Daily Aid 114: Sallie Mae Federal Student Loan Proposal

Student Financial Aid News

From InsideHigherEd:

Sallie Mae (ticker: SLM), which as the country’s largest student loan provider has a lot to lose from the Obama administration’s proposal to eliminate the Family Federal Education Loan Program, is floating an alternative that would save the program but cut its costs significantly. In a letter to sent to its college customers, the lender outlined a plan that would entail permanently extending the emergency programs that Congress put in place in 2007 to ensure the continued availability of student loans given the distress in the financial markets but, like the Obama plan, contract out to companies through auction the right to service all federal student loans. Competing analyses of the Sallie Mae plan by Mark Kantrowitz, publisher of Finaid.com, and the New America Foundation put the savings from the plan at between 80 and 90 percent of that promised by the administration’s proposal to move to 100 percent direct lending.

Commentary

In reading the Sallie Mae proposal, there are a couple of loopholes. First, there’s a Master Loan Purchase in the legislation which effectively requires the Department of Education to purchase any federal student loan issued by a student loan company. While this doesn’t impact federal Stafford loans, it does include the credit-based parent PLUS loan and graduate PLUS loan, which creates an incentive to lend without risk to the lender. Currently, the credit restrictions on PLUS loans are looser than on private student loans, so the Department of Education would end up buying loans issued to borrowers who probably shouldn’t be issued loans.

While there is language for servicers sharing the risk of default, their participation in default prevention is limited in scope to 4 years after a loan enters repayment. If you look at historical data for loan defaults, a lot of borrowers run into trouble around year… seven. Within 4 years of repayment, you have effectively 3 years of deferment plus a year of forbearance which means that the lender can theoretically encourage a borrower to keep putting off payment until after their responsibility for the loan ends.

Finally, there’s no language in the proposal about origination and guarantee fees for borrowers, only eliminating fees for lenders.

Will this proposal be in the best interests of students? Honestly, I don’t think so, any more than President Obama’s plan to eliminate the FFEL federal student loan program. While the President’s plan effectively puts any form of customer service or incentive to prevent default through competing lenders in the tank (bad for students), creating any kind of program where originating loans without risk to the lender is also bad for students.

The best solution in my mind would be something along the lines of the current securitization model, which allows the Department of Education to buy loans, combined with eliminating the distinction of Direct vs. FFEL lending (allowing students and schools 100% choice of any lender they want, ensuring that no student or school is ever without a lender in bad times but allowing lenders to compete in good times), and a clause in the buyback mechanism that says if a student loan sold to the government enters default, the lender has to buy it back from the government at cost. That would ensure a strong financial incentive for lenders to aggressively prevent defaulted student loans.

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