Focus on Middlemen in Student Aid Reform

July 11, 1993|By THOMAS TOCH

As the cost of college spirals upward, federal aid has becomecrucial to more and more students. Today, 6 million students, or 40 percent of those in postsecondary education, rely on Uncle Sam to help pay their tuition bills.

This student aid system is flawed, and the Clinton administration wants to fix it.

In the boldest reform proposal since the inception of the present system in the 1960s, the president is calling for colleges and vocational schools to make federally-funded loans directly to students rather than relying on banks and other lenders. Such a step, Secretary of Education Richard Riley argues, would save taxpayers money and allow students to borrow at lower interest.

But for months, the 8,000-plus banks, secondary markets and other institutions that finance and administer the $57 billion federal student loan program have laid siege to the Clinton plan. They have hired a raft of big-name Washington lobbyists to convince Congress that the U.S. Department of Education is incapable of managing a direct lending program. They have paid high-profile economists to debunk the administration's cost-saving estimates. And they have warned darkly in letters to colleges that direct lending is "a dangerous experiment" that "threatens to jeopardize the flow of loan money to students" and place "a costly burden on schools."

They are justified in questioning the education department's likely stewardship of direct lending: As the department's inspector general's office has pointed out, budget cuts and bureaucratic inertia within the department have contributed to extensive waste, fraud and abuse in the student aid system in recent years.

But in many instances, the performance of the financial middlemen has been lacking, too. Their failings have been costly and have impeded efforts to reform the student loan system.

Congressional conferees are scheduled to take up the Clinton bill in coming days. A watered-down version favored by the Senate fails to address fully the problems wrought by the players in the aid system.

When the system was created in the 1960s, policy-makers envisioned that many lenders would participate and quasi-state agencies known as guaranty agencies would police lenders and reimburse them for loans that students failed to repay. But lenders balked at making low-interest loans to students, a high-risk group, and states didn't want to bail out lenders.

To lure lenders and guaranty agencies, the federal government was forced to offer substantial subsidies and to play the role of lender-of-last-resort to guaranty agencies when they couldn't collect on bad loans.

Overnight, financial institutions found themselves in the position making large, low-risk profits from the student aid system. The federal government paid $6.1 billion in 1991 to lenders and other financial institutions to manage $57 billion in student loans.

"There has been some disingenuousness" on the part of financial institutions which say that the large subsidies they receive are needed to make a fair return, acknowledged Roy Nicholson, the chief executive of United States Aid Funds, Inc., one of the largest players in the loan program. The Senate bill would cut the middlemen's subsidies somewhat.

But other problems have not been addressed. Two years ago, officials of Florida Federal Savings Bank, then the third largest student lender in the country, were convicted of ordering employees to falsify records to roughly 17,000 borrowers in a six-month period, then filing claims worth $35 million with guaranty agencies based on the false documents.

Last year, the education department's inspector general scrutinized a sample of 32 lenders and found a quarter of them had sought illegitimate subsidy payments from the federal government.

Investigations have turned up problems with guaranty agencies

as well. The education department recently reviewed a sample of 130 loans guaranteed by the California guaranty agency and found a key piece of information, the date students began repaying their loans, to be inaccurate in every instance.

A 1990 audit revealed that the Pennsylvania guaranty agency overbilled the education department by at least $778,000. The department didn't act to recover the money until last year, however, blaming heavy work loads and high staff turnover for the delay.

The department's less-than-aggressive policing encourages abuses by the middlemen. So do misplaced incentives.

Lenders, for example, have little motivation to pursue deadbeats aggressively because the system allows them to receive payment on virtually 100 percent of their bad loans.

And it's in the financial interest of the guaranty agencies not to go after scofflaws too aggressively. By law, they are permitted to get reimbursed for bad loans by the federal government, then pursue the bad loans further and retain 30 percent of the funds they recover. Guaranty agencies earned no less than $200 million, or 13 percent of their total revenues, this way in 1991.

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