Pilfered Dreams: The Story of Student Loans and Sallie Mae

“The horse has escaped, the barn door has been locked, and the stockholders are locked outside while their sons and daughters, owing unmanageable student loan debts, have been left to burn inside.”

The post you are about to read is a horror mystery, a tragedy, a calamity just about to happen. It is a story about young people who have been burdened with huge amounts of debt on the promise of a future career that will enable them to pay it off. They complete two or three years successfully at their chosen college, and can’t return in September, because they can’t find another year of student loan tuition funding. Suddenly, they have a debt of $50-100,000 and no way to complete the education that they’d hoped would secure them the job they’ll need to pay off that debt burden.

The story reveals the gutting of a corporation recognized as one of the “100 Best Corporate Citizens,” according to Business Ethics magazine, on Fortune 500 and Forbes 500 lists. It owned, operated, or was affiliated with 15 different companies. It was just the sort of stock your pension fund manager would buy, your town official would invest in, you yourself might pick to own if you did pick stock. It was a “sure thing” backed 100% by US Government monies. It was just about to be bought for $25 billion dollars, and $60 per share, it had made 18 million dollars only last year, when suddenly, inexplicably, it suffered a loss of good fortune. It is inches above a junk bond worth about $16, running up $135 million in losses and other fees.

This is a story about how to shackle the best and brightest young people of a generation into crippling debt, before they’ve even become financially independent, and this debt they cannot escape with bankruptcy, nor disability, whether medically or emotionally crippling. The Government (via private lenders) must be paid, and will tap their unemployment or disability funds. There is no escape. This debt, like taxes, or the mob, can only be skirted by retreating underground for the rest of their financial life.

It begins at a brighter, sunnier time, during Johnson’s Great Society, when baby boomers left high school in droves, and, like the rat moving through the python, were faced with a choice of heading to college , leaving themselves open to the draft, or facing joblessness. Colleges, like the grade schools and high schools before them, were gearing up for larger classes and welcoming in a new generation of those born between roughly 1947-1965. It was a huge mass of traditional college-age students, the size of which we’ve not seen since, and our institutions of higher learning got to choose the best of them, while swelling their own professorial ranks, departments, buildings, egos and endowments.

These same institutions were left to struggle with how to keep alive and thrive when this flood of Baby Boomer enrollees graduated, and those that followed shrank the eligible ranks to a trickle. A cultural shift occurred, where more and more students, previously not thought of as “college material,” were encouraged to apply to these institutions: Non-traditional; older students; those who might bring special learning needs; or students from poorer families, in need of financial aid. As the economy worsened, education continued to promise the “key to a better life,” and loan officers and bankers were there to direct the flow of dollars. Parental homes were refinanced, savings were tapped, overtime was put in, and the cost of securing that educational key continued to steeply climb.

Overview

The Higher Education Act of 1965 (1) was legislation signed into United States law on November 8, 1965 as part of President Lyndon Johnson’s Great Society’s domestic agenda. The law was intended “to strengthen the educational resources of our colleges and universities and to provide financial assistance for students in postsecondary and higher education.” It increased federal money given to universities, created scholarships and low-interest loans for students, and established a National Teachers Corps. Sallie Mae sprang from this act, began her life as a government-sponsored entity (GSE) in 1972, and morphed into a quasi-private one, much like her siblings Freddie Mac and Fannie Mae between 1997-2004.

Two Ways to Get Into Student Loan Debt

Students have two options for finding monies guaranteed by this 1965 Act:

Public- Federal Direct Student Loan Program (FDSLP, also known as Direct which is how I’ll refer to it here.)

or Private – Federal Family Education Loan Program (FFELP I’ll call Private), which is handled through private banks & lending institutions.

They can also seek totally private funds through lending institutions, directly.

This “Private” funding may be called that but

“It’s not private at all. Frankly it’s a socialist-like system. It’s not as if this private entity is assuming any risks. No, no, no. The law makes sure that this so-called private entity has virtually no risk.”

That’s Michael Dannenberg of the New America Foundation speaking to Leslie Stahl back when Sallie Mae was a “private” federally insured student loan organization in her salad days.

“Sallie Mae makes money if you pay back on time. And Sallie Mae makes money if you don’t pay back on time. It shouldn’t be the case that Sallie Mae gets to play every hand at the poker table while the government is the one that keeps anteing up the money.”

That’s Elizabeth Warren of Harvard, also speaking to Ms. Stahl in the same 60 Minutes expose.

