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Federal Subsidies to Student Lenders Come Under Fire

By Sean Cavanagh — October 12, 2004 4 min read
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The House of Representatives last week approved a proposal to tighten a loophole that has allowed lenders participating in a federal student-loan program to reap hundreds of millions of dollars in revenues in recent years—and fueled acrimonious debate over why the payments weren’t halted sooner.

The Republican-sponsored proposal would close off a portion of the subsidies and redirect that funding to teachers who agree to work in high-poverty K-12 schools that receive Title I money. The measure appears to be making quick progress: After passing the House 414-0, the Senate was expected to take it up late last week and then send it to the White House, which supports the legislation.

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CHART: Sweet Subsidy

But that plan fails to satisfy critics who say it has loopholes of its own that would allow lenders to continue to rake in excessive profits on some student loans.

Questions about the subsidy have stirred outrage in Washington and beyond recently, particularly among student advocates who say the subsidy is ultimately socking taxpayers and squandering money that could be devoted to other financial-aid efforts for needy college-bound students.

“If we all agree this is a misuse of government funds, why don’t we just resolve it?” said Luke Swarthout, the higher education associate for the State Public Interest Research Groups, a student- and consumer-advocacy organization in Washington.

High Yields

At the heart of the controversy is a federal law that guarantees lenders a 9.5 percent yield, instead of the prevailing market rate, on loans financed with tax-exempt bonds issued before 1993. Known as “special allowance payments,” the guarantees apply to loans issued through the $42 billion-a-year Federal Family Education Loan Program.

Special allowance payments were created by Congress in 1980 as a way of guaranteeing banks, state lending agencies, and other nonprofit and for-profit lenders a fair rate of return on student loans. In 1993, Congress attempted to curtail the subsidy by eliminating the 9.5 percent yield for loans issued on or after Oct. 1 of that year.

But that measure left lenders with loopholes allowing them to continue collecting the higher yield, as detailed in a report released last month by the Government Accountability Office, the watchdog agency of Congress. Through a process known as recycling, for instance, a lender can reinvest money earned through the 9.5 percent subsidy to purchase additional loans that are legally guaranteed the same yield.

“Congress thought it was saying, ‘No more,’ but boy oh boy, it didn’t work out that way,” said Robert Shireman, the director of the Institute for College Access and Success, an Oakland, Calif., advocacy organization that has been following the subsidy issue.

As a result, payments to lenders eligible for the 9.5 percent subsidy soared from roughly $209 million in fiscal 2001 to $634 million through the first three quarters of fiscal 2004, the GAO says. That financial obligation does not necessarily result in money being taken away from other federal student-aid programs, but it adds to the overall financial burden of the federal government, which must cover the costs of the entitlement program. The GAO report estimates that closing the 9.5 percent subsidy could save nearly $5 billion between now and 2014.

The legislation introduced by the Republican chairmen of the House and Senate education committees, Rep. John A. Boehner of Ohio and Sen. Judd Gregg of New Hampshire, would close major portions of the 9.5 percent subsidy, but still allow lenders to continue recycling loans; it also would close the loopholes for only one year.

A one-year halt would allow Congress to address the subsidy issue in a more comprehensive way when it reauthorizes the Higher Education Act, said Alexa Marrero, a spokeswoman for Republicans on the House Education and the Workforce Committee. The HEA reauthorization is not expected to be completed this year.

Republicans also produced letters last week from lenders saying that reducing the subsidy by too great an amount would result in those organizations cutting services, such as college and financial-aid counseling, to student borrowers.

Targeting Teachers

The GOP plan would channel the subsidy savings toward an increase in federal student-loan forgiveness for teachers, from $5,000 to $17,500. Only teachers who agreed to work in Title I schools for at least five years in mathematics, science, or special education would be eligible under the plan which is similar to previous plans offered by the Bush administration and in Congress.

Democrats were critical of the proposal—and of the Department of Education for not doing more to end the subsidy sooner. They have argued that the department could have adopted an emergency regulation to end the subsidy without going through the formal rule-making process.

But in a letter to the GAO, Sally L. Stroup, the assistant secretary for postsecondary education, said the department believes it would have to go through the potentially lengthy rule-making process to shut down the subsidy on its own. The GAO disagreed with that reasoning.

Late last week, Rep. George Miller, the ranking Democrat on the House education committee, agreed to vote for the legislation because he saw it as a stopgap measure to halt at least some of the excessive subsidies, said Danny Weiss, a spokesman. But the Democratic lawmaker would fight to get rid of the subsidy completely during HEA reauthorization, he added.

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