When President Obama proposed ending the bank-based student-loan program, a month after taking office, his advisers presented the plan as a done deal. The student-loan industry was “on life support,” they said, a “middleman” whose time had passed.
Although the president had many factors in his favor, including Democratic control of Congress, the student-loan companies weren’t about to go down without a fight. Led by Sallie Mae, they spent millions of dollars on lobbying and campaign contributions and won over several lawmakers by warning of job losses in their backyards.
The loan companies’ defeat this spring has brought about major changes in student lending, which has been a competition between the public and private sectors since the early 1990s, when Congress and President Clinton created the government’s direct-lending program. With the end of the bank-based program, lenders and guarantors are scrambling to redefine themselves, either as service providers or as private student-loan companies. Many are expected to leave the business altogether, which would prompt a wave of consolidations.
While it’s too soon to know how this transformation will affect student borrowers, increased competition in the private student-loan market could drive down interest rates. But default rates on both private and federal loans could rise, lenders say, if guarantors and lenders can’t come up with the money to continue to offer the same level of debt-management service as under the bank-based federal program.
Cracks in the Coalition
From the beginning, the odds were stacked against student-loan companies. Stung by scandal and sapped by two rounds of cuts in federal subsidies, lenders were both unprofitable and unpopular—"a wounded animal,” in the words of one student-loan lobbyist. Their Republican allies in Congress were outnumbered by Democrats, who tend to favor direct lending over the bank-based program. And President Obama’s plan had populist appeal. By ending subsidies to banks, Congress could free up billions of dollars in aid for low-income students.
But student-loan companies, which had survived a similar battle with President Clinton almost two decades earlier, mounted a vigorous defense. They spent $3.1-million lobbying lawmakers in the first half of 2009 alone and offered a variety of proposals aimed at preserving a role for lenders and guarantors in the federal student-loan system.
But their initial campaign against the bill was disorganized, with a dozen or so groups looking out for their own interests. By the time the lenders and guarantors finally coalesced around one proposal, in July, the die had been cast for the president’s plan in the House education committee. When that panel approved the bill, two weeks later, not one Republican offered the lenders’ alternative as an amendment.
College financial-aid administrators opposed to the plan were even slower to react. While a few dozen sent letters warning lawmakers of the risks of thousands of colleges’ making a transition to direct lending, a majority of administrators stayed on the sidelines, wary of speaking out against a proposal that would free up billions of dollars in aid for students and colleges, and reluctant to stand up for an industry that had so recently been accused of offering kickbacks to colleges.
Democratic leaders, meanwhile, weren’t taking any chances. To improve the bill’s odds in the Senate, where their margin was narrower than in the House, lawmakers pushed through legislation that would shield the plan from a filibuster threat, helping it clear the chamber with little or no Republican support. To shore up support among members of the Congressional Black Caucus and Democrats from districts threatened with job losses, they agreed to provide billions of dollars to historically black colleges and to set aside for nonprofit lenders a portion of the contracts the government planned to award to help administer direct loans. The move served to deepen divisions among student-loan companies, pitting nonprofit lenders against for-profit ones.
The Education Department, too, wasn’t standing still. While lenders were raising doubts about the department’s ability to handle an influx of new borrowers, department officials were building the direct-loan system’s capacity and urging colleges to sign up for direct lending to prepare for the bill’s likely passage. Hundreds complied, increasing the direct-loan program’s volume by 40 percent in a year, and undermining opponents’ claims that the program couldn’t handle rapid growth.
Acting in a Crisis
Supporters of the bill capitalized on the financial crisis that had forced the government to intervene in the student-loan industry, providing lenders with capital for new loans and purchasing existing ones. While not confined to student loans, the market meltdown allowed supporters of the bill to argue that the bank-based program was unstable and would collapse when the emergency programs expired. It also weakened lenders’ claims that the government was preparing to take over student lending, allowing Democrats to argue that it’s hard to federalize a program that’s already financed and guaranteed by the federal government.
At the same time, mounting public frustration over rising college costs, coupled with widespread anger over bank bailouts, fueled a public backlash against the financial sector. Student groups exploited that anger with populist rhetoric, casting the student-loan bill as a choice between corporate welfare and aid to struggling students. They dubbed their campaign “Students Over Banks” and ran ads on CNN and MSNBC showing a greedy banker pocketing a student’s cash gifts at his graduation party.
“There was a lot of anticorporate sentiment out there,” said one House Democratic committee aide. “The word ‘bank’ came to symbolize something negative.”
When the House passed the bill, in September, the focus shifted to the Senate, and the debate turned to jobs. Warning that thousands of jobs could be lost in the transition to direct lending, the coalition of student-loan companies began to aggressively court moderate Democrats, in the hope of getting them to consider the loan industry’s proposal.