But we no longer have to worry about the obscene profit-making of those days. They are gone. Evaporated. And with it, went our tax dollars and retirement monies. All that is left behind are the shattered financial lives of students still paying huge debts each month.

The pump and dump is now complete.

What remains are empty holes in our pension funds, foreign investor’s portfolios, and private retirement funds, where a profitable stock used to be. Sallie Mae, a stock once courted less than a year ago by seven major banks willing to pay $60 a share, now sells in the mid- to low-teens. A company that once was praised for its innovation, administering more than $18 billion in college savings accounts for nearly 10 million customers, now bears junk bond status.

The horse has escaped, the barn door has been locked, and the stockholders are locked outside while their sons and daughters, the students, owing unmanageable student loan debts, have been left to burn inside.

Heading off to College: The Longer & Longer Winding Road

It should be no surprise that those with a college education have traditionally made more income than those without one. What has been surprising, however, is that the minimum qualifications for those jobs have continued to climb. What previously required a high school diploma, now requires an associates degree; an associates degreed job now requires a bachelors degree; and so on.

Even worse, as the economic conditions continue to deteriorate, students are horrified to find that even the jobs they’ve trained for aren’t hiring anymore, or now require more college education, or have been outsourced, or “in-sourced” through H-8 workers imported by employers for a fraction of the previous salary. They then return to college to “retrain,” hoping against hope that this next job will still be available by the time they leave school again. Each time, their student loan obligations continue to pile on.

Another notable difference in this current recession is that parents, who were once able to refinance their homes to help their sons and daughters meet rising tuition costs, are no longer able to do so. They can’t put in the overtime they had planned.

College during the Great Depression was only mildly impacted by the sinking economy, as, for the most part, only a tiny percentage of the population attended, and those that did were of the “upper crust” of society. This next one, however, will not be your Grandmother’s depression.

Therefore, as the percentages of those from working- and middle class families head off to college, and end up staying longer and longer, the number of those seeking student loans have also risen, as has the cost of tuition:

Student Loan Debt:
$30 billion in 1995-6
$85 billion in 2005-6

What has shrunk or stayed stagnant, however, are the outright grants, scholarships and endowments to students that actually lower the staggering tuition costs.

A Stacked Deck

When Direct Government lending was created, the initial assumption was that the bank-based Private program would be quickly overwhelmed by the government program. No one counted on the strength of the reaction from the lending industry.

Armed with “no lose” loans, promising interest rates at least 2.34 percent higher than rates paid on commercial loans, and guaranteed by the full faith of the US Government, private lending institutions and banks set out to stack the deck in their favor. Special regulations first were put in place by The Department of Education that prevented colleges and universities from offering both Direct and Private loans. Once these institutions were forced to choose–Direct or Private–gag rules were put in place to prevent government employees from promoting Direct student loans. This was despite the fact that President Bush’s own budget report said that the Direct program was cheaper to fund. In 2006 for every $100 loaned by private lenders, the cost to the government of subsidies, defaults and other items was $13.81, while the same amount lent through the direct loan program cost the government $3.85.

When Richard W. Riley, then the Secretary of Education, tried to make the direct lending program more competitive in 1999 and 2000 by reducing origination fees and interest rates, the private lenders sued, saying Mr. Riley had no authority to do this because these rates were set by Congress under the loan legislation.”

Despite budget savings, Republicans were against Direct loan programs, and slashed its budget from just over $7 billion in 2006 to $509 million budgeted for 2008, while being only slightly kinder to the Private funds. These they decreased from just over $28 billion in 2006 to just under $4 billion budgeted for 2008.

The effort was successful: the government’s share as a direct lender has declined and now amounts to less than a quarter of the total loans distributed. Therefore, while students took on $85 billion of student loans in 2005-6, governmentally insured loans shrank in 2008 from 35 billion to a bit more than 4 billion, with the vast majority being Private government insured loans–if they’ll be willing to participate. As you will learn, quite a few no longer want to loan money under the terms of this new law, scheduled to go into effect this year. They don’t think they’ll make enough money.

The remaining 81 billion in loan monies needed will have to be found by applying to the private banking institutions- missing the rules, fees or interest rate regulations of those governing publicly-funded programs.

In the recent student loan bill passed, government-insured lending terms became more favorable to students, while at the same time, Congress slashed these very same funds, making them difficult to find. It is sort of like a parent telling their teenager “Yes, you can get your license and drive my car” and then selling the car. Students might be excited about loans at favorable rates, but those loans will be exceedingly hard to find.

