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Student Loan Policy: A Horror Story

Observing student loan policy lately is like watching a late-night zombie movie: just when you thought that the monster was dead for good, it climbs out of its grave scarier and more dangerous than ever.

In recent months, banks have found a way to resurrect federal payments – repealed in 1993 – that guarantee them a 9.5 percent return on student loans, at taxpayer expense. They are now exploiting it ruthlessly to the tune of $1 billion a year.

The extra subsidies—originally intended to encourage states to make student loans—spiraled out of control, transferring massive amounts of cash to non-profits and banks alike. So Congress ended them in 1993 – or so everyone thought. But it turns out this horror movie has a second reel.

The plot twist was foreshadowed more than a year ago in a letter to the U.S. Department of Education by a Nebraska corporation named Nelnet. Nelnet may be little known on Wall Street, but it is a top donor to education leaders in Congress. In documents obtained under the Freedom of Information Act, it described its plan to stretch the law to claim hundreds of millions of dollars in additional federal payments.

Here's how Nelnet does it. Under the 1993 law, a shrinking number of loans remain eligible for the guaranteed 9.5 percent return. But Nelnet argued that once a loan was in the pre-1993 basket, it could keep the 9.5 percent guarantee even if it was removed from the basket. By shuffling loans in and out of this basket, therefore, Nelnet can endlessly expand its holdings of highly subsidized loans, with huge costs for taxpayers and no benefit at all for students.

Like a small-town sheriff, Department of Education officials failed to grasp the growing threat and didn't lift a finger stop Nelnet's scheme. Now, federal payments on 9.5 percent loans to Nelnet and others will total $6 billion in the coming years.

The obvious solution is for education officials to shut off the abuse. But like slasher victims walking toward the bump in the night instead of running out the front door, they can't seem to see the right thing to do.

The legal authority that Nelnet says allows its pyramiding scheme is found in the department's own interpretations, not in the law itself. So the department could quickly clarify its rules and taxpayers could rest easy. But inexplicably, Department of Education officials are asking Congress to pass legislation to fix the department's own rules. If Congress acts, it won't happen until at least next year, and the delay will cost additional billions.

Education should immediately—today—shut down the further expansion of 9.5 percent loans through new regulations. It should also determine what steps it can take to reverse the damage. And then Congress can eliminate special subsidies—like the tax-exemption on student loan bonds—and instead use market forces to set lender returns.

Unlike zombies, student loan policy isn't going to kill any young lovebirds. The tragedy here is that college students are facing skyrocketing tuitions and an unprecedented rising tide of college debt. Instead of putting a dent in growing gap between college tuition and student aid, billions of scarce taxpayer dollars are wasted guaranteeing student loan companies whopping profits. And our elected officials seem unwilling to lift a finger to stop it.

Bob Shireman and James Kvaal are director and research scholar at the Institute for College Access and Success, sponsor of StudentLoanWatch.org.

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