Ultimately the student-loan bill was married with legislation to overhaul health care, in part because Democrats needed $9-billion of the loan bill’s savings to pay for the health-care measure. The move also helped ensure the student-loan measure’s passage by making it harder for Democrats to vote against the bill. At the same time, the debate over the future of health care drowned out the conversation over the future of student loans.
“People weren’t paying attention” to the loan piece, said one Republican aide in the House. “Health care overwhelmed what would have otherwise been a big national debate.”
Lenders Adapt
In the weeks since the bill passed, the student-loan industry has begun to redefine itself, shifting its focus from issuing federal loans to providing private loans and borrower services. It is poised to morph from a diffuse network of hundreds of lenders and guarantors to a handful of companies that are increasingly dependent on federal and state contracts.
Already there are signs that the sector is shrinking. Last month Sallie Mae, the nation’s largest student lender, announced that it would lay off 2,500 employees by the end of 2011. EdAmerica, a nonprofit lender, has cut its marketing staff in half, to 12. National Student Loan Program, a guarantor, has laid off 23 employees, nearly 20 percent of its work force.
Some smaller lenders are looking to leave student lending altogether, selling their portfolios to companies with greater economies of scale. Last month Colorado’s CollegeInvest announced that it would sell its $1.5-billion portfolio of student loans to Nelnet for $35-million.
Mark Kantrowitz, publisher of FinAid, a Web site that provides student-aid advice, predicts as many as 10,000 layoffs in the industry over the next several years, as lenders unload portfolios and students pay off existing guaranteed loans.
Many of the jobs will be lost because the private sector will no longer originate or guarantee federal loans. To survive, some nonprofit lenders and guarantors are preparing to enter the private student-loan market for the first time, as either originators or providers of borrower services. That could mean lower interest rates for borrowers, says Peter Warren, president of the Education Finance Council, since nonprofit lenders can finance loans with tax-exempt bonds.
At least one for-profit lender is taking steps to keep its private student loans competitive. Sallie Mae, which saw its private-loan volume drop from $1.5-billion in the first quarter of last year to $840-million in the first quarter of 2010 amid declining demand for private loans, announced last week that it would drop the minimum interest rates on its Smart Option private loan from 4.25 percent to 2.88 percent.
Tim Ranzetta, president of Student Lending Analytics, an independent research company, estimates that private student borrowing declined by 25 percent in the 2009-10 academic year because of stricter underwriting standards and increased federal loan limits. But he expects it to pick up as college tuition continues to climb.
Paying for Borrower Services
Amid the upheaval, the biggest question mark is who will pay for borrower services, such as financial-literacy education, debt management, and default prevention, that student lenders and guarantors warned would vanish in the transition to the direct-loan program.
The Education Department says guarantors and nonprofit lenders can apply for grants to provide such services under a program that is slated to receive $150-million over the next five years. Critics say that’s not enough to sustain the current level of services.
“You can’t build a stable structure and business on that,” says Paul Combe, president and chief executive of American Student Assistance, a Massachusetts guarantor. “It’s a one-shot thing.” He argues that the federal government has an “obligation” to finance debt-management programs over the long term.
Still, Mr. Combe says, he is delighted that the conversation over student lending is finally shifting away from a debate between the direct-loan program and the bank-based program and toward how to best help students manage their debt. His agency was one of a handful of guarantors that was reimbursed by the federal government, under a contract that expired in 2008, for its success in preventing defaults. Mr. Combe has long said that guarantors should be “borrower advocates,” not debt collectors.
Default rates on federal student loans have climbed steadily in recent years, reaching 7.2 percent for borrowers who began repayment in the 2008 fiscal year. Among bachelor’s-degree recipients who graduated during the 2007-8 academic year, median debt was about $17,700 at public institutions, $22,380 at private not-for-profit institutions, and $32,650 at for-profit institutions, according to the College Board.
Now, since they can no longer guarantee new federal loans, many guarantors are focusing on the service side of their business. They are seeking financing not only from Washington, but also from state governments and colleges. Some hope to build on contracts to administer state grant programs and 529 college-savings plans. Others are marketing themselves to colleges as experts on how to comply with the federal-loan requirements and reduce defaults.
Meanwhile, nonprofit lenders await the details of a federal contract that will allow each of them to service at least 100,000 direct loans. The fine print could determine how many nonprofit lenders stay in business and continue to offer borrower services. If the servicing fees are too low, or the prospects of acquiring more loans too remote, some lenders may decide it’s not worth it, says Mr. Warren, of the Education Finance Council.
As the student-loan industry struggles to reinvent itself, some lenders say they are relieved to be out of the limelight—and Congress’ cross hairs.
“Politics have been very distracting,” Al Lord, Sallie Mae’s vice chairman and chief executive, said in a conference call with investors last month. “I hope its somebody else’s turn for a while.”