Let Me Entertain You

Schools that chose Private lenders began “preferred lender” lists — a list of lenders the colleges and universities “recommended” to student borrowers. More than 90% of student borrowers select a lender from their school’s preferred lender list. The Preferred Lender’s list is such a powerful marketing tool, that there have been investigations into allegations that financial aid administrators may be using factors other than a lender’s customer service record, handling of complaints or borrower’s discounts, to decide which banks go on it.

New York Attorney General Andrew Cuomo’s office listed these factors:

•Stock options. Six universities were the subject of investigations into whether their financial aid officials owned stock options in Student Loan Xpress, a lender that was on their preferred lists. CIT Group, the parent of Student Loan Xpress, placed three top executives with the division on paid leave after these investigations started.

•Revenue sharing. In these arrangements, a lender offers payments to a school based on the number of students referred to the lender. Some schools have defended these deals because the money usually goes into the school’s financial aid program. Cuomo, however, has argued that they’re illegal kickbacks that inflate the price that all students pay for loans. Six schools have agreed to reimburse $3.27 million to students who took out loans when revenue sharing agreements were in effect.

•Inducements. Cuomo and other critics have alleged that lenders cultivated financial aid administrators with sports tickets, trips to exotic locations and other perks.(2)

At Indiana University in 2004, for example, Sallie Mae, the nation’s largest student lender, offered $3 million that the university could use for “opportunity loans” to some students, if it left the Direct loan program. Indiana left, but said the $3 million was not the reason.

Bank of America, which won the University of Virginia’s student loan business, said in its 2002 proposal, that certain possible incentives had “the potential to violate” federal law. The bank, which said such a discussion was “normal” in the bidding process, suggested that it discuss the issues with university officials “during the oral presentation phase of the process.” Bank of America has decided not to participate in the Private student loan program this year.

Sallie Mae has paid out $2 million in fines and agreed to stop compensating financial aid officials with trips and other perks for serving on its student lending advisory boards. Sallie also agreed to stop running university call centers where its staffers often identified themselves as part of the university, rather than as part of Sallie Mae.

Citibank, the second-largest private lender, also agreed to a $2 million settlement. Settlement money collected from lenders will be used to educate students and their parents about loans, Cuomo said. Nelnet agreed to pay $2 million and quit offering some services to universities as part of a settlement.

Allegations like these left one writer to ask:

“How can (financial aid personnel) be providing objective information when they are actually working for the lender?”(3)

Financial Literacy Missing

Bank officials offering these loans have created complex plans and repayment reductions, making it difficult for students to compare between offerings. Most students I have talked to simply “trusted” the loan officers and the universities to “do right” by them and had no true understanding of the level of their debt or future capacity to pay it off. Much like the housing lenders, they assumed that if a bank was willing to lend it to them, they must be capable of repayment. Many were in for an ugly awakening. In California alone, 18-29% of those entering teaching or social work fields have unmanageable student loan debt, based on their expected salaries.

Those banks listed as the biggest players in the student loan biz in 2007 will come as no surprise to those familiar with troubled lending institutions:

Top Stafford lenders ranked by total
FY 2006 loan originations

Lender name – # of loans (million) Amt of loans ($ Billion)
(Fed Direct Student Loan ) $2.9 / $13.2
Sallie Mae - $1.8 / $7.9
JP Morgan Chase - $1.0 /$4.2
Citibank - $.9 / $4.3
Bank of America - $ .7 / $3.2
Wells Fargo EFS - $ .6 / $2.9
Wachovia Education - $ .6 / $2.8
College Loan Corporation - $ .4 / $1.6
U.S. Bank - $.3 / $1.2
Access Group - $ .1 / $1.3

Sallie Mae’s stock, clearly the lending gorilla in the room with almost 2 billion dollars worth of loans, went up twenty-fold since 1995.

Then, suddenly, inexplicably, Sallie Mae went broke. Her suitors, once anxious to buy her outright only a short year ago for 25 billion, now fought a legal suit to get out of that agreement and settled for lending her $31 billion instead:

Sallie Mae’s downward spiral saw losses of $1.6 billion, for the quarter ending Dec. 31, 2007, reversing her previous year’s profit of $18 million.

What happened? What happened to Sallie Mae’s profitability? Where did it go?

Slice and Dice: First Goes Your Home, then Goes Your Student Loans

Student loans are sold to investors the same way mortgages are sold to investors – bundled together in a process called securitization. And with a rising number of defaults and foreclosures in the mortgage industry, investors are increasingly wary of buying these types of loans. So, lenders need to increase the amount they pay in order for investors to be interested.

