Luke Swarthout is a U.S. Public Interest Research Group (U.S. PIRG) higher education advocate in Washington, DC. He is the author of Paying Back, Not Giving Back: Student Debt’s Negative Impact on Public Service Career Opportunities.
For the last two months American higher education has been embroiled in a scandal over the way colleges recommend banks to their incoming students. The story has the stench of personal corruption and for that it has earned front-page headlines. At the root of these improper relationships are billions of dollars in excessive subsidies that the federal government pays lenders that are now on the chopping block as Congress looks to reform the student aid programs.
Congressional leaders and the Bush administration have proposed pruning excessive payments to lenders like Sallie Mae (once the Student Loan Marketing Association), and the industry has launched on all out defense of their corporate welfare.
At the heart of Sallie Mae’s campaign is the simple claim that they earn only half a penny per year on every dollar they lend. Let’s pretend for a minute that they are actually representing their profit, and ignore the fact that they were the second most profitable Fortune 500 Company in 2005. What does half a penny really mean in the world of student loan finance?
In 2006 Sallie Mae held approximately 100 billion dollars in federal student loans. These loans are virtually risk-free and earn a guaranteed rate of return through federal subsidies. Taking the company’s claim about profit at face value, they earn approximately half a billion dollars a year just in interest from their federal loan business. While few people would bend down to pick up half a penny, most Americans, and most American companies, would drop to the ground for half a billion dollars a year in risk-free profit.
Of course, the half a penny that Sallie Mae advertises only applies to their margins in their federal student loan origination business, a mere fraction of their lending empire. Sallie Mae has leveraged its profitable lending business, developed while operating as a government sponsored enterprise (GSE), to buy up other major players in the loan business. This includes, in no particular order, a debt collection company, loan insurance agency, loan processing business, enrollment management firm. They are also major players in the growing and highly lucrative private student loan business.
In truth, Sallie Mae takes too much credit characterizing its profit as half a penny. Economists Deborah Lucas and Damien Moore, writing for the National Bureau of Economic Research (NBER), estimated that lenders make about one and a half cents on the dollar—quite a return on a risk-free asset. Sallie Mae’s own disclosure forms from 2005 claim they make an even larger return.
Still, the biggest problem with Sallie Mae’s claim isn’t their math but their sense of entitlement to billions of federal education dollars. These dollars are supposed to benefit students first and foremost, not private banks. At a time when state and federal grant funding remains stagnant and loan debt is skyrocketing, students want their pennies back.
According to the president’s budget this year, if Congress cut the subsidy rate to private lenders by one-half of one percent, they could free up $32 billion over the next decade. That’s enough money to increase the maximum Pell Grant award by nearly $1,000 or cut the interest rate for millions of student borrowers.
The question of whether to cut lender subsidies to pay for increased student benefits will be front and center in this Congress. The House and Senate are scheduled to consider major higher education reform this year, and the issue is one of the Democratic House leadership’s top domestic policy priorities. However, the education committees are prohibited by the budget from spending any new money to pay for reform. Any hope of this Congress making student debt more manageable or fixing the loan programs must come from reforming the excessive subsidies that Congress gives to private banks.
Congress should take a hard look at how lenders’ claims of razor-thin margins compare to the big profits they’re generating at the expense of students and taxpayers.
Pennies could mean a lot of change in federal education policy.