondaryEducation,CommitteeonEducationandLabor,U.S.HouseofRepresentatives,May30,1979.

6 Trends in Student Aid(Washington,D.C.:CollegeBoard,October2006).

7 Secondary Market Activities of the Student Loan Marketing Association, GAO/HRD-84-51(Washington,D.C.:GovernmentAccountabilityOffice,May1984).

8 Ibid.9 FredGallowayandHokeWilson,Reframing the Student Loan

Costing Debate.10RichardGeorge,Thoughts on the Industry’s Past and Present:

An Insider’s Perspective.11Aggregateloanlimitswereincreasedinthe1992HEA

reauthorizationfrom$17,250to$23,000forundergraduateloansandfrom$54,750to$65,500forcombinedundergraduateandgraduateloans.Inaddition,PLUSloanlimitswereincreasedtocoverthetotalcostofattendance,minusotheraid,andlimitsonPLUSloanswereeliminated.

12ChristopherMyers,“LendersAssailedinSenateProbeofStudent-LoanPrograms,”The Chronicle of Higher Education,October3,1990.

13ThomasJ.DeLoughry,“WillColleges,StudentsBeHelpedorHurt?LongTermEffectofStudent-LoanInvestigationDebated,”The Chronicle of Higher Education,October17,1990.

14Guaranty Agency Solvency: Can the Government Recover HEAF’s First-Year Liquidation Cost of $212 Million?, GAO/HRD-93-12BR (Washington,D.C.:GovernmentAccountabilityOffice,November1992).

15MichaelJ.Lea,Privatizing a Government Sponsored Enterprise: Lessons from the Sallie Mae Experience,(IndianaStateUniversity:NetworksFinancialInstitute,April2006).

16MarkG.Overend,“ThePrivatizationofSallieMae,”(ThirdConferenceonGovernmentSponsoredEnterprises,AmericanEnterpriseInstitute,Washington,D.C.,May23,2000).

17FinAid,“IllegalInducementsandPreferredLenderLists,”availableonlineat:http://www.finaid.org/educators/illegalinducements.phtml.

18SLM Corporation Annual Report 2005(Reston,Va.:SLMCorporation).

19U.S.DepartmentofEducation,Federal Family Education Loans Net Volume by Fiscal Year, FY 2008 President’s Budget,availableat:http://www.ed.gov/about/overview/budget/studentloantables/index.html.

20Trends in Student Aid(Washington,D.C.:CollegeBoard,October2006).

21SLMCorporation,Report to the United States Securities and Exchange Commission, Form 10-K,2006.

22U.S.DepartmentofEducation,Federal Student Aid Annual Report, 2006.

23 In1996,anamendmentwasaddedtoataxbillthatmadeiteasierfornonprofitsecondarymarketstoconverttofor-profitsecondarymarkets.ThisallowedSallieMaetopurchasenonprofitssuchasNellieMaeandSLFR.

24How Nonprofit Student Loan Officials Get Rich (briefingpaper,TheInstituteforCollegeAccessandSuccess,May26,2005).

25“SLMHoldingCorp.(SallieMae)toAcquireNellieMaeCorp.,”SLMHoldingCorporationPressRelease,May26,1999.

26Disclosure:SallieMae’smergerwithUSAGroupresultedin$1billionfortheLuminaFoundation.EducationSectorreceivesfundingfromtheLuminaFoundationforitsworkonundergraduateeducation.TheLuminaFoundationdidnotfundthisproject.

27StephenBurd,“InaMergerofStudent-LoanGiants,SallieMaeWillBuyMuchofUSAGroup,”The Chronicle of Higher Education,June23,2000.

28Summary Annual Report2000(Reston,Va.:USAEducation,Inc.“SallieMae”).

29ThisnumberincludesbothloansmadethroughSallieMae’sinternallendingbrands—brandsthatareownedbySallieMae—andloansmadethrough“forwardpurchaseagreements”withoutsidebanks.


31StephenBurd,“SallieMaeMovestoBuyStateAgencies,ScaringCritics,”The Chronicle of Higher Education,March31,2006.

32Budget of the United States Government, Fiscal Year 2008(OfficeofManagementandBudget,February2007).

33Final Audit Report: Special Allowance Payments to Nelnet for Loans Funded by Tax-Exempt Obligations, ED-OIG/A07F0017(Washington,D.C.:OfficeofInspectorGeneral,DepartmentofEducation,September2006).

34KellyField,“LenderAllowedtoKeepFederalOverpaymentsof$278-million,”TheChronicle of Higher Education,February2,2007.


35SLMCorporation,“DebtInvestorPresentation,FirstQuarterendedMarch31,2006,”(Reston,Va.:April21,2006).

36BasedoncommentsfromPaulCarey,formerExecutiveVicePresidentformarketingandbusinessservicesatSallieMae.OnlinechatwithStephenBurd,“SallieMaeandtheFutureoftheStudent-LoanIndustry,”The Chronicle of Higher Education,August9,2000,availableonlineat:http://chronicle.com/colloquylive/transcripts/2000/08/20000809carey.htm.


38U.S.DepartmentofEducation,Compilation of Student Aid Regulations,34SFR682.404(k)(4).

39Final Audit Report: United Student Aid Funds, Inc.’s Administration of the Federal Family Education Loan Program Federal and Operating Funds, ED-OIG/A05-B0033(Washington,D.C.:OfficeofInspectorGeneral,UnitedStatesDepartmentofEducation,April2002).

40Financial Audit: Guaranteed Student Loan Program’s Internal Controls and Structure Need Improvement, GAO/AFMD-93-20(Washington,D.C.:GovernmentAccountabilityOffice,March1993).

41RegionalInspectorGeneralforAuditRegionIX,“EdShouldProhibitConflictsofInterestbetweenGuarantyAgenciesandAffiliatedOrganizations,”ManagementImprovementReportNo.93-02,March15,1993.

42RichardGeorge,Thoughts on the Industry’s Past and Present: An Insider’s Perspective.

43SLMCorporation, Report to the United States Securities and Exchange Commission, Form 10-K,2006,pp.16–17.

44For Students or For-Profit?NewAmericaFoundation,HigherEdWatchBlog,October27,2006,availableonlineat:http://www.newamerica.net/blogs/2006/10/for_students_or_for_profit.

45NathanParmelee,“SallieMaeSnagsUpromise,”The Motley Fool, June2,2006,availableonlineathttp://www.fool.com/investing/small-cap/2006/06/02/sallie-mae-snags-upromise.aspx.

46Final Audit Report: Review of Financial Partners’ Monitoring and Oversight of Guaranty Agencies, Lenders, and Servicers, ED-OIG/A04E0009(Washington,D.C.:OfficeofInspectorGeneral,DepartmentofEducation,September2006).

47JonathanD.GlaterandKarenW.Arenson,“QuestionsonOfficials’TiestoLenders,”The New York Times,April25,2007.

48SamDillon,“Whistle-BloweronStudentAidIsVindicated,”The New York Times,May7,2007.

Leading Lady: Sallie Mae and the Origins of Today's Student LoanControversy

Publisher(s): Education Sector

Author(s): Erin Dillon

Date Published: 2007-05-01

Rights: Copyright 2007 Education Sector. All rights reserved.

Subject(s): Education and Literacy

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leading lady: sallie mae and the origins of today's

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