Sallie Mae’s seven suitors included the usual suspects: Bank of America, JPMorgan Case, Barclays Capital (BCS), Deutsche Bank (DB), Credit Suisse (CS), The Royal Bank of Scotland and UBS (UBS). In Oct. 2007, these banks backed out, claiming that the new law that reduced interest payment on subsidizing student loans had adversely affected earnings potential for the student lender and they were no longer interested in acquiring the student loan giant.

Sallie Mae Sues and Settles for New Financing
Once Sallie Mae lost her engagement offer, she sued, but, now desperate for cash, dismissed the suit upon promises of part of a deal receiving a new $31 billion financing facility in February of 2008. She had no choice. Standard & Poor’s analyst Ernest Napier said that were she unable to raise cash, S&P would downgrade her credit further. Still, they slashed her credit rating to a notch above junk, to “BBB-” from “BBB+.” or sub-investment grade. And to boot, the $31 billion credit line was subject to a number of unspecified “conditions.”

The downgrade “reflects a high degree of financial risk resulting from increased funding pressures, reduced profitability, and the impact of a weakening economy on asset quality,” S&P said. In other words, Sallie Mae was forced to offer her wares to the same investment groups as the rest of the banks, and too many were already bitten by bad mortgage debt. In the end, Sallie Mae’s stock lost $1.33, or 6.2 percent, to $20.13, and the shares have traded in a range of $16.19 to the low twenties for most of this year. Just yesterday, Associated Press noted that second-quarter profits plunged 72 percent as “funding costs” remained high. Sallie Mae’s chief executive, Albert Lord, said in a statement, “Our funding costs have been extraordinarily high throughout 2008.” Indeed. However, Mr. Lord’s personal finances are in great working order. It’s rumored that he’s put in his own private golf course, recently.

At a time when investors have been burned by the slicing and dicing of mortgage-backed securities, they are equally distrustful of student loan debt, and demand a premium return before considering the purchase.

It is a bit curious that the same “slice and dice” plan that has impacted the mortgage market, is now impacting the student loan market. Mortgage lenders gave money to homeowners who couldn’t afford the homes they purchased, and student loan lenders gave money to students who had no ability to pay those student loans back. In both cases, our government is anxious to bail out these renegade lenders, while pointing the finger shouting “moral hazard!” to the teenage individuals who borrowed the money.

The exception, of course, is that unlike homeowners who can leave the keys on the counter and walk away, there is no leaving the responsibilities attached to student loan debt short of criminality or death. Meanwhile, politicians are stumbling over themselves to provide ways to continue to fund student loan debt short of offering it directly to students! These are our new indentured servants. They are young, beautiful, and totally in a financial hole they cannot climb out of.

It is also the final stages of the “pumping and dumping” stock strategy we saw played out in the Dot.com fiasco. Should we believe that this new law has so dramatically impacted Sallie Mae’s ability to show a profit, that she’s been left in ruins? Let’s look at the law more closely to find out:

The New Law

The College Cost Reduction And Access Act (H.R. 2669)
For an Introduction to the bill:
See here:
or for more in-depth coverage, here.

The bill gradually cuts interest rates on subsidized Stafford loans for undergraduate students by half, according to the following schedule:

6.8% for loans first disbursed 7/1/06 to 7/1/08
6 % for loans first disbursed 7/1/08 to 7/1/09
5.6 % for loans first disbursed 7/1/09 to 7/1, 2010
4.5 % for loans first disbursed July 1, 2010 to July 1, 2011
3.4 % for loans first disbursed July 1, 2011 to July 1, 2012

However, just as loan interest has gone down to more manageable levels, the loans themselves are evaporating.

Defaults
In order to understand how student loan defaults impact Sallie Mae, let’s imagine that a student defaults on a $1000 loan. Prior to this bill, Sallie Mae was reimbursed not only for 98% of the principle, but all the interest still due. In addition, should the defaulting student pay the loan eventually, the lender would also be entitled to an additional 23% of that money as well.

+$980 + remaining compound interest owed
+$230 assuming the collection agency can collect $1000 from the student over time.
=$1210 + remaining interest.

On a $1000 loan, Sallie Mae ends up with $1210 PLUS all of the compound interest. The defaulted amount is actually sent to a collection agency, but this agency is also owned by none other than Sallie Mae.

The remaining $770. that the student eventually pays, goes back to the government.

Under the new law, Sallie’s extra collection is reduced to 16%:

+$980 + remaining compound interest owed
+$160 assuming the collection agency can collect $1000 from the student over time.
=$1140 + remaining interest.

In this case, slightly more money is returned to the Federal government, should the collection agency receive the full payment from the student with interest.

The law changes a number of other things:

The proposed legislation would allow the Secretary of Education to cancel the balance of any interest and principal due on any Federal Direct Loan – including Direct Stafford, PLUS, or Consolidation Loan – that is not in default for borrowers who:

Have made 120 monthly payments (ten years) on a Direct Loan after October 1, 2007 as part of an income contingent repayment plan or a standard repayment plan based on a 10-year repayment schedule.

And, are employed in a “public service job” and has been employed in a public service job during the 120 payment period. A public service job is defined as a full-time job in emergency management, government, military service, public safety, law enforcement, public health, public education, social work, public interest law services, child care, public library sciences, or any other job at an organization that is described in section 501(C)(3) of the Internal Revenue Code of 1986.

Wait a minute! You mean our young people get to be free of their debt by working in the military, public health, prison settings, child care, or detention camp…for a decade? Hot Diggitty!

Effective July 1, 2009:
Loan payments will be limited to 15 percent of a borrower’s discretionary income or 15 percent of the amount that a borrower’s (and spouse’s if applicable) adjusted gross income exceeds 150 percent of the poverty line, divided by 12. Unpaid interest and principal are capitalized and any outstanding loan balance is forgiven after 25 years of repayment. Upcoming traditional students will no longer have a lifetime of student debt.

Here’s the real rub, as I see it. No more indentured servitude for life. Even if you really mess up at 22, you are freed of that yoke by 47.
No wonder private bankers are expecting less return on investment.

As of April 29, 2008, 65 student loan originators have decided to exit or suspend their participation in all or part of the Federal Family Education Loan Program “Private” (FFELP) since last August. The most notable being Bank of America, who, a short time ago, wanted to buy into Sallie Mae. These providers account for 13.9 percent of the Stafford and PLUS loan origination volume under the (Private) FFELP and 76 percent of the consolidation volume under the (Private) FFELP.

When Sallie Mae, herself, threatened to exit the student loan market, (a threat much like Morton Salt refusing to sell salt), the Government took action: Under new regulations the government offered lenders the opportunity to re-sell the loans to the government to raise capital or use the loans as collateral for a below-market line of credit.
This is “beyond the beyond.” It is outrageous that our government will offer another bailout to a private corporation who does the very same task that the government, itself, refuses to do more of.

Government guarantees the loan, will buy back the loans, and will enable Sallie Mae to use the loans as collateral for cheaper lines of credit! The only thing the Government won’t do is to loan the money directly, itself, and save the taxpayers a lot of interest in the meantime. Thank goodness we aren’t talking real money here, or I’d think something was terribly terribly wrong!

Now, here’s what I think: If you remove the largest sources of student loans, people will turn to private bank loans. These private loans will be at a much higher interest rate. These banks can then cherry pick their borrowers, approving only those with the most highly desirable qualifications.

Governmental insured loans (at now increasingly favorable rates) are useless if you can’t find any. The lucky ones who do manage to grab a sip from the $507 million puddle of what remains of Federally insured loans, will become a cheap work force, eager to “put in their time” to rid themselves of student loan debt. If things keep going the way they have been going, these “public” type jobs will be the only ones available after a fashion.

So if you mimic the actions of the US Government, simply write a loan from yourself, payable to yourself, and use this loan as collateral to secure a cheaper line of credit. Then, use that line of credit to pay off your student loan. If you default on yourself, look at it this way, you are at least out of debt.

If those two sentences sound crazy, realize that this is the kind of pretzel logic we are living with here in the US. The US won’t fund medical care directly: we fund corporations who fund medicine called “insurance companies.” We won’t fund student loans, directly. Instead, we fund huge corporations, like Sallie Mae, who charge us for the privilege. And when Sallie Mae’s liquidity (source of private funding) evaporates we won’t ask questions. We’ll give her money out of the public till, to give to the very same students we refuse to fund. Then. should these students default, because they can’t afford the loans to begin with, we’ll pay her again with even more money, to bail her out. Even after all of this, she robs our retirement funds and public coffers and we say “Oh well, the hazards of the Free Market system!”

What a great Country to be a banker!!

(1) (Pub. L. No. 89-329)
(2) http://www.usatoday.com/money/industries/banking/2007-04-12-loan-cover-usat_N.htm
(3) http://www.usatoday.com/money/industries/banking/2007-04-12-loan-cover-usat_N.htm